4.2.2 How the Macroeconomy works Flashcards
Explain the Circular Flow of Income.
- Demonstrates how money moves from producers to households and back again in an endless loop
- Demonstrates inner-relationships between economic agents in the macro economy
What is the primary economic function of Households?
- Supply domestic firms with the FoPs: Land, Labour, Capital, Enterprise
What is the primary economic function of Firms?
- Supply private goods and services to domestic households and firms, as well as to households and firms abroad
Define the Rate of Return.
- Net gain/loss of an investment over a specified time period, expressed as a % of investments initial cost
Define Injections and state what they include.
- Variables in an economy that add to circular flow of income
Include: - Investment spending by firms (I)
- Gov spending (G)
- Exports (X) (payments from overseas customers, flow into UK economy)
Define Withdrawals (leakages) and state what they include.
- Variables in an economy that leak out of circular flow of income and reduce size of national income
Include: - Savings (S)
- Taxation (T)
- Imports (M) (payments to overseas suppliers, flow out of UK economy)
Define Aggregate Demand (AD) and state the components of it.
Total demand for all goods/services in an economy at any given price level over a period of time.
Components:
- Consumption (C)
- Investment (I)
- Gov spending (G)
- Net exports (exports - imports) (X - M)
State the formula for AD.
AD= C + I + G + (X - M)
Define Real National Output and state the formula.
- Output of an economy, taking into account inflation
- Real National Output= Nominal (money) national output / average price level
Explain the movements that occur in an AD curve.
- Rise in price level leads to contraction in AD
- Fall in price level leads to expansion in AD
Define Aggregate Supply (AS).
Total value of output of an economy at a given price level at a given point in time
Explain the movements in a SRAS curve.
- Rise in price level leads to an expansion in SRAS
- Fall in price level leads to contraction in SRAS
Describe the relationship between short-run and long-run Aggregate Supply.
- Short-run, all FoPs are fixed, with exception of labour- can be hired to cover increase in AD
- Long-run, all FoPs are variable and can be increased over time
- Long-run AS represents max possible output economy can produced as determined by its available FoPs.
Explain the Classical Economic Theory, in regards to LRAS.
- Suggests economy will always produce max that its factor resources allow
- Adam Smith’s 1776 release of ‘Wealth of Nations’, offers some of the most prominent concepts/theories in classical economics, e.g. theories to explain value, price, supply, demand and distribution.
- Helped countries move from monarchic rule to capitalistic democracies with self-regulation.
Explain the Keynesian Economic Theory, in regards to LRAS.
- Named after British economist John Maynard Keynes
- How AD strongly influenced economic output and inflation
-AD doesn’t necessarily equal a productive capacity of economy - Argue AD is volatile/unstable and that market economies often experience inefficient macroeconomic outcomes
- These economic fluctuations can be mitigated by economic policy responses coordinated by Gov and Central Banks- help stabilise economic output, inflation and unemployment
- Advocate a regulated market economy- predominantly priv sector, but with active role for gov intervention during recession and depression
- Developed during-after great depression from ideas presented by Keynes in his 1936 book: The General Theory of Unemployment, Inflation and Money
