UNIT 3

Question 1

national income and the circular income overview

Answer 1

Money leaves the circular flow of income through injections and leakages
Injections add money to the circular flow of income: government spending, investments, and imports
Leakages remove money from the circular flow of income: exports, savings, taxes

Question 2

ways of calculating national income

Answer 2

Expenditure approach: C+I+G+(X-M)
Income approach: W+R+I+P (the payments for the four factors of production)
Output approach: value of all finished goods and services produced in 1 year

Question 3

GNI

Answer 3

GNI is the sum of the nominal GDP and the net income earned abroad

Question 4

rGDP

Answer 4

Nominal GDP/GDP deflator x100

Question 5

purchasing power parity

Answer 5

a conversion factor that can be applied to GDP and GNI

Makes the standard of living comparison more accurate as goods cost different amounts in different countries

Question 6

Business cycle

Answer 6

The business cycle refers to the changes in real GDP in an economy over time

Question 7

Boom (business cycle)

Answer 7

increasing/high rates of economic growth (+inflation); low unemployment; positive output gap; high consumer confidence

Question 8

recession (business cycle)

Answer 8

when there are two or more consecutive quarters of negative economic growth. High unemployment; negative output gap; low confidence; low inflation

Question 9

using GDP/GNI to measure economic wellbeing

Answer 9

Real is better than nominal because it accounts for inflation
Per capita is better than total because it accounts for population differences
GNI is better than GDP because it counts for what is actually produced within a country’s borders

Question 10

limitations of GDP

Answer 10

GDP is an average per capita; does not accurately reflect the true distribution of income

No information on the quality of goods and services

No unpaid/voluntary work included

Differences in hours worked not included

Environmental factors not included

Question 11

OECD Better life index

Answer 11

11 variables such as housing, income, jobs, education…
Countries rated on each variable

Question 12

Happy Planet Index

Answer 12

wellbeing
life expectancy
eco footprint

Question 13

Happiness Index

Answer 13

Measures personal wellbeing in 10 different aspects, e.g. health, arts/culture, work, material

Question 14

aggregate demand

Answer 14

Total demand for all goods and services in an economy
AD = C+I+G+(X-M)
AD curve is downward sloping
A movement along AD is a change in the average price level
A movement of the entire AD curve is a change in one of the non-price determinants of AD

Question 15

determinants of consumption

Answer 15

Consumer confidence
Interest rates (high interest rates mean that people save, and spend less)
Wealth
Income taxes
Level of household indebtedness
Expectations of future price level

Question 16

determinants of investment

Answer 16

Interest rates (low interest rates means that businesses tend to invest)
Business confidence
Technology (businesses will invest if they identify technology that could lower costs of production)
Business taxes
Level of corporate indebtedness

Question 17

determinants of government expenditure

Answer 17

Political priorities
Economic priorities (fiscal policy)

Question 18

determinants of net exports

Answer 18

Income of trading partners (if trade partners experience an increase in income, their citizens will purchase more imports)
Exchange rate (domestic currency appreciation means that imports increase since they have increased purchasing power)
Trade policies (protectionism)

Question 19

short-run aggregate supply

Answer 19

AS is the total supply of goods and services in an economy at a specific price level at a given time

Short-run: a period in which wages and other factors of production are inflexible

Long-run: a period in which all factors of production are flexible (planning stage)

AS curve is upward sloping
A movement along the AS curve is a change in the average price level
A movement of the entire AS curve is a change in the non-price determinants of AS

Question 20

factors that shift LRAS

Answer 20

Quality and quantity of FOPs
Any change in the quality or quantity of FOPs will change the LRAS in the same direction, e.g. improving skills of workers, or technological advancements

Efficiency improvements
Process innovation, such as moving from labour intensive production to capital intensive production

Changes to institutions
Changes to laws, or increasing financial institutions may make it easier for new firms to enter markets

Question 21

non-price determinants of SRAS

Answer 21

cost of factors of production:
raw materials/energy
input costs change

indirect taxes:
additional cost of firms

Question 22

what are the macro objectives

Answer 22

Economic growth, low unemployment, low/stable rate of inflation, sustainable gov’t debt

Question 23

consequences of economic growth

Answer 23

Improved living standards; increased employment; increased incomes
Demand-pull inflation occurs and purchasing power falls; decreased leisure time
Improvement in the environment due to technological innovations
Environmental damage caused by externalities of production
Decreased levels of absolute poverty, more tax revenue
There may be reduced equity

Question 24

how to measure unemployment

Answer 24

ILO survey: a survey to a sample households where respondents self-determine unemployment
Claimant count: number of people claiming unemployment benefits or job seekers’ allowance. Often, there are significant barriers to claiming benefits.
Unemployment rates do not capture hidden unemployment (people who give up looking for a job)

Question 25

difficulties in measuring employment

Answer 25

Workers are underemployed (want to work more, or in a more skilled job than they do) This is a type of cyclical unemployment Also a consequence of structural unemployment Hidden unemployment (severe recessions) where people give up looking for jobs Unemployment disparities between racial groups, geographically

Question 26

real wage unemployment

Answer 26

Small firms are generally price takers in the labour market Wages are inflexible at a point higher than the market equilibrium when there is a minimum wage Excess supply of labour

Question 27

structural unemployment

Answer 27

Mismatch between jobs and skills in an economy Decrease in demand for a particular skill or job Structure of an economy changes, e.g. primary to secondary Workers can be retrained

Question 28

cyclical unemployment

Answer 28

Caused by a fall of AD in an economy, typically during a recession Since demand for labour is derived from the demand of goods and services, demand of labour also decreases

Question 29

frictional/seasonal unemployment

Answer 29

Seasonal unemployment occurs in industries with high seasonality, e.g. ski instructors Frictional unemployment occurs when workers are between jobs

Question 30

natural rate of unemployment

Answer 30

Lowest achievable rate of unemployment in a country Due to frictional, seasonal and structural unemployment, there can never be a 0% unemployment

Question 31

inflation

Answer 31

sustained increase in the general price level

Question 32

deflation

Answer 32

Deflation is a sustained decrease in the general price level

Question 33

disinflation

Answer 33

Disinflation is a decrease in the positive rate of increase in the general price level

Question 34

using CPI

Answer 34

CPI = cost of basket in year X/cost of basket in base year (first year) x 100

Question 35

limitations of CPI

Answer 35

does not capture the quality of the goods in a basket errors in data collection regional differences in consumption and inflation

Question 36

demand pull inflation

Answer 36

caused by excess demand shift of AD to the right

Question 37

cost push inflation

Answer 37

Caused by an increase in the cost of production Shift to the left of the SRAS Prices are up-bid

Question 38

consequences of inflation

Answer 38

Uncertainty for firms - decreased business confidence Decrease in purchasing power for consumers; real value of savings falls; fall in real income for those who are on fixed incomes Reduced international competitiveness of exports since they are now relatively more expensive Workers want higher wages

Question 39

demand side deflation malignant

Answer 39

A fall in the AD in an economy Increased unemployment Decreased consumer confidence; households will wait to spend rather than spending now, and fiscal/monetary policy becomes less effective Value of any debt is now worth more Exports are attractive to foreigners (may offset)

Question 40

supply side deflation benign

Answer 40

Excess supply due to the increase in quality or quantity of factors of production (outwards shift of SRAS) Average price levels fall and rGDP increases More workers are required, so unemployment falls Increased household confidence so consumption increases, increasing rGDP Exports are attractive to foreigners (may offset)

Question 41

Relative costs of unemployment versus inflation

Answer 41

There is generally an inverse relationship between unemployment and inflation Unemployment has personal (stress), economic (cost of benefits) and social (homelessness) costs Inflation worsens the standard of living, uncertainty, erodes the real value of savings

Question 42

sustainable levels of government debt

Answer 42

Debt to GDP ratio=Total amount of gov't debtGDP100 Budget deficits contribute to total government debt as they need to borrow money to cover the shortfall High levels of government debt will reduce that government’s credibility High national debt may cause defaults

Question 43

conflicts between macro objectives (economic growth)

Answer 43

EG-inflation conflict Increased economic growth increases inflation - above target inflation rate EG-environment conflict Increased economic growth may harm the environment due to the negative externalities of production and consumption EG-inequality conflict Profits of the owners of FOPs are generally disproportionate to that of the workers during periods of high economic growth

Question 44

trade-off between unemployment and inflation

Answer 44

Phillips curve The Short Run Phillips Curve demonstrates the tradeoff between unemployment and inflation A movement of the AD curve becomes a movement along the SRPC In the long run, the Phillips curve is vertical at the natural rate of unemployment This is because the labour market self corrects in the long run, and wages and prices are flexible At this point, only the inflation rate can change (the SRPC can shift)

Question 45

equality

Answer 45

economic outcomes are similar

Question 46

equity

Answer 46

economic fairness is similar; normative

Question 47

wealth inequality

Answer 47

difference in assets owned; income inequality: unequal flow/distribution of income to households

Question 48

Absolute poverty:

Answer 48

individuals cannot afford the basic necessities to live a healthy and safe existence; WB defines this as $1.90 a day

Question 49

relative poverty:

Answer 49

individuals living under 50% of the median household income in their area

Question 50

Lorenz curve

Answer 50

Graphical representation of the income inequality in an economy Line of perfect equality Gini coefficient = space between perfect equality and inequality/total area under perfect equality A Gini of 0 represents absolute equality (socialism)

Question 51

measuring poverty

Answer 51

International Poverty Line - $1.90 Minimum Income Standard (lowest amt. for what society considers) Multidimensional Poverty Index - health, living standards, education Urban households have different concepts of poverty to rural ones Rural households may be in long-term poverty

Question 52

poverty cycle

Answer 52

Low wages are the intersection of economic growth and human development Unemployment, informal unemployment, lack of education, primary sector Education and healthcare are not accessible with lower wage levels, so there is lower productivity and therefore lower wages

Question 53

causes of inequality

Answer 53

Differences in human capital (education) Inequality of opportunity (education, healthcare) Differences in resource ownership (assets generate income) Discrimination Unequal power and status (trade unions) Globalisation Market based supply-side policies like deregulation

Question 54

using taxation to reduce inequality and poverty: how? use indirect and direct taxes as examples

Answer 54

Taxes are used to redistribute income as to reduce income inequality in a nation They can be progressive, proportional or regressive Direct taxes Direct taxes are levied on income and profit; income tax, corporation tax, national insurance, inheritance tax Indirect taxes Indirect taxes are levied through the consumption of goods and services, e.g. VAT

Question 55

solutions other than tax to reduce inequality and poverty

Answer 55

Break the poverty cycle to improve standard of living Invest in human capital, e.g. education or reskilling Transfer payments / more generous ones to directly increase wages Increase national minimum wage Government spending on goods and services, e.g. schools, hospitals Policies to reduce discrimination

Question 56

real vs nominal interest rates

Answer 56

The nominal interest rate is the actual price borrowers pay lenders. The real interest rate accounts for inflation and better defines a consumer's purchasing power

Question 57

monetary policy definition, aim

Answer 57

monetary policy = demand side policy - use of interest rates and the money supply to influence AD, done by the central bank aim: Help government achieve macroeconomic objectives

Question 58

expansionary vs contractionary monetary policy

Answer 58

Demand-side policies can generate or damper economic growth

Question 59

fiscal policy definition, aim

Answer 59

Fiscal policy refers to the use of government spending and taxation to induce AD, done by the government, used to achieve macroeconomic objectives

Question 60

expansionary vs contractionary fiscal policy

Answer 60

Expansionary: lowering taxes, increasing government spending Contractionary: increasing taxes, decreasing government spending Typically presented as part of the government budget - so the government’s deficit affects fiscal policy

Question 61

effectiveness of monetary policy

Answer 61

strengths: - flexible, easy to reverse, incremental - short time lags - lack of political bias weaknesses: - limited scope of reducing interest rate when close to 0 - low consumer and business confidence

Question 62

government expenditure/revenue in terms of fiscal policy

Answer 62

Government revenue Taxation paid directly to the government, levied on income and profits Indirect taxes levied on spending Sale of goods and services (direct provision) Sale of government assets (privatisation) Government expenditure Transfer payments Current expenditures: daily payments required to run the country, e.g. wages Capital expenditures: investments in infrastructure and capital equipment

Question 63

goals of fiscal policy

Answer 63

low and stable inflation low UE promote stable economic environment for long term growth reduce business cycle fluctuations equitable distribution of income external balance

Question 64

effectiveness of fiscal policy

Answer 64

Strengths Can be targeted at specific industries Effective in restoring confidence in an economy during a recession Redistribution of income means improved equality Weaknesses Political pressure Unsustainable debt Conflicts between objectives/opportunity cost Time lags Crowding out (where expansionary fiscal policy leads to reduced private sector spending)

Question 65

supply side policies definition, aim and types

Answer 65

Aim to shift LRAS Can be interventionist (by the government, generally to correct market failure) or market based (generally to improve long-run obstructions to reaching YFE)

Question 66

market based policies

Answer 66

Market-based policies Increase incentives, e.g. reducing corporation tax Improve competition and efficiency, e.g. deregulation Reduce labour costs, e.g. institutional change - lowering minimum wage

Question 67

interventionist policies

Answer 67

Education and training improves the quality of human capital Healthcare improves long-run productivity of the workforce Research and development, infrastructure funding Industrial policies

Question 68

effectiveness of supply side policy

Answer 68

Demand-side effects of SSPs In the long run, interventionist SSPs can often lead to increases in AD (since government spending is a component of AD) Often, it adds increased productive potential to an economy (e.g. building a new airport which helps trade, but also gives contracts and jobs to the local economy) Evaluation of market-based policies Generally less burden on the government budget Better resource allocation Equity issues for market-based policies, especially those relating to labour Time lags Environmental impact Evaluation of interventionist policies Can target specific sectors for growth Improvements in living standards accross the board Cost/opportunity cost Time lags

Question 69

sustainable levels of government debt

Answer 69

debt to GDP ratio = total amount of debt/GDP * 100 Budget deficits contribute to total government debt as they need to borrow money to cover the shortfall High levels of government debt will reduce that government’s credibility High national debt may cause defaults

Question 71

the multiplier effect

Answer 71

The multiplier is the ratio of change in real income to the injection that created the change One individual’s spending is another’s income - a store owner may earn money from a purchase, who then goes on to spend it elsewhere. This initial consumption has led to a larger increase in national income. The size of the multiplier is dependent on the size of leakages that occur during the process Any change in the factors impacting disposable income will change the multiplier

Question 72

marginal propensity definition

Answer 72

The marginal propensity is the proportion of the next $ earned that a consumer saves, consumes, is taxed, or purchases imports with Sweden has a higher tendency to save than the US so their marginal propensity to save is higher; hence, the US has a bigger multiplier

Question 73

marginal propensity of... consumption saved taxes imports

Answer 73

MPC= ΔC/ΔY - prop. of additional income spent on consumption MPS= ΔS/ΔY - prop. of additional income saved MPT= ΔT/ΔY - prop. of additional income paid in tax MPM= ΔM/ΔY - prop. of additional income spent on imports

Question 74

keynesian multiplier

Answer 74

k=1/(1-MPC) (consumption method) k=1/MPW=1/(MPS+MPT+MPM) (withdrawal method)

Question 75

national debt