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Macroeconomics flashcards

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1 Aggregate demand and aggregate supply

The three methods of measuring national income: Output: sum of value added by every sector. Income: sum of factor incomes (wages, rent, interest, profit). Expenditure: C + I + G + (X − M) on final goods and services.
APC vs MPC: APC = C ÷ Yd (consumption out of all disposable income). MPC = ΔC ÷ ΔYd (out of extra income). APC + APS = 1 and MPC + MPS = 1.
Multiplier vs accelerator: Multiplier: links a change in spending to a larger change in income (k = 1 ÷ MPW). Accelerator: links a change in income to net investment (net investment = v × ΔY).
MPS 0.1, MRT 0.2, MPM 0.2. An injection of 30bn. Shift of AD?: MPW = 0.5, so k = 2. AD shifts by 2 × 30 = 60bn. The rise in real GDP is smaller if prices rise.
SRAS vs LRAS (OCR definitions): SRAS: aggregate supply when some costs, especially nominal wages, are fixed; slopes upwards. LRAS: productive capacity once costs and prices have adjusted; depends on factors and technology.
Macroeconomic equilibrium vs long-run equilibrium: Macroeconomic equilibrium: where AD equals SRAS. Long-run equilibrium: AD, SRAS and LRAS meet at one point.
Output gap and the economic cycle: Economic cycle: repeated fluctuation of real GDP around its long-run trend. Output gap = (actual − potential) ÷ potential × 100. Negative: spare capacity. Positive: overstretched resources.
Short-run vs long-run Phillips curve: SRPC: an inverse relationship between unemployment and inflation for a given expected inflation rate. LRPC: vertical at the natural rate of unemployment: no lasting trade-off.
Natural rate of unemployment vs NAIRU: Natural rate: unemployment left when the labour market clears (frictional plus structural). NAIRU: the rate at which inflation is stable. Often similar in value, but different ideas.
Inflation = expected + 0.6 × (5 − U), adaptive expectations, starting at 3%. U is held at 3.5%. Inflation in years 1 to 3?: Each year adds 0.6 × 1.5 = 0.9 points: 3.9%, 4.8%, 5.7%. Returning U to 5% leaves inflation at 5.7%: no lasting gain in jobs.
Keynesian vs classical (monetarist) view of the macroeconomy: Keynesian: the economy can stay below full employment; wages and prices are sticky, so demand management matters. Classical/monetarist: markets clear in the long run; LRAS is vertical, so demand policy affects only prices in the long run.
Stagflation and a cost-push shock: Cost-push shock: a rise in costs that shifts SRAS left. Stagflation: falling output (or slow growth) together with rising prices.

2 Economic policy objectives

Primary, secondary and tertiary sectors: Primary: extracting or harvesting natural resources. Secondary: making goods from materials (manufacturing, construction). Tertiary: services.
Nominal GDP 2,200 (index 100) then 2,310 (index 104). Real growth?: Real GDP in year 2 = 2,310 ÷ 104 × 100 = 2,221.15. Real growth = 21.15 ÷ 2,200 = 0.96%, although nominal growth was 5.0%.
Sustained vs sustainable growth: Sustained: growth that continues over a long period without being cut short by instability. Sustainable: growth that does not damage the environment or deplete resources future generations need.
Real growth of 1.5%, 2.0% and −0.5% in three years. Cumulative growth?: Multiply, do not add: 1.015 × 1.02 × 0.995 = 1.0301, so 3.01%.
Population 16+ 30.0m, employed 19.2m, unemployed 0.8m. Unemployment rate and inactivity rate?: Labour force = 20.0m, so unemployment = 0.8 ÷ 20.0 = 4.0%. Inactive = 10.0m, so inactivity = 10.0 ÷ 30.0 = 33.3%.
Hysteresis: A spell of unemployment raises later unemployment, because skills fade and employers screen out the long-term jobless.
Disinflation vs deflation: Inflation falls from 6% to 2%: disinflation; the price level still rises. Inflation of −1%: deflation; the price level falls.
CPI vs RPI: They use different averaging methods, treat housing costs differently (RPI includes mortgage interest payments) and cover slightly different households, so the two give different inflation rates.
Why aim for low and stable inflation rather than zero?: A little inflation lets real wages adjust without cutting money pay and keeps the economy away from the risks of deflation.
HDI, GPI and the Easterlin paradox: HDI: the cube root of health × education × income indices. GPI: consumption adjusted for inequality, plus unpaid work, minus pollution, depletion and crime costs. Easterlin: richer people are happier at a point in time, but average happiness rises little as a country grows.
Lorenz curve and Gini coefficient: Lorenz curve: cumulative % of income or wealth against cumulative % of households, poorest first. Gini: area between the diagonal and the curve ÷ area under the diagonal; 0 equal, 1 one household owns all.
Inequality vs poverty, and absolute vs relative poverty: Inequality is about gaps between shares; poverty is about falling below a line. Absolute: below a fixed real level for basic needs. Relative: well below a typical level, such as under 60% of median income.

3 Implementing policy

Average vs marginal tax rate: Average: tax over total income. Marginal: the rate on the extra income. In a progressive system, the marginal rate exceeds the average rate.
Progressive vs regressive tax: how to test: Look at the average rate, not the amount paid. Progressive: the average rate rises with income. Regressive: it falls. Proportional: it stays the same.
Direct vs indirect tax: Direct: on income, profit and wealth. Indirect: on spending. The legal payer of an indirect tax is the seller, but the burden may fall on the buyer.
Current vs capital spending, and overall vs current budget: Capital spending buys lasting assets; current spending covers running costs (debt interest is current). The overall budget balance includes capital spending; the current balance does not.
Budget position vs fiscal stance: Position is the balance (surplus, deficit or balanced). Stance is the direction policy pushes demand: expansionary, contractionary or neutral.
Cyclical vs structural budget balance: Cyclical: changes with the economic cycle without any new decision. Structural: what would remain with the economy at trend; it needs a policy change or lasting economic change.
Budget deficit, national debt and the debt-to-GDP ratio: Deficit: spending exceeds revenue this year (a flow). Debt: the stock owed on one date. Debt can rise in money terms while the debt-to-GDP ratio falls, if GDP grows fast enough.
Monetary policy instruments: The policy interest rate (which commercial rates follow), the money supply, quantitative easing and the exchange rate, used to influence AD and meet the inflation target.
Liquidity trap: Interest rates so low that further cuts fail to raise spending, as people hold cash. One reason for using quantitative easing.
Tax 30% and benefits lost at 45% of net pay. Effective marginal rate on an extra 100?: Net after tax = 70. Benefit lost = 0.45 × 70 = 31.5. Kept = 38.5, so the effective marginal rate is 61.5%.
Market-based vs interventionist supply-side policies: Market-based: deregulation, tax cuts, privatisation, labour market flexibility. Interventionist: state-funded training and education, infrastructure, subsidies for R&D (justified by spillovers). Both aim to shift LRAS right.
Adaptive vs rational expectations, and why credibility matters: Adaptive: forecasts based on past outcomes. Rational: forecasts use all available information. Under rational expectations a credible announcement can change behaviour quickly, lowering the cost of reducing inflation.

4 The global context

Globalisation (OCR): The process by which economies become more closely linked and more dependent on each other as goods, services, capital, people, technology and ideas cross borders. Free trade is one policy and one channel, not the whole process.
Absolute vs comparative advantage: Absolute: fewer resources per unit, or more output from the same resources. Comparative: giving up less of other goods to make a good (lower opportunity cost).
Heckscher-Ohlin theory: Countries export goods that use their abundant factor intensively and import the others. Weakness: it ignores technology, skills and economies of scale, and cannot explain much trade between similar countries.
Export price index 108, import price index 96. Terms of trade?: 108 ÷ 96 × 100 = 112.5, an improvement of 12.5%: each unit of exports buys more imports.
Export prices rise 8% and PED for exports is −2. What happens to export revenue?: Volume falls 16%, so revenue = 1.08 × 0.84 = 0.9072 of its old level, a fall of 9.3%. An improvement in the terms of trade can cut revenue when demand is elastic.
When does a tariff protect effectively? Two points to weigh: Size: a large importer can pass part of the tariff to exporters; a small one cannot. Time: temporary and declining protection beats permanent.
Tariffs on components, and the prohibitive tariff: Tariffs on inputs raise domestic costs. A prohibitive tariff cancels all imports, so its revenue is zero.
Free trade area, customs union, monetary union, economic union: FTA: no barriers between members, own external tariffs. Customs union: plus a common external tariff. Monetary union: plus a single currency and central bank. Economic union: plus a single market and common policies.
Trade creation vs trade diversion: Creation: dearer home output replaced by cheaper partner imports. Diversion: imports switched from a cheaper outsider to a dearer partner.
WTO: most-favoured-nation rule and bound tariffs: MFN: a concession given to one WTO member must be given to all. Bound tariff: a ceiling above which a member has promised not to raise a tariff.
Balance of payments: the four accounts and the identity: Current (goods, services, income, current transfers), capital, financial (direct, portfolio, other investment, reserves), and errors and omissions. They sum to zero.
Effective (trade-weighted) vs bilateral exchange rate; nominal vs real: Bilateral: between two currencies. Effective: an index against many partners weighted by trade. Real exchange rate: the nominal rate adjusted for relative price levels.
Purchasing power parity: absolute and relative: Absolute PPP: the exchange rate equals the ratio of the two price levels, so money buys the same basket everywhere. Relative PPP: the rate changes by the gap between the two inflation rates.
Marshall-Lerner condition and J-curve: Marshall-Lerner: a depreciation improves the trade balance only if PEDx + PEDm > 1 (positive values). J-curve: the balance worsens after a depreciation, then improves, because short-run elasticities are low.

5 The financial sector

Financial intermediary and the role of the financial sector: An institution linking savers with borrowers. The sector facilitates saving, lends to businesses and households, provides markets for equities and bonds, and facilitates payments.
Retail, commercial and investment banks: Retail: serves households and small firms. Commercial: lends to and takes deposits from businesses. Investment: issues and trades securities and advises large clients.
Coupon vs yield on a bond: The coupon is the fixed annual payment. Yield = annual payment ÷ price × 100, the return at the current price. Price and yield move in opposite directions.
Reserve ratio 10%, new deposit 100. Maximum total deposits and credit created?: Credit multiplier = 1 ÷ 0.10 = 10. Maximum deposits = 100 ÷ 0.10 = 1,000. Credit created = 1,000 − 100 = 900. A cash drain makes it smaller.
Fisher equation of exchange: MV = PT: money supply × velocity of circulation = price level × transactions. With V and T stable, a rise in M raises P in proportion (the quantity theory).
Lender of last resort: The central bank lends to solvent but illiquid banks against collateral, to stop a run spreading. It risks moral hazard: protection from loss encourages more risk.
Solvent vs illiquid: Solvent: assets exceed liabilities. Illiquid: cannot meet immediate demands for cash, even if solvent.
Capital ratio vs leverage ratio: Capital ratio: capital ÷ risk-weighted assets. Leverage ratio: capital ÷ total assets, so it cannot be gamed by low risk weights.
Microprudential vs macroprudential regulation: Microprudential: the health of each individual firm. Macroprudential: risks across the whole financial system (systemic risk).
IMF vs World Bank: IMF: macroeconomic stability, surveillance and short-term balance of payments lending, often with conditionality. World Bank: longer-term project and development finance.
Savings gap and microfinance in developing economies: Savings gap: the investment needed for a target growth rate minus domestic saving. Microfinance: small loans, savings and insurance for poor people and tiny firms excluded from formal finance.