Flashcards · 9708 · A Level Topic 9

The macroeconomy (A Level) flashcards

26 cards on A Level Topic 9, subtopics 9.1 to 9.4. Pick a subtopic or study them all.

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9.1 The circular flow of income

Multiplier: definition and formula for an open economy with government: The ratio of the final change in national income to the initial change in injections (autonomous spending) that caused it. k = 1 ÷ (mps + mrt + mpm), the reciprocal of the marginal propensity to withdraw. Change in Y = k × change in autonomous spending.
mps = 0.10, mrt = 0.30, mpm = 0.20. Investment rises by 90. Find the multiplier and the change in national income.: mpw = 0.60, so k = 1 ÷ 0.60 = 1.67. Change in Y = 90 × 1.67 = 150.
Average versus marginal propensity to consume: apc = C ÷ Yd (one level of income); mpc = change in C ÷ change in Yd. apc + aps = 1 and mpc + mps = 1. The apc can fall while the mpc stays constant when autonomous consumption is positive.
Autonomous versus induced consumption in C = a + bY: Autonomous consumption (a) does not depend on current income. Induced consumption (bY) changes with income. A change in income is a movement along the function; a change in wealth, interest rates, credit or confidence shifts it. For C = 30 + 0.8Y, at Y = 250, C = 230 and S = 20.
The accelerator: v = 2.5 and output rises 400 → 420 → 450 → 460. Find net investment each year, and the key point.: Net investment = v × change in output: 50, 75, then 25. Output keeps rising, but investment falls once growth slows. The accelerator makes investment volatile and helps explain the business cycle.
AD = 100 + 0.8Y and full-employment income is 600. Find equilibrium income and the deflationary gap.: Equilibrium: Y = 100 + 0.8Y, so Y = 500. At Y = 600, AD = 580, so the deflationary gap is 20 (the shortfall of AD at full employment). Income is 100 below full employment because of the multiplier of 5.

9.2 Economic growth and sustainability

Actual growth versus potential growth: Actual growth: the percentage rise in real GDP (AD shifts right; movement towards the PPC). Potential growth: the percentage rise in productive capacity (LRAS shifts right; the PPC moves out).
Output gap: formula, and what positive and negative gaps mean: Output gap (%) = (actual − potential) ÷ potential × 100. Positive: actual above potential, overheating, inflation pressure, low unemployment. Negative: spare capacity, falling inflation, high unemployment. A negative gap does not mean negative growth.
Actual output 1,045, potential 1,100, multiplier 2.2. What injection closes the gap?: Gap = −55, or −5.0%. Output must rise by 55, so the injection = 55 ÷ 2.2 = 25.
Phases of the business cycle: Boom: fast growth, low unemployment, rising inflation, positive gap. Downturn: growth slows. Recession or trough: output falls to its lowest; high unemployment. Recovery: growth returns and the gap closes. Causes include confidence, credit, the accelerator, the multiplier and shocks.
Automatic stabilisers: Progressive income tax and unemployment-linked benefits change automatically with income: in a slump tax revenue falls and benefits rise, so disposable income falls less; in a boom the reverse. They reduce the size of the cycle without any policy decision.
Inclusive growth and sustainable growth: Inclusive growth: benefits shared widely, with opportunities open to poorer households, regions and groups. Sustainable growth: meets today's needs while leaving future generations able to meet theirs. Natural capital losses are not shown in GDP.
GDP rises 2% while emissions per unit of GDP fall 5%. What happens to total emissions? And if intensity falls only 1%?: Emissions change = 1.02 × 0.95 − 1 = −3.1%, a fall. With intensity −1%: 1.02 × 0.99 − 1 = +1.0%, a rise. A slower growth rate of emissions is not a fall in emissions.

9.3 Employment/unemployment

Full employment: All those prepared and able to work at the prevailing wage can obtain a job; some frictional and structural unemployment remains. It is not zero unemployment.
Equilibrium versus disequilibrium unemployment: Equilibrium unemployment exists when the labour market clears at the equilibrium wage (frictional, structural, voluntary). Disequilibrium unemployment: labour supplied exceeds labour demanded at the going wage (real-wage or demand-deficient).
Natural rate of unemployment, and how to find cyclical unemployment: The natural rate is the unemployment remaining once the labour market has cleared: frictional, structural and voluntary. Cyclical = actual − natural. Labour force 40 m, actual 8.0%, natural 5.5%: 3.2 m − 2.2 m = 1.0 m cyclical.
Hysteresis: Unemployment that persists after its cause ends, because the equilibrium rate itself has risen: long spells out of work erode skills and contacts, and employers screen out long gaps, so unemployment stays high when demand recovers.
Geographical versus occupational mobility of labour, with causes of immobility: Geographical: ability and willingness to move area for work (limited by housing costs, moving costs, family ties, information). Occupational: ability and willingness to change type of job (limited by training cost and time, non-transferable skills, licences).
Which policy suits each type of unemployment?: Cyclical: fiscal or monetary expansion. Structural: training, wage subsidies, lower employer taxes. Frictional: job-matching and information. Geographical: relocation help, regional policy. Raising AD to push unemployment below the natural rate only works temporarily; it causes inflation.

9.4 Money and banking

Money: definition and four functions: Anything generally accepted as payment for goods and services and for settling debt. Functions: medium of exchange, store of value, unit of account and standard of deferred payment.
Quantity theory: MV = PT. M = 400, V = 6, T = 1,200. Find P, then P if M rises to 460.: P = MV ÷ T = 2,400 ÷ 1,200 = 2.00. With M = 460: P = 2,760 ÷ 1,200 = 2.30, a 15% rise, equal to the rise in M. This needs V and T constant, which can be challenged.
Bank credit multiplier: a new deposit of 800 enters a system with an 8% reserve ratio. Find total deposits and credit created.: Multiplier = 1 ÷ reserve ratio = 12.5. Maximum deposits = 800 × 12.5 = 10,000, so credit created = 9,200. The real effect is smaller: people hold cash, banks hold excess reserves, and borrowers may not want loans.
The three objectives of a commercial bank and the conflict between them: Liquidity (can meet withdrawals), security (loans are repaid) and profitability. The most profitable loans are the least liquid and riskiest, so banks must balance the three.
Quantitative easing (QE): The central bank creates reserves and buys assets, mostly government bonds, to raise the money supply and lending when policy rates are already very low. Bond prices rise, yields fall (a bond paying 4: 5% at a price of 80, 4% at 100). Weak if banks hoard reserves or loan demand is low.
Liquidity preference: the three motives for holding money: Transactions and precautionary motives depend on income (not interest-sensitive in the basic model). The speculative motive depends negatively on the interest rate, so L slopes down. In a liquidity trap L is horizontal at a very low rate.
Keynesian versus loanable funds theory of the interest rate: Keynesian: the rate is set where liquidity preference (L) meets a vertical money supply; more money lowers the rate. Loanable funds: the rate is set where demand for funds meets the supply of saving; bigger government borrowing raises the rate and can crowd out private investment.