MACRO

How is CPI calculated ?

A base year chosen where prices were relatively stable. A survey (ONS Expenditure and food survey) to identify a representative basket of consumer goods and services bought by a 'typical' household. Each item in shopping basket is weighted. Every month ONS surveys sample of prices for selection of representative goods and services fed into a computer to give an index. INitial value of index in base year was 100, change in prices causes change in index value. e.g. 110-112 inflation, 110-108 deflation.

Price index

A price index is a method of measuring the average change in prices of a group of defined products over time. The index value of 100 in the base (first) year is the benchmark against which to measure subsequent changes.

GDP

GDP is a monetary measure in (billions) of total output within a country's borders in a given time period. 3 estimates. Income method: add up all incomes earned producing a country's output. Expenditure method: add up all the money spent of a country's finished product.

AD rises as price level falls

wealth effect: a decrease in price level increases purchasing power of wealth which encourages households to increase consumption. Interest rate effect: A lower price level usually reduces interest rate and encourages greater spending on investment and consumer goods. Exchange rate effect as domestic prices fall, UK prices become more price competitive. Foreigners buy more UK products leading to higher UK exports (X) UK consumers switch from imports to UK made products increasing consumption.

aggregate demand

AD is the total planned spending on domestic output at a given price level, in a given time period, usually one year. AD consists of: Consumption (C) domestic household spending on consumer products. Investment (I) expenditure by UK firms on capital. Government spending (G) state expenditure on products but not transfer payments. Net exports (X-M) the difference between spending by overseas residents on UK output (X) and UK residents spending on overseas output (M)

Aggregate demand curve

An aggregate demand curve shows total planned spending on domestic output at a different price levels, over a given time period. The AD curve shows the quantity of goods and services that all households, firms, the government and the international sector want to buy at any price level.

Is price index reliable indicator of all prices

An index is an average. Different regions have different rates of inflation. Different households have different tastes. Given different consumption patterns can one set of weightings be representative of all economic agents. New or improved products may not be captured in the current index. It is possible for essential items such as food to rise while less essential items such as TV's to fall.

factors influence government spending:

Governments view on effectiveness of state intervention to correct market failure, recession increases government spending to boost AD and avert a depression. Economic system governments in countries such as united states which rely of free markets to allocate resources spend lower proportion of national income than planned economies such as cuba. Election cycle governments seeking re-election may increase spending on public services and social infrastructure to win political support. Economic cycle in a recession governments spending on unemployment benefits rises. Tax revenues, higher tax revenues allow more government spending on public services. Technological advances medical and IT advances lead to more government spending.

how do household and firm sectors interact ?

Households receive income for their labour and then consume the output of firms. Firms hire resources owned by households to produce goods and services for which they pay wages rent (income). firms receive payments when products are sold

inflation

Inflation is a sustained rise in the price level. This means that, on average, the prices of products in an economy are going up over time.

injections

Injections are additions of extra expenditure into the circular flow of income. Injections occur when firms receive income from selling their output to other firms investment (I), the government (G), or overseas through exports (X)

Investment

Investment (I) is spending by domestic firms on capital goods. Firms invest if they can make a profit from they're investment. Factors influence investment spending: Real disposable income households use extra income to increase consumption which encourages firms to invest in new equipment. Capacity utilization investment is encouraged where firms are operating close to full capacity. Interest rates affect the cost of borrowing money to finance expenditure on new machinery, A fall in interest rates increases potential profits and so encourages investment. Availability of credit decline in willingness or ability of banks to lend to firms reduces level of investment. Business expectations improved optimism about economic prospects increases investment. Macroeconomic stability firms that feel certain about future interest rates & exchange rates are more likely to invest. Corporation tax is tax paid on profits, corporation tax cuts allow firms to retain more profit and incentive to invest. Order books, firms with full order books are more likely to invest. Technological advances encourage investment.

nominal GDP

Is GDP valued at current prices. May be misleading because if price level doubles then nominal GDP doubles but real national GDP remains unchanged. It is not adjusted for inflation.

leakages

Leakages are household withdrawals of potential spending from the circular flow of income. Leakages occur when households put money aside in savings (S), to pay government tax (T)buy foreign made products imports (M)

price level

Price level is the average of the prices of a group of defined products.

real GDP

Real GDP is nominal GDP adjusted for inflation. Real GDP = Nominal GDP x price index in base year/current price index.

difference between CPI and RPI

The CPI excludes housing costs such as council tax & mortgage interest payments, included in the RPI. RPI inflation generally exceeds the CPI's.

government ?

The body that passes and enforces laws, collects taxes to finance public expenditure, and intervenes in the free market to change behaviour.

circular flow of income

The circular flow of income shows the flow of money from economic activity between households and firms. Households receive income for their services and use this money to buy the output of firms (consumption).

transfer payments ?

are unearned benefits paid out to households by the government e.g. unemployment disability and child allowances.

consumption

consumption is domestic household spending on products: factors affect (C): Real disposable income, an increase in disposable income increases consumption. Interest rates affect cost of borrowing and reward for saving. Fall in interest rates reduces incentive to save and reduces cost of borrowing, consumption rises. The availability of credit a decline in the willingness or ability of banks to lend to households reduces level of consumption. Consumer confidince improved optimism about economic prospect raises consumption. Wealth, higher house or share prices encourages more consumption e.g. remortgaging. Technological advances increases consumption. Distribution of income government policies that redistribute income from the rich to the poor increase consumption.

imports, exports and net exports

imports (M) is spending by domestic residents on products made overseas. Exports (X) is spending by overseas residents on domestically made products. Net exports (X-M) is the difference between a country's exports earnings and its total spending on imports. Factors affecting Net exports: Domestic real disposable income e.g. in a boom UK residents use higher incomes to buy more imports. Overseas real disposable income overseas agents generally reduce their spending on UK made products when their economy is in a recession and GDP and incomes are falling. International competitiveness relative price and and quality of domestic goods and services relative to foreign products. Exports rise and imports fall if domestic products become more competitive. Exchange rate a fall in the value of a countries exchange rate makes its exports cheaper and its imports more expensive. Government restrictions on free trade such as tariffs (tax on imports) and quotas (limits on volume of imports) reduce imports.

saving

saving is that part of disposable income which is not spent. factors influencing level of savings: Savings rise with level of real disposable income. The higher the average propensity to save, the greater the level of savings for a given level of income. A fall in consumer confidence if households are uncertain about their future level of income. Government policies such as ISA tax free savings schemes can encourage saving. Age structure of the population influences savings as the young and old often have little disposable income left to save. Wealth is the current value of assets. Savings increase with wealth.