4. The Macroeconomy

The flow must be dated and measured consistently. Domestic and national concepts differ according to whether factor income crosses borders.

Wages, rent, interest and profits generated by production over one year contribute to national income, even though the underlying assets are stocks.

Use the geographic boundary and depreciation adjustment explicitly. A country can have GDP above GNI if more factor income flows abroad than in; NNI is lower than GNI when depreciation is positive.

GDP £1,000bn plus net factor income from abroad £20bn gives GNI £1,020bn; subtracting £70bn depreciation gives NNI £950bn.

State which valuation is used before adjusting; otherwise the sign can be reversed.

If GDP at market prices is 900, product taxes are 80 and subsidies are 20, GDP at basic prices is 840.

The adjustment removes the amount needed to maintain the productive capital stock. Do not subtract every business cost or intermediate input.

If GNI is 1,020 and depreciation is 70, NNI is 950 in the same currency units.

Real flows are resources and goods; money flows are wages, rent, interest, profits and expenditure. Each receipt for one sector is spending or income for another.

A household receives wages from a firm, buys its output, pays tax to government and may buy an imported good; exports bring spending into the domestic flow.

In a simple model, total injections equal total leakages when the circular flow is stable. A change in one component affects income and output through linked spending, even when the multiplier is not calculated.

A rise in government infrastructure spending is an injection; households saving more is a leakage. If injections exceed leakages, national income tends to expand initially.

Suppose $I=150$, $G=200$, $X=100$, while $S=100$, $T=180$ and $M=120$. Injections are $450$ and leakages are $400$, so there are net injections of $50$ and national income tends to rise. Equilibrium would require one or more flows to adjust until the £50 gap closes.

An AD curve places the average price level on the vertical axis and real output demanded on the horizontal axis. Each point is an economy-wide planned-spending outcome at a different price level, not a single money total detached from prices.

If $C=500$, $I=120$, $G=180$, $X=90$ and $M=110$, net exports are $-20$ and $AD=500+120+180-20=780$. Use values from the same period and units.

A determinant that increases planned spending shifts AD right; one that reduces it shifts AD left. Trace the component before drawing the curve.

A lower interest rate may raise consumption and investment, shifting AD right; a fall in foreign income can reduce exports and shift AD left.

A lower price level can increase real purchasing power, reduce interest rates and improve net exports, so planned real expenditure rises. These are mechanisms, not movements of the curve’s determinants.

A fall in the domestic price level can make exports more competitive and reduce the money needed for transactions, increasing real output demanded along AD.

State assumptions when they matter. A depreciation raises net exports only if export/import volumes respond sufficiently; a tax cut's effect depends on households' spending response; supply-side effects of the same policy are analysed separately.

An AS curve places the average price level on the vertical axis and real output supplied on the horizontal axis. The short-run and long-run versions differ because costs and productive capacity adjust differently over time.

SRAS describes production while some input prices, contracts or capacity are fixed. LRAS describes sustainable output after adjustment. Moving along a curve uses existing capacity; expanding capacity requires an outward shift.

A sudden imported-oil price rise shifts SRAS left because firms' costs increase; it need not reduce long-run capacity. Net investment above depreciation expands capital stock, shifting LRAS right and potentially SRAS right as new capacity becomes usable.

Identify the changed variable first, then decide whether the new equilibrium lies on the old curve or requires a new curve.

A higher price level moves the economy along AD; a tax change that alters consumption shifts AD. A wage shock shifts SRAS; a higher price level alone does not.

If AD exceeds AS at the current price, firms see unintended stock falls and may increase output; if AS exceeds AD, inventories rise and output pressure weakens.

The intersection of AD and SRAS gives short-run output and price level; compare it with LRAS to judge whether output is above or below sustainable capacity.

An AD increase near a highly elastic section raises output/employment with little price pressure; near vertical capacity it is mainly inflationary. An SRAS contraction creates stagflation: higher prices with lower output and employment.

With simultaneous shifts, combine only definite directions. AD right plus SRAS left definitely raises the price level, but real output/employment are ambiguous. AD left plus SRAS right definitely lowers the price level, but output/employment are ambiguous. Compare relative shift sizes for the uncertain variable.

After a recession, stronger demand can move an economy from idle resources toward its existing capacity: actual output grows. New capital and better technology can also expand the capacity itself, creating potential long-run growth.

If real GDP rises from $500bn to$515bn, growth is $(15/500)×100=3$5,000 to about $4,952 despite total growth.

The distinction matters whenever inflation is present. A base year gives a common price structure for a time series; the exact index method can differ, but the purpose is the same—separate quantity change from price change.

If nominal GDP rises 8% while the general price level rises about 5%, real output has grown by roughly 3% rather than 8% (the exact result depends on the index calculation).

A temporary export surge can lift AD and use idle factories, raising actual output. Investment in new machinery may also expand the capital stock and shift LRAS/PPC outward, so its long-run effect can outlast the initial demand increase.

The impact depends on spare capacity, scale, time lags, confidence and complementary resources. A larger workforce can raise total GDP but not necessarily GDP per person; technology that is not adopted may add no usable capacity.

Ask five questions: Is there spare capacity? Is growth demand-led or supply-led? Is it temporary or sustained? How are gains distributed? Are environmental and resource costs controlled? Growth near full capacity is more inflationary; productivity-led growth can expand output with less price pressure.

Long-run growth may require a short-run opportunity cost: resources used for capital goods, education or infrastructure cannot produce as many consumer goods now. The payoff depends on whether investment is productive and sustainable.

The definition separates unemployment from inactivity. It also differs from underemployment, where someone has work but wants more hours or a better use of their skills.

Someone who has lost a job, can start next week and has applied for vacancies is unemployed. A full-time student who is not seeking work is economically inactive, even though they have no job.

If 2 million people are unemployed in a labour force of 40 million, the unemployment rate is 5%. A rise from 7.4% to 11.9% is 4.5 percentage points, or about a 60.8% increase relative to the original rate.

Technological unemployment is a specifically technology-caused form of structural unemployment: whether the exam expects the narrower or broader label depends on the options and wording. A worldwide permanent fall in demand for one product can be structural; a temporary economy-wide fall in AD is cyclical.

Severity depends on duration, numbers affected, regional concentration, mobility, retraining time and recovery prospects. Frictional unemployment can improve job matching; structural or technological unemployment may persist, while cyclical unemployment can spread across the whole economy.

In a recession, firms cut jobs and household spending falls, reinforcing weak AD. Tax receipts fall while benefit payments rise. If trained workers remain unemployed for years, lost skills and detachment can make recovery harder even after demand returns.

Cyclical unemployment may affect many industries but can reverse with recovery; structural or technological unemployment may be concentrated yet persist without retraining or mobility. Compare duration, scale, lost income/output and ease of remedy before judging seriousness.

Use the rate and the price level together. A fall from 8% to 3% inflation is disinflation, not deflation. Deflation can raise the real burden of debt and encourage delayed spending, but its effects depend on expectations and causes.

If an index moves from 100 to 108 and then to 111, inflation has slowed from 8% to about 2.8%; prices have not returned to 100.

Suppose spending weights are food 20%, clothing 10%, housing 40% and transport 30%. If their prices change by −2%, +4%, +10% and 0%, the weighted change is −0.4+0.4+4+0=4%. If CPI rises from 106.53 to 111.74, inflation over the interval is about 4.89%, not 5.21%.

Expectations can make either process persistent: workers and firms adjust wages and prices when they expect inflation. Imported inflation depends on exchange rates and foreign prices. Identify the initiating shock before naming the mechanism.

A consumer-spending boom can move AD right and raise the price level. A sudden energy-price rise can shift SRAS left, creating higher prices with weaker output—the pattern called stagflation.

With a fixed nominal interest rate of 4%, inflation of 6% gives a real return of about −2%: the lender or saver loses purchasing power while the borrower gains. If inflation falls to 3%, the real return becomes about +1%, even though prices are still rising.

Judge the cause, size, duration and predictability of inflation; indexation and bargaining power; how open the economy is; competitors’ inflation; exchange-rate movement; and the price elasticity of exports and imports. High, unexpected and prolonged inflation is usually more disruptive than low, stable inflation.