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Macro Economics Notes

Macro Economics Notes

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Published by Steve Ouma
Full semester notes on macroeconomics
Full semester notes on macroeconomics

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Published by: Steve Ouma on Nov 24, 2010
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Steve Ouma Oyugi Macro Economics Kimathi University College of Technology 2
nd 
Year 2
nd 
Semester 
Macroeconomics
 The Relationship between Macro andMicroeconomics
Microeconomics
deals with the behavior of individuals, consumers, factor owners, firms,individual industries and individual markets.
Macroeconomics
on the other hand dealswith a holistic approach of the economy bydealing with various aggregates, whichinclude:1.Total employees2.National income3.General price levels4.Inflation e.t.c.
Macroeconomics tries to explain what determines the level of total NationalEconomic activity and what causeseconomic growth.
 The classical economists had the basicprinciple that the economy had self -adjusting mechanisms to remain at fullemployment. This was based on the
 JB Saylaws of the market,
which says thatdemand creates its own supply.
British Economist JM Keynes
(1883 –1946) showed that an existence of greatand involuntary unemployment during thedepression of 1930 created the grounds onwhich macroeconomics is founded.
Central issues in Macroeconomics
Macroeconomics deals with the followingstudies, which makes up its scope:
1.
 Theory of 
income, output and employment.
The elements hereinare:
 Theory of consumptionfunction
 Theory of investment function
 Theory of business cycle
2.
 Theory of 
 prices
whose elementsare:
Inflation
Deflation
Reflation
Stagflation
3.
 Theory of 
Economic Growth
4.Macro theory of Economic Growth These elements are explained further as:
Employments and unemployment
 There are several causes of unemploymentand involuntary unemployment. Theyinclude:
1.
National income/Gross NationalProduct
– this is the total value of allfinal goods and services produced ina country within a year. Itdetermines per capita income, alsodetermined by the level of physicalcapital, human capital andtechnology.
2.
General price level and inflation
– The classical economists arguedthat inflation and prices wasdetermined by the amount of moneyin circulation.
Keynes introducedthe demand pool theory of inflation
caused by excessivedemand as can happen during boomor panic buying.3.Other causes of inflation could becost push inflation.
4.
Economic growth
– this issustained growth in nationalincomes. Keynes concentratedmainly on short-term growth but weknow that economic growth is afunction of levels of investment. Acertain level of economic growth isneeded to sustain a steady growth asexplained by growth models.
5.
Stagflation
– this is a special formof inflation resulting from the supplyside constraints. The Keynesianeconomy focuses mainly on demandside constraints, but modernmacroeconomists reveal supply sideconstraints, which can come fromsupply shocks.
6.
Balance of payments (BOP)
and[Exchange rates] - this is an analysisof transactions of the residents of acountry with the rest of the worldwithin a certain period. It takesaccount of imports, exports andcapital exchange leading to eithersupply or deficits. Exchange rate isthe rate at which a country’scurrency exchanges with another’scurrency.A microeconomic approach has limitationsto the extent that there it creates self confusing paradoxes. A firm will make moreprofits by cutting wages and thusmaximizing profits. This, when looked atfrom a macroeconomics view reducesaggregate demand.
Steve Ouma Oyugi Macro Economics7
th
July 2010
 Kimathi University College of Technology
 
Steve Ouma Oyugi Macro Economics Kimathi University College of Technology 2
nd 
Year 2
nd 
Semester 
Savings
An individual or a firms saving isencouraged but at a micro economic levelmay lead to a fall in the national income.Macroeconomic approach helps formulategovernment macro policies and thusaccelerating economic growth.
Extra work 
Advantages of Macroeconomics
1.Formulation and execution of economic policies by thegovernment.2.Indispensable for the study of macroeconomics, which is necessaryfor studying the vast fields of factorgeneralizations.3.Indispensable for the study of microeconomics. No laws of microeconomics can be formulatedunless pre-study of the aggregatesbearing on it have been made.4.Indispensable for the study of aggregate values. There is a cleardifference between individual andgroup behavior and as such what isapplicable to a firm may not be truefor the whole economy.5.Indispensable for guidinggovernments.
Disadvantage of Macroeconomics
1.The study of individual units in somecases is very important and as suchmicroeconomics is implementedinstead.2.Macroeconomics is applicable instudying homogeneous aggregatevariables only, and as such cant beapplied in the context of heterogeneous variables.3.An aggregative tendency does notinfluence all sectors of the economyin the same way thus precaution hasto be taken incase it happens. E.g.some industries may benefit morethan others with an increase in thegeneral price level.4.Macro-analysis is fruitful whenaggregate variables are accuratelymeasured. However even with anadvanced statistical procedure,desirable accuracy in themeasurement of macro-economicvariables is not possible e.g. it is noteasy to accurately measure thenational income of an economy.
National Income and National IncomeAccountingNational income
is the total market valueof all goods and services produced withinthe economy within a year. National incomeis a monetary measure and takes account of final goods without intermediaries.National Income = National Expenditure =National Product
Gross National Product
 This refers to the value of goods andservices produced by the residents of acountry, whether locals or foreigners. Thisconstitutes:1.Value of goods and servicesproduced and consumed by theconsumers (C).2.New capital goods plus inventories,not sold during a year (I).3.Goods and services from thegovernment (G).4.Net exports (X-M). Y=C+I+G+(X-M)5.Net factor income which thedifference between net factorincomes such as wages.
Gross Domestic Product
 This is the monetary value of goods andservices produced by the normalresidents and non-residents of a countryless the net factor incomes earnedabroad.GDP = GNP – NFI
Note
that net factor income is differentfrom net exports and imports and thusdon’t form part of GNP or GDP.
Net National Product
 This is the market value of all final goodsand services after providing fordepreciation.NNP = GNP – Depreciation
National Income and Factor Cost
;these take into account indirect taxesand subsidies. The difference betweentotal and direct taxes and subsidies isreferred to as Net Indirect taxes.NI (factor cost) = Net National Product –Indirect taxes + subsidies.
Circular Flow of Income
 This is a very simple model showing theworking of the economy, depictingmovements of resources between the
Steve Ouma Oyugi Macro Economics7
th
July 2010
 Kimathi University College of Technology
 
Steve Ouma Oyugi Macro Economics Kimathi University College of Technology 2
nd 
Year 2
nd 
Semester 
producers and consumers.It shows how income moves from one sectorof the economy to another in a series of monetary movements.
Two-Sector Model of Circular Flow of Income (Closed Economy)
In a simple microeconomic model, weassume that there is no governmentintervention and no foreign trade. In thiscase, the value of the Output Y Produced =the value of Output sold.
QuickTimeª and aBMP decompressorare needed to see this picture.
Identities
1.Y = C + IC-Consumption ExpenditureI - Investments
What happens to producedincome which is not consumed?
It is used to increase the inventories,which is treated as actualinvestments or savings.2.Y = C + SPutting equations 1 and 2 togetherproduces:C + I = C + SI = S
NB: -
In a simple two sector modelwhere there is no governmentintervention or foreign trade;Savings = Investments
Three Sector Model of Circular Flow of Income (Open Model)
In this model, the government is included. The intervention of the governmentinvolves:i)Taxationii)Government Expenditureiii)Government Borrowing
QuickTimeª and aBMP decompressorare needed to see this picture.
Identities
 The National Income Identity = Totalexpenditure1.Y = C + I + G Total income consumed, saved and taxed.2.Y = C + S + TSince; Y= E (Expenditure)3.C + I + G = C + S + T4.G - T (Deficit/Surplus) = S - IEquation 4 explains the government budgetdeficit. If the government expenditureexceeds the tax collected, then there wouldbe a budget deficit. To finance this deficit,the government borrows from the financialmarket and this reduces private investmenthence government borrowing crowds outprivate investment.
National Income Identity in a 4 SectorModel
In a 4-sector model, we introduce trade butwe assume that it is only the business firmsthat interact with the foreign countries.4 sector ModelsNI Identity1.Y = C + I + G + (X - M)Where (X - M) = Xn2.Y = C + I + G + XnBut Y = C + S + T Thus3.I + G + Xn = S + T The meaning of equation 3 is that the totalprivate investments + governmentexpenditure + net export = savings + Net
Steve Ouma Oyugi Macro Economics7
th
July 2010
 Kimathi University College of Technology

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