Macroeconomics Revision Notes
Macroeconomics = This is the branch of economics that studies the behaviour and performance of the
economy as a whole.
1. Macroeconomic Theory
Topics include: the circular flow of income – 1.1; aggregate demand (AD) - 1.2; aggregate supply
(AS) – 1.3; AD/AS Analysis – 1.4.
1.1. Circular Flow of Income
The circular flow of income = This is how money moves between various economic agents in an
economy through the process of trade and exchange.
Domestic consumption = This is when money flows to firms from households in exchange for goods
and services.
Income = This is when money flows to households from firms in exchange for the supply of labour.
The model:
Injection = This is money that enters the model, e.g:
Investment = This is money spent on firms to
increase their output (I).
Government spending = This is money in the
form of fiscal policy (G).
Exports = This is money spent on UK products
by other countries (X).
Leakages/withdrawals = This is money that leaves, e.g:
Savings = This is money people put in the bank to earn interest (S).
Taxes = This is money taken by the government (T).
Imports = This is money spent by the UK on products from other countries (M).
Gross Domestic Product (GDP) = This is the value of the country’s economy; it is all the aspects of
the circular flow of income model added together. You can calculate a country’s GDP by:
• National income = This is the value of what is earnt in an economy (NI).
• National expenditure = This is the value of all spending in an economy (NE).
• National output = This is the value of everything produced in an economy (NO).
• They are all the same thing: NI = NE = NO.
Closed economy = This is when money cannot enter or leave the circular flow of income.
Open economy = This is when money can enter and leave the economy.
• When injections > withdrawals the economy will get bigger.
• When injections < withdrawals the economy will get smaller.
• When injections = withdrawals the economy will stay the same size.
CAI PUGH 1
, Economy Growing Economy Shrinking
More jobs are created, so there is more Fewer jobs, so there is less spending.
spending.
Less need to spend on benefits. More need to spend on benefits.
More government tax revenue for investment. Less government tax revenue for investment.
Higher firm profits to expand, so they will Lower firm profits to expand, so they will
become more internationally competitive. become less internationally competitive.
1.1.1. The Multiplier Effect
The multiplier effect = This is when a change in injections causes a larger final change in GDP.
Fiscal multiplier = This is when the initial trigger is caused by government expenditure.
• Multiplier (K) = Change in real GDP (Y) / Change in Injections (J)
• K = Y/J
Factors affecting the multiplier include:
1. Propensity to spend on domestic products = In the UK, we tend to favour imports over
domestic, whereas in USA people are more passionate about buying domestic products.
2. Propensity to save = In Japan, people are very quick to save any extra income, whereas
people in the UK are far more likely to spend.
3. Marginal rate of tax = The UK has a fairly high rate of tax meaning a lot of extra income will
simply leave the economy, whereas in parts of Eastern Europe it is much lower.
4. Consumer confidence = Typically, during a time of economic growth the multiplier will be
larger than in a recession.
1.2. Aggregate Demand
Aggregate demand = This is the total amount of demand for goods and services in the economy.
The five categories:
Category Explanation
Domestic Consumption (C) This is the domestic produce purchased by
people within the UK.
Investment (I) This is the money spent by firms on buildings,
machinery and improving the skills of the
labour force.
Government Spending (G) This is money spent by the government on a
product or service.
Imports (M) These are the goods and services that are
purchased from other countries.
Exports (X) These are the goods and services sold to other
countries.
CAI PUGH 2
, 1.2.1. Calculating Aggregate Demand
Everything is added to the total except from the imports,
which is subtracted:
AD = C + I + G + (X – M)
1.2.2. The AD Curve
• At a price level of PL1, there is an aggregate demand
of Y1.
• As the price level falls to PL2, people increase con-
sumption (C)
• As prices fall, other countries look to purchase from
the UK and exports rise (X)
• As the price of goods from other countries has not
changed, people turn towards the relatively cheaper lo-
cal produce and imports fall (M)
• For all of these reasons, aggregate demand extends
to point B (Y2)
Anything that triggers a change in a component of AD
other than the price level will lead to a shift of the AD
curve:
• To the right if more is demanded (or imports fall).
• To the left if less is demanded (or imports rise).
CAI PUGH 3
Macroeconomics = This is the branch of economics that studies the behaviour and performance of the
economy as a whole.
1. Macroeconomic Theory
Topics include: the circular flow of income – 1.1; aggregate demand (AD) - 1.2; aggregate supply
(AS) – 1.3; AD/AS Analysis – 1.4.
1.1. Circular Flow of Income
The circular flow of income = This is how money moves between various economic agents in an
economy through the process of trade and exchange.
Domestic consumption = This is when money flows to firms from households in exchange for goods
and services.
Income = This is when money flows to households from firms in exchange for the supply of labour.
The model:
Injection = This is money that enters the model, e.g:
Investment = This is money spent on firms to
increase their output (I).
Government spending = This is money in the
form of fiscal policy (G).
Exports = This is money spent on UK products
by other countries (X).
Leakages/withdrawals = This is money that leaves, e.g:
Savings = This is money people put in the bank to earn interest (S).
Taxes = This is money taken by the government (T).
Imports = This is money spent by the UK on products from other countries (M).
Gross Domestic Product (GDP) = This is the value of the country’s economy; it is all the aspects of
the circular flow of income model added together. You can calculate a country’s GDP by:
• National income = This is the value of what is earnt in an economy (NI).
• National expenditure = This is the value of all spending in an economy (NE).
• National output = This is the value of everything produced in an economy (NO).
• They are all the same thing: NI = NE = NO.
Closed economy = This is when money cannot enter or leave the circular flow of income.
Open economy = This is when money can enter and leave the economy.
• When injections > withdrawals the economy will get bigger.
• When injections < withdrawals the economy will get smaller.
• When injections = withdrawals the economy will stay the same size.
CAI PUGH 1
, Economy Growing Economy Shrinking
More jobs are created, so there is more Fewer jobs, so there is less spending.
spending.
Less need to spend on benefits. More need to spend on benefits.
More government tax revenue for investment. Less government tax revenue for investment.
Higher firm profits to expand, so they will Lower firm profits to expand, so they will
become more internationally competitive. become less internationally competitive.
1.1.1. The Multiplier Effect
The multiplier effect = This is when a change in injections causes a larger final change in GDP.
Fiscal multiplier = This is when the initial trigger is caused by government expenditure.
• Multiplier (K) = Change in real GDP (Y) / Change in Injections (J)
• K = Y/J
Factors affecting the multiplier include:
1. Propensity to spend on domestic products = In the UK, we tend to favour imports over
domestic, whereas in USA people are more passionate about buying domestic products.
2. Propensity to save = In Japan, people are very quick to save any extra income, whereas
people in the UK are far more likely to spend.
3. Marginal rate of tax = The UK has a fairly high rate of tax meaning a lot of extra income will
simply leave the economy, whereas in parts of Eastern Europe it is much lower.
4. Consumer confidence = Typically, during a time of economic growth the multiplier will be
larger than in a recession.
1.2. Aggregate Demand
Aggregate demand = This is the total amount of demand for goods and services in the economy.
The five categories:
Category Explanation
Domestic Consumption (C) This is the domestic produce purchased by
people within the UK.
Investment (I) This is the money spent by firms on buildings,
machinery and improving the skills of the
labour force.
Government Spending (G) This is money spent by the government on a
product or service.
Imports (M) These are the goods and services that are
purchased from other countries.
Exports (X) These are the goods and services sold to other
countries.
CAI PUGH 2
, 1.2.1. Calculating Aggregate Demand
Everything is added to the total except from the imports,
which is subtracted:
AD = C + I + G + (X – M)
1.2.2. The AD Curve
• At a price level of PL1, there is an aggregate demand
of Y1.
• As the price level falls to PL2, people increase con-
sumption (C)
• As prices fall, other countries look to purchase from
the UK and exports rise (X)
• As the price of goods from other countries has not
changed, people turn towards the relatively cheaper lo-
cal produce and imports fall (M)
• For all of these reasons, aggregate demand extends
to point B (Y2)
Anything that triggers a change in a component of AD
other than the price level will lead to a shift of the AD
curve:
• To the right if more is demanded (or imports fall).
• To the left if less is demanded (or imports rise).
CAI PUGH 3
