Chapter 9

Introduction to the Macroeconomy

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 Warm UP

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https://www.youtube.com/watch?time_continue=207&v=T9l2yCH
5wBk

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 Learning Outcomes
Economic Theory
 Why study Macroeconomics
 The key concepts of GDP, Inflation,
Unemployment, Current account
 The concept of the business cycle
 The circular flow of income
 Leakages and injections
 Aggregate demand and aggregate supply
 How changes in aggregate demand and
supply lead to changes in equilibrium GDP
and inflation

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 Learning Outcomes
Business Applications

 Understand how to optimise investment

decisions by understanding the business
cycle

 Recognise how to use income elasticities to

profit during a recession

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What is macroeconomics?
• Macroeconomics examines the entire
economy
• Macroeconomics is a study of the
performance of national economy and
global economy

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Some issues from macroeconomics
• Why have some countries experienced rapid growth in
incomes over the past century while others stay stuck in
poverty?
• Why do some countries have high rates of inflation while
others maintain stable prices?
• Why do all countries experience boom periods and periods
of recessions — periods of rising/ falling incomes and
unemployment—and how can government policy reduce
the frequency and severity of recession episodes?
• Was it a good move for much of Europe to adopt a common
currency?
• Why China has large trade surplus and US has large trade
deficit?
• How can poor nations raise their standard of living?
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Why study Macroeconomics?
To open a firm or to extend the
business, what do you need?
•Money
•Workers
•Offices
•Computers
•……What more, what YOU need to
understand?

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 Business Problem:
Business cycles and economic uncertainty
• Business cycle
– Irregular and unpredicted variations in short-
run economic activity over the long-run trend
• Problems related to business confidence,
consumer confidence, investment and product
planning
• Understanding of how the economy works and
how it is likely to develop in the short, medium
and long term is of crucial importance for firms’
success at the markets.

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 Business cycle phases
- BOOM and BUST cycle -
Expansion: A speedup in the pace of
economic activity defined by high growth,
low unemployment, and increasing prices.
Peak: The upper turning point of a
business cycle and the point at which
expansion turns into recession.
Recession (or Contraction): A slowdown
in the pace of economic activity defined by
low or stagnant growth, high
unemployment, and declining prices. It is
the period from peak to trough. Prolonged
recession is Depression.
Trough: The lowest turning point of a
business cycle in which a recession turns
into an Recovery. 
https://corporatefinanceinstitute.com/resources/knowledge/economics/business-
cycle/

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Key Macroeconomic Indicators
- Outputs -
• GDP (Gross Domestic Product) – is a measure
of the total output produced by an economy in
a given year
• Inflation - is the rate of change in the average
price level
• Unemployment – is the number of individuals
seeking work that do not currently have a job
• Current account – is the difference between
exported and imported goods and services
(narrow definition)

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Key Macroeconomic Inputs
- Policy Inputs -

• Interest rates are the price of money and are

set by the central bank
• Government balance is the difference
between government revenues and spending
(surplus/deficit)

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Macroeconomic Indicators
GDP-RM

Source: NBRM
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 Macroeconomic Indicators
GDP fluctuations over long term trend growth - RM

First years of independence

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Macroeconomic Indicators
Inflation - RM

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Macroeconomic Indicators
Unemployment rate - RM

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Macroeconomic Indicators
Current account – RM

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Macroeconomic Indicators
NBRM Policy Rate

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Macroeconomic Indicators
RM Budget Balance

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The Circular Flow of Income
Households – own the
factors of production
or resources or inputs
(land, labour, capital,
enterprise)

Firms – produce
goods and services or
outputs. They provide
financial reward for
using the factors of
production.

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The Circular Flow of Income
• Economy – revolving flow of goods, productive
resources and financial payments
• The faster the flow, the higher the level of
economic activity
• Economic activity is measured by Gross
Domestic Product (GDP)

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 Leakages and Injections
• Leakage – income not spent on goods and
services within the economy
– Savings, taxation, imports
• Injections – additional spending that does not
come from income earned by households
– Investment, government spending, exports

Savings and investments

Taxation and government spending
Exports and imports

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Circular Flow with Injections and
Leakages

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National Income Determination
• Macroeconomics examines the entire
economy

• So, why not think of the macro economy as

one big market?
– Demand = aggregate demand (AD)
– Supply = aggregate supply (AS)
– Output = GDP (Y)
– Price = price level, or inflation (Π)

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 Total expenditure
A sum of all separate sources of spending
within the economy:

•C – Consumption by households
•I – Investments by firms
•G – Government spending
•NX – net exports (exports – imports)

•If total expenditure declines, less flow of goods

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 Aggregate Demand
• An AD is the total demand in an economy
• AD depends (inversely) on the price level
(downward sloping)
• If inflation increases, Central Bank increases
the interest rates which depresses the
demand (for instance, private consumption
and investments)

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Aggregate Demand

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Shifts in Aggregate Demand
• When one or more of the components of AD changes

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Aggregate Supply and Inflation
Real and Nominal values

• The difference between nominal and real

values
• Nominal values are not adjusted for inflation
• Real values are adjusted for inflation

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Example: Real and Nominal
values
• In 2016 your wage is 1000 euros
• Inflation rate at the end of 2016 is 2%
• If your wage in 2017 stays 1000 euros than –
your purchasing power is lower. Why?
• 2% of 1000 is 20 euros
• In 2017 you can buy 20 euros less goods and
services if your wage is not adjusted to
inflation
• You need 1020 euros to buy what 1000 could
purchase last year

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Aggregate Supply: without full
adjustment to prices
Short-run AS – upward sloping, positively related to
price increases (reduction in marginal costs)

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 Aggregate Supply:
with full adjustment to prices
Long-run AS – vertical, does not depend on prices
(wages are adjusted fully to price changes)

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Macroeconomic Equilibrium
Equilibrium for the entire economy occurs where
aggregate demand and aggregate supply intercept

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Changes to the Macro Equilibrium
AS is constant:
•If AD increases -
Inflationary boom
•If AD decrease -
Deflationary recession

AD is constant:
•If AS increases -
Deflationary boom
•If AS decrease - Inflationary
recession

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 Business Applications:
Profiting from Recession
• Over time an economy can grow at a faster
rate, a so-called ‘economic boom’, and then
move into a period of slower growth, an
‘economic recession’
• Irregular and unpredicted short-run
fluctuations over the long-run trend
• Plan investments

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 Business Application:
Predicting the Business Cycle

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Predicting the Business Cycle
• Aggregate demand
– Assess changes in consumption, investment,
government spending, net exports
• Aggregate Supply
– Difficult to assess likely changes? Changes in
prices of factor inputs, technical improvements
• Business Experience
– “feelings”, growth in order book, rise in profit
margins…

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 Business Applications:
Profiting from Recession
• Income elasticity (normal and inferior goods)
• Pricing (right price and ability to lower the
price to gain the market share, price
discounts for price elastic products – the risk
of price wars)
• Managing costs (variable yes, but fixed costs
and debt – financial payments are burden )
• Diversified portfolio/production

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Example: car brands

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 Conclusion: Business
application
Firms:
•That are adopting to changing
macroeconomic environment
•That are able to read the business cycle
•Are able to sell products during boom and
recession phases

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