Lilongwe University of Agriculture and Natural Resources

Faculty of Development Studies

Department of Agricultural and Applied Economics

Agricultural Economics II (AAE221)

Year 2

By
Sensei: MAONGA, B.B (PhD)
 Assessment

• Course work (Continuous) : 40%

• Assignments
• Mid-semester exams

• End of Semester Exams : 60%

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Topics
(1) Nature and scope of macroeconomics
(2) National Output and Determination of Equilibrium National
Income
(3) Unemployment and Inflation
(4) Supply-side policies: Keynesian Theory of Income, Employment
and Price Levels
(5) Managing the Economy 1_Fiscal Policy
(6) Managing the Economy 2_Money and Banking
(7) Managing the Economy 3_Monetary Policy
(8) International trade

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 Topic 1
NATURE AND SCOPE OF
MACROECONOMICS
 1. Concepts and Scope of Macroeconomics
 This topic examines the major concepts used in macroeconomic
analysis
1.1 Microeconomics and Macroeconomics: A Review
 In microeconomics, we study the behavior of individual
decision-making units such as dairy farmers, milk consumers ,etc.
 While microeconomics focuses on the decisions of individual
units, macroeconomics concentrates on the behavior of entire
economies, no matter how small or large they might be.

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Topic Objectives
 By the end of this topic students should be able to
1. Define macroeconomics,
2. Describe the main macroeconomic policy objectives
3. Explain the main macroeconomic issues
4. Explain economic growth and instability.
5. Describe sources of economic growth.
6. Discuss the business cycle.

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1.2 What is macroeconomics?
 "Macroeconomics is the branch of economics concerned with
aggregates, such as national income, consumption, and
investment ".
 Macroeconomics examines the economy as a whole and
answers questions such as:
 'What causes the economy to grow over time?',
 'What causes short-run fluctuations in the economy?'
 Thus,
 Macroeconomics is concerned with the behaviour of the
economy as a whole – with booms and recessions, the
economy’s total output of goods and services and the growth
of output, the rates of inflation and unemployment, the
balance of payments, and exchange rates.

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Macroeconomics (cont’d)
 Macroeconomics deals with the increase in the output and
employment over long periods of time – that is, economic
growth – and with the short-run fluctuations that constitute the
business cycle.
 Macroeconomics focuses on the economic behaviour and policies
that affect consumption and investment, the money and the trade
balance, the determinants of changes in wages and prices,
monetary and fiscal policies, the money stock, the national
budget, interest rates, and the national debt.
 Macroeconomics is interesting because it deals with important
issues. But it is fascinating (mesmerising/captivating) and
challenging too, because it reduces complicated details of the
economy to manageable essentials. Those essentials lie in the
interactions among the goods, labour, and assets markets of the
economy and in the interactions among national economies that
trade with each other.
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1.3 Objectives of macroeconomics
 Broadly, the objective of macroeconomic policies is to maximize
the level of national income, providing economic growth to raise
the utility and standard of living of participants in the economy.
 There are also a number of secondary objectives which are held
to lead to the maximization of income over the long run.
 While there are variations between the objectives of different
national and international entities, most economies follow the
ones detailed below:

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Main macroeconomic objectives
 Sustainability - a rate of growth which allows an increase in living
standards without undue structural and environmental difficulties.
 Sustainable Economic Development – the economic
development that meets the needs of the present
generation without compromising the ability of the future
generations to meet their own needs.
 Full employment - where those who are able and willing to have a
job can get one, given that there will be a certain amount of
frictional, seasonal and structural unemployment (referred to as
the natural rate of unemployment).

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Main macroeconomic objectives (cont’d)
 Price stability - when prices remain largely stable, and there is no
rapid inflation or deflation.
 Price stability is not necessarily the same as zero inflation, but
instead steady levels of low-moderate inflation is often
regarded as ideal.
 It is worth noting that prices of some goods and services often
fall as a result of productivity improvements during periods of
inflation, as inflation is only a measure of general price levels.
 However, inflation is a good measure of 'price stability'. Zero
inflation is often undesirable in an economy.

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Main macroeconomic objectives (cont’d)
 External Balance - equilibrium in the Balance of payments
without the use of artificial constraints. That is, exports roughly
equal to imports over the long run.
 Equitable distribution of income and wealth - a fair share of
the national 'cake', more equitable than would be in the case of
an entirely free market.
Increasing Productivity - more output per unit of labour per hour.
Also, since labor is but one of many inputs to produce goods and
services, it could also be described as output per unit of factor
inputs per hour.

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1.4 Major macroeconomic issues
 The major macroeconomic issues are as follows:
 Economic growth
 Full employment (Unemployment control)
 Inflation
 Balance of payment and exchange rates
 Balance of payments: deficits and surpluses
 Exchange rate movement.

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Macroeconomic issues:
1. Economic growth
 Economic growth involves a change in Gross National Product
with no change in the structure of society. The achievement of
substantial levels of growth is an aspiration of most policy
options.
 Economists define economic growth as either
(1) An increase in real GDP occurring over some time period.
This is useful for measuring growth in military potential or
political pre-eminence or superiority.
(2) An increase in real GDP per capita occurring over some time
period. This definition is useful for comparing living standards.
 Economic growth is calculated as a percentage rate of growth per
year

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Growth as a Goal
 Growth is widely held economic goal.
 The expansion of total output relative to population results in
rising real wages and incomes and thus higher standards of
living.
 An economy that is experiencing economic growth is better able
to meet people’s wants and resolve socioeconomic problems.
 A growing economy can undertake new programs to alleviate
poverty and protect the environment without impairing existing
levels of consumption, investment, and public goods production.
 In short, growth lessens the burden of scarcity.

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Positive features (benefits) of economic growth

(1) Increase in employment

(2) The standard of living of the people will be improved
(3) There will be an expansion and improvement in the
infrastructure
(4) Increased investment will be encouraged
(5) Improved technology from the increased investment will
stimulate production

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Negative features of economic growth
 Aside from the benefits, economic growth also involves some
costs as listed below
(1) The environment is threatened by factors such as building,
chemicals and motorways.
(2) There may be waste of resources which are very finite
(3) There is a probability that the increased wealth will not be
equitably distributed
(4) With urban expansion, not enough care may be taken to
safeguard the community against urban problems such as
intensive housing without green space and other facilities
leading to crime and vandalism.

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Arithmetic of Growth
 Economists pay so much attention to small changes in the rate of economic
growth – because those changes really matter.
 For a poor country, a difference of 1 percentage point (e.g. 6% to 5%) in
the rate of growth may mean the difference between starvation and mere
hunger.

The Rule of 70
 The mathematical approximation called the rule of 70 provides a
quantitative grasp of the effect of economic growth.
 The Rule of 70 gives an approximate number of years required to double
an economic indicator.
 For instance, Time taken to double real GDP = (70 ÷ annual percentage
rate of growth).
 Example: A 4% annual rate of growth will double real GDP in about
17.5 years (= 70 ÷ 4) .
 The rule of 70 is also used to estimate how long it will take the price level or
savings account to double at various percentage rates of inflation or
interest. 17
Main Sources of Growth
 Society can increase its real output and income in two
fundamental ways:
(1) by increasing its inputs of resources;
(2) by increasing the productivity of those inputs .
 Productivity is broadly measured as real output per unit of
input.
 Productivity rises
 when the health, training, education, and motivation of
workers are improved;
 when workers have more and better machinery and
natural resources with which to work; and
 when labor is reallocated from less efficient industries
to more efficient industries.

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The Business Cycle
 Sometimes growth gives way to recession and depression – that
is, to declines in real GDP and significant increases in
unemployment.
 At other times rapid economic growth gets marred by rapid
inflation.
 Both unemployment and inflation often are associated with
business cycles.
 The term business cycle refers to alternating rises and declines
in the level of economic activity, sometimes extending over
several years.
 Figure 1.1 shows graphic presentation of the phases of the
business cycle.

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Phases of the Business Cycle

Peak Growth Trend

Recession

Recession
Recovery
Trough

Figure 1.1: The business cycle

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Phases of the Business Cycle (Explained)
(1) Peak – At a peak, business activity has reached a temporary
maximum.
 The economy is at full employment and the level of real output
is at or very close to the economy’s capacity.
 The price level is likely to rise (inflation) during peak.
(2) Recession – A peak is followed by recession – a period of
decline in real output, income, employment, and trade.
 This downturn, which lasts 6 months or more, is marked by the
widespread contraction of business activity in many sectors of
the economy.
 But because many prices are downwardly inflexible, the price
level is likely to fall only if the recession is severe and
prolonged – only if a depression occurs

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Phases of the Business Cycle (Explained, cont’d)
(3) Trough – In the trough of the recession or depression, output
and employment “bottom out” at their lowest levels.
 The trough phase may be either short-lived or quite long.
(4) Recovery – In the expansion or recovery phase, output and
employment rise toward full employment.
 As recovery intensifies, the price level may begin to rise before
full employment and full-capacity production returns.

 Note: Although business cycles all pass through the same

phases, they vary greatly in duration and intensity. Many
economists prefer to talk of business fluctuations rather than
cycles because cycles imply regularity of occurrence.

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Causation of the Business Cycle
(1) Momentous innovations – such as the railroad, the automobile,
synthetic fibers, and microchips, have great impact on investment
and consumption spending and therefore on output, employment,
and the price level.
 Such major innovations occur irregularly and thus contribute to
the variability of economic activity.
(2) Major changes in productivity – When productivity expands,
the economy booms; when productivity falls, the economy
recedes.
(3) Monetary phenomenon – When the government creates too
much money, an inflationary boom occurs.
 Too little money triggers a decline in output and employment
and, eventually, the price level (deflation).
(4) Changes in the level of spending – In a market economy,
investment takes place only if the goods and services produced
can be sold at a profit. 23
Cyclical Impact of the Business Cycle
 Durables and Nondurables
Durables
 Firms and industries producing capital goods (such as housing,
commercial buildings, heavy equipment) and consumer durables
(such as cars, personal computers, refrigerators) are affected most
by the business cycle.
 This is so because purchase of new items tends to be
postponed during economic hard times.
Non-durables
 In contrast, service industries (such as health, legal) and industries
that produce nondurable consumer goods are somewhat insulated
from the most severe effects of recession.
 People find it difficult to cut back on needed medical and legal
services. Nor the purchase of many nondurable goods (such as
food and clothing) easy to postpone
 The quantity and quality of nondurables will decline, but not so
much as will purchases of capital goods and consumer durables.
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Macroeconomic issues:
2. Full Employment
 The dominant economic and social objective of government is to
achieve full employment.
 Full employment has been defined as a situation where work
is available for all those willing and able to work at the going
wage rate.
 To achieve this objective then the problem of unemployment
must be tackled.

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Macroeconomic issues:
3. Inflation Control
 Keeping prices under control is a major concern in any economy.
 Some governments consider achievement of low levels of
inflation as the prime macroeconomic target.
 There are two main forms of Inflation.
(1) Demand Pull inflation
 Demand Pull arises where aggregate demand is greater than
aggregate supply
(2) Cost Push inflation
 Cost push inflation is a consequence of increasing costs such
as wages and taxes pushing prices or cost of productuion up.
 There are a number of Deflationary Measures which can be
adopted in order to counter inflation.

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Macroeconomic issues:
4. The Balance of Payments
 In an open economy where there is a high level of dependency
on foreign trade the authorities must maintain vigilance over their
foreign trade because of the consequences in other areas.
 One important point for observation is the annual Balance of
Payments statistics.
 The balance of payments is a record of a country’s financial
transactions with the rest of the world.
 In the current account it records the movements of exports
and imports of both visible and invisible while the capital
account movements of capital in and out of the country are
recorded.

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Balance of trade deficit
 If a deficit on current account is recorded it is evidence that
there has been an excess of imports of goods and services
over exports of goods and services.
 The prime consequence of this is that there will be a fall in
demand for the national currency.
 If there is a decline in demand for the currency the value
could fall and this could lead to increases in interest rates
to protect the outflow of capital which will follow.

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References
 McConnell, R.C. and Stanley L. Brue (2002). Economics:
Principles, Problems, and Policies, 15th Edition, New York, USA,
McGraw-Hill Companies Inc. Chapters 13.

 World Commission on Environment and Development (WCED)

(1987). Our Common Future. Oxford University Press, Clays Ltd,
Bungay, Suffolk, Great Britain.

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