10. How the Macroeconomy Works (AQA A Level Economics): Flashcards

The circular flow of income model illustrates national income and the flow of money, resources and goods between economic agents.

True.

Because Income = Output = Expenditure, all three approaches should provide the same figure.

An injection is money added to the circular flow of income that increases its size.

The three injections are investment (I), government spending (G) and exports (X).

False.

When injections exceed withdrawals, national income increases and the economy grows.

A withdrawal is money that leaks out of the circular flow of income, reducing its size.

Equilibrium national income occurs where injections are equal to withdrawals.

The three withdrawals are savings (S), taxation (T) and imports (M).

Full employment is the level of income at which an economy operates at full capacity, on its production possibility frontier with no spare capacity.

True.

Disposable income is either saved or spent, so when savings rise, consumption usually falls.

The household savings ratio measures household savings as a proportion of household income.

A rise in interest rates increases savings (a withdrawal) and reduces consumption and investment.

Savings is the portion of household income that is not consumed, whereas investment is firms' spending on capital goods.

True.

Equilibrium national income is where withdrawals equal injections, which is also where aggregate demand equals aggregate supply.

Aggregate demand is the total demand for all goods and services in an economy at any given average price level.

Aggregate demand is calculated as AD = C + I + G + (X − M).

False.

A change in a determinant of AD causes a shift of the entire AD curve; only a change in the average price level causes a movement along it.

A change in the average price level causes a movement along the AD curve.

Consumption is the total spending on goods and services by consumers (households) in an economy.

An increase in a determinant of AD causes the curve to shift right, raising real GDP at every price level.

True.

A fall in the average price level causes a movement along the AD curve and an expansion of real GDP.

Investment is the total spending on capital goods by firms in an economy.

A rise in interest rates reduces consumption, as there is a greater incentive to save and loan repayments become more expensive.

Net exports are calculated as exports minus imports.

False.

Government spending in AD excludes transfer payments such as benefits and pensions.

A depreciation makes exports cheaper abroad and imports dearer, so net exports tend to rise.

Aggregate supply is the total supply of goods and services produced within an economy at a specific price level at a given time.

Short-run aggregate supply is the total output firms supply at each average price level in the short run, and it is upward-sloping.

As real output increases, firms must spend more to produce (e.g. higher wage bills), raising costs and average prices.

False.

A change in the average price level causes a movement along the SRAS curve, not a shift.

An increase in the average price level causes an expansion of real GDP along the SRAS curve.

The SRAS curve shifts when the conditions of supply change, usually through changes in the costs of production.

True.

A decrease in costs (or rise in productivity) shifts SRAS right, raising real GDP at every price level.

An increase in wage rates raises the cost of production, shifting the SRAS curve to the left.

A decrease in tax rates lowers firms' costs and shifts the SRAS curve to the right.

True.

Higher input costs mean fewer goods can be produced for the same money, so SRAS shifts left.

The average price level is on the vertical axis and real GDP (real national output) is on the horizontal axis.

True.

A fall in the average price level causes a movement along SRAS and a contraction of real GDP.

Long-run aggregate supply represents the potential capacity of an economy's factors of production.

The classical LRAS curve is vertical at the full employment level of output (Y_FE), the normal capacity level of the economy.

True.

The classical LRAS curve is vertical at Y_FE, where all available resources are fully employed.

An outward shift of the LRAS curve means the economy's productive capacity has increased.

The LRAS curve shifts outward when the quantity or quality of the factors of production improves.

False.

Only a shift in LRAS changes potential output; changes to SRAS do not.

Institutional structures are the established frameworks, organisations, regulations, norms and practices that govern the behaviour of economic agents.

The Keynesian view holds that an economy can get stuck at an equilibrium well below the full employment level of output, as in the Great Depression.

In the Keynesian model, aggregate supply is elastic at lower levels of output where there is spare capacity.

True.

Keynes argued governments should raise expenditure to shift AD and lift the economy out of a recessionary gap.

SRAS shifts with changes in the costs of production or productivity, whereas LRAS shifts with changes in the economy's productive capacity.

The full employment level of output is the normal capacity level of output where all available resources in the economy are fully employed.

Short-run macroeconomic equilibrium occurs where aggregate demand (AD) intersects short-run aggregate supply (SRAS).

Long-run macroeconomic equilibrium occurs where AD, SRAS and LRAS intersect, at the full employment level of output (Y_FE).

False.

Short-run equilibrium occurs where AD intersects SRAS; the LRAS curve is involved only in long-run equilibrium.

An economic shock is an unpredictable event that has macroeconomic consequences.

An increase in AD raises the average price level and increases real output, giving a new short-run equilibrium.

True.

An increase in SRAS shifts the curve right, lowering the average price level and raising real output.

An economic shock is an unpredictable event that has widespread macroeconomic consequences for growth, inflation and unemployment.

A demand-side shock is a sudden change in the level of private spending, such as a shift in consumer spending or business investment.

True.

It caused supply chain disruptions that raised energy and food prices and increased costs of production.

Free market economists believe the economy will always return to its normal capacity level of output in the long run.

A supply-side shock is an event that makes production across an economy more difficult.

True.

The credit crunch cut borrowing, investment and consumer spending, causing a fall in aggregate demand and recession.

The multiplier states that any injection into the economy leads to a greater final increase in national income than the value of the initial injection.

The marginal propensity to consume is the proportion of additional income that is spent on consumption.

The multiplier = 1 / (1 − MPC).

MPC = change in consumption ÷ change in income.

True.

A higher MPC means smaller leakages, so a greater share of income is re-spent and the multiplier is larger.

The multiplier process is based on the idea that one person's spending is another person's income.

False.

Higher taxes reduce disposable income and increase leakages, so the multiplier falls.

The multiplier = 1 / (1 − 0.75) = 4.

The accelerator process states that firms change their investment in capital goods to meet changes in the overall level of economic activity.

The multiplier can also work in reverse, reducing national income when injections fall.

Rising AD prompts accelerated investment in capital goods, which raises AD further, and this is then multiplied, making growth in national income more rapid.

False.

As the economy contracts, firms invest less in capital goods, which can trigger a negative multiplier effect.