macroeconomics

ceteris paribus

• means ‘all other things remaining equal’

• important assumption in economics as in the real world it is hard to isolate all different variables

role of assumptions

• make the world easier to understand

• assumptions allow economists to make models to answer different questions

macroeconomics

• study of behaviour of a country and how policies impact the economy as a whole

• analyses all individuals within entire countries up to a global scale

macroeconomic objectives

• health of an economy is determined by how well it is achieving a set of objectives defined by specific measures and targets

• for the uk there are 4 primary objectives and several secondary objectives

• targets are set for these objectives, and the strength of the economy is measured on the proximity to these targets

what is the acronym for the primary objectives of the uk?

• tige(r)

what are the uk primary macroeconomic objectives

Trade: balanced

Inflation: low and stable

Growth: steady and sustainable

employment: full

primary objective 1 - Trade: balanced

• the current account on the balance of payments measures the inflow and outflow of goods and services (i.e. exports and imports), investment incomes and transfer payments between the economy and the rest of the world

• target - whilst there is no set numerical target, the uk has consistently run a current account deficit for the last 2 decades - it is generally considered that a balanced current account or surplus would be better for the economy’s health - therefore the governments ongoing target is to continue to cut the country’s current account deficit

primary objective 2 - Inflation: low and stable

• where inflation is low and prices remain largely stable - no rapid inflation or deflation - this is not the same as 0 inflation, but instead steady levels of low-moderate inflation are desired as this gives a degree of flexibility to prices - in fact, 0 inflation is often a concern, as it is dangerously close to inflation

• target - the governments inflation target is a 2.0 (±1.0) % increase in consumer price index (a measure of general price level)

primary objective 3 - Growth: steady and sustainable

• level of output is increasing - so citizens have higher living standards - but at a rate where growth can be maintained

• target - no specific numerical target - government aims to achieve economics growth close to the long run trend rate - currently this is about a 2.5% increase in output (GDP) per year

primary objective 4 - employment: full

• where those who are able and willing to work either have a job or can get readily one - not the same as ‘zero unemployment’ given that there will be a certain amount of frictional, seasonal and structural unemployment (referred to as the natural rate of unemployment)

• target - uk aims to have the actual unemployment rate (percent of the labour force who are out of work) as close to the natural rate of unemployment as possible. In the UK, the office for budget responsibility estimates the natural rate of unemployment to be circa 4.5%

what are the secondary macroeconomic objectives?

redistribution of income (less inequality)

exchange rate stability

a balanced budget

environmental protection

secondary objective - redistribution of income: less inequality

• inequality is strongly correlated with shorter spells of economic expansion and less growth over time - reducing inequality sees average living standard rise and more people escape from poverty. 

• however, like some other economic objectives, the distribution of income is a partly subjective or normative issue and the target level depends on the who is being asked.

secondary objective - exchange rate stability

• countries, especially developing ones, pursue stable exchange rates to attract foreign capital and ensure stable foreign trade

secondary objective - a balanced budget

• over an economic cycle, governments aim to have their expenditure equal to the revenue they receive through taxes and other means. ​

• Too much spending will lead to growing national debt which is costly to pay back and may harm an economy’s growth in future.​

• Too much taxation represents a withdrawal of money circulating in the economy and cuts demand.​

secondary objective - environmental protection

• in meeting the primary objectives, the government aims to protect the environment as much as possible to protect future living standards as much as possible​

what is the scientific method?

• a method of acquiring knowledge via pro[posing and testing ideas

• method involves generating abstract models to help explain how a complex, real world operate

• there are 3 steps:

  • postulate a theory or model (put forward a hypothesis, capable of refutation)

  • gather evidence to support or refute the theory

  • accept, modify or refute the theory

output

quantity of goods and services produced in a given time period

national output

total output of an entire economy

productivity

output per unit of input - such as about, capital, or any other resource

gross domestic product (GDP)

• total value of all goods and services produced in one country over the period of a year

  • GDP measures the size of an economy - i.e. value of transactions between economic agents

why measure gdp?

• gdp per capita is used as a proxy to measure quality of life / living standards

• higher gdp means more goods and services are made - more g&s to go around means a better quality of life

• gdp data allows comparisons of living standards between countries and track changes over time

how do we measure gdp?

• expenditure method - adding up all money spent in an economy in a year

• income method - adding up all the money earned in a year

• output method - adding up all the value added by each firm each year (difference between value of what a firm puts out and what it takes in)

how are different methods of calculating gdp equal? + what is 1 drawback?

• spending in an economy = the value of everything sold - therefore everything made (E=O)

• income someone generates in a year , either for themselves or others, = value of money their output brings from selling it (O=I)

• people spend what they earn (E=I)

• however - difficulties in estimating mean slight differences - so countries collect data via all 3 methods + publish an average (UK) or all 3 measures separately (USA)

exclusions from gdp

• transfer payments - government transfers for which no goods or services are being paid for​

  • e.g. national insurance, government student grants, social security benefits

• private transfers of money from individual to another

  • e.g. pocket money, to individual selling a second hand car

• hidden economy - income not registered with inland revenue

why are gdp figures often revised?

• reflect new or improved data (e.g. final official data rat6her that estimated data

• reflect greater accuracy (e.g. better estimates of unreported activity)

• give a more accurate reflection of the underlying state of the economy for policy purposes

real vs nominal

real values are adjusted for inflation, while nominal values are not - as a result, nominal GDP will often appear higher than real GDP.​

total vs per capita

per capita means per person - per capita GDP is found by dividing total GDP by the population - per capita GDP is useful when comparing countries as it shows their relative performance

value vs volume

• volume refers to the real quantity of units of output produced in an economy (100,000 cars + 20,000 houses + …) - whereas the value of national income is the monetary cost of all goods at current prices​

• Value = volume x current price level​

economic growth

• an increase in the amount of goods and services produced by an economy over a period of time

measuring economic growth

% change in real GDP (or real GDP per capita) is the most common way of measuring economic growth

does increased GDP guarantee better living standards?

• no - to expect higher living standards there must be an increase in real GDP per capita

• this means a higher volume of g&s can be consumed per person - even then higher living standards are not guaranteed

limitations of gdp as a measure of living standards when making comparisons over time

• GDP doesn’t take into account population changes​ - (GDP per capita ​does)

• doesn’t take into account inflation​ - (real GDP / real GDP per capita ​does)

• quality of goods can change ​- (e.g. quality of a car 1950s vs today)

• not holistic - doesn’t account for all factors affecting living standards - ignores externalities / leisure/ pollution​

• inequality could have changed​ - GDP per capita can be skewed by outlying statistics ​

• nature of output that is being produced​ - e.g. defence vs healthcare ​

• statistical inaccuracies​ (e.g. Ghana)

• consumption vs investment - depends where the expenditure is and what are the long term gains - (e.g. high consumption in the SR may drive GDP but saving to then investment will drive GDP and living standards in the LR​)

limitations of gdp as a measure of living standards when making comparisons between countries

• countries can manipulate data ​- inaccurate information​

• different proportions of spending ​- (e.g. Iceland spending on heating vs South Spain )

• GDP doesn’t take into account population ​- (e.g. America vs China​)

• hidden economy is a different proportion in each country ​- (e.g. UK vs Mexico )

• purchasing power parity​ - exchange rate does not take into account the cost of living in each country - doesn’t take into account the quality of G&S being produced, just the value of production ​

• differences in leisure time and hours worked per day​ - e.g. USA 44 hours a week at work, Netherlands its 29​

• considerations of the type of job ​- e.g. miner vs bankers, job satisfaction ​

purchasing power

• a comparison of the prices of given goods in different areas after adjusting at the current exchange rate for the different currencies​

• it shows how far an amount of money goes in different places after switching to the local currency​

PPP exchange rate

• approximates the adjustment that must be made on the currency exchange rate between countries that allows the exchange to be equal to the purchasing power of each country's currency.​

• i.e. the exchange rate at which you could buy the same goods or services in both countries ​

ppp example

• if a hamburger sells in London for £2 but sells for $4 in New York, the implication is that the ppp exchange rate is £1 to 2 dollars

• however, the actual GBP:USD exchange rate is closer to £1 : $1.25​

• if you had $40 dollars in New York you could buy 10 burgers. ​

• going to London and exchanging $40 would give you £32, enough to buy 16 burgers!​

• a fixed amount of money goes further in the UK than it does in the USA. the Pound is undervalued against the Dollar.​

implication of ppp

• to compare living standards in different countries, we need to adjust for PPP so as to reflect how much people can actually buy with their incomes.​

• where is life better: a country with GDP per capita of 20,000 dollars but a house costs 50,000 dollars or a country with GDP per capita of 50,000 dollars but a house costs 250,000 dollars?​

gnp (gross national product)

• the total value of output produced by all the factors of production owned by a nation’s citizens.​

• GDP + income that residents have received from abroad, - income claimed by non-residents. (UK GNP = $2.79tn (2019)).​

gni (gross national income)

• the value of all output produced by an economy over time (GDP) plus net overseas interest payments and dividends.​

• GDP + net income paid into the country from overseas for such things as interest and dividends.(UK GNI = $3.07tn (2018)).​

why collect gnp and gni?

they give a more inclusive measure of the income of a country and therefore a more accurate guide to living standards, particularly for countries with large foreign receivables or outlays

classical economic theory

• higher income correlates to higher levels of utility (happiness) and economic welfare​

• starting from a low base, increasing income means enables a person to buy more essential goods and services, the basics of life such as food, shelter, health care and education - this leads to an increased quality of life

• as they get richer, they can then buy more luxuries too, as well as being further from financial distress

easterlin paradox

• as GDP per capita rises, the gains to happiness of every extra bit of income quickly diminishes

• one estimate is that an individual’s emotional well-being rose with earnings only up to a threshold of circa $75,000 a year.​

diminishing marginal utility of money

• money itself doesn’t bring any utility, but it is the consumption bought with money that does. But as we consume more and more, each additional unit of consumption derives less satisfaction. 1st glass of water vs 2nd glass vs … vs 10th glass.​

national happiness

a subjective concept considering the welfare of a country’s citizens​

measuring happiness

• a combination of surveys asking people to self-assess their own happiness as well as measurable indices which affect broader welfare levels ​

• e.g. levels of literacy, access to health care, political freedom, quantity of leisure, income levels and pollution levels.​

bhutan and gnh (gross national happiness)

• the government of Bhutan has been guided by a philosophy of trying to maximise GNH rather than GDP ​

• in the last 20 years Bhutan has doubled life expectancy, enrolled almost 100% of its children in primary school and overhauled its infrastructure.​

• criticisms - the subjective nature of what factors to include in GNH has led to it being labelled a propaganda tool - not least because the ethnic cleansing of the non-Buddhist ethnic Nepalese population as a result of the GNH cultural preservation objective.​​

wealth

Wealth is a stock concept. Assets owned e.g. buildings, land, savings, shares or human wealth e.g. skills and education​

income

Income is a flow concept: money generated from wealth e.g. wages, rent, interest​

Why is wealth spread more unequally than income?​

• Wealth can be thought of as the stock of left over income after consumption.​

• It costs everyone roughly the same the consume the essentials​

• For someone with high income this leaves them a lot of money each year which accrues to give a large wealth​

• For a low income individual however, the majority of their income is spent on these essentials, with little left over and so wealth doesn’t accrue very easily. ​

• This accumulation of wealth is accelerated as a person’s income is increased more and more by virtue of having wealth.​

• The level of wealth inequality continues to widen​

what is the circular flow of income

• An economic model showing the flow of G&S, the factors of production and their payments between households and firms within an economy​

• however only shows how money moves in a closed economy

what are injections and withdrawals?

• Injections: Money entering the circular flow of income​

• Withdrawals: Money leaving the circular flow of income​

what are 3 sources of injections and withdrawals

• Banks:​

  • Injection=investment​

  • Withdrawal=savings​

• Government:​

  • Injection=Government spending​

  • Withdrawal =Taxes​

• The Rest of the World:​

  • Injection=exports​

  • Withdrawal=imports

the labour force (lf)

• the people who are working or are willing and able to work in a country. It is everyone who would work if there were limitless jobs. They are Economically Active. ​

employed (E)

• The part of the labour force that are engaged with a job.​

  • Stat:  33.07 million people were in employment in the UK in February 2020 – a record!​

unemployed (U/E)

• The part of the labour force that are out of work and actively seeking employment at the current wage rate.​

  • Stat: An estimated 1.36 million people were unemployed in the UK in February 2020. ​

population of working age

• the number of people in the UK aged between 16 to 64.​

  • Stat: Circa 42.93 million people made up the PWA in the UK in February 2020. ​

economically inactive

• Those members of the PWA that are not either employed or actively seeking employment at the current wage rate. ​

• Economically inactive = PWA - LF​

  • E.g. students, stay at home parents, people enrolled on training schemes, early retirement, etc.​

why measure unemployment?

• unemployment represents a waste of scarce resources i.e. labour that is not being used to produce G&S

• so measuring unemployment with care is vital ask it informs about spare capacity and helps us determine whether an economy can cope with excess demand

underemployment

• those workers who are highly skilled but working in low paying jobs and part time workers who would prefer to be full time

  • they are not productive as they could be

employment rate

• the proportion of the population of working age that is currently employed

• employment rate = E/PWA

  • stat: uk employment rate = 77%

unemployment rate

• the proportion of the labour force that is not currently employed

• unemployment rate = U/E / LF

  • stat: uk unemployment rate = 4%

participation rate

• the proportion of a population of working age that is in the labour force i.e. economically active

• participation rate = LF/PWA

  • stat: uk participation rate = 80%

the claimant count

•  simply records the number of people receiving Jobseeker’s Allowance (i.e. unemployment benefits).​

how does the claimant count work?

• Those claiming JSA must declare that they are out of work, but capable of, available for and actively seeking work.​

• Only available to those aged between 16 and state pension age.​

• By counting the people on JSA, the government know how many people are unemployed.​

• They have to go to a job centre once every 2 weeks to confirm that they are in fact looking for a job

advantages of the claimant count

• Includes everyone claiming JSA. ​

  • Not a survey hence avoids sampling errors.​

  • Gives detailed local breakdowns highlighting differences in regional unemployment.​

• Compiled every month.​

  • Figures are always up to date.​

• Cheap to produce.​

  • All data comes from existing records held by job centres and The Department of Work and Pensions.​

disadvantages of claimant count

• Benefits cheats might still claim JSA.​

  • They might claim to be unemployed even if they are employed already in the ‘informal economy’ or if they are not genuinely seeking work.​

• Some unemployed may be unable to claim.​

  • Individuals may be seeking work but unable to claim JSA if their spouse has a high income.​

• Some people might not want to claim JSA.​

  • Those with great wealth or very high income may not bother to claim.​

  • Social stigma in claiming benefits.​

• Changes to conditions of claiming JSA and definition of CC unemployment.​

  • These have tended to push the figures downward. 40+ changes since 1979. For example:​

    • Change from those registered at job centres to those actually claiming JSA​

    • 16-18 year olds register for a government training scheme instead of claiming benefits​

    • Those seeking part-time employment can no longer claim JSA​

    • Those seeking full-time employment but who have a part-time job can’t claim JSA, they are classified as underemployed now​

    • Those in their 50s and 60s who are claiming a pension from previous work are excluded, even if they are still seeking employment.​

the labour force survey

• The labour force survey (LFS) is undertaken by the International Labour Organisation (ILO) and is a more direct assessment of unemployment, rather than those who claim benefit.  ​

how does the labour force survey work?

• The measure is based on an extrapolation of a quarterly survey of 85,000 individuals. They state whether they are unemployed based on meeting the following criteria:​

  • Have been out of work for 4 weeks.​

  • Be able to start work in the next 2 weeks, (i.e. readily available for work).​

  • Be able and willing to take on work for at least one hour per week.​

  • So part-time unemployment is included in the measure - though these workers are unlikely to claim unemployment benefit. This tends to make ILO unemployment higher than the Claimant Count.​

advantage of ILO labour force survey

• Uses an independently set methodology.​

  • Prevents government from interfering and artificially manipulating decreases in unemployment figures.​

• Uses the ILO definition.​

  • Adopted by many countries.​

  • Allows easy comparison between countries and aids clear policy making/comparative analysis. ​

• More inclusive measure as no requirement to be claiming benefits.​

  • Includes unemployed who may not receive JSA.​

  • This could be as they may not want to claim due to social stigma, their household income may be too high, they may already have a private pension preventing a claim, they might not have made sufficient NI contributions historically to be eligible.​

disadvantages of ILO labour force survey

• Additional cost to the ONS.​

  • They need to run a survey of 85,000 individuals.​

• Only a sample.​

  • There may be sampling errors.​

  • It may not be representative.​

can there be an increase in both the employment and unemployment rates?

• yes - as unemployment rate is U/E ÷ LF and the employment rate is E ÷ PWA it is possible for both rates to rise

• this can occur if there is immigration and both the unemployment rate and employment rate amongst the new members of the population is higher than in the existing population

net migration

•  the difference between the number of people immigrating (coming in) to and emigrating (going out) from of a country.​

advantages of immigration to the labour force

• Migrant workers tend to be more flexible than British citizens (e.g. Polish doctor accepting a job in a pharmacy).​

  • They find jobs quickly and are unlikely to add to unemployment figures themselves.​

  • They often take jobs which other British citizens didn’t want anyway – so migrants are not really forcing UK workers into unemployment.​

• Migrant workers themselves are consumers who demand G&S which, in turn, increases the derived demand for labour in other industries.​

  • Consequently, migrant workers tend to increase the employment figures more than they increase the unemployment figures.​

Balance of payments

• The BoP is a record of all transactions between one country and the rest of the world.​

  • It is made up of several different accounts

    • capital account

    • current account

    • financial account

  • It always sums to zero.​

Capital account

• Records the movement of fixed assets between countries.​

  • It records the movement of physical assets associated with migration or acquisition/disposal of intellectual assets.​

financial account

•  Records international investments and transactions in financial assets ​

  • Foreign Direct Investment (FDI): Records the investment of physical capital into an economy by foreign firms. ​

  • Portfolio Investment: The flows of money to purchase financial assets, such as bonds and derivatives. ​

  • Balance of banking flows: currency transfers, ‘hot money’, flowing in/out of banking system – often to take advantage of higher interest rates.​

current account

• A record of all payments for trade in goods and services + income flow. It is divided into four parts.​

  • trade in goods

  • trade in services

  • income

  • current transfers

how to figure out current account balance of a country

+ Exports of goods (inflow - credit)

- Imports of goods (outflow - debit)

+ Exports of services​

- Imports of services​

 ​

+ Net income (inflows of factor income from owning foreign factors of production, net of outflows of factor incomes to foreign owners of domestic assets)​

​

+ Net current transfers (government transfers to and from overseas organisations)​

​

current account surplus

•  A positive current account balance.​

current account deficit

A negative current account balance.​

trade in goods (component of current account)

•  The value of goods (visibles) a country sells to the rest of the world net of the value of goods they buy from the rest of the world.​

trade in services (component of current account)

• The value of services (invisibles) a country sells to the rest of the world net of the value of services they buy from the rest of the world.​

the balance of trade (in goods and services)

• The sum of the value of all goods and services sold by a country to the rest of the world (exports, X) net of the value of all goods and services bought from the rest of the world (imports, M). ​

• It is the value of their exports minus the value of their imports, X-M (i.e. net exports). ​

  • BOT Surplus: X>M ​

  • BOT Deficit: M>X​

net income (component of current account)

• income earned by domestic citizens who own assets overseas minus income earned by foreign citizens who own assets in this country.​

  • Net Income is sometimes called ‘primary income’ or ‘investment income’.​

  • Includes profits, dividends on investments abroad and interest.​

  • Can also include remittance payments.​

difference between net income and financial account

• If a UK resident bought stocks in a French firm, that would be an outgoing on the financial account

• But should the ownership of that stock pay the UK resident a dividend, the income they receive from it represents an incoming item on the current account.​

net current transfers (component of current account)

•  Where one country simply provides money to another country with nothing received directly in return.​

  • Current Transfers are sometimes called ‘secondary income’ or ‘international transfers’.​

  • Usually money transfers between central governments as aid or grants, such as those that the UK used to receive as part of the CAP from the EU.​

open economy

• An open economy is a type of economy where not only domestic actors but also entities in other countries engage in trade.​

  • In practice, almost all economies are interconnected through trade.​

  • But Economists often compare open economies to theoretical ‘closed’ economies, those not open to trade with other economies.​

interconnection between economies

•  As exports and imports flow between different economies, it is obvious that every economy experiences injections and withdrawals. ​

  • That is, if one economy has a current account (trade) surplus - a net injection – it must be that another is running a current account (trade) deficit – a net withdrawal. ​

example illustrating interconnectedness between economies via trade

• Imagine that the UK and China are the only two economies that exist. ​

• If the UK exports £100 of goods to China but imports £200 worth of goods, this will lead to a trade balance of minus £100. ​

• However, by symmetry, China is exporting £200 of goods and only importing £100, a £100 surplus.​

aggregate demand

• The total level of expenditure on all domestic output over a given period of time at a given price level​

components of aggregate demand

• Consumption (C): Total expenditure by households on goods and services.​

  • Stat: Consumption made up 66% of UK GDP in 2018.​

• Investment (I): Spending, by firms, on capital goods such as equipment and new buildings to produce more output in the future.​

  • Stat: Investment made up 17% of UK GDP in 2018.​

• Government Expenditure (G): Spending by the government for the benefit of the country’s citizens, funded by tax revenue and borrowing.​

  • Stat: Government expenditure made up 18% of UK GDP in 2018.​

• Net Exports (X-M): The value of the nation's total trade. It is the value of a nation's total exports of goods and services minus the value of all the goods and services it imports.​

  • Stat: Net exports made up -1% of UK GDP in 2018 (+29% for exports -30% for imports).​

aggregate demand equation

AD = C + I + G + (X – M)​

aggregate demand = consumption + investment + government expenditure + exports - imports

why may an increase in one factor affect aggregate demand more than an increase in another?

• A change in C has the biggest effect on AD compared to the other components.​

• 10% increase in C means a 6.6% increase in AD (10% increase in I only means a 1.7% increase in AD)​

• Therefore the easiest way to increase AD is to increase C.

what does the AD curve graph?

the relationship between price level and a nations real output/expenditure

why is the AD curve downwards sloping

• If the price level rises, whilst incomes remain constant, purchasing power will fall, therefore cutting demand (The real balance effect) ​

• Imports become relatively cheaper as the UK price level rises and are substituted for domestic demand.

movements along the AD curve

• Correspond to changes in price level.​

  • A fall in the price level leads to an expansion in AD.​

  • A rise in the price level leads to a contraction in AD.​

shifts of the AD curve

•  Correspond to shocks that directly or indirectly affect the magnitude of one or more of the different components of AD​

  • Endogenous shocks: A change in a component of AD ​

  • Exogenous shocks: A change in a variable which affects at least one of the AD components, but which itself is outside the AD model​

consumption

• Total expenditure by households in goods and services over a period of time.​

  • This includes demand for durables e.g. audio-visual equipment and vehicles & non-durable goods such as food and drinks which are “consumed” and must be re-purchased. ​

  • Stat: Consumption made up 66% of UK GDP in 2018​

average propensity to consume (APC)

the proportion of the income that a household spends

APC equation

Average propensity to consume = consumption / (disposable) income