7.How the macroeconomy works.

Question 1

Define national income, output and product.

Answer 1

Income- the flow of new output produced by the economy in a given time.
Output- the flow of new output produced (same as income)
Product- same as income and output.

Question 2

Define national capital stock and national wealth.

Answer 2

National capital stock (capital goods) is part of national wealth, which comprises of all physical assets owned within the economy in a given time.

Question 3

What does national income, output and expenditure measure?

Answer 3

Income- measures the incomes received by labour and other factors of production when producing goods.
Output- measures the actual goods and services produced by the economy.
Expenditure- shows the spending of incomes on the goods and services.

Question 4

List 6 main components of the circular flow of income diagram.

Answer 4

• Incomes (to households)
• Consumption (to firms)
• Goods and services (to households)
• Labour and other factors of production (to firms)
• Injection (investment, exports, government spending)
• Withdrawal (savings, imports, taxes)

Question 5

If injections is greater than withdrawals, what happens to national income?

Answer 5

National income will rise.

Question 6

When is national income at equilibrium?

Answer 6

When injections into the economy is equal to withdrawals.

Question 7

What is a reflationary policy?

Answer 7

A policy that will increase aggregate demand and increasing real output and employment.

Question 8

Define aggregate demand and aggregate supply.

Answer 8

AD is the total planned spending on real output produced within the economy.
AS is the level of real national output that producers are prepared to supply at different price levels.

Question 9

Describe the AD and AS curves, and where national income is on the graph.

Answer 9

AD- as price increases, real national output decreases.
AS- curved line, where real national output increases as price increases.
National income is at the equilibrium of AD and AS.

Question 10

What is an economic shock? What are the two types of shock and give examples.

Answer 10

An eonomic shock is when a sudden event happens, which hits the economy and triggers a affect in aggregate demand (demand-side) or aggregate supply
(supply-side).
War will affect AS as it will effect price of oil, and will affect AD as cause collapse in consumer and business confidence.

Question 11

What are the components of aggregate demand?

Answer 11

+consumer spending
+investment
+government spending
+net exports (X-M)

Question 12

What are the main factors that affect consumer spending and why?

Answer 12

• Interest rates- if they are high, more people will save, so less spending.
• Level of income- if people have larger disposable incomes they will spend more money on goods and services.
• consumer confidence- if consumer optimism is high, then they are likely to spend more.
• inflation- if expected to be high, then consumption on small goods is reduced, but on large expensive goods (e.g. cars) consumption is increased.

Question 13

What is the personal savings ratio and how is it measured?

Answer 13

It is the measure of actual saving as a ratio of total disposable income.
=actual personal saving/personal disposable income.

Question 14

What is the difference between investment and savings?

Answer 14

Investment is money by firms on capital goods, but savings is simply money not spent on consumption.

Question 15

What are the main factors which affect investment and why?

Answer 15

• interest rates- if interest rate rises, the cost of borrowing increases, so investment will fall.
• government policies- policy introduced to encourage investment. (e.g. zero corporation tax).
• expectations- if consumption is high, then a firms profits will be high, so they will increase investment, as demand for goods is high.
• new technology- new technology will increase investment as it is necessary for the production of the good.
• cost of capital goods- if the cost of capital goods has fallen, then investment will rise as it is cheaper to buy stock. -
• accelerator theory- rise in national income causes a rise in investment.

Question 16

Why do firms invest?

Answer 16

• to meet rising demand
• to be able to compete with other firms
• to keep up with developing demand
• to produce a better quality product
• to reduce production costs/ increase productive potential.

Question 17

What is the national income multiplier and how is it calculated?

Answer 17

The relationship between a change in aggregate demand and the resulting (usually larger) change in national income.
=change in national income/ initial change in AD.

Question 18

Define the marginal propensity to consume and how is it calculated?

Answer 18

It is the fraction of any increase in income that people plan to spend on consumer goods.
MPC=planned spending/total income.

Question 19

How is the value of the multiplier calculated?

Answer 19

=1/Marginal propensity to withdraw (1-MPC)

Question 20

Describe the relationship between the size of the multiplier and the effect it has on national income.

Answer 20

The smaller the MPW, the larger the impact of the multiplier. The larger the MPW, the smaller the impact.

Question 21

Describe why a decrease in corporation tax will lead to an increase in real GDP due to the multiplier theory. (5 steps)

Answer 21

• an decrease in corporation tax leads to
• an increase in the firms retained profits, leading to
• an increase in investment, so
• a rise in demand for goods, meaning
• an increase in employment as demand is high,leading to
• an increase in consumer spending, so rise in real GDP.

Question 22

Define short-run aggregate supply.

Answer 22

It is when the level of capital is fixed.

though utilisation of existing factors of production can be altered to change the level of real output

Question 23

Describe why the SRAS curve is an upward-slope.

Answer 23

Because

• firms aim to maximise profits
• in the short-run the cost of producing extra units of output increases as firms produce more.

Question 24

If AD increases at the beginning of the SRAS curve what effect will it have on price and real output?

Answer 24

It will cause an increase in price level, and a proportionately greater increase in real output.

Question 25

When AD increases on a SRAS curve, at what point on thee SRAS curve will demand shift to, to cause an increase in real output and a proportionately larger increase in price level.

Answer 25

AD will have shifted to the top end of the SRAS curve.

Question 26

What 5 factors cause a rightward shift in the SRAS curve?

Answer 26

• fall in a businesses cost of production.
• fall in labour unit costs.
• reduction in indirect government taxes.
• increases in government subsidies.
• technological development.

Question 27

Define long-run aggregate supply and describe the LRAS curve.

Answer 27

Long-run aggregate supply is when the economy is producing at its productive potential.
The curve is a vertical line.

Question 28

Where is the normal capacity level of output on a graph?

Answer 28

When the LRAS and SRAS meet (also known as long-run level of equilibrium).

Question 29

What 5 factors cause a rightward shift in the LRAS curve?

Answer 29

• technological progress
• increased mobility of factors of production, e.g. labour
• increased productivity of factors of production, e.g. labour
• increased quantity of capital and labour in the economy
• improved attitudes towards work/ increased incentives for workers.

Question 30

What shape is the Keynesian LRAS curve and what link does the free-market LRAS have with the PPF diagram?

Answer 30

A keynesian LRAS curve is horizontal, then curves into a vertical line.
The LRAS curve is the same as the PPF curve.