Flashcards · 7135 · Topic 3.2

The national economy in a global context flashcards

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3.2.1 The measurement of macroeconomic performance

The four main macroeconomic objectives: Economic growth, price stability (low and stable inflation), minimising unemployment, and a stable balance of payments on current account. Others: balancing the budget and a more equitable income distribution.
Why can governments rarely achieve all four objectives at once?: Policies affect several objectives. Raising AD for growth and jobs can raise imports (worse current account) and, near capacity, cause demand-pull inflation.
Match each indicator to its objective: Real GDP and real GDP per capita: growth. CPI and RPI: price stability. Unemployment measures: unemployment. Current account balance: external balance. Productivity: efficiency.
A price index rises from 100 to 108. What does that mean?: Prices have risen by 8% relative to the base year. An index number is relative, not an absolute value.
Features of a price index such as CPI: A base year set to 100, a basket of goods and services bought by a typical household, and weights reflecting each item's share of spending.
An index goes from 104.0 to 106.6. Inflation rate?: (106.6 − 104.0) ÷ 104.0 × 100 = 2.5%.
Real GDP vs nominal GDP: Real GDP is adjusted for inflation (constant prices); nominal GDP is at current prices. Growth is measured by the change in real GDP.
The balance of payments on current account: A record of trade in goods and services plus income flows (primary and secondary income) with the rest of the world.

3.2.2 How the macroeconomy works: the circular flow of income, aggregate demand/aggregate supply analysis, and related concepts

Injections and withdrawals in the circular flow: Injections: investment, government spending, exports. Withdrawals: saving, taxation, imports.
Equilibrium national income (circular flow): Planned injections equal planned withdrawals, so the flow is steady and income is not changing.
Full employment income: Income when every available resource is in use. Equilibrium can settle below it (spare capacity). Spending that pushes demand beyond it cannot raise real output further, so it puts pressure on prices.
Aggregate demand and its components: Planned spending on the economy's output at each price level. AD = C + I + G + (X − M).
Determinants of consumption and investment: Consumption: income, interest rates, wealth, confidence, credit. Investment: expected demand, interest rates, business confidence, technology, finance.
The multiplier process: An injection becomes someone's income; part is spent and becomes further income, part leaks out in saving, tax and imports. The final rise in national income is a multiple of the injection. More leakage means a smaller multiplier.
MPC is 0.75 (no tax or trade). Investment rises by 20bn. Final change in income?: Multiplier = 1 ÷ (1 − 0.75) = 4. Income rises by 4 × 20 = 80bn, if there is spare capacity.
What shifts SRAS?: Changes in costs of production: wage rates, raw material and energy prices, import prices (the exchange rate), indirect taxes and productivity.
What shifts LRAS?: Changes in the quantity or quality of resources: technology, education and skills, investment in capital, labour force size, and institutions.
Keynesian AS curve: Flat when there is a lot of spare capacity, rising as bottlenecks appear, vertical at full capacity. So the effect of a rise in AD on real output depends on spare capacity.
Diagram: a supply-side shock such as a rise in oil prices: SRAS shifts left (up). The price level rises and real output falls along the existing AD curve.

3.2.3 Economic performance

Short-run vs long-run economic growth: Short run: rising actual output, usually from higher AD using spare capacity. Long run: rising productive capacity (LRAS shifting right); the trend rate.
Output gap: actual 585, potential 600: (585 − 600) ÷ 600 × 100 = −2.5%, a negative output gap: spare capacity and cyclical unemployment.
The economic cycle: Fluctuations of actual output around the trend: boom, downturn, recession, recovery. Caused by demand-side and supply-side shocks.
ILO (LFS) measure vs claimant count: LFS: a survey using the ILO test: no job, available to start within two weeks, looked for work in the last four weeks. Claimant count: people claiming an unemployment-related benefit.
Frictional, structural and cyclical unemployment: Frictional: between jobs, searching. Structural: skills or location do not match vacancies. Cyclical: too little aggregate demand.
Unemployment rate: Unemployed ÷ labour force × 100, where the labour force is employed plus unemployed. Never divide by the whole population.
Demand-pull vs cost-push inflation: Demand-pull: AD shifts right; price level and real output rise. Cost-push: SRAS shifts left; price level rises while real output falls.
Deflation vs disinflation: Deflation: the price level is falling. Disinflation: the rate of inflation is falling but prices are still rising.
Who gains and loses from inflation?: Lose: savers when interest is below inflation, people on fixed incomes, workers whose pay lags. Gain: borrowers with fixed debts. Firms face menu costs and uncertainty.
Conflict: growth vs the current account: Rising incomes raise spending on imports; if imports grow faster than exports, the current account worsens.
Conflict: low unemployment vs price stability: Raising AD to cut unemployment can cause demand-pull inflation once the economy nears full capacity.

3.2.4 Macroeconomic policy

Monetary policy and the MPC: Central bank action on interest rates, money supply and credit. The Bank of England's Monetary Policy Committee sets Bank Rate to meet the government's 2% CPI inflation target.
What happens to AD when Bank Rate rises?: Market rates rise; borrowing is dearer and saving more rewarding, so C and I fall; the pound tends to appreciate, cutting net exports. AD falls, easing inflation after a lag.
Quantitative easing: The central bank creates electronic reserves to buy assets, mainly government bonds, lowering long-term interest rates to raise spending.
Real interest rate: The nominal rate adjusted for inflation: roughly nominal rate − inflation. A 4% rate with 5% inflation is a negative real rate, so savers lose.
Fiscal policy: Changes in government spending, taxation and the budget balance, used to influence AD (macro) and particular markets or groups (micro).
Direct vs indirect tax, and progressive tax: Direct: on income, profit or wealth. Indirect: on spending. Progressive: the average tax rate rises as income rises.
Budget deficit vs national debt: Deficit: spending greater than revenue in a period (a flow). National debt: everything the government owes on one date (a stock). A deficit adds to the debt.
Supply-side policies: Government measures to raise productive capacity and efficiency, shifting LRAS right: education and training, tax reform to improve incentives, deregulation, privatisation, labour market reform, infrastructure.
Supply-side vs demand-side policies: Demand-side (fiscal and monetary) policies shift AD and work faster. Supply-side policies shift LRAS, can lower inflation and unemployment together, but take years.
Free-market vs interventionist supply-side policies: Free-market: remove obstacles and strengthen incentives (tax cuts, deregulation, privatisation). Interventionist: government acts directly (education, training, infrastructure).