Macro Theme 2 Flashcards
1
Q
What is GDP?
A
- Gross Domestic Product
- value of all goods and services produced in a country in one year
- does not include earnings by its residents whole outside the country
2
Q
What is GNP?
A
- Gross national product
- Economic activity of the nationals of a country irrespective of where they are in the world
- GDP plus income paid into the country by other countries for such things as interest and dividends
3
Q
Give the equation for GNP:
A
- GNP = GDP + net income from abroad
4
Q
What is NDP?
A
- net domestic product
Net = gross - depreciation
5
Q
What is depreciation in the terms of capital goods?
A
- the decrease in value of capital goods
6
Q
GDP contains capital goods (machines) while…
A
NDP does not
7
Q
How is GDP measured?
A
- By adding up all of an economy’s incomes (wages, interest, profits and rents)
Or - Adding up all expenditures (consumption, investment, government spending and next exports)
Or - The value of all goods and services produced within a country
- Income = Expenditure = Value of output
8
Q
What is the equation for nGDP?
A
- rGDP x P
9
Q
What is nominal GDP?
A
- Total of goods and services consumed + government expenditures investments and exports minus total imports
- GDP that does not take into account inflation, just figures
10
Q
What is Real GDP?
A
- inflation-adjusted measure that reflects the value of all goods and services produced by an economy in a given year
- more accurate when calculating over time
11
Q
What does gross mean?
A
- when everything is taken into account
12
Q
What does net mean?
A
- after you’ve accounted for depreciation ( of capital goods)
13
Q
How is GDP per capita measured?
A
- by dividing total gdp (total gdp produced by a country) by the population
14
Q
What is GNP?
A
- gross national product
- the total market value of all goods and service produced by domestic residents (GDP) plus income that residents have received from abroad, minus income claimed by non-residents
15
Q
What is purchasing power parity?
A
- exchange rates derived from the same cost of a basket of goods in different countries
16
Q
GDP is published on a…
A
- rolling monthly basis
(Every month, on the past three months) - prelimary estimates in the first then revised each month as new data is obstained, also published annually.
17
Q
What is recession?
A
- two consecutive quarters of negative growth (contraction)
- it is not possible to define the economy as in recession from a preliminary estimate (ONS - no)
18
Q
How do you calculate GDP adjusted for PPP?
A
- divide GDP by the corresponding PPP
- removes price level differences between countries
19
Q
Why is economic growth measured accurately?
A
- its growth is an indicator of the success of current economic polices and guide to the future ones
20
Q
Are preliminary estimates accurate?
A
- yes compared to the final quaterly GDP
- estimate upwards a
21
Q
Standard of living does not just refer to income but also…
A
The quality of life and economic welfare
22
Q
Why might GDP not be a good measure of living standards in terms of how it is produced?
A
- Working hours (how long did it taker to produce)
- Working conditions (pleasant or unpleasant experience)
- Produced in a way that produces negative externalities (I.e air pollution in Dehli) or positive externalities
(Working conditions affect productivity)
23
Q
Why might real gdp not be a good measure of living standards in terms of what is produced?
A
- frivolous/merit/demerit goods
- main government spending on infrastructure vs frivolous spending - goods which stop us from being sad (military) vs goods which make us happy (entertainment)
- quality of the goods produced
24
Q
Why might GDP per capita be a bad measure of living standards?
A
- ignores income distribution
25
Why might gdp be a bad measure of living standards in terms of preservation?
- how much of it is preserved as wealth (housing stock/infrastructure)
26
GDP may increase other problems alongside economic growth such as:
- pollution
- congestion
- stress levels
All leading to worsening living standards
27
GDP does not include:
- improving quality of technological goods
- unofficial or unpaid work (value of goods that are consumed by producers rather than traded)
28
What is the easterlin paradox?
- the idea that happiness does rise with average incomes but only up to a point
- beyond this point marginal gains in happiness fall, perhaps because people care about relative as well as absolute incomes
29
How has the ONS responded to issues with living standards being measured with gdp?
- measuring national well being
30
What is inflation??
- sustained general rise in prices across an economy
31
How is inflation calculated?
- compile basket of goods (by sending out a compulsory expenditure survey annually (only used for RPI))
- collect prices for each good (fill out a price survey monthly - 150-200 prices record per good)
- assign weights to each goods (using expenditure survey)
- calculate weighted index
32
What is the equation for inflation?
• Inflation = (Σ ( price index * weights ) of each product ) - 100
33
How do you calculate weighted index?
Price index * weights
34
How do you calculate price index?
- Price Index = Price Level
- Nominal/real (same year)
35
What is CPI?
- consumer price index
- international comparable methodology
- representative of the entire population living in the country
- geometric mean (lower)
- no survey- look at calc from GDP
- when people give money
36
What is RPI?
- retailer price index
- different in different countries
- removes extremes (i.e old pensioners) ( expenditure patterns are too different and can skew data)
- more representative of how the medium person spends
- basket of goods come from surveys
- arithmetic mean (higher)
- when they receive money
37
What is disinflation?
- rate of prices going up has decreased
- contraction in inflation
38
What is deflation?
- decrease of prices
39
What is core inflation?
- the remaining inflation when governments strip out volatile goods
40
How do you convert a raw number to an index?
- raw number/base year raw number *100
41
What are the consequences of inflation?
- erodes value of earnings leading to a breakdown in the medium of exchange function of money
- erodes value of savings leading to a breakdown in the store of value function of money
- creates uncertainty which can turn to de-stabilising feedback loops - hyperinflation, low investment, wage/price spiral and breakdown in the functions of the price mechanism
- menu costs (cost incurred by businesses to update their prices)
- shoe leather costs (the time & effort spent by consumers in searching for the best price)
- loss of price competitiveness for an economy
42
What are four benefits of inflation?
- signals that resources are fully utilised
- allows negative real interest rates
- redistribute wealth from savers to borrowers (rich v poor, public debt) by eroding the value of debt
- permits the psychological illusion of progress whilst correcting excess supply in labour markets. People want to earn more each year creating cost push inflation if output does not go up proportionately.
43
How is cost push inflation caused?
- AS curve shits upwards
- price of factors of production increase
44
How is demand pull inflation caused?
- shift of AD right
45
What are the main macroeconomic objectives of a government?
- **improve the living standards**
- **sustainable in the long run**
- **equitable so that all citizens benefit**
- **steady real economic growth**
- **low unemployment**
- **controlled inflation**
- **an equilibrium in the balance of payments**
46
What do demand side policies have a primary affect on?
- AD
- typically these policies afffect the economy in the short-medium term
47
What do supply side policies have a primary affect on?
- AS
- medium-long term
48
What does fiscal policy manage?
- Government spending and revenues
-
49
What does monetary policy manage?
- the price (interest rate) and quantity of money in an economy
50
What do supply side policies manage?
- the rules that determine the incentives and framework within which economic activity is conducted
51
Monetary policy attempts to achieve…
Macroeconomic objectives by manipulating the price (interest rates) and/or quantity of money (supply) in an economy (AD)
52
Who is monetary policy managed by?
- the Bank of England
53
If interest rate increases, what effect will this have on consumers?-
- savings will increase
- interest payments on mortgages & existing loans increases
- house prices and financial asset prices will decrease
- this leads to less income available for consumption -> decrease in consumption
- AD decreases and inflation goes down
54
If interest rate increases what impact will this have on businesses?
- interest payments on existing loans will increase
- costs of new loans to fund investment will increase
- retained profits will decrease
- leading to a decrease in investment + AD
- decrease in inflation
55
If interest rate increases what impact will this have on the exchange rate?
- export prices will increase - decrease in export qty
- import prices will decrease - increase in import qty
- (X-M) decreases and AD decreases
- inflation decreases
56
How does quantity easing work?
1. The central banks creates electronic money and buys government bonds in the secondary market (from commercial banks) e.g the Bank of England created £375bn in the aftermath of the financial crash
(Impact on supply of loans)
2. This has the effect of increase the liquidity of commercial banks
3. This encourages commercial banks to lend (as there is an increase in confidence to the increase in cash) and the supply of loans in the credit markets increases (S1 to S2)
(Impact on demand for loans)
4. Simultaneously, bond prices in secondary markets to increase with the increased demand for bonds
5. As a result bond yields go down
6. Commercial interest rates tend to be benchmarked against bond yields so they go down
7. This encourages consumers and firms to borrow
(Impact on Economy)
8. In this way, QE encourages both the supply and demand for loans which in turns stimulates AD and inflation
57
Describe the correlation between the Bank of England and commercial bank interest rates.
- It sets an interest rate which affects commercial banks deposits with it
- It hopes that when it changes this rate commercial banks will follow and change the interest rate they charge.
- A benchmark interest rate is LIBOR which is used as a reference point against which other rates are set
- FInancial transactions between consumers and firms in the economy are intermediated by commercial banks
- interest rates that afffect behaviours are those set by commercial banks
- If commercial banks do not follow interest rate signals of the B.o.E then monerary policy is ineffective in influencing AD and Inflation
58
When is monetary policy ineffective?
1. When interest rates can’t go any lower and an expansionary policy is required
2. When financial institutions do not follow the central banks interest rate or money supply changes
3. When consumer/business confidence is low so they do not borrow
4. When savings and/or borrowings are low so the magnitude of the impact of the transmission mechanisms is low
5. In globally inter-connected financial markets when savers and borrowers can ignore domestic monetary signals and save/borrow overseas
6. When fiscal policy conflicts with monetary policy
59
What is the impact of quantities easing on equity?
- QE involves purchasing financial asset prices
- Prices of financial assets increases
- People who already own financial assets become better off and can increase their income to become even richer - distribution of wealth gets more unequal
- The quantity & price of assets being purchased increases the financial sectors earnings as they earn a % of each transaction.
- this increases the incomes even more of those in this sector while ad is being decreased, increasing income inequality
60
What impact does QE have on pensions?
- As QE involves purchasing financial asset prices with a view to driving down interest rate
- price of financial assets go up, yield of financial assets goes down
- pension funds calculate their future liabilities to pay annuities based on these yields
- as yields go down the value of these annuities they can pay go down - hurting the working population more than current pensioners
- govt. regulations require pension funds to increase their holdings of financial assets so that they can continue to pay the annuities they have committed to
- employees and firms have to increase pension contributions now
61
What is disposable income?
- the money that households have left from their salary/wages after they have paid their taxes and received any transfer payments
62
When savings decrease consumption…
Usually increases
63
How does an increase in interest rates affect consumption?
- creates a greater incentive to save
- therefore less consumption
- monthly repayment on loans/mortgages increase
- less consumption
- some may spend more as they already have a lot saved
64
The stronger the economy, the higher the consumer confidence therefore…
- consumers feel secure in their jobs and are confident of receiving regular salary payments
- consumption increases and saving decreases
65
Describe the wealth effect
- If asset prices rise homeowners wealth increases
- increasing homeowners consumption as they have more consumer confidence to borrow money
- if asset prices fall then homeowners wealth decreases
- homeowners start saving to replace lost wealthj
Eval: most homeowners believe prices fluctuate so ignore
66
What is investment?
- the total spending on capital goods by firms
- helps to increase the capacity (production possibilities) of an economy
- increased capacity = increased potential economic growth
67
What is depreciation in terms of goods?
- the decrease in monetary value of a capital good (asset) over time
- replacing old capital goods does not necessarily increase capacity
- it can, if the replacement technology means an increase in capacity is possible
68
What Is gross investment?
- the total amount of spending on capital goods
- replacing old capital goods and purchasing new capital goods
69
What is net investment?
- gross investment - depreciation
- provides info. On the addition of new capital goods to an economy
- better indication of the extra production possibilities that have been created through investment by firms
70
Firms will choose to invest if they…
- feel confident that they will make good return on their investment
- linked to the business objective of profit maximisation
71
How does rate of economic growth affect investment?
- increasing growth sends a signal that higher output will generate higher profits
- faster economic growth greater the urgency to invest
72
How do interest rates affecting investment?
- most investment by firms is financed through business loans
- decreasing interest rates encourages investment
- inverse relationship between investment and interest rates
73
How does demand for exports affect investment?
- if demand for exports increase, firms will likely invest to meet global demand
74
How do government & regulations influence investment?
- government intervention can increase investments (subsidies)
- government regulation can decrease investment (raise cost of production and lower profits)
75
How does business expectations & confidence affect investment?
- the longer a period of economic growth, the higher the business confidence will be.
=. If growth slows, future expectations of profits will decrease and investment decisions become harder
76
How do animal spirits affect investment?
- John Keynes believed firms exhibit too much optimism in the good times and take too many risks and make less rational investment decisions
77
How does access to credit affect investment?
- the easier the access to loanable funds, the higher the levels of investment. Some developing economies have low access to credit and this holds back investment
78
What is government expenditure influenced by?
- the trade/business cycle
- spending linked to achieving policy aims
79
How does the business cycle affect government expenditure?
- booming economy means low unemployment
- low unemployment means a lower level of benefits paid and therefore lower government expenditure
- booming economy means increase of tax revenue
- used to pay back government debt or increase expenditure on public goods
- expenditure increases
80
How do policy aims link to government expenditure?
- they are directly linked
81
What is the net trade balance?
- the difference between the value of exports and imports
82
How does the UK real income increasing affect net trade balance?
- consumers purchase more imports
- trade balance weakens
83
How does the real income increasing abroad effect the trade balance
- foreigners purchase more UK products - exports increase
- trade balance strengthens
84
How does the UK £ appreciating affect the trade balance?
- exports become more exspensive for foreigners so they decrease
- imports become cheaper for consumers so they increase
- trade balance weakens
85
How does the world economy booming affect the trade balance?
- increase demand for UK exports
- trade balance strengthens
86
What is protectionism?
Government policies that restrict international trade to protect domestic industries
87
What happens to trade balance if protectionism increases?
- effect on imports depends on retaliation measures from other countries
- decreased demand for imports as they are more expensive
- trade balance strengthens
88
What is aggregate supply?
- the total supply of goods/services produced with an economy at a specific price level at as given time
89
- why is the AS curve upward slopin?
- as real output increases, firms have to spend more to increase production
- leading to higher average prices
90
What is SRAS influenced by?
- changes in the costs of production or productivity
- short run referees to a time period where at least one f.o.p is fixed
91
What is LRAS influenced by?
- a change in the productive capacity of the economy
- productive capacity is changed by changes to the. Quality or quantity of f.o.ps
- when production capacity changes it is equivalent to a shift inwards/outwards of ppf
92
What is the classical LRAS curve based on?
- the view that in the long run the economy will always return to full employment level of output
- an economy will self correct
93
What is the view of the Keynesian LRAS curve?
- the economy will not always self correct and return to full employment, it can get stuck at an equilibrium below full employment level
- there is a role for the government to increase its expenditure to shift AD and change negative animal spirits in the economy
94
What is the substitution effect?
- if price of things go down you will swap from another good to this good
95
What is the real balance effect?
- As price level goes down, cash balances can purchase more goods and therefore people demand more
- savings go further
Why AD slopes downward
96
Describe the elasticity of AS
- AS is elastic at low levels of GDP
- AS is inelastic at high capacity
97
How can labour be increased in an economy?
- birth rate
- immigration
- better health care (more pop can work)
- government policy
- social change (female emancipation)
- income tax
- education (teacher training_
98
How can capital be increased?
- innovation
- government infrastructure
99
How can price of f.o.ps be affected?
- public sector wages
- inflation
- income tax
- pound weakness
100
What is equilibrium income or equilibrium real national output?
- when planned AD equals planned AS
101
What is the multiplier ratio?
- the ratio of change in real income to the injection that created the change
102
What is the multiplier process based on?
- the idea that one individuals spending is another individuals income
- due to successive rounds of spending final increase in national income is much larger than the initial injection
103
What affects the size of the multiplier?
- size of leakages (savings, taxes, import) / MPW
104
How many shifts of AD are there after an injection
2
- the initial injection shifts AD to the right
- the result of the multiplier process is there is a secondary movement of AD to the right
105
What are marginal propensities?
- the proportion of the next £ earned that’s a consumer saves, consumes, is taxed ,or purchases imports with
106
What is the marginal propensity to consume?
- the proportion of addition income that is spent
MPC = change in consumption / change in income
107
What is marginal propensity to save
- the proportion of additional income that is saved
- MPS = change in saving / change in income
108
What is marginal propensity to tax?
- the proportion of additional income that is paid in tax
- MPT = change in tax / change in income
109
What is marginal propensity to import (MPM)
- the proportion of addition income that is spent on imports
- MPM = change in M / change in Y
110
How can the multiplier be calculated?
- = 1/ (1-MPC)
- 1/MPW = 1/(MPM+MPS+MPT)
111
The greater the mpc…
The greater the value of the multiplier
112
A change in factors that impacts disposable income will…
Change the multiplier
(Taxes, interest rates, exchange rates, confidence)
113
What can the multiplier be used for?
- to judge economic growth caused by increased spending
114
What is one evaluation of the multiplier?
- there is a time lag as it takes times for the successive rounds of income to work through the economy
115
Changes to ……. Will cause short-run economic growth
Aggregate demand
116
What is long run economic growth caused by?
- improvements to the quality or quantity of the factors of production
- this includes all of the determinants of LRAS
117
When does actual economic growth occur?
- when there is an increase in the quantity of goods/services produced in an economy in a given period of time
- often measured by a % change in GDP
118
When is there potential growth?
- when there is an increase in the productive potential of an economy as demonstrated by a shift outward of the PPF/LRAS curve
119
What is export-led economic growth?
- growth that occurs as a result of an increase in the sale of goods/services to foreign countries
- (AD will increase)
120
What is a long-term growth trend?
- underlying trend rate of economic growth over a long era period of time
121
How is a long term growth trend determined?
- by constant increases in the productive capacity of an economy (AS)
122
What is an output gap?
- is the difference between the actual level of output (real GDP) and the potential level of output (potential GDP)
123
What determines potential GDP?
- size of labour force
- pace of productivity growth (output hour of work)
- which itself is independent on the amount of capital investment
124
How does potential GDP increase?
- accelerates if more people enter the labour force
- more capital is injected into the economy
- productivity of capital stock becomes more productive
125
Why do we care more about potential gdp instead of actual?
- potential gdp is the base/anchor by which we osscilate around
126
Why is it hard to measure output gaps accurately?
- hard to measure potential GDP
127
What does rapidly rising prices suggest?
- a positive gap is developing
- overcapacity + inflationary pressures
128
What does rising unemployment and slowdown suggest about growth?
- a negative output gap is developing
- spare capacity
129
What is the difference between Keynesian economists and classical economists when it comes to output gaps?
- keynesians believe that a negative output gap can exist in the long run as well as the short run
- classical economists believe that negative and positive output gaps can only exist in the short run
130
What is the trade business cycle?
- describes how the economy tends to exhibit recurring trends in economic growth rates
131
What are the four points that can be identified on the trade business cycle?
- boom; slump/slow down; recession; recovery
132
In boom periods there tends to be:
- high rates of economic growth
- low rates of unemployment/spare capacity
- demand pull inflationary pressures
- high consumer and business confidence
- improving government budget balance (as tax revenue rises and expenditure on benefits fall)
133
What is a recession
- a period of two or more consecutive quarters of negative economic growth
134
In a recession there tends to be:
- negative rates of economic growth
- high rates of unemployment - particularly demand deficient unemployment
- low rate of inflation
- low business and consumer confidence
- worsening government budget balance
135
What might cause a cycle?
- animal spirits and malinvestment enhanced by multipliers
- Minsky and asset bubbles - wealth effect
- politics
- price of fops as classical said but overcorrection
- all of the above
136
What could cause recoveries?
- classical are right
- political intervention
137
What is the main contributor to improvements in standards of living?
- economic growth
138
However there are negative aspects of economic growth, therefore…
- controversy about maintaining it as a central macroeconomic aim
- focus on societal well being is gaining traction
139
What are benefits of economic growth?
- increased incomes leading to better standards of living
- decreased levels of absolute poverty
- improvement in quality + quantity of environmentally friendly technologies
- higher sales revenue for firms and greater profits
- increased investment by firms increases potential output of the economy
- reduced expenditure by the government on benefits
- higher tax revenue due to rising incomes and surging corporate profits
- increased employment
140
What are the costs of economic growth?
- rising aggregate demand cause demand pull inflation (purchasing power on those with fixed income may fall)
- lack of equity in the distribution of income
- environmental damage caused by negative externalities of production
- increased inflation can harm export sales
- decreased export sales may lead to a delay in investment by firms
- increased income usually leads to greater consumption of demerit goods
- greater output often requires more time for workers and decrease leisure time/well being
