Week 8 Introduction to macroeconomics

1
Week 8Introduction to macroeconomics
2
Macroeconomics is ...

• the study of the economy as a whole
• it deals with broad aggregates
• but uses the same style of thinking about
  economic issues as in microeconomics.

3
Some key issues in macroeconomics

• Inflation
• the rate of increase of the general price level
• Unemployment
• a measure of the number of people looking for
  work, but who are without jobs
• Output
• real gross national product (GNP) measures total
  income of an economy
• it is closely related to the economy's total
  output

4
More key issues in macroeconomics

• Economic growth
• increases in real GNP, an indication of the
  expansion of the economys total output
• Macroeconomic policy
• a variety of policy measures used by the
  government to affect the overall performance of
  the economy

5
(No Transcript)
6
Inflation in UK, USA and Germany1960 - 2001
7
Unemploymentin UK, USA and Germany
8
Economic growthin UK, USA and Germany
9
The circular flow of income, expenditure and
output
10
Government in the circular flow
11
Adding the foreign sector

• To incorporate the foreign sector into the
  circular flow
• we must recognize that residents of a country
  will buy imports from abroad
• and that domestic firms will sell (export) goods
  and services abroad.

12
GDP and GNP

• Gross domestic product (GDP)
• measures the output produced by factors of
  production located in the domestic economy
• Gross national product (GNP)
• measures the total income earned by domestic
  citizens
• GNP GDP net income from abroad

13
Three measures of national output

• Expenditure
• the sum of expenditures in the economy
• Y C I G X - Z
• Income
• the sum of incomes paid for factor services
• wages, profits, etc.
• Output
• the sum of output (value added) produced in the
  economy

14
What GNP does and does not measure

• Some care is needed
• to distinguish between real and nominal
  measurements
• to take account of population changes
• to remember that GNP is not a comprehensive
  measure of everything that contributes to
  economic welfare

15
Output and aggregate demand
16
Aggregate output in the short run

• Potential output
• the output the economy would produce if all
  factors of production were fully employed
• Actual output
• what is actually produced in a period
• which may diverge from the potential level

17
Some simplifying assumptions

• Prices and wages are fixed
• The actual quantity of total output is
  demand-determined
• this will be a Keynesian model
• For now, also assume
• no government
• no foreign trade
• Later chapters relax these assumptions

18
Aggregate demand

• Given no government and no international trade,
  aggregate demand has two components
• Investment
• firms desired or planned additions to physical
  capital inventories
• for now, assume this is autonomous
• Consumption
• households demand for goods and services
• so, AD C I

19
Consumption demand

• Households allocate their income between
  CONSUMPTION and SAVING
• Personal Disposable Income
• income that households have for spending or
  saving
• income from their supply of factor services (plus
  transfers less taxes)

20
The consumption function
The consumption function shows desired
aggregate consumption at each level of aggregate
income
C 8 0.7 Y
Consumption
0
Income
21
The saving function
The saving function shows desired saving at
each income level.
Saving
S -8 0.3 Y
Since all income is either saved or spent on
consumption, the saving function can be
derived from the consumption function or vice
versa.
0
Income
22
The aggregate demand schedule
Aggregate demand is what households plan to spend
on consumption and what firms plan to spend on
investment.
Aggregate demand
C
Income
23
Equilibrium output
45o line
The 45o line shows the points at which
desired spending equals output or income.
Desired spending
This the point at which planned spending
equals actual output and income.
Output, Income
24
Effects of a fall in aggregate demand
45o line
Suppose the economy starts in equilibrium at Y0.
AD0
Desired spending
Y0
Output, Income
Notice that the change in equilibrium output
is larger than the original change in AD.
25
The multiplier

• The multiplier is the ratio of the change in
  equilibrium output to the change in autonomous
  spending that causes the change in output.
• The larger the marginal propensity to consume,
  the larger is the multiplier.
• The higher is the marginal propensity to save,
  the more of each extra unit of income leaks out
  of the circular flow.

26
Fiscal policy and foreign trade
27
Some key terms

• Fiscal policy
• the governments decisions about spending and
  taxes
• Stabilization policy
• government actions to try to keep output close to
  its potential level
• Budget deficit
• the excess of government outlays over government
  receipts
• National debt
• the stock of outstanding government debt

28
Government in the income-expenditure model

• YCIG (assumption no foreign trade)
• Direct taxes
• affect the slope of the consumption function
• and hence the slope of the AD schedule.
• Government expenditure affects the position of
  the AD schedule

29
Fiscal policy?
45o line
Aggregate demand
AD0
But this ignores some important issues prices,
interest rates, and the need to fund the
government spending.
Y0
Income, output
30
The government budget
The budget deficit equals total government
spending minus total tax revenue.
G, NT
Income, output
31
Foreign tradeand income determination

• Introducing exports (X) imports (Z)
• TRADE BALANCE
• the value of net exports (X - Z)
• TRADE DEFICIT
• when imports exceed exports
• TRADE SURPLUS
• when exports exceed imports
• Equilibrium is now where
• Y C I G X - Z

32
Exports, imports and the trade balance
X, Z
Income
33
Foreign trade and the multiplier

• The marginal propensity to import
• is the fraction of additional income that
  domestic residents wish to spend on additional
  imports.
• The effect of foreign trade is to reduce the size
  of the multiplier
• the higher the value of the marginal propensity
  to import, the lower the value of the multiplier.