DP1 Macroeconomics (Macro objectives)

Households: Provide factors of production (FOP) for firms in the factor market and demand for goods and services from firms in the product market

Firms: Produce and sell goods and services to households in the product market using resources bought from households

Government sector: Collects taxes from households and firms (leakages) and contributes government expenditure to public goods

Financial/Bank sector: Firms and households save money in banks (leakages) and banks provide them with loans or funds for investment (injections)

Foreign sector: Nation purchases goods from foreign countries (leakages) and earns money by selling domestic goods to foreign countries (injection)

Leakages: the withdrawal of money from the circular flow of income

Injections: the additional money added into the circular flow of income

If injections>leakages, national income increases.

If leakages>injections, national income decreases.

The total value of final goods and services produced within an economy over a period of time. It is measured using the expenditure method of consumer spending + government spending + investment spending + (exports-imports)

Expenditure approach: All expenditures from consumers, government, bank, foreign economy goes towards domestic firms.

Income approach: The money domestic firms receive from total expenditure is transferred to households as factor incomes in exchange of FOPs

Output approach: Firms use the FOPs to produce goods and services. Therefore, the total value of the output of goods and services is equal to the factor income used to purchase the FOPs which is equal to the total expenditures of all households.

A country’s economic output per person

The total income earned by all national FOPs independently of where they are located over a period of time

GDP+domestic income-foreign income

GNI includes output produced abroad by domestically owned factories and excludes outputs produced domestically by foreign owned factories

Foreign companies located in country A are earning more income than domestically owned companies are earning abroad

Nominal GDP/Real GDP x 100

Nominal GDP/GDP deflator x 100

Expansion: firms increase production to maximise profit → unemployment decreases → income increases → consumer and business confidence increases → consumer spending increases → AD increases → output increases → firm’s cost of production increases → price increases → inflation

Peak: high inflation, low unemployment, high AD, high consumer and business confidence

Recession: AD or AS decreases → production decreases → unemployment increases → income decreases, tax revenue decreases due to transfer payment → confidence decreases → consumption decreases

Trough: low AD, high unemployment, low income, low consumer spending, low confidence

Potential output = actual output, unemployment rate = natural rate of unemployment

Actual output>potential output, unemployment rate<NRU

Actual output < potential output, unemployment rate>NRU

• leisure time, working hours are unaccounted for

• economic well-being might be overstated as environment costs are not considered

• May be understated as they do not account for non-marketed goods or parallel economy

• Ignores all social aspects such as income distribution, access to healthcare, life expectancy, gender inequality, etc.

• happy planet index

• OECD better life index

• World happiness report

High real GNI per capita usually corresponds to a higher standard of living because higher average income leads to people purchasing more goods and services, paying more taxes for public goods, and to less poverty.

total value of demand for all goods and services in an economy by all stakeholders at different price levels over a time period

consumer spending, government spending, investment spending, net export

Wealth: if the value of existing assets rise, people feel wealthy so they consume more so AD shifts rightwards

Household Indebtedness: Borrowing and spending might shift AD to the right in the short run but future consumptions will decrease as households have to repay their debts so AD will shift leftward in the long run

Expectations of future prices: If consumers expect prices to rise in the future, they are incentivised to spend more and save less, now shifting AD to the right.

Consumer confidence: If they feel confident about the economy, then consumers will spend more which causes a rightward shift in the AD.

Real Interest Rates: If interest rates fall, consumers can borrow and spend money more easily as the repayment on that borrowing is low and also they are disincentivised to save when interest rates are low so AD shifts right.

Income Taxes: If income tax is low, households have more disposable income, so consumption will increase and AD will shift right.

Business confidence: If firms feel anxious about the economy (prices rapidly rising or recession looming), they will invest less which shifts the AD leftwards.

Interest rates: Interest rates have a huge effect on the firm’s decision to borrow as firms often borrow to finance large scale investments. If interest rate is high, this will disincentive firms to borrow which leads to a decrease in investment so AD shifts leftwards.

Business taxes: If business tax rates are high, there is less revenue left for firms to invest so AD shifts left.

Improvements in technology: If there are improvement sin the technology, the costs of production for firms decrease so firms will invest more and AD will shift right.

Corporate indebtedness: Firms borrow money to finance their expansion but when debt has to be repaid, firms will decrease investment in the future so AD will shift leftward.

Political priorities: Government might change government spending for political objectives.

Economic priorities: Government might change government spending to influence AD to boost macroeconomic goals.

total quantity of real GDP produced in an economy at different possible price levels

The total quantity of real output (real GDP) produced at different possible price levels in the short run when wages and other resource prices are constant

Wages: Fall in wages → Fall in cost of production → Rise in profitability → SRAS rightward shift

Non-labour resource prices: Fall in non-labour resource prices → Fall in cost of production → Rise in profitability → SRAS shift right

Supply shock: Unanticipated events that delay or destroy regular production of businesses → SRAS shift left

Indirect Taxes: Fall in indirect taxes → fall in cost of production → Rise in profitability → SRAS shift right

the maximum productive capacity of the economy- the total level of output that can be produced in an economy in the long run when factor prices are fully flexible.

This is when actual output is lower than potential output and unemployment is higher than the natural rate of unemployment. When AD falls, there is a temporary surplus of goods and services in the economy so firms are incentivised to lower prices to clear up excess inventories, causing price levels to drop. The drop in the price level leads to firms cutting production and as output falls below the full employment level of output, cyclical unemployment rises.

Inflationary gaps are formed when AD increases due to changes in any of the components of AD, which creates a temporary shortage as the amount of demand exceeds the amount of output. This puts an upward pressure on the prices, incentivising firms to raise prices to raise their profit. This causes the price level to rise which leads to more output being produced with lower unemployment.

Economy is in long run equilibrium at AD=SRAS=LRAS in PL1 and Yp. Increase in any of the components of AD causes AD to increase from AD1 to AD2, which causes a temporary shortage which puts an upward pressure on price and firms are incentivised to raise prices as the goods and services are being sold quickly. This results in a rise in price level, causing firms to increase output above the full employment level of output in the short run as wages and other prices of factors of production remain the same due to contracts. Unemployment falls as well followed by the increase in output. However, in the long run, the inout costs rises as it matches the general price level so the firm’s cost of production increases causing the SRAS to shift leftwards from SRAS1 to SRAS2. Real GDP falls from Y2 to Yp and the average price level further rises from PL2 to PL3. The full employment level of output is restored at Yp and economy returns to its long run equilibrium.

The economy is in the long run equilibrium at AD=SRAS=LRAS at PL1 and Yp. Due to a decrease in any of the components of AD, AD shifts leftwards from AD1 to AD2, which causes a temporary surplus of goods and services. This surplus incentives firms to decrease prices to clear excess inventory which causes average price levels to fall from PL1 to PL2. As a drop in the price level cause the firms’ products to be sold in lower prices, in the short run, firms have no choice but to cut production as wages and other costs of FOPs’ prices remain the same due to contracts which causes a fall in output from Yp to Y2 and a rise in unemployment, creating a deflationary gap. However, in the long run, prices of FOPs drop to match the average price level and wages fall as workers accept lower wages which causes the SRAS curve to shift right from SRAS1 to SRAS2. Therefore, the real output returns from Y2 to Yp and the price level falls further from PL2 to PL3. The full employment level of output is restored at Yp and economy returns to its long run equilibrium.

the increase in the maximum productive capacity of the economy

Increase in the quantity of factors of production:

Discovery of new raw materials such as tradable commodities or natural resources causes an increase in the country’s endowment of factors.

Increase in physical capital through investment from firms and government

Increase in the quality of factors of production:

Improvements of human capital and productivity such as skills, health, and experience, which increases the efficiency of labour so more output can be produced with the same labour hours

Improvements in the quality of physical capitals through technical advancements to increase the efficiency of physical capital

the increase in real GDP

Increase in demand for goods and services which increase the demand for workers so reduction in unemployment

Increase in efficiency in production by reducing resource use, and reducing underemployment

Impact on the standard of living:

Economic growth means a growth in real GDP meaning that people have a higher average of income now. This means they have higher purchasing power and that there is an increase in ability for them afford their needs and wants which increases the standard of living.

Environment:

Economic growth does

Redistribution of income: