How the macroeconomy works

• National capital stock- the stock of capital goods such as building and machinery in the economy that has accumulated over time
• national income- the flow of new output produced by the economy in a particular period

  national output- the flow of new output produced by the economy in a particular year
• National income=National output=national expenditure

  • national output measures the actual goods and services produced by the economy
  • National income measures the incomes received from factors of production
  • National expenditure shows the spending of these incomes on g and s
• circular flow of income(closed economy) - an economy with no international trade no intervention from anything

  
• Injections- spending entering the circular flow of income

  • Government spending (G)
  • Investment from firms (I)
  • Exports (x)
• withdrawals- a leakage of spending out of the circular flow of income

  • Taxes (T)
  • Imports (M)
  • saving (S)
• Circular flow of income (investment and savings) (savings > investment)

  • Reduces GDP
  • If households save more than firms are willing to invest, the extra savings are not being spent on new investment. This creates a gap in the circular flow of income.
  • Less money being spent on goods and services. which leads to lower demand for g and s
  • Firms notice this and May make some of the factors of production redundant
  • Income for households decline which then reduces consumption even more
  • Lower demand → Less production → Less income → Slower economic growth (reduced GDP).

  
• Circular flow of income (investment and savings) (investment> savings)

  • Increases GDP
  • If firms invest More money flows into the economy as businesses invest in capital, which increases demand for goods and services.
  • If firms invest they spend more on the factors of the production which means increase income for households.
  • Households then spend part of this increased income, boosting consumption.
  • Multiplier Effect:As firms invest more, they pay workers, suppliers, and businesses, leading to more consumption, more demand, and higher GDP.

  
• Multiplier effect- when an initial injection into the circular flow of income causes a bigger final increase in real national income
• Circular flow of income (government spending And taxes)

  (government spending>taxes)

  • Increases GDP
  • Firms will take on more factors of production which leads to higher income for households (through wages and profits).
  • Households, with increased income, consume more goods and services, boosting demand further.
  • Positive multiplier effect
  • Expenditure(Government spending)> receipts (taxes) = budget deficit which is expansionary

  
• Circular flow of income (government spending and taxes)

  (Taxes>government spending)

  • Decreases GDP
  • Households have less disposable income due to higher taxes, leading to lower consumption.
  • Firms face reduced demand and revenue which means they take less of the factors of production on
  • Firms may decrease income or layoff workers
  • Negative multiplier effect
  • Receipts(taxes) > expenditure (government spending)= surplus which is contractionary

  
• Aggregate demand - the total planned spending on real output produced within the economy
• Aggregate demand= C+I+G+NX

  • C- consumption by households
  • I- investment by firms
  • G- Government spending by the government
  • Nx- net exports by foreigners
• Aggregate demand diagram

  • A fall in the price level causes an expansion in demand
  • A rise in the price level causes an contraction in demand

  
• Why is the demand curve sloping downwards

  • Higher prices lead to a fall in the value of real incomes so G and S become less affordable
  • High inflation means higher interest rates discourage spending and savings becomes more attractive

  
• Shifts in the Ad curve increase in demand

  • Consumers have more confidence so they spend more
  • Lower interest rates which means more borrowing and spending in the economy
  • Increase in government spending

  
• Shifts in the AD curve decrease in demand

  • Consumer confidence is low so don’t spend as much money
  • High interest rates so discourages borrowing and spending
  • Austerity a reduction in government spending

  
• Influences on consumer spending - makes up 60% of GDP

  • Interest rates- if interest rates are low cheaper to Borrow so spending and investment increase
  • Consumer confidence - if consumers fear unemployment may feel less confident about the economy thus spend less
  • level of Income
• Influences on investment

  • Rate of economic growth- if growth is high firms will be making more revenue. More profits available to invest
  • Business expectations and confidence- if firms expect a higher rate of return they will invest more. businesses May postpone investments
  • interest rates- as interest rates fall investment increases as the cost of borrowing is less and the return to lending is higher
  • Access to credit- if banks are unwilling to lend firms will find it harder to gain access to credit.
• The accelerator process:

  • The accelerator effect suggests that the level of investment in an economy is related to the change in GDP. A higher rate of economic growth causes more Investment.
  • If the rate of economic growth is slowing, but the economy is still growing the level of investment might fall.
  • The level of investment is more volatile than the rate of economic growth.
• The trade cycle - the stage of economic growth that the economy is in

  • Real output increases when there are periods of economic growth. This is the recovery stage
  • The boom is when economic growth is fast
  • During recessions real output falls and negative economic growth

  
• Aggregate supply- the level of a real national output that producers are prepared to supply at different average price levels
• Aggregate supply is determined by

  • Labour costs
  • The price of raw materials
  • Government regulation or intervention
• Causes of the shift right of the SRAS curve: (decrease in production costs)

  • Decrease in wages (not in the SR)
  • Increase in physical capital stock
  • Increase in technology
  • Increase in subsidies
  • Decrease in business taxes
  • Expectations that the price level will decrease

  1. Price Level: decrease

  2) GDP: increase

  3) Unemployment: decrease

  
• Causes of the shift left of the SRAS curve: (increase in production costs)

  • Increase in wages (not in the SR)
  • Decrease in physical capital stock
  • Decrease in technology
  • Decrease in subsidies
  • Increase in business taxes

  1. Price Level: increase

  2) GDP: decrease

  
  

  3) Unemployment: increase

  
• Long run aggregate supply curve

  • The long run aggregate supply curve (LRAS) shows the potential supply of an economy in the long run. This is when prices, and the costs and productivity of factor inputs, can change. Similarly to the PPF, it can show the economy’s productive potential.

  
• The factors which influence the level of economic activity are:

  • Employment: influences production and consumption
  • Confidence: influences the level of spending and investment
  • Events: natural disasters or Christmas influence the level of consumer spending
  • Other factors: such as taxes and interest rates influence how much firms and consumers borrow, save or spend.
• The multiplier effect refers to how an initial increase in AD leads to an even bigger increase in national income.

  • If an economy has a lot of spare capacity, extra output can be produced quickly and at little extra cost.
  • A small increase in AD will lead to a large increase in national income

  
• Marginal propensity to consume (MPC)

  • A consumer’s marginal propensity to consume is how much a consumer changes their spending following a change in income.
  • The higher the MPC, the bigger the size of the multiplier.
• Marginal propensity to save (MPS)

  • A consumer’s marginal propensity to save plus the marginal propensity to consume is equal to 1.
  • If consumers save more than they spend, the size of the multiplier will be small.
• Equation to calculate this

  • 1/MPS
  • 1/1-MPC
• Factors influencing LRAS either the quality or quantity

  • Technological advances
  • Changes in relative productivity
  • Changes in education and skills
  • Changes in government regulations
  • Demographic change and migration
  • Competition policy
• LRAS diagram

  • When short run and long run intersect this point is on the ppf
  • There no is output gap the output gap is zero
  • Full employment equilibrium

  
• Shift in the LRAS diagram

  • When long run aggregate supply is shifted to the left of the macroeconomic equilibrium this point is outside the ppf
  • The economy is at a state of supercharged
  • Creates a positive output gap where actual is greater than potential
  • Above full employment equilibrium

  
• Shifts in the LRAS diagram

  • When long run aggregate supply is shifted to the right of the macroeconomic equilibrium this point is within the ppf
  • This is not productively efficient and economy maybe in recession
  • A negative output gap is created where potential is greater than actual
  • Under full employment equilibrium

  
• Keynesian LRAS

  The Keynesian view suggests that the price level in the economy is fixed until

  resources are fully employed. The horizontal section shows the output and price level when resources are not fully employed; there is spare capacity in the economy. The vertical section is when resources are fully employed.