Chapter 3 M acro-economic environment

1. Chapter 3Macro-economic environment

2. Topic list 1 The structure and objectives of the economy 2 Factors which affect the economy 3 The determination of national income 4 The business cycle 5 Inflation and its consequences 6 Unemployment

3. Topic list 7 Objective of economic growth 8 Government policies for managing the economy 9 Fiscal policy 10 Monetary policy 11 The balance of payments

4. 1 The structure and objectives of the economy • Income and expenditure flow • The total sales value of goods equal to the total expenditure on goods • The amount of expenditure equal to the total income of households

5. 1 The structure and objectives of the economy • Withdrawals and injection into the circular flow of income • Withdraws: • savings ,taxation, import expenditure • Injections: • investment, government spending, • export income

6. 2 Factors which affect the economy • Multiplier in the national economy • Injection of a certain size leads to a much larger increase in national income • An initial increase in expenditure will have a snowball effect

7. 2 Factors which affect the economy Aggregate supply and demand • aggregate demand is the total demand in the economy for goods and services • The aggregate demand curve • The aggregate supply refer to the ability of the economy to produce goods and service • Aggregate supply curve

8. 3 The determination of national income • An equilibrium national income will be reached where aggregate demand equals aggregate supply. • Inflationary gap • Deflationary gap

9. 4 The business cycle • Recession • Depression • Recovery • boom

10. 5 Inflation and its consequences • Inflation is the name given to an increase in price levels generally .it is also manifest in the decline in the purchasing power of money. • Redistribution of income and wealth • Balance of payments effects • Uncertainty of the value of money and prices • Resource costs of changing prices • Economic growth and investment

11. 5 Inflation and its consequences • Consumer price indices • Retail prices index • consumer prices index • Underlying rate of inflation • RPIX • RPIY

12. 5 Inflation and its consequences • Causes of inflation • Demand pull factors • Cost push factors • Import cost factors • Expectations • Excessive growth in money supply

13. 6 Unemployment • Rate of unemployment • Consequences of unemployment • Loss of output • Loss of human capital • Increasing inequalities in the distribution of income • Social costs • Increased burden of welfare payments

14. 6 Unemployment • Causes of unemployment • Real wage unemployment • Frictional unemployment • Seasonal unemployment • Structural unemployment • Technological unemployment • Cyclical or demand-deficient unemployment

15. 6 Unemployment • Government employment policies • Spending more money directly on jobs • Encouraging growth in private economy • Encouraging training in job skills • offering grant assistance to employers • Encouraging labour mobility • Reducing real wages to market clearing levels • Abolishing closed shop agreements • Abolishing minimum wage regulations

16. 7 Objective of economic growth • Economic growth measured by increases in the real gross national product per head of the population • Actual economic growth is the annual percentage increase in national output, fluctuates with trade cycle. • Potential economic growth is the rate at which the economy would grow if all resources utilised

17. 7 Objective of economic growth • Factors needed for sustained economic growth • Adequate level of new investment • Natural resources • Technological progress • External trade influences on economic growth

18. 7 Objective of economic growth • Advantages of economic growth • Higher income per head • High consumption • Better standard of living • Provide welfare services • Disadvantages of economic growth • Faster use of natural resources • Create pollution • structural unemployment • Require cut in consumption

19. 8 Government policies for managing the economy • Objectives of economic policy • Achieve economic growth • Control price inflation • Achieve full employment • Achieve a balance between exports and imports

20. 8 Government policies for managing the economy • Government spending • Wages and salaries to employees • Materials, supplies and services • Capital equipment • Interest on borrowings and repayments of capital • Benefits and pensions to those entitled to such

21. 8 Government policies for managing the economy • Significance of government tax and spending decisions to companies • Expenditure decisions by government affect suppliers to the government • There is a knock-on effect throughout the economy of government spending • Taxation affects consumers` purchasing power • Taxes on company profits and tax allowances affect the after-tax return • Investment by the public sector in which industry will benefit • Public sector investment have a longer time scale or less quantifiable economic benefits

22. 8 Government policies for managing the economy • Economic planning • Legal system relating to business • Responsibility for macro-economic management • Raise trade barriers to protect domestic industry • Subsidise exports or promote them • Encourage inward investment by foreign countries • Regional policy is of small scale economic planning

23. 8 Government policies for managing the economy • Government influence over commercial decision • Output capacity • Competition • Monopolies • Sales demand

24. 8 Government policies for managing the economy • Government influence over operational decision • Health and safety • Employment • Consumers • tax

25. 9 Fiscal policy • Components of the budget • Expenditure • Revenues • Borrowing

26. 9 Fiscal policy • Budget surplus and budget deficit • Budget surplus is government `s income exceeds its expenditure, and there is a negative PSNCR or public sector debt repayment (PSDR) • Budget deficit is government` s expenditure exceeds its income, there is a PSNCR.

27. 9 Fiscal policy • Functions of taxation • Raise revenues for the government • Cause certain products to be priced to take into account social costs • Redistribute income and wealth • Protect industries from foreign competition

28. 9 Fiscal policy • Direct taxes is paid direct by a person to the revenue authority. • Proportional tax • Progressive tax • Indirect taxes is collected by the revenue authority from an intermediary • Specific tax • Ad valorem tax

29. 10 Monetary policy • Objectives of monetary policy • Ultimate objective: • inflation, balance of trade , full employment and real economic growth. • Intermediate objectives : • level of interest rates , growth in the money supply , the exchange rate for sterling , the expansion of credit ,the growth of national income

30. 10 Monetary policy • The money supply as a intermediate target of monetary policy • Short-term effect may be unpredictable • The effect on interest rates might be erratic • Time lag before anything can be done • Time lag before control of the money supply alters expectations about inflation and wage demands

31. 10 Monetary policy • Interest rates as a target of monetary policy • Rise in interest rates will raise the price of borrowing ,and investment plans may be curtailed, individuals expected to reduce or postpone consumption. • Other effects of raising interest rates • Keep the value of sterling higher ,keep the cost of exports high ,discourage the purchase of exports • Attract foreign investors into sterling investments

32. 10 Monetary policy • The exchange rate as a target of monetary policy • Fall in the exchange rate give stimulus to exports and reduce demand for imports, adds to the rate of inflation • Increase in the exchange rate have the opposite effect • Exchange rate is dependent on both domestic rate of inflation and the level of interest rates

33. 10 Monetary policy • Targets and indicators • Leading indicator • Coincident indicator • Lagging indicator

34. 10 Monetary policy • Monetary indicators • The size of the money stock • Interest rates • The exchange rate ,the trade-weighted exchange rate index • The size of the government` s borrowing • Government borrowing as a percentage of gross domestic product

35. 10 Monetary policy • Monetary policy and fiscal policy • Monetary policy act as subsidiary support to fiscal policy and demand management • Low interest rates and absence of credit control • High interest rates • Strict credit controls

36. 11 The balance of payments • The nature of the balance of payments Monetary policy act as subsidiary support to fiscal policy and demand management • Income • From employment of UK residents by overseas firms • From capital investment overseas • Transfers • Public sector payments to and receipts from overseas such as EU • Non-government sector payments to and receipts from bodies such as EU

37. 11 The balance of payments • Equilibrium in the balance of paymentsIncome • Balance of payments is in equilibrium over a period of years ,the exchange rate remains stable and autonomous credits and debits are equal in value.

38. 11 The balance of payments • Surplus or deficit in the current account • Deficit :borrow more and more from abroad ,sell more and more of its assets, pressure on the exchange rate to depreciate in value • Surplus: invest the surplus abroad or add it to official reserves

39. 11 The balance of payments • How can a government rectify a current account deficit • Depreciation of the currency • Measures of Restrict imports • Domestic deflation to reduce aggregate demand

40. Q 3.5 Q 3.11