Circular flow of income
The ciruclar flow of income shows the flow of money from economic activity between households and firms. Households earn income by hiring out their factor services to firms. Workers receive wages or salaries; lending out capital earns interest; entreprene
Price level
The price level is the average of the prices of a group of defined products. It is reported as an index value. The level of economic activity in an economy in a given time period is measured using GDP. The value of GDP can go up either because more produc
Measuring nominal and real GDP
GDP is a monetary measure (� billions) of total output within a country's borders in a given time period. Current prices: The prices operating in the year GDP was produced. Constant prices: The prices operating in a base year. A base year is the benchmark
Aggregate Demand
Aggregate Demand (AD) is the total planned spending on domestic output at a given price level, in a given time period, usually one year. components of Aggregate demand: Consumption (C): Domestic household spending on consumer products. Investment (I): exp
Consumption
Consumption (C) is domestic household spending on products. Factors affecting level of consumption: Real disposable income, it is the main determinant on the level of consumption, an increase in disposable income increases consumption. The average propens
Saving
Saving is a decision to postpone consumption. For households, savings is that part of disposable income which is not spent. Average propensity to save (aps) is the proportion of disposable income which is saved. Factors influencing level of savings: Savin
Investment
investment (I) is spending by domestic firms on capital goods. Firms invest if they can make a profit from their investment. Factors that influence investment spending: Real disposable income, households use extra income to increase consumption which enco
Government
Factors likely to influence government spending: The governments view on the effectiveness of state intervention to correct market failure. The economic recession starting in 2009 have seen a significant increase in government spending in an effort to boo
Net exports
Imports (M) is spending by domestic residents on products made overseas. Exports (X) is spending by overseas residents on domestically made products. Net exports (X-M) is the difference between a countrys exports earnings and its total spending on imports
Aggregate demand curve
An aggregate demand curve shows total planned spending on domestic output at different price levels, over a given time period. The quantity of goods and services that all households, firms, the government and the international sector want to buy at any pr
changes in aggregate demand and the multiplier
A change in aggregate demand can be brought about by: A change in the price level causing a movement along the AD curve. A change in a component of AD causing a shift in the aggregate demand curve. The multiplier effect is the process by which a change in
Aggregate supply
Aggregate supply (AS) is total planned output by all domestic producers at a given price level. Increasing the level of total planned output requires producers in an economy to use more land, labour and captial. For example firms raise production by hirin
productive capacity
Potential GDP: Potential GDP is the highest level of output (real GDP) a country can produce with current resources that delivers both full employment and stable inflation. Potential GDP is determined by the quantity and quality of resources available to
Actual and potential GDP: output gaps
Potential output is the highest level of real GDP a country can produce that delivers both full employment and stable inflation. Actual GDP is the level of real GDP produced by a country in, say one year. Potential and actual GDP can diverge. An output ga
Economic shocks
Economic shocks are unanticipated events that affect aggregate demand or supply. They cause a shift in aggregate supply or demand curve. External shocks are an unexpected event that takes place outside the UK, but affects the UK economy, e.g. US recession
Changes in aggregate demand
Changes in AD and AS move the economy to a new level of macroeconomic equilibrium which changes the amount of income households earn and spend, the amount of output produced by firms, the number of workers employed or unemployed and the price level hence
Changes in aggregate supply
The impact of a change in aggregate supply depends on: The level of aggregate demand, the magnitude of the change in aggregate supply
Government macroeconomic policy.
The government is responsible for managing the economy. Government action can affect key economic variables such as the level of output, unemployment, and inflation and has a large influence on economic performance (how well a country is using its scarce
Government macroeconomic policy. cont
informal economy: undeclared economic activity means: Economic data becomes unreliable (underestimated). The government receives less tax revenue and is less able to fund public services. Lower productivity as firms operating in the informal economy stay
Macroeconomic policy objectives
A policy is a course of action. An objective is a desired outcome. Government policies are measures taken by the state to achieve the stated aim such as low inflation or high economic growth. The government selects those measures oct likely to deliver dat
Inflation
Inflation is a sustained rise in the price level over time. The rate of inflation is the percentage increase in the price level over a given period of time, usually one year. Purchasing power is the amount of products a unit of currency, e.g. one pound, c
Inflation: cont.
High, unstable, accelerating and unanticipated inflation over several years imposes far higher economic costs than short lived, low, stable, declining and anticipated inflation. Particularly when the inflation rate is in excess of rivals. Cost push inflat
Income Distribution
Income distribution is the extent to which national income is shared out between households. To improve access to essentials and correct inequality the state intervenes and redistributes income by using taxes collected from the rich to pay benefits to the
Unemployment
The working age population refers to men aged 16 to 64 and women aged 16 to 59. The labour force is the total number of people employed and those registered as unemployed. unemployment is a situation when people who are willing and able to work are unable
Economic growth
Economic growth is an increase in real GDP. The annual growth rate is found by: (current real GDP - last years real GDP) / last years real GDP x 100. Economic growth occurs when there is an increase in real GDP and/or an increase in productive capacity. R
Economic stability
Economic stability is the absence of large fluctuations in the macro economy. An unstable economy has large swings in economic activity, high inflation, and excessive volatility in exchange rates and financial markets. A stable economy improves confidence
Balance of payments:
The balance of payments records economic transactions between residents of a country and the rest of the world. There are two sections: Current account records money flows between UK & Overseas residents arising demo trade in goods and services, income fr
components of current account
Balance of trade in goods (visible trade) the difference between exports and imports of tangible products, e.g. oil, manufacturers and components between UK residents and non-residents. Balance of trade in services (invisible trade) the difference between
Exchange rates
An exchange rate is the price of one currency in terms of another currency or currencies. A effective exchange rate is an index value based on a basket of currencies of the UK's main trading partners, weighted according to the importance of each one to a
Main factors influencing the supply and demand of a currency.
International competitiveness in terms of price and quality of UK products compared with overseas made alternatives. A fall in the price, or improvement in the quality, of UK made products increases their competitiveness. UK consumers switch away from imp
Depreciation of the pound affect import and export revenues.
Usually a sterling depreciation reduces the price of UK exports while increasing the price of UK imports. However this assumes: Importers pass on increased costs in the form of higher prices. They may opt to absorb higher import prices by cutting their pr
Macroeconomic policy
major macroeconomic policy objectives: low and stable inflation, low unemployment, high and sustainable economic growth, a satisfactory balance of payments, economic stability, an acceptable distribution of income. There are two main types of macro policy
Taxation and government spending
Governments raise taxes to: Finance public expenditure e.g. education, health and defence. Finance transfer payments e.g. unemployment benefit. Discourage purchases of harmful demerit goods such as alcohol and cigarettes. Influence the level of aggregate
Government budgets
The budget position is the relationship between government spending and tax revenues. There are three potential positions: Balanced budget: government revenue equals government expenditure i.e. G=T. Budget surplus: government revenue is greater than gover
Fiscal policy
neutral fiscal policy aims to have no impact on the future levels of aggregate demand. Reflationary fiscal policy aims to increase the future level of AD. Deflationary fiscal policy aims to lower the future level of AD.
Fiscal policy influence on unemployment:
Cyclical unemployment is caused by a lack of Aggregate demand, the government can use fiscal policy to boost aggregate demand causing firms to hire unemployed workers to increase output: Higher government spending means more workers are required, e.g. to
fiscal policy affect economic growth
Sustained economic growth requires an increase in long run aggregate supply. Specific types of spending and tax cuts can boost growth: Increased government spending on education and training increases productivity. Income tax cuts increase the reward of w
fiscal policy improve Balance of payments
A current account deficit can be reduced or even eliminated if government action reduced domestic spending on imports while increasing exports. Two fiscal measures can be taken: Expenditure reducing policies lowers domestic Aggregate demand hence the dema
factors that limit effectiveness of fiscal policy
Demand management using fiscal policy needs the right amount of G-T at the right time lags. This has proved problematic in practice: Inaccurate economic data, governments take action on the basis of economic data, e.g. if the ONS announces a recession, th
Monetary policy
Monetary policy is the use of the money supply, credit, and interest rates to influence the level of AD. An interest rate is the price of money, the cost of borrowing and the reward for lending and saving. The impact of interest rate change depends on the
How effective is monetary policy?
Most nations now use monetary policy as the main means of influencing the level of AD to achieve macro objective. Interest rates are: -Highly flexible -Have a faster impact on AD than fiscal policy measures - Blunt instrument, e.g. higher interest rates t
Supply side policy
Supply side policies are measures designed to increase potential output. Supply side refers to economic agents involved in production. Successful supply side policy increases potential GDP and so shifts the LRAS curve to the right, given matching increase
Why do government regulate firms:
Unregulated production can endanger workers and generate negative externalities e.g. pollution. Monopolies can exploit their market power, firms incur higher costs in ensuring government laws, rules and regulations are observed. Deregulation occurs when g
Can tax cuts increase productive capacity?
-Cutting income tax rates encourages the economically inactive to join the labour force and the unemployed to take jobs, workers are more willing to undertake overtime. -Workers may have target income and use higher disposable incomes brought about by tax
trade unions
Trade unions may use their labour market power to: -force wages above their equilibrium. -resist new working practices that improve productivity or insist on over manning. Trade unions can increase productive potential. - Firms that are unable to hire are
How effective is supply side policy?
-Time lags, it can take years for education and training to generate higher productivity. -Unexpected responses, e.g. companies may use corporation tax cuts to raise dividends, not investment, workers may use tax cuts to work less hours and maintain the s
reducing unemployment
Government can opt for policy instruments designed to tackle the causes of unemployment, potential measures include: -Fictional unemployment arises through norma labour turnover and the resultant delays in applying for interviewing and accepting jobs. Job
Controlling inflation
The policies adopted depend upon the cause of price instability, potential measures include: -cost push inflation, requires government action to lower costs, for example the state can restrict wage increases, cap council tax increases, or encourage an app
Achieving satisfactory Balance of payments
Policies focus on the cause of balance of payments disequilibrium, with respect to current account imbalances. Policy measures to export earnings and reduce import expenditure include: -deflationary demand management to lower spending on imports. -import