Economic theory
Download
1 / 128

Economic Theory - PowerPoint PPT Presentation


  • 126 Views
  • Uploaded on

Economic Theory. Shashi Abeysinghe B.Sc(eng), CIMA. Micro-economics. What’s the difference between Microeconomics & Macroeconomics?. Microeconomics examines small economic units, the components of the economy. For example: individuals, households, firms, industries

loader
I am the owner, or an agent authorized to act on behalf of the owner, of the copyrighted work described.
capcha
Download Presentation

PowerPoint Slideshow about ' Economic Theory' - dakota


An Image/Link below is provided (as is) to download presentation

Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author.While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server.


- - - - - - - - - - - - - - - - - - - - - - - - - - E N D - - - - - - - - - - - - - - - - - - - - - - - - - -
Presentation Transcript
Economic theory

Economic Theory

Shashi Abeysinghe

B.Sc(eng), CIMA



What s the difference between microeconomics macroeconomics
What’s the difference between Microeconomics & Macroeconomics?

  • Microeconomics examines small economic units, the components of the economy. For example: individuals, households, firms, industries

  • Macroeconomics looks at aggregates.

  • For example: national output, overall price level, aggregate unemployment


What is a market
What is a Macroeconomics?market?

  • The interaction of buyers & sellers of a good or service


Questions relevant to all economies market oriented or not
Questions relevant to Macroeconomics?all economies, market-oriented or not

  • What goods & services should be produced and how much?

  • How should the goods & services be produced?

  • Who gets the goods & services?

  • How do changes in the production & distribution mixes take place?


In a market economy these questions are handled by the market
In a market economy, these questions are handled by the market.

  • What & how much to produce:determined by demand & supply conditions, individual choices, & pursuit of profit.

  • How to produce:determined by technology & resource costs.

  • Distribution:based on ability & willingness to pay the price.

  • What if consumer wants or technology change?Those changes alter demand & supply, which changes prices, profits, & consequently output levels & distribution.


The circular flow
The Circular Flow market.

Product Markets

money to pay for goods & services

goods & services

Households & Resource Owners

Firms

labor & other resources

resource payments such as wages, rents, & interest

Resource or Factor Markets


The market is not the only way that the basic questions of economics can be answered
The market is not the only way that the basic questions of economics can be answered.

  • In some less developed nations, a traditional economic system is used.

  • Custom & tradition determine the answers.

  • Social arrangements & culture dictate the solutions.

  • Change occurs very gradually.


Historically the former soviet union had a command economy
Historically the former Soviet Union had a economics can be answered.command economy.

  • Resources are government/publicly owned and centralized control is used to determine what is produced, how it is produced, and how it is distributed.


No country in the world has a purely market or purely command economy
No country in the world has economics can be answered.a purely market or purely command economy.

  • They have mixed economies with both market and government sectors.

  • In this course, we will deal primarily with the market system.


The market supply and demand
The Market: economics can be answered.Supply and Demand


What is the law of demand
What is the law of demand? economics can be answered.

  • The lower the price of a good, the larger the quantity consumers will buy.

  • So the demand curve slopes downward from left to right.


What is the difference between demand quantity demanded
What is the difference between economics can be answered.demand & quantity demanded?

  • Demand is the entire curve that shows the relation between price & quantity purchased.

  • Quantity demanded is one particular quantity on the demand curve.


Example apple market
Example: Apple Market economics can be answered.

Price of apples(in dollars)

The demand for apples is the curve D.

The quantity demanded of apples when the price is 25 cents is 6 thousand bushels.

$ 0.25

D

6

Quantity of apples(in thousands of bushels)


What factors change demand that is shift the entire curve
What factors change demand economics can be answered.(that is, shift the entire curve)?

  • Consumer income

  • Prices of substitutes and complements

  • Tastes

  • Consumer expectations


Example apple market1
Example: Apple Market economics can be answered.

Price of apples(in dollars)

If income increases, people will buy more apples at every price & the entire curve will shift to the right.

D2

D1

Quantity of apples(in thousands of bushels)


What makes the quantity demanded of apples change
What makes the quantity demanded of apples change? economics can be answered.

  • In other words, what causes a movement along the demand curve for apples?

  • A change in the price of apples.

  • That’s it, only a change in the price of apples.


Example apple market2
Example: Apple Market economics can be answered.

Price of apples(in dollars)

Suppose the price of apples falls from 25 cents to 20 cents.

Then the quantity demanded of apples rises from 6 thousand bushels to 8 thousand bushels.

$ 0.25

$ 0.20

D

6

8

Quantity of apples(in thousands of bushels)


What is the law of supply
What is the law of supply? economics can be answered.

  • The higher the price of a good, the larger the quantity firms will be willing to produce and sell.

  • So the supply curve slopes upward from left to right.


What is the difference between supply quantity supplied
What is the difference between economics can be answered.supply & quantity supplied?

  • Supply is the entire curve that shows the relation between price & quantity provided.

  • Quantity supplied is one particular quantity on the supply curve.


Example apple market3
Example: Apple Market economics can be answered.

Price of apples(in dollars)

S

The supply of apples is the curve S.

The quantity supplied of apples when the price is 22 cents is 7 thousand bushels.

$ 0.22

Quantity of apples(in thousands of bushels)

7


What factors change supply that is shift the entire curve
What factors change supply economics can be answered.(that is, shift the entire curve)?

  • Technology

  • Prices of inputs (for example: land, labor, machinery, raw materials)

  • Weather (in the case of agriculture)


Example apple market4
Example: Apple Market economics can be answered.

Price of apples(in dollars)

S2

S1

If rainfall is low, the supply of apples will be reduced. At each price, there will be fewer apples provided.

Quantity of apples(in thousands of bushels)


What makes the quantity supplied of apples change
What makes the quantity supplied of apples change? economics can be answered.

  • What causes a movement along the supply curve for apples?

  • Just a change in the price of apples.


Example apple market5
Example: Apple Market economics can be answered.

Price of apples(in dollars)

S

$ 0.22

When the price of apples falls from 22 cents to 20 cents, the amount provided falls from 7 thousand bushels to 6 thousand bushels.

$ 0.20

Quantity of apples(in thousands of bushels)

6

7


What is equilibrium
What is equilibrium? economics can be answered.

  • It is a state of balance, where there is no tendency for things to change.


Equilibrium occurs where the quantity demanded equals the quantity supplied, which is at the intersection of the supply and demand curves.


Example apple market6
Example: Apple Market quantity supplied, which is at the intersection of the supply and demand curves.

Price of apples(in dollars)

S

Here the equilibrium price is 22 cents & the equilibrium quantity is 7 thousand bushels.

$ 0.22

D

Quantity of apples(in thousands of bushels)

7


Suppose there is an increase in the price of pears quantity supplied, which is at the intersection of the supply and demand curves.(a substitute for apples).

Then the demand for apples will increase.

Equilibrium price increases & equilibrium quantity increases.

price

S

P2

P1

D2

D1

quantity

Q2

Q1


Suppose there is a long spell of bad weather for apple growing.

Then the supply of apples will decrease.

Equilibrium price increases & equilibrium quantity decreases.

S2

price

S1

P2

P1

D

Q2

quantity

Q1


Example: cigarette market growing.

Suppose that the surgeon general comes out with stronger health warnings.

That will reduce the demand for cigarettes.

Simultaneously, there is a year of bad weather.

That decreases the supply of cigarettes.


So S & D both decrease. growing.

The equilibrium quantity decreases. Equilibrium price may increase, decrease or stay the same. In this example, the price remained the same.

price

S2

S1

P2 =

P1

D1

D2

quantity

Q2

Q1


Resources are limited; wants are unlimited growing.

Scarcity = not enough resources to produce the goods to satisfy

our wants.

Resources: Adam Smith in his Wealth of Nations (1776)

divided resources into land, labor and capital.

http://www.adamsmith.org/smith/won-intro.htm


Adam Smith’s 3 resources: Land, Labor and Capital growing.

1. LAND: used as shorthand for any natural resource,

not simply for agricultural land.

2. LABOR: manual power + skill ("human capital")

3. CAPITAL: produced means of production

for example, hammers, drill presses, computers ...

.

Although money is used to BUY all the above,

money is not itself a productive resource.

Capital grows through investment –.


Scarcity means that choices are necessary
Scarcity means that choices are necessary. growing.

  • When you can’t have all you want of everything, you must make choices.

  • Microeconomics is the study of how to make the best possible ( or the optimal) choice under the constraint of limited resources.


Tradeoffs and the production possibility frontier
Tradeoffs and the Production Possibility Frontier growing.

  • Economists would want to develop a more precise model of the tradeoffs involved –

  • And that model can be represented graphically by a “Production Possibility Frontier”, showing the choices which are

  • -- possible (on or within the frontier)

  • -- efficient (exactly on the frontier)

  • -- inefficient (within the frontier)

  • -- impossible (beyond the frontier)


Cadillacs growing. ... 1944 and 1946

Opportunity cost of tank = 10 passenger autos

M5 Tank

Cadillac Coupe


M5 tanks growing.

The tank-auto trade-off:

an economist's view using the

Production Possibility Frontier

500

Autos

5,000


M5 tanks growing.

The tank-auto PPF:

one POSSIBLE point is

(2000 autos, 300 tanks)

another POSSIBLE point is

(4000 autos, 100 tanks)

500

300

Autos

5,000

2,000


M5 tanks growing.

The tank-auto PPF:

an IMPOSSIBLE point is

(4000 autos, 300 tanks)

500

300

Autos

4,000

5,000


M5 tanks growing.

500

200

an INEFFICIENT point is

(1000 autos, 200 tanks)

Autos

1,000

5,000


M5 tanks growing.

The tank-auto equation:

TANKS = 500 – 0.1 AUTOS

Check out a few values:

AUTOS TANKS

0 500

1000 400

2000 300

2001 299.9

500

Autos

5,000


M5 tanks growing.

  • Equation in general form:

  • TANKS = a + b AUTOS

  • How to find the equation from the graph:

  • a = Y-INTERCEPT = 500

  • b = SLOPE = rise over run = - 500 divided by 5000 = - 0.1

500

Autos

5,000


What the intercept means: growing.

TANKS = 500 – 0.1 AUTOS

IF we produced zero autos, we could produce up to

500 tanks, since

TANKS = 500 – 0.1 (0) = 500

M5 tanks

500

Autos

5,000


What happens when the intercept changes: growing.

TANKS = 600 – 0.1 AUTOS

IF we produced zero autos, we could produce up to

600 tanks, since

TANKS = 600 – 0.1 (0) = 600

The PPF would shift OUT and parallel to itself.

M5 tanks

600

500

This might be due to an increase in the resources available for production – for example, an increase in the labor force, and a new assembly line in the factory

Autos

5,000

6000


What the slope means: growing.

TANKS = 500 – 0.1 AUTOS

IF we were producing 2000 autos and 300 tanks

and if we decided to produce one more auto, we would have to reduce tank production to 299.9

The OPPORTUNITY COST of an auto is

one-tenth of a tank.

M5 tanks

500

Autos

5,000


What happens when the slope changes: growing.

TANKS = 500 – 0.05 AUTOS

If autos = 0, TANKS = 500

If autos = 5,000, TANKS = 250

If autos = 10,000, TANKS = 0

The possibility exists of producing more autos – perhaps some way of producing auto transmissions (but NOT tank transmissions) more rapidly has been discovered.

M5 tanks

500

Autos

5000

10,000


Introduction growing.

to Macroeconomics


Macroeconomics
Macroeconomics? growing.

  • A Study of aggregate behavior of

  • Macroeconomic variables

  • GDP

  • Price level

  • Employment

  • Interest rate

  • BOP


Let us look at the world economy today
Let us look at the world economy today growing.

  • Some Statistics


The circular flow of income

The circular flow of income growing.

The interdependence of

goods markets

and

factor markets


The interdependence of goods and factor markets
The interdependence of goods and factor markets growing.

FIRMS

(suppliers of goods and services,

demanders of factor services)

HOUSEHOLDS

(demanders of goods and services,

suppliers of factor services)


Rs growing.

Rs

Factor

services

Goods

S

S

PF2

P2

PF1

P1

D2

D2

D2

D1

D1

QF1

Q2

QF2

Q1

Factor

services

Goods

Rs

Rs

(2)

Producer

supply

(3)

Factor

demand

P

P

O

O

Q

Q

(4)

Factor

supply

(1)

Consumer

demand


The circular flow of income1

The circular flow of income growing.

Consumption, injections, withdrawals and equilibrium


Consumption of growing.

domestically

produced goods

and services (Cd)

Factor

payments

The circular flow of income

Firms

Households


Export growing.

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

In an opened economy

INJECTIONS

Consumption of

domestically

produced goods

and services (Cd)

Factor

payments

WITHDRAWALS


Macroeconomics policies growing. Microeconomic policies are intended to influence or control macroeconomics variables in order to achieve macroeconomics relationships and outcomes.

  • Fiscal policy-

  • The government’s decision over taxation and public spending, which are incorporate in the government’s budget, is referred to as fiscal policy.

  • Monetary policy-

  • Central bank’s control over money supply affecting interest rate is known as monetary policy.

  • Trade policy-

  • The government’s actions influencing international trade constitute trade policy.

  • Eg: - Tariffs,

  • Quantitative restrictions on import trade,

  • Subsidies on export trade,

  • Controls over the payments of foreign exchange


Macroeconomics policies cont
Macroeconomics policies cont.. growing.

  • Exchange Rate policy-

  • The system of exchange rate maintained in the economy is the exchange rate policy. This includes different systems such as fixed, floating or managed floating exchange rate systems.

  • Redistributive policy-

  • The governments usually design policy measures to redistribute income for the benefit of low-income groups. Income distribution through taxation and welfare are important components of the redistributive policy, included in the government budget.


Economic growing. Growth


Economic growth growing.

- An increase in an economy's ability to produce goods and services

- Sustainable increase in real output or real income of an economy

  • Therefore increasing economic output, is possible under two conditions:

  • More resources are used in the economy.

  • Existing resources are used more efficiently.


Measurement of Economic Growth growing.

1. Current Real GDP

2. National Output

3. PPF


Current real gdp
Current Real GDP growing.

Rate of GDP growth in yeart=

[Real GDPt - Real GDPt-1]/Real GDPt-1

Calculate GDP Growth


  • Controversies in economic growth growing.

  • GDP is not regarded as a good way of indicating the standard of living of individuals and households in an economy.

  • The current measure of GDP is not good at reflecting the damage to the environment caused by much economic activity.

  • Ignores unpaid, voluntary work

  • How has an economy developed?

  • Which industries does it depend on?

  • How sustainable are the routes that a country has chosen to follow towards the goal of growth?

  • How can we measure human happiness?


National output
National Output growing.

  • Relationship between total national outputs (Y) to inputs:

  • Output = Level of technology in the economy+ (productive services of capital + Labour input + Natural resource input) 

  • Y = A+ (K+L+R)

Output Grows due to:

-An increase in productive factors (K, L or R)

-An improvement in Technology (A)


Contribution to the economic growth
Contribution to the economic Growth growing.

  • 1. Human Resources

  • Increase in number of workers

  • Increase in working time

  • Improvement in quality of work force

    • Education, Training, Experience, Positive working attitudes

  • Use of technology

    • Computers, automated equipments

  • Improve working conditions

    • Rewards, pleasant working environment

Employment Rise

Increase in Contribution


  • 2. Natural resources growing.

  • Resources availability within the country

  • 3. Capital Formation

  • Machines, equipments, buildings and inventories

  • Depreciated when used in production

  • Grows due to investment


  • 4. Technology change and Innovation growing.

  • R & D is an economic activity aimed at producing technology

  • Invention – Discovery of New knowledge

  • Innovation – Incorporate new knowledge into production techniques

  • New tools and machines

  • Training and Experience

  • New Management practices & new ways of organizing activities


  • Sources of Growth - Where does it come from? growing.

  • The sources of growth include:

  • Natural resources

  • Labour

  • Capital

  • Technology

    • The pace of technological change will depend on:

      • Scientific skills of the country

      • Quality of education

      • Amount of GDP devoted to research and development



Total factor productivity
Total Factor Productivity growing.

  • Increase in output given the productive factors

  • Total Factor Productivity measured by change in Technology

  • A = Y - (K+L+R)

  • -Labour Productivity output per unit of Labour input

  • Y/L

  • -Labour productivity can improve due to :

  • Technology improvements

  • Capital accumulation – Capital Labour ratio


Actual and potential economic growth economic growth and the production possibility curve

(Actual and potential economic growth) growing.

Economic Growth and the Production Possibility Curve


Growth through making a fuller use of resources growing.

x

Production inside

the production

possibility curve

y

v

Food

O

Clothing


Growth in potential output growing.

Now

Food

O

Clothing


Growth in potential output growing.

5 years’ time

Food

Now

O

Clothing


Cost of economic growth
Cost of Economic Growth growing.

  • Inequality of income

  • Pollution and other negative externalities

  • Loss of non-renewable resources

  • Lifestyle changes


Growth and the business cycle

Growth and the business cycle growing.

The business cycle


The business cycle

Potential output growing.

3

4

2

Actual

output

1

The business cycle

National output

3

4

2

1

O

Time


The business cycle1

Trend growing.

output

The business cycle

Potential output

National output

Actual

output

O

Time


Growth and the business cycle1

Growth and the business cycle growing.

The business cycle

in practice



Growth rates in selected industrial countries
Growth rates in selected industrial countries growing.

Germany

UK

Japan

USA

France

Annual growth rate (%)


Causes to the booms and recession
Causes to the booms and Recession growing.

  • Random shocks

  • Policy-induced

  • Imported cycles

  • Expectations


Barriers to economic growth growing.

  • Insufficient or contaminated land

  • Substandard labor supply

  • Poor technical infrastructure

  • Poor social infrastructure

  • Poor industrial infrastructure



Why international trade is essential
Why international trade is essential ? growing.

  • Every Country lack some vital resources that it can get only by trading with others

  • Each country’s climate, labour force, & other endowments make it a relatively efficient producer of some goods & efficient producer of other goods

  • Specialization permits larger outputs & offer economies of large-scale production


Modern governments use three main devices when seeking to control trade
Modern Governments use three main devices when seeking to control trade

  • Tariff

    • Tax on imports

  • Quota

    • Legal limit on amount of goods import

  • Export Subsidy

    • Payment by the government to exporters to permit them to reduce the selling price


Foreign exchange market
Foreign Exchange Market control trade

  • Foreign currencies are bought and sold for local currencies

Exchange Rate

  • The price of foreign currency that has to be paid by the buyers of and, received by the suppliers of foreign exchange


Participants in the market
Participants in the Market control trade

  • Bank customers

  • Commercial Banks

  • Central Bank


Balance of payment
Balance of Payment control trade

  • Statistical Records of foreign exchange transactions of a country

  • Two main accounts

    • Inflow

    • outflow


The balance of payments account
The Balance of Payments Account control trade

  • The current account

    • International Trade in goods and services

    • Net Factor income flows

    • Net transfers








The balance of payments account1
The Balance of Payments Account control trade

  • The capital account

  • The financial account

    • investment

    • flows to and from reserves









Exchange rate
Exchange Rate control trade

  • The domestic price of a foreign currency unit or the foreign price of a domestic currency unit

    • LKR 100=US$ 1

    • US$ 0.01=LKR 1

  • Spot Exchange Rate – Current exchange rate quoted for immediate delivery

  • Forward Exchange Rate – Future exchange rate quoted for today for delivery after a time lag



Exchange rate system
Exchange Rate System against foreign currency

  • Floating exchange rate System

    • ER is determined in the foreign exchange Market demand for and supply of foreign exchange

  • Fixed exchange system

    • Determined by the central Bank


Where do the supply demand come of foreign exchange
Where do the Supply & Demand come of Foreign Exchange? against foreign currency

  • International Trade in Good & Services

  • International trade in financial instruments (Stocks & Bonds)

  • Purchase of physical assets


Determination of exchange rates
Determination of exchange rates against foreign currency

  • The equilibrium exchange rate

    • BoP equals zero

    • Demand – Inversely related to the ER

    • Supply – Positively related to ER


Determination of the rate of exchange
Determination of the rate of exchange against foreign currency

S by UK

Price of £ in $/Exchange Rate

D by USA

Q of £ /Foreign Exchange


Determination of the rate of exchange1

b against foreign currency

a

QS

QD

Determination of the rate of exchange

S by USA

$ price of £

D by UK

Q of $


Determination of the rate of exchange2

c against foreign currency

d

QD

QS

Determination of the rate of exchange

S by USA

$ price of £

D by UK

Q of £


Fixed versus floating exchange rates
Fixed versus Floating Exchange Rates against foreign currency

  • Advantages of fixed exchange rates

    • certainty

    • no speculation (if rate is absolutely fixed)

    • prevents 'irresponsible' government policies

  • Disadvantages of fixed exchange rates

    • conflicts with other macro objectives

    • danger of competitive deflations

    • problems of international liquidity

    • difficulties in adjusting to shocks

    • speculation


Fixed versus floating exchange rates1
Fixed versus Floating Exchange Rates against foreign currency

  • Advantages of free-floating rates

    • automatic correction

    • no problem of international liquidity

    • insulation from external events

    • less constraint on domestic macro policy

  • Disadvantages of free-floating rates

    • possibly unstable exchange rates

    • speculation

    • uncertainty for business

      • but use of forward markets

    • lack of discipline on economy


How to boost economic growth how can we grow more
How to Boost Economic Growth - How can we grow more against foreign currency

  • The policies to boost growth split into two types:

  • Demand-side policies ( fiscal policy and monetary policy)

  • Supply-side policies


Demand side policies
Demand-side policies against foreign currency

  • To boost the level of aggregate demand and therefore growth, the government needs to use deflationary policies. These are policies that help to generate more demand. They include:

  • Fiscal policy

  • Cutting tax rates to boost people's disposable income

  • Increasing the level of government expenditure

  • Monetary policy

  • Cutting interest rates to encourage more borrowing and spending


Supply side policies
Supply-side policies against foreign currency

  • These are policies that aim to boost the potential for the economy to grow - in other words to supply more. They are policies that should make the economy more productive and more responsive to change. Examples include:

  • Cutting tax rates - this gives people the incentive to work harder and be more productive

  • Cutting benefits - this gives the unemployed a bigger incentive to find a job; a harsh policy (but a fair one???).

  • Promoting education and training - this should make the workforce more skilled and therefore more productive.

  • Promoting research and development (R & D) - spending on R & D will help find new more efficient ways to produce and should lead to better and more varied products.

  • Promoting mobility - if the economy is to be as flexible as possible, people need to retrain where necessary and they need to move to where the jobs are. The government has to help encourage this.


The causes of economic growth
The Causes of Economic Growth against foreign currency

  • Economic Growth is caused by improvements in the quantity and quality of the factors of production that a country has available i.e. land, labour, capital and enterprise. Conversely economic decline may occur if the quantity and quality of any of the factors of production falls.

  • Improving the Quantity and Quality of Land Resources

  • Improving the Quantity and Quality of Human Resources

  • Improving the Quantity and Quality of Capital Resources



ad