Chap 4 - Macroeconomy

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Aggregate demand

• Total spending on an economy’s goods and services at a given price level in a given time period.

Aggregate demand curve

• shows the relationship between the general price level and real output

Reasons for downward sloping AD curve

1. Wealth effect

   • PL ⬆

   • Amount of goods & services that people’s wealth can buy ⬇

   • AD ⬇

2. Interest rate

   • PL ⬆

   • Borrowing money ⬆

   • Interest rate ⬆

   • Cost of borrowing ⬆

   • Consumption ⬇

   • AD ⬇

3. International trade effect

   • Price export ⬆

   • Demand export ⬇

   • AD ⬇

Components of AD

1. Consumption

2. Investment

3. Government spending

4. Net export (X-M)

Factors of consumption

1. Income tax

2. Interest rate (cost of borrowing)

3. Consumer confidence

4. Level of welfare payment

5. Wealth effect

6. Availability of credit

Gross investment

• Total investment on new capital inputs.

• or

• Total expenditure by firm in acquiring new capital goods.

Net investment

• Gross investment - depreciation

Factors of investment

1. Tax on company profit (corporate tax)

2. Interest rate (cost of borrowing)

3. Availability of credit

4. Business confidence

5. Rate of economic growth

Policies to promote investments

1. Tax relief

2. Subsidy

3. Reduce regulation & bureaucracy

Factors of government spending

1. Level of economic activity

2. Fiscal policy

3. Political reasons

4. Correction of market failure

Budget deficit

• Government spending more than tax

Budget surplus

• Government spending less than tax

Factors of Net exports

1. Real income

2. Exchange rate

3. State of the global economy

4. Degree of protectionism

5. Non-price factors

Aggregate supply

• Total quantity of goods & services produced in an economy at different price levels.

Short run aggregate supply

• Total output an economy can produce at different level while some factors of production are fixed.

Reasons for +ve relationship between PL & Real output

1. Profit effect

   1. The more supply, the lower average cost.

2. Cost effect

   1. Working existing labour overtime

3. Misinterpretation effect

   1. Mistake inflation for increasing prices that gives more profits

Factors of SRAS

1. Cost of raw materials & energy

2. Exchange rates

3. Indirect tax

4. Subsidies

5. Wage rate

Long run aggregate supply (LRAS)

• Total output of goods & services produced at different price level while factors of production are flexible.

Classical LRAS

Keynesian LRAS

1. Long run, wages & prices are flexible & maintain full employment

   1. Graph is vertical line

2. Wages are sticky

   1. Graph is J shaped

Factors of LRAS

1. Technology advancements

2. Productivity

3. Education & skills

4. Government regulation & tax

5. Demography & net immigration

6. Competition policy

Equilibrium

• When AD=AS & injection=withdrawal

• No tendency for PL & GDP to change

Inflation

• A sustained rise on average price level.

Deflation

• A sustained fall on average price level.

Disinflation

• Average price level rises at a slower rate

Consumer Price Index (CPI)

• An index that shows the average change in prices of a representative basket of products purchased by households.

• Weighted price relative of selected year / Weighted price relative of BASE year x 100

Steps to calculate CPI

1. Choose a base year

   1. Standard yr with no unusual events

2. Selecting items

   1. Find items to include inside basket

3. Giving each item a weight

   1. Weight based on proportion of total expenditure on the item

4. Obtaining new prices for each item

   1. Price changes is recorded

5. Find weighted price relative

   1. New price x Weight

6. TADAAA CPIIIIII

Rate of inflation

• [New CPI - Old CPI (previous yr)] / Old CPI x 100

Difficulties in finding CPI

1. Hard to find base year

2. Survey issue

3. Outdated weights of goods

Money value vs Real data

1. Data measured at current price

2. Data adjusted for inflation.

Real data = Nominal value - Inflation rate

Demand-pull inflation

• Inflation caused by AD rising more than AS

Factors of demand-pull inflation

1. Depreciation of exchange rate.

2. Fiscal policy

3. Low interest rates

Cost push inflation

• Inflation caused by increase in cost of production.

Factors of cost push inflation

1. Cost of raw materials

2. Fall in exchange rate

3. Rising labor cost

4. Expectation of inflation

5. Profit-push inflation

   1. Dominant firms in a market use their market power to increase prices.

Internal Consequences of inflation

1. Redistribution of income

   • Borrowers can pay back less

   • Lenders receive back less.

2. Investment falls

   1. Uncertainty

3. Shoe leather costs

   1. Consumers/ Producers waste time trying to find cheapest deals

4. Menu costs

   1. gotta change the labels of menus and shii

5. Wage spiral inflation

   1. Consumers expect more inflation

   2. Consumer spend more before inflation comes

   3. Demand-pull inflation

External Consequences of inflation

1. International competitiveness :down

2. Current account deficit

3. Currency depreciate

Benefits of inflation

1. Stimulates output (increase in profits)

Which inflation is better?

• Demand pull (output ⬆) better than Cost push inflation (output ⬇)

Causes of deflation

1. Decrease in AD

2. Increase in AS

3. Decrease in money supply

   • Less lending

   • Less spending

   • Less consumption

   • Less AD

Effects of deflation

1. Redistribution of income

   • Fixed income earners, pension receiver, saver & LENDERS would gain. (real income ⬆)

   • Borrowers will lose (pay back more)

   • Government debt ⬆

2. Saving ⬆

3. Low investment

   • Uncertainty

   • Low profits, so no money to Invest

4. Fall in confidence level

5. Cyclical unemployment

6. Saving ⬆

7. Export Price competition ⬆

   1. Export Price ⬇

   2. Demand export ⬆

8. Recession

   1. Fall in output

Working age population

• Economically active + Economically inactive

Labour force

• Economically active

• Employed + Unemployed

Factors of Labour force

1. School leaving age

2. No, of people who remain in full-time education

3. Retirement age

4. Proportion of women who join the labour force.

Labour force participation rate

• Economically active OVER Working age population x 100

Economically inactive

• People of working age who are not looking for a job

  • Students

  • Retired

  • Sick

  • Looking after family

  • Discouraged workers

Discouraged workers

• People unable to find job and no longer looking for work.

Employed

• People who are either working for firms or other organization or self-employed

Employment rate

• No. of people employed OVER Working age population x 100

Unemployed

• willing to work, but no job yet

Unemployment rate

Number of people unemployed

OVER x 100

Number of people in the labour force

Underemployed

• Part timers who want to work more hours.

Measures of unemployment

1. Claimant count measure

   1. A measure of unemployment based on those claiming unemployment benefits,

2. Labour force survey

   1. A measure of unemployment based on a survey that identifies people who are actively seeking a job

Problems with claimant count

1. Open to manipulation by politicians

2. May exclude people

   1. Willing to work but not eligible for benefits

   2. Part timers (classified as underemployed)

3. May include people

   1. claiming benefit but not available for work

   2. claiming fraudulently

Problems with labour force survey

1. Expensive

2. Time consuming

3. Difficult to collect data from LARGE geographic area

4. Difficult to collect data from large informal sector

Problems w measuring unemployment

1. Inactivity rates

   1. Discouraged workers aren’t considered unemployed

   2. Rise in inactivity, fall in unemployment is MISLEADING

Types of unemployment

1. Frictional

   1. when people are transferring between jobs

2. Structural

   1. changes in pattern of economic activity, lack required skills

3. Cyclical

   1. Lack of AD, recession

4. Seasonal

   1. Arises in seasons of the year when demand is low

5. Technological

   1. Caused by advances in technology

Consequences of unemployment

1. Labour resources are wasted

2. Living standards ⬇

3. AD ⬇

4. Gov spending ⬆

5. Income inequality ⬆

6. High rate of crime ⬆

Circular flow of income

• A model of economy which shows the movement of physical goods & services (product market) between households, firms, the government and the rest of the world and their corresponding flow of payments in money terms together with the supply of factors of production (factor market)

Closed economy

An economy that does not trade with other economies.

Open economy

Economy that is involved in trade with other economies.

Types of economy!

1. Closed economy (2 sector)

2. Open economy (3 sector)

   • → Saving → Financial sector → Investment

   • → Taxation → Government → Gov spending

3. Open economy (4 sector)

   • → Saving → Financial sector → Investment

   • → Taxation → Government → Gov spending

   • → Imports → International sector → Exports

Injection

• Money flows into the circular flow of income.

  1. Government spending (G)

  2. Exports (X)

  3. Investment by firms (I)

Leakages

• Money flows out of the circular flow of income.

  1. Tax (T)

  2. Imports (M)

  3. Saving (S)

National income statistics

• Total income of an economy over a particular period of time.

Uses of national income

1. Standard of living comparison

2. Economic performance

3. National planning

4. Sectoral contributions

   1. Allows government to identify which sector contributes most to economic growth

5. Economic policy

   1. Important tool in macroeconomic policy and analysis

Types of measurement of national income

1. Gross domestic product (GDP)

   1. Total value of all goods & services produced within a country over a period of time

   2. Includes Gross investment

2. Gross national income (GNI)

   1. Total income earned by a country’s residents over a period of time.

   2. Includes Gross investment

3. Net national income (NNI)

   1. GNI - depreciation

   2. Includes Net investment

Ways to calculate Gross domestic product (GDP)

1. Expenditure method

   1. Total expenditure on goods & services

   2. AD formula

2. Income method

   1. Total income earned from producing country’s output.

3. Output/Product method

   1. Total production of good’s & services of a country

Net income abroad

• Income residents received from abroad - Income foreigners receive from the country

Depreciation

• Decrease in the market value of an asset over time from influential economic factors

Market price vs Basic price

• Actual price paid by consumer taking into account of indirect taxes & subsidies

• Prices charged by producers before the addition of subsidies and indirect taxes.

Economic growth

• An increase in economy’s output

Economic growth rate

• Percentage change in real gdp

• ref to equation in notes

Nominal GDP

• GDP measured in terms of current price

Real GDP

• GDP measured at constant price, taking into account of inflation.

GDP per capita & Real GDP per capita

• Average/Real average income of each person in an economy

• GDP or REAL GDP over Total population

Causes of economic growth

• Discovery of natural resources

• Education & training

• Labour participation rate

• Investment

• Technology advancements

Benefits of Econ growth

1. Increase in standard of living

2. High employment

3. Budget surplus

   1. Increase income → Increase tax rev for gov

Disadvantages of economic growth

1. Environmental damages

2. Depletion of non-renewable resources

3. Rising inflation

4. Increase income inequality