Flashcards in Macroeconomics Deck (89):
1
GDP is
market values (not quantities) of final goods and services in the economy
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3 Methods of measuring GDP
1. expenditure method
2. production method
3. income method
3
Net Domestic Product (NDP) is
A measure of GDP less depreciation on capital equipment
4
Gross net expenditure is
Expenditure on output in NZ (GNE = C + I + G)
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Gross National Income (GNI) is
NZs GDP plus income generated overseas by NZ residents and firms, minus income generated here by non NZers
GNI = Net international investment income + GDP
6
Components of GDP
C + I + G + NX
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Real GDP, and drawback of using it?
market value of final goods and services in the economy measured in base year prices (adjusted for inflation). Drawback is that prices could change relative to each other.
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Nominal GDP
market value of final goods and services in the economy measured in current prices
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Inputs of Productivity
inputs / factors of production directly determine productivity. COuld be; physical capital, human capital. natural resources, technological knowledge. Productivity depends on some combination of these factors
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Production function shows
If the economy has a low level of capital, then adding an extra unit of capital is going to increase output quite largely, but if the economy has a large amount of capital then not a large change in output will occur.
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Commodity Money
Goods that can be used as money but also have their own value eg gold.
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4 functions of money
1. medium of exchange
2. unit of account
3. store of value
4. standard of deffered payment
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Fiat money
paper money authorised by a bank or government and does not have to be exchanged for gold or other commodities
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M1
narrowest definition of money supply - includes paper money and coins that are in circulation - not held by the bank or government, plus value of demand deposits by banks.
15
Demand deposits
Also called current deposits, transferable by cheque, debit cards and at eftpos terminals, through electronic transfer -- available on demand and repayable in notes and coins
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M3
M1, plus all other deposits with domestic and foreign banks operating in New Zealand
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Broad Money
M3 plus deposits into non banking deposit taking institutions such as finance companies, and cash management trusts.
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Reserve ratio
Ratio of deposits to reserves.
Simple deposit multiplier = If the reserve ratio were 10%, 1/0.1 = 10. Thus $9 has been created.
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Financial systems provide 3 services
1. risk sharing
2. liquidity
3. Information
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OCR
form of monetary policy utilised by RBA to control interest rate, which influences inflation
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Price Level
Measure of average prices of goods and services in the economy
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Inflation
Sustained, continuous increase in the price level in the economy.
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Consumer Price Index
Average measure of prices in the economy of general household goods.
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Substitution bias (CPI)
Discrepancy not considered by the CPI which is when consumers will substitute towards goods that are relatively less expensive. Therefore index overstates increase in price of living by not considering consumer substitution
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Unmeasured quality changes (CPI)
Discrepancy not considered by the CPI which is when the quality of a good rises from one year to the next.
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Introduction of new goods (CPI)
Discrepancy not considered by the CPI which is when there is a change in purchasing power brought about by new goods. eg new goods = greater variety, dollar more valuable
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Formula for CPI changes
value in 2010$ = value in 1980$ = (CPI 2010/ CPI 1980)
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Inflation can be unfair because
income distribution can become disproportionate. People on fixed incomes are likely to experience reduced purchasing power, and the extent of this depends on whether inflation was anticipated or not.
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4 costs of anticipated inflation on the economy
1. menu costs (to firms of changing prices)
2. Income redistribution
3. Those holding wealth in paper money suffer
4. those holding debt at zero interest are gainers
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cost of unanticipated inflation
1. fixed incomes or pensioners will loose if incomes are not adjusted upwards
2. Borrowers gain and lenders loose when inflation is higher than expected
3. People on fixed incomes may gain or lose
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Deflation
decline in the general level of prices in the economy
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Problems with deflation:
1. decline in general price level in the economy
2. Reduced asset values and wealth
3. Gain to consumers from falling prices may be negated by falling wages
4. Real interest rate rises above nominal interest rate, discouraging business borrowing and reducing effeciveness of monetary policy.
33
Hyperinflation
Extremely rapid increases in the general price level, Money loses value fast so households try to avoid holding it. Associated with political instability and recession.
34
Demand pull inflation
more money -> more spending -> more pressure on supply -> prices are pulled (bid) up in the market
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Cost push inflation
Result of negative supply shock, anything that causes a decrease in AS of goods and services eg increase import prices, increase in wages, increase in indirect taxes, increase in monopoly power in product markets, natural disaster
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Trade deficit, Trade Surplus
Deficit: Negative NX (imports > exports)
Surplus: Positive NX (imports < exports)
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Flow of goods (detriments of net exports)
1. tastes of consumers for domestic and foreign goods
2. prices of goods at home and abroad
3. exchange rates which people can use domestic currency to buy foreign currencies
4. incomes of consumers at home and abroad
5. cost of transporting goods from country to country
6. policies of government to international trade
7. If we are poor then we will import less, if rich more
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Net Capital Outflow (NCO)
Purchase of foreign assets by domestic residents minus purchase of domestic assets bought by foreigners. eg when NZ resident buys shares overseas, money raises NZs NCO, when Aus resident buys shares in NZ, purchase decreases NZs NCO.
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Detriments of Net Capital Outflow
1. Real interest rates being paid on foreign assets
2. Real interest rates being paid on domestic assets
3. Perceived economic and political risks of holding assets abroad
4. Government policies that affect foreign ownership of domestic assets
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Current Account Balance (CAB)
Net Exports plus Net foreign income. (NX + NFI)
NFI is negative (paying back loans and profits NZers make in NZ)
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Balance of payments condition
CAB must balance NCO, if NCO is negative, New Zealand needs to borrow to balance it out.
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Gross National Domestic Income (GNDI)
C + I + G + NX + NFI
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National Saving
Income of nation that is left after paying for current consumption and government purchases.
Y - C - G = I + NX + NFI
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Nominal Exchange Rate.
Rate at which a person can trade the currency of one country for the currency of the other.
45
2 ways to express nominal exchange rate
1. units of foreign currency per one NZD
2. units of NZD per one foreign currency
46
Appreciation of the exchange rate
increase in the value of a currency as measured by the amount of foreign currency it can buy
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Depreciation of the exchange rate
decrease in the value of a currency as measured by the amount of foreign currency it can buy.
48
Real exchange rate
Rate at which a person can trade goods and services of one country for goods and services of another.
Depends on nominal exchange rate and prices of goods in the 2 countries measured in local currencies.
Key detriment of what a country imports and exports.
49
Formula for Real exchange rate
Nominal exchange rate x domestic price / foreign price
or
Real exchange rate = nominal exchange rate x PNZ/Pforeign
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How does a trade deficit lead to a depreciation
If NZ is currently running a trade deficit (M>X) then in total the supply of NZ$ to foreign exchange market will be greater than the demand for NZ$. The price must fall to get the exchange rate back into place (depreciation). This depreciation will eliminate the trade deficit.
51
Purchasing power parity
If the law of one price were not true, unexploited profit opportunities would exist. - ie in open competitive markets, domestic prices will tend to adjust so that everything costs the same everywhere.
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Net foreign debt
difference between the amount NZ lends to other countries and the amount NZ borrows from overseas
We need to borrow to finance our investment
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Aggregate Demand (AD)
Relationship between PL and level of real GDP demanded by households, firms, the government and net exports
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Short run aggregate supply (SRAS)
curve showing the relationship in the short run between the price level and quality of real GDP supplied by firms
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Wealth effect (on AD)
Causes downward slope in AD as change in PL affects consumption
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Interest rate effect (on AD)
Causes downward slope in AD as change in PL affects investment
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International trade effect (on AD)
Causes downward slope in AD as change in PL affects NX
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SRAS is upward sloping because
firms will produce more as PL increases, and prices of inputs tend to rise more slowly than price of final products.
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LRAS
Shows relationship between PL and quantity of Real GDP supplied. Implies that in LR, increase of PL doesn't affect Real GDP, vertical line at potential or full employment.
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Fiscal policy
directly affects public and private spending on GDP
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monetary policy
indirectly affects private sector spending by adjusting money supply or interest rates
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Expansionary monetary policy
reduce OCR, IR decrease. Investment encouraged, maybe increase in Consumption spending. Real GDP and PL increase. Policy success depends on IR decreases being passed on through economy, and elasticity to decreased IR.
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Contractionary Monetary Policy
OCR increase, IR increase. Investment and consumption discouraged, NX decrease, AD decrease, PL and GDP decrease. Success depends on IR increase being passed on and elasticity to increased IR.
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Problems with monetary policy
1. Doesnt affect all people equally
2. high IR to control inflation can lead to inward capital flows which push up exchange rate, negative impact on trading sector
3. Doesnt find root of the problem
4. Hurts real exchange rate
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trick to remember expansionary monetary policy
RB decrease OCR -> IR decrease -> I, C, NX increase -> AD shift right -> Real GDP, PL increase
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trick to remember contractionary monetary policy
RB increase OCR -> IR increase -> I, C, NX decrease -> AD shift left -> Real GDP, PL decrease
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Fiscal policy
Intentional use of changes in government spending, transfers, or taxes to effect changes in AD.
68
Influences of fiscal policy on AD (2)
1. Multiplier effect: each dollar spent by the government can raise AD for goods and services by more than a dollar. Formula = 1/ (1-MPC)
2. Crowing out effect: Increase in govt spending causes increase in IR, which causes decrease in investment, and a reduction in demand. As AS curve slopes upwards, there will be a direct impact on prices, some spending will go to higher prices rather than real GDP.
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Contractionary fiscal policy
Decrease in govt spending/increase taxes to shift AD left and reduce inflation
70
Budget as an automatic stabiliser.
government automatically has a deficit during a recession because tax revenue decreases and they need to pay more unemployment benefits. Progressive tax system works as a stabiliser because it maintains incomes during a recession and dampens expansionary pressures during a boom
71
fiscal policy and deficit
expansionary fiscal policy = increase deficit (bc spending more)
contractionary fiscal policy = decrease deficit
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Fiscal Policy in LR
Fiscal policies that expand the capacity of the economy and increase rate of economic growth. Shift LRAS right.
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Labour force
sum of all employed and unemployed workers in economy
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Unemployment rate:
percent of unemployed
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Discouraged workers
People who were available for work but have not looked for a job during the previous 4 weeks because they believe no jobs are available for them
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Formula for unemployment rate
(no.of unemployed / labour force) x 100
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3 problems with measuring the unemployment rate
1. number of discouraged workers increases during a recession, thus the official unemployment rate appears lower than it actually is
2. Underemployed workers - people who work part time but want more hours
3, People who claim to be unemployed but are not can lead to the unemployment rate being overstated
78
Trends in labour force participation
Higher participation rate: more labour available, higher level of potential GDP
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Costs of unemployment to economy (6)
1. Loss of GDP
2. Loss of Human Capital
3. Retraining costs
4. Unemployment benefit payments cause drain on budget
5. Opportunity cost of funds directed towards unemployment benefits
6. Loss of tax revenue: personal, company, GST, exise
80
Cost of unemployment to individual
1. Loss of income
2. Loss of skills
3. Retraining costs
4. Low self esteem
5. Social problems
81
Cyclical unemployment
Caused by recession. Also known as demand deficit. Falling sales = cut backs on production, less workers needed
82
Frictional unemployment
Short term, matching workers with jobs, eg school leavers or people re-entering the workforce
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Seasonal unemployment
Variations in weather, tourism etc
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Structural unemployment
Persistent mismatch between skills and characteristics of workers and requirements of jobs
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Full employment
No cyclical unemployment, but frictional and structural still exist.
86
Natural rate of unemployment
Normal rate of unemployment consisting of structural unemployment plus frictional unemployment
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Non accelerating rate of unemployment (NAIRU)
level of employment below which the rate of inflation will rise
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Self correction for a recession
1. Short run effect of a decline in AD, AD shifts left, Real GDP decrease
2. Adjustment back to potential GDP in the long run. SRAS shifts right, could take years
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