MACRO ECONOMICS

M. A. BAQUI KHALILY
Spring 2019
 BASIC ISSUES
• Distinguish between Micro-economics and Macro-
economics
– Microeconomics deals with individual and industry level
analysis of economics behavior and resource allocation;
– Macroeconomics are concerned with the economic behaviour
at the aggregate level; relationship between output, price level,
inflation and growth is explained by aggregate demand and
aggregate supply.
• Three issues:
(1) How do we explain high and persistent unemployment?
(2) How do we explain inflation?
(3) What determines economic growth?
 Goals of Macro Economy
• Complementary Goals
– Low unemployment and high economic growth

• Conflicting Goals
– Low unemployment and low inflation
(Will be better understood when you will understand the
relationship between consumption and investment)
 FOCUS IN MACROECONOMICS
• Describes the economy on the highest level of aggregation

• Therefore focuses on:

– GDP (GNP), Consumption,

– Savings, Investment,
– Money, Inflation,
– Unemployment, Public finance deficit,
– Current account deficit, Public debt,
– Exchange rate, Interest rate and others

• Analysis is based on aggregation in five sectors.

 FIVE SECTORS
• Households:
– all population, own and provide factors of production
(labour, land, capital) to the firms,
– receive payments (income) from them and
– generate expenditures for goods and services (for final
consumption)

• Firms:
– “own” technology,
– employ factors,
– produce goods and services for
• final consumption (households, government, export)
or
• intermediate use (other firms, incl. foreign)
 FIVE SECTORS (Cont.)
• Government (state):

– Collects taxes
– Manages activities that society expects from it:
• spends on goods and services for public purpose (e.g. defence), on
employees in state administration, even owns some firms (that
produce goods and services) – “produces” public services
• finances transfers and social benefits

• Financial sector:
– provides transmission services that channel money from savers to
borrowers (incl. government)

• Foreign sector:
– purchases goods and services (exports),
– sells goods and services (imports),
– generates flows of capital out and into the domestic country (FDI in or
out, debt financing, equity capital)
 General Role of the State
• State executes different policies/interventions that affect general
welfare of the society

• Different groups (with different vested interests) may have different

thoughts about the role of state here, examples:

– Efficient allocation of the resources ⇒ cultivating the markets,

regulatory and competition policies

– Provision of essential services (e.g. basic education, defence)

– Attempting to achieve a fair distribution of wealth across the
society ⇒ welfare policies

– Ensuring society’s needs (police, defence, legal system, coping

with the externalities, etc.) ⇒ general role of state, not a policy
 General Role of the State

– Transfer payments, providing minimal living standards (social

policies, e.g. unemployment benefits)

– Long-term social policies, e.g. securing the stable health care

and pension systems

– Regulation of natural monopolies

– External social costs (e.g. drugs) and benefits (e.g. free

vaccination) of the society

– Support to industry and commerce

 Macroeconomic policies
• Fundamental measure of the economy: income(output),
expressed as gross domestic product (GDP)

• GDP development over time: GDP growth:

– Over long period: long term growth
• In search policies the determine the long-term
differences in economic level among the countries
– Over shorter period: business cycle
• In search policies that help to overcome the
fluctuations of GDP
 Macroeconomic Policies
• Other basic economic variables, closely interlinked
with/influencing both short- and long-term GDP growth

– (un)employment
– inflation
– Interest and exchange rate
– Components of aggregate demand: household
consumption, private investment, expenditure of the state,
exports, imports
– Factors, determining the aggregate supply: amount of
capital and labor available, general productivity of country’s
economy
– Public finance deficit
– Debt of public and private sector (and sum of both)
– Current account deficit and balance of payments
 Macroeconomic Policies
• When translated into policies, this entails
– Fiscal policy
– Monetary policy
– Exchange rate policy
– International trade policy

• However, there are many other policies, more like

intervention-policies:
– Supply-side policy
– Price and income policies
– Employment policy
– … and maybe some other policies (according the ideology,
political inclination and maybe populism of policy-makers)
 BASIC CONCEPTS
• Gross Domestic Product:
– Value of all goods and services produced during a period.
– Basic measure of economic activity.
• Need to differentiate:
– Nominal versus real GDP: Nominal GDP at current price, and
real GDP is at constant price adjusted for inflation). Ratio of
nominal GDP and real GDP is GDP deflator.
– Levels of GDP versus growth GDP
• GDP (absolute) versus Per-capita GDP (GDP divided by
population)
• Employment and Unemployment rate (percentage of
labor force remaining unemployed)
 Basic Concepts
• Macroeconomic performance is judged by
– Inflation rate (Change in cost of living)
– Growth rate of output
– Rate of unemployment
• Business Cycle
– Movement of economic activity (e.g., GDP) around the path of trend growth.
There will be peak and down.
– GDP does not grow along the trend line.
• Aggregate Demand:
– Relationship between spending on goods and services and the level of
prices.
• Aggregatte Supply:
– Relationship between amount of goods and services that firms produce and
price level
• The basic tools for analyzing output, price level, inflation, and
growth are aggregate demand and aggregate supply.
 Needs to Remember Always
• Net National Product (NNP)
= GDP plus net factor payment from abroad less
depreciation
• National Income (NI):
– NNP less indirect tax (e.g., VAT) and other taxes (duty)
• Personal Income (PI):
- NI less corporate profit plus government
transfer, interest adjustment and dividend
• Disposable Personal Income (DPI):
– PI less personal tax and non-tax payment
Two definitions:
1. Total expenditure on domestically-
produced final goods and services
2. Total income earned by domestically-
located factors of production
 Why expenditure = income
In every transaction,
the buyer’s expenditure becomes the
seller’s income.
Thus, the sum of all expenditure equals
the sum of all income.
 Circular Flow
Income($)

Labor

Households Firms

Goods(bread)

Expenditure($)
 Consumption
• the value of all goods and services bought by
households. Includes:
• durable goods last a long time
ex: cars, home appliances
• non-durable goods last a short time
ex: food, clothing
• Services work done for consumers
ex: dry cleaning,
air travel.
 Investment
spending on [the factor of production] capital.
def2: spending on goods bought for future use.
Includes:
 business fixed investment
spending on plant and equipment that firms will use
to produce other goods & services
 residential fixed investment
spending on housing units by consumers and
landlords
 inventory investment
the change in the value of all firms’ inventories
 Investment VS. Capital
• Capital is one of the factors of production.

At any given moment, the economy has a

certain overall stock of capital.
• Investment is spending on new capital.
Example (assumes no depreciation):
 1/1/2002:
economy has $500b worth of capital
 during 2002:
investment = $37b
 1/1/2003:
economy will have $537b worth of capital
 Stocks vs. Flows

Flow
Stock

Examples of flow will be savings, Overdraft

Examples of stock (at a given point in time)will be wealth, investment