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Lec 14: Revision

Lecture 14: 2011 S2 BM0008 Exam focus for Main Macroeconomics Exam Paper
Please note that if you are on MC on the examination day, you have to submit your MC via SOA and original MC to the Student Affairs Office (next to Koufu) WITHIN the time limit. The committee agreed that with effect from 2009/10 S1, students’ MC submission will not be taken into account at supplementary assessment unless there are good reasons to be considered otherwise (eg hospitalisation, accident, etc). Students who are absent from supplementary assessment will be awarded 0 marks for the respective components.

Macroeconomics vs Microeconomics


Macroeconomics is focused on the movement and trends in the economy as a whole, while in microeconomics the focus is placed on factors that affect the decisions made by firms and individuals. The factors that are studied by macro and micro will often influence each other, such as the current level of unemployment in the economy as a whole will affect the supply of workers which an oil company can hire from, for example.

Format of Exam
Section A 30 marks (Compulsory section)  Questions with sub-parts,  Short questions focusing on ‘define…’, ‘briefly explain…’, ‘calculate…’, ‘state the assumptions of…’ Section B 40 marks (3 Choose 2, 20 marks each)  Questions with sub-parts Section C 30 marks (Compulsory section)  Case Study Questions with sub-parts

The Four Macroeconomic Goals
A A 3. A 4. A
1. 2.

steady growth of the national output high level of employment stable price level satisfactory balance-of-payments

Positive Economics - an analysis limited to statements that are verifiable Normative Economics - an analysis based on value judgment

Central Economic Problems
Scarcity-Choice Dilemma (i) Resources are scarce (limited) (ii) People’s wants are unlimited

There are 4 Types of Resources (4 Types of Factors of Production)
• natural resources • renewable, non-renewable • receives rent (and cost of raw materials)


• workers • skills, knowledge, physical • receives wages

Limited resources + unlimited wants  Choices have to be made

Choice and Opportunity cost

The opportunity cost of obtaining a good or service is the next-best good or service that must be given up in order to obtain the preferred one.

• man-made goods used for • special type of labour production • creativity in combining • plants, machinery, equipment resources to produce goods • receives interest • receives profits
Note that Capital in this case DOES NOT REFER to Financial Capital 18




2.. However. These. however. 5: Economic Bads GDP is overstated when production creates pollution. the less time they have for rest and leisure. Kind and Quality of Products GDP can be overstated when it does not take into consideration the kind of goods being produced. 2: Distribution. Shortcomings of GDP 1: Non-market Transaction GDP is understated when there is no buying and selling involved this is not counted such as a homemaker’s work. GDP per capita/ GNP per capita What is it? Calculation and implications What is the shortcomings of GDP/GNP per capita 1: Measurement Errors 2: Ignores Income Distribution 3: Exchange Rate fluctuations 4: Difference in Purchasing Power 2 . the GDP could be high but a big proportion is spent on military goods GDP can be understated when it does not consider the quality of the product.e. how it has improved over time.. are not included in GDP. For e. as GDP only measures the market value. Intermediate goods Second hand goods Transfer payments 3 Ways To Calculate GDP 1. 3. 3. Expenditure Approach – total up all expenditures Income Approach – total up all factor payments (income to factors of production) Output Approach – total up value of all final goods and services (not included in textbook) 2. 4: Underground Economy Government Businesses Financial markets S P Households D Q GDP can be understated when Illegal activities produce goods and services regardless of whether these goods and services are permitted by the law. the GDP will be larger. Factor markets S W D Q 3 Things that GDP excludes 1. the longer they work. DIY jobs. The amount of pollution is not deducted from GDP.Lec 14: Revision The 4-Sector Circular Flow Model Product markets S P D Q Foreign economies Shortcomings of GDP 3: Neglect of Leisure Time GDP is overstated when the people work longer.g. i.

There is usually high unemployment. 3 . Real GDP per year peak peak trough Real GDP recession recovery The Natural Rate of Unemployment (this is not a situation where everyone is employed) (i) The “Full Employment Rate” is achieved when 3% or less Unemployment Rate is achieved (Frictional + Structural Unemployment rate only) (Note that Cyclical Unemployment is not counted here at all). it starts to rise again. which is defined as an upturn in the business cycle during which real GDP rises. unemployed Unemployment X 100 rate (%) = civilian labour force time recession recovery Note: Defn labour force is not the same as defn being employed one business cycle What is a business cycle? Real GDP per year peak peak trough Real GDP recession recovery Unemployment . a recession will take place. time one business cycle After the peak has been reached. Labour Force Participation Rate. Real GDP per year peak peak trough Unemployment Rate . They are peak. trough and recovery. There is usually full employment and inflation. recession. a recession is defined as 2 consecutive quarters (6 months) of decline in real GDP.Definition In Singapore.Calculation - The calculation of the Unemployment Rate. The peak is when the real GDP reaches its maximum. time one business cycle After real GDP falls to its minimum.Lec 14: Revision What is a business cycle? One full business cycle consists of 4 phases. A recession refers to a downturn in the business cycle during which real GDP declines. after rising during a recovery. Usually. who are actively seeking employment. This is called the recovery. (ii) The “Natural Rate of Unemployment” = This Rate of Full Unemployment (as defined above). (ii) Therefore the unemployment rate refers to the percentage of people in the labour force who are without jobs and are actively seeking jobs. What is a business cycle? The point in which real GDP falls to its minimum is called the trough. the unemployed refers to those (i) who are 15 years of age and above.

2. Expectations Wealth Price level Interest rate Stock of durable goods 4 . Diversifying the concentration of the economy that is based on seasonally employed industries. employment agencies or availability of info over the internet between employers and job seekers. Why does the consumption function shift? (determinants) 1. training and skill redevelopment to better equip the workers with employable skills to fill the existing job vacancies 7 C2 = a2 + b Yd 6 R e al c o n s u m p ti o n ( tr illi o n s o f d o ll a r s p e r y e a r) 4 5 C1 = a1 + b Y d Movement along the consumption function B 3 a2 2 a1 1 4 5° 0 1 2 A Straight line C1 to C2 Change in nonincome determinant increases autonomous consumption measured by points a1 and a2 3 4 5 6 7 8 Upward shift in the consumption function from C1 to C2 R e al dis p o s a ble i n c o m e ( t r i ll i o n s o f d o l l a r s p e r y e a r ) Policies to reduce Unemployment 3. Increasing the product range of the industry (eg. enhancing the “employability” of structurally unemployed workers. hospitals. 3. improving information flow through job listing in print media. Creating events like the Great Singapore Sale (GSS). etc. Policies to reduce Unemployment 2. Reducing Seasonal Unemployment • • • • Equipping people to have more than one skill. Policies to reduce Unemployment 4. etc). training. and re-training. Arts Festival. Reducing Frictional Unemployment • Policies to reduce Unemployment improving the information flows between employers and job seekers. • the government have to take the initiative to pump more expenditures into the economy (such as through planning public projects such as schools. roads. fruit industry). Reducing Cyclical Unemployment • is the most difficult to address. 5. 4.Lec 14: Revision 1. Reducing Structural Unemployment • Movement along and Shifts in the Consumption Function C = Yd 8 Point A to B Increase in real disposable income government policies that provide education. • the government could also reduce taxes and/or interest rates to encourage spending in the economy.

land. cash or anything of value) gain or lose financially during inflation? Asset Appreciation Rate > Inflation Rate = Gain Asset Appreciation Rate < Inflation Rate = Lose 5 . equipment. 3. When we talk about inflation rate. Three Main Price Indexes Impact of Inflation (the impact is the reverse for deflation) (A) Fixed Income Earners   Here income refers to one’s earnings A general rise in prices will shrink people’s purchasing power (B) Wealth Owners Inflation can benefit holders of wealth if the value of their assets increase as prices rise  But if the value of their assets does not increase as prices rise. it is less commonly used than the CPI. measures the prices of all goods and services included in GNP. (b) Producer Price Index (PPI) based on the prices of raw materials. 2. The PPI is an early indicator of inflation.  Do people who own assets (properties. intermediate goods. However.Lec 14: Revision The 3 Forms of Inflation 1. we are usually referring to change in this index. they suffer from inflation!   Examples of wealth: properties. It is a much broader index compared with the CPI or the PPI and is thus the best indicator of the general price level. etc Three Main Price Indexes (c) GNP Deflator sometimes called the “GNP price index”. stocks. and finished goods of firms. Demand-pull inflation Cost-push inflation Imported inflation How do we calculate inflation/deflation? Inflation or deflation = The formula for CPI market basket cost in current year prices market basket cost in base year prices X 100 [ price index in a given year – price index in previous year ] X 100 price index in previous year (a) Consumer Price Index (CPI) measures the average level of prices of goods and services commonly consumed by households.

e.  And creditors lose because they receive less for payment of the loan. (D) Savers  If inflation is higher than interest earned on savings – savers’ money will buy less & less goods so they lose out! Different types of Gaps GDP gap (along the X axis) = Actual GDP – Potential GDP Recessionary Gap = The amount by which aggregate expenditures fall short of the amount required to achieve full employment equilibrium Inflationary Gap = The amount by which aggregate expenditures exceed the amount required to achieve full employment equilibrium What is fiscal policy? How do governments close inflationary and recessionary gaps? According to Keynesian theory. employment and price level i. use government spending or taxes to influence the nation’s spending.Lec 14: Revision (C) Debtors & Creditors  Inflation makes loans cheaper in real terms – think in terms of how much the value of debt can buy!  This means debtors gain because the loan is cheaper to pay off. change G &/or T depending on whether it is good or bad times AE Expansionary & Contractionary Fiscal Policy AE AE function AE function Real GDP Real GDP Expansionary Contractionary To close recessionary To close inflationary gap gap • Increase govt spending • Decrease govt spending (G) (G) • Decrease taxes (T) • Increase taxes (T) Effects of Spending multiplier (a) Spending multiplier =1 / (1 – MPC) or 1 / MPS (b) Increase in Real GDP = Initial increase in autonomous expenditures X spending multiplier Effects of Tax multiplier (always negative) (a) Tax multiplier = 1-spending multiplier (b) Change in Real GDP = Change in taxes (∆T) X tax multiplier Expansionary & Contractionary Monetary Policy AE AE function AE AE function Real GDP Real GDP Expansionary To close recessionary gap • buy govt securities • lower discount rate • reduce minimum reserve requirement Result: interest rate falls  C & I increase Contractionary To close inflationary gap • sell govt securities • increase discount rate • increase minimum reserve requirement Result: interest rate rises  C & I falls 59 6 .

Option 4 .Import Quotas  A limit on the quantity of a good that may be imported in a given time period of time. Devaluation of a domestic currency increases the price of imported goods in terms of the local currency. cultural & political understanding and cooperation  Increase Competition and Prevent Monopolies Gains From International Trade  Economic Development International trade encourages domestic companies to be more competitive. Quotas are more effective and precise than tariff. Trade promotes social.Foreign Exchange Control  It is a form of quota fixed in terms of foreign currency.Embargo.  Alleviate Domestic Shortages Supplement domestic supply through import. with the intended effect of raising the price of the imported good. this may invite retaliation from the foreign country against home goods being exported. Also.Import Tariffs  Tax on import. quotas directly limit trade to pre-determined levels. By restricting the supply of particular foreign currency to particular purchases.  7 . technology will be transferred from developed to developing countries through trade. However. The country can only sell homeproduced commodity. If the country is unable to meet demand. the situation (shortage) will only be relieved if the embargo is lifted.  This is a law that bars trade with another country. it would only be effective if the demand for the imports is price elastic and local goods are competitive in terms of quality. Gains From International Trade  World Peace and Prosperity Option 2 . While tariffs affect international trade directly through distorting prices and costs away from the free-trade level. The effect is to raise the price of the commodity. Falling Unit Cost With more goods produced for the world. the government is able to exercise a great deal of control over which commodities are imported and in what quantities. hence productive. Option 5 – Devaluation Devaluation is lowering the value of one currency relative to another. However. there is Economies of Scale. Option 3 .Lec 14: Revision Gains From International Trade  Protectionist measures and trade barriers Option 1 .

oanda.exchangerate.7243 (apprx) 1/0.3806 Singapore dollar  value of one US dollar in terms of  Singapore dollars OR 1 Singapore dollar = 0. The End  Most What are the goals of FTAs? FTAs aim to increase two-way trade.3806 SGD 1 SGD = 0.3806 (apprx) www.7243 US dollar value of one Singapore dollar in  terms US dollar Exchange rate quotation… 1 USD = 1.7243 USD Conversion: 1/ exchange rate 1/1.7243 = 1. importantly .com/convert/classic 8 .Lec 14: Revision Free Trade Agreements What are Free Trade Agreements? (FTAs) Free Trade Agreements are agreements between two countries or two groups of countries to remove any barriers to trade between them. thereby increasing economic progress and prosperity and trade between the two www.that CHEATING is a serious offence it is simply not worth it  Good luck for your exams  You can make it  Example: Exchange rate quotation 1 US dollar = 1.3806 = 0.