Macroeconomics Introduction

1. MacroeconomicsIntroduction Frederick University 2014

2. Economic Agents government Final goods and services L, N, K households firms

3. Factors Generating Economic Problems • Scarcity of resources • Technological changes • Changes in tastes and preferences

4. Generators Scarcity of resources Technological changes Changes in tastes and preferences Questions What (and how much) How For whom Main Economic Questions

5. Questions What and how much How For Whom Problems Efficiency in allocation Efficiency in motivation Efficiency in distribution Main Economic problems

6. Economics Economics is the study of how economic agents make decisions what to produce, how to produce, and for whom to produce

7. Microeconomics vs. Macroeconomics • Microeconomics – studies how economic agents make decisions what, how and for whom to produce from the point of view of individual households and firms • Macroeconomics - studies how economic agents make decisions what, how and for whom to produce from the perspective of the impact of these decisions on the national economy as a whole.

8. Major Macroeconomic Issues • Output • Employment and Unemployment • Price Level

9. Issues Output Employment and Unemployment Price level Objectives High level and rapid growth of output High level of employment and low level of involuntary unemployment Price level stability Macroeconomic objectives

10. Production Possibilities Frontier Production Possibilities Curve W 20 A 16 B C 12 16 F 0 6 10 M

11. Physical and Institutional PPF Physical PPF – indicates the potential of the economy to produce, constrained by the physical availability of resources w Physical PPF Institutional PPF M Institutional PPF – indicates the potential of the economy to produce, constrained by the physical availability of resources and by the rules and traditions followed by the decision makers

12. Institutional PPF and Potential Output • Potential Output – the maximum sustainable level of output that the economy can produce, given the productive capacity, the economy’s technological efficiency, and the rules and traditions, followed in the economy • When actual output exceeds potential output, price inflation tends to rise • When actual output falls below the potential, unemployment tend to increase

13. The Rate of Employment and The Rate of Unemployment • Employment Rate – reflects the fraction of working population over 16 and below 64 years • Unemployment rate – reflects the percentage of unemployed in the labor force • Labor force = employed + unemployed • Unemployment rate = [unemployed : (employed + unemployed)] x 100% • Natural rate of Unemployment – the rate of unemployment, determined by the institutional PPF and potential output.

14. Price Stability and the Rate of Inflation • Price stability – the price level is unchanged or rises very slowly • The Consumer Price Index (CPI) - measures the average price of goods and services bought by consumers • Rate of Inflation – the percentage change in the overall price level from one year to the next • Inflation 2012 = [(CPI20012 – CPI2011) : CPI2011] x 100%

15. Aggregate Demand AD – the quantity of GDP, which the economic agents are planning to buy at every price level,ceteris paribus Price level AD depends on: AD The willingness of households to buy output The willingness of firms to buy output Government fiscal and monetary policies output

16. Aggregate Supply Aggregate supply (AS) - the total quantity of goods and services that the firms in the country are willing to produce and sell at every price level, ceteris paribus. AS depends on: Price level AS Physical PPF – resources and technology Potential output determined by institutions, shaping costs, efficient use of resources Output

17. P AS and AD determine: equilibrium output the level of employment and unemployment the price level and the rate of inflation the balance of payments Macroeconomic Equilibrium AD AS E Output

18. Expenditures on final goods and services Final goods and services HOUSEHOLDS FIRMS Production factors Primary Income The Circular Flow

19. GDP • Gross Domestic Product – value of final goods and services produced in the economy within a year • Final goods and services – produced during the current period and not used in the production of other goods and services • Intermediate goods • The double counting problem

20. Stages of the production process of 1/2 kilo of bread: Wheat from the farmer – € 0.15 Flour from the miller – €0.43 Bread from the backer – €0.84 Value added Wheat – €0.15 Flour – €0.28 Bread – €0.41 Total Value added= = 0.15 + 0.28 + 0.41 = 0.84 Value Added

21. Economic Agents households firms government foreigners Expenditures C + I + G + X - M Expenditure Approach

22. Expenditure approach GDP = C + I + G + X – M = АЕ Aggregate Expenditures

23. Income approach GDP = ∑ primary income = • Wages and salaries • + proprietors’ income • + interests • + rents • + dividends • + retained earnings • + depreciation

24. Expenditure approach vs. Income approach АЕ • Indirect taxes • + subsidies = Primary income

25. Three approaches to GDP calculation • The value added approach • The expenditure approach • The income approach

26. GDP vs. GNP • GDP – created on the national territory • GNP – created by the citizens of the country

27. Net Domestic Product GDP (АЕ) – depreciation allowances = NDP

28. Domestic Income, Personal Incomeand Disposable Income GDP (income approach) - Depreciation = NDP (income approach) = Domestic income Domestic income - Retained earnings - Corporate taxes - Social security +Transfer payments to the households _________________________________ = Personal income -households’ income taxes = Disposable income

29. GDP Shortcomings • underground activities • income distribution • leisure time • demerit activities • market prices • public goods production at factor prices • quantity vs. quality • net exports might not contribute to the growth of welfare

30. Real vs. Nominal GDP • Nominal GDP – GDP at current prices • Real GDP – GDP at constant prices (base year prices – chosen year) • Index – the change in the value of an indicator compared to its previous level, taken as a base (= 100) • GDP deflator = (Nominal GDP : Real GDP) х 100