2.4 Flashcards
(78 cards)
1
Q
What is an open economy ?
A
An open economy is one in which there is foreign trade
2
Q
What is a closed economy ?
A
A closed economy is one in which there is no foreign trade
3
Q
What is the circular flow of income ?
A
- Households own the factors of production
- They supply these factors of production to firms
- Firms then use these factors of production to produce goods and services
- In return for providing the factors of production, households receive income, rent, wages and profit
- Households, then use some of the rewards to purchase goods and services from firms
4
Q
What are the three ways of measuring the level of economic activity ?
A
- National output (O) - The value of the flow of goods and services from firms and households
- National expenditure (E) - The value of spending by households on goods and services
- National Income (Y) - The value of income paid by firms to households in return for land, labour and capital
- O ≡ E ≡ Y
5
Q
What is the equation for aggregate demand (AD) ?
A
- Consumer expenditure + Investment + Government expenditure + (exports-imports)
- C + I + G + (X-M)
6
Q
What is wealth ?
A
- Wealth is the value of a stock of assets owned by someone
- Savings in bank accounts
- Ownership of real estate
- Shares/stocks in a business
7
Q
What is income ?
A
- Income is the flow of money going to factors of production
- Wages and salaries
- Rental income from property
- Interest from savings
8
Q
What is the Gini coefficient ?
A
- The gini coefficient is commonly used to measure income inequality, 0-1
- The higher the number, the greater the degree of income inequality
9
Q
What is an Injection ?
A
An injection into the circular flow is a monetary addition to the economy
10
Q
How could you remember the injections ?
A
- IGE
11
Q
What are the three injections ?
A
- Investment - spending by firms on new capital equipment like factories, offices and machinery
- Government spending - Spending by central, local and other government agencies
- Exports - spending by foreigners on goods and services made in the UK
12
Q
What is a withdrawal ?
A
Where money is removed from the economy
13
Q
How could you remember the withdrawals ?
A
STI
14
Q
What are the three withdrawals ?
A
- Saving by households/firms - Money which is saved and not spent by households or firms
- Taxes paid to the government - Taxes take money from both households and firms
- Imports - Goods and services that are bought from abroad by both households and firms
15
Q
What happens when injections are larger than withdrawals ?
A
Higher spending to reflect a rise in national income
16
Q
What happens when withdrawals are larger than injections ?
A
Lower spending to reflect a fall in national income
17
Q
What do Keynesian and classical economics agree about the AD curve ?
A
In the short run, the AD curve is downward sloping whilst the AS curve is upward sloping
18
Q
Where is the equilibrium level of output (short run) ?
A
It occurs at the intersection of the AD and AS curves.
19
Q
How does an increase in AD shift the curve ?
A
An increase in AD shifts the curve to the right
20
Q
What are the components of AD ?
A
- Consumption
- Investment
- Government spending
- Exports - Imports
21
Q
How will an increase in these components affect AD ?
A
An increase in the components of AD will increase AD and therefore shift the curve to the right
22
Q
Describe the rise in AD in the short run
A
- AD curve shifts from AD1 to AD2
- Equilibrium output then rises from Y1 to Y2 whilst the price level rises from P1 to P2.
23
Q
What does a rise in AD increase ?
A
A rise in AD increases both real output and the price level in the short run
24
Q
How does a decrease in AD shift the curve ?
A
A decrease in AD shifts the AD curve to the left
25
How will a decrease in the components of AD affect AD ?
A decrease in the components of AD will decrease AD and therefore shift the curve to the left
26
What does a fall in AD decrease ?
A fall in AD will lead to both a fall in real output and the price level
27
How does a fall in SRAS in the short run shift the curve ?
It shifts the curve upwards and leftwards
28
What are some of the factors that can cause a fall in SRAS in the short run?
- Wages of workers might rise
- Raw material prices may go up
- Taxes on goods and services might be raised
- Anything that decreases supply
29
Describe the fall in SRAS in the short run
- The SRAS curve shifts from SRAS1 to SRAS2.
| - Equilibrium output then falls from Y1 to Y2. At the same time, the price level rises from P1 to P2.
30
What does a fall in SRAS in the short run cause ?
A fall in SRAS therefore leads to a fall in output but a rise in the price level in the short run
31
How does a rise in SRAS in the short run shift the curve ?
It shifts the curve downwards and to the right
32
What are some of the factors that can cause a rise in SRAS in the short run?
- Wages paid may decrease
- Raw material prices may go down
- Taxes on goods and services might fall
33
What does a rise in SRAS in the short run cause ?
A rise in SRAS will lead to a rise in equilibrium output and a fall in the price level
34
Where is the equilibrium level of output (long run) ?
It occurs at the intersection of the LRAS curve and the AD curve
35
How does an increase in AD affect the AD curve ?
- It pushes the curve to the right
| - But the classical and Keynesian models are different
36
What determines a shift in the AD curve ?
- A change in the determinants of aggregate demand
| - C, I, G and X-M
37
What does the LRAS curve show (classical economics) ?
- It shows the supply curve for an economy at full employment
38
What does the LRAS curve mean ?
This means there can be no unemployment in the long run, according to classical economists
39
Describe the rise in AD in the classical model
- AD curve shifts to the right from AD1 to AD2.
| - The equilibrium price level rises from P1 to P2 but equilibrium real output remains the same at Q.
40
What does a rise in AD lead to ?
A rise in the price level but no change in real output in the long run
41
What does the Keynesian LRAS curve show ?
The economy is at full employment where the curve is vertical but it can be in disequilibrium at less than full employment and in recession when horizontal
42
Describe the rise in AD in the Keynesian model
- The AD curve rises along the LRAS curve
| - Goes sideways until the LRAS curve is straight and then it goes upwards
43
What does a rise in AD lead to ?
- It could lead to many things, depending on where the increase is
- The shift in aggregate demand from AD1 to AD2 will increase equilibrium output from Y1 to Y2 without raising the price level from P
- A rise in aggregate demand from AD3 to AD4 will increase both equilibrium output and equilibrium prices.
- AD4 to AD5 there will only be an increase in the price level and no change in real output
44
What is the point of disagreement between the two economic ideas ?
The extent to which workers react to unemployment by accepting real wage cuts
45
What do classical economists argue ?
- A rise in unemployment will lead to cuts in real wages
- These cuts will increase the quantity demanded of labour and reduce the quantity supplied, returning the economy to full employment quickly and automatically
46
What do Keynesian economists argue ?
- They argue that wages are sticky downwards
- Workers will refuse to make wage cuts and will fiercely resist cuts in their real wage
- The labour market will therefore not clear except perhaps over a very long period of time
47
What does a rise in LRAS mean ?
A rise in LRAS means that the potential output of the economy has increased
48
What might cause a rise in the LRAS ?
- Increased incentives to work
| - Improvements in technology
49
Describe the rise in LRAS in the classical model
A shift in the aggregate supply curve from LRAS1 to LRAS2 will increase equilibrium output from Y1 to Y2. Equilibrium prices will also fall from P1 to P2.
50
What does a rise in LRAS lead to ?
Both higher output and lower prices
51
Describe the rise in LRAS in the classical model
- A shift in the aggregate supply curve from LRAS1 to LRAS2 increases full employment equilibrium output from YE to YF.
- If the economy is at slightly less than full employment, with an aggregate demand curve of AD2, then the shift to the right in the LRAS curve will still be beneficial to the economy, increasing output and reducing prices.
- If the aggregate demand curve is AD3, an increase in aggregate supply has no effect on equilibrium output. It remains obstinately stuck at YD.
52
What does a rise in LRAS lead to ?
It will increase output and reduce prices if the economy is at full employment
53
What is the multiplier effect ?
The multiplier effect is when injections into the circular flow of income eventually lead to an even bigger increase in national income
54
How is the multiplier determined ?
- The multiplier is determined by the size of the withdrawals from the circular flow
- The larger the withdrawals are the lower the multiplier will be
55
What is the multiplier ratio ?
The multiplier ratio (K) measures the proportionate change in national income in response to a change in injections and withdrawals
56
What is the equation for the multiplier ratio ?
- K = change in real output / change in injections
| - K = change in Y / change in J
57
What is a positive multiplier ?
When an initial increase in an injection (or decrease in withdrawal) leads to a greater final increase in real GDP
58
What is a negative multiplier ?
When an initial decrease in injection (or increase in a withdrawal) leads to a greater final decrease in real GDP
59
What is MPC ?
- Marginal propensity to consume
| - The proportion of any extra income that is spent on goods and services
60
What is the equation for MPC ?
Change in consumption / Change in income
61
Which people are likely to have a higher MPC ?
- People with lower incomes
| - When you are struggling to afford the basics, you are likely to spend any extra income you get.
62
What is MPS ?
- Marginal propensity to save
| - It is the proportion of any additional income that is saved
63
What is the equation for MPS ?
Change in savings / Change in income
64
Which people are likely to have a higher MPS ?
- People with higher incomes
| - If you already have what you need, you might choose to save the extra income instead
65
What does MPC and MPS total up to ?
MPC + MPS = 1
66
What is MPT ?
- Marginal propensity to tax
| - The proportion of any new income that is paid as taxes
67
What is the equation for MPT ?
Change in taxation / Change in income
68
What is MPM ?
- Marginal propensity to import
| - The proportion of any new income that is spent on imports
69
What is the equation for MPM ?
Change in spending on imports / Change in income
70
What is MPW ?
- Marginal propensity to withdraw
| - It is the proportion of extra income that is withdrawn from the economy
71
What is its formula ?
MPW = MPS + MPT + MPM
72
What is the relation between the multiplier effect and MPW ?
The multiplier formula is 1 / MPW
73
What is the effect of a higher multiplier ?
- The higher the multiplier the larger the increase in national income caused by injections will be
- This is because injections trigger secondary increases in national income
74
What effect does a higher multiplier have on AD ?
It causes AD to increase by a larger amount
75
What are the effects of an increase in AD ?
- Higher output (higher economic growth)
- Higher employment due to an increase in firms need for labour
- Higher inflation if economy is not in a recession, if the economy is in a recession then there will be no inflation
76
What will happen to the multiplier if MPS increases ?
MPW would increase and therefore the multiplier would decrease, because of the equation multiplier = 1 / MPW
77
What will happen to the multiplier if MPT increases ?
MPW would increase and therefore the multiplier will decrease, because of the equation multiplier = 1 / MPW
78
What will happen to the multiplier if MPM increases ?
MPW would increase and therefore the multiplier will decrease, because of the equation multiplier = 1 / MPW
