MACROECONOMICS

&
INSTITUITIONAL CONTEXT OF
BUSINESS
  WHAT IS MACRO ECONOMICS

The study of the large economy as a whole

 Macro was created to :

 Measure the health of the whole economy
 Guide government policies to fix problems

 For all the countries there’re 3 major economic goals ;

Promote economic growth
Limit unemployment
Keep prices stable (Limit inflation)
• Policy goals – growing the economy, – reducing inflation, – creating jobs
and – managing trade with other countries.

• Models and frameworks – how to measure the size of the economy, – the
circular flow of funds model and its components, – how to apply supply and
demand arguments to the whole economy and

• Policy options – fiscal and – monetary policies.

• Achieving policy goals – finally we consider the range of policies that could
be implemented to try to achieve the policy goals we started with and their
likely implications
 ECONOMIC GROWTH

 Economic growth is best defined as a long-term expansion of

the productive potential of the economy. Sustained economic
growth should lead higher real living standards and rising
employment.

 The growth potential of an economy is dependent upon two

things;
i. The amount of economic resources.
ii. The productivity of these factors of production
 THE BENEFITS OF ECONOMIC GROWTH

  Improvements in living standards : Growth is an important

avenue through which per capita incomes can rise and absolute
poverty can be reduced in developing nations.
  More jobs: Growth creates new jobs
  The accelerator effect of growth on capital investment : Rising
demand and output encourages investment in capital
  Greater business confidence : Growth has a positive impact on
profits & business confidence
  The “fiscal dividend”: A growing economy boosts tax revenues
and generates the money to finance spending on public and merit
goods and services without having to raise tax rates
  Potential environmental benefits – as countries grow richer,
they have more resources available to invest in cleaner
technologies
 PROBLEMS

 • Is economic growth fast enough to keep up with population

growth?
 • Growth rates have to exceed inflation rates for benefits to
arise (i.e. "real" growth has to occur).
 • Growth may be in ‘demerit’ goods, such as illegal drugs.
 • Growth may be at the expense of the environment or
through exploitation of the poor.
 • The gap between rich and poor may grow, as the benefits
from growth are not evenly distributed.
 • Rapid growth means rising incomes and this often ‘sucks
in’ imports, worsening the balance of trade, rather than
benefiting domestic producers
 INFLATION

Inflation is a rise in the general level of prices of goods and services

in an economy over a period of time. It is also manifest in the
decline in the purchasing power of money.

It is often described as “too

much money chasing too
few goods”
 DEMAND-PULL INFLATION

 • If demand for goods and services in the economy is growing

faster than the ability of the economy to supply these goods
and services, prices will increase – the classic case of too
much money chasing too few goods.
 • Demand-side policies would focus on reducing aggregate
demand through tax rises, cuts in government spending and
higher interest rates.
 • One type of demand-pull inflation is that due to excessive
growth in the money supply
 COST-PUSH INFLATION

 • If the underlying cost of factors of production increases,

this is likely to be reflected in an increase in output prices as
firms seek to maintain their profit margins irrespective of the
level of aggregate demand.

 • Reasons for cost increases include rising factor prices,

rising import prices and increases in indirect taxes.
 THE HARMFUL EFFECTS OF INFLATION:

 1. Distorts consumer behavior − People may bring forward the

purchases because they fear higher prices later. This may lead to
unnecessary shortages.

 2. Redistribute income −People with fixed incomes or those who lack

bargaining power will become relatively worse off as their purchasing
power falls.

 3. Redistribute wealth − If the rate of interest is below the rate of

inflation, borrowers are gaining at the expense of lenders.

 4. Undermines business confidence − Fluctuations in inflation make it

difficult for business people to predict the future.

 5. Weakens the external competitive position − If a country’s inflation

exceeds its competitors, then it makes export less attractive and
imports more attractive (assuming no change in exchange rates).
INFLATION RATES IN SRI LANKA

In 2017, the
average inflation
rate in Sri Lanka
amounted to about
6.54 percent
compared to the
previous year.

A healthy inflation
is identified as
around 2%.
 UNEMPLOYMENT

 Unemployment occurs when a person who is actively

searching for employment is unable to find work.

A person is deemed to unemployed only if he/she is

willing and able to at the prevailing conditions but
unable to find work. Also citizens who are not in the
minimum working age(16 years in Sri Lanka), Full time
students , Retired personal and institutionalized
persons are not considered as unemployed.
 TYPES OF UNEMPLOYMENT

 The main categories of unemployment are voluntar y and

involuntar y unemployment. When unemployment is voluntary,
it means that a person has left his job willingly in search of
other employment. When it is involuntary, it means that a
person has been fired or laid off and must now look for
another job.
 CYCLICAL UNEMPLOYMENT

 • This is sometimes referred to as demand-deficient,

persistent or Keynesian unemployment.

 Cyclical unemployment occurs when an economic activity

slows down due to economic crisis.As the demand for goods
and services fall, people who were producing lose jobs..

 Unpredictable and cannot tell an exact time where economy

will be ok
 FRICTIONAL UNEMPLOYMENT

 This refers to those people who are short-term unemployed as

they move from one job to another.

 . Normally it takes a certain time for a person to find another

job. This is a least problematic from an economic standpoint.
 STRUCTURAL AND TECHNOLOGICAL
UNEMPLOYMENT

 Structural unemployment arises

when the qualification/skill of a
person is not enough to meet his
job responsibilities. It normally
occurs due to technological
changes and lack of skill
development or skills become
obsolete.
 SEASONAL UNEMPLOYMENT

 Demand for some goods and services are highly seasonal,

e.g. demands for fruit pickers. This in turn creates highly
seasonal demand for workers. This can create regional
economic problems in areas where a significant proportion of
the workforce is employed in these seasonal industries.
 REAL WAGE UNEMPLOYMENT

 Real wage unemployment occurs when wages are set above

the equilibrium level causing the supply of labour to be
greater than demand

 • This type of unemployment can occur in industries that are

highly unionised. By keeping wages artificially high by the
threat of strike action and closed shops, the number of
people employed in the industry is reduced.
 CONSEQUENCES OF UNEMPLOYMENT

 (a) Loss of output-. If labour is unemployed, the economy is

not producing as much output as it could. Thus, total national
income is less than it could be, because economic resources
are not being fully used.

 (b) Loss of human capital-. If there is unemployment, the

unemployed labour will gradually lose its skills, because skills
can only be maintained by working.

 (c) Increasing inequalities in the distribution of income.-

Unemployed people earn less than employed people, and so
when unemployment is increasing, the poor get poorer.
 (d) Social costs. -Unemployment brings social problems of personal suffering
and distress, and possibly also increases in crime such as theft and vandalism.

(e) Increased burden of welfare payments.- This can have a major impact on
government fiscal policy, because governments will have to pay out more in
state benefits whilst collecting less through tax revenue.

Individual Cost
Stress, depression, Living standards

Costs of unemployment Social Cost

Vandalism, Theft

Economic cost

Burden on tax payers, loss of out put

Government cost
Loss on tax revenue