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Lecture 8: The National Economy

Lecture 8: The National Economy. Macroeconomic Objectives. Distinction between microeconomics and macroeconomics The major macroeconomic issues economic growth unemployment inflation balance of payments and exchange rates balance of payments deficits and surpluses exchange rate movements.

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Lecture 8: The National Economy

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  1. Lecture 8: The National Economy

  2. Macroeconomic Objectives Distinction between microeconomics and macroeconomics The major macroeconomic issues economic growth unemployment inflation balance of payments and exchange rates balance of payments deficits and surpluses exchange rate movements

  3. Consumption of domestically produced goods and services (Cd) Factor payments The circular flow of income Firms Households

  4. The Circular Flow of Income Withdrawals (W) net saving (S) net taxes (T) import expenditure (M) Injections (J) Investment (I) government expenditure (G) export expenditure (X)

  5. Export expenditure (X) Investment (I) Government expenditure (G) BANKS, etc ABROAD GOV. Import expenditure (M) Net taxes (T) Net saving (S) The circular flow of income INJECTIONS Consumption of domestically produced goods and services (Cd) Factor payments WITHDRAWALS

  6. The Circular Flow of Income The relationship between injections and withdrawals the links between them planned injections may not equal planned withdrawals Equilibrium in the circular flow The circular flow and the four macroeconomic objectives

  7. Export expenditure (X) Investment (I) Government expenditure (G) BANKS, etc ABROAD GOV. Import expenditure (M) Net taxes (T) Net saving (S) The circular flow of income INJECTIONS Consumption of domestically produced goods and services (Cd) Factor payments WITHDRAWALS

  8. QWhich of the following would represent a rise in aggregate demand (AD)? A rise in saving. A fall in investment. An increase in taxes. A fall in consumption. A rise in exports.

  9. Demand for goods and services produced within a country AD = C + I + G + X – M Household spending (C) the largest component by value typically over half of aggregate demand Consumption in practice grows at roughly the same rate as disposable income in the long run smoother than disposable income in the short run The Components of Aggregate Demand

  10. What factors influence consumption? disposable income what of responses to short run or temporary changes in income? and long-run or permanent changes in incomes? expected future income the financial system enabling smoothing of consumption debt servicing costs The Components of Aggregate Demand

  11. What factors influence investment? increased consumer demand expectations cost and efficiency of capital equipment rate of interest availability of finance The Components of Aggregate Demand

  12. What factors influence government spending? differentiate between types of spending current and capital transfers and goods and services independent of the level of national income in any given year? but, level of national income will influence level of spending in the long term changes in national income ‘support’ aggregate demand The Components of Aggregate Demand

  13. What factors influence expenditure on imports? national income exchange rates The Components of Aggregate Demand

  14. What factors influence export expenditure? national income in foreign economies other countries’ circular flow of incomes exchange rate The Components of Aggregate Demand

  15. J = I + G + X Cd Incomes W = S + T + M The circular flow of income: The Equilibrium Level of National Income

  16. Withdrawals (W) / Leakage 3 types of withdrawal into the circular flow of income • Saving (S): Households don’t spend all their income. They save same, and these savings out of income are withdrawals from the circular flow of income quite simply because savings are not spent. • Taxation (T): Households must pay some of their income to the government, as taxation. Taxes cannot be spent by households, because the funds go to the government. • Imports (M): When we consider national income, we are interested in the economic wealth that a particular country is earning. Spending on imports is expenditure, but on goods made by firms in other countries. The payments for imports go to firms in other countries, for output created in other countries. Spending on imports therefore withdraws funds out of a country’s circular flow of income.

  17. Injections (J) 3 types of injection into the circular flow of income • Investment (I): Investment in capital goods is a form of spending on output, which is additional to expenditure by households. Just as savings are a withdrawal of funds, investment is an injection of funds into the circular flow of income, adding to the total economic wealth that is being created by the country. • Government Spending (G): Government spending is also an injection into the circular flow of income. In most mixed economies, total spending by the government on goods and services represents a large proportion of total national expenditure. The funds to spend come from either taxation income or government borrowing. • Exports (X): Firms produce goods and services for export. Export earn income from abroad and therefore provide an injection into a country’s circular flow of income.

  18. Effect on national income of a change in injections and/or withdrawals J > W : national income rises W > J : national income falls The Keynesian diagram: the withdrawals and injections approach the withdrawals curve The Equilibrium Level of National Income

  19. Deriving equilibrium national income W Cd, W, J O Y

  20. Effect on national income of a change in injections and/or withdrawals J > W : national income rises W > J : national income falls The Keynesian diagram: the withdrawals and injections approach the withdrawals curve the injections curve The Equilibrium Level of National Income

  21. Deriving equilibrium national income W J Cd, W, J O Y

  22. Effect on national income of a change in injections and/or withdrawals J > W : national income rises W > J : national income falls The Keynesian diagram: the withdrawals and injections approach the withdrawals curve the injections curve equilibrium The Equilibrium Level of National Income

  23. Deriving equilibrium national income W a J b Cd, W, J If injections exceed withdrawals, national income will rise. O Y1 Y

  24. Deriving equilibrium national income c d Y2 Cd, W, J If withdrawals exceed injections, national income will fall. W J O Y

  25. Deriving equilibrium national income x Cd, W, J Equilibrium national income is where W = J. W J O Ye Y

  26. The Keynesian diagram: the income and expenditure approach the 45° line The Equilibrium Level of National Income

  27. Deriving equilibrium national income Y = Cd + W Cd, W, J W J O Y

  28. The Keynesian diagram: the income and expenditure approach the 45° line the expenditure curve The Equilibrium Level of National Income

  29. Deriving equilibrium national income E = Cd + J Cd J Cd, W, J Y = Cd + W W J O Y

  30. The Keynesian diagram: the income and expenditure approach the 45° line the expenditure curve equilibrium The Equilibrium Level of National Income

  31. Deriving equilibrium national income e f Cd, W, J Y = Cd + W If aggregate expenditure exceeds national income, national income will rise. E = Cd + J Cd W J O Y1 Y

  32. Deriving equilibrium national income g h Cd, W, J Y = Cd + W If national income exceeds aggregate expenditure, national income will fall. E = Cd + J Cd W J O Y2 Y

  33. Deriving equilibrium national income z x Cd, W, J Y = Cd + W Equilibrium national income is where Y = E (and W = J). E = Cd + J Cd W J O Ye Y

  34. QGiven the following data (in £bn), what will happen to equilibrium national income?C = 100, I = 20, M = 30, X = 25,S = 18, T = 28, G = 26 Increase Decrease Stay the same

  35. The Multiplier The multiplier: introduction the circular flow of income and effects of changes in injections definition of the multiplier: ΔY/ΔJ The withdrawals and injections approach graphical analysis: shift in the J line

  36. The multiplier: (a) a shift in injections b J2 J2 DJ DW = DJ a c Ye1 Ye2 DY W, J Multiplier = DY / DJ = DY / DW = ca / bc W J1 J1 O Y

  37. The Multiplier The multiplier: introduction the circular flow of income and effects of changes in injections definition of the multiplier: ΔY/ΔJ The withdrawals and injections approach graphical analysis: shift in the J line the formula : 1/mpw or : 1/(1–mpcd)

  38. The multiplier: (a) a shift in injections b J2 J2 DJ DW = DJ a c Ye1 Ye2 DY W, J Multiplier = DY / DJ = DY / DW = ca / bc = 1/mpw W J1 J1 O Y

  39. The Multiplier The multiplier: introduction the circular flow of income and effects of changes in injections definition of the multiplier: ΔY/ΔJ The withdrawals and injections approach graphical analysis: shift in the J line the formula : 1/mpw or : 1/(1–mpcd) graphical analysis: shift in the W line The income and expenditure approach graphical analysis: shift in the E line

  40. The multiplier: (c) a shift in the expenditure curve Ye1 E, W, J Y E1 O Y

  41. The multiplier: (c) a shift in the expenditure curve E, W, J Y E2 E1 O Ye1 Ye2 Y

  42. The multiplier: (c) a shift in the expenditure curve Multiplier = DY / DJ = c-a / b-a c DY b DJ E, W, J Y E2 E1 a O Ye1 Ye2 Y

  43. QWhich of the following would cause the value of the multiplier to fall? A cut in the level of government spending. An increase in the marginal propensity to consume. A fall in the level of investment. The population becomes more thrifty, and saves a larger proportion of any rise in income. Exports rise faster than imports.

  44. GDP: the measure of national income Methods of measuring GDP the product approach the income approach the expenditure approach Measuring National Income and Output

  45. The circular flow of national income and expenditure (1) Production (2) Incomes (3) Expenditure

  46. Measuring National Income and Output • The three ways of measuring GDP • The product method • the problem of double counting • the measuring of value added • gross value added (GVA) • some qualifications • stocks • government services • ownership of dwellings • taxes and subsidies on products

  47. Measuring National Income and Output • The income method • adding factor earnings • some qualifications • stock appreciation • transfer payments • direct taxes; taxes and subsidies on products

  48. Measuring National Income • The product method • The income method • From GVA to GDP • The expenditure approach • C + G + I + X – M

  49. QGiven the following data about an economy (in £bn), what is the level of national income?Saving 100 Consumption 350 Exports 200 Imports 250Net tax revenue 120 Gov. expenditure 140 Investment 130 £470bn £480bn £570bn £670bn £820bn

  50. Measuring National Income and Output • Taking account of: • inflation • population • purchasing power (PPP measures)

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