lecture slides 2013 vietnam sem3

MODULE 1: CONCEPTSECONOMIC METHODOLOGY & THE ECONOMISING PROBLEMMEASUREMENT - GDP, UNEMPLOYMENT & INFLATION

School of Economics, Finance and Marketing

RMIT UniversitySchool of Economics, Finance and Marketing*Economic Methodology & the Economising Problem

Economics: Foundations and Models - Chapter 1Choices and Trade-Offs in the Market - Chapter 2Learning Objectives:

Discuss the following important economic ideas: people are rational; people respond to incentives; optimal decisions are made at the margin.Understand the issues of scarcity and trade-offs, and how the market makes decisions on these issues.Understand the role of economics in modern analysis.Distinguish between microeconomics and macroeconomics.Use a production possibility frontier to analyse opportunity costs and trade-offs.Understand the basics of trade.


RMIT UniversitySchool of Economics, Finance and Marketing*EconomicsA social science concerned with the allocation of scarce/limited resources between unlimited and often competing needs and wants.

Scarcity: The situation in which unlimited wants exceed the limited resources available to fulfill them. Trade-off: The idea that because of scarcity, producing more of one good or service means producing less of another good or service.


RMIT UniversitySchool of Economics, Finance and Marketing*Resource CategoriesResources are divided into 4 main categories.Land: all natural resources.Labour: Requires a fundamentally scarce resource - TIME.Capital:Human capital: knowledge & skills that people developPhysical Capital: buildings, machinery tools, etc.Enterprise or entrepreneurial ability


RMIT UniversitySchool of Economics, Finance and Marketing*Three ideas are primary throughout the course:

People (economic agents) are rational.

People (economic agents) respond to economic incentives.

Optimal decisions are made at the margin. Economics and Individual Decisions


RMIT UniversitySchool of Economics, Finance and Marketing*Economic ModelsEconomics deals with generalities/statements about regularities, concerning economic behaviour. Models are simplified representations of the real world. Ceteris Paribus A hypothesis in an economic model: A statement about an economic variable that may be either correct or incorrect. Economic variable: Something measurable that relates to resources that can have different values. In testing hypotheses, economists distinguish between correlation and causality.


RMIT UniversitySchool of Economics, Finance and Marketing*Positive versus Normative

Positive: Claims that attempt to describe the world as it is. Statements of facts. Can be tested empirically.

Normative: Claims that attempt to prescribe how the world should be. Opinions. Cannot be tested empirically.


RMIT UniversitySchool of Economics, Finance and Marketing*Macroeconomics versus MicroeconomicsMicroeconomics: The study of how individuals make decisions. Microeconomics considers how households and firms make choices, how they interact in markets, and how the government attempts to influence their choices.

Macroeconomics: Enables us to better understand the structure and behavior of the entire economy (regional, national or global) and to consider issues associated with measuring performance. Macroeconomics is the study of the economy as a whole and includes topics such as inflation, unemployment, and economic growth.


RMIT UniversitySchool of Economics, Finance and Marketing*Scarcity and Trade-offsWhat to produceHow to produce itWho will receive the products

Commanding Heights Episode 1, Chapter 2: The Old Order Fails

WHO DECIDES?


RMIT UniversitySchool of Economics, Finance and Marketing*


RMIT UniversitySchool of Economics, Finance and Marketing* Production Possibilities FrontierHow to achieve the greatest possible satisfaction of societys material wants given scarce resources?Full employment

Full productionAllocative efficiencyProductive efficiency


RMIT UniversitySchool of Economics, Finance and Marketing* Production Possibilities Frontier

Represents the maximum possible combinations of goods & services that can be produced with a given quantity of factors of production and given technology.


RMIT UniversitySchool of Economics, Finance and Marketing*An "increase in efficiency" suggests that an economy:Has moved from a point outside of, to a point on, its production possibilities curve.Has decided to produce more consumer goods and fewer capital goods.Is able to get less output from a given amount of input.Is able to get more output from a given amount of input.

Check Your Knowledge


RMIT UniversitySchool of Economics, Finance and Marketing* Opportunity Cost Any movement along the PPF involves the concept of opportunity cost.

Can only obtain more of one good by having less of the other.The opportunity cost of any activity is the highest-valued alternative that must be given up to engage in the activity under consideration.


RMIT UniversitySchool of Economics, Finance and Marketing* Increasing & Constant Opportunity Costs10Scarce resources are not equally suitable in all productive activities. Economic resources are not completely adaptable to alternative uses. Scarce resources are equally suitable in all productive activities. Economic resources are completely adaptable to alternative uses.



Trade-offs and disaster reliefMore funds for one disaster relief means less funds for other charities.

Consider the opportunity cost as well as the direct financial costs associated with the Queensland floods.


RMIT UniversitySchool of Economics, Finance and Marketing*Economic GrowthOver time PPF can move outwards.

Achieved through economic growth.

The following will push the PPF out: Capital accumulation. Technological progress.Increased resources


RMIT UniversitySchool of Economics, Finance and Marketing*Here is a production possibilities table for watches and bags in Consumer Land.

Draw a PPF that corresponds with the data in the table.

Why must Consumer Land sacrifice successively larger amounts of watches to acquire more bags. What type of opportunity costs is it facing?Check Your Knowledge

Production AlternativesType of productABCDEWatches (in millions)109740Bags (in millions)05101520


RMIT UniversitySchool of Economics, Finance and Marketing*c.If the economy is currently at production alternative D: i. What is the opportunity cost of five million more bags?What is the opportunity cost of three million more watches?

Where would the economy be operating if a recession in Consumer Land resulted in 2 million people losing their jobs?

If the production possibilities frontier for Consumer Land was a straight line, what would it indicate about the countrys opportunity costs? What does this indicate regarding resources?

Suppose improvement occurs in the technology of producing watches but not in the production of bags. Illustrate the impact on the original production possibilities frontier.Check Your Knowledge


RMIT UniversitySchool of Economics, Finance and Marketing*We can use the production possibility frontier and the concept of opportunity cost to explain the economic gains from specialisation and trade. (ECON1086: International Trade covers the important topic of international trade in more detail).

Trade: the act of buying or selling a good or service in a market.

Trade


RMIT UniversitySchool of Economics, Finance and Marketing*PPF and International TradeMercantilism held that countries would grow wealthy by accumulating gold and silver. They would do so by exporting as much as possible, and importing as little as possible.

Adam Smith put forward the idea that the wealth of a nation depends on the incomes of the people in the country and what they are able to consume, not on the gold and silver held by the monarchs and the nobles.

According to Smith, imports rather than exports are the purpose of trade. Imports of goods and services rather than the accumulation of gold and silver improve peoples standard of living.


RMIT UniversitySchool of Economics, Finance and Marketing*Absolute and comparative advantage.

Absolute advantage: The ability of an individual, firm or country to produce more of a good or service than competitors using the same amount of resources.

Comparative advantage: The ability of an individual, firm or country to produce a good or service at a lower opportunity cost than other producers. Trade


RMIT UniversitySchool of Economics, Finance and Marketing*The Benefits of International TradeDavid Ricardos theory of comparative advantage (developed in 1817) showed how a country could improve the income of its citizens by allowing them to trade with people in other countries.

International trade allows nations to increase the productivity of their resources through specialisation and thereby to realise a higher standard of living than is possible in the absence of trade.

Trade enables a country and the world to produce and consume more than would be possible without trade.


RMIT UniversitySchool of Economics, Finance and Marketing*The basis for trade is comparative advantage not absolute advantage.

Individuals, firms or countries are better off if they specialise in producing goods and services for which they have a comparative advantage and obtain other desirable goods and services by trading. Trade


RMIT UniversitySchool of Economics, Finance and Marketing*Measurement : GDP, Unemployment, Inflation

Measuring Total Production, Income and Economic Growth - Chapter 4Economic Growth, The Financial System and Business Cycles Chapter 5 (pp. 119-120)Unemployment - Chapter 9 ( pp. 246-262)Inflation - Chapter 10 (pp. 272-280)Learning Objectives:Explain how total production in an economy is measured.Discuss whether GDP is a good measure of economic wellbeing.Discuss the difference between real and nominal variables.Understand how the economic growth rate is measured. Define the unemployment rate and the labour force participation rate, and understand how they are calculated.Explain the economic costs of unemployment.Identify the different types of unemploymentDefine the price level and the inflation rate, and understand how they are calculated.Use price indexes to adjust for the effects of inflation.Distinguish between the nominal interest rate and the real interest rate.Discuss the problems caused by inflation.


RMIT UniversitySchool of Economics, Finance and Marketing*GDPGross Domestic Product (GDP): The total market value of all final goods and services produced in the economy during a specific period.

Gross National Product (GNP): The total market value of all final goods and services produced by residents of a country (eg. Vietnamese residents) during a specific period.

GDP includes only the market value of final goods.Final good or service: A good or service purchased by a final user.Intermediate good or service: A good or service that is an input into another good or service, such as a tyre on a truck.GDP includes only current production.


RMIT UniversitySchool of Economics, Finance and Marketing*Methods to Measure GDPThree alternative methods to measure GDP:

The Production or Value Added Method: The sum of the value of all goods and services produced by industries in the economy in a year minus the cost of goods and services used in production leaving the value added. The Expenditure Method: The sum of the total expenditure on goods and services by households, investors, government and net exporters (exports minus imports).The Income Method: The sum of the income generated by resources used in the production of goods and services (includes the sum of wages, salaries and supplements plus rent, interest, profit and dividends).


RMIT UniversitySchool of Economics, Finance and Marketing*Net Export Expenditure


RMIT UniversitySchool of Economics, Finance and Marketing*Simple RelationshipsRGDP = Y = AE = C + I + G + NX

For a closed economy we simply remove the external sector which makes our income function:

Y = C+ I + G

I = Y C G

Stotal = Sprivate + Spublic

Sprivate = Y + TR C T and Spublic = T G TR, hence

Stotal =

Thus:


RMIT UniversitySchool of Economics, Finance and Marketing*One bag of flour is sold for $1.50 to a bakery, which uses the flour to bake bread that is sold for $4.00 to consumers. A second bag of flour is sold to a consumer in a grocery store for $2.00. Taking these three transactions into account, what is the effect on GDP? GDP increases by $1.50. GDP increases by $3.50. GDP increases by $6.00. GDP increases by $7.50.



RMIT UniversitySchool of Economics, Finance and Marketing*Components of GDPConsumption: Spending by households on goods and services, not including spending on new houses.Investment: Spending by firms on new factories, office buildings, machinery (planned), and inventories (unplanned), and spending by households on new houses. Government purchases: Spending by federal, state, and local governments on goods and services.Net exports: The value of exports minus the value of imports.GDP = C + I + G + NX


RMIT UniversitySchool of Economics, Finance and Marketing*Some Actual Values Table and graph of components of GDP, 2006/07



GDP does not reflect total current production as production from the following sources are not reflected in its calculation:

Household production: Goods and services people produce for themselves.

The black economy: Buying and selling of goods and services that is concealed from the government to avoid taxes or regulations or because the goods and services are illegal.Issues in the Measurement of GDP: Shortcomings of GDP as a measure of total production


RMIT UniversitySchool of Economics, Finance and Marketing*Shortcomings of GDP as a measure of wellbeing:The composition and distribution of GDP is not captured in GDP measures. The value of leisure is not included in GDP.The level, quality of and access to health care is not measured in GDP.GDP does not accurately reflect improvements in the quality of products. GDP is not adjusted for pollution or other negative effects of production. GDP does not reveal anything about social problems that also impact on overall societal wellbeing.

Does GDP measure what we want it to measure?


RMIT UniversitySchool of Economics, Finance and Marketing*Nominal (Money or Current) GDP versus Real GDPInflation or deflation complicates the comparison of figures measuring GDP over time, because GDP is a price-times-quantity figure. Nominal GDP could increase over time because of increased output, increased prices or both.Suppose the economy had a money GDP of $1,000 in 2008, which results from the production of 1,000 apples that sell at a price of $1 per apple. Would it be better off in the year 2009 with a money GDP of $2,000?What would be your conclusion if you found out that the $2,000 GDP resulted from the production and sale of 1,000 apples at a price of $2 per apple?



Price and QuantitiesYearPrice of applesQty. of applesPrice of burgersQty. of burgers2006$1100$2502007$2150$31002008$3200$4150YearCalculating GDP using current prices200620072008YearCalculating GDP using constant prices (base year 2006)200620072008


RMIT UniversitySchool of Economics, Finance and Marketing*Calculating Real GDP Real GDP (RGDP): The value of final goods and services evaluated at base year prices.Nominal GDP: The value of final goods and services valuated at current year prices.Nominal GDP can change over time due to changes in either price or output. RGDP shows changes in output only.GDP statisticians select a base year and use this over a specified period to measure RGDP in order to make meaningful comparisons of GDP over time.A simple rule: RGDP equals base year prices times current year quantities.

Real GDP versus Nominal GDP



The Economic Growth Rate: the rate of change in real GDP from one year to another.

Calculating Economic GrowthSlide *


RMIT UniversitySchool of Economics, Finance and Marketing*Slide *Measuring UnemploymentUnemployment rate: percentage of the labour force that is unemployed.

Labour-force Participation rate: percentage of the adult population in the labour force.

Labour force = No. of employed + No. of unemployed


RMIT UniversitySchool of Economics, Finance and Marketing*Slide *Types of UnemploymentFrictional UnemploymentIncludes workers who are in the process of voluntarily switching jobs, workers who are temporarily laid off because of seasonality, and new entrants into the labour force. Largely due to imperfect information.Structural UnemploymentUnemployment due to fundamental changes in the kinds of jobs that the economy offers. Workers may have inappropriate skills. Cyclical unemploymentDue to a deficiency in aggregate demand for goods and services.


RMIT UniversitySchool of Economics, Finance and Marketing*Full Employment and the Natural Unemployment RateWhen cyclical unemployment is zero, there is full employment.Full employment is therefore achieved when real GDP is equal to its long-run potential GDP.At full employment, there will inevitably be some structural and frictional unemployment.The unemployment rate at full employment is termed the natural rate of unemployment.The natural rate of unemployment is not forever fixed and will vary as rates of frictional and structural unemployment change.


RMIT UniversitySchool of Economics, Finance and Marketing*Issues in the Measurement of UnemploymentDiscouraged workers: individuals who have given up looking for work but would like to work.Underemployment: All part-time workers are classified as employed. Yet many part-time employees may want to work full-time. (Underemployment may also apply to causal workers who work in excess of 1 hour per week and are counted as employed even though they might like to work more hours).Truthfulness issues


RMIT UniversitySchool of Economics, Finance and Marketing*InflationPrice level: a measure of the average prices of goods and services in the economy.

Inflation rate: The percentage increase in the price level from one year to the next.

Deflation: A decline in the general price level in the economy.


RMIT UniversitySchool of Economics, Finance and Marketing*Consumer Price Index (CPI): An average of the prices of the goods and services purchased by the typical urban family of 4 in an economy.The Market Basket: In Vietnam, the General statistics office identifies:A typical or representative Vietnamese household.The goods and services purchased by the household (this is the market basket). Measuring Inflation


RMIT UniversitySchool of Economics, Finance and Marketing*Consumer Price IndexThe CPI is the most commonly known price index and is based on changes in the price of a given basket of consumption g&s.

Fixed basket of 4 apples and 2 burgersYearPrice of applesPrice of burgers2006$1$22007$2$32008$3$4YearCost of basket200620072008YearConsumer price index (2006 is the base year)200620072008


RMIT UniversitySchool of Economics, Finance and Marketing*InflationInflation rate calculated used the CPI:2007:

2008:


RMIT UniversitySchool of Economics, Finance and Marketing*The CPI is the most widely used measure of inflation. Is the CPI accurate?Four sources of bias in the CPI may lead to its overstating the inflation rate.Substitution biasIncrease in quality biasNew product biasOutlet bias Issues in the Measurement of Inflation


RMIT UniversitySchool of Economics, Finance and Marketing*The GDP Deflator: GDP also allows us to calculate changes in the price level over time. The GDP deflator is a measure of the price level calculated by dividing nominal GDP by real GDP and multiplying by 100.The Producer Price Index (PPI): an average of the prices received by producers of goods and services at all stages of the production process.

Other Measures of Inflation


RMIT UniversitySchool of Economics, Finance and Marketing* The purchasing power of the dollar falls over time as prices rise. Price indexes, such as the CPI, allow us to adjust for the effects of inflation so we can compare dollar values over time. For example; we can find the 2008 purchasing power equivalent of a $20,000 salary in 1980. We use the following formula:

Using Price Indexes to Adjust for the Effects of Inflation


RMIT UniversitySchool of Economics, Finance and Marketing*HyperinflationExtremely rapid increases in the general price level.In periods of hyperinflation, money loses value so rapidly, that firms and households try to avoid holding it. Hyperinflation is often associated with political instability and usually accompanied by recession.


RMIT UniversitySchool of Economics, Finance and Marketing*Nominal interest rate: The stated interest rate on a loan.Real interest rate: The nominal interest rate minus the inflation rate.Deflation: A decline in the general price level in the economy. Real versus Nominal Interest Rates


MODULE 2: MARKETSTHE PRICING MECHANISMTHE PRODUCT MARKETTHE LABOUR MARKETEXCHANGE RATE MARKETFINANCIAL MARKETSMONEY MARKET


RMIT UniversitySchool of Economics, Finance and Marketing*The Pricing Mechanism

Where Prices Come From: The Interaction of Demand and Supply - Chapter 3

Learning Objectives:

Understand the factors that influence the demand for goods and services.Understand the factors that influence the supply of goods and services.Explain how equilibrium in a market is reached and use a graph to illustrate equilibrium.Use demand and supply graphs to predict changes in prices and quantities.Commanding Heights Episode 1, Chapter 3: Communism on the Heights


RMIT UniversitySchool of Economics, Finance and Marketing*The Market for an Individual Good or ServiceThe market is one method of producing and rationing scarce goods and resources. A market is when a group of buyers and sellers of a particular good or service interact. Supply and Demand refer to the behaviour of individual householders (or consumers) and firms as they interact with one another in the market. A competitive market is a market in which there are many buyers and sellers, so that each has a negligible impact on price.


RMIT UniversitySchool of Economics, Finance and Marketing*Individuals Demand for a Good or ServiceA demand schedule shows the various amounts of a product consumers are willing to purchase at each specific price point, ceteris paribus (all other things being equal).

The negative or inverse relationship between price and the quantity demanded is known as the Law of Demand.


RMIT UniversitySchool of Economics, Finance and Marketing*Market and Individual Demand

Kates Demand

The market demand curve is the horizontal sum of the individual demand curves


RMIT UniversitySchool of Economics, Finance and Marketing*A Change in Demand versus a Change in the Quantity Demanded A change in demand occurs if any determinant of demand (other than the price of the good or service itself) changes. This will shift the demand curve.An increase in demand shifts the demand curve to the right and will result in a new equilibrium (P and Q).A decrease in demand shifts the demand curve to the left and will result in a new equilibrium (P and Q).A change in the quantity demanded occurs if the price of the good or service itself changes. This is reflected by a movement along an existing demand curve.An increase in price will lead to a decrease in the quantity demanded.A decrease in price will lead to an increase in the quantity demanded.


RMIT UniversitySchool of Economics, Finance and Marketing*Determinants of Demand (Factors that will Shift the Demand Curve)

1.Tastes or PreferencesA change in tastes in favour of a product causes an increase in demand.2.Population and DemographicsAn increase in the number of consumers in the market represents an increase in demand.3.IncomeNormal goods: demand varies directly with income. An increase in income causes an increase in demand.Inferior goods: demand varies inversely with income.


RMIT UniversitySchool of Economics, Finance and Marketing*Determinants of Demand (cont.)4.Prices of Related GoodsSubstitutes: A good that can be used in place of another good. A decrease in the price of a substitute good causes the demand for the other good to decrease.Complements: Goods that must be used jointly. A decrease in the price of one good causes the demand curve for the other good to shift to the right.5.ExpectationsConsumer expectations of higher future prices may result in an increase in demand.



Shifts and Movements


RMIT UniversitySchool of Economics, Finance and Marketing*What effect will each of the following have on the demand for NIKE running shoes?NIKE running shoes become more fashionable.The price of REBOCK running shoes, a popular substitute, goes down.Consumers anticipate that prices on all running shoes will fall next month.There is a rapid increase in the population due to increased immigration.Check Your Knowledge


RMIT UniversitySchool of Economics, Finance and Marketing*Supply for a Good or Service

A supply schedule shows the various amounts of a product that producers are willing and able to produce at various prices, ceteris paribus (all other things being equal).

Positive or direct relationship between price and quantity supplied is known as the Law of Supply.


RMIT UniversitySchool of Economics, Finance and Marketing*Market and Individual SupplyMarket supply refers to the sum of all individual supplies for all sellers of a particular good or service.

Graphically, individual supply curves are summed horizontally to obtain the market supply curve


RMIT UniversitySchool of Economics, Finance and Marketing*A Change in Supply versus a Change in the Quantity Supplied A change in supply occurs if any determinant of supply (other than the price of the good or service itself) changes. This will shift the supply curve.An increase in supply shifts the supply curve to the right and will result in a new equilibrium (P and Q).A decrease in supply shifts the supply curve to the left and will result in a new equilibrium (P and Q).A change in the quantity supplied occurs if the price of the good or service itself changes. This is reflected by a movement along an existing supply curve.An increase in price will lead to an increase in the quantity supplied.A decrease in price will lead to a decrease in the quantity supplied.



Determinants of Supply (Factors that will Shift the Supply Curve)Resource prices: A decrease in price of inputs lowers production costs and increases supply.Technology: Technological improvements lowers production costs and increases supply.Prices of Substitutes in ProductionExpected Future PricesNumber of sellers: The larger the number of suppliers, the greater is market supply.



Shifts and Movements


RMIT UniversitySchool of Economics, Finance and Marketing*Market EquilibriumThe intersection of the supply curve and the demand curve for the product indicates the equilibrium price and quantity.

At the equilibrium price: quantity demanded = quantity supplied;The intentions of both buyers and sellers coincide. There is no incentive to alter the price.


RMIT UniversitySchool of Economics, Finance and Marketing*Market Disequilibrium: Shortages & Surpluses A surplus causes a competitive bidding down of price by suppliers. A shortage causes a competitive bidding up of price by buyers.Commanding Heights Episode 1, Chapter 9: Germanys Bold Move


RMIT UniversitySchool of Economics, Finance and Marketing*Market ClearingQuantityPriceD0SP0Q0A


RMIT UniversitySchool of Economics, Finance and Marketing*What will happen to the equilibrium price and quantity of butter in each of the following cases? State whether demand or supply (or both) have shifted and in which direction. A rise in the price of margarine; A rise in the price of bread; A tax on butter production and an increased preference for butter over margarine. Check Your Knowledge


RMIT UniversitySchool of Economics, Finance and Marketing*The Product Market

Economic Growth, the Financial System and Business Cycles - Chapter 5 (pp. 125-133) Aggregate Expenditure and Output in the Short-Term - Chapter 7 (pp. 174, 177-187)Aggregate Demand and Aggregate Supply Analysis - Chapter 8 (pp. 212-225)Learning Objectives:

Understand what happens during business cycles and their relationship to long-run economic growth. Discuss the determinants of aggregate demand and distinguish between a movement along the aggregate demand curve and a shift of the AD curve.Discuss the determinants of the four components of aggregate expenditure and define the marginal propensity to consume and the marginal propensity to save.Discuss the determinants of aggregate supply, and distinguish between a movement along and a shift of the AS curve.


RMIT UniversitySchool of Economics, Finance and Marketing*The Business CycleThe economy grows over time, but there are irregular fluctuations in its rate of growth from year to year.The business cycle refers to the periodic but irregular ups and downs in the level of growth in economic activity over a period of time.


RMIT UniversitySchool of Economics, Finance and Marketing*Economic FluctuationsIrregular and unpredictable. Most macroeconomic quantities fluctuate together. Changes in the economys output of goods and services are strongly correlated with changes in the economys utilisation of its labour force. Potential real GDP: The level of real GDP attained when all firms are producing at capacity.Actual real GDP fluctuates around the long-run potential in the Business Cycle.


RMIT UniversitySchool of Economics, Finance and Marketing*Slide *Aggregate DemandAD curve shows the amounts of goods and services (RGDP) that will be purchased at any given price level. AD is the relationship between the price level and RGDP.Overall price level of goods and servicesAn increase in the price level decreases the value of money because each dollar you have buys less.When the price level increases how much we can buy with $1 decreases, in other words, the value of money decreases in terms of goods and services purchased.

AD = C+I+G+NX = AE


RMIT UniversitySchool of Economics, Finance and Marketing*Aggregate Demand Slopes DownwardsThree key factors help explain the downward slope of the AD curve and hence the inverse relationship between the overall price level and the level of RGDP demanded.Wealth EffectChanges in the price level, with other things remaining the same, change real wealth, thus changing the level of spending.Interest Rate EffectHigher prices requires more money for purchases. Higher interest rates discourages business investment and reduces consumption expenditure on consumer durables.International Trade EffectHigher prices causes consumers to spend less on domestically produced goods and services (g&s) and more on imported g&s.


RMIT UniversitySchool of Economics, Finance and Marketing*Components of AE - Shifts of ADChanges in consumer spendingExpenditures by households on durable goods, non-durable consumer goods, and on services.Changes in investment spendingthe purchase of capital goods - plant and equipment, residential structures, and changes in inventory - that can be used in the production of other goods and services.Changes in Government spendingConduct of fiscal policy: changes in government purchases of goods and services and taxation.Changes in Net Foreign spending(Export - Imports) = Net Exports


RMIT UniversitySchool of Economics, Finance and Marketing* C = CO + cYIf income is considered a primary determinant of consumption then:

C: Total consumption expenditureCO: Autonomous/exogenous consumption. Captures the effect of the non-income factors. MPC: Marginal propensity to consume. Extra consumption associated with an extra dollar of disposable income.MPS: Marginal propensity to save. Extra savings associated with an extra dollar of disposable income.Based on the principal that Yd = C + SConsumption Spending


RMIT UniversitySchool of Economics, Finance and Marketing*Slide *Slide *Slide *If consumption spending increases from $350 million to $358 million when income increases from $412 million to $432 million it can be concluded that the relevant marginal propensity to consume is: 0.2 0.4 0.6 0.8Check Your Knowledge


RMIT UniversitySchool of Economics, Finance and Marketing*Consumption SpendingThe level of consumption spending is influenced by:WealthLevel of consumer debtExpectations e.g. future incomes or pricesAvailability and the cost of creditAge distribution of the population


RMIT UniversitySchool of Economics, Finance and Marketing*Investment Spending The level of investment spending is influenced by:Interest rateExpectations and business sentimentAcquisition, operating and maintenance costsBusiness taxesTechnological change/innovationCapital stock


RMIT UniversitySchool of Economics, Finance and Marketing*Government SpendingThe level of government expenditure is influenced by:Discretionary Fiscal Policy: deliberate changes in government spending and tax revenue used to help stabilise the economy.Expansionary fiscal policy involves:Increases in government spendingLowering of taxesA combination of the twoContractionary fiscal policy involves:Decreases in government spendingIncreasing of taxesA combination of the two


RMIT UniversitySchool of Economics, Finance and Marketing*Net Foreign SpendingThe three most important variables that determine the level of net exports are:

The price level in Vietnam relative to the price level in other countries.The growth rate of GDP in Vietnam relative to the growth rates of GDP in other countries.The exchange rate between the Vietnam dollar and other countries currencies.


RMIT UniversitySchool of Economics, Finance and Marketing*The short-run aggregate supply curve (SRAS) shows the relationship in the short-run between the price level and the quantity of real GDP supplied by firms.

Aggregate Supply


RMIT UniversitySchool of Economics, Finance and Marketing*The Slope of the Short-run Aggregate Supply Slope (SRAS)The SRAS is upward sloping, showing that in the short-run firms will produce more in response to higher prices. The reason for this is that the price of inputs tends to rise more slowly than the price of final products due to wage and price rigidities.Nominal Wages RigiditiesIf the price level falls, real wages rise, production costs increase; firms hire less labour, thus producing a smaller output.Price RigiditiesNot all firms adjust prices immediately in response to changes in the price level; affecting their competitiveness, sales and thus production.


RMIT UniversitySchool of Economics, Finance and Marketing*The variables that shift the SRAS curve include:Expected changes in the future price level.Adjustments of workers and firms to errors in past expectations about the price level.Unexpected changes in the price of an important natural resource. Plus any factor that shifts the LRAS curve.

Note: Factors 1-3 shift only the SRAS curve not the LRAS curveShort-Run Aggregate Supply


RMIT UniversitySchool of Economics, Finance and Marketing*The long-run aggregate supply curve (LRAS) shows the relationship in the long-run between the price level and the quantity of real GDP supplied. Long-Run Aggregate Supply (LRAS)The long-run aggregate supply curve shows that in the long-run increases in the price level do not affect the level of RGDP.


RMIT UniversitySchool of Economics, Finance and Marketing*Shifts in the long-run aggregate supply curve occur because potential GDP increases over time. Anything that shifts the LRAS also shifts the SRAS.Increases in GDP (or economic growth) which shift the LRAS are due to:An increase in resources.An increase in the capital stock.New technologyChanges in government policy (Incentives to work and invest)

Factors that Shift the LRAS Curve


RMIT UniversitySchool of Economics, Finance and Marketing*Macroeconomic EquilibriumPrice LevelRGDPSRASADYfP0LRAS


RMIT UniversitySchool of Economics, Finance and Marketing*What effects might each of the following have on aggregate demand and/or aggregate supply and why?A widespread fear of depression among consumers.A tax leading to a 2% increase in petrol prices.A decrease in interest rates.A decrease in government spending on higher education.The discovery of cheaper energy sources.Check Your Knowledge


RMIT UniversitySchool of Economics, Finance and Marketing*The Labour Market Unemployment - Chapter 9 (pp.262-264)Learning Objectives:

Explain what factors determine the unemployment rate.Explain labour market equilibrium and disequilibriumExplain the consequence of labour market disequilibriumDescribe the changes that have occurred in the determination of wages in Vietnam and discuss the possible effects on unemployment.


RMIT UniversitySchool of Economics, Finance and Marketing*The Labour MarketThrough the workings of the supply of labour and demand for labour, the levels of employment and the representative equilibrium wage rate is determined.The labour market is a resource market meaning that firms are the demanders and householders are the suppliers in this market. The labour market as presented, can be understood in terms of a representative model (in reality there are many distinct labour markets)

Supply of labour: Quantity of labour provided by households at various wage rates.Demand for labour: Quantity of labour hired by firms at various wage rates.


RMIT UniversitySchool of Economics, Finance and Marketing*Real Wage RateReal wage = nominal wage/overall price level = w/pReal wage is the amount of purchasing power that each worker receives and which the firm pays for each unit of labour.The wage rate can be viewed as the opportunity cost of leisure.


RMIT UniversitySchool of Economics, Finance and Marketing*social attitudes towards work and leisurenumber of workers with the required skills.

Changes in any of these other determinants will cause a shift in the supply curve for labour.

Supply of LabourA household decides on the allocation of time b/w (a) market activity(b) non-market activityThe real wage rate determines the quantity of labour supplied.Other determinants of labour supply include:


RMIT UniversitySchool of Economics, Finance and Marketing*Demand for LabourThe demand for labour ultimately depends upon, or derives from, the demand for the final product(s) that the labour is used to produce.Firm decides on the benefits of hiring an extra worker by looking at labour productivity. Available production technology determines how much output is produced from given amounts of capital and labour.


RMIT UniversitySchool of Economics, Finance and Marketing*A short-run Production function shows how much output a firm can produce given various amounts of labour. Most production functions have the property of diminishing marginal product. The greater the number of workers used in producing output, the less additional output that comes from each additional worker. Demand for Labour


RMIT UniversitySchool of Economics, Finance and Marketing*Labour Market EquilibriumIn a perfectly competitive labour market, the wage rate and level of employment is determined by the intersection of the demand and supply curves.


RMIT UniversitySchool of Economics, Finance and Marketing*Causes of UnemploymentWhen wages are set above their market-clearing level: Minimum wage lawsUnions and collective bargaining: Prevent downward wage flexibilityEfficiency wages: Firms may make higher profits by paying above market-clearing wage rates (link between wages and worker effort, worker quality and company turnover)Government Policies that influence the incentive to work:Job network & unemployment benefits and unemployment insuranceDeficiency in Aggregate DemandCyclical unemployment


RMIT UniversitySchool of Economics, Finance and Marketing*Why did Henry Ford pay his workers twice as much as other car manufacturers?


RMIT UniversitySchool of Economics, Finance and Marketing*When a union bargains successfully with an employer, in that industry The unemployment and wages increase. Unemployment and wages decrease. Unemployment decreases and wages increase. Unemployment increases and wages decrease.Check Your Knowledge


RMIT UniversitySchool of Economics, Finance and Marketing*Advantages of deregulation: Numerical and functional labour market flexibility: Numerical flexibility: ease with which firms can vary the quantity of labour inputs.Functional flexibility: ease with which the tasks performed by workers can be altered.Disadvantages of deregulation: Relate primarily to equity, and in particular, the vulnerability of workers in weak bargaining positions.Such workers are often low paid and low skilled.Minimum wages may be used to ensure greater equity.Labour Market Regulation and Deregulation


RMIT UniversitySchool of Economics, Finance and Marketing*The Exchange Rate Market Macroeconomics in an Open Economy - Chapter 14 (pp. 404-410)Learning Objectives:

Explain how exchange rates are determined.The difference between the direct and indirect quotations of exchange rates.How changes in exchange rates affect the prices of imports and exports.The exchange rate market model.


The Nominal Exchange RateThe rate at which one currency is exchanged for another.Direct: Vietnamese Dong required to purchase a unit of foreign currency:

School of Economics, Finance and Marketing*RMIT University


RMIT UniversitySchool of Economics, Finance and Marketing*Nominal Exchange Rate Movements Depreciation: where a currency (say the AUD) is worth less in terms of another currency (say the USD). In other words the AUD has become less valuable. So, it takes more AUD to purchase a unit of the USD ($1USD). In this case the AUD can also be said to have weakened relative to the USD. Appreciation: means a particular currency (say the AUD) is worth more in terms of another currency (say the USD). So, it takes less AUD to purchase a unit of the USD ($1USD). In this case the AUD can also be said to have strengthened relative to the USD.


Nominal Exchange RateDepreciation: the VND is worth less in terms of another currency. i.e. is less valuable. So, it takes more VND to purchase a unit of foreign currency. Exchange rate increases.Appreciation: means the VND is worth more in terms of another currency. So, it takes less VND to purchase a unit of foreign currency. Exchange rate decreases.School of Economics, Finance and Marketing*RMIT University


RMIT UniversitySchool of Economics, Finance and Marketing*When the dong weakens, each dong buysmore foreign currency, and so buys more foreign goods.more foreign currency, and so buys fewer foreign goods.less foreign currency, and so buys more foreign goods.less foreign currency, and so buys fewer foreign goods.Check Your Understanding


Exchange Rate MarketMarket forces in the form of supply and demand determine the level of the foreign exchange rate.

SFX is derived from any transaction which involves a payment from non-residents to residents. Converting foreign currency to domestic currency.DFX is derived from any transaction which involves a payments from residents to non-residents. Converting domestic currency to foreign currency.School of Economics, Finance and Marketing*RMIT University


Exchange Rate MarketSchool of Economics, Finance and Marketing*RMIT University


School of Economics, Finance and Marketing*Changes in Net ExportsIncreased ExportsDecreased ImportsRMIT University


Changes in demand for Vietnam-produced goods and services and changes in the demand for foreign-produced goods and services.Changes in the desire to invest in Vietnam and changes in the desire to invest in foreign countries.Changes in the expectations of currency traders about the likely future value of the dong and the likely future value of foreign currencies.Speculators: Currency traders who buy and sell foreign exchange in an attempt to profit by changes in exchange ratesShifts in demand and supplySchool of Economics, Finance and Marketing*RMIT University


School of Economics, Finance and Marketing*If domestically produced goods increased in price relative to foreign produced goods,exports would increase and imports would decrease resulting in an appreciation.exports would decrease and imports would increase resulting in an appreciation. exports would decrease and imports would increase resulting in a depreciation.exports would increase and imports would decrease resulting in a depreciation.Check Your UnderstandingRMIT University


School of Economics, Finance and Marketing*Check Your UnderstandingA rise in domestic interest rates relative to interest rates in other countries may lead to an exchange rate depreciation and an increase in net exports. an exchange rate appreciation and a fall in net exports. an exchange rate depreciation and a fall in net exports. an exchange rate appreciation and an increase in net exports. RMIT University


RMIT UniversitySchool of Economics, Finance and Marketing*The Financial Market Economic Growth, the Financial System and Business Cycle - Chapter 5 (pp. 117-124)Learning Objectives:

Discuss the role of the financial system in facilitating economic growth.Understand the link between savings and investment and how these are facilitated by the financial system.To introduce the loanable funds model and understand the sources of demand and supply in this market.To understand the significance of the real long term rate of interest in driving investment decisions.


RMIT UniversitySchool of Economics, Finance and Marketing*The Financial system: The system of financial markets and financial intermediaries through which firms acquire funds from households.

Financial intermediaries include banks and non-bank financial institutions.Financial markets include the share and bond markets. Shares: financial securities that represent partial ownership of a firm.Bonds: financial securities that represent promises to repay a fixed amount of funds.

Saving, Investment and the Financial System


RMIT UniversitySchool of Economics, Finance and Marketing*Financial intermediaries, such as banks, mutual funds, pension funds, and insurance companies, act as go-betweens for borrowers and lenders.Financial markets enable firms to raise funds by selling financial securities (shares or bonds directly to savers).As well as facilitating the channeling of funds from savers to borrowers the financial system provides three key additional services for savers and borrowers:risk sharing,liquidity, andinformation.The Role of the Financial System


RMIT UniversitySchool of Economics, Finance and Marketing*The demand for loanable funds is determined by the willingness of firms to borrow funds to engage in new investment projects. The supply of loanable funds is determined by the willingness of households to save, and by the extent of government saving or dissaving (borrowing / budget deficit). Equilibrium in the market for loanable funds determines the real interest rate and the quantity of loanable funds exchanged. Loanable Funds Market Model


RMIT UniversitySchool of Economics, Finance and Marketing*Loanable Funds Market


RMIT UniversitySchool of Economics, Finance and Marketing*Explaining Movements in Savings, Investment and Interest RatesAn increase in the demand for loanable funds


RMIT UniversitySchool of Economics, Finance and Marketing*Explaining Movements in Savings, Investment and Interest Rates

The effect of a budget deficit on the market for loanable funds


RMIT UniversitySchool of Economics, Finance and Marketing*Who was better for economic growth: Scrooge the saver or Scrooge the spender?

Ebenezer Scrooge: Accidental promoter of Economic growth?


RMIT UniversitySchool of Economics, Finance and Marketing*The Money Market Money, Banks and the Central Bank - Chapter 11

Learning Objectives:

Define money and discuss its functions.Discuss the definition of the money supply.Explain how financial institutions create money.Illustrate and discuss the money market.


RMIT UniversitySchool of Economics, Finance and Marketing*Money: Assets that people are willing to accept in exchange for goods and services or for payment of debts.Asset: Anything of value owned by a person or firm.Barter: exchange of goods or services for other goods or services.Barter requires a double coincidence of wants.Commodity money: A good used as money that also has value independent of its use as money. Fiat money: Money such as paper currency that is authorised by the central bank and has no intrinsic value except in its function as money.

What is Money and Why do we Need it?


RMIT UniversitySchool of Economics, Finance and Marketing*Money in a World War II prisoner of war camp.During World War II cigarettes were used as money in some prisoner of war camps.


RMIT UniversitySchool of Economics, Finance and Marketing*What can serve as money?What makes a good suitable to use as a medium of exchange? There are five criterion:

The good must be acceptable to most tradersIt should be a standardised qualityIt should be durableIt should be valuable relative to its weightIt should be divisibleWhat is Money and Why do we Need it?


RMIT UniversitySchool of Economics, Finance and Marketing*Functions of MoneyMedium of exchangeBuying and selling goods and servicesMoney eliminates need for a coincidence of wants required for trade to occur in a barter economy.Unit of accountAssist the measurement of the relative worth of various goods, services and resources.Store of valueA form in which to store wealth due to its liquidity and convenienceStandard of deferred payment


RMIT UniversitySchool of Economics, Finance and Marketing*Check Your KnowledgeThe statement 'a Dell laptop costs $2500' illustrates which function of money? Store of value Medium of exchange Standard of deferred payment Unit of account


School of Economics, Finance and Marketing*How do we Measure Money Today?M1: The narrowest definition of the money supply which includes all the paper money and coins that are in circulation meaning what is not held by the banks or governments plus the value of all demand deposits with banks. M3: M1, plus all other deposits with domestic and foreign owned banks operate domestically.Broad Money: M3, plus deposits into non-bank deposit-taking institutions less holdings of currency and deposits of non-bank depository corporations, such as finance companies, money market corporations and cash management trusts.

RMIT University


RMIT UniversitySchool of Economics, Finance and Marketing*Fractional Reserve Banking SystemBanks are concerned with.Providing safekeeping facilitiesMaking a profitTo be 100% safe, the banks would need to keep all deposits safe in their vaults.To make a profit, the banks would need to lend out deposits at a higher rate of interest.SOLUTION: recognition that only a small proportion of depositors are likely to want to convert deposits to cash on any given day. Banks need to keep enough to meet reasonable day to day requirements and lend the rest to make a profit.


RMIT UniversitySchool of Economics, Finance and Marketing*Check Your KnowledgeIn World War II, cigarettes were used as money in some prisoner of war camps. Given this, we would expect to see prices of other goods expressed in terms of cigarettes. people bartering instead of using cigarettes as money. only government-issued cigarettes being accepted as money. no one ever smoking cigarettes in the prisoner of war camps.


RMIT UniversitySchool of Economics, Finance and Marketing*Reserves: Deposits that a bank keeps as cash in its vault or on deposit with the State Bank of Vietnam. Reserve Ratio: A banks ratio of reserves to deposits, Excess Reserves: Reserves above the normal ratio of reserves to deposits. Financial institutions such as banks are able to create money through the simple deposit multiplier process.Financial Institutions and the Creation of Money


RMIT UniversitySchool of Economics, Finance and Marketing*Banks and Money CreationAssume the required reserve ratio is 10% and $1,000 is deposited into Bank A.

Bank AAssetsLiabilities

Bank BAssetsLiabilities


RMIT UniversitySchool of Economics, Finance and Marketing*Banks and Money CreationFrom the original deposit a new loan is created that result in further deposits into the financial systemBank A= $1,000Bank B= $900Bank C= $810Bank D= $729BankTotal change in demand account deposits = $10,000

Bank CAssetsLiabilities


School of Economics, Finance and Marketing*The Simple Deposit MultiplierThe simple deposit/credit/money multiplier: The ratio of the amount of deposits created by banks to the amount of new reserves.

Change in deposits = initial deposit x multiplier ($1,000 x 10 = $10, 000)Change in the money supply = change in demand account deposits initial deposit ($10,000 - $1,000 = $9,000)RMIT University


RMIT UniversitySchool of Economics, Finance and Marketing*Other things the same if reserve requirements are decreased, the reserve ratio?decreases, the money multiplier increases, and the money supply decreasesincreases, the money multiplier increases, and the money supply increasesdecreases, the money multiplier increases, and the money supply increasesincreases, the money multiplier increases, and the money supply decreasesCheck Your Knowledge


RMIT UniversitySchool of Economics, Finance and Marketing*Money Supply Notes and Coins; Bank deposits and Non-Bank Financial Institution deposits Ms determined exogenously


RMIT UniversitySchool of Economics, Finance and Marketing*The Money MarketThe Demand for Money


RMIT UniversitySchool of Economics, Finance and Marketing*The Money MarketShifts in the Money Demand Curve


RMIT UniversitySchool of Economics, Finance and Marketing*Check Your KnowledgeThe money demand curve is downward sloping becauselower interest rates cause households and firms to switch from money to financial assets. lower interest rates cause households and firms to switch from financial assets to money. lower interest rates cause households and firms to switch from money to bonds. lower interest rates cause households and firms to switch from money to shares.


RMIT UniversitySchool of Economics, Finance and Marketing*Slide *Money Market and Equilibrium


RMIT UniversitySchool of Economics, Finance and Marketing*Check Your KnowledgeA decrease in real GDP can increase money demand and increase the interest rate. decrease money demand and increase the interest rate. decrease money demand and decrease the interest rate. increase money demand and decrease the interest rate.


MODULE 3: INFLATION, UNEMPLOYMENT, GOVERNMENT POLICY, DEVELOPMENT AND GROWTH MONETARY POLICYFISCAL POLICYRECESSION, INFLATION & THE LONG-RUNDEVELOPMENT & GROWTH


RMIT UniversitySchool of Economics, Finance and Marketing*Monetary Policy Monetary Policy - Chapter 12Learning Objectives:

Define monetary policy and describe the main goal of monetary policy in VietnamDescribe how the State Bank of Vietnam affects interest rates. Use aggregate demand and aggregate supply graphs to show the effects of monetary policy on real GDP and the price level.Discuss the State bank of Vietnams use of monetary policy.Discuss the role of the State Bank of Vietnam


What Is Monetary Policy?Monetary policy: The actions taken by the Central Bank of a nation to affect interest rates and/or exchange rates.

Generally the main goals of Monetary policy arePrice StabilitySustainable Economic Growth.School of Economics, Finance and Marketing*RMIT University


State Bank of VietnamThe State Bank of Vietnam defines its principal roles as:Promoting monetary stability and formulating monetary policy.Promoting institutions stability and supervising financial institutions.Providing banking facilities and recommending economics policies to the government.Providing banking facilities for the financial institutions. Managing the countrys international reserves.Printing and issuing banknotes.Supervising all commercial banks activities in Vietnam. Lending state money to the commercial banks.Issuing government bonds, organising bond auctions.Being in charge of other roles in monetary management and foreign exchange rates.Slide *

State Bank of VietnamCentral banks in most developed economies usually describe their aims in terms of the pursuit of non-inflationary growth.Today, theres a consensus that price stability should be the overriding objective of monetary policy.School of Economics, Finance and Marketing*RMIT University


External BalanceWhen there is a decrease in the demand for Vietnamese Dong and the currency weakens; the exchange rate moves to the upper end of the established band, the Authority purchases VND from banks and/or sells government securities to banks. The money base (supply) will decrease, pushing up Vietnamese dong interest rates. Higher domestic interest rates relative to foreign interest rates induce capital inflows into the nation and reduce outflows.Supply of foreign currency (FX) increases and demand for foreign currency decreases, strengthening the currency and restoring stability.School of Economics, Finance and Marketing*RMIT University


External BalanceSchool of Economics, Finance and Marketing*RMIT University


External BalanceWhen there is an increase in the demand for Vietnamese Dong and the market exchange rate strengthens and the exchange rate moves to the lower end of the established band, the authority sells Vietnamese dong to banks and/or buys government securities from banks. The money base (supply) will increase, pushing down Vietnamese Dong interest rates. Lower domestic interest rates relative to foreign interest rates restrain capital inflows into the nation, encouraging outflows. Supply of foreign currency (FX) decreases and demand for foreign currency increases, weakening the currency to restore stability.School of Economics, Finance and Marketing*RMIT University


External BalanceSchool of Economics, Finance and Marketing*RMIT University


Internal BalanceGoal: Maintain the inflation rate within a particular band.Sale and purchase of government securities changes bank reserves and thus their ability to extend credit, thus changing the money supply and the interest rate.The Monetary Authority targets interest rates by affecting system liquidity.Monetary policy influences the size of bank reserves. This influences:The size of the money supply.The interest rate and the availability of credit.Investment spending, interest-sensitive consumption spending thus output, employment and the price level.School of Economics, Finance and Marketing*RMIT University


Open Market OperationsMonetary Authority actions designed to change interest rates by changing system liquidity to change the cost of credit and thus economic activity and the price level.Easy Money: Authority announces its decision to reduce interest rates it buys government securities to maintain the lower interest rates; expanding the money supply and reducing the cost of credit.Tight Money: Authority announces its decision to increase interest rates it sells government securities to maintain the higher interest rates; reducing the money supply and increasing the cost of credit.School of Economics, Finance and Marketing*RMIT University


Internal Balance Contractionary PolicyDecrease in the money supply Increase domestic interest ratesRMIT UniversitySchool of Economics, Finance and Marketing*


Internal Balance Expansionary PolicyIncrease in the money supply Lower domestic interest ratesRMIT UniversitySchool of Economics, Finance and Marketing*


If the interest rate is below the Central Bank's target, the Central Bank would:buy bonds to increase the money supply.buy bonds to decrease the money supply.sell bonds to increase the money supply.sell bonds to decrease the money supply.Check Your UnderstandingRMIT UniversitySchool of Economics, Finance and Marketing*


RMIT UniversitySchool of Economics, Finance and Marketing*Check Your UnderstandingIf the Central Bank pursues expansionary monetary policy then interest rates willfall and GDP will fall.rise and GDP will rise.fall and GDP will rise.rise and GDP will fall.


RMIT UniversitySchool of Economics, Finance and Marketing*Equilibrium in the Money MarketWith interest rate targeting, the money supply curve is a horizontal line at the Central Banks target interest rate.


Monetary Policy EffectivenessResponsiveness of capital flows, consumption and investment to changes to changes in interest rates.Phase of the business cyclePrivate decisions of lenders and borrowers.Size of the expenditure multiplierRMIT UniversitySchool of Economics, Finance and Marketing*


RMIT UniversitySchool of Economics, Finance and Marketing*Suppose you are the monetary policy adviser for the government. The economy is experiencing a large and prolonged inflationary trend. What change in open market operations would you recommend? Check Your Understanding


RMIT UniversitySchool of Economics, Finance and Marketing*If the central bank buys bonds and securities in the open market, this is likely to lead to a rise in interest rates and a depreciation of the Vietnamese dong. a fall in interest rates and a depreciation of the Vietnamese dong. a fall in interest rates and an appreciation of the Vietnamese dong. a rise in interest rates and an appreciation of the Vietnamese dong. Check Your Understanding


RMIT UniversitySchool of Economics, Finance and Marketing*Why Does The Share Market Care about Monetary Policy?The share market reacts when the Central Bank implements policy to either raise or lower interest rates.


RMIT UniversitySchool of Economics, Finance and Marketing*Fiscal Policy Aggregate Expenditure and Output in the Short Run - Chapter 7 (pp. 195-200)Fiscal Policy - Chapter 13Learning Objectives:Define the multiplier effect and use it to calculate changes in equilibrium GDP.Define fiscal policy.Explain how fiscal policy affects AD and how the government can use fiscal policy to stabilise the economy.Explain how the multiplier process works with respect to fiscal policy.Discuss the difficulties that can arise in implementing fiscal policy.Explain how the federal budget can serve as an automatic stabiliser. Discuss the long-run supply side effects of fiscal policy.


RMIT UniversitySchool of Economics, Finance and Marketing* Fiscal Policy: Changes in Government taxes and purchases that are intended to achieve macroeconomic policy objectives, such as full employment, price stability, and healthy sustainable rates of economic growth.Fiscal PolicyCommanding Heights Episode 1, Chapter 5: Global Depression



There are two key approaches to fiscal policy; following rules implied by automatic stabilisers or else implementing a discretionary fiscal policy. Automatic stabilisers: Government spending and taxes that automatically increase or decrease along with the business cycle.Discretionary fiscal policy: when the government is taking actions to change spending or taxes to achieve its objectives.Rules (Automatic Approach) versus Discretionary Action


RMIT UniversitySchool of Economics, Finance and Marketing*Expansionary fiscal policy Increasing government expenditure, or decreasing taxes, or both. The goal is to shift aggregate demand to the right.Appropriate when the economy is in a below full-employment equilibrium.Contractionary fiscal policyDecreasing government expenditure, or increasing taxes, or both. The goal is to shift aggregate demand to the left. Appropriate when the economy is at an above full-employment equilibrium. Using Fiscal Policy to Influence Aggregate Demand


RMIT UniversitySchool of Economics, Finance and Marketing*Check Your KnowledgeFiscal policy refers to the government's ability to regulate the functioning of financial markets. spending and taxing policies used by the government to influence the level of economy activity. techniques used by firms to reduce its tax liability. the policy by the State Bank to affect the interest rate.


RMIT UniversitySchool of Economics, Finance and Marketing*The multiplier effect: The series of induced increases in consumption spending that results from an initial increase in autonomous expenditures. The process by which an increase in autonomous expenditure leads to a larger increase in real GDP. Autonomous expenditure: Expenditure that does not depend on GDP. Multiplier: The increase in equilibrium real GDP divided by the increase in autonomous expenditure.

The Government Purchases (Expenditure) and Tax Multipliers


The Multiplierthe theory of the multiplier states that in initial increase in public spending will lead to an eventual increase in the level of output of some multiple of that initial spending if the multiplier is 2, then $10 million in initial spending will lead to an increase of $20 million in total outputif the multiplier is 4, then an initial increase of whatever amount will lead to spending rising four times as much each person receiving the first round of expenditure spends some themselves and saves some same with each subsequent round saving causes the expenditure growth to peter out but the continuing round of spending continues past the first recipient



RMIT UniversitySchool of Economics, Finance and Marketing*An initial increase in autonomous government spending, such as building new railway lines, will increase aggregate demand by an amount that is more than the initial amount of new spending. The Government Purchases or Expenditure Multiplier in ActionThe multiplier effect and aggregate demand


RMIT UniversitySchool of Economics, Finance and Marketing* The Multiplier EffectThe multiplier effect occurs both when autonomous expenditure increases and when it decreases.The multiplier effect makes the economy more sensitive to changes in autonomous expenditure than it would otherwise be.The larger the MPC, the larger the value of the multiplier.Our formula for the multiplier is very simplified, but nevertheless serves to illustrate the process.



The Government Purchases (Expenditure) and Tax Multipliers


RMIT UniversitySchool of Economics, Finance and Marketing*Assume the consumption function for a closed economy is C=50+0.8Y and that investment is equal to $30bn. Calculate the equilibrium level of income/output for this economy.Calculate what will happen to equilibrium income and output if the government undertakes expansionary policy of $15bn.



RMIT UniversitySchool of Economics, Finance and Marketing*Multiplier EffectivenessFixed PriceVariable Price


RMIT UniversitySchool of Economics, Finance and Marketing*Crowding Out Effect


Crowding out effect Money Market and Loanable Funds MarketRMIT UniversitySchool of Economics, Finance and Marketing*


RMIT UniversitySchool of Economics, Finance and Marketing*Check Your KnowledgeIf crowding out occurs, an increase in government spendingdecreases the interest rate and consumption and investment spending rise. decreases the interest rate and consumption and investment spending decline. increases the interest rate and consumption and investment spending rise. increases the interest rate and consumption and investment spending decline.


RMIT UniversitySchool of Economics, Finance and Marketing*Goals of Fiscal PolicyRecessionary Gap = GDP Gap ke Inflationary Gap = GDP Gap ke


RMIT UniversitySchool of Economics, Finance and Marketing*Putting Everything Together


RMIT UniversitySchool of Economics, Finance and Marketing*Successful Fiscal Policy


RMIT UniversitySchool of Economics, Finance and Marketing*Is it that Simple? Does it matter what the type of government expenditure?


RMIT UniversitySchool of Economics, Finance and Marketing*Case Against InterventionFiscalLagsRecognitionAdministrative/LegislativeOperational/ImplementationExpansionary bias leading to a Political business cycleCommanding Heights Episode 1, Chapter 11: Chicago Against the Tide


RMIT UniversitySchool of Economics, Finance and Marketing*Budget deficit: The situation in which the governments spending is greater than its tax revenue.Budget surplus: The situation in which the governments expenditures are less than its tax revenue.The budget can serve as an automatic stabiliser.Federal government deficits increase automatically during recessions because: Tax revenues fall.Unemployment benefits increase.Federal government deficits decrease or surpluses increase automatically during expansions because: Tax revenues increase.Unemployment benefit payments decrease.

Deficits, Surpluses and Government Debt


RMIT UniversitySchool of Economics, Finance and Marketing*Check Your KnowledgeTo counteract the effect of automatic stabilisers during a recession and keep the budget balanced, the government must ________ government spending, or ________ taxes, and which will ________ aggregate demand. decrease; increase; reduceincrease; decrease; increase increase; increase; reduce decrease; decrease; increase


RMIT UniversitySchool of Economics, Finance and Marketing*Should the federal budget always be balanced?Is government debt a problem?These questions are related and the answer is not always clear-cut.Economists examine the debt, and the interest on the debt in proportionate terms to determine if it is a problem.

Deficits, Surpluses and Government Debt


RMIT UniversitySchool of Economics, Finance and Marketing* During the 1990s the Australian Federal government operated successive government deficits of over $10 billion dollars. Clearly the government of the day was engaging in vigorous expansionary policy.Do you agree with this statement?



RMIT UniversitySchool of Economics, Finance and Marketing*Supply side policies: Fiscal policies that have long-run effects by expanding the productive capacity of the economy and increasing the rate of economic growth. These policy actions primarily affect aggregate supply, by shifting the long-run aggregate supply curve to the right. The Effects of Fiscal Policy in the Long-Run



The supply side effects of a tax changeThe Effects of Fiscal Policy in the Long-Run


RMIT UniversitySchool of Economics, Finance and Marketing*The long-run effects of tax policy:We can look at the effect on aggregate supply of each of the following taxes: Individual income taxCompany income taxTaxes on capital gainsThe Effects of Fiscal Policy in the Long-Run


RMIT UniversitySchool of Economics, Finance and Marketing*Tax simplification: There are also potential gains to be derived from simplifying the tax law.Resources diverted to tax compliance and tax minimisation can be put to more productive use.Tax simplification may improve the efficiency of firm and household decision making. The Effects of Fiscal Policy in the Long-Run


RMIT UniversitySchool of Economics, Finance and Marketing*Long Run Implications of Supply Side PoliciesSupply side policies can increase long run aggregate supply, thereby reducing the upward pressure on prices following an increase in aggregate demand


RMIT UniversitySchool of Economics, Finance and Marketing*Recession, Inflation and the Long-Run Aggregate Demand and Aggregate Supply Analysis - Chapter 8 (pp. 226-234)Unemployment - Chapter 9 (pp. 256-257)Inflation - Chapter 10 (pp. 280-287)Learning Objectives:Use the aggregate demand and aggregate supply model to illustrate the difference between short-run and long-run equilibrium.Use the dynamic aggregate demand and aggregate supply model to analyse macroeconomic conditions.Understand the difference between demand-pull and cost-push inflation.Explain the quantity theory of money and use it to explain how high rates of inflation can occur.


RMIT UniversitySchool of Economics, Finance and Marketing*Costs to the economy as a whole:Loss of gross domestic product.Loss of human capital.Net drain on the budget.The opportunity cost of funds directed towards welfare payments. Costs to the unemployed:Loss of income.Loss of skills.Loss of self esteem.Unemployment may contribute to family break-ups, health problems, mental illness, crime and political unrest. The Costs of Unemployment



The short-run and the long-run effects of a decrease in aggregate demandRecession


RMIT UniversitySchool of Economics, Finance and Marketing*In general, wages rise with inflation. Inflation can, however, affect the distribution of income. The extent of redistribution depends partly on the degree to which inflation was anticipated or unanticipated.Costs of Inflation The problem with anticipated inflation: Menu costs the costs to firms of changing prices.Risk particularly for contracts with a time element The problem with unanticipated inflation:There are winners and losers, depending on whether inflation is higher or lower than anticipated.For example: those on fixed incomes, such as aged pensions, will lose if inflation is higher than anticipated.Borrowers may gain and lenders lose when inflation is higher than anticipated.


RMIT UniversitySchool of Economics, Finance and Marketing*Causes of InflationMonetary growth greater than growth in RGDPDemand-pull inflation Increases in ADCost-push inflation Supply ShocksStagflation: a combination of inflation and recession, usually resulting from a supply shock.

Commanding Heights Disc1, Chapter 12: The Spectre of Stagflation


RMIT UniversitySchool of Economics, Finance and Marketing*Connecting money and prices: The equation of exchange. The connection between money and prices is expressed in the following equation.

Velocity of money: The average number of times each dollar in the money supply is used to purchase goods and services included in GDP.

Monetary Growth > Growth in GDPThe Quantity Theory of Money


RMIT UniversitySchool of Economics, Finance and Marketing*According to the assumptions of quantity theory, if the money supply increases 5% then at full employmentnominal and real GDP would rise by 5%.nominal GDP would rise by 5%; real GDP would be unchanged.nominal GDP would be unchanged; real GDP would rise by 5%.neither nominal GDP nor real GDP would change.Check Your Knowledge


RMIT UniversitySchool of Economics, Finance and Marketing*The quantity equation is transformed to:

Growth rate of money supply + growth rate of velocity = growth rate of the price level + growth rate of real output

Which we can rearrange as:

Inflation rate = growth rate of money supply + growth rate of velocity - growth rate of real output

If Irving Fisher is correct and velocity is constant, then the growth rate of velocity is zero, so we can rewrite the equation as:

Inflation rate = growth rate of the money supply growth rate of real output

The Quantity Theory of Inflation


RMIT UniversitySchool of Economics, Finance and Marketing*According to the quantity theory of money, inflation is caused byGDP growing faster than the money supply.GDP growing at the same rate as the money supply.the money supply growing faster than GDP.the money supply growing slower than GDP.Check Your Knowledge


RMIT UniversitySchool of Economics, Finance and Marketing*Suppose the money supply is currently growing at 4 % per year, while real GDP is growing at 2%, calculate the inflation rate assuming Irving Fisher is correct in his assumption regarding the velocity of money. Check Your Knowledge



The short-run and long-run effects of an increase in aggregate demand - Demand-pull inflation and a price-wage spiral

Demand-Pull Inflation


RMIT UniversitySchool of Economics, Finance and Marketing*An increase in aggregate demand causes an increase in ________ only in the short run, but causes an increase in ________ in both the short run and the long run.the price level; real GDP real GDP; real GDP real GDP; the price levelthe price level; the price level Check Your Knowledge


RMIT UniversitySchool of Economics, Finance and Marketing*We can create a dynamic aggregate demand and aggregate supply model by making three changes to the basic model:Potential re

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