MACRO

INTRO TO MACROECONOMICS

* Circular flow of income

what one person spends is what someone else earns

⇐""

C¥¥im]
)
A

Households

✓
✓
Bank
^

Import

savings

•
factors of production and type of income

Capital ( firms borrow to

buy capital → interest )
-

pay

Entrepreneurship ( receive profits )

-

Land ( pay rents )

Labour ( firms wages )

pay

leakages
•

savings Is )

taxation (T)

injections
-

investment II )

funds (F) -

G- 5

→
equilibrium :
leakages = injections
5 -1T = It F

•
total income = total expenditure = total output E GDP
 Definition

* Gross Domestic Product ( GDP )

total monetary value of all goods and services

economy produces in 1
an
year

* Gross National product C GNP )

= GDP + factor income from abroad

*
National Income

the sum of all incomes earned in a year

( wages interest profits ,
rents )
, ,

*
Aggregate Expenditure = Consumption + Investment + Govt spending + Net Exports

( Export-Import )

AE = C t I + G + NX

consumption -

individual 's spending

investment -
firm 's spending

* closed
economy
it does not trade with the rest of the world
Economic Growth

•
actual economic growth
-

increase in GDP ( real income )

increase in productive capacity

•

potential economic growth

-

* Economic growth determination

actual growth potential growth

-

SR LR

GDP GNP

*
Benefits of economic growth

more consumption possibilities

•

output T → consumers have more choice

standard of T
living
•

income T → afford better goods

tax 4 → GS on infrastructure welfare services T
,

life expectancy T
•

T
income 4 →
living conditions ,
healthcare

improved diet and healthcare

•

spending innovation 4
•

on

new technologies improve standard of living ( washing machine )

reduce inequality
•

collect tax from the rich → fund benefit schemes

* Drawbacks of economic growth

inflation
•

possible depletion of
•

non -
renewable natural resources

detrimental externalities the environment

•

on

( pollution and noise deforestation )

,

increase inequality
•

technical progress may only benefit some groups

and leave other jobless

 AGGREGATE DEMAND

total spending on goods and services produced

within an
economy over a
given period

price
level

AD

output = income = expenditure = real GDP

closed economy → AD = Consumption + Investment + Government spending

* Consumption
-

factors affect consumption :

income
•

•
benefits payments ( JSA and UC )
e.g

marginal propensity
•
to consume

+ 1 the proportion of income that a

person spends on consumption
+ )
gradient of consumption function

Ay
•

taxes Y -

T = Yd ( income -

tax =
disposable income )

consumption function
-

C. = Co + C
,
Yd C -

consumption

co autonomous consumption spending

-

( has no link to income )

to
(
G -

marginal propensity consume

Yd -

disposable income

C = Co + GYD
( income after tax )

Ac

save = 40
Ay
I
Co AY = 100 spend = 60

MPC = Af =
1--60 = 0.6
MPS = If = +4T =
0.4
100 +100
Ay Ay
+

Yd

S
S =
-

Co + # ×Y
A- y marginal propensity to save

As a proportion of income that a person save

-

AY
gradient of savings functions
-

0
Y
⇐
-

Co
Ay
* Investment

factors affect investment

* •
interest rates ( cost of borrowing )
market conditions ( tastes and preference )
•

* Government spending

GS = T → balanced budget
tax revenue
govt

spending receipts

GS 7 T →
budget deficit → increase national debt

GS 5 T →
budget surplus → the is not fully invested
economy

*
Multiplier effect
C )
any change in
spending no matter what its source

will lead to a change in national income which is bigger

than the initial change in spending
( I spending →
Ay → I spending )

* The multiplier
-

a measure of multiplier effect

ratio of the final in national income

a
change
-

to the initial spending

change in

Any
A- spending

I MPC 0.9 multiplier 1-

multiplier =
=
→ = = 10

1- MPC I -0.9

* Factors affect AD

real income

income tax →
disposable income

corporation tax → investment

exchange rate
-

interest rate

business 1 consumer confidence

value of the
currency
£4 →
price of export dearer → D for export to

price of import cheaper D for T

→
→
import

export L import → deficit AD falls

 AGGREGATE SUPPLY

total amount of all

goods and services produced within the economy

price
level SRAS

output

*
factors influence As

price of materials
•

wages of
•
workers

•
amount of available capital

level of
technology
•

size of the available

•
labour force

•
workers incentives

of human
quality
•

capital

rigidities ( inability adapted

•

market to be )
 UNEMPLOYMENT

UR
•

= I UR -

unemployment rate

L V -

number of ppl unemployed

L -

the workforce
population

wages
( p)

Po

Pi

D
D1

Q ( number of workers )
0FQ , Q
-

Unemployment

labour market

*
Measuring Unemployment
'
claimant count

counting ppl who are registered for unemployment benefits

2
International Labour Organisation ( IL0 ) unemployment survey
ask 40,000 households about their
employment status

( 80,000 adults )

* Hidden unemployment
-

those who choose to undertake studies

part time workers ( who wish to work full time )

-

those who work in the black

economy
-

discouraged workers ( left the workforce )

* Paticipation rate =
labour force

total population of
working age
* Different types of unemployment

'
Cyclical unemployment ( demand -

deficient )

Lack of aggregate demand

-

Often occur during recession

Demand for goods and services → demand for labour

( derived demand )

PL AD SRAS

AD1

P.
t
p,

Y, Yo Y
-

unemployment

2
Structural unemployment

technological change and globalisation

-

the industry disappear

3
Frictional unemployment
-

ppl are in -

between jobs
-

lack of info of job vacancies

e. g fresh graduates

4
Seasonal unemployment
temporary workers in tourism only employed in the summer
-

are

farmers , workers in agricultural industry

students looking for temporary work in the
-

summer

5
Regional unemployment
manufacturing may be confined to certain regions
-

production moved
-

overseas

→
geographical immobility unable to move to the area where demand
-

for labour is higher

•
Voluntary unemployment
people choosing not to work
-

occurs when the

economy is
operating at full capacity
-

generous unemployment benefits high income tax disincentive workers

-

+ →
* Costs of
unemployment
•

unemployment leads to serious economic and social consequences

loss of output forever

-

loss of individual self -

esteem

burden on
family
skills declining
-

depression → alcoholism suicidal

-

crime rates 4

costs
government
•

on

higher govt spending on unemployment benefits

-

→
opportunity costs -
could have been spent on education ,
healthcare ,
national defense

less income tax receipts revenue

less spending → less indirect tax receipts

*
Remedies for unemployment
'
Demand side policies ( short run solution )

direct intervention by the government fiscal

expansionary policy
-

→
stimulate AD

→
reflate the
economy
→
reduce ( )
unemployment especially cyclical

2
Supply side policies ( long run solution )

attempt to boost economic

growth by making markets work
efficiently and
freely
-

more

example
-

training
•

investment
technology
•
in new

•
reduce unemployment benefits + income tax

deregulating
•
labour market

advertise job vacancies

•

•
reduce power of trade unions

* Okun 's law

describe the relationship between GDP growth and the unemployment rate

Ut Ut I ( G 3% )
-
-

= -

-
i

✓ v v

unemployment unemployment GDP

rate in period t rate in period t -
I

% Iv
example by
7 →
:
growth =
unemployment rate :

-
I (7%-31) = -2 %

2
 Okurislawrelationship
between GDP growth rate

rate
and unemployment
( G 3% )×
4- 4. ,
-1g
-

black part
market time undertake
discouraged studies

/
workers

I I /
f FEET
"

uhniedmdpefoyment@t_tburdensdf.es
lose
lose output
L

teeny /

/ /IP%IIIo%erate I
on
family -

_inda_

vnemploymmFno
crime
popkingage
'

lining
alcoholism

lack of claimant unemployment

/
recession AD
count survey
I ppl 40,000 households
SRASI count who ask

: unemployment
AD

cyclical
types of registered about their
status
working
unemployment
-

if I
certain

%
Inoue
frictionthot seaso④
"
abroad
structural
technological / enough 1
ppl in-between into tourism
changes globalisation jobs about

vacancies
agricultural

expansionary
fiscal
policy

}emedDes7da③
-
inflate
AD

deregulating
labour
markets
advertise
jobs vacancies
_§Ih '
training
investment
I
/ reduce
unemployment benefits ,
reduce
income tax
power of
trade union
 INFLATION

a sustained rise in the general price level

*
Inflation rate

Pt -

Pt ,
Tt
-

Pt -
I

L V
✓

inflation rate price level price level

in period t in period t I
in period t
-

*
Inflation occurs when the increase in the price level is continuous and general
not just an individual price of goods
event often
unique which ppl buy most

*
Measuring Inflation

price index ( CPI )

•

consumer

" "

identify representative consumer + find out what they spend

-

a on

write down the exact and brands of the products

-

names

→
the most popular goods will be put together C basket of goods )

weight the prices according to their

importance and frequency of purchase
-

→ the weighted prices is known as the CPI

•
retail price index ( RPI )

exclude payments on
housing costs and mortgage repayments

commonly used
by guts to calculate increases in pensions and welfare payments
-

*
Types of inflation

inflation ( ) unanticipated ( unexpected )

can be anticipated expected or

Creeping inflation
•

prices increase gradually and

slowly ( up to 5% )

Strato
•
-

inflation

moderate increase in the level ( 10-20%7

price

Hyperinflation
•

extremely large and accelerating increase in the price level

the result of government inject too much ( due to war or economic depression )
money

loss of confidence in country 's currency

→
severe a

→
ppl seek for other currencies or
gold
*
Causes of inflation

'
Demand -

pull inflation

exceed AD →
pull price
-

up

normally when the at full capacil

economy is
operating
-

occurs

PL AD ,

AD SRAS

A
inflationary
gap [ Po

Yo Yi Y

2
Cost -

push inflation
when cost of factor inputs increases
-

Occurs

raw materials

+1
energy

wages

causes
-

increase in demand / global shortages of raw materials

oligopoly : cartels collude to sustain high prices

+) depreciation of cost of factor of
exchange rates →
imported
T supply of labour Iv wage T
unemployment
→
→

PL

AD SRAS , SRAS

the ability of a firm to increase

the price depends on PED

p,

Po

Yi Yo Y

3
Other causes

too much in the

economy
-

money
innovation ( products competition brings down prices )
expensive initially
-

new are →
* Costs of inflation

•
overall international trade competitiveness decline

( FT →
price of export 4 → demand for exports to →
export revenue 4)

•
fixed -

income earners worse off

( fixed -

rate bonds , savings account )

•
lenders lose out ,
borrowers gain

( nominal debts are inflated away )

Owners of real estate better off

( value of the property increases )

and t
spending
•

uncertainty → investment

•
loss in confidence in the
currency

increased accountancy for firms

•

charges

costs the cost of ( incurred by firms )

changing
•

menu price
-

( printing new lists , sending to customers , advertising new prices )

shoe leather costs the wasted when inflation

resources
encourages ppl
-

to reduce their money holding

( try to convert money into goods to keep value of the money )

*
Remedies for inflation

Fiscal measures ( contraction any

)

+ I Reduce GS

+ ) Increase taxation

Monetary policies ( contraction ary )

+1 Increase bank rates ( interest rates )

→
borrowing becomes dearer

→
discourage spending and investment

+ )
sale of securities
government
→
lock the
purchasing power of consumer for a certain period
the amount that banks have to hold with the Central Bank

Increase in cash reserve ratio

→
lower the amount that bank can use for lending and investment

Supply -

side policies
Increase long-term competitiveness and
productivity
+ ) Weaken trade union → restrict rises
wage
 * Inflation and unemployment =
stagflation
-

occurs when there is a depressed level of real output l AD Iv )

and
rising in factor input ( lead to cost -

push inflation )

stagflation is often a result of cost push inflation

-

PL SRAS , SRAS
p

PI
push
[
Cost -

inflation
po

Yi Yo Y
-

unemployment
 DEMAND -

SIDE POLICIES

MONETARY POLICY

conducted by a central bank → control the money supply

total amount of money in circulation in an
economy

changing the short ( discount )

•
-

term nominal interest rate rate

interest rate which a central bank charges when tending to commercial banks

C operations )
•

quantitative easing open market

)
govt buys
+
securities central bank increases
→
money supply
( inject money directly into the economy )

Iv ( cost
interest rates of borrowing )
to

stimulate borrowing
+

T
spending + investment

govt sells securities → withdraw money from circulation

changing liquidity reserve ratio

a fraction of a deposit which commercial banks must hold as cash

*
narrow and broad money

Narrow money CM0 ) -

liquid assets ( cash )

Broad money CM4 ) liquid and liquid assets

-

non

process where
*
monetary transmission mechanism -

the central bank influence economic activity

and inflation 1 unemployment level by setting the nominal interest rate

setting nominal interest rate for a period of time

affect interest rates of

mortgages and
tending
to

asset prices and currency

exchange rate can be affected

influence investment decisions

knock -

on effect on demand for labour and wage rates

 *
Expansionary monetary policy

money AD ,
interest PL
SUPPLY ( M)

(
✓
rate
(i)
M , AD SRAS

price of
money

p,

i po

i,

liquidity CL )

Ms cash balance
Ms . ,
} Yo Y, Y
( CB )
quantity of

money

change in MS effects on the

economy

→
consequences :
-

lower interest rate

higher price level

-

higher GDP
-

lower unemployment
-

*
Contraction any monetary policy

i
M
PL
M ,
AD SRAS

AD ,

"

pp
i

MS , Ms . CB Yi Yo Y

change in MS effects on the

economy
o­
 FISCAL POLICY

conducted by the government → control taxation and government spending

* the multiplier -

a measure of multiplier effect

ratio of the final change in national income

•

to the initial change in spending

( 4 )
govt spending →
greater 4 in national income

multiplier = AY

A spending

crucial
•

in
estimating the effectiveness of fiscal policy

*
multiplier effect

any change in spending ,

no matter what its source
,

will lead to a
change in national income

which is bigger than the initial in

change spending
A spending → AY → A spending

* fiscal
problems with
policy
time it
lags -

takes time for the

policy to have impact on the
economy

+ ) information issues -

the govt may underestimate I overestimate

the amount the amount of GS needed

*
Expansionary fiscal policy

PL
SRAS

p,
G5T

Taxation µ
} " AD

Iv

Po higher price level C inflation )

higher output
AD , + ) lower unemployment
AD

Yo Y, Y

*
Contraction any fiscal policy

PL

SRAS

GS1V

Taxation ,
/ 4

lower price level ( deflation )

Po
+
) lower GDP
P,
)
+
higher unemployment

AD
AD ,

Y, Yo Y
 GLOBALISATION
the increasingly integrated nature of national

economies into a single international market

* 4 main parts of economic integration

-

free trade of goods and services

free movement of labour

-
free movement of financial capital
-

free exchange of
technology and intellectual capital

*
Benefits

+ ) free trade → eliminate tariffs and subsidies between countries

promote economic growth

reduce unemployment

lower prices for consumers

less -

developed countries benefit from FDI

increase productive capacity

flexible emigration → workers can maximise earnings

+) of scale from
economies →
gains specialisation
+ I increase competition → benefit consumer

* Costs

increase unemployment in developed countries

( as production moves to low -

wage countries )

)
+
dependency in other countries for the essentials

problematic if relations / supply chain problem

get worse

+) 4 risk of
contagion
( economic problem 1 be quickly transmitted to another )
in country can

potentially 4 inequality
( globalisation concentrates among the top income group )

countries compete to make

exports more competitive

through currency devaluations

 INTERNATIONAL TRADE

the exchange of goods and services between countries through exports and imports

*
invisible trade -

trade of intangible goods ( services )

e.
g. financial services , advertising ,
distance education

* absolute advantage ability of 1

country produce more output of a good ( or service )
-

( if 2 countries possess the same resource input )

A
country can produce more output with the same resources as
country B

→
country A is absolutely more efficient

*
comparative advantage the marginal opportunity costs of 1
good in terms of the other good
-

differ between countries

*
terms of trade -

the ratio of export prices relative to import prices

weighted index of average export prices

= 100 ×

weighted index of average import

prices

*
trade blocs -

countries sign free -

trade agreements

e.
g. the EU ,
ASEAN

the EU
promotes trade between its members by removing trade barriers and

harmonised
creating a
regulatory environment .

→ costs can be reduced by providing incentives to specialise and increasing competition

costs of the euro ( € )

)
+
Eurozone members having lost their own independent monetary policy
a single nominal interest rate is set by the European Central Bank

it is impossible to set an optimal interest rate for all members

•
benefits of the euro (E)

+)
the elimination of exchange rate effects on transaction costs
 BALANCE OF PAYMENTS

a record of all of the transactions of the citizens

of with the rest of the world

a
country
( all money that moves in and out of a
country )

Balance of Payments is formed of 2 parts current account

capital account

* Current Account -

the profit 1 loss from day -

to -

day transactions

•
trade account = exports -

imports
= net export
→ trade balance

components
•

involving tangible goods ( products )

+ ) transactions raw materials fuel manufactured
, ,

transactions involving intangibles ( services ,

tourism ,
insurance , advertising ,
investment income )

+ ) ( remittances )
private money transfers

)
payments ( international aid )
+
official transfer

*
Capital Account

capital flow ( CF ) =
capital inflows -

capital outflows

components
•

( bII?%IIm"III.IIIII.LI?InIeres+rates )
short run capital flow currency speculation

+ )
long run capital flow ( investments in foreign companies →
capital gains from closing out

these investments )

* Balance of
payments
foreign exchange reserves used to settle any balance of payments deficit
•
-

( FER )

•
BOP 7 0 →
surplus ( FER t )

BOP 5 0 deficit ( FER t )

•
→

current account is affected by the index of the terms of trade

through the price elasti cities of demand for exports and imports

if exports are price elastic

PT →
greater proportionate Iv in export volumes

total values of
exports average price volume
-

= ×

→
pp → total values of exports Iv

→
improve the terms of trade

→
deteriorate the current account
 EXCHANGE RATES

of 1 in terms of another
price currency currency

appreciates when it gains value against another

•
a currency currency
depreciates when it loses value

* Fixed exchange rates

domestic currency is assigned fixed value with respect to other

•

currencies
a
peg
-

central bank intervenes in the foreign exchange by buying selling

•

market or

the domestic
currency
→ maintain the exchange rate peg using its foreign exchange reserves

Vietnam Uk
VND £
SD SDI
£

25k 1- - -
-

25k

D ,

Df DVND

Q£ QVND

→ don't have control over your own monetary policy

→ benefit trades ,
businesses

I demand for VNDT

,
the UK govt will
buy more VND

instead of increase exchange rate )

*
Floating exchange rate

market forces demand and supply are free to determine

an equilibrium in exchange rates

VND f-
SVND
5£ 5£
1-
15k

25K 2¥
D,
15K

Df
DVND

Vietnam Q£ UK QVND

£ has depreciated VND has appreciated

 ECONOMIC DEVELOPMENT

an improvement in economic conditions which

leads to higher standard of

living and a better

quality of life for people

* Factors determine economic development C other than economic

growth )
access to clean water
-

birth and mortality rates

education
-

freedom of choice

infrastructure
-

literacy rates
-

self -

esteem

*
Meaning of development ( according Michael Toda ro )

sustenance ( the
ability to meet basic needs )

self esteem
-

freedom of action and expression

* Measure of economic development

•
Human Development Index ( HDI )

consists of the of
average :

standard of l based GDP per capita in PPP terms )

living on

+1 life expectancy at birth

adult
literacy

•
Human Poverty Index ( HPI ) or Multidimensional Poverty Index ( MPI )

consists of 3 parts :

+1
probability at birth of a life
expectancy of less than 40
years

percentage of illiterate adults

of sufficient standard of
percentage ppl without a
living

•
Gini Coefficient

reflects the extent of the

inequality of income distribution