1
AS ECONOMICS: THE NATIONAL ECONOMY
3.2.1 – The measurement of macroeconomic performance
3.2.1.1 The objectives of government economic policy
Four factors considered when measuring macroeconomic success
Economic Ideally our capacity to produce goods will grow over time
growth - Higher output = more affluent (richer) economy, as value of output =
value of incomes for workers and owners of FOP
- Steady rate of growth desired (no recessions)
Full employment Ideally we will have an efficient economy in which all resources are used
and everyone able and willing has a job
- High employment increases welfare of society
Price stability Ideally we will have control over prices and low inflation (2%)
Balance of trade Ideally exports will be greater than or equal to imports
Smaller objectives:
- Achieving an equitable distribution of income i.e. income equality (minimising
the margin between the rich and the poor)
- Balancing the budget → fiscal austerity/fiscal stimulus
3.2.1.2 Macroeconomic indicators
Economic indicators Economic statistics that provide information about:
- The expansions and contractions of business cycles
Performance indicators Provides information for judging the success or failure of a
particular type of government policy
- Lead indicators: provide information about the future state
of the economy
- Lag indicators: provide information about past and possibly
current economic performance, and the extent to which
policy objectives have been achieved
Policy objectives Targets or goals that government wants to achieve
Policy instruments Techniques used by government to achieve policy objectives
1|T. Chaudhary
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Policy objective Policy instruments Policy indicators
Full employment Monetary policy Claimant count figures
Fiscal policy ILO statistics
Supply-side policy Labour force survey
Economic growth Monetary policy GDP
Fiscal policy GDP per capita
Supply-side policy
Stable prices Monetary policy RPI
Fiscal policy CPI
Supply-side policy
Balance of payments Monetary policy % of GDP
Fiscal policy ONS figures
Supply-side policy
3.2.1.3 Uses of index numbers
Index numbers
Index number A weighted average of a group of items compared to a given base value
that is typically 100
- In the following years, percentage increases and decreases cause
changes in the index number relative to the previous year
- Therefore enable accurate comparisons to be made over time
Measurement of inflation
Weighting Where a commodity is given a weighting proportional to its importance in the
general pattern of consumer spending
Calculating index numbers:
1. Select a base year and give the index number 100 to all goods
EG: Apples = 50p = Index 100
2. Calculate annual percentage price increase for the good and apply this to index
EG: Apples = 75p = Increase of 50% = Index 150
3. Weight and average all figures to get an overall index figure
EG: Apples = 150 (x weight: 2), Plums = 120 (x weight 1) → Inflation = 420/3 = 140
4. Take 100 from this figure to get an overall figure for inflation
140 – 100 = 40 → Inflation = 40% from Year 1 to Year 2
3.2.2 – How the macroeconomy works: the circular flow of income,
AD/AS analysis, and related concepts
3.2.2.1 The circular flow of income
Flow Something measured over a specific period of time e.g. income
Stock Something that has value at a point in time e.g. wealth is the stock of assets
National wealth Stock of all goods that exist at a point in time that have value in the
economy
National income Flow of new output produced by the economy in a particular period (also
called national output and national product)
2|T. Chaudhary
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National income = national output = national expenditure
- National output measures actual goods and services produced by the economy
- National income measures the incomes received by labour and other FOP when
producing the goods and services
- National expenditure shows the spending of these incomes on goods and services
The four sector economy
Injection Spending entering the circular flow of income
- Investment, government spending and exports
- Increases national income/output/expenditure
Withdrawal Leakage of spending power out of the circular flow of income
- Savings, taxation and imports
- Reduces national income/output/expenditure
Planned saving = planned National income in equilibrium
investment
Injections = withdrawals National income in equilibrium
Injections > withdrawals National income rising
Injections < withdrawals National income falling
3.2.2.2 Aggregate demand and aggregate supply analysis
Aggregate demand Total planned demand for final goods and services produced in an
economy at a given price level in a given time period, made up of:
- Consumption (C)
- Investment (I)
- Government Expenditure (G)
- Net Exports (Exports = X, Imports = M)
The identity for aggregate demand is: C + I + G + (X – M)
Aggregate supply Total planned supply of goods and services produced within an
economy at a given price level in a given time period
The interaction of these two forces produces a macroeconomic equilibrium
Macroeconomic equilibrium
Equilibrium national income Level at which AD=AS or when withdrawals=injections
3|T. Chaudhary
, 4
Aggregate demand
Increase in AD Decrease in AD
AD1 → AD2 = rise in output and prices 1. Reduction in aggregate demand
AD2 → AD3 = small rise in output and great rise in prices
2. Unemployment → fall in national
Beyond AD3 = no change in output and rise in prices
(INFLATION)
income
3. Business expectations fall
1. Aggregate demand rises faster than 4. Investment falls
aggregate supply 5. Government tax income falls
2. Inflation occurs 6. Benefit expenditure rises
3. Increase in imports 7. Budget deficit
4. Balance of payments deficit
Economic shocks
Demand-side shock An unexpected event that increases/decreases AD rapidly
- Changes in spending due to the ‘wealth effect’
- Interest rates
- Tax rates
- Exchange rates
Supply-side shock An unexpected event that increases/decreases AS rapidly
- Changes in price of raw materials e.g. oil
- Indirect taxes such as VAT
- Subsidies
- Immigration
3.2.2.3 The determinants of aggregate demand
Aggregate demand
Why the AD curve slopes downwards
- Lower prices → wealth effect
- Consumers buy more at lower prices
- Fall in price of UK goods → fall in price of UK exports
- Fall in price of UK goods → rise in price of UK imports
- Consumers expect prices to rise → increased consumption
4|T. Chaudhary
AS ECONOMICS: THE NATIONAL ECONOMY
3.2.1 – The measurement of macroeconomic performance
3.2.1.1 The objectives of government economic policy
Four factors considered when measuring macroeconomic success
Economic Ideally our capacity to produce goods will grow over time
growth - Higher output = more affluent (richer) economy, as value of output =
value of incomes for workers and owners of FOP
- Steady rate of growth desired (no recessions)
Full employment Ideally we will have an efficient economy in which all resources are used
and everyone able and willing has a job
- High employment increases welfare of society
Price stability Ideally we will have control over prices and low inflation (2%)
Balance of trade Ideally exports will be greater than or equal to imports
Smaller objectives:
- Achieving an equitable distribution of income i.e. income equality (minimising
the margin between the rich and the poor)
- Balancing the budget → fiscal austerity/fiscal stimulus
3.2.1.2 Macroeconomic indicators
Economic indicators Economic statistics that provide information about:
- The expansions and contractions of business cycles
Performance indicators Provides information for judging the success or failure of a
particular type of government policy
- Lead indicators: provide information about the future state
of the economy
- Lag indicators: provide information about past and possibly
current economic performance, and the extent to which
policy objectives have been achieved
Policy objectives Targets or goals that government wants to achieve
Policy instruments Techniques used by government to achieve policy objectives
1|T. Chaudhary
,2
Policy objective Policy instruments Policy indicators
Full employment Monetary policy Claimant count figures
Fiscal policy ILO statistics
Supply-side policy Labour force survey
Economic growth Monetary policy GDP
Fiscal policy GDP per capita
Supply-side policy
Stable prices Monetary policy RPI
Fiscal policy CPI
Supply-side policy
Balance of payments Monetary policy % of GDP
Fiscal policy ONS figures
Supply-side policy
3.2.1.3 Uses of index numbers
Index numbers
Index number A weighted average of a group of items compared to a given base value
that is typically 100
- In the following years, percentage increases and decreases cause
changes in the index number relative to the previous year
- Therefore enable accurate comparisons to be made over time
Measurement of inflation
Weighting Where a commodity is given a weighting proportional to its importance in the
general pattern of consumer spending
Calculating index numbers:
1. Select a base year and give the index number 100 to all goods
EG: Apples = 50p = Index 100
2. Calculate annual percentage price increase for the good and apply this to index
EG: Apples = 75p = Increase of 50% = Index 150
3. Weight and average all figures to get an overall index figure
EG: Apples = 150 (x weight: 2), Plums = 120 (x weight 1) → Inflation = 420/3 = 140
4. Take 100 from this figure to get an overall figure for inflation
140 – 100 = 40 → Inflation = 40% from Year 1 to Year 2
3.2.2 – How the macroeconomy works: the circular flow of income,
AD/AS analysis, and related concepts
3.2.2.1 The circular flow of income
Flow Something measured over a specific period of time e.g. income
Stock Something that has value at a point in time e.g. wealth is the stock of assets
National wealth Stock of all goods that exist at a point in time that have value in the
economy
National income Flow of new output produced by the economy in a particular period (also
called national output and national product)
2|T. Chaudhary
,3
National income = national output = national expenditure
- National output measures actual goods and services produced by the economy
- National income measures the incomes received by labour and other FOP when
producing the goods and services
- National expenditure shows the spending of these incomes on goods and services
The four sector economy
Injection Spending entering the circular flow of income
- Investment, government spending and exports
- Increases national income/output/expenditure
Withdrawal Leakage of spending power out of the circular flow of income
- Savings, taxation and imports
- Reduces national income/output/expenditure
Planned saving = planned National income in equilibrium
investment
Injections = withdrawals National income in equilibrium
Injections > withdrawals National income rising
Injections < withdrawals National income falling
3.2.2.2 Aggregate demand and aggregate supply analysis
Aggregate demand Total planned demand for final goods and services produced in an
economy at a given price level in a given time period, made up of:
- Consumption (C)
- Investment (I)
- Government Expenditure (G)
- Net Exports (Exports = X, Imports = M)
The identity for aggregate demand is: C + I + G + (X – M)
Aggregate supply Total planned supply of goods and services produced within an
economy at a given price level in a given time period
The interaction of these two forces produces a macroeconomic equilibrium
Macroeconomic equilibrium
Equilibrium national income Level at which AD=AS or when withdrawals=injections
3|T. Chaudhary
, 4
Aggregate demand
Increase in AD Decrease in AD
AD1 → AD2 = rise in output and prices 1. Reduction in aggregate demand
AD2 → AD3 = small rise in output and great rise in prices
2. Unemployment → fall in national
Beyond AD3 = no change in output and rise in prices
(INFLATION)
income
3. Business expectations fall
1. Aggregate demand rises faster than 4. Investment falls
aggregate supply 5. Government tax income falls
2. Inflation occurs 6. Benefit expenditure rises
3. Increase in imports 7. Budget deficit
4. Balance of payments deficit
Economic shocks
Demand-side shock An unexpected event that increases/decreases AD rapidly
- Changes in spending due to the ‘wealth effect’
- Interest rates
- Tax rates
- Exchange rates
Supply-side shock An unexpected event that increases/decreases AS rapidly
- Changes in price of raw materials e.g. oil
- Indirect taxes such as VAT
- Subsidies
- Immigration
3.2.2.3 The determinants of aggregate demand
Aggregate demand
Why the AD curve slopes downwards
- Lower prices → wealth effect
- Consumers buy more at lower prices
- Fall in price of UK goods → fall in price of UK exports
- Fall in price of UK goods → rise in price of UK imports
- Consumers expect prices to rise → increased consumption
4|T. Chaudhary
