Introduction to Macroeconomics

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Introduction to Macroeconomics

• Chapter No.1

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What is Macroeconomics?

• Macroeconomics is the study of the structure and
  performance of national economies and of the
  policies that governments use to try to affect
  economic performance of a country.

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Issues in Macroeconomics

• What determines a nation's long-run economic
  growth?
• What causes a nation's economic activity to
  fluctuate?
• What causes unemployment?
• What causes prices to rise?
• How does being part of a global economic system
  affect nations' economies ?
• Can government policies be used to improve a
  nation's economic performance?

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• Some Important Concepts

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Long - Run Economic Growth

• Difference in standard of living in different
  countries.
• Some economies experienced sustainable economic
  growth.
• Some nations have never experienced sustained
  growth or have had periods of growth offset by
  periods of economic decline.
• Hence the period of rapid economic growth which
  is offset period of economic decline is known as
  long run growth.

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Output of the U.S. economy 1869-2008
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• The long-run growth in USA is a result of
  increase in population and average productivity
  of labour Force.
• APL TP/L

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Business Cycle

• Macroeconomists use the term business cycle to
  describe short-run, but sometimes sharp,
  contractions and expansions in economic activity.
• The downward phase of a business cycle, during
  which national output may be falling or perhaps
  growing only very slowly, is called a recession.

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Unemployment

• Unemployment is the number of people who are
  available for work and are actively seeking work
  but cannot find jobs.
• It is measured by unemployment rate.
• Ur Number of unemployed/Total labour force
• Recessions have led to significant increases in
  unemployment.

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Analytical Question

• Can average labour productivity fall even though
  total output is rising? Can the unemployment rate
  rise even though total output is rising?

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Inflation

• When the prices of most goods and services are
  rising over time, the economy is said to be
  experiencing inflation.
• The percentage increase in the average level of
  prices over a year is called the inflation rate.
• High inflation also means that the purchasing
  power of money erodes quickly.

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Problem No.1

• Here are some macroeconomic data for the country
  of O for the years 2008 and 2009.

2008 2009
Output 12000 14300
Employed 1000 1100
Unemployed 100 50
Total labour force 1100 1150
Prices 2 2.5
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Required

• a. Average labour productivity in 2008 and 2009.
• b. The growth rate of average labour productivity
• between 2008 and 2009.
• c. The unemployment rate in 2008 and 2009.
• d. The inflation rate between 2008 and 2009.

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What Macroeconomists Do?

• Macroeconomic Forecasting
• Macroeconomic Analysis
• Monitoring of the economy and think about
• the implications of current economic events.
• Macroeconomic Research

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Economic Theory

• An economic theory is a set of ideas about the
  economy that has been organized in a logical
  framework. Most economic theories are developed
  in terms of an economic model.
• Economic model is a simplified description of
  some aspect of the economy, usually expressed in
  mathematical form.

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Economic Policy

• Set of instruction to control the performance of
  the economy.
• There are two types of macro economic policies
• Fiscal Policy
• Monetary Policy

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Economic Analysis

• Positive Analysis
• Normative Analysis

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Positive Analysis

• A positive analysis of an economic policy
  examines the economic consequences of a policy
  but doesn't address the question of whether those
  consequences are desirable.
• e.g. if a tax is imposed on a good its price will
  tend to rise.

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Normative Analysis

• A normative analysis of policy tries to determine
  whether a certain policy should be used.
• e.g. a tax should be imposed on tobacco to
  discourage smoking

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Analytical Question 2

• Which of the following statements are positive in
  nature and which are normative?
• a. A tax cut will raise interest rates.
• b. A reduction in the payroll tax would primarily
  benefit
• poor and middle-class workers.
• c. Payroll taxes are too high.
• d. A cut in the payroll tax would improve the
  President's
• popularity ratings.
• e. Payroll taxes should not be cut unless capital
  gains taxes are cut also.

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Classical Versus Keynesians

• Classical Approach
• Adam Smith (1776)
• Published book Wealth of Nation.
• Concept of invisible hand
• Keynesian Approach
• Great Depression (1936)
• John Maynard Keynes
• General theory of Employment, Interest and Money

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The Classical Approach

• The invisible hand of Economics General welfare
  will be maximized (not the distribution of
  wealth) if
• there are free markets
• individuals act in their own best interest.

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The Classical Approach (continued)

• To maintain markets equilibrium the quantities
  demanded and supplied are equal
• Markets must function without impediments.
• Wages and prices should be flexible.

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The Classical Approach (continued)

• Thus, according to the classical approach, the
  government should have a limited role in the
  economy.

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The Keynesian Approach

• Keynes (1936) assumed that wages and prices
  adjust slowly.
• Thus, markets could be out of equilibrium for
  long periods of time and unemployment can
  persist.

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The Keynesian Approach (continued)

• Therefore, according to the Keynesian approach,
  governments can take actions to alleviate
  unemployment.

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The Keynesian Approach (continued)

• The government can purchase goods and services,
  thus increasing the demand for output and
  reducing unemployment.
• Newly generated incomes would be spent and would
  raise employment even further.

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Evolution of the Classical-Keynesian Debate

• After stagflation high unemployment and high
  inflation of the 1970s, a modernized classical
  approach reappeared.
• Substantial communication and cross-pollination
  is taking place between the classical and the
  Keynesian approaches.

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Unified Approach to Macroeconomics

• Individuals, firms and the government interact in
  goods, asset and labour markets.
• The macroeconomic analysis is based on the
  analysis of individual behaviour.

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The Unified Approach (continued)

• Keynesian and classical economists agree that in
  the long run prices and wages adjust to
  equilibrium levels.
• The basic model will be used either with
  classical or Keynesian assumptions about
  flexibility of wages and prices in the short run.

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The Measurement and Structure of the National
Economy

• Chapter No.2

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National Income Accounts

• The national income accounts are an accounting
  framework used in measuring current economic
  activity.

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Approaches of Measurement

• Product Approach (excluding output used in
  intermediate stage of production).
• Income Approach (income received by the producer
  of output)
• Expenditure Approach (amount of spending by the
  ultimate purchaser of the output).

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Product Approach

• The product approach measures economic activity
  by adding the market values of goods and services
  produced, excluding any goods and services used
  up in intermediate stages of production.
• Concept of value added (value of output minus
  value of input)

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Income Approach

• The income approach measures economic activity by
  adding all income received by producers of output
• Rent, are the income from from property received
  by house hold
• Interest, Private business pay to house hold
• Wages, received by workers.It is largest
  component of National Income
• Profit, received by owners of firm

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Expenditure Approach

• The expenditure approach measures activity by
  adding the amount spent by all ultimate users of
  output.

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The Expenditure Approach to Measuring GDP

• The expenditure approach measures GDP as total
  spending on final goods and services produced
  within a nation during a specified period of
  time.
• Total spending on goods and services includes
• Consumption (C)
• Investment (I)
• Government Expenditure (G)
• Net Export (NX)

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Consumption

• Consumption is spending by domestic households on
  final goods and services, including those
  produced abroad.
• Consumption expenditures are grouped into three
  categories
• Consumer durables (car, television, mobile)
• Nondurable goods (food, cloth, fuel)
• Services (Education, Health care, Financial
  Services)

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Investment

• Investment includes both spending for new capital
  goods, called fixed investment, and increases in
  firms' inventory holdings, called inventory
  investment.
• Fixed investment in turn has two major
  components
• Business Investment
• Residential Investment

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Government Expenditure

• Government expenditure include any spending by
  the government for a currently produced good or
  service.
• It also include the transfer payment (benefit) to
  the individuals of the country.

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Net Export

• Net exports are exports minus imports.
• If exports are greater than imports NX gt0.
• If exports are less than imports NXlt0.

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Income-Expenditure Identity

• Y GDP total production (or output)
• total income
• total expenditure
• Y C I G NX.

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Fundamental Identity of NationalIncome Accounting

• total productiontotal incometotal expenditure

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Gross Domestic Product

• Gross domestic product used to measure the over
  all economic activity of a country.
• GDP is calculate by using the following
  approaches
• Product approach
• Expenditure approach
• Income approach

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Product Approach

• A nation's gross domestic product (GDP) as the
  market value of final goods and services newly
  produced within a nation during a fixed period of
  time.

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Market Value

• Goods and services are counted in GDP at their
  market values that is, at the prices at which
  they are sold.
• Advantages
• It allows adding the production of different
  goods and services.
• Disadvantages
• Some useful goods and services are not sold in
  formal markets.

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Market Value (Cont)

• Some nonmarket goods and services are partially
  incorporated in official GDP measures. An example
  is activities in the so-called underground
  economy.
• The underground economy includes both legal
  activities (hidden from government record keepers
  to avoid payment of taxes) and illegal activities
  (drug dealing and gambling).

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Newly Produced Goods and Services

• As a measure of current economic activity, GDP
  includes only goods or services that are newly
  produced within the current period.

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Final Goods and Services

• Only the value of final goods and services
  include in the measurement of GDP.
• Final goods also include capital goods and
  inventory investment.

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GDP Versus GNP

• Gross National Product is the market value of
  final goods and services newly produced by
  domestic factors of production during the current
  period, whereas GDP is production taking place
  within a country.
• GNP GDP NFP
• GDP GNP - NFP

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Net Factor of Payment

• NFP is the income earned by the domestic factor
  of production from the rest of the world.
• From the above definition,
• GDP GNP NFP
• In developed economies GNP GDP.
• In Underdeveloped economies GNP gt GDP.

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Measures of National Income

• Net National Product
• Less Capital Consumption Allownce
• Add Subsidy
• National Income at market price
• National Income at factor cost
• Personal Income
• Personal Disposable Income

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Private Disposable Income (PDI)

• Private disposable income, measures the amount of
  income the private sector has available to spend.
• Mathematically,
• PDI Y NFP TR INT - T
• Y gross domestic product (GDP)
• NFP net factor payments from abroad
• TR transfers received from the government
• INT interest payments on the government's
  debt
• T taxes.

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Net Government Income (NGI)

• Net government income equals taxes paid by the
  private sector, T, minus payments from the
  government to the private sector (transfers and
  interest payments on the government debt)
• Mathematically,
• NGI T TR -INT

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Saving

• Private Saving private saving is equal to
  private disposable income minus consumption.
• Spvt (YNFPTRINT-T)-C
• Government Saving It is defined as net
  government income less government purchases of
  goods and services.
• Sgov (T - TR - INT) -
  G.

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National Saving

• S Spvt Sgov
• (YNFPTRINT-T)-C (T - TR - INT) - G.
• S I CA
• Uses of Spvt
• 1, Spvt is used to fund new capital (Investment)
• 2, Provide the resource to Govt needs to finance
  its budget deficit (-Sgov)
• 2, Foreign lending

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Current Account (CA)

• The current account balance equals payments
  received from abroad in exchange for currently
  produced goods and services (including factor
  services), minus the analogous payments made to
  foreigners by the domestic economy.
• CA NX NFP
• NX X M
• NFP Income from abroad Payment made to abroad

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National Wealth

• The value of all assets own by a person or
  country.
• Current assets Current Liabilities
• It is total wealth of the residents of a country,
  it consist two parts
• 1, Domestic physical assets (Stock of capital,
  goods, Land)
• 2,Net foreign assets Countries foreign
  assets(foreign stock, bonds and factories own by
  domestic resident) minus its foreign liabilities
  (domestic physical and financial assets own by
  foreigners)
• Note Domestic financial assets held by domestic
  residents are not part of National wealth.

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National wealth can change in two ways.

• 1, Value of existing assets or liabilities that
  make up national wealth
• Stock Prices
• The wearing out or depreciation of physical
  assets which corresponded to a drop in the value
  of asset
• 2, National Saving
• Increase in domestic stock of capital
• Increase in stock of net foreign assets
• ( NXNFP)

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Nominal and Real GDP

• Nominal GDP measure the current dollar value of
  the output of the country
• Total output at current prices
• Y Pn X Qn
• Pn new price, Qn new
  Quantity
• Real GDP measure output at base year or constant
  prices
• Y Pb X Qn Pb Base year price

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GDP deflator

• The GDP deflator is a measure of the level of
  prices of all new, domestically produced, final
  goods and services in an economy
• GDP deflator nominal GDP / Real GDP
• Pn X Qn / Po X Qn
• Real GDP nominal GDP / GDP deflator
• nominal GDPReal GDP X GDP deflator

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Consumer Price Index ( CPI)

• Consumer Price Index
• measures changes in the price level of a market
  basket of consumer goods and services purchased
  by households. The CPI in the Pakistan is defined
  by the ministry of finance as "a measure of the
  average change over time in the prices paid by
  urban consumers for a market basket of consumer
  goods and services.

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Calculation of Growth rate

• Growth Rate
• (Current Previous/ Previous) X100

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Difference b/w CPI and GDP price Index

• Three main differences are
• 1, GDP deflator measure prices of all goods
  services produced where as CPI measure the prices
  of only goods services bought by consumer.
• 2, GDP deflator shows the prices of all goods
  services produced domestically, imported goods
  are not included in GDP deflator. CPI consider
  imported goods.
• 3, CPI is computed using fixed basket of goods.
  GDP deflator allows the basket of goods to change
  overtime as the composition of GDP deflator.

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Cost of Living

• The dollar does not buy as much as it did ten
  year ago the cost of every thing almost gone up.
• Which price index better explain increase in cost
  of living.
• GDP deflator ( understate increase in cost of
  living)
• Base year price
• CPI ( overstate cost of living)
• substitute goods

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Interest rate

• Rate of return promised by a borrower to a lender
  is called nominal interest rate.
• Real Interest rate ( r)
• An interest rate that has been adjusted to remove
  the effects of inflation to reflect the real cost
  of funds to the borrower, and the real yield to
  the lender.
• Real Interest Rate Nominal Interest Rate -
  Inflation (Actual)
• The real interest rate of an investment is
  calculated as the amount by which the nominal
  interest rate is higher than the inflation rate.
• Expected Real Interest Rate Nominal Interest
  Rate - Inflation (Expected)

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• Stock variables
• measure at a point of time like money supply
• Flow Variables
• Variables that can measure per unit of time
• GDP

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Circular Flow of Income In Closed Economy
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