How The Macro Economy Works

Question 1

What does the circular flow of income show?

Answer 1

How money moves in the economy

Question 2

What are the factors of production households provide to firms?

Answer 2

Labour, land, capital

Question 3

Explain the basic circular flow of income or draw down the diagram

Answer 3

Firms pay households (wages, rent, interest) (income) and households spend this income on goods/ services (expenditure) from firms. Profits earned by firm owners also return to households.

Question 4

What are the factors of production and what do they transfer to in the circular flow of income

Answer 4

Labour - wages
Land - rent
Capital - interest
Enterprise - profit

Question 5

What is a withdrawal in circular flow of income give examples

Answer 5

Leakages, money leaving the economy for example savings, taxes, imports

Question 7

What are injections in the circular flow of income? Give examples

Answer 7

Money entering the economy for example exports, investment and government spending

Question 8

What is equilibrium in circular flow of income?

Answer 8

Wheb injections = withdrawals, the economy is in equilibrium national income stays the same.

Question 9

Give an example of national income expansion

Answer 9

Increased government spending > boosts injections > flow expands > national income rises.

Question 10

Definition of aggregate demand

Answer 10

Aggregate demand is the total demand for goods and services in an economy at a given price level and in a given time period.

Question 11

What is the formula for aggregate demand

Answer 11

AD = C + I + G + (X - M)

C = Consumption
I = investment
G = Government spending
X-M = Net exports ( exports - imports )

Question 12

What are shifts on the ad curve caused by? And give specific examples.

Answer 12

Changes in either C , I , G , or ( X - M )
E.g
Tax changes
Interest rates changes
Confidence
Government policy

Question 13

What is a demand side shock? Give examples

Answer 13

A demand side shock is a sudden, significant change in AD
E.g interest rates changes Confidence rise, housing market crash.

Question 14

What effects can I demand side shock have?

Answer 14

Can reduce real gdp and confidence > amplified though multiplayer and accelerator effect.

Question 15

How do Keynesian economists believe demand side shock could be solved?

Answer 15

Through government intervention in such cases

Question 16

Definition of determinate of aggregate demand and what is it influenced by?

Answer 16

The total value of planned spending on goods and services in and economy over a given time period
Influenced by consumption, investment, government spending and net exports

Question 17

What are factors that influence consumption

Answer 17

Income levels
Wealth levels
Job security and unemployment
Confidence
Expectations of future inflation

Question 18

Investment definition

Answer 18

Investment is spending that increases a country’s capital stock

Question 19

What are the different types of investment

Answer 19

Physical capital: e.g machinery, equipment
Human capital: e.g training, education

Question 20

What are factors that affect investment

Answer 20

Interest rates
Expected growth and demand
Profitability
Government policy ( tax, subsidies…)
Efficiency of financial institutions

Question 21

What are the types of government spending?

Answer 21

Current spending: daily operations (benefits, salaries)
Capital spending: long term investment ( e.g infrastructure)

Question 22

What are factors that affect government spending?

Answer 22

Cost of borrowing
Budget deficit and national debt
Confidence in the economy
Political priorities

Question 23

What is net export

Answer 23

Exports - imports

Question 24

What factors affect net exports

Answer 24

Exchange rate
Inflation
Quality of good
Relative income levels
Domestic spare capacity ( more imports if limited resources )

Question 25

Savings definition and how is it measured

Answer 25

Disposable income not spent it is measured by the savings ratio s / y

Question 26

What are factors that affect saving

Answer 26

Interest rates Confidence and job security Future inflation expectations Income levels ( higher income = higher marginal propensity to save)

Question 27

What does the accelerator process link and how does it work?

Answer 27

It links changes in real income to changes in investment. How it works: If real income rises, firms expect more future demand so they invest more now.

Question 29

What does short run aggregate supply show?

Answer 29

SRAS shows the total quantity of output firms are willing to produce of different price levels in the short run.

Question 30

What is movement up the SRAS and what are movements down the SRAS called?

Answer 30

Movements up = contraction Movements down = expansion

Question 31

What are shifts in SRAS caused by?

Answer 31

Caused by changes in production costs: Labour/ raw material costs Exchange rates ( affecting import costs) Business taxes or subsidies

Question 32

Give examples of positive supply side shocks

Answer 32

Tech improvements, resources discoveries

Question 33

Give examples of negative supply side shock

Answer 33

Bad harvests, oil prices rise > cost push inflation.

Question 34

What is the difference between short run and long run aggregate supply?

Answer 34

Short run - at least one factor of production is fixed Long run - all factors at variable Long run - full employment levels of output.

Question 35

Long run aggregate supply (LRAS) definition

Answer 35

LRAS represents the economy’s maximum productive capacity when all resources are fully employed.

Question 36

What are factors that shift LRAS to the right?

Answer 36

Productivity growth Increased quality or quantity of factors of production Tech improvements Greater enterprise and innovation Cultural changes ( e.g more labour market participation ) Mobility factors ( e.g people can move to where jobs are ) Economic incentives ( lower taxes, more investment )

Question 37

What is ad / as equilibrium? And what does it show

Answer 37

Ad / AS equilibrium is where AD = AS It shows current price level and real gdp

Question 38

What are the two main models of LRAS

Answer 38

1. Classical LRAS 2. Keynesian LRAS

Question 39

Explain classical LRAS

Answer 39

Vertical line - output is fixed at full capacity. Price changes do not affect output LRAS shifts right with improvements in FOP’s

Question 40

Explain the Keynesian LRAS

Answer 40

It’s a curve with a: Flat section - spare capacity Upward section - increasing costs Vertical end - full capacity Output can increase without inflation if spare capacity exists