MACRO-ECONOMICS

Key Concepts

• Objectives of Inflation

• Objectives of Unemployment

• Objectives of Economic Growth

• Objectives of Balance of Payment

• Policies of Government
Macro Economics

• It is the study of economic behaviour with reference to the whole economy, or

government e.g. Aggregate demand, aggregate supply and total income of factors

of production.
Factors that affect business activity

• Confidence of consumer overspending.

• Increase or decrease in aggregate demand(total demand in the economy)

• Available capital

• New technology and new techniques

• Other government policies

Factors that affect business activity

• Exchange rate

• Interest rates

• Culture

• Trends set by consumer

Objectives of Inflation(price stability)

• A general increase in prices and fall in the purchasing value of money.

Causes of Inflation

• Demand pull inflation. It happens when aggregate demand (total demand) of

any commodity increases; e.g. basic necessity likes shortage of sugar. An

increase in demand for a product would lead to a rise in prices demanded by

businesses.
• Cost push inflation. It happens when cost of manufacturing increases in an
economy and at that time it is not possible for manufacturer to sell the products
at previous prices. An increase in prices of inputs would cause businesses to
increase price of the finished goods charged from customers leading to inflation.
• Imported inflation: It happens when a country or a personal (trader) buys goods
from other countries at high prices it brings inflation e.g. rental process plant,
high price inputs that would lead to an increase in the price charged from
customers.
• Inflationary expectations: When customers expect the prices of commodities will
increase in future, they tend to increase demand that results in demand pull
situation.
• Inflationary gap. It is the situation in which resources are fully utilized and

aggregate demand is increasing but increasing supply is not possible.

• Deflationary Gap. It is the situation in which resources are under utilized which

means full capacity of resources is not utilized.

• Hyper inflation. It is situation in which inflation rate is more than 100%. It
happens normally in wars or in natural disasters.
• Example 2008. The most recent example of hyperinflation, Zimbabwe's currency
woes hit a peak in November 2008, reaching a monthly inflation rate of
approximately 79 billion percent, Germany. Perhaps the best-known example of
hyperinflation, though not the worst case, is that of Weimar Germany. At its
height, hyperinflation in Weimar Germany reached rates of more than 30,000%
per month, causing prices to double every few days
• Money supply inflation. If there is an increase in money supply in a country
(increase in currency rate) the value (importance) of money will decrease. So
prices of commodities will increase (because traders will ask for more currency
notes)
The total stock of money circulating in an economy is the money supply. The
circulating money involves the currency, printed notes, money in the deposit
accounts. The increase in the money supply will lead to an increase in consumer
spending. Increased money supply causes reduction in interest rates and further
spending and therefore an increase in AD.
Indicators of inflation

There are three inflation indicators

1. Leading indicator. It is a proactive indicator that gives indication in advance or

before time of economic situation in future as a result of government action. For

example privatization of electricity

2. Coincident indicator. It provides indication at the point of government action. For
example increase in petroleum prices.
3.Lagging indicator. It gives indication after the action has taken place. It is a
reactive indicator. For example government exports wheat and after five months
there is shortage in the country.
Factors / tools to calculate Inflation

1. Retail price index (RPI). It is a measure to calculate general inflation. It is

basically %age change month by month in average price levels of

commodities or services released by majority of customers. For this purpose

current prices are collected regularly

• Consumer price index (CPI). It is replacement of RPI. It basically measures every
change in price over the period of time paid by consumers for market basket of
consumer goods and services. Market basket (commodity bundle): It refers to a
fixed list of items. Specifically to track progress of inflation in an economy or in a
specific market.
Problems of High Rate of Inflation

• Redistribution of income and wealth. : In a time of inflation debts such as bank loans

fall in real value over time. Borrowers gain from the falling real value of debt. At the

same time, lenders and savers lose because the value of their loan or savings falls. For

example, an individual with cash savings might be earning 3% after tax when inflation

is 5%: if so he is losing 2% in real terms each year. The effect of inflation is therefore to

shift wealth from savers and lenders to borrowers.

• Labor and material costs will rise.
• difficult to forecast inflation rates. When it is difficult to forecast inflation rates
setting prices can become a problem
• The rich might get richer & the poor get poorer. Another effect of inflation is to
reduce the real value of households on fixed incomes or incomes that rise by less
than the rate of inflation each year, such as many pensioners. The rich might get
richer (because their income is often protected against inflation, for example by
salary rises) whilst the poor get poorer.
Objectives of Unemployment

• It is a situation in which people are able to work but cannot find a job or do not

desire for a job.

Causes of Unemployment
• Cyclic unemployment. It is also called "Demand deficient unemployment" it is a
situation in which people get unemployed because of “No” or “Low” demand. it
happens normally in decline or depression slump. When the national economy is
growing, demand for labour increases and unemployment should fall. When the
economic cycle goes into recession, the demand for labour fills and
unemployment increases. Governments try to deal with cyclical unemployment by
managing the economy and trying to achieve real economic growth
• Frictional unemployment. It is a situation or a gap between old job and new job.
This is short-term unemployment when individuals are dismissed from their
work, for example because they have been made redundant or because they did
not like the job they were doing. The Period between these two jobs is known as
"frictional unemployment". It might take them a little time to find a new job.
Until they do, they are unemployed. However, the unemployment should not last
long.
• Structural unemployment. It occurs when there is a long term structural change
in economy; e.g. a country is moving from manufacturing to service industry like
U.K (as cost is low in service but employee gets unemployed). or Structural
unemployment is long-lasting unemployment that comes about due to shifts in
an economy. This type of unemployment happens because though jobs are
available, there's a mismatch between what companies need and what available
workers offer. For example, as old industries have declined, new industries have
emerged, such as higher tech manufacture, IT, computing, insurance, and
internet based companies. However, these new industries may require a different
skill set to previous manufacturing jobs, and it is this that can cause structural
unemployment.
• Technological unemployment. It occurs when there is a new technique or new
technology being introduced and old skills are no longer needed. It is a short
term change; e.g. computerized working. The new technology replaces manual
labour. This can happen when manufacturing processes are automated.
Technological unemployment can add to structural unemployment.
• Seasonal unemployment. This is unemployment, often within a particular
industry, because the demand by firms for labour is higher at some times of the
year than at the other. For example, the demand for agricultural labour might be
very seasonal, and there might be high levels of unemployment in the industry in
the low-season periods
• Voluntary unemployment. It is a situation in which people are willing to be
unemployed e.g. Pakistan "where 1 member is earning and rest are resting"
• Real Wage Unemployment. Normally trade unions/ labour union are blamed for
real wage unemployment, because they demand higher wages be paid for their
workers . Other economists blame minimum wage laws . leading a rising in the
labor force and leaving many people unemployed.
Disadvantages of Unemployment
• Burden falls on the government

• There will be no sales tax. (low demand)

• There will be no income tax

• Standard of living will decrease

Disadvantages of Unemployment
• Crime rate will increase

• Unequal distribution of wealth in society

• Investment in new businesses will reduce

Objectives of Balance of Payment

• The balance of payments is the record of all international trade and financial

transactions made by a country's residents.

Components of Balance of Payment

There are three components of balance of payment

1. Current account= balance of trade + net factor income from abroad+ unilateral transfers(A

unilateral transfer is a one-way transfer of money, goods, or services from one party to

another.)

2. Capital account= long-term investments

3. Financial account= foreign direct investment + portfolio investment+ other investments.

Balance of payment Deficit

• A balance of payments deficit means the country imports more goods, services

and capital than it exports. It must borrow from other countries to pay for its

imports.
Balance of payment Surplus

• A balance of payments surplus means the country exports more than it imports. Its

government and residents are savers. They provide enough capital to pay for all

domestic production. They might even lend outside the country.

International payments disequilibrium
Definition: An international payment disequilibrium occurs when the value of a
country’s imports is not equal to the value of exports. (previous slide balance of
payment deficit)
Impact of Balance of Payments
Economic Indicator Individuals/Households Businesses
Surplus  Higher demand for the goods and  Greater demand for their goods and
services. services typically translates into
 Greater opportunities for greater profitability.
individuals’ jobs.  Businesses expanding or increasing
 Higher income because of higher the goods and services they offer.
job opportunities.  Greater employment.
 Greater expenditure on goods and
services by households as well as
individuals.
Deficit  Fewer job opportunities.  Lower demand for goods / services
 Reduced expenditure on goods / results in lower profits.
services.  Leads to business contraction.
 Lower income of households
leading to reduced expenditure.
Objectives of Economic Growth

• It means rising trend in employment + higher standard of living + Short term

growth (immediate benefit). “Short term growth is calculated through the GDP

factor”.
How to Measure Economic Growth

• Gross domestic product is the best way to measure economic growth. It takes into

account the country's entire economic output. It includes all goods and services

that businesses in the country produce for sale. It doesn't matter whether they are

sold domestically or overseas.

Gross Domestic Product (GDP)

(AD) = C + I + G + (X – M)

This means: Aggregate demand (AD) = Consumer spending (C) + Investment by

firms (I) + Government spending (G) + Demand from exports (X) – Imports (M).
Advantages of economic growth

• Higher standards of living

• Higher employment

• Extra revenue for government

Advantages of economic growth

• Income of public will increase

• There will be more savings

• If more saving->more investment ultimately

Policies of Government

There are three main policies to achieve objectives

• Demand side policies

• Supply side policies

• Analysis through trade cycle

Demand Side Policies

Demand side policy Government policies that aim to control price inflation
and unemployment by influencing total aggregate demand in the economy.
Government takes support for this purpose from

1. Fiscal policy

2. Monetary policy
Fiscal policy(revenue - expenses)

Fiscal policy is the means by which a government adjusts its spending levels and

tax rates to monitor and influence a nation's economy. It is the sister strategy to

monetary policy through which a central bank influences a nation's money supply.
These two are the major sources of revenue
• Direct taxes, which are paid directly by an individual to the Revenue authority.
These taxes include income tax, property tax, capital gains tax and corporation
taxes .
• Indirect taxes, which are paid indirectly through an intermediary. Sales tax or VAT
are examples of indirect taxes.etc
Using Fiscal Policy
• If an economy is suffering from stagnation (low growth) and high unemployment
the government may increase its expenditure and/or reduce taxation. This will
lead to an increase in aggregate demand. The downside of such an approach can
be a corresponding increase in inflation as increase in demand will push prices of
goods and services upwards. Increased government expenditure would also lead
to a budget deficit. A budget deficit occurs when a government spends more than
what it collects in the form of taxes. In such a situation the deficit is financed
through borrowing and the amount of borrowing needed to finance the deficit is
called PSNCR (Public Sector Net Cash Requirement).
Just for explanation
“Stagnation economy is a very slow growing economy is stagnation economy”
• If an economy is facing the challenge of high inflation the government may
decrease its expenditure and/or increase taxation. The result would be a
decrease in aggregate demand as people would pay higher taxes and have less
money to spend resulting in lower inflationary pressure. The downside of such a
policy is a possibility of low growth as demand of goods and services will result in
low business revenue and possibly high unemployment. It is also very difficult for
governments to reduce its expenditures as most of its expenditures are on public
welfare projects like hospitals and education. If a government collects more than
what it spends it is said to have a surplus on its budget or a negative PSNCR
(Public Sector Net cash Requirement
Monetary policy

Monetary policy is the macroeconomic policy laid down by the central bank. It

involves management of money supply(exchange rate and currency value) and

interest rate and is the demand side economic policy used by the government of a

country to achieve macroeconomic objectives like inflation, consumption, growth

and liquidity.
Using Monetary Policy:
• If an economy is suffering from stagnation (low growth and high interest rates)
the central bank may reduce interest rates in order to stimulate the economy.
Borrowing capital becomes cheaper and incentive to retain savings accounts
reduces resulting in higher investment and increased aggregate demand. Thus
increasing growth and reducing unemployment. The downside of such a policy
can be the resultant increase in inflations.
• If an economy is facing high inflation the central bank may decide to increase its
interest rates. Borrowing capital will become expensive and retaining and
investing in savings accounts become lucrative. This results in a reduction in
aggregate demand thus reducing inflation. A reduction in inflation also has a
positive effect on balance of payments as the country’s products become
cheaper. The downside of such a policy is the possibility of low growth
accompanied with increased levels of unemployment.
• It is important to note that the changes in interest rates does not result in instant
shifts in economy and the transmission might take considerable time.
Supply Side Policy

Government policies that aim to increase aggregate supply in an economy are

known as supply side policies. These policies attempt to remove constraints on

productivity of resources (local public are restricted to find resources)

Actions to control supply side policy
• Tax reduction(reduce taxes to increase supply)

• Competition(control the competition between companies)

• Privatization(encourage privatization to increase supply)

• Deregulation (ruling out old rules)

Actions to control supply side policy
• Labour market reforms i.e. trade unions and labour under control

• Improving education and training

• New research
Analysis through trade cycle/ economic cycle.