Unit 2: Macroeconomic Performance and Policy

Economic growth is the percentage increase in real GDP: the inflation-adjusted value of goods and services produced within an economy. $growth=(real\ GDP_t-real\ GDP_{t-1})/real\ GDP_{t-1}\times100$.

Growth can raise material living standards when it increases real output and real income per person, supporting consumption, employment and tax-funded services.

$GNI = GDP + net\ primary\ income\ from\ abroad$. Net primary income is residents' income received from overseas minus income paid overseas to non-residents.

For living-standard change, prefer real per-capita data: deflate nominal output and then divide by population. $GDP\ per\ capita=GDP/population$. Preserve units when moving between billions and millions.

Use the same measure, price basis, currency treatment and time interval. Compare percentage growth rates rather than raw changes when economies begin at different sizes, and distinguish a one-period movement from a sustained trend.

Purchasing Power Parity (PPP) converts incomes using the relative price of a comparable basket of goods and services. It asks how much currency is needed in each country to buy equivalent purchasing power.

PPP-adjusted real GDP or GNI reduces distortions from market exchange rates and different price levels, making international comparisons of material output or income more meaningful.

A positive rate that falls from 4% to 1% is slower growth, not contraction. A negative rate means the level of real GDP fell during that period.

In this syllabus, a recession is two consecutive quarters of negative real GDP growth. Both adjacent quarterly growth rates must be below zero.

A recession can reduce income, consumption, profits, investment and tax receipts while increasing unemployment and welfare spending. Its scale depends on depth, duration, policy response and affected sectors.

Use real per-capita PPP data and supporting social/environmental indicators, while recognising that measurement quality and national conditions differ.

Wellbeing indicators may include self-reported life satisfaction alongside health, education, employment, security, relationships, environment, leisure and material living standards.

Higher real income can raise subjective happiness by meeting needs, reducing financial insecurity and widening choices. The gain may weaken at higher incomes, and distribution, working conditions, health, freedom and environment can outweigh the income effect.

If inflation falls from 6% to 2%, prices are still rising and the price level is higher. Only a negative inflation rate indicates deflation.

Select a representative basket, measure household expenditure shares as weights, collect prices, set a base-year index (usually 100), and combine price relatives using the weights.

For weighted percentage changes: $inflation=\sum(weight\times percentage\ price\ change)/100$. Between index values: $inflation=(CPI_t-CPI_{t-1})/CPI_{t-1}\times100$.

With 80% spent on an item rising 25% and 20% on an item rising 20%, inflation is $(80\times25+20\times20)/100=24\%$.

Regularly update items and weights so new products and changed consumption patterns enter, while obsolete items leave. This improves representation but cannot remove household-specific differences.

A producer or wholesale price index measures changes in prices received by producers or paid for inputs at an earlier stage of production.

Rising input or factory-gate prices can increase firms' costs and later feed into consumer prices if firms pass them on. Falling producer prices may signal weaker future cost pressure.

Trace the initiating change through AD or SRAS and state conditions. Wage growth can be demand-pull through consumption and cost-push through labour costs; context decides which chain dominates.

Demand-deficient deflation is often damaging because output and employment fall. Supply-driven price falls can accompany higher real output and real income.

Impact depends on expected versus unexpected change, wage/indexation, cause, rate, duration, indebtedness, spare capacity and trading partners' inflation.

Under the ILO measure, an unemployed person is without work, has actively sought work in the previous four weeks and is available to start within the next two weeks. A labour-force survey identifies people meeting these conditions.

$unemployment\ rate=unemployed/labour\ force\times100$. The labour force is employed plus unemployed people, not the total population.

Identify the labour-market mechanism, not only the industry. A recession points to demand deficiency; technology can create structural unemployment when displaced workers cannot readily fill new jobs.

Long unemployment can erode human capital and employability, turning a cyclical loss into a more persistent structural problem.

A graduate in a job that does not require their skills may be skill-underemployed. A part-time worker wanting and available for more hours may be time-underemployed.

A lower unemployment rate can mean people found work, but it can also mean unemployed people became inactive. A higher employment rate is stronger evidence of increased use of labour, though population composition and underemployment still matter.

$net\ migration=immigration-emigration$. Positive net migration means more people arrive than leave.

The balance of payments records all transactions between residents and the rest of the world. Accounting entries balance overall once financial flows, reserves and errors/omissions are included.

$trade\ balance\ in\ goods\ and\ services=X-M$. A surplus is positive because exports exceed imports; a deficit is negative because imports exceed exports.

Calculate each period's balance first, preserving negative signs, then subtract the earlier balance from the later one. Moving from -$10bn to -$4bn is a $6bn improvement even though the balance remains in deficit.

$current\ account=trade\ in\ goods+trade\ in\ services+primary\ income+secondary\ income$. A positive total is a surplus; a negative total is a deficit.

A deficit means current-account outflows exceed inflows and must be matched by corresponding financial/capital entries and reserve or error adjustments. A surplus means current-account inflows exceed outflows.

Aggregate demand (AD) is total planned expenditure on domestically produced final goods and services at each average price level in a given period.

The AD curve slopes downward in price-level/real-output space: a lower price level raises the real value of money balances, can reduce interest-rate pressure and makes domestic output relatively competitive, increasing planned real expenditure.

$AD=C+I+G+(X-M)$: household consumption, investment, government expenditure and net exports.

To find a missing component, rearrange the identity and preserve the sign of net exports. Savings, taxes and transfers are not added as separate AD components.

Higher consumption, investment, government expenditure or net exports shifts AD right; lower planned expenditure shifts it left.

State the determinant, its effect on disposable resources/incentives/confidence, the change in consumption and therefore the direction of AD.

Disposable income is either consumed or saved: $Y_d=C+S$. Therefore $S=Y_d-C$ for a given period.

With disposable income fixed, more saving means less consumption and more consumption means less saving. When income changes, consumption and saving can both rise, so the relationship is not always a one-for-one movement in observed totals.

Because consumption is part of AD and saving is a withdrawal from the circular flow, a rise in saving at unchanged income tends to reduce AD in the short run.

The savings ratio is the percentage of household disposable income not spent on consumption.

$savings\ ratio=household\ saving/household\ disposable\ income\times100$.

If disposable income is $50,000 and consumption is$46,000, saving is $4,000 and the savings ratio is$4,000/$50,000\times100=8\%$.

A higher ratio usually lowers current consumption, shifts AD left and increases withdrawals; a lower ratio usually raises consumption, shifts AD right and may raise real output and the price level.

$net\ investment=gross\ investment-depreciation$. Positive net investment expands the capital stock; zero maintains it; negative means depreciation exceeds gross investment.

Investment depends on expected return relative to financing cost, so one influence may be outweighed by uncertainty, spare capacity or weak demand.

If firms respond, investment raises AD immediately and can expand productive capacity and LRAS later. The size depends on confidence, demand, credit, policy credibility and project eligibility.

Only government purchases of current goods/services and capital enter $G$ directly in AD. Transfer payments influence AD indirectly when recipients consume.

Exchange-rate effects depend on demand elasticities, contracts, imported inputs and time lags. Values can initially respond differently from quantities.

Aggregate supply (AS) is the total real output that firms in an economy plan to produce at each average price level during a given period.

AS must be interpreted with a time horizon. Short-run aggregate supply reflects current input costs and some fixed resources; long-run aggregate supply reflects the economy's productive capacity.

A conventional short-run AS curve slopes upward: at a higher average price level, firms can find it profitable to raise real output while some wages and other input costs adjust more slowly.

As spare capacity is used, bottlenecks and rising marginal costs can make further output expansion increasingly inflationary. Long-run curve shapes are treated separately because they represent capacity rather than this short-run response.

Choose a price level on the vertical axis, move horizontally to the AS curve and then down to read planned real output.

A higher price level causes an extension along an upward-sloping AS curve; a lower price level causes a contraction. Lower production costs shift SRAS right, while greater productive capacity shifts LRAS right.

With AD fixed, SRAS left raises the price level and reduces real output; SRAS right lowers the price level and raises real output.

The size depends on import dependence, firms' ability to absorb costs, spare capacity, duration and simultaneous AD changes. A net energy exporter may gain income from higher world prices even while domestic users face higher costs.

On the Keynesian curve, the effect of an AD shift depends on the economy's starting segment. Near the vertical section, extra demand mainly raises the price level; on the horizontal section, it mainly raises real output.

A rightward LRAS shift raises potential real output and, with AD fixed, tends to lower the equilibrium price level. A leftward shift reduces capacity and tends to raise the price level.

Effects depend on labour-force participation, skill match, implementation, time lags and whether policies genuinely improve productive efficiency. Net migration can shift both LRAS through labour supply and AD through spending.

The circular flow links households and firms. Households supply factors of production and receive income; they spend on firms' output, creating revenue that funds further production and income.

For the economy, one person's spending is another's income: output, expenditure and income are alternative measures of the same production flow.

Income can be consumed or saved; saving adds to wealth. Wealth can generate income or affect consumption through confidence and collateral.

Net injection is $I+G+X-(S+T+M)$. Its sign indicates whether these flows add to or remove from the circular flow, other things equal.

An increase in an injection, with withdrawals unchanged, raises firms' revenue, output and income and can trigger a positive multiplier process.

An increase in a withdrawal, with injections unchanged, reduces domestic revenue, output and income and can trigger a negative multiplier process.

As income changes, saving, tax and imports respond, so withdrawals move until planned injections equal planned withdrawals at a new equilibrium.

Reflationary fiscal policy can raise $G$ or reduce $T$; deflationary policy can reduce $G$ or raise $T$. Trade surpluses add net export injection, while deficits create net withdrawal through trade.

Equilibrium real national output is the level of real output/income at which planned aggregate demand equals planned aggregate supply. In circular-flow terms, planned injections equal planned withdrawals.

If planned expenditure exceeds current output, inventories fall unexpectedly and firms expand production. If output exceeds planned expenditure, inventories accumulate and firms contract production.

Identify the determinant, shift the relevant curve, locate the new intersection and compare both coordinates. Consumption, investment, government expenditure and net exports shift AD; short-run costs or long-run capacity shift AS.

The size of the output response depends on spare capacity and the AS shape. With classical vertical LRAS, an AD shift changes the long-run price level but not potential output.

The multiplier is the ratio of the final change in national income to the initial autonomous injection: $k=\Delta Y/initial\ injection$.

An injection becomes income for workers and firms. They spend a fraction of that extra income, creating another person's income; each round is smaller because saving, tax and imports withdraw part of the addition. The rounds continue until the remaining additions are negligible.

A fall in autonomous spending starts the same chain in reverse, so national income can fall by more than the initial withdrawal.

In a closed simplified model, $MPC+MPS=1$. With proportional tax/import leakages, $MPW=MPS+MPT+MPM$ and a larger MPW means a smaller multiplier.

If $MPC=0.6$, then $k=1/(1-0.6)=2.5$. An initial $4$ billion injection gives a final income increase of $2.5\times4=10$ billion, ceteris paribus.

If $k=5$, then $MPW=1/5=0.2$ and, in the simplified MPC formula, $MPC=1-0.2=0.8$.

An autonomous change in $C$, $I$, $G$ or $X-M$ shifts AD initially. The multiplier process makes the eventual shift in AD and national income larger than the first spending change.

The multiplier helps estimate fiscal, investment or export shocks, but estimates vary with the cycle, distribution, openness, tax system and time horizon.

Actual growth is movement of current output; potential growth is outward movement of capacity. Actual output can rise towards unchanged capacity, while capacity can rise without being fully used.

Aggregate demand is $AD=C+I+G+(X-M)$. A rise in consumption, investment, government expenditure or net exports shifts AD to the right, ceteris paribus.

With spare capacity, firms can respond mainly by raising real output and employment. Near full capacity, the same AD increase is more likely to raise the price level and produce less real growth.

Export-led growth occurs when expanding exports are a major driver of rising real GDP. Stronger foreign demand raises $X$, net exports and aggregate demand.

Higher exports increase firms' orders and revenue, so they expand output and employment. The new incomes generate further consumption through the multiplier. Repeated access to larger markets can also encourage investment, specialisation, learning and economies of scale.

These changes increase the quantity or productivity of factors of production, shifting LRAS to the right and moving the production possibility frontier outwards.

The effect depends on implementation and quality: investment can be misallocated, migration's impact depends on skills and participation, and excessive or weak competition can reduce innovation incentives.

Productivity measures output per unit of input, commonly real output per worker or per hour worked. For labour productivity: $productivity=real\ output/labour\ input$.

Higher productivity lets the same labour and other inputs produce more. It can lower unit costs, improve competitiveness and shift LRAS to the right, raising potential growth.

If lower costs improve net exports or higher expected returns stimulate investment, AD may also rise. However, the new capacity produces actual growth only when there is sufficient demand to use it.

Benefits depend on growth per person, distribution, sustainability, spare capacity and the type of output. Real GDP can grow while median living standards stagnate or environmental quality falls.

The size of each cost depends on the source, pace and policy framework of growth. Cleaner technology, carbon pricing, redistribution and supply expansion can alter the trade-offs.

The actual growth rate is the percentage change in real GDP over a period: $((real\ GDP_t-real\ GDP_{t-1})/real\ GDP_{t-1}) imes100$. The long-term trend growth rate is the estimated sustainable average rate at which potential output grows.

The output gap is the difference between actual real output and estimated potential real output, often expressed as a percentage of potential output: $gap=((Y-Y^*)/Y^*) imes100$.

Identify actual equilibrium output, identify potential output at LRAS, compare their horizontal positions, and label the distance between them. A leftward AD shift can create or widen a negative gap.

A positive gap commonly follows AD exceeding sustainable capacity; a negative gap commonly follows deficient AD. Supply shocks and changing potential output can also change the gap, so diagnose both actual and potential output.

These are tendencies, not definitions. Inflation can coexist with a negative gap after an adverse supply shock, and unemployment never falls to zero because frictional and structural unemployment remain.

Actual GDP is estimated, but potential output cannot be directly observed. Analysts must estimate the output consistent with sustainable factor use and stable inflation.

Two credible estimates may differ in size or even sign, and real-time estimates can be revised later. Policy based on a falsely positive gap may be too tight; policy based on a falsely negative gap may intensify inflation.

Governments seek sustained increases in real GDP and, especially, real GDP per capita. Actual growth raises current output; potential growth raises the economy's sustainable capacity.

Growth can raise employment, incomes, profits and the tax base, creating scope for higher material living standards and public services.

Low and stable inflation means a small, predictable rise in the general price level. An inflation target states the rate the monetary authority aims to achieve using monetary policy.

Low unemployment means that most people willing and able to work can find employment. It reduces lost output and skills, poverty, benefit spending and the social costs of joblessness.

The objective is not zero unemployment: frictional job search remains, and structural mismatch may persist even when aggregate demand is strong.

Current-account equilibrium means avoiding a persistent, unsustainable deficit or surplus in trade in goods and services, primary income and secondary income.

A large persistent deficit may require continuing external finance and create debt or exchange-rate vulnerability; a large persistent surplus can indicate weak domestic demand and impose adjustment pressure on partners.

Balance can limit debt accumulation and interest costs, but the appropriate balance depends on the economic cycle and the quality of spending.

Greater income equality means narrowing excessive differences in disposable income, often through progressive taxes, transfers, public services and wider access to education and employment.

The short-run Phillips curve shows a possible inverse relationship between inflation and unemployment. Stronger AD can reduce cyclical unemployment but create demand-pull inflation and wage pressure.

The curve can shift after supply shocks or changed inflation expectations. Supply-side improvement can reduce inflation and unemployment together, so the trade-off is neither fixed nor guaranteed.

Growth based on fossil energy, extraction and congested production can raise emissions, waste and resource depletion. Environmental rules or taxes may raise firms' short-run costs and slow measured output growth.

The objectives can align when clean innovation, renewable infrastructure, energy efficiency and pollution pricing shift production toward lower external cost. Better environmental quality can also protect health and productivity.

Evaluate the source of growth, time horizon, technology and policy design. A temporary investment cost may enable cleaner potential growth later.

If domestic inflation persistently exceeds that of trading partners, domestic exports become less price competitive and imports relatively attractive, tending to worsen the current account, ceteris paribus.

Deflationary policy may lower inflation and imports, improving the current account, but can reduce growth and employment. Exchange-rate appreciation may lower imported inflation yet worsen net exports.

Effects depend on exchange rates, elasticities, non-price competitiveness, imported input costs and supply capacity.

Growth can widen inequality when gains accrue mainly to asset owners, high-skilled workers, profitable regions or capital-intensive firms.

Growth can narrow inequality when it creates broad employment, raises low wages, finances public services and is paired with progressive taxes, transfers and access to skills.

Compare real disposable incomes across the distribution, not just average GDP per capita. The source, ownership and policy treatment of growth determine the outcome.

Supply-side policies aim to increase productivity, competition and incentives, raising sustainable productive capacity and shifting LRAS right.

Successful policy can raise potential growth and employment while easing inflation pressure. Some measures also raise AD in the short run.

Results require genuine competition and capable regulation. Deregulation can weaken worker, consumer or environmental protection; lower tax or benefits can worsen inequality and public finances.

Infrastructure and training spending can raise AD now and LRAS later. Separate the multiplier effect from the eventual productivity effect.

Market policies may be quicker and cheaper but can create market failure; intervention can correct coordination and finance gaps but risks government failure.

Reflationary policy raises AD to support output and employment; deflationary policy lowers AD to reduce demand-pull inflation or external/budget imbalance.

Higher government purchases directly raise $G$ in AD; cuts reduce it. Infrastructure may additionally raise LRAS if it improves productivity.

Lower income tax can raise disposable income and consumption; lower profit tax can raise retained profit and investment; indirect-tax changes can affect both prices/costs and demand.

Changes in spending or tax begin multiplier rounds, but saving, tax and imports leak income. Tax changes depend on households' and firms' responses.

Tightening reverses these directions: borrowing and spending fall, saving is encouraged, credit creation slows and inflation pressure may ease.

The reserve requirement is the share of deposits banks must hold rather than lend. QE is asset purchase with newly created central-bank money, not ordinary government spending.

Lender-of-last-resort support can prevent a liquidity crisis spreading, but conditions and supervision are needed to limit moral hazard.

Fiscal policy can target groups, regions and infrastructure but faces political/implementation lags and debt cost. Monetary policy can change quickly and independently but is broad, uncertain and weak near very low rates or during credit stress.

A policy mix can combine demand stabilisation with supply-side measures, but conflicting settings can offset each other.