Macro - economics

Market failure

This is when the market Iails to allocate resources eIIectively because the true costs oI
the good or service are not considered when making a purchasing or production decision.
Examples oI this might be the case oI monopolies restricting supply or the over
production oI de-merit goods and the under production / use oI merit goods.

Economists claim that markets are by nature eIIicient. This is because, according to the
laws oI economics, shortage oI a good or service Iorces up prices, which then acts as a
signal to would be entrepreneurs to switch resources into the production oI that good or
service, Irom less proIitable ones.

However, while all the above is true to an extent, it only works when we include the
private costs oI a good or service, not the external costs to society, which are never
included in a companies proIit and loss account.


Tradable Permit

A tradable permit is a permit which allows a company or country to produce a de-merit
good up to and including a certain level.

Government Objectives - page 206 - 207

Country GDP per
Capita
Unemployment Inflation Balance of
Trade
(Millions)
HDI (Human
Development
Index)
Sweden 43 654 8.3 0 7.4 0.885
Denmark 56 790 4.6 2.3 2.7 0.866
UK 35 165 7.7 3.2 -2 0.849
Turkey 11 500 14.1 8.4 -8.1 0.679
Georgia 4 670 16.9 1.7 -4.5 0.698
Croatia 15 600 14.7 11.8 -6 0.767
Russia 15 100 8.4 11.7 9.6 0.719
China 5 400 4.1 4.4 9.4 0.67
India 3 300 10.7 9.7 -1 0.51
Zimbabwe >100 95 5.1 -$807.5 0.513


Measuring national income - income method, expenditure method, output method.


Key terms in National Income Accounting

GDP - this is the total value oI all goods and services produced in a country and can be
calculated by the Expenditure Method, the income method or the output method.

Expenditure Method

This is calculated by adding up all the goods and services sold in a country and is divided into
consumer expenditure ( C ), public expenditure (G), Fixed Capital Iormulation / Investment (I).
You then add this Iigure to exports (X) and take away imports (M).

You then take oII sales taxes and add on subsidies so that you are measuring the real value oI
goods and services in the country. To get Gross Domestic Expenditure.

Income method

This is calculated by adding up all the rewards Irom each oI the Iactors oI production i.e Income
Irom employment (labour), proIit (entrepeneurship), interest received (capital) and rent (land).

You then take oII Stock appreciation (the rise in stock values due to inIlation rather than increases
in value added) to get Gross Domestic Income.

Output Method

You add up all the output produced by each oI the industrial sectors Agriculture, energy,
manuIacturing, distribution, banking, education and Health and other public services.

You then have Gross domestic output

Gross National Product

Irrespective oI which ever oI the above that you do you end up with GDP (subject to statistical
errors). To get Irom GDP to GNP you take oII the net property income Irom abroad.

Net property income from abroad

The proIit coming into Turkey, made by Turkish citizens on proIits made overseas minus the
proIits repatriated i.e the proIits leaving Turkey, made by Ioreign citizens on investments in
Turkey.

Net National Product

GNP depreciation oI Iixed assets. Fixed assets mean machinery and inIastructure. To put it in
perspective, iI the government spends 2m replacing an old road, and the old road was valued at
1m then the real value oI that investment was 1m not 2m.

Real GDP

The value oI GDP aIter taking oII the rise in prices, so iI a countries GDP grows by 4 this year
but prices rise by 2 then the real rate oI GDP growth is only 2.

Put the Iollowing items into a table:

Expenditure Method:

Private consumption (c), Investment (I), government expenditure (G), sales tax, subsidies,
exports, imports, Gross Domestic expenditure at market prices, Gross Domestic expenditure at
Iactor cost.

Income Method:
Income Irom wages, proIit (private sector), proIit (public sector), rent, interest, stock
appreciation.

Output Method:
ManuIacturing, energy, agriculture, Iinancial services, other services, construction


Expenditure Method Income Method Output Method
Private consumption (c) income Irom wages ManuIacturing
Investment (I) proIit (private sector) energy
government expenditure (G) proIit (public sector) agriculture
-sales tax rent Iinancial services
subsidies interest other services
exports (x) stock market proIits construction
-imports(M)


GDP GDP GDP
+ProIits made by Ioreigners
on investments made in
Turkey
+ProIits made by Ioreigners
on investments made in
Turkey
+ProIits made by Ioreigners
on investments made in
Turkey
-ProIits repatriated by Ioreign
citizens on proIits made in
Turkey
-ProIits repatriated by Ioreign
citizens on proIits made in
Turkey
-ProIits repatriated by Ioreign
citizens on proIits made in
Turkey
GNP GNP GNP
Depreciation oI Iixed assets Depreciation oI Iixed assets Depreciation oI Iixed assets
NNP NNP NNP


Calculate the GDP of the following country using each method of National income counting

Expenditure Method

Consumer expenditure (C) 1 400 000, public expenditure (G) 430 000, Iixed capital
Iormulation (I) 400 000, exports (X) 160 000, imports (M) 120 000, subsidies 30 000 and
sales taxes (T) 110 000.

Calculate GDP at market prices and GDP at Iactor cost






ProIits received by Turkish citizens on investments made overseas 80 000. ProIits repatriated
Irom turkey 70 000. ThereIore, GNP

Income method

Income Irom employment 900 000, income Irom selI employment 260 000, private sector
proIits 100 000, public sector proIits 90 000, rent 120 000, interest 70 000, stock
appreciation 40 000, Statistical error (6000)






GDP

Net property income Irom abroad 30 000. GNP

Output Method

Agriculture 150 000, energy 90 000, manuIacturing 300 000, distribution 140 000, banking
190 000, education and health 110 000, other public services 260 000, statistical error 4000

GDP

Net property income Irom abroad 30 000. GNP

GNP depreciation oI Iixed assets

GDP / population

GDP inIlation (rise in prices)


Calculate the GDP of the following country using each method of National income counting

Expenditure Method

Consumer expenditure ( C ) 400 000
Public expenditure (G) 130 000
Fixed Capital Iormulation (I) 70 000
Exports (X) 60 000
Imports (M) (80 000)

GDP at market prices

Sales taxes (75 000)
Subsidies 5 000

GDP at Iactor cost
Statistical error 2400

GDP at Iactor cost


Income method

Income Irom employment 303 000
Income Irom selI employment 60 000
Private sector ProIits 50 000
Public sector proIits 40 000
Rent 50 000
Interest 40 000
Stock appreciation (30 000)

Statistical error (1000)

GDP

Output Method

Agriculture 50 000
Energy 50 000
ManuIacturing 100 000
Distribution 40 000
Banking 120 000
Education and Health 80 000
Other public services 68 000

Statistical error 4000

GDP

GDP - net property income from abroad ______- Depreciation ____________

Real NY v nominal

Real GDP is the nominal rate oI GDP inIlation to Iind the real level oI GDP

Per capita

Real GDP / population per capita GDP. Highest in the world Luxemburg

Limitations of GDP data

Comparing two countries with diIIering GDP levels is an indicator oI development. For
example, looking at the worlds richest countries, measured by GDP and looking at the
worlds most developed nations, measured by HDI (human development index), the lists
are very similar. Generally speaking the worlds richest nations are also the most
developed.

But there are limitations to GDP data.

For instance take two countries UK and France. The UK has the higher GDP. Does
this mean that the UK is richer than France? Not necessarily as the diIIerence is
relatively small and so the diIIerences are not signiIicant enough to say conclusively that
one is richer than the other. For instance perhaps income levels in France are more
equally distributed than UK.

Perhaps UK is more expensive to live than France?
Perhaps tax rates are higher in UK?
Perhaps the inIormal sector is larger in France, which do not get included in the Iigures?

However, now lets consider two diIIerent countries Germany and Turkey. In this case
the GDP oI Germany is 3 times higher per capita than Turkey. While there are
limitations oI GDP analysis, the vast diIIerence between the GDP rates oI each country is
signiIicantly large in order to say conclusively that Germany is a richer than Turkey.

Circular flow of NY - page 208

Macroeconomic models - Components of AD

AD CGIX-M
Consumption government spending investment exports - imports

AS v AD Equilibrium level of NY

Where AS AD

Inflationary Gap

The gap between the rate oI inIlation when the economy is in equilibrium and the level oI
inIlation when AD ~ AS

Deflationary Gap

The gap between the rate oI real GDP when the economy is in equilibrium and the level
oI GDP when the economy is in recession

GDP deflator

page 246
The shape of the AD / AS curve

SR keynes Monetarist

Average AS Average AS
Prices Prices






Real GDP Real GDP


LR keynes compromise

Average AS Average AS
Prices Prices






Real GDP Real GDP


Shifts in AD and AS - Caused by ?

AD shifts are caused by

Changes in tax rates and government spending (Iiscal policy)
Changes in interest rates and the money supply
Rises in real GDP
A Iall in the exchange rate making exports cheaper

AS shifts are caused by

A change in oil prices or other external shocks to the economy
Improvements in technology or production methods
Investments in education and training which increases productivity levels
Changes in exchange rates which makes imports more expensive

Keynesians - fiscal policy

This is the control oI the economy through government spending and taxes. In recession,
the government will inject money into the circular Ilow by lowering taxes (income tax
and sales tax) and / or raising government spending

Monetarists - monetary policy

This is the control oI the economy through interest rates and the money supply. In times
oI recession, the government should lower interest rates and in times oI excessive
inIlation they will lower the money supply and raise interest rates.

E.g. the average UK person earns $ 45 000 a year giving them an aIter tax wage, per
month oI $3100. The average house costs $ 230 000 meaning a mortgage oI
approximately $ 170 000.

Monthly payments at 5, thereIore, are $900 leaving a total disposable income oI $2200.
II, however, the government reduces interest rates to 2.5 then monthly mortgage
payments become $450, giving every household an extra $450 a month to spend.

Between 1960 and 2009, governments throughout the world abandoned Iiscal policy
(Keynesianism) and just controlled the economy through interest rates (monetarism).

Supply side theorists

Supply side economists (laissez Iaire economists) believe that governments should not
intervene in the economy as governments cannot control AD in the long run as the
markets are selI-correcting.

Strengths and weaknesses of these policies

The biggest strength oI supply side policies are that they provide real growth in GDP /
National income. Ultimately, rises in AD are limited in their eIIectiveness because they
can only push GDP up to the PPF. In the long run, only by shiIts in AS will the economy
improve. E.g. Fiscal measures might make an unemployed person work. Their output
leads to a rise in GDP. However, in the long run, Iurther rises in GDP can only be
sustained by increasing the productivity oI that worker either by retraining or improving
the technology that he or she has to work with.

Secondly, rises in GDP through shiIts in AS do not increase inIlation pressure. In Iact
they do the opposite. II an economy can increase its AS then it can even raise AD
(through Iiscal and monetary policy) without causing inIlation.

Multiplier

The multiple by which an increase in government spending leads to a more than
proportional rise in AD. E.g. government builds a road, the company hires workers and
provide a contract to a cement Iactory etc. Those workers spend their money elsewhere,
which generates additional income etc.

Accelerator

How a rise in AD will ultimately lead to a rise in investment as companies must invest to
satisIy the new demand.

Crowding out

This is the crux oI the Keynesian v Laissez Faire debate. Do increases in AD inevitably
lead to Crowding out? Monetarists and Laissez Faire economists say it does while
Keynesians say that it does not. Crowding out means when increases in government
spending crowds out private sector investment. E.g. President Obama`s 1 trillion Iiscal
stimulus package, borrowed Irom the Chinese will lead to a rise in interest rates which
will make it more diIIicult Ior companies and individuals to borrow money.

Economically active population

People who are willing and able to work, within the workIorce. Ie the number oI people
employed and unemployed. Housewives, children, students and the elderly are not
economically active. Sometimes called the labour Iorce.

How is unemployment measured

The oI the labour Iorce (economically active population) without paid employment

Unemployment - types of

Structural unemployment - unemployment caused by people lacking either the
geographical or occupational skills to take the jobs that are on oIIer in the economy. e.g.
an unemployed steel worker living in a town where the steel works have closed down.

Cyclical unemployment - unemployment caused by a down turn in the economy. To
calculate the level oI cyclical unemployment within an economy you subtract the level oI
unemployment when the economy is in equilibrium with the level oI unemployment
when the economy is in recession.

Frictional unemployment - unemployment caused by somebody looking Ior a new job.

Seasonal unemployment - a person unemployed Ior part oI the year.

Costs of unemployment

Budget deIicits as governments collect less and spend more on welIare beneIits
Productivity and output Ialls
Higher rates oI crime and social unrest / protests
Higher income inequality

Dealing with Unemployment

Worksheet worksheet on unemplovment
Macro -economics measuring national income

Cyclical unemployment this can be overcome by Iiscal policy (Keynesianism),
monetary policy (monetarism) or by doing nothing and waiting Ior the economy to
correct itselI (laissez Iaire economists). Removing minimum wage. Increase government
spending. Investment projects to stimulate the circular Ilow oI national income.

Structural unemployment training programs, retraining Ior the unemployed, reducing
welIare beneIits, investment in new technology

Frictional unemployment - lower bureaucratic requirements, job centers, specialist
newspapers advertising the available jobs etc.

Inflation - cost-push and demand pull.

Cost push inflation

InIlation cause by rises in the AS, the same as the supply curve in micro-economics. E.g
rising oil prices, higher wage demands, a rise in sales tax or a Iall in the value oI the
currency.

Demand Pull Inflation

InIlation caused by rises in AD, the same as the demand curve in micro-economics. E.g
reductions in interest rates or income tax, a rise in the money supply or an increase in the
popularity oI a countries products overseas.

Creeping inflation and hvper inflation (worksheet)

Laissez Faire economics v Interventionist economics

We (Turkey and most other countries around the world) are in the same position
recession` deIined as 2 consecutive quarters oI negative GDP growth. Eg 2009 growth
rates

http://www.photius.com/rankings/economy/gdprealgrowthrate20090.html

World 3.8
Poland 4 (top EU country)
Greece 2.8 (2
nd
highest in EU)
USA, UK, Turkey below zero
Italy, Ireland, Spain below them

So what should a country do - something or nothing?

First the nothing approach according to Laissez Iaire economists, the markets are selI-
correcting. The background to this recession was the very high rates oI inIlation in the
world in the period 2006 2008. Essentially, everybody was spending money they did
not have, running up huge credit card bills and other debts. Banks, Ior their part,
contributed to the mess by lending out money to people who couldn`t pay it back. The
much mentioned PWAJI`s (people without assets, jobs or income) who were lent
money to buy their trailers when they didn`t have jobs to pay the loans back. Credit cards
given to all and sundry. ThereIore, ineIIicient businesses sprung up that shouldn`t,
houses got sold that shouldn`t and prices oI housing, oil, Iood and other commodities rose
to a level that no-one could aIIord. ThereIore, this recession is payback time.

In the recession, the ineIIicient businesses are Iailing, houses, oil, stocks etc are Ialling in
price to a sensible level and Irom there the world can gradually recover.

Now the something approach (Keynesian, interventionist economists)

Keynesian economists by contrast do not see the markets as selI-correcting. For them
recessions are something that a government can control. Lets suppose the Turkish GDP
is normally $800 billion but in 2009 Iell to $700 billion the GDP gap or recessionary gap
$100 billion. ThereIore, so say economists, the government needs to make up the
diIIerence. Say the value oI the multiplier is 2, then the government needs to inject an
additional $50 billion into the circular Ilow in the Iorm oI government spending or lower
taxes (Iiscal policy).

Eg`s

America GDP in 2008, 14.75 trillion $
2009, 13.25 trillion $

ThereIore, the output gap is $ 1.5 trillion. Suppose the Americans spend 40 oI their
income then the multiplier eIIect is 1 / 0.6 1.66. ThereIore, according to Keynesians,
Obama must inject 1.5 / 1.66 $ 900 billion into the circular Ilow to make up Ior this
output gap.


Imports
Goods and Services Saving
Tax
Expenditure






Injections:

Government spending
(must be increased by $900b)
Investment
Exports Factor rewards

Factors oI production



Will Obama`s package work?


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decompressor
areneededtoseethispicture.



Businesses
Households
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decompressor
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So should a government use Keynesian measures or not?

Advantages:

- It provides a short-term solution and much needed short-term relieI.
- It provides conIidence Ior companies to invest (accelerator theory)
- The economy, once in Iull employment, can generate new jobs, new -
wealth etc and, thereIore, new tax revenues to repay the debts incurred.

Disadvantages:

- The money injected into the circular Ilow through increased government
spending or lowering taxes has to be repaid the current Iiscal stimulus
package oI USA has increased USA`s national debt by an additional 1 trillion
$
- The question will always be asked are these jobs that are created really long
term jobs or merely temporary. Does the government investment not stiIle
private investment (crowding out) by taking away scarce resources oI land,
labour e.t.c

Phillips Curve

InIlation
LR Phillips curve

Q Natural rate oI unemployment



NAIRU

Q Unemployment

-


Quantity theory of money

Worksheet

Functions of money
Worksheet functions and uses of monev
Running the economv

Wage cost spiral

This is the explanation used to describe why governments should not artiIicially stimulate
the economy via Iiscal and monetary policy. Firstly, our economy is in equilibrium.
Point A.
Average
Prices AS3
AS2
AS

AD2

A AD
LRAS

Real wage


Now what happens is the economy suIIers an external shock e.g. a rise in oil prices.
Aggregate Supply shiIts to AS2. Our new equilibrium point is B. At this point the
government can do nothing, simply biting the bullet and accepting a short-term loss oI
GDP. OR it can try and artiIicially stimulate the economy, raising AD to AD2.
UnIortunately, this does not work because the resulting rise in inIlation Iorces wage costs
up Iurther. (AS2 AS3). This cycle brings about an inevitable consequence oI recession
as eventually Iirms are Iorced to lay oII workers because they cannot aIIord to keep
paying them.

Multiple-choice questions
Macro economics work
General Revision

Taxes (Progressive v Regressive)

All governments need to tax their citizens to pay Ior inIrastructure
projects, welIare payments and transIer payments (civil service
wages). The question is, which type oI tax system is best,
America`s regressive system or Sweden`s progressive system?

Progressive tax system Regressive tax system

Sweden Germanv UK America Turkev India / Russia
France Australia


What are progressive taxes?

A progressive tax is a tax where the rich pay a higher oI their income than the poor eg
income tax, luxury taxes, property taxes, corporation tax (tax on company proIits)

Regressive taxes

Regressive taxes are taxes where the poor pay a higher oI their income than the rich
e.g sales tax, Ilat rate tax on property Ior example, SSK.

A proIile oI two people, one rich, the other poor

Mehmet is a CEO and he earns, every month $50 000. By contrast, Alan is an
unemployed lay about, earning $500 a month. In country A the top rate oI tax is 50
with sales tax oI 10. Mehmet pays a much higher rate oI tax than Alan, which is Iairer.
Country B has a top tax rate oI 20 and sales tax oI 20. This time, both Alan and
Mehmet pay roughly 20 oI their income in tax. This is a much less Iair system but at
least Mehmet is now discouraged Irom his plan to live in Dubai to avoid taxes.

Income inequality

This is measured by the gini co-eIIicient

Laffer Curve

Tax rate









Tax revenue collected

Lorenz Curve


oI the wealth
owned







A

B



poorest oI population

Gini co eIIicient is calculated by A / (A B)

Communist Utopia (red)
Alanopia (purple) (corrupt AIrican dictatorship)
Mehmetopia (western European country)

ThereIore, our gini co-eIIicient in our communist utopia 1
In Alanopia the gini co-eIIicient is very low ie 0.1 0.2 the poorest 50
earn just 5 oI the wealth (5 / 50)
By contrast, in Mehmetopia the gini co- eIIicient is 0.5 meaning that the
bottom 50 own 25 oI the wealth (25 / 50)