econ - macro y1

• Economic growth


  The annual percentage change in Real National Output (RNO)

  OR Gross Domestic Product (GDP)
• Unemployment


  • Indicator of people in the economy that don't have jobs
  • Objective is for unemployment to be low (full employment)
• Inflation


  • Indicator of the rate of growth of prices in an economy
  • Objective is for inflation to be low and stable (e.g. 2% target in UK)
• Trade


  • Indicator of the value of imports of goods and services compared to the value of exports
  • Objective is for balanced trade (exports = imports)
• Distribution of income


  • Indicator of how incomes are distributed across households
  • Objective is for a fair distribution of income (normative consideration)
• Circular flow of income

  A very useful way of modeling the economy
• Fundamental economic agents

  • Households
  • Firms/Businesses
• Circular flow of income

  1. Households provide factors of production (land, labor, capital, enterprise) to firms

  2. Firms combine factors of production to make goods and services

  3. Households receive factor incomes from firms

  4. Households spend factor incomes on goods and services made by firms
• Leakages from the circular flow

  • Savings (S)
  • Taxes (T)
  • Imports (M)
• Injections into the circular flow

  • Investment (I)
  • Government spending (G)
  • Exports (X)
• If injections are greater than leakages

  Economic growth is rising
• If injections are less than leakages

  Economic growth is decreasing
• If injections and leakages are equal

  Economic growth is in macroeconomic equilibrium
• GDP (Gross Domestic Product)


  Our measure of economic growth
• Methods to calculate GDP

  • Output method (final value of all goods and services produced)
  • Income method (sum of all factor incomes)
  • Expenditure method (total expenditure on goods and services)
• Aggregate demand

  The total demand for a country's goods and services at a given price level in a given time period
• Aggregate demand equation

  Aggregate demand = Consumer spending (C) + Investment spending by firms (I) + Government spending (G) + Net export spending (X - M)
• Aggregate demand is a measure of total expenditure on a country's goods and services
• The aggregate demand curve is downward sloping
• Aggregate demand curve

  • Price level on y-axis
  • Real GDP on x-axis
• When the price level falls

  Aggregate demand increases (extends)
• When the price level rises

  Aggregate demand decreases (contracts)
• Wealth effect

  As the price level decreases, the purchasing power of income increases in real terms, so people are richer and more likely to spend, increasing consumption and aggregate demand
• Trade effect

  As the price level decreases, exports become more competitive and imports become less competitive, increasing net exports and aggregate demand
• Interest effect

  As the price level decreases, interest rates can be kept lower, stimulating higher consumption and investment, and reducing the exchange rate, boosting net exports, increasing aggregate demand
• The aggregate demand curve shifts when there is an increase or decrease in C, I, G, or (X-M), independent of changes in the price level
• Consumption


  The total spending by households on goods and services in the economy
• In the UK and USA, consumption is a massively important part of aggregate demand, accounting for around 66% of aggregate demand
• Aggregate demand equation

  AD = C + I + G + X - M
• Marginal propensity to consume


  The willingness of a household to spend any extra income that they earn
• The multiplier effect should be mentioned anytime a factor shifts aggregate demand
• Real disposable income


  Income left after taxes and national insurance have been paid, adjusted for inflation
• Cuts in income tax or increases in tax-free allowance

  Increase real disposable income, increasing the marginal propensity to consume and consumption
• Interest rates are cut

  Cost of borrowing falls, incentive to borrow and spend increases, rate of return on saving falls, reducing incentive to save, increasing consumption
• Households have variable rate or tracker mortgages

  Interest rate cuts lead to lower monthly mortgage repayments, increasing disposable income and consumption
• Availability of credit


  If low, can reduce the impact of lower interest rates on consumption
• Consumer confidence


  Linked to job prospects and unemployment level - higher confidence leads to higher marginal propensity to consume
• Asset prices (house prices, share prices, bond prices) increase


  Individuals feel wealthier, increasing their marginal propensity to consume
• Household indebtedness is high

  Individuals are more likely to save rather than spend, reducing consumption
• Other factors that can affect consumption include the age structure of the population