Notesale: Turn your study into money

Document Preview

Extracts from the notes are below, to see the PDF you'll receive please use the links above

---

Week 9
...

Aggregate Demand and Aggregate Supply
The Circular Flow of Income
Macroeconomic activity can be viewed as a series of transactions between
Households and Firms in which money flows in one direction and goods and services
in the other
...
We do
however separate business into the industrial sector and the financial sector,
characterised by money inputs in the form of household savings and monetary
outflows in the form of portfolio investment
...
Finally, most economies operate to varying degrees in the global
economy, generating export revenues and import expenditures
...


ABROAD

Import
Net
expenditure (M)
Net
taxes (T)
saving (S)

WITHDRAWALS

Consumption demand generates revenue flows to business and factor payments
(wages and profits) constitute household incomes
...
Out of their income households
1

Save (S), generating funds for the financial sector to invest in industry (I)

2

Pay taxes(T), providing funds for government expenditure (G)

3

Buy imported goods and services (M), providing funds for the rest of the world to
purchase exports (X)

The level of economic activity can be measured in various ways, of which the most
straight- forward is Gross Domestic Product, obtained by adding up all the
expenditures in the economy:

C+G+I+X–M
C

=

Consumption spend

G

=

Government spend

I

=

Investment spend

X

=

eXport spend

M

=

iMport spend

Macro-economic equilibrium
This is established when AD intersects with SRAS
...
At price level P1, AD is equal to SRAS – i
...
at this price level, the value of
output produced within the economy equates with the level of demand for goods
and services
...
If the general price level is too high for
example, there will be an excess supply of output and producers will experience an
increase in unsold stocks
...
If the price level is below equilibrium, there will be
excess demand in the short run leading to a run down of stocks – a signal for
producers to expand output
...
(Assume that there is no shift in AD)
...
SRAS1 shifts outwards to SRAS3 and a new
macroeconomic equilibrium will be established at Y3
...
This might be
caused for example by a decline in business confidence (reducing planned
investment demand) and a fall in exports following a global downturn
...

The result of the inward shift of AD is a contraction along the short run aggregate
supply curve and a fall in national output (i
...
a recession)
...
We would expect to see a rise in unemployment
...
It is
defined as the difference between the actual level of national output and its potential
level and is usually expressed as a percentage of the level of potential output
...
If actual GDP is less than potential GDP (e
...
real output level Y1)
then there is a negative output gap
...
High unemployment indicates an excess supply of labour in the
factor market which means there is downward pressure on real wage rates
...

Positive output gap – upward pressure on inflation
If actual GDP is greater than potential GDP i
...
a level of real GDP of Y2 then there is
a positive output gap
...
g
...
The main economic problem is likely to be
demand pull and cost-push inflation
...
In the next time period, a rise in wage rates shifts SRAS upwards
until actual and potential GDP are identical – assuming labour markets are flexible
...
Sustained economic growth should lead higher real
living standards and rising employment
...

Growth and the Production Possibility Frontier
An increase in long run aggregate supply is illustrated by an outward shift in the PPF
...

•

Higher Living Standards – for example measured by an increase in real
national income per head of population
...


•

Fiscal Dividend: Growth has a positive effect on government finances boosting tax revenues and providing the government with extra money to
finance spending projects

•

The Investment Accelerator Effect: Rising demand and output
encourages investment in new capital machinery – this helps to sustain the
growth in the economy by increasing long run aggregate supply
...
The two main concerns
are firstly that growth can lead to a pick up in inflation and secondly, that growth
can have damaging effects on our environment, with potentially long-lasting
consequences for future generations
...
Producer then take
advantage of this by raising prices for consumers

•

Environmental concerns: Growth cannot be separated from its
environmental impact
...
Growth that
leads to environmental damage can have a negative effect on people’s quality
of life and may also impede a country’s sustainable rate of growth
...


Many economists and environmentalists are concerned about the impact that rapid
economic growth can have on our limited scarce resources and our environment
...
In other words, an estimate of how fast the economy can
reasonably be expected to grow over a number of years without creating an increase
in inflationary pressure
...
This can lead to demand-pull and costpush inflation
...
e
...

The result is downward pressure on prices and rising unemployment because
of a lack of aggregate demand
...
Some factors, such as changes
in consumer and business confidence, aggregate demand conditions in the UK’s
trading partners, and monetary and fiscal policy, tend to have a mainly temporary
effect on growth
...

The importance of the supply-side of the economy
The trend rate of growth is determined mainly by the supply-side capacity of a
country – i
...
the extent to which LRAS increases year-on-year to meet a higher level
of demand for goods and services
...
e
...
g
...
An increase in LRAS allows the economy to operate at a higher level of
aggregate demand – leading to sustained increases in real national output
...
g
...
The Government has invested heavily in a number of
employment schemes designed to raise employment including New Deal and
reforms to the tax and benefit system
...
And we might also
consider the effects that migration of workers into the UK from overseas,
including the newly enlarged European Union, can have on our total labour supply
(2) The growth of the nation’s stock of capital – driven by the level of fixed
capital investment
...
Higher investment also provides
workers with more capital to work with
...

(3) The trend rate of growth of productivity of labour and capital
...
The root
causes of improved efficiency come from making markets more competitive and
achieving better productivity within individual plants and factories
...

(4) Technological improvements are important because they reduce the real
costs of supplying goods and services which leads to an outward shift in a country’s
production possibility frontier

Gross Domestic Product

The Business Cycle & the 4 Macroeconomic
Objectives
High output, low unemployment
but
high inflation, current account deficit

Potential output

3
2

3

4
Actual
output

4
2
1

O

1
Low inflation, current account surplus
but
low output, high unemployment

Time

1 Upturn
2 Expansion
3 Peaking out
4 Slowdown or recession
The wavy line is a stylised picture of the business cycle: the fluctuations in economic
activity (measure by actual GDP) that characterise economic growth
...
Turning points in the business cycle are explained by reference to the
interaction of two different forces:
The Accelerator:
The effect on GDP of increase in investment that results from an increase in output
E
...
, Greater output => firms expect demand to rise => increase in investment =>
growth in output => further increases in investment … accelerating expansion

Multiplier:
The factor by which change in an injection (I, G, X) is multiplied to lead to larger
change in equilibrium national output
Determined by withdrawals (S, T, M) in each ‘round’
E
...
G increases => incomes increase =>, less S and T, spent => …
The rising line shows the growth of maximum capacity of the economy
...

As an economy converges on the maximum potential growth line (at 3), it may
experience low unemployment but large inflationary pressures, so that
macroeconomic policy will be concerned to control inflation; to stop the economy
overheating
...

In the long run, government policy will target potential economic growth: attempting
to increase the rate of growth of capacity by supply side policies

---