Introduction to Macroeconomics PDF

CHAPTER 8 INTRODUCTION TO MACROECONOMICS  LEARNING OUTCOMES  Understanding the origin of the development of macroeconomics.  Understanding macroeconomic variables.  Identifying relationships between variables.  Recognising the basic tools of macroeconomics.  INTRODUCT...

CHAPTER 8 INTRODUCTION TO MACROECONOMICS  LEARNING OUTCOMES  Understanding the origin of the development of macroeconomics.  Understanding macroeconomic variables.  Identifying relationships between variables.  Recognising the basic tools of macroeconomics.  INTRODUCTION  Development of macroeconomics.  Discuss related macroeconomic variables and the relationship between one variable to another that has an impact on the economy.  Basic tools of macroeconomics. The initial discussion of this chapter highlights the origin and development of macroeconomics.  MACROECONOMICS  The history of macroeconomics developed after the outbreak of the World Economic Recession.  Adam Smith and David Ricardo were pioneers of classical economics that proposed a basic macro-theory.  Discussions of macroeconomics cover national income and economic growth, inflation, unemployment, finance and banking, trade and macro-policy (monetary and fiscal).  MODERN MACROECONOMICS KEYNESIAN ERA  John Maynard Keynes (1936) – proposed modern macroeconomics – through the article “The General Theory of Employment, Interest and Money”.  "Keynesian Economics" - emphasises the importance of the government's role in regulating the economy to ensure economic stability, especially during recessions.  Due to the economy will not always reach equilibrium automatically.  MODERN MACROECONOMICS KEYNESIAN ERA  The government needs to intervene through fiscal policy and monetary policy.  Addressing issues such as unemployment, ensuring sufficient aggregate demand, etc.  After World War II, the field of POST-WORLD 1. macroeconomics grew rapidly. 2. Keynesian economics became the basis of WAR II many government economic policies around the world, especially after the war. The weaknesses of the Keynesian 3. Many countries use fiscal and monetary theory began to be replaced by policies to control the economic cycle and new theories of Monetarism. maximise economic growth.  In the 1970s, the weakness of Keynesian POST-WORLD 4. theory was highlighted when the phenomenon of stagflation (high inflation and unemployment) hit several developed countries. WAR II 5. A new theory exists - Monetarism put forward by Milton Friedman. 6. Monetarism – the importance of controlling the money supply – controls inflation and believes that the market will return to equilibrium without too much government intervention. 7. Macroeconomics continues to evolve – a variety of new approaches – a combination of ideas from POST-WORLD Keynesianism and Monetarism. Rational expectations and business cycle theory – WAR II 8. essential in understanding economic change. 9. Globalisation and technological developments have also had an impact on the macroeconomy. 10. Various issues – the role of global financial institutions, international trade relations, and financial crises impacting the global economy.  MACROECONOMIC VARIABLES  Macroeconomic variables refer to the main factors that affect the economy as a whole.  The variables are economic growth rates, inflation, unemployment and employment, balance of payments, deficit spending, interest rates, exchange rates, per capita income, investment, social welfare index, etc.  ECONOMIC GROWTH  Economic growth  An increase in the amount of goods and services produced by an economy in a certain period - 1 year.  GDP is the main measurement of economic growth. MALAYSIA - GDP – ECONOMIC GROWTH 1980-2023  GROWTH RATE FORMULA GDP is a measure of the rate of economic growth Growth Rate = GDP Year 2 − GDP Year 1 × 100% GDP Year 1 1.1  GROSS DOMESTIC PRODUCT(GDP) Measured by 1. Nominal GDP o Valuing goods and services at market prices – there is an inflationary effect, which is a general increase in the price of goods and services. o Usability - the formation of economic policies, monitoring of economic performance, as well as for comparison between countries in the global context. GROSS DOMESTIC PRODUCT (GDP) 2. Real GDP o Assess prices of goods and services using fixed prices from the base year – no inflationary effect. o The real economic growth of the country – measures the growth of economic output without being affected by price changes.  GDP DEFLATOR  GDP Deflator is calculated to see if the country is experiencing inflation or deflation. GDP defla𝑡𝑜𝑟 = GDP 𝑛𝑜𝑚𝑖𝑛𝑎𝑙 × 100 GDP real 1.2 TABLE 1.2: GDP NOMINAL, GDP REAL & GDP DEFLATOR Price of Price of Quantity Quantity YEAR burger donut of burger of donut TABLE 1.2: GDP NOMINAL, GDP REAL & GDP DEFLATOR Nominal GDP Calculation 2021 (RM1 price of burger × 100 burger) + (RM2 price of donut × 50 donut) = RM200 2022 (RM2 price of burger × 150 burger) + (RM3 price of donut × 100 donut) = RM600 2023 (RM3 price of burger × 200 burger) + (RM4 price of donut × 150 donut) = RM1,200 Real GDP Calculation (2021 as base year) 2021 (RM1 price of burger × 100 burger) + (RM2 price of donut × 50 donut) = RM200 2022 (RM1 price of burger × 150 burger) + (RM2 price of donut × 100 donut) = RM350 2023 (RM1 price of burger × 200 burger) + (RM2 price of donut × 150 donut) = RM500 CDP Deflator Calculation 2021 (RM 200 ÷ RM 200) × 100 = 100 2022 (RM 600 ÷ RM 350) × 100 = 171 (price increased of 71%) 2023 (RM 1,200 ÷ RM 500) × 100 = 240 (price increased of 140%)  IMPORTANT CONCEPTS 1. BUSINESS CYCLE - fluctuations in GDP. A complete round of fluctuations and ups in GDP, hence it is said the occurrence of a business cycle. 1. Expansion 2. Peak Recession 6 Phase 3. 4. Trough 5. Depression 6. Recovery  Peak – marks the highest point in the business cycle. At this stage, economic activities reach BUSINESS CYCLE their maximum level Recession – is a state of contraction. This phase sees a decline in economic activity. Trough – the lowest point in the business cycle, - economic activities reach the lowest level - Unemployment high, consumer spending low, and businesses are operating below capacity. However, it is also the point where the economy begins to recover. Depression –long-lasting form of recession - economy is in a very weak state and may take a long time to recover - GDP falls sharply and unemployment is very high. Recovery – the economy begins to emerge from the trough phase. GDP growth and consumer demand begin to increase again. Unemployment begins to decline and business investment recovers. Expansion – the economy expands and shows economic growth.  IMPORTANT CONCEPTS 2. INFLATION, DEFLATION, STAGFLASI & DESINFLATION Inflation refers to an Deflation – a decrease increase in the increase in in the general price the price of goods and level. services. Stagflation – There are both Disinflation – conditions of unemployment There is a decrease and high inflation. in the inflation rate.  01 INFLATION INDICATOR  IHP – Consumer  IPP – Producer  IHPb – Construction - Building Materials  01 INFLATION INDICATOR  IHP – The average change in the price of goods and services purchased by consumers at any given time.  IPP – changes in the price that manufacturers receive for their goods and services before they reach the end consumer.  IHPb – measure price changes in the development sector.  02 FORMULA IHP 𝐼𝐻𝑃 = Price of the current year × 100 Price of the base year 1.3 Rate of inflation = 𝐼𝐻𝑃 current year − 𝐼𝐻𝑃 base year × 100 𝐼𝐻𝑃 base year 1.4  Inflation causes the value of money to fall/decline. This is shown by the comparison between the base CPI and the current CPI. 03 THE RELATIONSHIP Money value (𝑁𝑊) = 𝐼𝐻𝑃base × 100% BETWEEN 𝐼𝐻𝑃 current 1.5 INFLATION RATES AND MONEY VALUE 03 THE RELATIONSHIP BETWEEN INFLATION RATES AND MONEY VALUE A positive inflation rate indicates a general price increase, while a negative inflation rate indicates a general price decline (deflation). Inflation rate : Year 2000 and 2023 Value of money between the years 2000 and 2003: Inflation rate = 125 − 100 × 100 Value of money (𝑁𝑊) = 100 x 100 100 125 = 25% = 80%  Prices in 2023 are 25% higher  The value of money has than prices in 2000. fallen/declined by 20% (100 − 80) in 2023 compared to 2000.  03 RELATIONSHIP BETWEEN INFLATION AND INTEREST RATES  Inflation Rate - the average rate of increase in the price of goods and services in the economy. When inflation rises, the purchasing power of money decreases.  Interest Rate – is the rate charged by the bank/financial institution on the loan given. Interest rates are also used by central banks as a monetary policy tool to control inflation.  Both indicators are important to the economy and are very influential. 03 RELATIONSHIP BETWEEN INFLATION AND INTEREST RATES  Inflation causes interest rates to rise.  An increase in interest rates will reduce the demand for money for purchasing activities, and increase borrowing costs (personal loans (consumption) and private loans (investment) decrease. and increase savings.  However, an increase in interest rates can increase savings.  Principally: when inflation rises, central banks raise interest rates to control inflation. On the other hand, if inflation is low (the economy is weak), interest rates may be reduced to encourage spending and investment. LABOUR FORCE, EMPLOYMENT & UNEMPLOYMENT RATE Total Unemployment × 100% Unemployment Rate = Total Labour Force 1.6 a. Example: b. U n e m p l o y m e n t r a t e : Total Employment = 5,500,000 Total Unemployment = 500,000 500,000 × 100% = 8.33% 6,000,000 Note: An unemployment rate of around 4% is known as natural unemployment LABOUR FORCE, EMPLOYMENT & UNEMPLOYMENT RATE Source: https://images.search.yahoo.com Figure 1.4: Unemployment in Malaysia, 1982-2019 and January – April 2020  THE RELATIONSHIP BETWEEN UNEMPLOYMENT AND INFLATION  In the short term, unemployment and inflation are usually inversely related.  An inverse relationship between the level of unemployment and the rate of change in wages (wage inflation).  THE RELATIONSHIP BETWEEN UNEMPLOYMENT AND INFLATION Figure 1.5 Phillips Short- Term Curve  EXCHANGE RATE  Exchange rate – the value of a country's currency in comparison with the currencies of other countries.  Trade relations between countries will involve the occurrence of foreign currency exchange.  The stronger the exchange rate, the higher the value of the country's money.  INTEREST RATE  Interest rates are an important variable that controls the macroeconomic course of a country.  Interest rates can have a significant impact on the economy as a whole.  Interest rate affects: 1. Investment – affects total employment. 2. Consumption – Consumers borrow money from a bank (loan). 3. Inflation – raising interest rates to control high inflation. 4. Currency exchange rate– Interest rates can affect currency exchange rates. 5. Economic balance– Interest rates are a monetary policy tool for central banks to strike a balance between stable economic growth, controlled inflation, and overall financial stability.  BALANCE OF PAYMENTS Balance of payments- Balance of payments- statements showing indicators of economic health, transactions between influence on currencies, countries. economic policies, and external balances. MACROECONOMIC POLICY  Financial/Monetary Policy Central Bank o Controlling the money supply o Interest rate. o Central banks change the total money supply (money) and interest rates to control aggregate demand to achieve the objectives of full employment and price stability. MACROECONOMIC POLICY  Fiscal Policy Government expenditure and taxation change policy to control aggregate expenditure/demand to achieve full employment and price stability.  Fiscal Tools/Instruments o Taxes o Expenses (expenses for development activities, subsidies, transfer fees, etc. MACROECONOMIC POLICY  Trade policy The policy of controlling international trade through foreign exchange rates to ensure a stable balance of payments for the country.  Foreign exchange policy  Central Bank will control the exchange rate of a country's currency with a foreign currency. MACROECONOMIC POLICY  Measures/steps that can be taken care 1. Exchange rate control Set a fixed or floating exchange rate. 2. Intervention in the foreign exchange market. Buying/selling national currencies to control the value of the currency. MACROECONOMIC POLICY  Measures/steps that can be taken care 3. Determining capital flows Controlling foreign currency inflows and outflows, by introducing regulations governing foreign direct investment (FDI) and portfolio investments. 4. Management of foreign reserves Foreign currency reserves to accommodate international trade needs and ensure that countries have access to foreign funds in the event of a crisis. 5. Various other policies. THANK YOU