How the Macroeconomy works

National income/output/product: The flow of new output produced in the economy over a period of time e.g. a year.

It is produced by the stock of physical capital (national capital stock) and human capital.

National income measures the incomes received by labour and other factors of production when producing the goods and services

Nominal national income is the value of national output at the prices existing in the year that national income is measured. Real national income is the value of national output, adjusted for inflation.

If worn out capital is not replaced, the national capital stock will shrink - as will the national income. Less is spent on consumption, more available for consumption.

An increase in net investment leads to an increased national capital stock - economic growth.

National income = national output = national expenditure

National income - measures the incomes received by labour and other factors of production when making good and services. national output - measures actual goods and services produced by an economy  

National output - measures actual goods and services produced by an economy  

National expenditure - spending on the goods and services produced by the economy 

In exchange for income, households provide labour. Firms provide goods in exchange for consumption

S+T+M = Injections (spending entering the circular flow of income)

I+G+X= Withdrawals (a leakage of spending power out of the national income)

More injections, national income rises.

SRAS to the right (vice versa for left) 

A decrease in wages, an increase in physical capital stock, or advancement of technology. 

AD to the right (vice versa for left)

More consumption (maybe due to expansionary monetary policy), investment, government spending (expansionary fiscal policy)

An economic shock is an unexpected event hitting the economy. They can be demand or supply side, and favourable/unfavourable.

Demand side can affect consumer/business confidence. Supply side can affect prices and supply 

AD = C+I+G+(X-M)

Consumption (and therefore saving) is affected by interest rates, level of (expected future) income, wealth, consumer confidence, distribution of income (whole economy) expectations of future inflation

Investment is affected by the rate of interest, prices of capital & labour, nature of technological process, if banks favour long or short-term investments and if Govts provide subsidies or taxes.

Difference between saving and investment

Saving = income not spent on consumption

Investment = planned demand for capital goods

Accelerator theory of investment

An increase in national investment increases the level of investment

AD influences economic activity (production & consumption of goods & services as well as the factors of production)

Employment - more demand - more employers to make more output (depends on steepness of AS curve)

Multiplier - the relationship between a change in AD and the resulting usually larger change in national income

Change in income/initial change in government spending.

SRAS curves are determined by price levels and production costs.

To produce more output, price levels must increase. Higher revenues are needed to offset the higher production costs in order to ensure profit levels (an aim of firms).

Movement along the shallow part of the SRAS curve - larger increase in real income. More reflation

Movement along the steep part of the SRAS curve - larger increase in price level. More inflation

At FE-  inflation as the economy is producing at full capacity.

Any change other than price level - shift of the SRAS Curve.

Rightward shift = deflation. fall in production costs, fall in unit labour cost, reduction in indirect taxs, increase in subsidies and technical progress.

In the long run, AS is not influenced by the price level. Long run supply reflects the economy's production potential.

LRAS curve shown at nomal capacity of output (FE economy is used to). Sustainable level of output when eonomy is on PPF.

Where LRAS and SRAS meet = equlibrium national income. Normal capacity.

The position of the vertical LRAS curve is determined by:

The state of technical progress, quantities, productivity and mobility of factors of production, existence of economic incentives, institutional structure of economy 9e.g. legislation, banks)

Increase = LRAS to right, PPF outward. Long ruin economic growth