Notesale: Turn your study into money

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INTRODUCTION TO MACROECONOMICS
The Scope of Economics
The 4 major macroeconomic issues:
Macroeconomic issues

Description

Economic growth

Avoid both recessions & excessive short-term growth that can’t be sustained

Unemployment

Represents a waste of human resources as unemployment benefits use up
government revenues

Inflation

Low & stable inflation help the process of economic decision making


Balance of payments &
exchange rate




A country’s balance of payments account records all transactions (debit &
credit) between the residents of that country and the rest of the world
Selling exports earns foreign currency; buying imports uses up foreign
currency
Spending more foreign currency than we earn will cause 2 problems:
 The balance of payments will go into deficit (imports > exports)
 The exchange rate will fall
...

Government macroeconomic policy objectives:

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

High & stable economic growth
Low unemployment
Low inflation
Avoid balance of payments deficits &
excessive exchange rate fluctuations

Linked through
aggregate demand
(AD)

These policy objectives
may conflict, societies
face trade-offs between
economic objectives

The Circular Flow of Income

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

Aggregate demand = total spending on goods & services produced within the country
AD = + I + G + X or AD = C + I + G + X – M
Firms PRODUCE goods & services and EMPLOY labour & other factors of production
...

Factor market provides INPUTS for the production of goods & services
...

Money = a stock concept (a certain quantity of money in the economy at a given time)
Income = a flow concept (measured so much per period of time)
MONEY ≠INCOME
Relationship between MONEY & INCOME: Velocity of circulation

2 major
groups

INNER
FLOW

Inner flow






Firms pay money to households (e
...
wages & salaries, dividends on shares, interest & rent) for using the
services of the factors of production
...

The flow will continue at the same level if
 Households spend all their incomes on buying domestic goods & services
 Firms pay out all this income received as factor payments to domestic households
 The velocity of circulation does not change
In the real world, not all income is passed on round the inner flow; some is withdrawn
...
g
...

“ Benefits = ‘negative tax’ ”  transfer payments




Import expenditure

Although the money consumers spend on such goods initially flows to domestic
retailers, it will still flow abroad either when the retailers or wholesalers
themselves import them, or when domestic manufacturers purchase imported
inputs to make their products
...

Invest in plant & equipment, spend the $ on building up stocks of inputs, semifinished/finished goods etc
...

 If injections > withdrawals, the level of expenditure will rise, AD will rise too
...
Total output in the economy will rise,  national
income will rise
...

2
...

4
...
The economy will be brought back
to a state of equilibrium where injections = withdrawals
...
e
...


Adjustments:
 Appreciation of stock or inventory (i
...
increase in value due to increased price)
is excluded from value added, since it does not contribute to real increase in
output
...
g
...

 Ownership of dwellings
 Taxes and subsidies on products are normally excluded from GVA since they are
not part of value-added
...
g
...

Adjustments
 Appreciation of stock or inventory is excluded
...
g
...

 People’s income are counted before the payment of income & corporation
taxes, i
...
the gross income
...
But taxes are added and subsidies are subtracted if we
want to arrive at GDP at market price
...

Y=C+I+G+X-M
[Consumption expenditures (C), Investment expenditure s (I), Government
expenditures (G), Exports (X)
...
]
** The 3 methods MUST give the same result: National product = national income = national expenditure

To improve the accuracy of GDP figures:
Taking account of
Inflation

Description

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

Population


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

Exchange rates

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

Nominal GDP / money GDP measures GDP at current prices,  take no
account of inflation
...
e
...

How much real GDP has changed from 1 year to another can be shown
...

Measuring GDP per head of the employed populations allows us to compare
how much the average worker produces
...

Comparing GDP between countries is hard since GDP figures are expressed in
different currencies with different purchasing power
...

Purchasing-power standard (PPS) GDP: GDP is measured at a country’s PPP
exchange rate

Problems of measuring national output:


The output of some goods & services goes unrecorded, so the nation’s output is understated
...
g
...

Employing more nannies to look after children may overstate the rate of growth in output
...
g
...

 They are not declared for tax purposes, e
...
to avoid VAT
...


Problems of using GDP to measure welfare:
Problems

Description

Production does not equal
consumption

Production is desirable only if it enables us to consume more
...
If GDP arise due to an increase in export, unless
there is a resulting increase in imports, or else it will benefit the
consumers abroad, not domestic consumers
...

Leisure and pleasant working conditions are not included in GDP figures
...
g
...


Total GDP figures ignore the
distribution of income

Some people grow very rich while others don’t which causes a growing
inequality
...
GDP statistics is a good indicator of the level of production of goods & incomes generated
2
...


14
...

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Actual growth: % annual increase in national output, i
...
rate of growth in real GDP
 Actual growth tends to fluctuate while potential growth tends to be steadier
...
An increase in resources (natural resources, labour, capital)
2
...
e
...
This allows for
 Firms with planned degree of spare capacity to meet unexpected demand or for hold-ups in supply
 Some unemployment as people move from job to job
...
e
...

 If AO < PO, output gap = negative, i
...
the economy is operating below normal capacity utilization
...

Two major policy issues concerned with economic growth:
1
...
Long-run issue of what determines the rate of potential economic growth

Business cycle (AKA trade cycle): The periodic fluctuations of national output around its long-term trend


4 phases of business cycle:
1
...
The expansion: there is rapid economic growth
3
...
The slowdown, recession or slump: no growth or even a decline in output

** The level of output is highest in phase 3
...

Full-capacity output

Trend output

Actual output

In practice, business cycles are highly irregular in 2 ways:
1
...
The magnitude of the phase

Causes of fluctuation in actual growth:
Short run
Variations in the growth of aggregate demand
** AD & aggregate output fluctuate together in short run, but
a rapid rise in AD is not enough to ensure a continuing high
level of aggregate output over years without expanding
potential output
...
The growth in aggregate demand
2
...
e
...
Supply side of the economy is concerned rather than the
level of AD over the long term
...
Capital
 The nation’s output depends on its stock of capital (K), e
...
K rises, output rises
 If we ignore the problem of machines wearing out or becoming obsolete & needing
replacing, then stock of capital will increase by the amount of investment: DK = I
Marginal efficiency of capital ← MEC =




(1)
The amount
of resources
available

D
D

=

D

The higher this rate of new investment, the higher will be the PG rate
= ×
Determinants of the rate of investment:
 Confidence of business people about the future demand for their products
 Profitability of business
 Tax regime
 Rate of growth in economy
 Rate of interest
Over the long term, if investment is to rise, then people must save more (&
consume less) to finance that extra investment

2
...
e
...
g
...

3
...

 Even if new raw materials (e
...
oil) are discovered, this will result only in short-term
growth
...

Unless all factors of production,  the rate of growth is likely to slow down
...

If a rise in labour and capital leads to a more intensive use of land and natural
resources, the resulting growth in output may be environmentally unsustainable
...

New skills, improved education/training, better health   productivity of labour
Innovation & inventions

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(2)
Productivity

The effects of actual growth on potential growth:
Argument 1: Potential growth is not influenced by actual growth
...

 Such advances are independent of the state of the economy
...

 It is vital to achieve high long-term growth rates that the economy experiences continuous and stable
growth in actual output
...
Focus on the demand side or the supply side of the economy
...

 Increase aggregate supply by concentrating on measures to increase potential output
2
...

 (From political view) Free up the market to allow the private enterprise to reap substantial
rewards from investment in new techniques and new products
...

Major determinant of potential output as investment both increases the capital stock and leads to the
development of new technology
...

** Generally the effects on AD happen more quickly than those on AS

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