Introductory Macroeconomics Questions and Answers

These introductory macroeconomics questions and answers will direct you to more resources to help in your study of macroeconomics.

Introductory Macroeconomics Questions and Answers

What is the Circular Flow of Income?

The Circular Flow of Income

The Circular Flow of Income Model is often used to show students how the key macroeconomic relationships of income, expenditure and production are derived.

circular flow of income model

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What is Gross Domestic Product?

What is Gross Domestic Product?

What is Gross Domestic Product or GDP is a fundamental question for macroeconomics students.

Gross Domestic Product or GDP is the the usual measure for production in an economy.

GDP is a measurement for the production of goods and services at the final market price to consumers in a given time period.

Simply GDP is the measure of all the country’s output in a given time period.

Because of this definition, output is goods and services.

People often think of products as only physical goods. However services such as a restaurant meal, buying insurance or transport are important products in an economy.

The GDP statistic captures only the final sale to the consumer.

Items not included in GDP are;

  • ♦The individual intermediate sales as value is added from growers, to producers, to wholesaler to retailer,
  • ♦Voluntary work or ‘not for cash’ sales (the black economy), and
  • ♦Expenditure made on overseas products (imports).

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What is GDP per Capita?

What is GDP per Capita?

This is the GDP in a country divided by the population to determine the GDP per person.

GDP per capita is widely used to compare countries standard of living but does not consider how evenly income is distributed, or is it  an indicator of how efficiently resources are used.

The measure GDP per Capita is the relative wealth of an economy, so countries of different population can be compared.

To learn more about this, as a starting point, take this Introductory Macroeconomics Tutorial Course

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What is Economic Growth?

What is Economic Growth?

Economic growth is the change in GDP over time.

Economic growth is considered an economic objective of government as it is associated with a better standard of living flowing from more jobs, higher incomes and increased consumption.

The business cycle charts the changes in GDP growth over time. This informs economists of the health of the economy as it moves through the cycles of peaks and troughs.

This chart from https://tradingeconomics.com shows the GDP growth rate for Australia and the cycles evident over the quarters.

(Trading Economics, https://tradingeconomics.com/australia/gdp-growth-annual, accessed on 19 April 2018)

macroeconomics australia GDP growthTo learn more about this, as a starting point, take this Introductory Macroeconomics Tutorial Course

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What is the business cycle?

What is the Business Cycle?

The business cycle refers to the fluctuations in gross domestic product (GDP) over time. In all economies there are accelerations, decelerations, peaks and troughs with Australia’s business cycle following other major country’s business cycle.

Sometimes the peaks and troughs are deeper and steeper and expansion phases are short lived.

Governments aims to conduct economic policy which will even out fluctuations and keep economic activity increasing as steadily as possible.

Where the GDP growth is negative for two successive quarters most economists are of the view the economy is in a recession.

To learn more about this, as a starting point, take this Introductory Macroeconomics Tutorial Course

Introductory Macroeconomics Tutorial Course

What is unemployment?

Unemployment

Unemployment is the situation where people are actively seeking a job at current wage rates but are unable to find work.

The unemployment rate is the number unemployed as a percentage of the total labour force.

The labour force is the number of unemployed and unemployed.

Throughout the business cycle there will be variations in the number of people employed.

The participation rate is also an important measure as it is able to express the percentage of people who are ‘participating’ in the labour market.

As the economy expands and the business cycle is heading upwards people have more confidence in looking for work and will actively seek work, which increases the Labour Force

How is the unemployment rate measured?

The major source of information comes from the Australian Bureau of Statistics when it publishes the Monthly Labour Force Survey.

This survey defines an unemployed person as someone who is aged over 15 years, who was not employed in the survey week and has been actively looking for work during the four weeks leading up to the survey.

Unemployment types

People are unemployed for a variety of reasons:

  • ♦ Seasonal unemployment: Changes in employment levels are due to the season eg tourism.
  • ♦ Frictional unemployment: Employment changes are due to the normal transition from one job to another. At any point in time there will be people caught between changing jobs.
  • ♦ Structural unemployment: Employment changes due to the lack of skills or mobility required to obtain newly created jobs. Skills may be technological obsolete or no longer required in the workforce.
  • ♦ Cyclical unemployment: Employment changes are as a result of the business cycle going through peaks and throughs.

Terms

  • ♦ Long-term unemployed: People how have been unemployed for a substantial amount of time because of some sort disability
  • ♦ Hidden unemployment: Arises because people are discouraged from looking for work because of high levels of unemployment and lack of job opportunities.
  • ♦ Full employment: There is a certain level of unemployment where if we go below this there is an upward pressure on wages which flows through to prices and which creates higher levels of inflation.
  • ♦ Natural unemployment: Because of long-term, frictional and structural unemployment there will be a certain level of unemployment that cannot be reduced.

To learn more about this, as a starting point, take this Introductory Macroeconomics Tutorial Course

Introductory Macroeconomics Tutorial Course

What is aggregate demand and supply?

What is Aggregate Demand?

Macroeconomics looks at the economy as a whole, whereas microeconomics looks at individuals, businesses and sectors of the economy.

After looking at the ‘Circular Flow of Income Model’, the relationship between production , income and expenditure helps understand the bigger picture.

Total production in the economy can be expressed as aggregate supply and total expenditure can be expressed as aggregate demand.

On a diagram we can start to analyse the forces on the macroeconomics.

what is aggregate demand and supply

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What are the components of aggregate demand?

Components of Aggregate Demand

In macroeconomics we can use the circular flow of income model to understand how the economy operates.

It can be used to explain the components of aggregate demand and aggregate supply and understand the implications of these components and their effects on the economy.

In the five sector circular flow model the sectors are households, business, financial sector, government and the overseas sector.

We can see that Aggregate Demand = C + I + G + (X- M)

where C = consumption spending by consumers, I = investment spending, G = government spending, X = exports of domestic production and M = imports by domestic consumers.

This relationship forms the basis of the Australian National Accounts, which is compiled and published by the Australian Bureau of Statistics.

Consumption (C)

Consumption is the spending by households on final goods and services. It is the largest component of aggregate demand.

The Australian Bureau of Statistics (ABS) conducts a periodic Household Expenditure Survey (HES) to determine what the average household spends their income on. Not surprisingly the Survey indicates that richer households save a greater proportion of their incomes than poorer households.

Economists need to understand the relationship between income, consumption and saving to determine the impact of changes on output  (economic activity) and employment.

Interest rates and the availability of credit have a big impact on consumption expenditure.

The proportion of income saved by households is the marginal propensity to save.

The proportion of income spent is the called the marginal propensity to consume.

Investment (I)

Investment is the spending by the private sector on goods used for production (capital).

Investment spending is important because of its size, volatility and its potential to influence potential output.

Government economic policy can influence investment spending by changes in,

  • ♦ monetary policy (interest rates)
  • ♦ fiscal policy ( tax policy).

Government spending (G)

Government spending includes both a consumption and investment component.

Things like wages and salaries of teachers and doctors and nurses in the public system and public servants as well as expenditure on investment items like building schools, roads and bridges.

Government spending doesn’t include spending on things like benefit payments for pensioners or the unemployed. These are called ‘transfer payments’ as they are not payments for any production.

Government spending  (G) depends on the governments ‘fiscal policy’.  Governments decide if the economy needs extra government spending to boost aggregate demand.

The overseas sector (X-M)

Net exports or exports minus imports have a very important effect on the Australian economy.

How competitive Australian production is on world markets also affects how many exports we sell to the overseas sector.

Imports and exports are also affected by the external policies of the government, that is how heavily the government protect or grant concessions to local industry through tariffs, subsidies and quotas.

The current exchange rate is also a very important factor in affecting the level of imports and exports.

What is a multiplier effect?

What is the Multiplier Effect?

Changes in expenditure, give rise to larger changes in income and output.

The multiplier effect is where a change in one of the components of aggregate spending leads to a much larger change in the production of the economy.

GDP (E) = C + I + G + (X – M)

The multiplier effect is greater if people spend a greater proportion of their extra income. The proportion of income spent on consumption is called Marginal Propensity to Consume (MPC) and the amount saved is the Marginal Propensity to Save (MPS).

Stimulus funding in the Global Financial Crisis (GFS) in Australia went to lower income people, who have a tendency to spend a larger proportion of their income on consumption (retail and hospitality areas). This money then in turn provides income for others as it moves through the circular flow process.

Stimulating the Economy

An event can stimulate an economy many times over through a multiplier effect on total expenditure.

Think of the Sydney to Hobart Yacht Race, which brings people to Hobart to celebrate the end of the race.

People stay in accommodation, eat at restaurants and travel to tourist attractions. The spending employs people and provides more income in the Hobart economy. Those extra incomes in turn provide a means for people to spend even more on consumption (consumer spending) and so it goes on.

For this reason, regional areas will want to host major events to stimulate there local economies.

Alternatively imagine the spiralling downwards from the effects of a major industry shutting down in Hobart.

If other producers suffer from losing jobs it will cause flow-on effects to other local producers who in turn may have to put off staff with the associated loss of incomes in the community.

The multiplier effect means that a change in a component of aggregate demand can produce bigger changes in total economic activity.

To learn more about this, as a starting point, take this Introductory Macroeconomics Tutorial Course

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What is aggregate supply made up of?

 

What is Aggregate Supply?

In the short run aggregate supply can be expanded but in the long run the countries potential output is fixed by the quantity of resources it has. In the long run the aggregate supply graph looks like this in the long run and short run.

Things that will be determinants of aggregate supply are;

Aggregate Supply♦ resource quantities (land size, labour force size, entrepreneurial ability, capital availability)

♦ resource qualities (labour quality and capability, educational level)

♦ resource prices (wage rates, import prices, exchange rate), and

♦ the legal and institutional environment (taxes, regulations, political stability etc)

To learn more about this, as a starting point, take this Introductory Macroeconomics Tutorial Course

Introductory Macroeconomics Tutorial Course

What is inflation?

What is Inflation?

Inflation is a continuing rise in the general level of prices.

Inflation results in our money having less purchasing power – our money is worth less.

Deflation is the opposite, a decrease in the level of prices.

Inflation results in:

  • ♦ higher interest rates (people want to see a gap between the inflation rate and their saving rate or it is not worth saving money)
  • ♦ increased spending
  • ♦ reduced saving levels
  • ♦ decline in international competitiveness
  • ♦ bracket creep (income falling into higher tax rates) as wages rise
  • ♦ reduced standard of living

Types of Inflation

Some terms that you might come across are:

  • ♦ Hyperinflation- very rapid inflation
  • ♦ Stagflation- inflation and high unemployment exist together
  • ♦ Demand-pull inflation- rising prices are occurring because of growing demand is creating shortages because demand exceeds supply.
  • ♦ Cost-push inflation- rising costs or production are flowing through to the prices of goods and services.
  • ♦ Underlying rate of inflation- the trends in inflation with the seasonal and policy decisions removed.
  • ♦ Headline rate of inflation- this is the rate measured by the CPI.

Aggregate demand and supply diagrams can be used to explain the cause of inflation – demand pull and cost push.

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How do you measure inflation?

The Consumer Price Index

The Consumer Price Index measures inflation of consumer goods.

The index is based on the cost of consumer goods and services a consumer would buy in capital cities.

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What is the exchange rate?

What is the Exchange Rate?

In a market system the price of the currency is the exchange rate and this is determined by the interaction of supply and demand.

This is where the currency is floating (not regulated or fixed by the government). Many countries have a fixed or regulated currency exchange rate.

movements in the exchange rate
Factors of supply for the currency;

Domestic individuals and businesses who wish to sell $A to pay for;

  • ♦ holidays overseas
  • ♦ overseas imports
  • ♦ investments overseas

Factors of demand for the currency;

Overseas individuals and businesses who wish to buy $A to pay for;

  • ♦ holidays in Australia
  • ♦ Australian exports
  • ♦ investments in Australia

To learn more about this, as a starting point, take this Introductory Macroeconomics Tutorial Course

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What is international trade?

What is International Trade?

International trade is the exchange of both goods and services for money that takes place between countries.

Goods and services are exported or imported to and from countries. The payments cause flows of  currency in and out of the country.

These currency transaction will require exchanges between the domestic and overseas currencies.

macroeconomics imports and exports

To learn more about this, as a starting point, take this Introductory Macroeconomics Tutorial Course

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How does international trade influence the exchange rate?

The flows of money in and out of a country for various reasons have an effect on the exchange rate of the currency.

how do imports and exports affect the exchange rate


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What is the effect of high and low currency rates on international trade?

This is how a low currency rate affects international trade. The opposite is true for a high currency rate.

how does the exchange rate affect imports and exports


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What is money?

What is Money?

Money is used in modern economies to exchange goods and services. The financial system has developed in response to society’s need to use money.

Since the 1970s, there has been a rapid development in other substitutes for money (notes and coins) such as credit cards, direct debit facilities and other plastic cards.

Australia has what is known as ‘token money’. This means the real physical value of notes and coins is a token value of the monetary value. Historically most countries started with gold and silver coins equal to their face value.

To learn more about this, as a starting point, take this Introductory Macroeconomics Tutorial Course

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What is the financial system?

What is the Financial System?

The system that allows funds to be exchanged between those with funds to lend and those who wish to borrow those funds is called the financial system.

The financial system needs to be strong and regulated, so that the people and businesses in the economy have confidence and trust they will not lose their money if they lend money to investors.

There needs to be available funds for individuals and businesses to borrow to fund investment for private and commercial activity.

To learn more about this, as a starting point, take this Introductory Macroeconomics Tutorial Course

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What are financial intermediaries?

What are Financial Intermediaries?what are financial intermediaries

Financial intermediaries are the middle institutions that take funds from people with surplus funds (lenders), to repackage them for lending to individuals and businesses for private and commercial reasons (borrowers).

Examples of financial intermediaries are Banks, Credit Unions and Building Societies.

Financial Intermediaries establish links between borrowers and lenders

    • ♦ Collect and organise savings for investment
    • ♦ Provide a secure form of savings and a competitive form of investment
    • ♦ Provide a payments service (cheques, electronic exchange )
    • ♦ Offer other forms of financial services.

To learn more about this, as a starting point, take this Introductory Macroeconomics Tutorial Course

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What do banks do?

What do Banks Do?

Banking dates well back in history as far as recorded in Roman times when money could change hands in the Roman Forum. 

The origin of the word bank comes from an Italian name. The Italian name for a bench is Banco and is the Italian name for a bank.

In the middle ages, collecting interest on loans was regarded as sinful and people performed this job on the street on a bench.

The first Italian ‘banks’ in the 1600’s gave receipts when people deposited silver and gold and these receipts became regarded as ‘money’. 

In those days, banks held reserves of gold equal to the money that was on issue in the economy. This is now not normally the case.

To learn more about this, as a starting point, take this Introductory Macroeconomics Tutorial Course

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What is a financial market?

What is the Financial System?

The financial system also includes many financial products such as;

  • ♦ Insurance
  • ♦ Superannuation
  • ♦ Shares
  • ♦ Debentures and other loan parcels
  • ♦ Derivatives of financial products

Demand and supply determines the market price when financial products are traded in a market. An example is the share market where buyers and seller interact to transact shares at a equilibrium price.

To learn more about this, as a starting point, take this Introductory Macroeconomics Tutorial Course

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How are interest rates determined?

In a financial market, interest rates are the price of money. The price is determined by the supply and demand for a financial product.

how are interest rates determined

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What does the Reserve Bank of Australia do?

The Reserve Bank Of Australia

Under legislation, the RBA has the role to ensure that the bank’s monetary and banking policy is used to help the Australian population. 

Specifically, it has to ensure;

  • (a) the stability of the currency of Australia
  • (b) the maintenance of full employment in Australia; and
  • (c) the economic prosperity and welfare of the people of  Australia.

Since 1993, the policy is to remain independent from government in managing the economy, and through monetary policy ensure that inflation sits between 2 and 3%.

To learn more about this, as a starting point, take this Introductory Macroeconomics Tutorial Course

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Who are regulators in the Australian financial system?

Institution

Responsibility

Reserve Bank of Australia

www.rba.gov.au

Monetary Policy, Financial system stability, Payment system regulation
Australian Prudential Regulation Authority

www.apra.gov.au

Deposit taking institutions, Life and General insurance,  Superannuation

Australian Securities and Investments Commission

www.asic.gov.au

 Competition, consumer protection financial market integrity

To learn more about this, as a starting point, take this Introductory Macroeconomics Tutorial Course

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What is monetary policy?

What is Monetary Policy?

what is monetary policy

Monetary policy can decrease interest rates in the economy by manipulating the cash rate lower by increasing the money supply through ‘open market operations’ where the economy needs stimulation to increase activity.

Monetary policy can also dampen the economy if aggregate demand is increasing too fast and inflation is a threat.

Open market operations are the buying of government securities in the open market. This puts more money into the economy as the RBA purchases the securities in exchange for the purchase price.

The RBA has kept interest rates at historically low levels of 1.5% because of concerns for weakness in the economy, particularly consumer sending.

Other interest rates, such as loan rates are higher than the overnight cash rate as institutions take a profit to manage loans and are higher the more the riskiness of the loan.

To learn more about this, as a starting point, take this Introductory Macroeconomics Tutorial Course

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Hopefully these introductory macroeconomics questions and answers have helped you understand this important topic.