Macroeconomics notes

Government aims
 Employment
 Inflation
 Growth
 Balance of payments

Policies used to achieve these aims

 Fiscal policy
 Monetary policy
 Supply side policy

Ways to measure success of an economy

 GDP  National debt

 Balance of trade  Equality of income
 Employment levels  Inflation
 Happiness of population  Environmental concern
 Standard of living  Stability
 Foreign Direct Investment  Average wage

 Zero hours contract- technically employed but non-fixed hours and some weeks with no
work or pay
 Quantitative easing- allowing more money into the economy which has pushed up
house prices
 Gross Domestic Product- the amount of goods/services produced in one country
 Gross National Product- GDP+ British companies located overseas
 Purchasing Power Parities- how much a good costs in different currencies relative to
each other, similar to exchange rate but unaffected by stock market e.g. £20 trainers
cost 200C in China so the PPP is £1=10C
 Inflation- a sustained increase in the general prices of goods and services in an economy
 Disinflation- a decrease in the rate of inflation
 Consumer Price Index- Index of hundreds of consumer goods prices used to calculate
inflation
 Employment

 Claimant count- number of people claiming unemployment benefits. It has come under
criticism because the gov can manipulate it to make unemployment seem lower than it
is

Costs of unemployment

 Physical and mental effects on population

 Higher crime rates
 Gov has to pay more out in benefits and receives less income tax
 Loss of output that the workers could have produced

Types of unemployment

 Frictional- unemployment between jobs

 Seasonal- e.g. construction workers or holiday workers
 Structural- when demand for labour is less than supply e.g. shipbuilding or steelworks in
Redcar
 Cyclical- unemployment during a recession compared to during a boom

 Unemployment is at a 7 year low of 5.4%

 Inflation is at -0.1-0.1% so real wages are growing slightly
 Investment has been low so productivity has also been low
 Immigration has increased the labour supply so it puts downward pressure on wages
 The National Living Wage will increase wages soon

Inflation and Deflation

 If wages don’t rise with inflation then it put financial strain on the consumer
 Standards of living may fall if wages don’t keep pace with inflation
 Inflation can cause exports to fall as prices rise for potential buyers abroad
 Deflation lowers profits so less growth and less money in the economy
 Deflation means people stop buying goods and services because they know the price will
continue to fall so investment will stop too
 Interest rates will increase to offer some return on savings which causes problems for
borrowers or people with mortgages
 Shoe leather costs- time and effort spent trying to find info on better deals when prices
change
 Menu costs- administrative cost to businesses when prices change
 Psychological cost- affects consumer confidence in the economy
 Redistribution costs- people on fixed incomes (e.g. pensioners) get left behind
 If you borrow on a fixed rate and then inflation happens and your wages increase, you
will find it easier to pay back

Balance of Payments
1) The current account- payments for the purchase and sale of goods and services are
recorded.
1) Trade in goods
2) Trade in services
3) Income+ current transfers- Gov transfers to and from overseas organisations such as
the EU. Income account is the factors of production owned abroad and the income
earned from those assets which is sent back to the country of origin, e.g. Polish
workers sending money back to family from the UK
4) Current balance- difference between total exports and total imports

2) The capital and financial accounts- money flow associated with saving, investment,
speculation and currency stabilisation are recorded

Current account deficit

Consists of:

1) Difference between exports and imports of goods and services

2) Difference between what British investors earn abroad and foreign investors earn here
3) Difference between money sent to and from migrant workers

In total, how much Britain is lending or borrowing from abroad.

 The deficit isn’t a major problem because Britain is one of the fastest growing rich
countries with lots of FDI which is why there is a big deficit.
 Britain is seen as a good bet for foreign investors.
 If Britain exited the EU, it will disturb the equilibrium and investors may not see
Britain as such a secure investment.
 Aggregate Demand
Factors affecting Aggregate Demand:

 Gov spending- fiscal deficit, spending more than receiving

 Exports and Imports- less demand in the Eurozone + oil and commodity prices down

AD= consumption + investment + gov spending + balance of trade

Prices
Output

 Prices represent the rate of inflation

 Output can be aligned with economic growth

- If prices go up, interest rates increase because borrowing increases so consumption

decreases
- AD falls as prices rise because higher interest rates will reduce consumption and
investment and high interest rates mean a loss of international competitiveness
- If interest rates increase, people with variable mortgage repayments will have to pay
more as interest so they will have less disposable income.
- Marginal efficiency of capital- interest rates go up and investment decreases

Shifts in the AD curve

 If employment increases, the AD curve shifts to the right because more employment
leads to more consumption
 Unemployment is decreasing so more output is demanded
 The National Living Wage could mean people have more disposable income so
consumption will increase
 There is a lot of FDI in the UK which shifts the AD curve to the right
 - The output of the UK is low because of a lack of demand in the Eurozone so
consumption and investment are low.
- A lot of goods sold in the UK are imported and then sold on. This means they count
for consumption but not for investment because we don’t make them
- High exchange rate to the £ makes it hard to export
- Import prices such as oil have fallen
- The fall in import expenditure has accounted for the deficits in gov spending,
investment and exports.

- The wealth effect- if asset prices increase, wealth doesn’t increase but people
owning these assets can cash in for more
- Real incomes may not increase as much as asset prices
- The stock market has fallen as property/assets are seen as a better investment

Investment

Investment is a derived demand from consumption. UK growth has been relatively high
despite weak demand in Europe for UK goods. The gov have introduced loose monetary
policy, (low interest rates) to encourage investment and consumption.

Aggregate Supply
Short Run Aggregate Supply
P1
P

SRAS curve- the rate of firm’s costs rather than total

costs e.g. wage rate not wage bill
Q

The short run- at least 1 f.o.p. is fixed

1 way to increase output without changing f.o.p. is to

make workers work overtime or increase productivity

Over time costs more so prices will increase to reflect

that
Q1

Shifts in the SRAS curve

- Rate of costs not total costs

- Increase in tax would shift it to the left
- Subsidies would shift it to the right
- Changes in raw material prices would also shift it
 Long Run Aggregate Supply

Classical LRAS curve

P
Depends on the quality of the f.o.p. in an economy

Regardless of price, there is only so much an economy can produce

It can shift due to immigration or new tech

Keynesian LRAS curve

Below P, the f.o.p. don’t make themselves available e.g.

workers being paid lower than min wage will not want to work
P or produce anything

Market economy?

LRA
S
P

SRA
A S

A
D
Q

1. What happens to A when AD shifts and why?

LRAS
If the AD curve shifts to the right, it will cause a movement
SRAS1
along the SRAS curve. P1 rises to P2 and Q1 rises to Q2.
P3 C Over time, the SRAS curve will shift to SRAS1 and a new
SRAS
equilibrium will form at C with a higher price of P3 but the
P2 A
B same real output of Q1.
P1
AD changes but LRAS doesn’t so inflation occurs.

AD1 Overtime only lasts until B then workers demand higher

AD wages so prices rise to P3.
Q1 Q2
 2. What happens to A when SRAS shifts and why?

LRAS
If the SRAS curve shifted down to SRAS1, then it
would cause a movement along the AD curve which
SRAS
would lead to a rise in QD and prices to fall from P1
P1 A
SRAS1 to P2 and a new equilibrium at B
B
P2

AD

Q1 Q2

3. What happens to A when LRAS shifts and why?

LRAS LRAS1

A shift in LRAS to LRAS1 will cause a movement along

SRAS the AD curve and an increase in QD. The price level will
P1 A therefore, lower from P1 to P2.

P2 B

AD

Q1 Q2

 Too much AD can lead to demand-pull inflation, where suppliers increase prices to cope
 If firms costs go up and SRAS shifts up then it can cause cost-push inflation
 Investment will shift both the SRAS and LRAS curve to the right, decreasing prices and reducing
costs
 The multiplier effect

Households

Initial investment £100

10% 10% 10%
100+90+81+72.9…
10+9+8.1…=£100 1 2 3 4 = £1000
3 2 1

Firms

 Money ‘leaks’ out of the economy through savings, taxes and imports
 If initial investment is £100, firms pay this out to workers/households.
 10% ‘leaks’ of the economy and 90% is reinvested back into firms through consumption
 Firms repay this 90% out and another 10% ‘leaks’ and so on
 In this instance, the multiplier is 10 because £100 -> £1000

Calculating the multiplier

C= consumption MP= marginal propensity  MPC (increase in C) = ΔC/ ΔY
S= saving Y= income  MPS (increase in S) = ΔS/ ΔY
T= taxation M= imports  MPT (increase in Tax rev)= ΔT/ ΔY
W= total withdrawals
 MPM (increase in M) = ΔM/ ΔY
 MPW (increase in W)= (S+T+M)= ΔW so ΔW/ ΔY

Formula for the multiplier= 1/ (1-MPC) or 1/ (MPS+MPT+MPM) or 1/MPW

 A fall in MPW would increase the value of the multiplier and vice versa
 A fall in MPC would decrease the multiplier and vice versa

AD AD1 AD2
Initial investment will shift output
from Q1 to Q2 and shift the AD curve
to AD1. The multiplier effect then
leads to a further shift in AD to AD2
P and an increase to Q3.

Q1 Q2 Q3
 National income

Withdrawals Injections

 Savings  Investment
 Taxes  Gov. spending
 Imports  Exports

 National output (O)- value of goods and services from firms to households
 National expenditure (E)- value of spending by households on goods
 National income (Y)- value of income paid by firms for f.o.p.
 O=E=Y

 Wealth- stock of assets e.g. land, labour or capital

 Income- the rent, interest, wages and profits generated by these assets
 Income is the flow of money derived from owning assets

Macroeconomic Policies
Demand side policies

 Monetary policy- manipulation of interest rates and money supply by the gov
 Fiscal policy- use of taxes,gov spending and gov borrowing

Interest rates as a monetary policy instrument

 Lower interest rates can increase asset prices and promote spending/borrowing and
investment
 Higher interest rates cause a fall in AD
 Lower interest rates can cause a fall in the exchange rate
 This can lead to more exports and fewer imports which boosts AD

Quantitative easing- Bank of England has the licence to buy assets of commercial banks and
institutions for money. This money doesn’t always filter into the economy due to it going abroad or
into bank vaults.

Supply side policies

  These aim to shift SRAS to the right
 This enables producers to increase the quantity and quality of f.o.p. which shifts LRAS right

Market based and interventionist approaches

Increasing incentives

Market based

 Lower tax on income and lower welfare benefits, subsidise workers

 Eradicate poverty and unemployment trap
 Lower corporation tax on profits to promote investment and growth
 Subside research and development

Interventionist

 Tax on income has little effect on labour supply

 Gov invests in research and development itself rather than subsidising
 Gov chooses which R&D to subsidise through grants#

Promoting competition
Market based

 Privatise many sectors because private companies are more incentivised

 Deregulate services to increase firms in the market
 Reduce power of monopolies and unions which fix prices
 No industrial policy

Interventionist

 Argue that private firms put profit before good service or quality
 More nationalisation and argue that deregulation leads to ‘creaming’ of markets
 Creaming- firms only providing where it is most profitable and neglecting other areas
 Industrial policy- the gov promotes and supports firms that it considers are important

Reforming the labour market

Market based

 Use policies to limit power of trade unions

 Argue that a min wage/National Living Wage should be abolished
 Labour market flexibility- the degree to which demand and supply in a labour market respond to
external changes

Interventionist

 Argue that a min wage encourages employees to work harder and reduces unemployment
 Higher min wage can boost productivity

Improving the skills and quality of the labour force

Market based

 State-funded schools can compete for students

 Schools set their own curriculum
 Gov can subsidise training for firms to encourage it

Interventionist

 Gov sets curriculum, teaching methods and targets

 Gov can provide training through schemes

Economic Growth
 Export-led growth- more exports boosts AD which shifts growth to the right
 A weakness of demand side policies is that they cause inflation in the long run
 In the short run they help and can help getting out of deflationary circumstances
 Investment-led demand is ideal because it boosts LRAS as well as AD

Impacts of economic growth

 Consumers- better living standards, higher happiness and life expectancy but more
inequality and the Easterlin paradox
 Firms- more productive and happy workforce, increased capability and profits but markets
can disappear
 Government- happier population, better educated/more skilled too, increased gov spending
so possibly larger fiscal deficit
 Living standards- developing countries are more likely to benefit because more developed
countries benefit less from growth