Flashcards · 9640 · AS Topic 2

The national economy in a global environment (AS Level) flashcards

38 cards on AS Topic 2, subtopics 3.2.1 to 3.2.4. Pick a subtopic or study them all.

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3.2.1 The measurement of macroeconomic performance

The four core macroeconomic objectives of government: Economic growth, price stability, minimising unemployment, and a stable balance of payments on current account.
Three further macroeconomic objectives named in the 9640 specification: Balancing the government budget, an equitable distribution of income and wealth, and protecting the environment.
Match each objective to an indicator: growth, price stability, unemployment, external balance, equity: Growth: real GDP (and real GDP per capita). Price stability: consumer price index. Unemployment: unemployment rate. External balance: current account of the balance of payments. Equity: Gini coefficient.
Gini coefficient: A summary measure of income or wealth inequality on a scale from 0 (perfect equality) to 1 (perfect inequality).
Nominal versus real data: Nominal: measured in the prices of the period recorded. Real: adjusted to remove the effect of inflation, so genuine changes over time can be compared.
Index number: formula and example. A basket costs 120 in the base year and 138 three years later.: Index = value in given year ÷ value in base year × 100. 138 ÷ 120 × 100 = 115: prices have risen 15% since the base year (base year = 100). Weights give components with a larger share more influence.
Give an example of a conflict between macroeconomic objectives: Cutting interest rates to raise growth and cut unemployment raises spending, which can push demand-pull inflation above target; a weaker currency also raises import prices. Growth and jobs are traded against price stability.

3.2.2 How the macroeconomy works

Injections and withdrawals in the circular flow of income: Injections: investment, government spending, exports. Withdrawals: saving, taxes, imports. Equilibrium income is where injections equal withdrawals.
Aggregate demand: Total planned spending on a country's output at each price level. AD = C + I + G + (X − M).
MPC and MPS, with an example: disposable income rises from 300 to 340 and consumption from 250 to 280: MPC = ΔC ÷ ΔYd = 30 ÷ 40 = 0.75. MPS = ΔS ÷ ΔYd = 10 ÷ 40 = 0.25. MPC + MPS = 1.
The multiplier: formulas and an example with MPS 0.04, MPT 0.16, MPM 0.30 and an injection of 25: k = 1 ÷ MPW, where MPW = MPS + MPT + MPM (or 1 ÷ (1 − MPC)). MPW = 0.50, so k = 2. Income rises by 25 × 2 = 50.
Why might the real effect of an injection be smaller than the multiplier formula suggests?: Larger leakages mean a smaller multiplier; near normal capacity extra demand raises prices rather than real output; rounds of spending take time; expectations can change saving behaviour.
What shifts SRAS, and what is a movement along it?: A change in the price level is a movement along SRAS. A change in production costs shifts it: higher money wages, raw material prices or indirect taxes shift it left; higher productivity shifts it right.
LRAS: shape and determinants: Vertical at the normal capacity level of output. Shifted right by more capital, better technology, a larger working population, higher productivity, enterprise, factor mobility, positive attitudes and economic incentives. A rightward shift is underlying growth.
Diagram in words: a cost-push shock in the AD/AS model: Axes: price level and real output. Higher costs shift SRAS left. The new equilibrium has a higher price level and lower real output. Price up with output down points to a supply-side shock.
The basic accelerator: Investment depends on the rate of change of output, not its level. If output keeps rising but more slowly, net investment falls; if output is constant, net investment is zero. This makes investment volatile.

3.2.3 Economic performance

Short-run versus long-run economic growth: Short-run: a rise in actual real GDP, often from using spare capacity (AD shifts right; a point moves towards the PPD boundary). Long-run: a rise in productive capacity, the trend rate (LRAS shifts right; the boundary shifts out).
Output gap: formula and example. Potential output 560, actual 551.6.: Output gap = (actual − potential) ÷ potential × 100. (551.6 − 560) ÷ 560 × 100 = −1.5%: a negative output gap (actual below potential).
Phases of the economic cycle, and a common definition of recession: Boom, slowdown, recession, recovery. Recession: commonly two consecutive quarters of falling real GDP. A slowdown (growth falling but positive) is not a recession.
Demand-side versus supply-side shocks: effect on output and the price level: Negative demand shock: AD left, output and price level both fall. Negative supply shock: SRAS left, output falls and the price level rises. (Positive shocks reverse these.)
ILO unemployment rate: example with 3,360,000 employed and 140,000 unemployed: Labour force = employed + unemployed = 3,500,000. Unemployment rate = 140,000 ÷ 3,500,000 × 100 = 4.0%.
Cyclical, structural, frictional and seasonal unemployment: Cyclical: weak AD, a negative output gap. Structural: mismatch of skills or location with vacancies. Frictional: the time taken to search for and move between jobs. Seasonal: yearly patterns in demand.
Inflation, deflation and disinflation: Inflation: a sustained rise in the general price level. Deflation: the price level falls. Disinflation: the rate of inflation falls but prices still rise.
Demand-pull versus cost-push inflation: Demand-pull: AD shifts right (higher spending, faster money supply growth); real GDP rises and unemployment usually falls. Cost-push: SRAS shifts left (wages, commodities, energy, indirect taxes); real GDP falls and unemployment usually rises.
Real change: nominal pay rises 2.2% while inflation is 3.5%: Real change = (1 + nominal) ÷ (1 + inflation) − 1 = 1.022 ÷ 1.035 − 1 ≈ −1.3%. Real pay falls.
The four parts of the current account of the balance of payments: Trade in goods, trade in services, primary income (employment and investment income across borders) and secondary income (one-way transfers such as remittances and aid).
What can worsen a country's current account balance?: Faster growth at home (more imports), higher inflation than trading partners, an appreciation (if demand for exports and imports is elastic enough) and slower growth abroad. Higher productivity improves it.
Short-run trade-off versus long-run solution for conflicting objectives: In the short run demand-side policy moves the economy along SRAS, so one objective (low unemployment) is traded for another (low inflation). Supply-side policy shifts LRAS right, raising output without adding to inflation.

3.2.4 Macroeconomic policy

Monetary policy: prime and subsidiary objectives: Prime objective: usually to control inflation (an inflation target). Subsidiary: moderating fluctuations in economic activity.
What happens to AD when the central bank raises its policy interest rate?: Loan rates rise, so borrowers have less to spend and consumption falls. Investment falls as funds cost more. Asset prices and confidence fall. The currency may appreciate, cutting net exports. AD shifts left, easing inflationary pressure.
Why is monetary policy less suitable for cost-push inflation?: Monetary policy works on demand. It cannot lower costs directly, so cutting AD to fight cost-push inflation lowers output and jobs without removing the cause.
Quantitative easing (QE): The central bank buys government bonds with newly created money. Bond prices rise and yields fall, so borrowing is cheaper and asset prices higher, and AD shifts right. Limits: banks may hold reserves rather than lend; confidence may be low.
Fiscal policy, budget deficit and national debt: Fiscal policy: deliberate changes to government spending and taxation. Budget deficit: spending exceeds revenue in a year (a flow). National debt: the stock of past borrowing not yet repaid.
Progressive, proportional and regressive taxes: Progressive: the average tax rate rises with income. Proportional: the same average rate at every income. Regressive: the average rate falls as income rises (a fixed fee of 300 is 2% of 15,000 but 0.5% of 60,000).
Cyclical versus structural budget balance: Cyclical: the part caused by the position in the economic cycle (in a downturn tax falls and benefit spending rises). Structural: the part that would remain at potential output. Actual balance = structural + cyclical.
Supply-side policy versus supply-side improvement: Policy: a deliberate government measure to expand productive capacity or efficiency. Improvement: any gain in capacity or efficiency, including those firms make on their own (innovation, private training). Test: would it have happened without the policy?
How can a cut in the marginal income tax rate shift LRAS?: A lower marginal rate raises the reward for extra work, so people work more hours or join the labour force. Labour supply rises and LRAS shifts right. Evaluation: the income effect can make the response small.
Examples of supply-side policies and their main limit: Education and training, infrastructure, business tax cuts or investment incentives, welfare reform, deregulation, industrial policy. Limits: long time lags, cost to the budget, and they need enough demand to use the extra capacity.