The Short-run Macroeconomic Equilibrium

A very simplified Keynesian model is used to show the short-run macroeconomic equilibrium. For example, the rate of interest is fixed to simplify the model by keeping constant money in the economy. It is also assumed that production and employment depend on the amount of spending. In that we mean that if people buy more then firms will produce more, providing that they have the spare capacity available. The basic formula we use is that the level of National Income is equal to the domestic consumption plus the three withdrawals from the circular flow of income. Or, in shortened terms: Y = Cd + W. In this model, aggregate demand is actually known as aggregate expenditure (E) and relies on the amount of domestic consumption and the injections into the circular flow of income (J). Also written as AD = E = Cd + J. We reach a point of equilibrium when withdrawals equal injections and at this same point National Income will equal aggregate expenditure. If injections were to be higher than withdrawals then National Income would rise and the withdrawals would rise until withdrawals is once again equal to injections. Now enter the 45 degree line.

The 45 degree line shows the relationship between National Income and consumption, withdrawals and injections. Consumption and withdrawals are endogenous - their value is determined by the model. However injections are exogenous, meaning their value is determined independently of the model.

At ever point on the 45 degree line (Y), the items on each axis equal each other. The C line is consumption. It differs from Cd because it doesn't contain taxes and export spending. Consumption is a function of National Income: C = f(Y). As National Income rises, so does consumption - hence the upwards slope. It crosses the 45 degree line because poorer people may be required to spending above their earnings to survive where as richer people spend less than they earn, therefore at the end of the line it is below the Y line. The slope is given by the marginal propensity to consume - the proportion of any increase in National Income that goes on consumption. It is the change in consumption divided by the change in National Income. 

Consumption is determined by a whole bunch of different things: 

• Taxes
• Expected future incomes
• Expected future prices
• Consumer confidence
• Household wealth 
• Attitudes of the lenders
• Age of 'durables'
• Distribution of income

Any changes in these cause a shift in the consumption function whereas a change in National Income causes a movement along the consumption function. 

Now onto the withdrawals. The amount saved depends on the marginal propensity to save (mps). The proportion of an increase in National Income that is saved. Mps = Change in savings / Change in N.I. Taxes is pretty much the same - it depends on the marginal propensity to tax (mpt), or changes in tax / changes in N.I. It tends to rise as National Income rises because income tax is progressive. Finally imports - depending on the marginal propensity to import. Or, mpm = change in imports / change in National Income. 

Total withdrawals will look something like this: 

Injections now and we'll start with investment. It is determined by the following things: Consumer demand, expectations, interest rate, availability of finance and cost/efficiency of capital equipment. Replacing new equipment will rely on National Income. Government spending is independent of National Income in the short term, Exports is also classed as independent on National Income to keep the model simpler.  

That's it for the background on the theory. Next we'll be moving on to how National Income is determined from all of this. Stay tuned.

Sam. 

The Circular Flow Of Income

*I'd like to start by wishing everyone a happy new year! I hope you all had a good time over the festive period and are getting back into the swing of things as life returns to normal. I've had a great 4 week break and am now back studying, which mean the blog will be starting again on a consistent basis until Easter!*

Today's focus will be on the circular flow of income. I'm aware this has already been discussed but like I mentioned in a previous post I do plan on going over things again in a little more depth. The best way to learn about the circular flow of income is to actually see the flow graphically:

I'll now break the flow down into it's different sections, starting with the inner flow. The inner flow consists of the factors payments going from the firm to the households and payments for goods (consumption) flowing in the opposite direction. Firms pay money to households in the form of wages, interest and rent in return for the services of these factors of production. On the other side, households pay money to firms when they consume the firms goods and services. Note we're talking only about domestic firms and domestic households here.

In a scenario where all money was spent then that would complete the flow. However, in reality, not all money is spent. This is where the concepts of injections and withdrawals from the flow come in. Withdrawals are exactly what they sound like: money being taken out of the flow. It comes in three main forms. Firstly, savings. When money is deposited in banks or other financial institutions for the future that money has been withdrawn from the flow. Taxation is another withdrawal. Income tax and national insurance comes out of a households income whereas VAT comes out of a households consumption. Receiving benefits from the government is essentially a 'negative tax'. It's a tax that is flowing in the opposite direction. Therefore the total withdrawal in the form of net taxes is total taxation minus benefit payments. The final withdrawal is import spending. This is money that has left the flow of income because it is spent on goods and services abroad.

Injections, defined as additional money flowing into the economy, also comes in three forms. Firstly: investment. Investment is money that firms spend after gaining it through financial institutions. Secondly there is government spending. This includes such things as spending on roads, hospitals, schools and the like. It does not include state benefits, that is important to note! Finally, the other injection is export spending. Money that has come from people abroad buying our domestic goods and services.

There is a slight relationship between the withdrawals and injections into the circular flow of income. For example, suppose more money is saved (withdrawal) then more money will be available for banks to lend out to firms for investment (injection). The higher taxation is (withdrawal), the more like the government are to increase spending (injection). However, we must remember that these choices are made by different people. The choice to save and the choice to invest are made by two completely different, independent parties and therefore each will have their own agenda. Due to this we can say that injections may not equal withdrawals, however they could.

The final point I'd like to discuss here is equilibrium in the circular flow if income. Like most things in economics, market forces are able to bring the circular flow to equilibrium. I'll give an example. Suppose that injections exceed withdrawals. This may be because investment has rise, but irrespective of the reason due to  this national income will rise (because of more money circulating). A higher national income means that people can consume more, but as well as this people can also save more, pay more taxes and buy more imports. Therefore withdrawals will rise, and continue to rise up to a point where it is equal to injections. This is when equilibrium has been reached and national income will remain constant until another change occurs.

Thank you for reading guys and girls. Contact me if you have any questions or feedback, have a good day/night! Sam.

The Economy During Interwar Britain

We've seen how the economy functioned prior to war and during the First World War in the last few blog posts, now we'll move on to the economy between the two world wars. Instability is the major recurring theme in this period. We see two major recessions, one between 1920 and 1922 and another from 1929 to 1932. There's also a slight one between 1937 and 1938, but this wasn't as sever. If you look at this in context with the rest of the world, Britain's economy is actually relatively stable yet still under-performing comparatively to the other large economies. If we look at growth statistics we can see that in the latter half of the interwar era the economy was growing at a respectable 2.2%, however before this the economy actually shrunk and therefore the growth average for the whole interwar period (1913-1937) isn't at all impressive.

There were many weaknesses to the interwar economy, as you'd expect. Firstly, international trade was falling. We'd relied so heavily on it in the 1870-1914 period but now it was dwindling rapidly. In 1913, international trade and services was at 30% of GDP. In 1938 it was only 15%. The levels of trade did not exceed the 1913 levels until after the Second World War. One of the causes for this fall in trade is that world output grew faster than world trade. Essentially this meant that demand for Britain's goods would fall because the market was getting more competitive as supply was increasing. Here are some statistics to back that point up:

• 1929 - There is 80% higher production of manufactured goods than in 1913.
• Britain's market share for manufactured goods fell from 30% in 1913 to 22% in 1937.

An example of this downturn in trade can be seen in the cotton industry. In 1914, Britain was a net exporter of cotton, with 80% of what was produced being shipped abroad. Other markets around the world, such as India, began to become self-sufficient behind tariff walls and therefore didn't import as many. Other countries such as Japan began to produce cotton too at a lower cost because of the low-wages. Because of this British cotton exports halved over the period 1913 to 1936.

Another issue with the economy is the mass unemployment. In the good years it's still at 8%, in the worse years it could reach as high as 17%. However, the issue was mostly geographical, or regional. The north of England, Wales, Scotland and Northern Island were the worst affected. These ares tended to rely a lot on the older Victorian industries such as coal and cotton. In the South and the Midlands, new developing industries were adopted, such as cars and chemicals and therefore unemployment here was at a reasonable level. Old industries were failing and not enough new jobs were being created to keep the unemployment down. 

Some economists began to argue that the problem with the economy was an inflexible labour market after 1914. Why was this? Well, trade unions had gained a lot more power, there were generous unemployment benefits giving no incentive to find work and institutions could set their own minimum wage rates. This made wages pretty stuck and unable to change much to changes in prices. However, it isn't crystal clear that wage flexibility was that much greater than before 19144. Benefits only got better as time went on. Keynes got involved and argued that government monetary and fiscal policy was the problem... debate ensues!

Thanks for reading!

Sam. 

Britain and the International Economy, 1870 - 1914

During the period from 1870 up to the start of the First World War in 1914 the British economy changed a lot. As well as this, the international economy as a whole had a spectacular change around so that conditions in 1870 in no way matched those in 1914. Firstly, world trade was growing. The rate at which it was growing was outstripping world output which shows the industrialisation, falling transport costs and mass emigration that was happening across the globe. In Britain, trade grew 35 fold over the 19th century.

Let's focus more on Britain now. Foreign Trade stayed fairly constant in the time period given, in terms of the fact it was at 30% of GNP in 1870s and also at this level in 1913. As a bit of background, it was at 10% in the 1830s and 17% in the 1850s. During 1870 and 1913 foreign trade as a percentage of GNP did fall, but it recovered just before the First World War. The majority of this foreign trade was in the form of manufactured goods, although it was declining. For example, 56% of exports in 1870 were textiles but textiles only made up 37% in 1910. As far as imports go, we imported a lot of food and raw materials because we weren't self sufficient in these, apart from coal.

We'll move on to the balance of payments position for Britain now. Before 1914, imports exceeded exports. Exports of goods only made up two thirds of our imports between 1870 and 1900. However, it wasn't all bad because Britain had a very sophisticated 'invisible' sector for this time; this comprised of business services and overseas investment. With the exports of these included in the mix Britain actually ran a surplus which increased between 1851 and 1913. We have many reasons as to why a lot of funds were leaving the country in terms of these 'invisible' goods, they are split into two groups: 'pushing' funds out factors and 'pulling factors'.

'Pushing' funds out factors are basically the factors in Britain that meant it was in the best interests of investors to send their money abroad. They include:

•  The safe investments in Britain gave very poor returns compared to the equivalent abroad.
• High return investments in Britain were all very high risk.

The other factors are called 'pulling' factors. These are factors that come from the countries abroad that encourage investment. They include:

• Large infrastructure spending abroad because of industrialisation. 
• Overseas governments were issuing bonds with returns of 4-5% in comparison to the 2% return in Britain.

Britain played a vital role in the world balance of payments during this time period as well. We ran deficits with industrial countries and surpluses with the primary producers. So, we were in deficit to countries such as the USA but ran surpluses with countries in Asia and South America. 

Some contempories came to the conclusion that Britain was in a weak position at the time. They argued that Britain's share of world exports was falling and they were beginning to import more and more manufactured goods. The British exporters were falling behind in more advanced products. They had solutions, however. They felt British business needed to be more efficient in their production techniques to make them competitive on the world market again. They also felt that government policy was to blame, especially free trade. The idea behind free trade was that it would maximise the wealth of all nations by the theory of comparative advantage, and this in turn would maintain Britain's dominant position in the world economy. However, most major economies didn't adopt it and the protectionist countries actually grew faster than Britain after 1870. 

I'll round things off there. Basically, we can conclude that from 1870 to 1914 Britain was comparatively having a bit of a rough period. It kept a surplus on its balance of payments and was still very much a key player in the world economy. But, other countries were catching up. Britain had lost its place as the dominant exporter of manufactured goods and was adopting policies (free trade) that weren't effective. Next I'll move on to the interwar period of the British economy to see how that changed. Thanks for reading!

Sam. 

Preferential Trading Arrangements

Preferential trading arrangements refer to such things as trade blocs. Trade restrictions are held with the rest of the world but lower restrictions or none with member states. There are three types of preferential trading arrangement:

• Free Trade Area - This is when member states remove tariffs and quotas with one another. However, restrictions on trade with non-member states are kept individual to each nation.
• Customs Union - This is the same as above, but in addition there are common external restrictions on trade with non-member states. 
• Common Markets - This takes it one step further and the members operate as a single market. This means as well as the features of the above arrangements there is also a common taxation system, common laws regarding production, employment and trade, free movement of labour and capital and no special treatment by governments to their own domestic industries. Additionally to this, we sometimes see fixed exchange rates between members and common macroeconomic policies. 

Next we move on to trade creation and trade diversion, which come as a result of preferential trading arrangements. First, trade creation. This is when consumption shifts from a high-cost producer to a low-cost producer as a result of of joining the customs union. Normally this is due to obtaining the goods cheaper from other members of the union. As with most things, this can be modeled on a diagram! 

Trade Creation Diagram

This is it, the trade creation diagram. Let's explain it a bit. SDom and DDom are the domestic supply and demand of a good. Before the EU, the country had to pay at the 'PEU + tariff' price so domestic production was at Q2 and domestic demand was at Q1. The imports here were the difference between Q1 and Q2. With the joining of the EU, the price was now the PEU price, lower than before. This meant domestic supply had fallen to Q4 and domestic demand had risen to Q3. So the new imports level is the difference between Q3 and Q4, which is higher than before. Thus, trade has been created. 

Trade diversion works in very much the opposite way. This is when consumption shifts from a lower cost producer outside the customs union to a higher cost producer inside it. There is a net loss in world efficiency now the higher cost producer is being used. 

Trade Diversion Diagram

This is the trade diversion diagram. The country was initially paying price P1 for the good, meaning they consumed at Q1 and produced at Q2. Price falls to P2 because of the joining of the EU. We can see here, that consumer surplus has improved. The original consumer surplus at price P1 has now increased to include the areas 1, 2, 3 and 4 on the diagram. We also notice a loss of producer surplus by area 1 which will be the fall in profits. No tariffs are paid out anymore, so the areas 3 and 5 are lost to the government in terms of revenue. This leaves an overall net gain of areas 1 + 2 + 3 + 4 - 1 - 3 - 5 = 2 + 4 - 5. Here we can decide whether the trade diversion has been beneficial or detrimental. If the size of area 5 which we have lost is greater than the size of areas 2 plus 4 which we've gained then there is a net loss, otherwise we've achieved a net gain. 

If there are high external tariffs or a small cost difference between goods produced inside and outside of the union then a customs union is likely to lead to trade diversion.

In the long term, a customs union could have advantages and disadvantages, I'll name a few of both:

• Advantages:
• Increased market size - allows firms to potentially exploit economies of scale to lower costs.
• Better terms of trade with world markets because of the power of the customs union.
• Increased competition which will stimulate efficiency and bring costs down.
• Disadvantages:
• Resources may flow to the geographical centre for the lower transport costs leaving depressed regions on the edge of the union.
• Mergers will be encouraged which will boost monopoly powers.
• Diseconomies of scale.
• The administration costs of maintaining the union.

The basics of preferential trading arrangements in one blog post, tadaaa! Thank you for reading, keep sharing and following the blog! Thanks guys, have a good day.

Sam.

European Economic Issues: Background to the EU

The European Union we know today was formed back in 1957 wen the Treaty of Rome was signed and it came into operation on the 1st of January. It was initially called the European Economic Community. Initially, it had six member states whom had started to integrate their economies as early as 1952 with the European Coal and Steel Community which removed trade restrictions between the countries in an attempt to gain economies of scale and be able to compete with the U.S.A. Most internal tariffs had been abolished and common external tariffs introduced by 1968. However, the European Union at this point was still a 'customs union' rather than a 'common market' because restrictions were still in place on trade (legal, administrative and fiscal).

Many policies were in place at this point that made the EU a very integrated economy, these include:

• Common Agricultural Policy - Includes common high prices for farm products and import duties to bring foreign food up to EU prices.
• Regional Policy - Grants to firms and local authorities in deprived regions.
• Competition Policy - For example, Article 81 of the Amsterdam Treaty says that agreements between firms cannot be made if it will affect competition in trade between member states. 
• Taxation - VAT is the standard form of indirect tax through the EU.

A further move towards making the EU a single market came in 1987 with the Single European Act. This aimed to remove any extra barriers and form a common market by 1992 using the principle of mutual recognition. This meant that if a firm could do something under the rules of one EU country that firm could do it in all EU countries. It stopped individual governments from making special rules that would keep competition from other EU countries out. In June 1997, the 'Action Plan' aimed to remove any remaining barriers before the launch of the euro currency in January 1999. The 'Internal Market Scoreboard' was published every six months to show the progress made towards the abandonment of restrictions. The last two nations joined the EU in 2007: Bulgaria and Romania to make it 27 members. 

The EU now consists of 27 states. These states are classed into different categories depending on the population of the countries. For example, 6 'big' nations are part of the EU. A 'big' nation in terms of population means that the population is greater than 35 million. Germany and the United Kingdom are two of these 6 'big' countries. Next comes the mid-sized countries of which there are two: Romania (22 million) and the Netherlands (16 million). Smaller than these still are the 'small' countries with a population of between 8 and 11 million, this category includes Greece and Belgium. Finally the rest of the countries are referred to as 'tiny' nations making up less than 5% of the EU25's population between them. Examples of these 'tiny' nations are Denmark and Finland.

As with population, the EU nations can also be categorised based on their income per capita. This is GDP divided by population and is a good way of comparing the wealth of a country with another. 12 countries fall into the 'high' income category. As you'd expect, Germany and the U.K are in this category as well as the likes of Denmark and Italy. 7 countries are classed as medium income; Greece, Portugal and Cyprus are examples of this. The rest of the EU nations fall under the low income band. Luxembourg is the richest country when looking at income per capita, they have an income per capita that's more than double France. The poorer countries have generally done better economically since joining the EU. Here is a graph to show the income per capita figures graphically, taken from the Eurostat website.

Source: http://epp.eurostat.ec.europa.eu/tgm/graph.do?tab=graph&plugin=1&pcode=tec00114&language=en&toolbox=sort


The economies in the EU are very uneven in their sizes. For example, the following six nations together make up over 80% of the EU's economy: Germany, France, Italy, Spain, Netherlands and the United Kingdom. The rest of the countries are once again sorter into categories such as 'small', 'tiny' and 'minuscule' depending on the size of their economy. 'Small' is an economy that accounts for between 1% and 3% of the EU's overall economy. Sweden and Belgium, for example. 'Tiny' is an economy that accounts for less than 1% of the EU's overall economy and Hungary and Belgium fall under this title. Finally, 'minuscule' refers to an economy that makes up less than one tenth of 1% of the EU's economy (Latvia, Estonia, Malta).

EU countries tend to most of their trading with, well, themselves. Roughly two thirds of imports of exports are to or from Western Europe. Exports to North America make up roughly 10% of the total and to Asia even less, around 8%. About 80% of these EU exported goods are industrial goods.

The EU's budget has to balance each year. The four sources of funding for the budget are tariff revenue, agricultural levies, VAT resource and GNP based (A tax paid by members based on their GNP). All countries tend to contribute roughly 1% of their GDP to the EU budget, meaning it's not a 'progressive' tax. Germany and the United Kingdom are at the top of the spectrum of countries that donate a lot more than they receive in benefit from being part of the EU, whereas Spain and Greece gain a lot more in benefits than they donate to the EU. The majority of the EU budget is spent on agriculture, roughly 46%, hence the Common Agricultural Policy we hear a lot about.

That's a rough insight into the background and habits of the EU. I wanted to lay some foundations for some of the posts on European economic issues that are to come. Thank you for reading, stay tuned!

Sam.

The World Coffee Market

As i was sort of on the theme of the world economy, imports and exports and that sort of thing i thought i'd bring you this little snippet which i found quite interesting. Basically it's a bunch of facts about the world coffee market. Roughly 10 years ago the world coffee economy was worth $30 billion, $12 billion of this the producers received. However, nowadays the world coffee economy has grown and is worth roughly $50 billion, yet only $8 million goes to the producers. I sense some injustice here. It just goes to show how these big multi-national companies who have expanded globally have effected the lives of the basic producers. Obviously a lot is being done with 'fair-trade' and the like, but it will still take a lot to return the coffee market back to how it was with the producers, the ones putting the most effort into making the coffee, getting a larger cut of the proceeds.

Coffee is the worlds second most traded commodity, falling just behind oil. I thought that was staggering, very unexpected from my point of view. 60% of the coffee is produced in Latin America and 70% of the coffee is produced on farms of less than 12 acres. We can infer from this that the majority of coffee is produced by small time farmers working small plots of land, and this just adds to the frustrations regarding the pay for the producer. If the majority of coffee was produced by large scale companies it wouldn't matter so much as earning less isn't the end of the world for them. But when it comes to a poor farmer in Latin America, it makes all the difference!

Over 60 developing countries are involved in the production of coffee, with over 100 million being employed in the industry. Just makes you wonder whether if the producers received even something like 10% more than they currently are, how much the economies of these less economically developed countries would improve. It's not even a stable market either, making it all the more worrying and fascinating at the same time. The price of raw coffee can fluctuate by up to 40% in one year. Worrying from the point of view of the farmers in Latin America who have no stable income, but fascinating from the point of view of a market economist looking at how and why the price fluctuates and why by so much! Interesting. What are your thoughts?

Little ramble with something that was on my mind, i found the coffee market very interesting so expect a longer, more thought out post in the near future when i find time. Think about where your money is going next time you buy your coffee beans too! Thanks for reading.

Protectionism (Macroeconomics)

Protectionism refers to the protection of a domestic industry from foreign competition. There are many types of protectionism which i'll run through later on in this post. The free movement of goods and services is restricted between countries and economic blocs to try and protect a countries own industries from the powers of competition from abroad. The main types of protectionism are as follows:

• Tariffs
• Quotas
• Voluntary Export Restraints
• Foreign Exchange Restraints
• Embargoes
• Red Tape

Tariffs is very much self-explanatory. A tariff, or tax, on a good being imported into the country from abroad.  The effect of the tariff will be moving the supply curve of the good backwards by the value of the tariff. A tariff will protect domestic firms, especially new firms, by making it more expensive for goods to be imported and therefore raising the price, allowing home-grown firms to compete more. It's useful when it comes to goods from the likes of China and India. These countries have such low costs of production that they can afford to sell the goods at prices much lower than those of domestic firms in the United Kingdom. Therefore, these tariffs add to the production cost meaning that imported goods will cost more and allow domestic firms to compete more. 

A quota is also a fairly self-explanatory form of protectionism. It is a limit on the supply of a good or service into a country from abroad. An example would be a quota restriction on the import of t-shirts from China. The government may create this quota in the form of a number of goods, i.e 20,000 t-shirts per year, or they could do it by value, i.e £4 million worth of t-shirts per year. Supply of the good will fall which will in turn help domestic industries once again to compete as well as potentially raise the price of the goods. A problem with quotas, however, is that it can cause international disputes such as the one between China and the EU about the importing of Chinese textiles. More can be read about that by clicking here.

Voluntary export restraints are an agreement between one country and another to limit their exports to each other of certain goods. This is normally made between countries who are on good terms with one another or who are in the same economic bloc. Foreign exchange restrictions are a type of protectionism that doesn't appear much. This is when a government seeks to reduce imports by limiting the amount of foreign exchange made available to those within the country who wish to buy imported products. Basically, the supply of foreign money to buy these imports will be limited so not as may goods can be purchased from abroad. 

The final two now: embargoes are a ban on the import or export of products to/from a particular country. For example, a ban on weapons to a country with poor human rights records. Red tape is the idea of making importing difficult by creating lots of paperwork and procedures to delay and therefore discourage the imports. 

There is, of course, an argument for going ahead with protectionism. Firstly and potentially most importantly, it gives the government the ability to control imports which can therefore improve the trade balance. If the trade balance is in the red the government can use any form of protectionism in an attempt to curb spending on imports and improve the trade balance. Protectionism is very beneficial to declining domestic industries as well as the new industries. Both these industries aren't at the stage to be totally competitive and therefore could easily be wiped out from cheap imports. However, protecting them by limiting imports or raising the price allows these firms to get a proper foot in the market, expand and grow enough to be able to compete with the cheaper imported goods and services. Finally, it's also a method for generating revenue for the government if the protectionism comes in the form of a tariff. This tariff placed by the government goes straight in their pocket and can therefore help to eradicate budget deficits as well as improve investment power. 

With all advantages does come disadvantages, and the case of protectionism is no exception. Consumers will experience a welfare loss due to higher prices and the loss of consumer surplus. It can also be regressive for low income families as the protection will effect everyone equally, therefore those with less money will feel it the most. Raw materials may well become more expensive. This is far from beneficial for domestic industries as production costs will rise and therefore profits will be squeezed. Retaliation is another big thing that could crop up as a direct result. Putting a form of protectionism on imports from a certain country could cause that country to do the same back, which will restrict the exporting potential of the country and could worsen the balance of trade.  Finally, maybe a minor disadvantage, but there is the administration and implementation costs of the protections to take into account.

That pretty much sums up protectionism for you. Decide or yourselves whether you think they're beneficial or not, but at the end of the day forms of protectionism will always be used. Thanks for reading guys, stay tuned and share the blog if you find it useful!

Exchange Rates (Macroeconomics)

Exchange rates are something that affects all of us, be it directly or indirectly. Exchange rates are basically the value of a currency compared to that of another currency. They fluctuate a lot, which leads to price changes.

I'll be using the Sterling (£) in my examples throughout. Firstly, let's look at what determines the value of a currency. The value of the £ is determined by the free market, so therefore the powers of demand and supply dictate the value of the £. The majority of the demand for the £ will come from trading partners demanding the U.K's exports and therefore needing the £ to buy them. The majority of the supply of the £ comes from us demanding foreign imports, and needing to sell the £ to get foreign currency to buy the imports.

An increase in the demand for the £ will increase the value compared to other currencies. This is often referred to as a "strengthening of the £" or an "appreciation". Obviously, a fall in demand for the £ will have the opposite effect. An increase in the supply of the £ will decrease the value compared to other currencies. This is often known as a "weakening of the £" or a "depreciation". A decrease in supply will have the opposite effect, raising the value.

Another key factor that influences the demand and supply of the £ is interest rates. If interest rates in the U.K. are high, then we will see a high demand for the £ as people will make a better return off of it in U.K. banks. This will increase the value of the currency. A decrease in interest rates will see money flow out of the U.K. in search of a better return on their investment and therefore demand and the value of the £ will fall.

There are two different exchange rate mechanisms. The first one is the floating mechanism. This is when the value of the currency is determined by the free market - the powers of demand and supply. The advantage of this mechanism is that theoretically the exchange rate should automatically adjust which will eliminate any imbalances withing the Balance of Payments. The other is the fixed mechanism. This is when the exchange rate is fixed and determined by the government or central bank of a country. The bonus to this is that it gives more stability to the value of the currency but runs the risk of goods becoming to un-competitive if it's too high or the market can be flooded if it's too low.

That's the lot for exchange rates, thanks. Also, any requests for what to come next? Post it in comments and ill see what i can do. Thanks for reading, follow the blog if you enjoy!

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.

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. :-)

Aggregate Demand (Macroeconomics)

Well, the first post on a macroeconomic topic. I'll start with the very basics - aggregate demand.

Aggregate demand, often shortened to just AD, is the total demand for goods and services in an economy at a given price level. No longer are we looking at just individual markets, but the demand in the economy as a whole. When we say price level, we are referring to the average price of products produced in the economy. Price levels go up and we have inflation, which will be explained in a later post.

Aggregate demand is made up of 5 components. These 5 components are consumer expenditure (C), investment (I), government spending (G) and net exports [exports (X) - imports (M)]. Therefore, aggregate demand equals C + I + G + (X - M). Each component will be detailed individually in later posts, but i'll give a brief description of each here.

• Consumer expenditure - This is often called consumption, it is spending by households on products and generally makes up the biggest proportion of aggregate demand. 
• Investment - This is spending on capital goods, such as machinery and delivery vehicles. It's the most volatile component. 
• Government spending - This is government injecting money into economy through spending on things such as the NHS. 
• Exports - Simply put, the value of goods we sell abroad.
• Imports - The opposite of above, the value of goods we buy from abroad.

So, each of these components make up the overall value of aggregate demand. The next post will look at consumer expenditure. Thanks.