The Trade Cycle (Macroeconomics)

In the economy, there are times in which people spend more and manufacturers produce more. There are also periods in which the opposite occurs.. telling us that the amount of economic activity fluctuates over time. Economic activity refers to the level of spending, production and employment in the economy at any given time. More economic activity normally means increased economic growth.

Economic activity is measured by GDP, which stands for Gross Domestic Product - the value of all goods and services produced within the economy in a given time period. The trade cycle describes the fluctuation in economic activity over time.

Here we have a diagram that maps out the fluctuation in economic activity. At the peak of the trade cycle there is high levels of demand and investment, pay increases, profits are high, increased house prices and strong inflationary pressures. 

In the recession period there is negative growth, meaning GDP is falling.. for two successful quarters (6 months). In this time there is normally falling demand, low investment, rising unemployment and a fall in profits and confidence. 

The slump is when the economy has hit the bottom of the trade cycle.. The only way is up after that (hopefully!). Here we have high unemployment, very low levels of demand and investment and low inflation. 

Finally, the recovery period. This is when the economy starts growing again - GDP rises again. We'd expect a rise in incomes, output and employment here. Also, there should be increases in demand and investment as the economy starts to grow again. 

One of the government macroeconomic goals is to achieve stable economic growth - meaning these fluctuations aren't desirable. Therefore the government takes measures to try and avoid the worst effects of the trade cycle - these are called counter-cyclical policies. They are: 

• Changes in the tax levels.
• Changes in public spending.
• Interest rate changes. 

That is the lowdown on the trade cycle, hope it helps. Thanks for reading. 

Economic Growth (Macroeconomics)

Economic growth is when an economies Real GDP increases, so a sustained increase in real output and income in a period of time. It can be shown by an outward shift on a PPF curve or a rightward shift of AD on an AD/AS diagram, providing there's enough spare capacity in the economy.

Economic growth is caused by anything that increases AD, providing there is enough spare capacity available. What also causes it is increases in the efficiency in using factors of production. What can cause this is improvement in education and training, improving labour mobility, increasing competition and obtaining more factors of production.

The benefits of economic growth include:

• Increased output, employment and income.
• Improved standard of living.
• Improved health, education and public services.

However, there also costs of economic growth. These are:

• Degrading of the environment by using up resources and creating waste.
• Increased stress and a faster pace of life.
• Increased inequality, difference between rich and poor.

That's the basics of economic growth, you can come to your own conclusion about whether it is desirable in large quantities etc. Thanks.

The Circular Flow of Income (Macroeconomics)

The circular flow of income is basically exactly what it says it is, it shows the flow of income around the economy. It is best shown visually using this diagram:

This diagram shows the circular flow of income around the economy, as well as the flow of goods and factors of production. We can see "Rent, wages and profit" travelling from the firms to households. These are all payments for the factors of production you can see flowing in the opposite direction, from households to firms, next to the arrow. "Payment for goods and services" is flowing from households to firms and as you can see on the arrow next to that, goods and services are travelling in the opposite direction. So from this we can see that money flows around the economy in a circular motion, from firms to households and back to the firms again.

However, this would assume that no more money ever enters or leaves the economy, which we know is almost always untrue. So therefore, we can add a few more things to the diagram. Firstly injections into the economy. Injections means money being put into the economy from an external source. The three main types of injection and government spending, exports and investment. All three of these add additional money into the circular flow of income. Secondly leakages from the economy. This means money that exits the economy for one reason or another. The three main types of leakages are taxation, imports and savings. All these three factors reduce the amount of money in the circular flow of income.

That's it for the basics on the circular flow of income. Thanks for reading, sorry about the delay.

The Multiplier (Macroeconomics)

The Multiplier is a concept developed by John Maynard Keynes. He was a famous economist born in 1883, he passed away in 1946. His concept said that "any increase in injections into the economy (investment, government expenditure or exports) would lead to a proportionally bigger increase in National Income." Basically, this translates to any new money being pumped into the economy will have a larger effect on GDP than the initial injection.

Why is this? Well, because one persons spending is another persons income, and that income will increase their purchasing power and hence their spending.

Lets try an example. Say i had £100 in my pocket. I gave all that money to my friend for looking after my dog for the day. Then, that person puts £25 into savings and spends the remaining £75 on a new TV from a guy they met. This guy then saves £25 and uses the remaining £50 to pay a neighbor to wash his car. This cycle could go on and on, but lets leave it there and say the neighbor puts all £50 into savings. The initial £100 has now exited the economy. However, on its way through the economy it has had a larger effect on GDP. The £100 turned into (100+75+50) £225 worth of spending in the economy.. and thus shows that the multiplier is a true theory.

The multiplier has a few equations related to it:

• The Multiplier = 1 ÷ MPW
• Change in GDP = Initial injection x (1 ÷ MPW)

MPW stands for marginal propensity to withdraw. This is the proportion of any extra income that we save, spend on imports or is taxed. 

That's the theory behind the multiplier effect, briefly put. Thanks for reading. 

Aggregate Demand & Supply (Macroeconomics)

A classic AD/AS diagram has two axis. On the y axis (vertical one) we have price levels. Reading of this axis we will be able to see if the price levels in the economy have increased or decreased, thus seeing if there's been inflation or deflation in the economy. On the x axis (horizontal one) we have real GDP. The real part just means the figure has been adjusted slightly so it's in line with inflation. From the axis we will be able to read off the GDP of the economy so we can determine whether the economy has grown or shrunk. Also, we can determine from this axis whether unemployment has risen or fallen.

When we bring both aggregate demand and aggregate supply together and model them on the same diagram the two curves cross. This point is know as the macroeconomic equilibrium. This means both aggregate demand and aggregate supply are equal. 3 of the Governments's main objectives are to achieve full employment, low and stable inflation and to achieve steady economic growth. All of these can be viewed on an AD/AS diagram. Here is a standard AD/AS diagram:

As you can see, the AD curve hits the LRAS curve at the point where the LRAS curve begins to become vertical. This means that full employment has been achieved, or thereabouts. If AD was to shift to the left, it would mean unemployment has increased and the government would have to attempt to stimulate aggregate demand again to increase employment. It would do this by increasing any of the factors... (AD = C+I+G+(X-M)).

The government set the Bank of England the objective of stable prices (a target of 2% inflation). For this to be achieved, aggregate demand must not exceed the point of full employment on the diagram. If this would happen, you can see that price levels would increase dramatically and price levels rising is inflation.

To achieve economic growth, the AD curve would need to shift to the right - meaning Real GDP will have increased. To achieve this growth without inflation, the LRAS curve would need to shift to the right as well as the AD curve if the economy was operating at full employment. This would create some extra capacity for the economy to expand into.

There you have the three government objectives displayed and explained on a diagram. That's it for AD/AS diagrams.. Refer back to the individual posts about aggregate demand or aggregate supply if you're confused. Next up will be a short introduction to the multiplier effect. Thanks.

Aggregate Supply (Macroeconomics)

So, what is aggregate supply?
Well, aggregate supply is the total output of goods and services that producers in an economy are willing and able to supply at different price levels in a given time period. Aggregate supply can be modeled on a diagram in two ways: the long run and the short run.

In this diagram we have a long run aggregate supply curve, sometimes shortened to just 'LRAS'. We can see that initially supply increases as the price level increases as businesses stand to make more profit. The curve then hits at vertical point. This point is know as full employment. What this means is that all factors of production are fully employed so there can be no more growing. So, after this point the only change that occurs is the increase in price levels. The point of full employment is similar to operating on the edge of the PPC which was described in a previous post. The next post will go into further detail about the long run diagrams. 

Another way aggregate supply can be modeled is in the short run. 

Here we have aggregate supply in the short run, sometimes referred to as just 'AS'. In this the curve is simply sloping upwards as factors of production ca easily be increased or improved in the short run. The AS may increase (shift to the right on the diagram) if there are falls in production costs or a fall in wages. It may decrease (shift to the left on the diagram) if production costs increase or something like the price of oil increase. 

Going back to the long run aggregate supply curve now. It has the potential to shift if aggregate supply changes. 

The causes of changes in the LRAS curve are:

• A fall in interest rates. This will encourage businesses to invest therefore allowing them to expand and increase supply. This will shift LRAS to LRAS 1 on the diagram. If interest rates rose the opposite would happen and we could end up at curve LRAS 2 on the diagram.
• Unemployment related benefits could be reduced. This would encourage more to try and get back into work, thus giving more potential labour for firms. This will increase LRAS to LRAS 1. The opposite would happen if unemployment related benefits were increased.
• Education and training will improve the productivity of the workforce.. pushing LRAS out to LRAS 1. If funding for education and training was cut then LRAS may fall to curve LRAS 2.

That's pretty much it for a brief overview of aggregate supply. In the next post i'll be looking at aggregate supply and aggregate demand together and how these can be modeled on one diagram. Thanks for reading!

Aggregate Demand - Net Exports (Macroeconomics)

Right, the last component of aggregate demand: net exports. Net exports is the result of subtracting the value of imports from the value of exports. Imports is the value of goods bought from abroad by a country, exports is the value of goods sold abroad.

Both exports and imports are influenced by the same things, so therefore they can be grouped together into net exports. These are the influencing factors:

• Disposable income abroad. This refers to how much money people in other countries have available to spend. Therefore, if people have more money then they are likely to purchase more goods - potentially ones from our country, thus exports will rise and the value of net exports will increase. If disposable income abroad is low then exports will fall and the value of net exports will fall. 
• Disposable income at home. This refers to how much money people at home have available to spend on luxuries. The more money people have at home, the likelier they are to spend - which can result in a rise in imports. Rising imports will have a negative effect on net exports on the overall aggregate demand. Vice versa.
• Protectionism. Protectionism will be explained in depth in a later post, but i'll briefly mention it here as it's relevant. This is measures taken by a government to restrict trade. Normally these limit imports, so lots of protectionism at home may have a positive impact on net exports as imports will fall. However, lots of protectionism in countries abroad may limit exports and thus net exports will fall. 
• Exchange rates. These play a large part in the value of net exports. A fall in a countries exchange rate will reduce the price of exports and raise the price of imports, thus exports should rise and imports fall - resulting in an increase in net exports. A rise in a countries exchange rate will raise the price of exports and make imports cheaper, therefore making exports fall and imports rise. The overall effect will be a fall in net exports. 

These are the main influencing factors on net exports. And with that comes the end of the posts about the components of aggregate demand. Next up i'll move on to aggregate supply. Thanks. :-)