UGBS 204: Macroeconomics for Business PDF

UGBS 204: MACROECONOMICS FOR BUSINESS INTRODUCTION TO MACROECONOMICS Feb, 2022 UGBS 204 (slide 1) June, 2022 1 / 38 What will we be doing? Basic theory of Macroeconomic principles, theory and concepts UGBS 204 (slide 2)...

UGBS 204: MACROECONOMICS FOR BUSINESS INTRODUCTION TO MACROECONOMICS Feb, 2022 UGBS 204 (slide 1) June, 2022 1 / 38 What will we be doing? Basic theory of Macroeconomic principles, theory and concepts UGBS 204 (slide 2) June, 2022 2 / 38 What will we be doing? Basic theory of Macroeconomic principles, theory and concepts Application of basic macroeconomic to explain everyday behaviour of households and businesses UGBS 204 (slide 2) June, 2022 2 / 38 What will we be doing? Basic theory of Macroeconomic principles, theory and concepts Application of basic macroeconomic to explain everyday behaviour of households and businesses Implications of economic events for you (as an individual) and your business UGBS 204 (slide 2) June, 2022 2 / 38 What will we be doing? Basic theory of Macroeconomic principles, theory and concepts Application of basic macroeconomic to explain everyday behaviour of households and businesses Implications of economic events for you (as an individual) and your business Policy response to economic shocks UGBS 204 (slide 2) June, 2022 2 / 38 What will we be doing? Basic theory of Macroeconomic principles, theory and concepts Application of basic macroeconomic to explain everyday behaviour of households and businesses Implications of economic events for you (as an individual) and your business Policy response to economic shocks How individuals, businesses respond to government policy UGBS 204 (slide 2) June, 2022 2 / 38 What will we be doing? Examples Ination rate for May 2022 is 27.6% 12th consecutive month of increase What are the causes? What are the implications for businesses and individuals? UGBS 204 (slide 3) June, 2022 3 / 38 What will we be doing? Examples What is GDP? How is it measured what is economic growth and why does it matter? Why does the economy grows fast sometimes and slowly at other times UGBS 204 (slide 4) June, 2022 4 / 38 What will we be doing? Examples Exchange rate determination Why is the Ghanaian cedi always depreciating What are the economic fundamentals that determine the exchange rate? UGBS 204 (slide 5) June, 2022 5 / 38 What will we be doing? Examples Exchange rate determination Why is the Ghanaian cedi always depreciating What are the economic fundamentals that determine the exchange rate? 2021 Census 13.7% of the labour force was unemplyed Too low? How did they arrive at this number? What does this mean? UGBS 204 (slide 5) June, 2022 5 / 38 What will we be doing?: Examples Monetary Policy Committee of the Bank of Ghana in May increased the Monetary Policy Rate to 19% in its last few meetings What does this mean for cost of borrowing for small businesses? UGBS 204 (slide 6) June, 2022 6 / 38 What will we be doing?: Examples Monetary Policy Committee of the Bank of Ghana in May increased the Monetary Policy Rate to 19% in its last few meetings What does this mean for cost of borrowing for small businesses? In March 2018 the BoG introduced the new method for setting interest rate: Ghana Reference Rate What was the rationale? Why does it matter? UGBS 204 (slide 6) June, 2022 6 / 38 What will we be doing?: Examples Monetary Policy Committee of the Bank of Ghana in May increased the Monetary Policy Rate to 19% in its last few meetings What does this mean for cost of borrowing for small businesses? In March 2018 the BoG introduced the new method for setting interest rate: Ghana Reference Rate What was the rationale? Why does it matter? 2022 Budget E-levy UGBS 204 (slide 6) June, 2022 6 / 38 Macroeconomics Macroeconomics studies the economy as an aggregate unit It is unlike micro which focuses on individuals markets macro focuses on all markets aggregated into one UGBS 204 (slide 7) June, 2022 7 / 38 Macroeconomics Macroeconomics studies the economy as an aggregate unit It is unlike micro which focuses on individuals markets macro focuses on all markets aggregated into one Typical issues studied in Macro Gross Domestic Product, Employment and Unemployment Ination & interest rates Fiscal and Monetary policy Economic growth and business cycles UGBS 204 (slide 7) June, 2022 7 / 38 Two main issues in Macro 1 Long-run economics Growth: 1 What determines long-term per capita income? 2 Why are some countries rich and some poor? 2 Business Cycle: 1 These are the short-term uctuations in output 2 What causes recessions? Are they all alike? Can they be avoided? 3 How can monetary and scal policy minimize the eects of economic uctuations? UGBS 204 (slide 8) June, 2022 8 / 38 Big Themes 1 Growth: What determines long-term growth? Why are some countries rich and some poor? 2 Business Cycle: What causes recessions? Are they all alike? Can they be avoided? Is there an economy's speed limit? 3 Ination: What causes ination (hyperination)? Why do we care? 4 Monetary and scal policy: Can monetary and scal policy stabilize the economy? How? Why does the BoG targets ination ? When do budget decits become a concern? 5 Financial Markets: Why do nancial markets respond to macroeconomic news? UGBS 204 (slide 9) June, 2022 9 / 38 Why Do We Study Macroeconomics? Understand the impact of government policy UGBS 204 (slide 10) June, 2022 10 / 38 Why Do We Study Macroeconomics? Understand the impact of government policy Impact of exchange rate movements UGBS 204 (slide 10) June, 2022 10 / 38 Why Do We Study Macroeconomics? Understand the impact of government policy Impact of exchange rate movements Interest rate uctuations and cost of borrowing UGBS 204 (slide 10) June, 2022 10 / 38 Why Do We Study Macroeconomics? Understand the impact of government policy Impact of exchange rate movements Interest rate uctuations and cost of borrowing Financial markets and investors responds to macroeconomic news UGBS 204 (slide 10) June, 2022 10 / 38 Why Do We Study Macroeconomics? Understand the impact of government policy Impact of exchange rate movements Interest rate uctuations and cost of borrowing Financial markets and investors responds to macroeconomic news Sales forecast UGBS 204 (slide 10) June, 2022 10 / 38 Some Basic Concepts (1) GDP: It is the market value of nal goods and services newly produced within a xed period of time, within the geographic boundaries of a country UGBS 204 (slide 11) June, 2022 11 / 38 Some Basic Concepts (1) GDP: It is the market value of nal goods and services newly produced within a xed period of time, within the geographic boundaries of a country Unemployment is the number of people who are available for work and actively looking for work but cannot nd jobs the unemployment rate is the fraction of the labour force that without employment UGBS 204 (slide 11) June, 2022 11 / 38 Some Basic Concepts (1) GDP: It is the market value of nal goods and services newly produced within a xed period of time, within the geographic boundaries of a country Unemployment is the number of people who are available for work and actively looking for work but cannot nd jobs the unemployment rate is the fraction of the labour force that without employment Ination: it is the rate at which the general/average level of prices in an economy increases Deation refers to decreases in the general level of prices in an economy UGBS 204 (slide 11) June, 2022 11 / 38 Some Basic Concepts (2) Business cycles: refer to the short-run contractions and expansions in economic activity in an economy It refers to the cycles of recessions and recoveries that characterizes economies in the short run UGBS 204 (slide 12) June, 2022 12 / 38 Some Basic Concepts (2) Business cycles: refer to the short-run contractions and expansions in economic activity in an economy It refers to the cycles of recessions and recoveries that characterizes economies in the short run Macroeconomic policies: these are the two main sets of policy tools available to the government (central bank) for aecting short-term economy activity Fiscal policy refers to the use of government spending and taxes to aect economic activity Monetary policy refers to changes in money supply that are used to aect the level of economic activity and/or control the rate of ination UGBS 204 (slide 12) June, 2022 12 / 38 Classicals vs Keynesian Approaches Most of the disagreements in positive macroeconomics have their roots in the disagreements between the Classical and Keynesian schools of thought UGBS 204 (slide 13) June, 2022 13 / 38 Classicals vs Keynesian Approaches Most of the disagreements in positive macroeconomics have their roots in the disagreements between the Classical and Keynesian schools of thought At the heart of this disagreement is the speed of adjustment of prices in various markets UGBS 204 (slide 13) June, 2022 13 / 38 Classicals vs Keynesian Approaches Most of the disagreements in positive macroeconomics have their roots in the disagreements between the Classical and Keynesian schools of thought At the heart of this disagreement is the speed of adjustment of prices in various markets Classicals, following Adam Smith's Invisible Hand, believe that markets adjusts almost instantly so all markets are always in equilibrium this gives no room for scal and monetary policy UGBS 204 (slide 13) June, 2022 13 / 38 Classicals vs Keynesian Approaches Most of the disagreements in positive macroeconomics have their roots in the disagreements between the Classical and Keynesian schools of thought At the heart of this disagreement is the speed of adjustment of prices in various markets Classicals, following Adam Smith's Invisible Hand, believe that markets adjusts almost instantly so all markets are always in equilibrium this gives no room for scal and monetary policy Keynesians believe that adjustments can take a long time, the economy can be in disequilibrium for a while in the long run, we are all dead UGBS 204 (slide 13) June, 2022 13 / 38 Circular-ow model The circular ow model is a simple way to visually show the economic transactions that occur between households and rms in the economy UGBS 204 (slide 14) June, 2022 14 / 38 Circular-ow model The circular ow model is a simple way to visually show the economic transactions that occur between households and rms in the economy Firms hire and use factors of production from households for use in the production process UGBS 204 (slide 14) June, 2022 14 / 38 Circular-ow model The circular ow model is a simple way to visually show the economic transactions that occur between households and rms in the economy Firms hire and use factors of production from households for use in the production process Firms then produce and sell the goods and services to households UGBS 204 (slide 14) June, 2022 14 / 38 Circular-Flow UGBS 204 (slide 15) June, 2022 15 / 38 Households in the Circular-Flow Households are the owners of factors of production UGBS 204 (slide 16) June, 2022 16 / 38 Households in the Circular-Flow Households are the owners of factors of production They sell these factors of production to rms in return for wages and rents UGBS 204 (slide 16) June, 2022 16 / 38 Households in the Circular-Flow Households are the owners of factors of production They sell these factors of production to rms in return for wages and rents With these incomes (wages and rents) they buy and consume goods and services produced by rms UGBS 204 (slide 16) June, 2022 16 / 38 Markets in the Circular-Flow Market for factors of production households supply (sell) factors of production rms buy the factors of production UGBS 204 (slide 17) June, 2022 17 / 38 Markets in the Circular-Flow Market for factors of production households supply (sell) factors of production rms buy the factors of production The factors of production land, labor and capital UGBS 204 (slide 17) June, 2022 17 / 38 Markets in the Circular-Flow Market for factors of production households supply (sell) factors of production rms buy the factors of production The factors of production land, labor and capital Market for goods and services rms sell the goods and services (supply side) households buy the goods and services (demand side) UGBS 204 (slide 17) June, 2022 17 / 38 What is National Income Accounting? National income accounting refers to the framework for measuring the current level of economic activity By current level of economic activity we mean GDP UGBS 204 (slide 18) June, 2022 18 / 38 What is National Income Accounting? National income accounting refers to the framework for measuring the current level of economic activity By current level of economic activity we mean GDP In Ghana the calculation is done by the Ghana Statistical Service UGBS 204 (slide 18) June, 2022 18 / 38 What is National Income Accounting? National income accounting refers to the framework for measuring the current level of economic activity By current level of economic activity we mean GDP In Ghana the calculation is done by the Ghana Statistical Service Three main approaches to the calculation amount of output produced, excluding output used up in intermediate stages incomes received by the producers of output amount of spending by the ultimate purchases of output UGBS 204 (slide 18) June, 2022 18 / 38 Measuring GDP We dened GDP as the market value of nal goods and services newly produced within a xed period of time, within the geographic boundaries of a country UGBS 204 (slide 19) June, 2022 19 / 38 Measuring GDP We dened GDP as the market value of nal goods and services newly produced within a xed period of time, within the geographic boundaries of a country We are interested in market value so we value each good at the price at which they are sold we cannot add oranges to taxi services we convert physical quantities into cedi value UGBS 204 (slide 19) June, 2022 19 / 38 Measuring GDP We dened GDP as the market value of nal goods and services newly produced within a xed period of time, within the geographic boundaries of a country We are interested in market value so we value each good at the price at which they are sold we cannot add oranges to taxi services we convert physical quantities into cedi value We are also interested in nal goods only we exclude intermediate goods and services UGBS 204 (slide 19) June, 2022 19 / 38 Measuring GDP We dened GDP as the market value of nal goods and services newly produced within a xed period of time, within the geographic boundaries of a country We are interested in market value so we value each good at the price at which they are sold we cannot add oranges to taxi services we convert physical quantities into cedi value We are also interested in nal goods only we exclude intermediate goods and services Finally, we are interested only newly produced goods and services in that period purchases of goods and services produced in the previous periods are excluded. UGBS 204 (slide 19) June, 2022 19 / 38 Three approaches to calculating GDP Product approach/value-added approach measures economic activity by adding up the market value of all newly produced goods and services, excludes intermediate inputs to avoid double counting also computes economic activity by summing up value-added at each stage of production UGBS 204 (slide 20) June, 2022 20 / 38 Three approaches to calculating GDP Product approach/value-added approach measures economic activity by adding up the market value of all newly produced goods and services, excludes intermediate inputs to avoid double counting also computes economic activity by summing up value-added at each stage of production Income approach measures GDP by summing up all incomes received by factors of production wages/salaries of workers, rents paid to xed assets, prots received by business owners, interest accruing to capital UGBS 204 (slide 20) June, 2022 20 / 38 Three approaches to calculating GDP Product approach/value-added approach measures economic activity by adding up the market value of all newly produced goods and services, excludes intermediate inputs to avoid double counting also computes economic activity by summing up value-added at each stage of production Income approach measures GDP by summing up all incomes received by factors of production wages/salaries of workers, rents paid to xed assets, prots received by business owners, interest accruing to capital Expenditure approach measures GDP by adding all spending by ultimate users of nal output household expenditures, rms' investment expenditures government purchases of goods and services UGBS 204 (slide 20) June, 2022 20 / 38 All Three approaches are Equivalent The Fundamental Identity total income=total production=total expenditures UGBS 204 (slide 21) June, 2022 21 / 38 All Three approaches are Equivalent The Fundamental Identity total income=total production=total expenditures Income=expenditures: what sellers of the total output receive must be equal to what buyers spend UGBS 204 (slide 21) June, 2022 21 / 38 All Three approaches are Equivalent The Fundamental Identity total income=total production=total expenditures Income=expenditures: what sellers of the total output receive must be equal to what buyers spend Production=expenditures: the market value of total production equals the amount spent on it UGBS 204 (slide 21) June, 2022 21 / 38 All Three approaches are Equivalent The Fundamental Identity total income=total production=total expenditures Income=expenditures: what sellers of the total output receive must be equal to what buyers spend Production=expenditures: the market value of total production equals the amount spent on it Income=production: Market value of production should equal what is paid to factors of production UGBS 204 (slide 21) June, 2022 21 / 38 All Three approaches are Equivalent The Fundamental Identity total income=total production=total expenditures Income=expenditures: what sellers of the total output receive must be equal to what buyers spend Production=expenditures: the market value of total production equals the amount spent on it Income=production: Market value of production should equal what is paid to factors of production This identity means that the all the three approaches to measuring GDP are equivalent UGBS 204 (slide 21) June, 2022 21 / 38 Computation of GDP (expenditure approach) The expenditure approach is the most common (most important) approach used in computing GDP UGBS 204 (slide 22) June, 2022 22 / 38 Computation of GDP (expenditure approach) The expenditure approach is the most common (most important) approach used in computing GDP sums up four main sources of expenditure on GDP: Y = C + I + G + NX UGBS 204 (slide 22) June, 2022 22 / 38 Computation of GDP (expenditure approach) The expenditure approach is the most common (most important) approach used in computing GDP sums up four main sources of expenditure on GDP: Y = C + I + G + NX C: consumption expenditures: durables, non-durables, services UGBS 204 (slide 22) June, 2022 22 / 38 Computation of GDP (expenditure approach) The expenditure approach is the most common (most important) approach used in computing GDP sums up four main sources of expenditure on GDP: Y = C + I + G + NX C: consumption expenditures: durables, non-durables, services I: Gross domestic private investment: business xed investment residential investment (houses) inventories (produced but not sold) UGBS 204 (slide 22) June, 2022 22 / 38 Computation of GDP (expenditure approach) sums up four main sources of expenditure on GDP: Y = C + I + G + NX UGBS 204 (slide 23) June, 2022 23 / 38 Computation of GDP (expenditure approach) sums up four main sources of expenditure on GDP: Y = C + I + G + NX Government expenditures on goods and services expenditures on law enforcement, defense, salaries of govt workers etc capital expenditures on roads and other infrastructure Excludes transfer payments eg SSNIT pensions, interest payments on debts UGBS 204 (slide 23) June, 2022 23 / 38 Computation of GDP (expenditure approach) sums up four main sources of expenditure on GDP: Y = C + I + G + NX Government expenditures on goods and services expenditures on law enforcement, defense, salaries of govt workers etc capital expenditures on roads and other infrastructure Excludes transfer payments eg SSNIT pensions, interest payments on debts NX: net exports total exports minus total imports UGBS 204 (slide 23) June, 2022 23 / 38 GDP vs GNP Gross National Product (GNP) is the market value of nal goods and services newly produced by domestic factors of production during the current period This is the total nal output produced by the nationals/citizens of a country UGBS 204 (slide 24) June, 2022 24 / 38 GDP vs GNP Gross National Product (GNP) is the market value of nal goods and services newly produced by domestic factors of production during the current period This is the total nal output produced by the nationals/citizens of a country The dierence between GDP and GNP is called the Net Factor payments from abroad (NFP) UGBS 204 (slide 24) June, 2022 24 / 38 GDP vs GNP Gross National Product (GNP) is the market value of nal goods and services newly produced by domestic factors of production during the current period This is the total nal output produced by the nationals/citizens of a country The dierence between GDP and GNP is called the Net Factor payments from abroad (NFP) NFP is incomes/earnings paid to domestic factors of production by the rest of the world less income paid to foreign-owned factors of production by the domestic economy UGBS 204 (slide 24) June, 2022 24 / 38 GDP vs GNP Gross National Product (GNP) is the market value of nal goods and services newly produced by domestic factors of production during the current period This is the total nal output produced by the nationals/citizens of a country The dierence between GDP and GNP is called the Net Factor payments from abroad (NFP) NFP is incomes/earnings paid to domestic factors of production by the rest of the world less income paid to foreign-owned factors of production by the domestic economy GDP=GNP-NFP UGBS 204 (slide 24) June, 2022 24 / 38 From GDP to Disposable Income (private) Disposable income is the amount of income available to the private sector to spend (and save) UGBS 204 (slide 25) June, 2022 25 / 38 From GDP to Disposable Income (private) Disposable income is the amount of income available to the private sector to spend (and save) This is income after deductions (taxes, SSNIT, etc) plus transfer payments UGBS 204 (slide 25) June, 2022 25 / 38 From GDP to Disposable Income (private) Disposable income is the amount of income available to the private sector to spend (and save) This is income after deductions (taxes, SSNIT, etc) plus transfer payments NFP is incomes/earnings paid to domestic factors of production by the rest of the world less income paid to foreign-owned factors of production by the domestic economy UGBS 204 (slide 25) June, 2022 25 / 38 From GDP to Disposable Income (private) Disposable income is the amount of income available to the private sector to spend (and save) This is income after deductions (taxes, SSNIT, etc) plus transfer payments NFP is incomes/earnings paid to domestic factors of production by the rest of the world less income paid to foreign-owned factors of production by the domestic economy For the economy as a whole, total private disposable income is: Disposableincome = Y + NFP + TR + INT − T TR is transfer payments from government, INT is interest payments T is taxes UGBS 204 (slide 25) June, 2022 25 / 38 Aggregate Savings Total savings in an economy is the sum of private and government savings UGBS 204 (slide 26) June, 2022 26 / 38 Aggregate Savings Total savings in an economy is the sum of private and government savings Private savings is disposable income less consumption Spriv = Disposableincome − C = Y + NFP + TR + INT − T − C UGBS 204 (slide 26) June, 2022 26 / 38 Aggregate Savings Total savings in an economy is the sum of private and government savings Private savings is disposable income less consumption Spriv = Disposableincome − C = Y + NFP + TR + INT − T − C Government savings is the government net income less government purchases Sgovt = (T − TR − INT ) − G UGBS 204 (slide 26) June, 2022 26 / 38 Aggregate Savings Total savings in an economy is the sum of private and government savings Private savings is disposable income less consumption Spriv = Disposableincome − C = Y + NFP + TR + INT − T − C Government savings is the government net income less government purchases Sgovt = (T − TR − INT ) − G national (aggregate savings) is the sum of the two S = Spriv + Sgovt = Y + NFP − C − G (1) UGBS 204 (slide 26) June, 2022 26 / 38 Uses of Private Savings Starting with the equation for national savings (1) we can substitute the expression for Y S = Y + NFP − C − G = C + I + G + NX + NFP − C − G UGBS 204 (slide 27) June, 2022 27 / 38 Uses of Private Savings Starting with the equation for national savings (1) we can substitute the expression for Y S = Y + NFP − C − G = C + I + G + NX + NFP − C − G We can simplify this expression to obtain: S = I + (NX + NFP) (2) UGBS 204 (slide 27) June, 2022 27 / 38 Uses of Private Savings Starting with the equation for national savings (1) we can substitute the expression for Y S = Y + NFP − C − G = C + I + G + NX + NFP − C − G We can simplify this expression to obtain: S = I + (NX + NFP) (2) The sum of NX and NFP is called the Current Account balance from the balance of payments accounts S = I + CA This equation states that national savings are used to nance national investment and the current account balance It also means that the CA balance is the excess of national savings over investment UGBS 204 (slide 27) June, 2022 27 / 38 The Twin Decits The national income accounting identities can also be used to illustrate the so-called twin decits UGBS 204 (slide 28) June, 2022 28 / 38 The Twin Decits The national income accounting identities can also be used to illustrate the so-called twin decits This is the relationship between the government budget decit and current account decit UGBS 204 (slide 28) June, 2022 28 / 38 The Twin Decits The national income accounting identities can also be used to illustrate the so-called twin decits This is the relationship between the government budget decit and current account decit From our previous denitions, GNP is given by Y = C + I + G + NX + NFP => Y − C − I = G + CA UGBS 204 (slide 28) June, 2022 28 / 38 The Twin Decits The national income accounting identities can also be used to illustrate the so-called twin decits This is the relationship between the government budget decit and current account decit From our previous denitions, GNP is given by Y = C + I + G + NX + NFP => Y − C − I = G + CA If we subtract taxes from both sides, we have Y − C − I − T = G + CA − T => S − I = CA − (T − G ) UGBS 204 (slide 28) June, 2022 28 / 38 The Twin Decit (2) S − I = CA − (T − G ) This equation states that the excess of private savings over private investment nances the current account and the government budget decit. UGBS 204 (slide 29) June, 2022 29 / 38 The Twin Decit (2) S − I = CA − (T − G ) This equation states that the excess of private savings over private investment nances the current account and the government budget decit. If private savings equal private investment, then the CA equals government budget decit. T − G = CA UGBS 204 (slide 29) June, 2022 29 / 38 The Twin Decit (2) S − I = CA − (T − G ) This equation states that the excess of private savings over private investment nances the current account and the government budget decit. If private savings equal private investment, then the CA equals government budget decit. T − G = CA The last expression suggests that if the government runs a budget decit, in the absence of excess savings from the private sector, this translates into current account decit UGBS 204 (slide 29) June, 2022 29 / 38 Economic Performance Over Time Typically, we calculate GDP per capita (per capita income) GDP population UGBS 204 (slide 30) June, 2022 30 / 38 Economic Performance Over Time Typically, we calculate GDP per capita (per capita income) GDP population How well is the Ghanaian economy doing today compared with three years ago? UGBS 204 (slide 30) June, 2022 30 / 38 Economic Performance Over Time Typically, we calculate GDP per capita (per capita income) GDP population How well is the Ghanaian economy doing today compared with three years ago? Ghana is now a lower middle income country! Really?? UGBS 204 (slide 30) June, 2022 30 / 38 Economic Activity or Economic Wellbeing? GDP calculates the level of economic activity within an economy UGBS 204 (slide 31) June, 2022 31 / 38 Economic Activity or Economic Wellbeing? GDP calculates the level of economic activity within an economy Some use GDP as a measure of economic wellbeing higher GDP per capita means higher income; ability to meet basic needs and more UGBS 204 (slide 31) June, 2022 31 / 38 Economic Activity or Economic Wellbeing? Several limitations to using GDP (GDP per capita) as a measure of economic wellbeing UGBS 204 (slide 32) June, 2022 32 / 38 Economic Activity or Economic Wellbeing? Several limitations to using GDP (GDP per capita) as a measure of economic wellbeing Distributional issues Does not matter if only the president owns/uses all the economic resources and the rest of us starve UGBS 204 (slide 32) June, 2022 32 / 38 Economic Activity or Economic Wellbeing? Several limitations to using GDP (GDP per capita) as a measure of economic wellbeing Distributional issues Does not matter if only the president owns/uses all the economic resources and the rest of us starve Non-welfare elements add to GDP: high military spending does not mean our standard of living is improving UGBS 204 (slide 32) June, 2022 32 / 38 Economic Activity or Economic Wellbeing? Several limitations to using GDP (GDP per capita) as a measure of economic wellbeing Distributional issues Does not matter if only the president owns/uses all the economic resources and the rest of us starve Non-welfare elements add to GDP: high military spending does not mean our standard of living is improving Non-market production: Not every good/service is counted Baby-sitting is not counted but the employing a nanny to do the same is counted UGBS 204 (slide 32) June, 2022 32 / 38 Real vs Nominal GDP? Real GDP measures actual physical volumes of economic activity GDP at constant prices excludes changes in prices UGBS 204 (slide 33) June, 2022 33 / 38 Real vs Nominal GDP? Real GDP measures actual physical volumes of economic activity GDP at constant prices excludes changes in prices Nominal GDP is the cedi value of the all economic activity measures value of GDP in current cedis includes changes in both physical quantities and prices UGBS 204 (slide 33) June, 2022 33 / 38 Real vs Nominal GDP? Real GDP measures actual physical volumes of economic activity GDP at constant prices excludes changes in prices Nominal GDP is the cedi value of the all economic activity measures value of GDP in current cedis includes changes in both physical quantities and prices The dierence between growth of nominal and real GDP is solely due to changes in prices UGBS 204 (slide 33) June, 2022 33 / 38 Real vs Nominal GDP: example Assume the economy of Ghana produces only Kelewele and Pure water UGBS 204 (slide 34) June, 2022 34 / 38 Real vs Nominal GDP: example Assume the economy of Ghana produces only Kelewele and Pure water Our goal is to compare GDP between 2010 and 2014 UGBS 204 (slide 34) June, 2022 34 / 38 Real vs Nominal GDP: example Assume the economy of Ghana produces only Kelewele and Pure water Our goal is to compare GDP between 2010 and 2014 Nominal GDP 2010 Nominal GDP 2014 Real GDP 2014 Kelewele 15 @ GHC 10 20 @ GHC 15 20 @ GHC10 Pure water 50 @ GHC 2 60 @ GHC 2.50 60 @ GHC 2 Total GHC 250 GHC 450 320 UGBS 204 (slide 34) June, 2022 34 / 38 Real vs Nominal GDP: example In the example above, what is the growth rate of nominal GDP between 2010 and 2014? 450−250 250 ∗ 100% = 80% UGBS 204 (slide 35) June, 2022 35 / 38 Real vs Nominal GDP: example In the example above, what is the growth rate of nominal GDP between 2010 and 2014? 450−250 250 ∗ 100% = 80% In the example above, what is the growth rate of real GDP between 2010 and 2014? 320−250 250 ∗ 100% = 28% UGBS 204 (slide 35) June, 2022 35 / 38 Real vs Nominal GDP: example In the example above, what is the growth rate of nominal GDP between 2010 and 2014? 450−250 250 ∗ 100% = 80% In the example above, what is the growth rate of real GDP between 2010 and 2014? 320−250 250 ∗ 100% = 28% In this example, we call 2010 the base year, as the prices from this year are used for calculating changes in real GDP UGBS 204 (slide 35) June, 2022 35 / 38 Real vs Nominal GDP: example In the example above, what is the growth rate of nominal GDP between 2010 and 2014? 450−250 250 ∗ 100% = 80% In the example above, what is the growth rate of real GDP between 2010 and 2014? 320−250 250 ∗ 100% = 28% In this example, we call 2010 the base year, as the prices from this year are used for calculating changes in real GDP In Ghana, the real GDP is now calculated using 2006 as the base year UGBS 204 (slide 35) June, 2022 35 / 38 Price indexes: GDP deator A price index is a measure of the average level of prices for a specied set of goods and services relative to the prices in a specied base year UGBS 204 (slide 36) June, 2022 36 / 38 Price indexes: GDP deator A price index is a measure of the average level of prices for a specied set of goods and services relative to the prices in a specied base year The GDP deator is a price index that measures the overall level of prices goods and services included in the GDP UGBS 204 (slide 36) June, 2022 36 / 38 Price indexes: GDP deator A price index is a measure of the average level of prices for a specied set of goods and services relative to the prices in a specied base year The GDP deator is a price index that measures the overall level of prices goods and services included in the GDP GDPdeflator = GDP nominal GDPreal ∗ 100 UGBS 204 (slide 36) June, 2022 36 / 38 Price indexes: GDP deator A price index is a measure of the average level of prices for a specied set of goods and services relative to the prices in a specied base year The GDP deator is a price index that measures the overall level of prices goods and services included in the GDP GDPdeflator = GDP nominal GDPreal ∗ 100 In our example, the GDP deator is 450 320 ∗ 100 = 140.63 UGBS 204 (slide 36) June, 2022 36 / 38 Consumer Price Index and Ination The GDP deator can be used to measure the rate of ination UGBS 204 (slide 37) June, 2022 37 / 38 Consumer Price Index and Ination The GDP deator can be used to measure the rate of ination The Consumer Price Index (CPI) is a more common measure of ination UGBS 204 (slide 37) June, 2022 37 / 38 Consumer Price Index and Ination The GDP deator can be used to measure the rate of ination The Consumer Price Index (CPI) is a more common measure of ination The CPI is a price index of consumer goods it contains a xed typical market basket of goods and services but may be revised as needed UGBS 204 (slide 37) June, 2022 37 / 38 Consumer Price Index and Ination The GDP deator can be used to measure the rate of ination The Consumer Price Index (CPI) is a more common measure of ination The CPI is a price index of consumer goods it contains a xed typical market basket of goods and services but may be revised as needed We use the CPI to calculate ination rate as follows: Pt+1 −Pt πt+1 = Pt ∗ 100% UGBS 204 (slide 37) June, 2022 37 / 38 Real vs Nominal Interest rates The interest rate, generically, is the rate of return promised by a borrower to a lender UGBS 204 (slide 38) June, 2022 38 / 38 Real vs Nominal Interest rates The interest rate, generically, is the rate of return promised by a borrower to a lender The real interest rate on an asset is the rate at which the real value (purchasing power) of the asset increases over time UGBS 204 (slide 38) June, 2022 38 / 38 Real vs Nominal Interest rates The interest rate, generically, is the rate of return promised by a borrower to a lender The real interest rate on an asset is the rate at which the real value (purchasing power) of the asset increases over time The nominal interest rate is the rate at which the nominal value of the asset increases over time UGBS 204 (slide 38) June, 2022 38 / 38 Real vs Nominal Interest rates The interest rate, generically, is the rate of return promised by a borrower to a lender The real interest rate on an asset is the rate at which the real value (purchasing power) of the asset increases over time The nominal interest rate is the rate at which the nominal value of the asset increases over time We derive the real interest rate from the nominal by adjustment for expected ination: r = i − πe where r is the real interest rate, i is the nominal interest rate UGBS 204 (slide 38) June, 2022 38 / 38  Economic Growth Long-Run Economic Growth The University of Ghana Business School UGBS 204: Macroeconomics for Business UGBS 204: Lecture two  Economic Growth Outline 1 Economic Growth Meaning of Economic Growth Importance of long-term Growth Sources of Economic Growth Economic growth and income distribution UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution Outline 1 Economic Growth Meaning of Economic Growth Importance of long-term Growth Sources of Economic Growth Economic growth and income distribution UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution What is Economic Growth? Economic growth relates to long-term changes in real GDP UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution What is Economic Growth? Economic growth relates to long-term changes in real GDP Can be defined as expansion of the country’s potential GDP or national output UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution What is Economic Growth? Economic growth relates to long-term changes in real GDP Can be defined as expansion of the country’s potential GDP or national output It is sustained expansion in the production of goods and services in an economy over time UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution What is Economic Growth? Economic growth relates to long-term changes in real GDP Can be defined as expansion of the country’s potential GDP or national output It is sustained expansion in the production of goods and services in an economy over time A steady increase in the market value of goods and services produced by an economy overtime UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution What is Economic Growth? Economic growth relates to long-term changes in real GDP Can be defined as expansion of the country’s potential GDP or national output It is sustained expansion in the production of goods and services in an economy over time A steady increase in the market value of goods and services produced by an economy overtime Economic growth can also be seen as expansion of a country’s production possibilities frontier UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution Economic Development Economic development is close related to economic growth UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution Economic Development Economic development is close related to economic growth Broadly speaking,the process of economic development refers to sustained expansion in the capacity of an economy to provide for the material wellbeing of its members above and beyond the level of subsistence UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution Economic Development Economic development is close related to economic growth Broadly speaking,the process of economic development refers to sustained expansion in the capacity of an economy to provide for the material wellbeing of its members above and beyond the level of subsistence While growth of income per capita is an essential for economic development, economic growth does not necessarily lead to economic development UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution Economic Development Economic development is close related to economic growth Broadly speaking,the process of economic development refers to sustained expansion in the capacity of an economy to provide for the material wellbeing of its members above and beyond the level of subsistence While growth of income per capita is an essential for economic development, economic growth does not necessarily lead to economic development Economic development can be seen as economic growth accompanied by material changes in peoples standards of living UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution Outline 1 Economic Growth Meaning of Economic Growth Importance of long-term Growth Sources of Economic Growth Economic growth and income distribution UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution Importance of long-term growth rate According to World Bank’s World Development Indicators, Ghana GDP per capita in 1960 was $182.98 UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution Importance of long-term growth rate According to World Bank’s World Development Indicators, Ghana GDP per capita in 1960 was $182.98 In the 50 years since 1960, annual per capita GDP growth rate was 4.036% so the per capita GDP in 2010 was $1323.1 GDP per capita2010 = $182.98(1 + 0.04036)50 UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution Importance of long-term growth rate According to World Bank’s World Development Indicators, Ghana GDP per capita in 1960 was $182.98 In the 50 years since 1960, annual per capita GDP growth rate was 4.036% so the per capita GDP in 2010 was $1323.1 GDP per capita2010 = $182.98(1 + 0.04036)50 If the growth rate of per capita income over the subsequent 50 years had been only 1 percentage point higher, what will GDP per capita be in 2010? GDP per capita2010 = $182.98(1 + 0.05036)50 = 2134.6 UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution Growth and standards of living Per capita income/GDP is the total GDP divided by the total population UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution Growth and standards of living Per capita income/GDP is the total GDP divided by the total population It is commonly used as a measure of the standard of living of a country UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution Growth and standards of living Per capita income/GDP is the total GDP divided by the total population It is commonly used as a measure of the standard of living of a country Economic growth is very important for expanding living standards Sometimes people measuring economic growth with increases in the per capita GDP UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution Growth and standards of living Per capita income/GDP is the total GDP divided by the total population It is commonly used as a measure of the standard of living of a country Economic growth is very important for expanding living standards Sometimes people measuring economic growth with increases in the per capita GDP A steady increase in the market value of goods and services produced by an economy overtime UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution Growth and standards of living Rapid economic growth allows countries to more of everything to their citizens better food and bigger homes more resources for health care universal education for children better pensions for retirees UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution Outline 1 Economic Growth Meaning of Economic Growth Importance of long-term Growth Sources of Economic Growth Economic growth and income distribution UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution.....“Many roads lead to Rome” There are many different successful strategies to sustained economic growth UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution.....“Many roads lead to Rome” There are many different successful strategies to sustained economic growth Britain became world economic leader in the 19th century by pioneering the Industrial Revolution UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution.....“Many roads lead to Rome” There are many different successful strategies to sustained economic growth Britain became world economic leader in the 19th century by pioneering the Industrial Revolution Japan became world economic superpower by initially imitating foreign technologies it then developed high level of expertise in manufacturing and electronics UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution The four wheels of growth Although there different individual paths to sustained economic growth, there are common fundamental factors the underlie all sustained economic expansion UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution The four wheels of growth Although there different individual paths to sustained economic growth, there are common fundamental factors the underlie all sustained economic expansion Aggregate production/ GDP (Q) is produced using the following technological relationship: Q = AF (K , L, R) where A: level of technology in the economy K is productive services of capital L is labour units R is raw material inputs UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution The four wheels of growth Although there different individual paths to sustained economic growth, there are common fundamental factors the underlie all sustained economic expansion Aggregate production/ GDP (Q) is produced using the following technological relationship: Q = AF (K , L, R) where A: level of technology in the economy K is productive services of capital L is labour units R is raw material inputs If GDP is produced with these inputs, growth rate of GDP will come from growth rate of these inputs UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution Human Resources and Economic growth Human resources refer to the quantity and quality of labour inputs UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution Human Resources and Economic growth Human resources refer to the quantity and quality of labour inputs The quantity of human resources refer to the labour supply UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution Human Resources and Economic growth Human resources refer to the quantity and quality of labour inputs The quantity of human resources refer to the labour supply The quality of the labour resources depend on education, skills, discipline motivation etc UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution Human Resources and Economic growth Human resources refer to the quantity and quality of labour inputs The quantity of human resources refer to the labour supply The quality of the labour resources depend on education, skills, discipline motivation etc Many economists believe that the quality of labour inputs is the single most important element of economic growth UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution Capital and Economic growth Capital includes tangible capital goods like roads, power plants equipment and machines like trucks and computers intangible goods like computer software UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution Capital and Economic growth Capital includes tangible capital goods like roads, power plants equipment and machines like trucks and computers intangible goods like computer software One of the important stories of economic growth in the recent times is rapid accumulation of capital UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution Capital and Economic growth Capital includes tangible capital goods like roads, power plants equipment and machines like trucks and computers intangible goods like computer software One of the important stories of economic growth in the recent times is rapid accumulation of capital Accumulation of this capital requires sacrifices of current consumption over many years this means higher savings that used to finance investment that builds up this capital UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution Capital and Economic growth Capital includes tangible capital goods like roads, power plants equipment and machines like trucks and computers intangible goods like computer software One of the important stories of economic growth in the recent times is rapid accumulation of capital Accumulation of this capital requires sacrifices of current consumption over many years this means higher savings that used to finance investment that builds up this capital Therefore, the savings rate is a key determinant of economic growth in many models of economic growth UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution Natural Resources and Economic growth Important natural includes arable land, oil, gas, forests, water and mineral deposits UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution Natural Resources and Economic growth Important natural includes arable land, oil, gas, forests, water and mineral deposits Some currently developed countries have grown primarily on the basis of their ample resource base prime examples are Canada and Norway UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution Natural Resources and Economic growth Important natural includes arable land, oil, gas, forests, water and mineral deposits Some currently developed countries have grown primarily on the basis of their ample resource base prime examples are Canada and Norway However, as the example of many African countries show, possession of abundant resources is neither necessary nor sufficient for economic success UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution Technology, innovation and Economic growth Technological change denotes changes int he processes of production or introduction of new products and services UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution Technology, innovation and Economic growth Technological change denotes changes int he processes of production or introduction of new products and services Technological change promotes growth by enhancing productivity process inventions such as steam engine, internal combustion engine, microprocessor greatly increased productivity UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution Technology, innovation and Economic growth Technological change denotes changes int he processes of production or introduction of new products and services Technological change promotes growth by enhancing productivity process inventions such as steam engine, internal combustion engine, microprocessor greatly increased productivity According neoclassical growth models, technological progress is the main source of sustained long-term growth in living standards UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution Technology, innovation and Economic growth Technological change denotes changes int he processes of production or introduction of new products and services Technological change promotes growth by enhancing productivity process inventions such as steam engine, internal combustion engine, microprocessor greatly increased productivity According neoclassical growth models, technological progress is the main source of sustained long-term growth in living standards Technological progress is however a complex and multifaceted process and there is not clear formula for acheiving success UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution Outline 1 Economic Growth Meaning of Economic Growth Importance of long-term Growth Sources of Economic Growth Economic growth and income distribution UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution Growth and income distribution When we use per capita income as the yardstick we ignore the effect of growth on income distribution UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution Growth and income distribution When we use per capita income as the yardstick we ignore the effect of growth on income distribution Not everyone benefits from growth equally because growth is normally distributed through increased wages and higher profits; The poorest who are unemployed therefore do not share in the growth UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution Growth and income distribution When we use per capita income as the yardstick we ignore the effect of growth on income distribution Not everyone benefits from growth equally because growth is normally distributed through increased wages and higher profits; The poorest who are unemployed therefore do not share in the growth When growth is driven mainly by technological change it leads to loss of jobs, and thus not everyone shares in the growth UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution Growth and income distribution Thus we should note that in even in periods of high growth, the distribution may be unequal UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution Growth and income distribution Thus we should note that in even in periods of high growth, the distribution may be unequal Some will face extreme poverty and hardships and so there will be need for redistribution policies to avert the hardships UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution Growth and income distribution Thus we should note that in even in periods of high growth, the distribution may be unequal Some will face extreme poverty and hardships and so there will be need for redistribution policies to avert the hardships Empirically the relationship between economic growth and income distribution is not clear UGBS 204: Lecture two  Meaning of Economic Growth Importance of long-term Growth Economic Growth Sources of Economic Growth Economic growth and income distribution Growth and income distribution Thus we should note that in even in periods of high growth, the distribution may be unequal Some will face extreme poverty and hardships and so there will be need for redistribution policies to avert the hardships Empirically the relationship between economic growth and income distribution is not clear Redistribution policies are pro-poor policies to make growth share growth. Here the increment in real GDP is redistributed through gov’t. intervention UGBS 204: Lecture two  Business Cycles Demand-determined Output in the Keynesian System Equilibrium in the Simple Keynesian System National Income Determination UGBS 204: Macroeconomics for Business UGBS 204: Lecture three  Business Cycles Demand-determined Output in the Keynesian System Equilibrium in the Simple Keynesian System Outline 1 Business Cycles 2 Demand-determined Output in the Keynesian System 3 Equilibrium in the Simple Keynesian System UGBS 204: Lecture three  Business Cycles Demand-determined Output in the Keynesian System Equilibrium in the Simple Keynesian System What are Business Cycles? Denition Business Cycles are economywide uctuations in total national output, income, and employment usually lasting for a period of 2 to 10 years, marked by widespread expansion or contraction in most sectors of the economy UGBS 204: Lecture three  Business Cycles Demand-determined Output in the Keynesian System Equilibrium in the Simple Keynesian System What are Business Cycles? Denition Business Cycles are economywide uctuations in total national output, income, and employment usually lasting for a period of 2 to 10 years, marked by widespread expansion or contraction in most sectors of the economy Business cycles have two main phases: expansion and recession UGBS 204: Lecture three  Business Cycles Demand-determined Output in the Keynesian System Equilibrium in the Simple Keynesian System Phases of Business Cycles UGBS 204: Lecture three  Business Cycles Demand-determined Output in the Keynesian System Equilibrium in the Simple Keynesian System Phases of Business Cycles An expansion is continuous period of increase in total output, employment and incomes marked by growth of many sectors of the economy UGBS 204: Lecture three  Business Cycles Demand-determined Output in the Keynesian System Equilibrium in the Simple Keynesian System Phases of Business Cycles An expansion is continuous period of increase in total output, employment and incomes marked by growth of many sectors of the economy A recession is a recurring period of decline in total output, income and employment lasting usually from 6 months to a year and marked by widespread contractions in many sectors of the economy. UGBS 204: Lecture three  Business Cycles Demand-determined Output in the Keynesian System Equilibrium in the Simple Keynesian System Phases of Business Cycles An expansion is continuous period of increase in total output, employment and incomes marked by growth of many sectors of the economy A recession is a recurring period of decline in total output, income and employment lasting usually from 6 months to a year and marked by widespread contractions in many sectors of the economy. A depression is a very deep and extended recession UGBS 204: Lecture three  Business Cycles Demand-determined Output in the Keynesian System Equilibrium in the Simple Keynesian System Characteristics of Recessions Sharp contraction in consumer spending this reects in unexpected accumulation of business inventories especially of consumer durables UGBS 204: Lecture three  Business Cycles Demand-determined Output in the Keynesian System Equilibrium in the Simple Keynesian System Characteristics of Recessions Sharp contraction in consumer spending this reects in unexpected accumulation of business inventories especially of consumer durables Fall in labour demand rst fall in work hours, followed by layos UGBS 204: Lecture three  Business Cycles Demand-determined Output in the Keynesian System Equilibrium in the Simple Keynesian System Characteristics of Recessions Sharp contraction in consumer spending this reects in unexpected accumulation of business inventories especially of consumer durables Fall in labour demand rst fall in work hours, followed by layos Fall in ination rate as consumer demand falls, the price level increases more slowly or may decline UGBS 204: Lecture three  Business Cycles Demand-determined Output in the Keynesian System Equilibrium in the Simple Keynesian System Characteristics of Recessions Sharp contraction in consumer spending this reects in unexpected accumulation of business inventories especially of consumer durables Fall in labour demand rst fall in work hours, followed by layos Fall in ination rate as consumer demand falls, the price level increases more slowly or may decline Sharp falls in business prots UGBS 204: Lecture three  Business Cycles Demand-determined Output in the Keynesian System Equilibrium in the Simple Keynesian System Sources of Business Cycles Two main theories of business cycles: exogenous and internal UGBS 204: Lecture three  Business Cycles Demand-determined Output in the Keynesian System Equilibrium in the Simple Keynesian System Sources of Business Cycles Two main theories of business cycles: exogenous and internal Exogenous sources of business cycles are factors outside the economic system that lead to economic uctuations eg elections, oil price shocks, discovery of new resources, wars etc UGBS 204: Lecture three  Business Cycles Demand-determined Output in the Keynesian System Equilibrium in the Simple Keynesian System Sources of Business Cycles Two main theories of business cycles: exogenous and internal Exogenous sources of business cycles are factors outside the economic system that lead to economic uctuations eg elections, oil price shocks, discovery of new resources, wars etc Internal sources of business cycles look at mechanisms within the economic system that generate expansions and contractions UGBS 204: Lecture three  Business Cycles Demand-determined Output in the Keynesian System Equilibrium in the Simple Keynesian System Sources of Business Cycles (2) Business cycles may also be induced by aggregate demand or aggregate supply UGBS 204: Lecture three  Business Cycles Demand-determined Output in the Keynesian System Equilibrium in the Simple Keynesian System Sources of Business Cycles (2) Business cycles may also be induced by aggregate demand or aggregate supply Demand-induced business cycles result from uctuations in aggregate demand eg uctuations in business investment are a major source of business cycles UGBS 204: Lecture three  Business Cycles Demand-determined Output in the Keynesian System Equilibrium in the Simple Keynesian System Sources of Business Cycles (2) Business cycles may also be induced by aggregate demand or aggregate supply Demand-induced business cycles result from uctuations in aggregate demand eg uctuations in business investment are a major source of business cycles Supply-induced business cycles result from shocks to production that lead to uctuations in economic activity eg the oil price shocks of the early 1970s, discovery of new technology UGBS 204: Lecture three  Business Cycles Demand-determined Output in the Keynesian System Equilibrium in the Simple Keynesian System Introduction We consider output determination in the Keynesian model UGBS 204: Lecture three  Business Cycles Demand-determined Output in the Keynesian System Equilibrium in the Simple Keynesian System Introduction We consider output determination in the Keynesian model Output is demand-determined Factors of aggregate demand play a key role in the determination of the level of equilibrium output the determinants of aggregate demand determines the equilibrium level of output. UGBS 204: Lecture three  Business Cycles Demand-determined Output in the Keynesian System Equilibrium in the Simple Keynesian System Introduction We consider output determination in the Keynesian model Output is demand-determined Factors of aggregate demand play a key role in the determination of the level of equilibrium output the determinants of aggregate demand determines the equilibrium level of output. This explains determination of output in the short-run UGBS 204: Lecture three  Business Cycles Demand-determined Output in the Keynesian System Equilibrium in the Simple Keynesian System Aggregate Demand Aggregate demand shows the total quantities of goods and services demanded by households, rms, governments and the external sector at various price levels also called the aggregate expenditures UGBS 204: Lecture three  Business Cycles Demand-determined Output in the Keynesian System Equilibrium in the Simple Keynesian System Aggregate Demand Aggregate demand shows the total quantities of goods and services demanded by households, rms, governments and the external sector at various price levels also called the aggregate expenditures Aggregate demand tells us where the GDP we have produced go UGBS 204: Lecture three  Business Cycles Demand-determined Output in the Keynesian System Equilibrium in the Simple Keynesian System Aggregate Demand Aggregate demand shows the total quantities of goods and services demanded by households, rms, governments and the external sector at various price levels also called the aggregate expenditures Aggregate demand tells us where the GDP we have produced go AD = C d + I d + G + NX where C d is desired consumption, and I d is desired investment UGBS 204: Lecture three  Business Cycles Demand-determined Output in the Keynesian System Equilibrium in the Simple Keynesian System Determinants of Aggregate Demand To understand the determinants of aggregate demand, we need to understand the determinants of the various components of AD UGBS 204: Lecture three  Business Cycles Demand-determined Output in the Keynesian System Equilibrium in the Simple Keynesian System Determinants of Aggregate Demand To understand the determinants of aggregate demand, we need to understand the determinants of the various components of AD To start with the level of government purchases, it is plausible that this depends on the level of economic activity If the level of economic activity is low, the government might spending more to boost the level of AD UGBS 204: Lecture three  Business Cycles Demand-determined Output in the Keynesian System Equilibrium in the Simple Keynesian System Determinants of Aggregate Demand To understand the determinants of aggregate demand, we need to understand the determinants of the various components of AD To start with the level of government purchases, it is plausible that this depends on the level of economic activity If the level of economic activity is low, the government might spending more to boost the level of AD We will assume that the level of government purchases is xed at an exogenous level G0 UGBS 204: Lecture three  Business Cycles Demand-determined Output in the Keynesian System Equilibrium in the Simple Keynesian System Determinants of Consumption The main determinants of consumption are Current income Future income Wealth Interest rates Taxes UGBS 204: Lecture three  Business Cycles Demand-determined Output in the Keynesian System Equilibrium in the Simple Keynesian System The Keynesian Consumption Function (1) The Keynesian consumption function species consumption as a function of current disposable income: C = α +βY d where Y d is disposable income UGBS 204: Lecture three  Business Cycles Demand-determined Output in the Keynesian System Equilibrium in the Simple Keynesian System The Keynesian Consumption Function (1) The Keynesian consumption function species consumption as a function of current disposable income: C = α +βY d where Y d is disposable income We call α autonomous consumption: It is the level of consumption that does not depend on income ie the consumption when income is zero UGBS 204: Lecture three  Business Cycles Demand-determined Output in the Keynesian System Equilibrium in the Simple Keynesian System The Keynesian Consumption Function (1) The Keynesian consumption function species consumption as a function of current disposable income: C = α +βY d where Y d is disposable income We call α autonomous consumption: It is the level of consumption that does not depend on income ie the consumption when income is zero β is the marginal propensity to consume (MPC) It measures the change in consumption per unit change in income UGBS 204: Lecture three  Business Cycles Demand-determined Output in the Keynesian System Equilibrium in the Simple Keynesian System The Keynesian Consumption Function (2) The Keynesian consumption function as specied has a number of properties UGBS 204: Lecture three  Business Cycles Demand-determined Output in the Keynesian System Equilibrium in the Simple Keynesian System The Keynesian Consumption Function (2) The Keynesian consumption function as specied has a number of properties The MPC is constant UGBS 204: Lecture three  Business Cycles Demand-determined Output in the Keynesian System Equilibrium in the Simple Keynesian System The Keynesian Consumption Function (2) The Keynesian consumption function as specied has a number of properties The MPC is constant The Average Propensity to Consume (APC) decreases with income: The APC is the fraction of income that is spent on consumption APC = C /Y d = α Yd +β UGBS 204: Lecture three  Business Cycles Demand-determined Output in the Keynesian System Equilibrium in the Simple Keynesian System The Keynesian Savings Function Recall that the part of disposable income that is not spent on consumption is saved UGBS 204: Lecture three  Business Cycles Demand-determined Output in the Keynesian System Equilibrium in the Simple Keynesian System The Keynesian Savings Function Recall that the part of disposable income that is not spent on consumption is saved We can use this fact to derive the savings function S = Y − C = Y − α − β Y = −α + (1 − β )Y d d d d UGBS 204: Lecture three  Business Cycles Demand-determined Output in the Keynesian System Equilibrium in the Simple Keynesian System The Keynesian Savings Function Recall th