Macroeconomic Concepts

EVOLUTION OF ECONOMIC IDEAS CLASSIFICATION OF ECONOMICS MACROECONOMIC CONCEPTS - NATIONAL INCOME - MULTIPLIER EFFECT - MACROECONOMIC POLICY INSTRUMENTS

ECONOMIC DOCTRINES

SALIENT POINTS OF ECONOMIC DOCTRINES

PHILOSOPHERS - Social dimensions of business/economics PHYSIOCRATS - Land: Source of wealth - Laissez-faire MERCANTILISTS - Trade/Commerce: Main sources of wealth - Government intervention necessary CLASSICISTS - Individual: Best judge - Market: Decisions about Production, Consumption, Distribution - Government: No role

SALIENT POINTS OF ECONOMIC DOCTRINES

NEO- CLASSICISTS

- Technical analysis of production - Price theory - Market imperfections - Allocation: Profit/Utility maximization - Market imperfections - Cyclical unemployment - Government: Key role

KEYNESIANS

DEFINITION OF ECONOMICS
THE DISCIPLINE OF ECONOMICS DRAWS HEAVILY ON OTHER DISCIPLINES INCLUDING: - Philosophy - Social Sciences - Behavioral Sciences - Political Science - History IT ADDRESSES ISSUES THAT EMERGE AT THE INTERFACE OF THESE DISCIPLINES

DEFINITION OF ECONOMICS
IT ESSENTIALLY DEALS WITH DECISIONS ABOUT RESOURCES - Land, Labor, Capital, Materials - Production, Consumption - Pricing, Market - Allocation, Distribution - Social Needs Key driver: Scarcity

CLASSIFICATION OF ECONOMICS

Analysis of the behavior of an economy Broad economic aggregates national income, employment, trade . . .

Analyses of the behaviors of individuals, households, firms Producers, consumers and their interactions in markets

- DEVELOPMENT ECONOMICS - DEVELOPMENT ECONOMICS - RESOURCE ECONOMICS - RESOURCE ECONOMICS - ENVIRONMENTAL ECONOMICS - ENVIRONMENTAL ECONOMICS - PROJECT ECONOMICS - PROJECT ECONOMICS - ENERGY ECONOMICS - ENERGY ECONOMICS

MACROECONOMICS
MACROECONOMICS IS THE STUDY OF BROAD ECONOMIC AGGREGATES - National Output (National Income) - Employment - Inflations - Foreign Trade PERFORMANCE OF A COUNTRY MEASURED IN TERMS OF THESE BROAD AGGREGATES IS A REFLECTION OF THE STATE OF THE ECONOMIC HEALTH OF A COUNTRY

NATIONAL OUTPUT
NATIONAL OUTPUT - MOST IMPORTANT ENTITY DISCUSSED IN MACROECONOMICS OTHER EQUIVALENTS OF NATIONAL OUTPUT: - National Income - Gross National Product (GNP) - Gross Domestic Product (GDP)

NATIONAL OUTPUT (Gross Domestic Product: GDP)

THE CIRCULAR FLOW OF MACROECONOMICS
(TWO SECTOR MODEL)

MEASUREMENT OF GDP
FLOW-OF-PRODUCTS APPROACH GDP - Total money value of the flow of final products (goods & services) FLOW-OF-EARNINGS APPROACH (Flow-of-Cost Approach) (Flow-of-Income Approach) GDP - Total of (Primary) Factor Earnings GDP (Flow-of-Products) = GDP (Flow-of-Earnings)

NATIONAL OUTPUT ( CONTD. )

DOUBLE COUNTING - In flow-of-products approach, double counting is avoided by including in GDP only final goods and not the intermediate goods that are absorbed in making the final goods

- In-flow-of-earnings approach, double counting is avoided by using the concept of value added

THE CONCEPT OF VALUE ADDED

VALUE ADDED
Value added by a firm is the value of its output minus the value of the intermediate inputs purchased from other firms Value that the firm adds by means of its factor services

GDP ( CONTD. )

GDP ( CONTD. )
GDPGROSS = C + IGROSS NDPNET = C + INET GDP = NDP + Depreciation GDP = C + I + G (Government expenditure, excluding Transfer Payments) GOVERNMENT: SOURCES OF INCOME - Taxes, Bonds, Printing new money, Borrowings

GDP ( CONTD. )

TREATMENT OF TAXES (IN OUR MODEL) FLOW-OF-EARNINGS APPROACH Income includes direct taxes that go to govt. (the rest is spent on consumption and savings which becomes investment)

GDP ( CONTD. )
INDIRECT TAXES Loaf of bread Value Added Costs Indirect Taxes Price in Upper Loop Price in Lower Loop

$1 $0.20 $1.20 $1.00

GDP ( CONTD. )
Price in Upper Loop = Price in Lower Loop + Indirect Taxes We must subtract from the market value the amount of indirect taxes less any subsidies (subsidies are negative indirect taxes) paid to the consumers GDP at factor prices (costs) (value added) GDP at market prices

GDP ( CONTD. )
THE FOREIGN CONNECTION
SO FAR OUR DEFINITION OF GDP IS:

GDP = C + I + G OPEN ECONOMIES TRADE WITH EACH OTHER

GDP ( CONTD. )
Terminology:
X - M = NET EXPORTS Exports Imports NET EXPORTS POSITIVE (+) IF X > M NEGATIVE (-) IF M > X DEBT OBLIGATIONS

TRADE
PRINCIPLES - Absolute Advantage - Comparative (Relative) Advantage BASIC OF TRADE$ - COMPARATIVE ADVANTAGE Example*: Australia v Japan (food/car)

GDP ( CONTD. )
Australia 1 unit of food 1 unit car 1.25 hrs 100 hrs Japan 1 hr 50 hrs

==> Japan - Absolute advantage in food & car Comparative advantage in car ==> Australia - Comparative advantage in food David Ricardo * Ref: Samuelson, et el. (1992)
$

GDP ( CONTD. )
COMPARATIVE ADVANTAGE Real Wages/hr Australia 4/5 Uf 1/100 Uc Japan 1 Uf 1/50 Uc 50 Uf

Price of a unit of car 80 Uf

GDP ( CONTD. )
TRADE V NO TRADE
Assume: - Final price ratio: 60 - Each worker buys 60 Uf and 1 Uc Real Wages No trade (hrs of work) Australia 175 Japan 110 100 10%

With trade (hrs of work) 150 ==> 16.7%

GDP ( CONTD. )
GDP = C + I + G + (X - M) GNE NET (GROSS EXPORTS NATIONAL EXPENDITURE) GDP is the dollar value of a nations production. It comprises the dollar value of consumption (C), gross domestic investment (I), government purchases of goods & services (G), and net exports (X - M)

NATIONAL ACCOUNT ( CONTD. )

PURPOSES OF NA
Size of the economy (international comparisons) Growth of the economy (expansions, contractions) Relative contribution & significance of various components (C, I, G, X - M) Analysis of changes in national output (GDP) in response to policy changes

NATIONAL ACCOUNT ( CONTD. )

SIZE OF THE ECONOMY
- Movement over time (expansion, Contraction) - International comparisons COUNTRY GDP ($) per capita 1 2 3 30,000 3,000 12,600

NATIONAL ACCOUNT ( CONTD. )

ECONOMIC GROWTH Time series comparisons Nominal GDPs cannot be directly compared Index

NATIONAL ACCOUNT ( CONTD. ) Example

Increase in GDP between 1995 - 2000 1) 72% 2) 20%

NATIONAL ACCOUNT ( CONTD. )

Price index - Consumer Price Index (CPI) - Wholesale Price Index (WPI) - Retail Price Index (RPI) - GDP Deflator

CONTRIBUTION & SIGNIFICANCE OF VARIOUS COMPONENTS (C, I, G, X-M)

Australias GDP account for 1999-2000 Current Prices $Bn (1999-2000)

Consumption Investment Government Adjustments (x - m . . . .)

78% 20% 4% (-) 2

Consumption & investments play crucial roles in a nations economy High C, Low I Low C, High I Low Growth High Growth

(Japan, Singapore, S. Korea, Taiwan, HK)

CONSUMPTION
INCOME IS A MAJOR DETERMINANT OF CONSUMPTION (AND SAVINGS) PROPENSITY TO CONSUME - Response of consumption to change in incomes MARGINAL PROPENSITY TO CONSUME (MPC) - Extra amount consumed when income increase by a Dollar

CONSUMPTION
INCREASE IN INCOME = CONSUME + SAVE CONSUMPTION, SAVING LEVEL OF INCOME CONSUMPTION PART OF INCREASE IN INCOME = MARGINAL PROPENSITY TO CONSUME e.g. $1 = 70c + 30c Income Consumption Saving MPC = 0.7 MPC for Society = MPC/Individuals

 MARGINAL PROPENSITY TO SAVE (MPS)

MPS = 1 - MPC = 1 - 0.7 MPS = 0.3 DETERMINANTS OF C (OR SAVINGS) - Income - Tax structures - Price levels

INVESTMENT(I)
ROLES OF INVESTMENT
SHORT-RUN EFFECTS Increase of total demand, output, and employment LONG -RUN EFFECTS Capital formation

DETERMINANTS OF INVESTMENT
REVENUES - Level of GDP an important determinant of investment COSTS (COST OF INVESTING) - Interest rates (cost of borrowing) - Taxes (for example, personal, corporate) EXPECTATIONS - Business confidence

MULTIPLIER EFFECT OF INVESTMENTS

Increase in investment will increase national income by a multiplied amount - by an mount greater than itself! Decision $1000 investment

MULTIPLIER EFFECT OF INVESTMENTS

INCREASE IN INCOME CARPENTER + LUMBER PRODUCER PRODUCER I PRODUCER II PRODUCER III PRODUCER IV . . INCOME ($) 1000 2/3

MPC

SPENDING ($) 667

667 444 296 197 . .

2/3 2/3 2/3 2/3 . .

444 296 197 . . .

TOTAL INCOME

3000

Source: Samuelson (1980)

 One unit increase in investment results in more than one unit increase in national income Investment Total income $1000 $3000 = 3 * 1000

$1000 investment resulted in increase in national income by $2000

INVESTMENT

Y= C + I + G

PERFORMANCE

+ (X - M)

RECESSIONARY TIMES - Low private consumption - Low business investment POSSIBLE WAY TO INCREASE NATIONAL INCOME Increase I through G (Taxes) (MULTIPLIER EFFECT OF INVESTMENT)

BALANCE OF PAYMENTS
Balance of payments of a country is a record of economic transactions between the country & the rest of the world Merchandise: - Exports & Imports of Goods (Trade Balance) Services: - Exports & Imports of services - Shipping / air: Transport - Tourism - Insurance - Financial / Consultancy Services

 Income: - Dividends from Australian companies to overseas owners share holders or investors - Foreign earnings of Australian investors - Interest payments on loans& credits Unrequited transfers - Money brought by newly arrived migrants & other people

 OVERALL BALANCE
ACCOUNT

BALANCE ON CURRENT

Balance of capital account - Amount of overall capital inflow that is needed to offset the deficit on the current account National debt - Cumulative effect of past borrowings

APPROPRIATENESS OF GDP AS A MEASURE OF ECONOMIC WELFARE? GDP New

INSTRUMENTS OF MACROECONOMIC POLICY

Definition: a policy instrument is an economic variable under the direct or indirect control of the government; changes in policy instruments affect one or more of the macroeconomic objectives

INSTRUMENTS OF MACROECONOMIC

SUMMARY
A change in macro-economy policy through any of the policy instruments will affect all national objectives (output, employment, prices, trade) Each policy instrument has a marked impact on a specific objective, but affects other as well Trade-offs are inevitable Choice depends on objectives