AS Macroeconomic Revision*
A Rogers
May 14th 2011
Textbook part II: The National and International Economy
*The revision notes below include an overview of the macroeconomic principles covered
during the year. You must make sure you are able to explain all of the terms in bold type
 Definition and an example;
 Causes or determinants of;
 What affects them and is affected by them;
 What their interaction and outcomes depends on.
Overview: Macroeconomics investigates the performance of the whole economy including
the price level and output for the whole economy using aggregate demand and
aggregate supply analysis. It involves the understanding and analysis of macroeconomic
performance indicators and how governments use fiscal, monetary and supply side
policies to intervene in the market mechanism and correct market failures.
Aggregate Demand
Total demand for all goods and services from consumers, firms the government and
overseas exports including:
Consumer Expenditure + Investment+ Government spending + (eXports-iMports)
C + I + G + X - M= AD
Consumption: Spending by households on consumer products. It is the largest component
of aggregate demand. What affects consumption? You should be able to explain precisely
how and why each of these affects consumption.

Disposable income;

Expected income;

Wealth;

Consumer confidence

Interest rates;

Government policy;

Demographics—age and structure of the population;

Exchange rates;

Inflation.
Investment: Expenditure taken by firms to add to their capital stock. What affects
Investments? You should be able to explain precisely how and why each of these affects
investment.
 Business Optimism—changes in expectations and incomes
 Interest Rates
 Past and current profits
 High current capacity utilisation
 Technological advances—including the price of capital equipment
 Government activities—including taxation and spending affecting business
Government Taxation and Expenditure: The government levies charges on consumers
and firms as well as provides goods and services to the public.
Tip: Here it is helpful to review the unit on Market failure and Government Intervention,
(pp55-73) to support your understanding of what affects government taxation and
expenditure
What affects Government Expenditure? You should be able to explain precisely how and
why each of these affects government spending and taxation.
 Price Instability
 Unemployment--note: government spending does not include transfer payments
and job seekers allowance.
 Balance of Payments-including supporting business competitiveness
 Economic growth and activity
 Political issues and decisions
Net Exports are exports, (goods and services sold abroad), minus imports, (goods and
services purchased abroad). What affects Exports and Imports? You should be able to
explain precisely how and why each of these affects the balance between exports and
imports.
 Exchange rates
 Inflation
 Interest rates
 Domestic and foreign incomes
 Government protectionist policies-you should understand and be able to explain
protectionism in detail, (pp161-163).
Note: make sure you remember that spending on imports reduces a country’s aggregate
demand because the spending is going on foreign products, not domestically produced
products.
Savings: Savings is disposable income minus consumer expenditure. Savings is not a
component of aggregate demand but influences the spending undertaken by households,
firms, the government and foreigners. Make sure you fully revise pages 85-87.
Using Diagrams
The Aggregate Demand Curve
Aggregate Demand Curve: The aggregate demand curve shows the relationship between
the total level of demand at an overall price level. The curve slops downwards because the
level of economic activity is greater at lower prices than at higher prices.
 As prices decrease the “real wealth” of those holding cash increases and they will
spend more;
 When prices are low, interest rates tend to be low. This encourages both investment
and consumption expenditure;
 A reduction in the price level increases the competitiveness of exports and reduces
imports.
You should be able to explain what is included in AD and what causes shifts in and
movements along the AD curve.
What causes movement along the aggregate demand curve?
 A change in change in price including a rise in the general price level causes a
reduction in real output/demand; a fall in the general price level causes an increase
in real output/demand.
What causes shifts in the aggregate demand curve?
 A change in consumption attitudes towards spending and saving, (the marginal
propensity to consume and save);
 A change in the firm’s desire to add to physical capital and inventories;
 A change in government demand for goods and services;
 A change in exchange rates increasing or reducing export demand.
Key factors affecting changes in output, employment and inflation: the size of the
initial change, the size of the multiplier, the original level of economic activity.
Aggregate Supply: The total amount of goods and services that firms wish to supply to an
economy at a given price level in a given time period. The inputs include the factors of
production: Land, Labour, Capital and Enterprise.
You should be able to explain what is included in AS and what causes shifts in and
movements along the AS curve, in the short run and in the long run. A change in AS
means that the total output that producers are willing and able to supply at any given price
level has changed.


Short run changes are largely du to changes in the cost of production.
Long term shifts supply are those which alter their productive capacity and are due to
changes in the quality and quantity of resources such as:
◦ Immigration Increasing the quantity of labour
◦ Investment in additional capital goods, or the replacement of capital goods
with improved technology;
◦ Improvements in education and training;
◦ Reduction in rules and regulations improving business productivity;
◦ Schemes which improve infrastructure and influence the ability of workers to
relocate.
Key factors affecting changes in AS: the size of the change and the initial level of
economic activity.
You should be able to define and explain the significance of the following:
Macroeconomic equilibrium
The circular flow
Factor services
The multiplier effect
Sustainable Economic Growth
Trend Growth
The Output Gap
Macroeconomic Policy Objectives: Methods of monitoring and evaluating the
performance of the economy on a macroeconomic level to determine whether an
intervention is necessary.
You should be able to explain all of the causes and consequences of the policy
objectives, why they are important, how they are measured and why they are difficult
to measure.
Economic growth: when an economy increases its output.
◦ Stable economic growth is growth which can continue over time
◦ Economic growth usually decreased unemployment.
◦ Governments focus on economic stability, where economies avoid significant
fluctuations around the trend rate of growth.
You must be able to explain how economic growth is measured and the difference between
GDP and Real GDP and its significance as an indicator of standards of living.
You should be able to explain labour productivity
Price Stability: the control of inflation.
◦ Inflation is a sustained rise in the price level measured as a % change in the CPI.
◦ High inflation imposes costs on society and reduces the effectiveness with which
markets work.
◦ The price level can increase as the result of either increases in AD or AS; cost
push or demand pull.
◦
Sustained inflation can only take place if there is also a sustained increase in the
money supply, seen as persistent shifts in the demand curve.
Full Employment: when those wanting and able to work can find employment at the going
wage rate.
◦ Frictional unemployment is while people are in between jobs;
◦ Structural unemployment occurs when there is a mismatch between workers
skills and the skills needed.
◦ Demand deficient unemployment occurs as a result of the economy being below
the level of full employment;
◦ Involuntary unemployment is when workers would like to accept a job at the
going rate but are unable to find employment.
◦ Unemployment benefits may encourage some workers not to accept jobs as the
opportunity cost of working is high.
Balance of payments: The balance of payments is a set of accounts that contains the detail
of the transactions that take place between the residents of one economy and the rest of the
world.
◦ Balance of payments must always equal 0. A current account deficit must be
balanced by a surplus on the finance account. A surplus on the finance account
is generally the receipt of loans to finance the current account deficit.
◦ A deficit on the current account means that, countries are spending more than
they are earning.
◦ Current account deficits can only be maintained as long as their future earning
potential is good.
◦ The quantity of exports of goods and services from the UK depends partly on
income levels in the rest of the world and partly on the competitiveness of UK
goods and services.
◦ The competitiveness of UK goods and services depends partly on the exchange
rate and partly on relative price levels.
Policy Conflicts
Growth and Inflation
◦ Rising AD may lead to rising prices and an increase in spending on imports.
◦ If the economy is close to its full capacity, economic growth will be a cause of
higher rates of inflation if growth is generated by increases in AD that are not
matched by increases in AS.
◦ As the output gap narrows, inflationary pressure can build up.
◦ It is possible to avoid inflation by increasing the economy’s productive capacity
Economic Growth and Unemployment
◦ Increasing labour productivity may reduce employment in the short run, if firms
choose to produce the same output but with fewer workers.
Economic Growth and the Balance of Payments
◦ Rising consumption is likely to increase the demand for imports.
◦ Imports of capital goods will increase the productive potential of an economy,
resulting in a greater ability of firms to meet domestic demand
Managing Policy Objectives:
Macroeconomic policies are used to help stabilise the economy by influencing shifts in
aggregate supply and demand.
Demand Side Policies: Short to medium term policies that affect both firm’s and
consumer expenditure and confidence in the future of the economy.
Fiscal Policy—Using government expenditure and taxation to influence the path of
the economy;
Problems with Fiscal policy:
1. Difficulty in knowing when and by how much to expand public spending or
cuts taxes.
2. Crowding out: The government raises tax rates to finance public sector
spending but results in the private sector having less to spend itself.
3. Contractionary policies can reduce competiveness, employment and
economic growth.
4. Expansionary policies can cause inflation and unemployment.
You should be able to explain types of taxes.
Monetary Policy—those used by the Bank of England to affect the money supply
and interest rates.
Supply Side Policies: Medium to long term policies aimed at improving the production
potential of the economy and to encourage investment. Supply side policies are aimed
at:
◦ Labour market improvements:
 Education and training;
 Measures to reduce voluntary unemployment;
 Labour market reforms including reducing trade union power;
 Incentives to get people to work harder, such as reducing the
marginal tax rate.
◦ Improving Competition
 Removing restrictions/barriers to trade.
 Removing monopolies, predatory pricing, price fixing etc.
 Privatisation
◦ reduction of subsidies to inefficient producers
◦ Increasing Enterprise and Productivity:
o Policies aimed to improve both incentives and the prospects for
entrepreneurs and small businesses
o Reducing VAT thresholds,
o Reducing administration for small businesses;
o Reducing corporation tax;
o Funding/encouraging research and development.
o Privatization
o NMW
You should be able to explain the significance and the effectiveness of the above to the
economy and be able to describe the following:
The determination of exchange rates
The relationship between exchange rates and interest rates as well as import and
export prices.
The areas of the world with which the UK trades
Advantages gained from trade
Methods of protectionism
Exam Skills: Preparing and structuring your essays. For longer mark questions you should
always plan your answers before starting to write.
Example: Q: Discuss the effectiveness of monetary policy in reducing inflation.
1. Identify the meaning of the command word in the question to ensure that your
answer fully, (in this case: discuss, which means to show both sides of the argument
and a judgement on which side is stronger)
2. Underline the variables in the question. Most questions include at least two variables
such as: discuss the effectiveness of monetary policy in reducing inflation.
3. Identify the key concepts that need defining, in this case: monetary policy and
inflation. Consider not only the policies that are used to reduce inflation but also
their effectiveness
4. Note the concepts that you intend to analyse, for example, what impacts on the
effectiveness of monetary policy.
5. Make a judgement regarding the effectiveness of monetary policy based on the
evidence you have provided, (what its effectiveness depends on).