Macroeconomics

Macroeconomics

• is the branch of economics that studies the behavior and performance of an economy as a whole.

• focuses on the aggregate changes in the economy such as unemployment, growth rate, gross domestic product and inflation.

• analyzes the decisions made by countries and governments.

Economic equality principle

• "One man's spending is another man's income".

• e.g. a donut bought for 5 dollars- the 5 dollars spent (expenditure) is the same 5 dollars earned by the baker (income) and the same 5 dollars that the donut itself is worth (output)

• ∑O = ∑Y = ∑E

• sum of output= sum of income= sum of expenditure

• value of output= value of income paid to resource owners=value of spending by households to produce the output.

• worth of donut= income of the baker=money spent on donut

Where:

• ∑ means "sum of"

• O means Output

• Y means Income

• E means Expenditure

Disequilibrium

• occurs when total output ≠ total expenditure (∑O ≠ ∑E).

• Means the economy is producing more or less than what is being spent.

• Example: If people buy more than is produced (e.g. using leftover stock), ∑E > ∑O. (expenditure exceeds output). Firms increase production.

• Example: If people buy less than is produced (e.g. during a recession with decreased confidence in the economy) ∑E < ∑O. Firms decrease production to reduce unsold stock and lower prices until ∑E = ∑O.

• Firms respond by adjusting production (increase or decrease) until macroeconomic equilibrium is reached again (∑O = ∑E).

circular flow

draw diagram

Macroeconomic equilibrium

occurs when the sum of the withdrawals or leakages is equal to the sum of all injections, i.e. 

 S + T + M = I + G + X 

savings, taxes and rates, imports (leakages) = investments, government services, exports (injections)

macroeconomic disequilibrium

• if leakages exceed injections, there’s disequilibrium- more money out than in. economy contracts until sum of injections equal sum of leakages

• if injections exceed leakages, there’s disequilibrium- more money in than out. economy expands until sum of leakages equal sum of injections

Multiplier effect

• Macroeconomic equilibrium does not occur instantly; it takes time for the economy to adjust.

• This is because injections (like investment or exports) and leakages (like savings or imports) affect various sectors multiple times, leading to a chain reaction of spending. This process is known as the multiplier effect.

Example of multiplier effect

• Government invests $1 billion in infrastructure, construction workers earn income and spend a portion of it on goods and services, such as groceries or transport.

• The businesses they purchase from then receive income and, in turn, re-spend part of it on wages, supplies, rent, and other expenses.

• This process continues through multiple rounds, with each transaction creating new income for someone else.

• As a result, the impact of the original $1 billion is amplified, leading to a total increase in output that is greater than the initial amount—this is known as the multiplier effect.

GDP

total market value of all final goods and services produced in a country during a period of time (usually a year). 

Approaches to calculating GDP

1. The incomes and earnings approach

2. The expenditure approach

3. The production approach

the production approach

the value of all goods and services is calculated

Incomes and earnings approach

adding all incomes (national income) received, allowing for depreciation of capital equipment and net indirect taxes

National income

 is the total income generated from the sale of goods and services produced in the economy.

NI consists of:

• Wages, salaries and benefits paid to employees

• Income from unincorporated businesses

• Rental income

• Corporate profits

• Net interest payments

Expenditure approach

• measures the total expenditure/ aggregate expenditure (planned expenditure) on final goods and services produced by the four main sectors of the economy.

• aggregate expenditure equation: AE = C + I + G + (X - M) can also be AE = C + I + G1 + G2 + (X - M) when government spending is split into current and capital components.

Consumption (C) - durable, non durable and services

personal consumption expenditure from households, sensitive to change

• Expenditure on non-durable goods, e.g. food, clothing, transport.

  • Technically, things that will last up to 3 years.

  • Typically 30% of consumption spending.

• Expenditure on services, e.g. doctors, plumbers, mechanics, education, etc.

  • Typically 60% of consumption spending- take up MORE of spending

  • more essential and expensive e.g. car insurance, council rates

• Expenditure on durable goods, e.g. white goods (heavy consumer durables such as air conditioners, refrigerators, stoves), brown goods (relatively light electronic consumer durables like TVs, radios, computers), vehicles

  • Technically, things that will last longer than 3 years.

  • Typically 10% of consumption spending.

Private investment (I)

(investments by firms and building of new houses)

• Business expenditure on new capital equipment which will produce the final goods and services, and expenditure on buildings and structures

• Fixed investment - privately funded expenditure on equipment and structures (which are long term assets) used in production

• Residential fixed investment - private expenditure on new housing, which is capital owned by private individuals or business

• Changes in business inventories - stocks of goods that have been produced but not yet sold (part of current production held as assets, so they’re investment in resources that can be used in future production)

Circular flow investment spending

Volatile because it involves risk and uncertainty

may increase because of more savings (more money in banks/ financial intermediaries to lend to businesses), increased business confidence (stable economy) and lower interest rates (easier to take loans for investment)

Government spending (G) - current (G1) and capital expenditure (G2)

• G1 - current expenditure on day-to-day functions of government, e.g. salaries of government employees, goods and services used by hospitals and schools, welfare payments, etc.

• G2 - capital expenditure to provide for future needs such as new schools, hospitals, road projects, etc.

Net export spending (X-M)

The value of goods and services sold overseas (X for exports) minus the value of goods and services bought from overseas (M for imports)

• positive net exports: brings money into country, boosting economic growth and strengthening currency BUT can reflect weak domestic consumption

• negative net exports: money flowing into country, reflects strong domestic demand and access to a variety of products BUT can lead to trade deficit which may hurt local industries and weaken currency

output

total value of goods and services produced by an economy in a certain period

real flow

households provide factors of production, firms give goods and services

• items

money flow

resources for income

factors of production (land, labor, capital) by households, in exchange for wages, rent, interest, dividends, profit by firms

• money

Chain volume measures

adjusted for inflation

seasonally adjusted

adjusted to remove effects of regularly occurring seasonal events on spending