Introduction to Macroeconomics

1. Introduction to Macroeconomics Chapter No.1

2. 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.

3. 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?

4. Some Important Concepts

5. 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.”

6. Output of the U.S. economy 1869-2008

7. The long-run growth in USA is a result of increase in population and average productivity of labour Force. APL = TP/L

8. 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.

9. 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.

10. Analytical Question Can average labour productivity fall even though total output is rising? Can the unemployment rate rise even though total output is rising?

11. 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.

12. Problem No.1 • Here are some macroeconomic data for the country of O for the years 2008 and 2009.

13. 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.

14. What Macroeconomists Do? • Macroeconomic Forecasting • Macroeconomic Analysis Monitoring of the economy and think about the implications of current economic events. • Macroeconomic Research

15. 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.

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

17. Economic Analysis • Positive Analysis • Normative Analysis

18. 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.

19. 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

20. 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.

21. 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

22. 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.

23. 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.

24. The Classical Approach (continued) • Thus, according to the classical approach, the government should have a limited role in the economy.

25. 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.

26. The Keynesian Approach (continued) • Therefore, according to the Keynesian approach, governments can take actions to alleviate unemployment.

27. 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.

28. 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.

29. 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.

30. 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 aboutflexibility of wages and prices in the short run.

31. The Measurement and Structure of the National Economy Chapter No.2

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

33. 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).

34. 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)

35. 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

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

37. 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)

38. 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)

39. 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

40. 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.

41. Net Export • Net exports are exports minus imports. • If exports are greater than imports NX >0. • If exports are less than imports NX<0.

42. Income-Expenditure Identity • Y = GDP = total production (or output) = total income = total expenditure; Y = C + I + G + NX.

43. Fundamental Identity of NationalIncome Accounting total production=total income=total expenditure

45. 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

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

47. 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.

48. 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).

49. 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.

50. 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.