3. macro economics
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7/28/2019 3. Macro Economics
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Macroeconomics
The field of economics that studies thebehavior of the aggregate economy throughconsidering economy
wide elements:
changes in (un)employment
national income
rate of growth
gross domestic product
inflation and price levels
Objectives Full employment
Real economic growth growth in national income per head of population
improved living standards
an acceptable distribution of wealth
Price stability Limited inflation
An acceptable balance between exports and imports Manageable balance of payments over time.
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The Circular Flow
The main stream
flows clockwise
around the circle,
first as income
from firms to
households the
lower half of the
circle then as
spending from
households to
firms
the upperhalf of the circle.
For each flow of
money there is
an equal and
opposite flow of
goods or
resources.
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Gross Domestic Product
Considered as:
The total market value of all final goods and servicesproduced within the country in a given period of time(usually a calendar year).
The sum of value added at every stage of production (theintermediate stages) of all final goods and servicesproduced within a country in a given period of time.
The total output of goods and services during a year,measured at purchase price.
Consumption + Investment + Government Spending
+/- Balance of payments.
Consumption
Private (household) consumption influenced
by:
the level of households incomes,
the rate of tax, and
the portion of a households income that is
saved.
Investment
Made by organizations and households in
capital items:
Buildings
Construction works
Plant and equipment
New houses (household capital expenditure).
Government spending
Covers all government consumption (on final
goods and services) and government
investment (e.g. infrastructure).
In most economies, government spending
forms a large portion of the countrys GDP
and will be determined by the governmentsfiscal policy.
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Balance of payments
The value of exports minus the value of imports.
GDP measures what is produced domestically,
thus:
exports are included (as these would not be
recorded under household or government
expenditure)
imports are deducted (as they would not have been
produced domestically, yet will be included within
household and government expenditure as
consumption).
GDP: Expenditure Approach Using the expenditure approach, an economys
aggregate expenditure equals the sum of
Consumption, C
Investment, I
Government Purchases, G
Net Exports, (Exports, X, minus Imports, I)
C + I + G + (X M) = Aggregate Expenditures = GDP
Inflationary and deflationary gap
In a situation where resources are alreadyfully employed, there may be an inflationarygap since increases in demand will cause pricechanges, but no variations in real output. A
shift in demand or supply will not only changethe national income, it will also change price
levels. A deflationary gap exists when there is
insufficient demand available in the economyto generate a full-employment equilibrium. Inother words there is not enough being boughtto provide jobs for everyone who wants them.
Factors that influence level of
business activities
Consumer confidence
Aggregate demand
Capital (availability of finance)
Exchange rates
Use of resources (new tech, adv in educationetc)
Government policy
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Business trade cycle Recession
A general definition of being in a recession is
when GDP is negative for two or more
consecutive quarters.
As demand falls and businesses reduce their
output, individuals may lose their jobs and as a
result, there is increased pressure on household
incomes and demand falls yet further.
Returns on investment will decline with some
projects being cut or put on hold. Orders will
decline, inventory levels reduce, prices will fall
and some business will face closure.
Depression
Depression is a severe economic downturn that
will usually last several years. Annual GDP decline
will be of the order of -5% to -15%.
The main driving factor is a loss of consumer
confidence. Consumers do not buy, but try to
survive on basic goods and services and savewhat they can.
Some characteristics of a depression are mass
unemployment, restriction of sources of finance,
reduced output and currency volatility.
Recovery
As and when consumer confidence returns
businesses will begin to retool, restock and
employ more people.
As recovery continues, the output level will
rise above the general trend line, entering into
the boom phase.
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Boom
Households will have higher incomes due tohigher salaries, higher share of profits and
higher dividends.
Capacity and labor become fully utilized. Thiswill lead to increasing costs as competition forlimited resources intensifies or the demand ismet through importing. Increasing the salesprice may also be a result of trying to controldemand.
I nfl ation
Inflationis a sustained increase in theaverage price level
Hyperinflation: Extremely highinflation, German hyperinflation of1922/23
A sustained decrease in the averageprice level is called deflation
A reduction in the rate of inflation iscalled disinflation
The rate of increase of the general level of
prices being a sustained increase in the
aggregate or general price level in an
economy.
Various measures include CPI, RPI, PPI, IPI,
OPI
A CPI attempts to measure changes over time
in the monetary cost of a statistically
weighted representative basket of goods
and services.
Causes of Inflation
Demand-pull inflation isinflation initiated by anincrease in aggregatedemand.
Cost-push, orsupply-s ide,inf lat ionis inflation caused by anincrease in costs.
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Costs of inflation
Consequences of high inflation include:
Lower standards of living
Redistribution of income: Fixed income,borrowers vs. lenders
Disincentive to save : e.g. Buy today, or it will beexpensive tomorrow
Impact on money, imports and exports
Causes uncertainty and stifles businessinvestments
Wage-price spiral
Shoe Leather costs. If inflation forces up the
price of raw materials or components, the
firm will be forced to shop around for cheaper
raw materials or components, again increasing
costs to management.
Increasing menu costs. If inflation is at a high
level, firms will have to continuously re-price
goods. This re-pricing brings with it costs such
as reprinting of brochures, sales details etc.
Unemployment
The amount of joblessness in the economy. A person is generally unemployed if they are willing and
able to work, but cannot find employment.
Categories include: Real wage: caused by wages in the labor market being
pushed beyond the equilibrium as a result of trade unionaction or minimum wage requirements, resulting inbusinesses being able to afford to employ fewer staff.
Frictional: caused by workers moving between jobs
Seasonal: caused because of seasonal fluctuations indemand for labor
Structural: : caused by structural change in the economy,leading often to a change in skills required.
Cyclical: caused by the fall in aggregate demand.
Hidden
Unemployment
Consequences include:
Adverse social effects social blight
Greater divisions within society
Higher governmental costs
Loss of potential for maintaining or increasingnational output and income
Loss of work skills and experience
Government policies include:
Job creation schemes, grant assistance, incentives
Labour mobility schemes
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Stagnation
A relatively long period of very low or no
economic growth
Economic growth of less than 2% - 3%
Slow or sluggish growth = existing
unemployment levels cannot be lowered
Weak demand for goods and services
Stagflation
A combination of high unemployment and
high inflation
Reduced job opportunities, lower pay
packages and rising prices
Reduced demand for goods and services and
increased in prices of raw materials.
International Payments
Disequilibrium
Occurs when the balance of payments isnegative.
The balance of payments:
Is a record of a countrys transactions with the rest ofthe world
Shows the net receipts from various aspects of trade
and consists of the current and financial account. A separate capital account shows the impact of the
capital elements contained within the current andfinancial accounts.
Current account
The record of payments in trade and services,
sub divided as:
balance of payments (trade) in goods - visibles
balance of payments (trade) in services, e.g.
tourism, insurance - invisibles
net income flows (e.g. wages and investmentincome)
net current transfers (e.g. government aid).
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Financial account
A measure of the net payments to and from
other countries for investment purposes, e.g.
investment abroad (outward investment)
investment from abroad (inward investment)
Monetary policies
Those actions taken by the government or
the central bank to achieve economic
objectives using monetary instruments.
These actions may either directly control the
amount of money in circulation (the money
supply) or attempt to reduce the demand for
money through its price (interest rates)
Money supply
Can be controlled through:
Interest rates
Credit controls
Direct intervention by central bank
Foreign exchange
Open market operations
The impact on a business of higher interest rates
People may borrow less because
it costs more money to pay back
the loan
So people buy fewer
consumer goods
So businesses sell
fewer products
It costs the business more
money to pay back any loans
So the business needs to
find more money to pay
back its loans
The business decides not
to invest in new
equipment
The business may make less profit
The business becomes less competitive
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The impact on a business of lower interest rates
People may borrow more
because it costs less money to
pay back the loan
So people buy more
consumer goods
So businesses sell
more products
It costs the business less money
to pay back any loans
So the business needs
to find less money to
pay back its loans
The business decides to
invest in new equipment
The business may make more profit
The business becomes more competitive
Exchange rate
The exchange rate is the price of one currency
expressed in terms of another.
If the UK exchange rate increases it means the
pound sterling is stronger and other
currencies are weaker
Appreciation
Depreciation
Fiscal policy
Action by the government to achieve economicobjectives through the use of the fiscalinstruments of taxation, public spending and thebudget deficit or surplus.
Reflate an economy through:
Increased government spending
Reduced taxation
Deflate an economy through:
Reducing government expenditure
Increasing taxation
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Borrowing:
To the extent that a government's expenditure
exceeds its income it must borrow to make up
the difference.
The amount that the government must
borrow each year is now known as the Public
Sector Net Cash Requirement (PSNCR) or in
UK it is was formerly named as Public Sector
Borrowing Requirement (PSBR).
Fiscal policy
Reflating problems:
Intervention into a free market
Unemployment
Time lags
Tax cuts may not boost domestic demand
Budget deficit plus increased inflation
Deflating problems:
Government spending cannot be drastically cut
Time lags
Increased taxes discourages enterprise
Supply side approach
Policies that focus on creating the right
conditions in which private enterprise canflourish
Raise the capacity of the economy to providethe output demanded.
The private sector, being driven by the profitmotive, is deemed to be more efficient atproviding the output required than the publicsector
Supply side approach
Supply side policies include:
low tax rates to encourage private enterprise
the promotion of a stable low inflation economy
limited government spending and intervention
a balanced fiscal budget
deregulation of industries
reduction in the rights of employees/power of tradeunions
increase in the training and education of the workforce
increase of business infrastructures
a reduction in planning legislation
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Taxation
Used to:
raise revenues for the government (fiscal policy)
raise barriers to activities considered undesirable
price products at their social costs
redistribute income and wealth
protect industries from foreign competition and
dumping
Taxation forms
Proportional taxation Based on a fixed proportion of the item base
Progressive taxation Increases as the tax base increases
Direct taxes Paid directly to the government can be
proportional or progressive and are usuallyunavoidable
Indirect taxes Not paid directly by the end user, but are collected
by the government through an intermediary
Economic growth
Measured by increase in the real GNP per
head of the population
Actual economic growth is the annual
percentage increase in national output, which
typically fluctuates with the trade cycle
Potential economic growth is the rate at which
the economy would have grow if all resources
were fully utilized
Consequences of economic growth
+ increase in income per head
+ higher level of consumption
+ better living standard
+ better social services without increasing taxes
- Depletion of natural resources- Create pollution
- Structural unemployment
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Privatization
For:
an increase in competition
a short-term boost to government revenues
a widening of share ownership
Against:
public sector monopolies become private sector ones
loss of economies of scale if broken up
deteriorating quality of service
profit is the motive and not social welfare
Barriers to international trade
Tariffs
Quotas
Embargos
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