Macroeconomic Models
· Income: Measures the flow of money a person or an economy receives each years.
· Wealth: The sum or stock of all your assets. (Car, Shares)
* Wealth can be used to generate income. Wealth↑, Consumer Confidence↑
· Assets: Items that you own.
· The Circular Flow of Income: An economic model showing the flow of goods and services,
factors of production and their payments between households and firms within an economy.
* Assumption of Simplified Model:
1. There is no foreign trade and no government influence
2. Only two groups: Households & Services
3. Households spend all their income on goods and services
4. Firms spend all their income on factors of production
* Firms buy factors of production and pay factor incomes to households in return.
* Households spend the factor incomes on goods and services produced by firms.
* National Income = National Expenditure = National Output
- The total national expenditure from households across the economy must come from
the total national income they earn. Households spend national expenditure on the total
national output of goods and services produced by firms in the economy.
· Injection: Government Spending, Investment, Exports
· Withdrawals: Savings, Taxes, Imports
· We can measure the national output by using real GDP
· Gross Domestic Product (GDP): The total value of goods and services produced in the
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economy over a period of time within a country. RNO =
* We measure GDP growth on a quarterly basis.
,· Nominal Value: Expressed in monetary terms. Current price
· Real Value: Takes into account inflation. Constant price
· Opportunity Cost: The benefit given up of the next best alternative.
· Trade-Off: Choosing more of one thing can only be achieved by giving up something else.
· Aggregate Demand: The total demand for all goods and services in an economy at any
given price level over a period of time. AD = C + I + G + (X - M)
* C: 60%, of AD; I: 14% of AD, G: 25% of AD, (X - M): 1% of AD —— UK
* The higher the level of AD in an economy, the higher the level of economic activity.
Why Aggregate Demand Curve Slop Downwards:
1. Income Effect: A rise in prices is not matched straight away by a rise in income. People
have lower real incomes can afford to buy less, leading to a contraction demand.
2. Substitution Effect: If prices in the UK rise, exports will decrease and imports will
increase, leading to a contraction demand.
3. Real Balance Effect: A rise in prices will lead to a decrease in the real value of the
money people save in bank. Therefore, they will feel less secure and save more, causing
a contraction in AD.
4. Interest Rate Effect: Rising prices means that there is a higher demand for money. If
supply of money stays the same, interest rate will rise. This means, more people will
save more and spend less. Therefore, AD will contract.
· Price Level: The average price of all goods in an economy.
· Disposable Income: The amount of income left over after paying taxes.
· Benefits: Payment made to unemployed or low income workers. Increase in consumption
· Wealth Effect (Pigou Effect): Occurs when consumers increase consumption due to an
increase in the value of assets.
,· Interest Rate: The return on savings. The cost of borrowing.
· Factors Determines the Level of Consumption:
Disposable Income; Interest Rates; Personal Debt (loans); Personal Wealth; Confidence
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· Saving Ratio: Saving Ratio = * 100%
· Determinants of Saving: Interest Rates, Consumers Confidence; Inflation
· Investment: Money spent on improving factors of production to raise productivity.
· Gross Investment: Spending on capital assets. Total amount spent on new capital inputs.
· Net Investment: Gross investment - Depreciation - Replacement Costs
· Credit Crunch: Banks stop lending, the credit stops flowing around the economy.
· Animal Spirits : Collective mood of investor. It refers to the state of confidence held by
consumers and business. High animal spirits mean that investor confidence is high.
· Influences on Investment:
The Rate of Economic Growth; Business Expectation & Confidence; Interest Rates;
Demand of Exports; Access of Credit; Influence of Government and Regulation
· Accelerator Effect: It happens when an increase in national income results in a
proportionately larger rise in capital investment spending.
· Multiplier Effect: Occurs when an initial injection in to the economy leads to a larger final
increase in the level of real national output. It is not always positive.
· Downward Multiplier Effect: Occurs when an initial withdrawals leads to a larger final
decrease aggregate demand.
· Multiplier Ratio: How much GDP will increase in total following an initial injection into
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the economy. Multiplier Ratio =
· Marginal Propensity to Consume (MPC): How much consumers will spend if given an
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additional pound. Multiplier Ratio =
, * A high MPC means consumers are more likely to spend, less likely to save.
· Marginal Propensity to Withdraw (MPW): The proportion of any additional income that is
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withdrawn from the circular flow. Multiplier Ratio = MPW = MPS + MPT + MPM
Marginal Propensity to Save; Marginal Propensity to Tax; Marginal Propensity to Imports
· Effects of the Economy on the Multiplier:
1. There are constantly changing variables that will all impact on the multiplier
(Unemployment, Economic Growth, Inflation, Exchange Rate)
2. If there is little spare capacity, then any increase in AD met not be able to be met by firms.
3. The size of the multiplier is hard to measure as it takes into account numerous factors.
4. It is likely that those on low income will have a higher MPC.
· Short-Run: The actual annual percentage change in real national output. (GDP)
* At least one of the factors is fixed
· Long-Run: An increase in the potential productive capacity of the economy.
* No fixed factors
· Productivity: Output per unit Input.
· Aggregate Supply : The total value of output of the economy at a given price level at a
given point in time.
· SRAS curve slope upwards because if firms want to increase output in the short run,
they don’t have time to hire new workers. So they have to pay their current workers
overtime pay, which increases the firm’s costs and forces them to increase their price.
· Factors Influencing SRAS: Costs change → Shift SRAS
Costs of Raw Material and Energy; Exchange Rate; Tax Rate
* Low tax rate can attract international companies and investment.
