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Session Objectives

Topic 10
 Define macro-economic policy
 Explain the main determinants of the
Macroeconomic Factors level of business activity in the economy
and how variations in the level of
business activity affect individuals,
households and businesses

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Session Objectives Session Objectives

 Explain the impact of economic issues  Describe the main types of economic
on the individual, the household and the policy that may be implemented by
business: government and supra-national bodies to
i) Inflation maximise economic welfare
ii) Unemployment  Recognise the impact of fiscal and
iii) Stagnation monetary policy measures on the
iv) International payments disequilibrium individual, the household and
businesses

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Difference between Macro- and
Macroeconomics
Micro-economics
 It is the study of how society allocates  Microeconomics –study of economic
scarce resources which have alternative behaviour of individual consumers, firms
uses, between competing ends. and industries
 It focuses on:  Macroeconomics – Considers
 Overall demand for goods and services aggregate behaviour and the sum of
 Output of goods and services individual economic decisions
 Supply of factors of production
 Total incomes earned by providers of factors
of production

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Macroeconomic Policy Factors Influencing Level of


Objectives Business Activity
 Economic Growth  Confidence
 Inflation  Aggregate demand
 Unemployment  Capital
 Balance of Payments  Use of Resources
 Government Policy
 Exchange Rate Movements

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Confidence Aggregate Demand

 Greater Consumer confidence lead to  It is the total demand for the country’s
higher business confidence and higher output
investment in new factories  It is calculated as:
 Confidence is adversely affected by AD = Consumer spending + Investment by
political instability, disasters, firms + Government spending + Demand
unemployment, inflation from exports – imports
 Higher demand results in firms
increasing output
 Higher demand can result in inflationary
pressure
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Capital Use of Resources

 Firms need finance to invest in new  New Technology and more efficient
projects working practices can improve
 Greater availability of finance results in productivity and lower costs
higher investments  Advances in level of education
 Lower interest rates will make capital
cheaper

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Government Policy Exchange Rate Movements

 Governments can increase or decrease  Strengthening currency will make a


the level of aggregate demand through country’s exports more expensive
fiscal policy  Imports will get cheaper
 Investment in the infrastructure of the
economy can attract investment

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Trade Cycles Trade Cycles

 Recession starts when demand begins


to fall.
 Reduction in demand feeds into
household incomes and the economy
moves into a slump
 Slowly economic activity begins to
pickup and the economy moves to
recovery.
 The economy will expand pushing
upwards into boom.
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Stagnation and Economic
Problems with Growth
Growth
 Growth implies:  Growth may not keep up with population growth
 More goods demanded and produced  Growth rates should exceed inflation rates for
 People earn more and can afford more benefits to arise
goods  Growth may be in illegal goods like drugs
 More people should have jobs  Gap between haves and have nots may grow
 Measurement of growth is difficult given the
existence of black market
 Rapid growth means rising incomes and leads
to imports thus worsening BOP condition

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Inflation Unemployment

 Government wants stable prices and low  Unemployment is a problem because:


inflation because:  Unemployment benefits
 Inflation causes uncertainty and stifles  Rise in crime
investment  Waste of human resources
 Not all incomes rise in line with inflation
 Inflation may cause civil unrest

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Balance of Payment Economic Policy Options

 It is a statement of the balance of a  Fiscal Policy options


country's trade and financial transactions  Monetary policy options
with the rest of the world over a specific  Demand and supply side policies
period - usually a year.
 A long-term trade deficit needs to be
financed.
 A long-term trade can lead to inflationary
surpluses leading to loss in international
confidence

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Fiscal Policy options Fiscal Policy options

 Fiscal policy refers to government’s


taxation and spending plans. It
includes:
 A balanced budget: In the medium to
long term, government should aim to
achieve a balanced budget
 Government income = Government
Expenditure

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Running a Budget Deficit Running a Budget Deficit

 Govt income < Govt expenditure =  Deflationary gap is said to exist when
Budget deficit the current equilibrium level of national
 Budget deficit is financed through income is too low to provide
borrowing employment opportunities for all those
 It is referred to as the Public Sector Net seeking work
Cash Requirement  The government follows an
 It is often used to close a deflationary expansionary policy to boost demand
gap and reduce unemployment

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Running a Balanced Surplus Monetary Policy Options

 Govt income > Govt expenditure =  Monetary policy refers to management


Budget surplus of money supply in the economy.
 This may lead to inflation  It can involve:
 Inflationary gap exists  Changing interest rates
 Government follows a contractionary  Setting reserve requirements for banks
policy to reduce aggregate demand  Trading in foreign exchange markets

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Expansionary / Contractionary
Money Supply
Monetary Policy
 Expansionary increases the money  Money supply is the total amount of
supply and contractionary decreases it money in the economy.
 Expansionary combats unemployment  Measures of money supply include:
in a recession and contractionary raises  M0 = Notes and coins in circulation and
interest rates to combat inflation balances at the country’s Central Bank
 M4= Notes and coins and all private sector
sterling bank / building society deposits

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Reserve Requirements Open Market Operations

 Banks operate a fractional reserve  By buying and selling its own bonds the
system. government is able to exert some
 Only a part of their deposit is kept in control over the money supply
cash.  By buying back its bonds, it will release
 The proportion of deposits retained in more cash
cash is known as the reserve asset  By selling it will reduce the money in
ratio or liquidity ratio. circulation

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Demand and Supply Side
Interest Rates
Policies
 High interest rates suppress demand o Classical view (Do nothing)
for money due to increased cost of o Keynesian View (Demand Side)
borrowing. Over a period of time the o Monetarist view (Supply Side)
money supply will react to this reduced
demand for money by contracting.
 In UK interest rates are set by Central
bank

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Achieving Policy Objectives: Achieving Policy Objectives:


Growth Unemployment
 Cut interest rates  Cyclical unemployment
 Running a budget deficit  Unemployment is due to small demand to
create employment
 Supply side policies (Increase the
 Monetarist can reduce this unemployment
availability of skilled labour through by supply-side measures
training schemes etc
 Frictional Unemployment
 Others:  People who move from job to job are short
 Protectionist measures to reduce imports term unemployed
 Creating a stable economy  Can be reduced by a provision of better
 Tax incentives to boost growth information through job centres and supply
policies
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Achieving Policy Objectives: Achieving Policy Objectives:
Unemployment Unemployment
 Structure and Technological  Seasonal Unemployment
Unemployment  Creates highly seasonal demand for
 Caused due to structural change in workers
economy leading to change in skills  Real Wage Unemployment
required
 Occur in industries that are highly
 Supply side policies will be more effective unionised
• Government funded retraining schemes
 By keeping wages artificially high by the
• Business start up advice and soft loans
threat of strike action and closed shops, the
• Help with worker relocation costs
number of people employed in the industry
• Improved information on employment
is reduced
opportunities

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Achieving Policy Objectives: Achieving Policy Objectives:


Inflation Inflation
 Demand-pull inflation  Cost-push inflation
 If demand for goods and services in the  If the underlying cost of factors of
economy is growing faster than the ability production increases, this is likely to be
of the economy to supply these goods and reflected in an increase in output prices as
services, prices will increase firms seek to maintain their profit margin
 Demand side policies would focus on
reducing aggregate demand through tax
rises, cuts in government spending and
higher interest rates

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Achieving Policy Objectives: Achieving Policy Objectives:
Inflation Inflation
 Imported inflation  Monetary inflation
 A weakening of the national currency will  Inflation can result from over expansion of
increase the cost of imports and lead to money supply as it increases the
domestic inflation purchasing power
 This can be reduced by policies to  If the expansion is faster than the supply of
strengthen the national currency goods it will lead to inflation

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Achieving Policy Objectives:


Balance of Payments
 Balance of Payment Deficits
 Expenditure reducing strategies: Shrink
the domestic economy and thus reduce
demand for imports
 Expenditure switching strategies:
• Import controls
• Boost exports
• Lower exchange rates or devaluation in case of
fixed exchange rates

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