semester 2 macroeconomics week 1,2,3,4,5,6,7,8,9 Flashcards
(30 cards)
The Circular Flow of Income Model
The Circular Flow of Income model illustrates how money moves through the economy. It highlights the relationship between households, firms, and the government.
Inner flow: Households provide labor to firms, earning wages (factor payments), and spend their income on goods and services.
Withdrawals (W): Money leaving the economy via savings (S), taxes (T), and imports (IM).
Injections (J): Money entering the economy via investment (I), government spending (G), and exports (EX).
Equilibrium: When J = W, national income remains stable. If J > W, the economy grows; if W > J, the economy shrinks.
What are the four phases of the business cycle, and how do they impact businesses?
The business cycle describes fluctuations in economic activity over time:
Upturn: The economy recovers from a recession, and demand starts to increase.
Expansion: Growth accelerates, investment rises, and unemployment falls.
Peaking-out: Growth slows, inflation may rise, and interest rates may increase.
Slowdown/Recession: Demand falls, unemployment rises, and GDP contracts.
Actual Growth: The percentage increase in real GDP (actual production).
Potential Growth: The percentage increase in the economy’s capacity to produce (e.g., technological advances).
International Business Cycles: Economies are interconnected; global crises (e.g., COVID-19 lockdowns) can push multiple countries into recession.
When does Unemployment occur? - Types & Effects
Unemployment occurs when people actively seek work but cannot find jobs. Key types include:
Frictional Unemployment: Temporary unemployment due to job transitions (e.g., graduates looking for work).
Structural Unemployment: Caused by shifts in the economy (e.g., automation replacing factory jobs).
Cyclical Unemployment: Occurs during economic downturns when demand falls.
Seasonal Unemployment: Jobs that vary by season (e.g., tourism, agriculture).
Real-Wage Unemployment: When wages are too high, reducing demand for workers.
Unemployment Rate:
Costs of Unemployment:
Financial hardship for individuals.
Reduced consumer spending, impacting businesses.
Government burden (increased welfare payments, lower tax revenue).
Inflation - Causes and Effects
Inflation is the general increase in prices over time, reducing purchasing power.
Demand-Pull Inflation:
Caused by excess demand in the economy (e.g., government stimulus, rising consumer confidence).
Cost-Push Inflation:
Caused by higher production costs (e.g., rising wages, supply chain disruptions).
Spiraling Inflation:
When demand-pull and cost-push effects reinforce each other, leading to sustained inflation.
Inflation is measured using:
Consumer Price Index (CPI) – tracks the cost of a typical household’s goods & services.
Retail Price Index (RPI) – includes housing costs (e.g., mortgage interest).
GDP Deflator – measures price changes in all domestically produced goods/services.
Costs of Inflation:
Reduces purchasing power – people afford fewer goods with the same income.
Creates uncertainty – discourages investment.
Worsens income inequality – affects fixed-income earners more.
Classical vs. Keynesian Macroeconomics
Two dominant schools of thought in macroeconomics:
Classical Economics
Believes in free markets where supply and demand naturally balance.
Say’s Law: “Supply creates its own demand” → an increase in production increases income, which in turn increases spending.
Market forces restore equilibrium → Unemployment is temporary.
Policy stance: Minimal government intervention; balanced budgets (Taxes = Gov. Spending).
Keynesian Economics
Developed by John Maynard Keynes during the Great Depression.
Demand-driven economy: Recessions occur when demand falls.
Government intervention is necessary to boost demand (e.g., through public spending).
Wages & prices are sticky → markets do not adjust quickly.
Paradox of Thrift: Increased saving reduces spending, leading to lower demand and economic contraction.
Keynesians explain cyclical fluctuations in the economy by examining the causes of fluctuations in the level of aggregate demand.
Aggregate Demand & Aggregate Supply (AD-AS Model)
What happens when aggregate demand increases in the Keynesian vs. Classical model?
The AD-AS model explains economic fluctuations:
Aggregate Demand (AD)
Total spending in an economy:
𝐴
𝐷
=
𝐶
+
𝐼
+
𝐺
+
(
𝑋
−
𝑀
)
AD=C+I+G+(X−M)
C = Consumption
I = Investment
G = Government spending
(X - M) = Net exports
Aggregate Supply (AS)
Total output produced by firms:
Short-run AS (SRAS): Upward-sloping; businesses respond to higher demand by increasing production.
Long-run AS (LRAS): Vertical (Classical view) or upward-sloping (Keynesian view), depending on how flexible prices and wages are.
Classical View: AS is vertical → increasing AD only causes inflation. If aggregate demand increases, people expect higher prices.
Workers demand higher wages, but these are cancelled out by inflation.
As a result, they’re not motivated to work more, and unemployed people aren’t more likely to take jobs.
Firms raise prices to cover costs, not because of higher real demand, so no real sales or output growth occurs.
➡️ Conclusion: Boosting demand just causes inflation, not real economic growth.
In fact, it could hurt the economy long-term by reducing business confidence and investment.
- the counter asrgument here is that wages and prices are sticky therefotre they do not adjust immediately in responses to changes in AD, this means firms will experiance an increase in output and employment before wages adjust in the short run - hysterisis can amplify these effects to the longer term also or positive economic expectations.
Keynesian View: AS is upward-sloping → increasing AD raises output and employment.
Keynesian model: AD increase leads to higher output and employment (if economy is below full capacity).
Classical model: AD increase leads only to inflation, as the economy is already at full capacity.
- y axis is price
x - axis is gdp or national output - demand pull inflation shifts ad to the right , following effects are a shift upewards in the sras curve when input costs rise due to the economy exapanding
- cost push inflartion shifts sras upwards due to increasing input costs, subsequently the ad curve shifts right due to implementation of fiscal and monetary policies which are implemented to tackle inflation, unemployment and or target interest rates.
the dynamic short run aggregate supply curve is upward sloping in the short run because wages are sticky and adjust after prices therefore firms will increase prices to satisfy extra demand for low/0 costs thus widening profit margins in the short run hence intuitively explaining why the curve is upward sloping
The dynamic aggregate demand curve is downward sloping because as prices rise central banks will increase interest rates to reduce national income thus creating the downward sloping aggregate demand curve
How do Monetarists explain inflation, and how does their view differ from Keynesians?
Monetarists argue that inflation is always caused by excessive money supply growth (MV = PY).
Keynesians believe inflation can also result from demand-pull (high demand) or cost-push (rising production costs).
Where:
M = Money supply
V = Velocity of money (how often money circulates)
P = Price level
Y = Real output (GDP)
Key Ideas:
Inflation is caused by excessive money supply growth.
Long-run Phillips Curve is vertical → no long-term trade-off between inflation & unemployment.
Monetarists reject Keynesian “Stop-Go” policies (government demand management) because they create inflation without long-term gains.
Why do expectations matter in macroeconomic policy?
Expectations affect how businesses and consumers respond to policies. If people expect inflation, they demand higher wages, which can lead to a self-fulfilling inflation cycle. If people expect economic growth, they spend and invest more, boosting demand.
Two Views on Expectations:
Pessimistic View (Rational Expectations):
People anticipate policy changes and adjust behavior accordingly.
Example: If the government increases spending, people expect inflation and demand higher wages → neutralizing the policy’s effect.
Optimistic View (Keynesian Perspective):
In times of economic slack, government spending can boost output.
Expectations depend on business conditions (e.g., high unemployment means firms won’t immediately raise prices).
Policy Implications:
If expectations adjust quickly → fiscal & monetary policies lose effectiveness.
If expectations adjust slowly → government intervention can stimulate demand.
Q1: What is the focus of the Keynesian model in macroeconomics?
Q2: What is the Withdrawals-Injections (WJ) model, and what are its components?
Q3: What happens when national income (Y) increases?
Q4: What determines injections in the WJ model?
Q5: How does equilibrium national income occur in the WJ model?
Q6: What is the Keynesian Cross (KC) model, and how is equilibrium determined?
A1: It explains the short-run static relationship between aggregate variables in the goods market, helping to predict short-term changes in the economy.
A2: It explains how money flows between different sectors of the economy:
Withdrawals (W) = Savings (S) + Taxes (T) + Imports (IM)
Injections (J) = Investment (I) + Government Spending (G) + Exports (EX)
A3: Withdrawals increase because:
Savings (S) increase – determined by the Marginal Propensity to Save (MPS).
Taxes (T) increase – determined by the Marginal Propensity to Tax (MPT).
Imports (IM) increase – determined by the Marginal Propensity to Import (MPM).
The Marginal Propensity to Withdraw (MPW) = ΔW / ΔY.
A4: Injections do not depend on national income (Y) and include:
Investment (I) – Planned in advance by businesses.
Government Spending (G) – Determined by fiscal policies.
Exports (EX) – Dependent on foreign economies.
A5: When Withdrawals (W) = Injections (J).
If W > J, national income decreases.
If J > W, national income increases.
A6: It models equilibrium national income where:
Income (Y) = Domestic Consumption (Cd) + Withdrawals (W).
Expenditure (E) = Domestic Consumption (Cd) + Injections (J).
Equilibrium occurs when Y = E.
45 degree model
the kc cross model has endogenous variables which rise as national income rises. these are depicted by the 45 degree loine and are consumption, consumption demand and withdrawals which again all increase as national income rises
Q7: What happens when aggregate expenditure (E) is greater than national income (Y)?
Q8: What is an inflationary gap, and how does it impact the economy?
Q9: What happens when national income (Y) is greater than aggregate expenditure (E)?
Q10: What is a deflationary gap, and how does it impact the economy?
A7: National income increases, leading to an inflationary gap.
A8: It occurs when aggregate expenditure (E) exceeds full-employment national income, leading to demand-pull inflation.
A9: National income decreases, leading to a deflationary (recessionary) gap.
A10: It occurs when aggregate expenditure (E) is below full-employment national income, causing unemployment and slow economic growth.
Q11: What is the multiplier effect?
Q12: How is the injections multiplier (K) calculated?
Q13: What happens to the multiplier if the Marginal Propensity to Withdraw (MPW) increases?
Q14: What is the relationship between the Withdrawals Multiplier (k) and MPW?
Q15: What are the steps in the multiplier process?
Q16: How does the multiplier effect impact Aggregate Demand (AD)? refer to ad/as model
𝑘
A11: It measures how a change in injections (J) or withdrawals (W) impacts national
income (Y). The increase in Y is larger than the initial change in J.
the lower the mpw the greater the multiplier effect as withdrawals subdue/ dampen the recirculation of the injection into the economy as people are withdrawing through getting taxed saving or importing goods
How It Works
Initial Injection – Government spending, investment, or exports inject money into the economy.
Increased Income – Businesses and workers receiving this money will spend a portion of it on goods and services.
Further Spending – The money circulates through the economy, generating more income and spending at each stage.
Total Impact – The final increase in GDP is greater than the initial injection due to repeated rounds of spending.
A12:
k = (1/(1-mpc))
A13: The multiplier decreases because a higher MPW means more money is leaked out of the economy through savings, taxes, or imports.
A14:
1
𝑀
𝑃
𝑊
k=
MPW
1
If MPW = 0.5, the multiplier is 2.
If MPW = 0.25, the multiplier is 4.
A15:
Step 1: Increase in injections (e.g., government spending rises by £160m).
Step 2: National income (Y) increases.
Step 3: Consumption (Cd) increases.
Step 4: More withdrawals (W), reducing further increases.
Step 5: The process continues but slows over time.
A16:
A rise in government spending (G) shifts AD right.
The economy expands if AS is not at full employment.
Q17: What is the accelerator effect?
Q18: How does the accelerator effect interact with the multiplier?
Q19: What causes booms and recessions to persist?
Q20: What causes booms and recessions to end?
Q21: Why is investment the most volatile component of aggregate demand (AD)?
Q22: How do Keynesians explain business cycles?
A17: It describes how changes in national income (Y) influence investment (I).
When Y increases, businesses invest more.
When Y decreases, investment (I) falls or stops.
A18:
Step 1: A rise in injections (J) increases national income (Y) (Multiplier Effect).
Step 2: Firms invest more (Accelerator Effect).
Step 3: Higher investment causes another round of Multiplier Effects.
Step 4: The cycle continues until the economy stabilizes or contracts.
A19:
Time lags in policy responses.
Multiplier-Accelerator interactions creating cycles.
Herd behavior (bandwagon effects).
A20:
Economic ceilings and floors – natural limits to growth or contraction.
Echo effects – past cycles influencing future cycles.
Random shocks – unexpected events like oil price shocks or financial crises.
Government intervention – policies to increase injections (J) or reduce withdrawals (W).
A21: Investment depends on business confidence, expectations, and income growth. A small drop in demand can cause investment to fall dramatically.
A22: Business cycles (natrual fluctuation in the economic activity over time characterised by booms and recessions) are caused by fluctuations in aggregate demand (AD), particularly due to instability in private-sector investment. - The Keynesian view of cyclical fluctuations in the economy is that it is due to causes of fluctuations in the level of aggregate demand. A major part of the Keynesian explanation of the business cycle is the instability of private-sector expenditure. Investment is the most volatile component of aggregate demand
Flashcard 1: Money & Its Functions
Q1: What is the definition of money?
Q2: What are the four main functions of money?
Q3: What are the ideal attributes of money?
Q4: What is the difference between barter and fiat money?
Q5: What are the different definitions of the money supply?
Flashcard 1: Money & Its Functions
A1: Money is any asset that is widely accepted as a means of payment and store of value in an economy.
A2: The four main functions of money are:
Medium of exchange – Used to buy and sell goods/services.
Store of wealth – Retains value over time.
Unit of account – Standard measure for pricing goods.
Standard of deferred payment – Facilitates future payments.
A3: Ideal attributes of money include:
Durability – Long-lasting.
Divisibility – Can be broken into smaller units.
Transportability – Easy to carry and use.
Non-counterfeitability – Difficult to fake.
A4:
Barter is a system where goods and services are exchanged directly without money.
Fiat money has no intrinsic value but is accepted as legal tender by government decree.
A5:
Narrow definition: Includes only cash and easily accessible bank deposits.
Broad definition: Includes cash, bank deposits, and other liquid assets (e.g., M1, M2, M3, M4).
Flashcard 2: Financial System & Banks
Q6: What is the role of the financial sector in the economy?
Q7: What are the two main types of financial institutions?
Q8: What are the differences between retail banks, wholesale banks, and building societies?
Q9: What are the key components of a bank’s balance sheet?
Q10: How do banks facilitate deposit-taking and lending?
Flashcard 2: Financial System & Banks
A6: The financial sector facilitates economic activity by:
Providing expert advice.
Channelling funds between savers and borrowers.
Transforming risk and maturity.
Enabling efficient payment systems.
A7:
Deposit-taking institutions (e.g., commercial banks, building societies).
Non-deposit institutions (e.g., insurance companies, pension funds).
A8:
Retail banks: Provide banking services to individuals and businesses.
Wholesale banks: Handle large transactions between financial institutions.
Building societies: Specialize in mortgages and savings accounts.
A9:
Liabilities: Customer deposits, borrowings.
Assets: Loans, securities, reserves.
A10:
Deposits: Banks accept savings and demand deposits.
Lending: Banks issue loans and mortgages while maintaining reserves.
Flashcard 3: Money Supply & Central Banks
Q11: What is the role of central banks (e.g., Bank of England, ECB)?
Q12: How does the central bank manage the money supply?
Q13: What is the money multiplier and how is it calculated?
Q14: What are the key causes of an increase in the money supply?
Q15: What are the differences between exogenous and endogenous money supply?
Flashcard 3: Money Supply & Central Banks
A11: The central bank controls the monetary system by:
Issuing currency.
Regulating banks.
Managing government borrowing.
Conducting monetary policy.
A12: The central bank controls money supply through:
Open market operations (buying/selling bonds).
Adjusting interest rates.
Setting reserve requirements for banks.
A13: The money multiplier shows how much the money supply expands due to bank lending:
Formula:
𝑚
=
1
𝐿
m=
L
1
where
𝐿
L is the reserve ratio.
Example: If the reserve ratio is 10%, then
𝑚
=
10
m=10.
A14: Causes of increases in money supply:
Lower reserve ratios (banks lend more).
Households/firms holding less cash.
Inflow of foreign funds.
Government deficit spending.
A15:
Exogenous money supply: Determined by the central bank.
Endogenous money supply: Changes in response to economic demand.
Flashcard 4: Interest Rates & Money Market Equilibrium
Q16: What are the key factors that influence interest rates?
Q17: What are the two main components/ types of the demand for money?
Q18: What is the relationship between money supply and inflation?
Q19: How does money market equilibrium affect exchange rates and trade?
Q20: How do governments use monetary policy to stabilize the economy?
Flashcard 4: Interest Rates & Money Market Equilibrium
A16: Interest rates are influenced by:
Inflation expectations.
Central bank policies.
Risk and liquidity factors.
Supply and demand for credit.
A17: The demand for money consists of:
Transactions & precautionary demand (L1) – Money needed for everyday transactions.
Speculative demand (L2) – Money held to take advantage of investment opportunities.
Total demand =
𝐿
1
+
𝐿
2
L1+L2.
A18:
Higher money supply → Lower interest rates → Higher inflation.
Lower money supply → Higher interest rates → Lower inflation.
A19: Money market equilibrium affects:
Interest rates: Changes in money supply impact borrowing costs.
Exchange rates: More money supply → Lower currency value.
Trade balance: Weaker currency → More exports, fewer imports.
A20: Governments use monetary policy to:
Stabilize inflation (adjusting interest rates).
Control unemployment (expanding or contracting money supply).
Regulate economic growth.
Flashcard 1: IS/LM Model and Goods Market Equilibrium
Q1: What does the IS/LM model represent in macroeconomics?
Q2: What is the IS curve, and what does it show?
Q3: How is the IS curve derived?
Q4: What causes movements along and shifts in the IS curve?
Q5: What is the relationship between investment, savings, and interest rates in the goods market?
provide a quick breakdown of IS and LM curves also.
Q5b: what are the 3 main influences on money demand - also define them.
Flashcard 1: IS/LM Model and Goods Market Equilibrium
A1: The IS/LM model explains equilibrium in the goods market (IS curve) and money market (LM curve), showing how interest rates and national income interact.
A2: The IS curve represents equilibrium in the goods market, showing combinations of interest rates (r) and national income (Y) where investment (I) = savings (S).
A3: The IS curve is derived by plotting different equilibrium national income levels (Y) for different interest rates (r). As r decreases, investment increases, shifting equilibrium output higher.
A4:
Movements along the IS curve: Caused by changes in interest rates, affecting investment and national income.
Shifts in the IS curve: Caused by changes in injections (J) (e.g., government spending, exports, investment) or withdrawals (W) (e.g., taxes, imports, savings).
A5: A fall in interest rates makes borrowing cheaper, increasing investment, which raises aggregate demand and output. Higher savings reduce consumption and investment, lowering output.
- IS curve breakdown - The IS curve shows the inverse relationship between interest rates and GDP. - the curve is downward sloping when interest rates fall investment increases which subsequently boosts gdp - shows equilibrium on the goods market
Lower interest rates → More investment → Higher GDP (Move right on IS curve).
Higher interest rates → Less investment → Lower GDP (Move left on IS curve).
Government policies, central banks, and business investment decisions impact the IS curve.
LM curve breakdown - The LM curve shows the positive relationship between interest rates and GDP in the money market.
Higher GDP → Higher money demand → Higher interest rates (Move up on LM curve).
Lower GDP → Lower money demand → Lower interest rates (Move down on LM curve).
Central banks influence the LM curve by adjusting the money supply, affecting interest rates and economic activity.
“LM” stands for Liquidity Preference-Money Supply. It represents the relationship between interest rates and GDP in the money market, where equilibrium occurs when money demand equals money supply.
IS” stands for Investment-Savings. It represents the relationship between interest rates and output (GDP) in the goods market, where equilibrium occurs when total spending (consumption + investment + government spending) equals total output.
Q5b: Transaction demand is stable and positively related to income.
Precautionary demand increases during economic uncertainty.
Speculative demand fluctuates based on interest rates and market conditions.
Flashcard 2: Money Market Equilibrium & LM Curve
Q6: What is the LM curve, and what does it represent? - also what is a liquidity trap
Q7: How is the LM curve derived?
Q8: What causes movements along and shifts in the LM curve? - why is the LM curve upwards sloping
Q9: How does the IS/LM model determine simultaneous equilibrium in the goods and money markets?
Q10: What happens when there is a rise in money supply (MS)? - Address the model
Flashcard 2: Money Market Equilibrium & LM Curve
A6: The LM curve represents equilibrium in the money market, showing combinations of interest rates (r) and national income (Y) where the demand for money (L) = supply of money (M). a liquidity trap - 🔹 A liquidity trap occurs when even though there is plenty of money in the economy, people aren’t borrowing or spending due to economic uncertainty.
A7: The LM curve is derived by plotting different equilibrium interest rates (r) for different national income levels (Y). Higher Y increases money demand, raising r to maintain equilibrium.
A8: Upward sloping: When GDP increases, demand for money rises, pushing interest rates up. - it shows equilibrium in the money market
Movements along the LM curve: Caused by changes in national income (Y), affecting money demand.
Shifts in the LM curve: Caused by changes in money supply (MS) or liquidity preferences.
A9: The IS/LM model finds simultaneous equilibrium where the goods market and money market are in balance (i.e., where IS = LM).
A10: A rise in money supply (MS) shifts the LM curve downward, reducing interest rates and increasing national income.
Flashcard 3: Transmission Mechanism & Policy Effects
Q11: What is the transmission mechanism in monetary policy?
Q12: How does a change in money supply affect aggregate demand and GDP?
Q13: What is the liquidity trap, and how does it impact monetary policy?
Q14: What are the main problems with the Money → Interest Rate link in monetary transmission?
Q15: What is the crowding out effect, and how does it impact investment?
xtra - what are fiscal and monetary policies?
Flashcard 3: Transmission Mechanism & Policy Effects
A11: The transmission mechanism explains how changes in monetary policy (MS, interest rates) affect investment, aggregate demand, and GDP. using 3 stages - Stage 1: money – interest rate link
Stage 2: interest rate – investment link
Stage 3: multiplier effect
A12: When money supply increases, interest rates fall, making borrowing cheaper, leading to higher investment, which increases aggregate demand (AD) and GDP.
A13: A liquidity trap occurs when interest rates are very low, and increasing the money supply has no effect on investment or AD because people hoard money instead.
A14: Problems with the Money → Interest Rate link:
Liquidity trap (no effect on interest rates).
Fluctuating money demand (volatility in interest rates).
A15: The crowding out effect occurs when higher government spending (G) raises interest rates, reducing private investment, which limits the impact of expansionary fiscal policy.
Definition: Monetary policy refers to central bank actions that influence money supply and interest rates to control inflation, employment, and economic growth.
Definition: Fiscal policy refers to government decisions on taxation and spending to influence the economy.
Flashcard 4: Keynesian vs Monetarist Views & AD Curve
Q16: What are the key differences between Keynesian and Monetarist views on the money market?
Q17: How do Keynesians and Monetarists differ in their views on investment?
Q18: How is the Aggregate Demand (AD) curve derived from the IS/LM model?
Q19: What happens when both injections and money supply increase simultaneously? (islm model)
Q20: How does the IS/LM model help explain macroeconomic policy decisions?
key week5 takeaway summary define/ talk about all these : is curve, lm curve, tramission mechanism(go in depth)
, liquidity trap, crowding out, keynesion vs monterists and ad curve from islm
Flashcard 4: Keynesian vs Monetarist Views & AD Curve
A16:
Keynesians: Believe interest rate changes have large effects on investment and output.
Monetarists: Believe interest rate changes have limited effects; focus on controlling the money supply e.g buying bonds to inject liquidity into the market and increase aggregate demand or sellling bonds to acheive the opposite effect. (MS). Moneterists essentially dont like overreliance on intertest rates. - they beleive that investment is not the most volatile componenet of aggregate demand
A17:
Keynesians: Investment is interest-elastic (responds strongly to r changes).
Monetarists: Investment is interest-inelastic (r changes have little effect).
A18: The Aggregate Demand (AD) curve is derived from IS/LM by examining how changes in Y and r affect AD components (C, I, G, (X-M)).
A19: If both injections (J) and money supply (MS) increase, the IS curve shifts right and the LM curve shifts downward, leading to higher Y and stable r.
A20: The IS/LM model helps policymakers determine:
Whether to use fiscal policy (G, T) or monetary policy (MS, interest rates).
The impact of central bank actions on investment and AD.
Summary of Key Takeaways:
📌 IS Curve – Goods market equilibrium; downward sloping; shifts with J/W changes.
📌 LM Curve – Money market equilibrium; upward sloping; shifts with MS changes.
📌 Transmission Mechanism – Interest rates link money market to real economy. - can have for monetarty policy or exchange rates and it explains the process of the immpact of changes in monetary policy, e.g interest rates falls, borrowing increases and savings decrease, household spending and investment increases thus increasing aggregate demand and creating a multiplier effect, then the economy self blances when inflation begins to build up - can be broken to 3 stages, interest rate change - borwwoing change, aggregate demand change (multiplier effect, which can also be boosted by accelerator effect)
📌 Liquidity Trap – When MS increases but interest rates stay low, reducing effectiveness.
📌 Crowding Out – Higher G raises r, reducing private investment.
📌 Keynesian vs Monetarist – Debate over money demand, interest rate effects, and AD.
📌 AD Curve from IS/LM – Shows macroeconomic equilibrium shifts.
is curve, lm curve, tramission mechanism, liquidity trap, crowding out, keynesion vs monterists and ad curve from islm
Flashcard 1: Fiscal Policy & Government Intervention
Q1: What is fiscal policy, and how does it influence the economy?
Q2: What are the key types of fiscal policy?
Q3: How do automatic stabilizers differ from discretionary fiscal policy?
Q4: What is fiscal drag, and how does it affect economic growth?
Q5: What are the main limitations of fiscal policy?
Flashcard 1: Fiscal Policy & Government Intervention
A1: Fiscal policy involves government spending and taxation to influence aggregate demand (AD), employment, and inflation. It stimulates or slows economic growth based on economic conditions.
A2:
Expansionary fiscal policy → ⬆️ Government spending, ⬇️ Taxes → ⬆️ AD, ⬆️ GDP (used in recessions).
Contractionary fiscal policy → ⬇️ Government spending, ⬆️ Taxes → ⬇️ AD, ⬇️ Inflation (used to cool down an overheated economy).
A3:
Automatic stabilizers (e.g., unemployment benefits, progressive taxation) adjust without government intervention.
Discretionary fiscal policy (e.g., stimulus packages) requires deliberate government action.
A4: Fiscal drag occurs when inflation pushes incomes into higher tax brackets, increasing tax payments and reducing consumer spending, slowing economic growth.
A5: Limitations of fiscal policy:
Time lags → Delayed impact due to policy implementation time.
Crowding out → Government borrowing can raise interest rates, reducing private investment.
Political constraints → Governments may avoid tax hikes/spending cuts for electoral reasons.
Flashcard 2: Monetary Policy & Interest Rate Control
Q6: What is monetary policy, and how does it impact aggregate demand?
Q7: How do central banks use interest rate changes to control inflation and economic growth?
Q8: What is quantitative easing (QE), and when is it used?
Q9: What are the challenges in implementing monetary policy effectively?
Q10: How do expectations play a role in the success of monetary policy?
Flashcard 2: Monetary Policy & Interest Rate Control
A6: Monetary policy controls money supply and interest rates to influence inflation, employment, and GDP.
A7:
Lower interest rates → Cheaper borrowing → ⬆️ Investment & consumption → ⬆️ AD.
Higher interest rates → Expensive borrowing → ⬇️ Spending & investment → ⬇️ Inflation.
A8: Quantitative easing (QE) is when a central bank buys financial assets (e.g., government bonds) to inject liquidity and lower long-term interest rates. Used in crises (e.g., 2008, COVID-19).
A9: Challenges include time lags, liquidity traps, and unintended asset bubbles.
A10: If people expect higher inflation, they may spend more now, making monetary policy less effective.
Flashcard 3: IS-LM Model & Policy Effectiveness
Q11: What does the IS-LM model represent, and how does it link fiscal and monetary policy?
Q12: How does expansionary fiscal policy affect the IS curve?
Q13: What happens to the LM curve when the money supply increases?
Q14: How do the IS and LM curves interact to determine equilibrium interest rates and output?
Q15: Why might monetary policy be ineffective in a liquidity trap?
Flashcard 3: IS-LM Model & Policy Effectiveness
A11: The IS-LM model shows equilibrium between goods market (IS curve) and money market (LM curve), linking fiscal & monetary policy.
A12: Expansionary fiscal policy shifts the IS curve right, increasing GDP & interest rates.
A13: More money supply shifts the LM curve down, lowering interest rates and boosting investment.
A14: The intersection of IS & LM determines equilibrium interest rates and output.
A15: In a liquidity trap, low interest rates fail to stimulate borrowing, making monetary policy ineffective.
Flashcard 4: Aggregate Demand & Supply-Side Effects
Q16: How do fiscal and monetary policies influence aggregate demand?
Q17: What is the multiplier effect, and how does it amplify fiscal policy?
Q18: Why might supply-side policies be necessary alongside demand-side policies?
Q19: How do tax cuts impact both aggregate demand and long-term growth?
Q20: Why might expansionary policies lead to inflationary pressures? - what type of inflation is created
Flashcard 4: Aggregate Demand & Supply-Side Effects
A16: Fiscal and monetary policies influence aggregate demand (AD) by shaping spending, investment, and government expenditures:
Fiscal Policy:
Expansionary (↑ AD): More government spending, tax cuts → higher consumer spending & investment.
Contractionary (↓ AD): Less government spending, tax hikes → lower demand.
Monetary Policy:
Expansionary (↑ AD): Lower interest rates, more money supply → cheaper borrowing & higher spending.
Contractionary (↓ AD): Higher interest rates, reduced money supply → discourages spending & investment.
A17: The multiplier effect means one unit of spending increases total GDP by more than one unit.
A18: Supply-side policies (e.g., deregulation, education investment) improve long-run productivity. - Supply-side policies focus on increasing productive capacity and efficiency in the economy by improving factors of production (labor, capital, and technology). These policies boost long-term productivity by:
Education & Training – A more skilled workforce leads to higher efficiency and innovation.
Tax Cuts & Incentives for Businesses – Encourages investment in technology and infrastructure.
Labor Market Reforms – Reducing unemployment benefits or increasing job flexibility encourages work.
Deregulation – Reducing red tape makes businesses more efficient and competitive.
Infrastructure Investment – Better transport and digital networks lower production costs and improve efficiency.
- Goods-side (demand-side) policies focus on boosting short-term demand for goods and services through government spending and monetary policies.
A19: Tax cuts ⬆️ disposable income → ⬆️ Consumption (AD) & ⬆️ Long-term business investment.
A20: Too much expansionary policy → Demand-pull inflation as excess demand pushes prices up. - what type
