ECN 102 Principles of Economics II PDF

ECN 102 Principles of Economics II Study Session 1: Macroeconomics Goals Introduction To win a football match, you must score a goal. The aim of most business enterprise is to maximize profit. Macroeconomics which deals with the trend of economy as a whole has objectives otherwise called goals. Some of which include: full employment, stability and economic growth. In this study session you will learn the concept of macroeconomics and each of the macroeconomics goals. Learning Outcomes for Study Session 1 At the end of this study, you should be able to: 1.1.Explain the Concept of Macroeconomics 1.2.Explain Full employment. 1.3.Explain Stability. 1.4.Discuss Economic growth. 1.1 Concept of Macroeconomics Macroeconomics is a section of economics that studies the behavior and performance of the economy as whole. It deals with the trend of the economy other than individual markets or companies. It tackles the general aspect of the economy. In Macroeconomics we study how well businesses are doing nationally and the various features that contribute to economic development. According to Prof. Boulding, "Macro Economics deals not with individual quantities as such but with aggregates of the quantities, not with individual incomes but with the national income, not with the individual prices but with the price level, not with the individual output but with the national output." Box 1.1: Definition of macroeconomics Macroeconomics is a section of economics that studies the behavior and performance of the ECN 102 Principles of Economics II economy as whole. 1.1.1 Scope of Macroeconomics The area Macroeconomics covers are as follows: 1. Theory of National Income 2. Theory of Employment 3. Theory of Money 4. Theory of general price level 5. Theory of economic growth 6. Theory of international trade 7. Macro theory of distribution 8. Theory of trade cycle Theory of National Income National income is the total value of goods and service produced by a country in a year. National Income Theory deals with its elements, methods of measurement and social accounting Theory of Employment This theory says that level of employment is not determined by price of labour but by the spending of money. It deals with the challenges of employment and unemploymentand how to tackle unemployment. Theory of Money It is the theory that shows the relationship of money supply with price level. The changes in demand and supply of money are also studied. Theory of General Price level It talks all about inflation, deflation; factors that affects increase and reduction in price. ECN 102 Principles of Economics II Theory of general price level discuss the average price level of goods and services available in the economy Theory of economic growth Theory of economic growth focuses on increase in potential output, standard of living, government fiscal and monetary policies. Theory International Trade It covers the policies of free trade and protection rights. It deals with the details of the nation‟s imports and exports and the conditions surrounding this. Macro Theory of Distribution It shows how different factors of production are known in the national income. It is the sharing of the national income among the factors of production Theory of trade cycle It shows the details of changes in level of employment, expenditure and general price level. It deals with the up and down level of economic activities In the study of macroeconomicsthe following topics/subjects define the scope 1. Aggregates of National Income and its determination 2. Theory of income and employment 3. Theory of Money and Banking 4. Fiscal Theory 5. Balance of Payment Aggregate of National Income and its determination ECN 102 Principles of Economics II National income is the cash worth of all the final goods produced by a country in a year. The demand for goods and services in a country is called aggregate demand (national expenditure). Y (national income) =investment expenditure on capital goods (1) +expenditure (C) Theory of income and employment This is a part of macroeconomics that talks about employment, output and prices in an economy. The theory of income and employment is a theory which packs all markets for final goods and services into a distinctproduct market, all financial markets into a distinctmoneymarket,and all markets for labor services into a distinctlabor market. Theory of Money and Banking Money which is a means of exchange of goods and services is introduced to the banking modelto know how open market (free market without regulations) affects total bank lending output Fiscal Theory This is the situation where government fiscal policies (government means of monitoring the nation‟s economy) affect price level Balance of Payment Balance of Payment (BOP) deals with the transactions between a country‟s residents and non- residents. It is also known as Balance of International payment. In-Text Question --------------------is a section of economics that deals with the study of behavior and Performance. ECN 102 Principles of Economics II In-Text Answer Macroeconomics Macroeconomics has clear goals or objectives. They are: 1. Full employment 2. Stability 3. Economic growth ECN 102 Principles of Economics II The figure below shows the three major goals of Macroeconomics Economic Full growth Employment Stablity Figure 1.1 Diagram showing Macroeconomics goals. 1.2 Full Employment Full Employment in macroeconomics can be defined as level of unemployment rate where there is no deficient unemployment. Demand deficient unemployment occurs when companies produce less hence hire less workers. In some cases fire workers and some other time the company can go bankrupt. The figure below is a display of words related to employment which is designed to boost your retention of this study. ECN 102 Principles of Economics II Figure 1.2Display of words relating to employment Source:http://www.hirevents.com/images/employment.jpg Full economy is the situation of the economy that gives the platform to work to individuals that are qualified. Full employment suggests zero or low unemployment of about three percent. In full employment, the economy is at the highest level where there is no demand deficient unemployment. Box 1.2: Definition of Full Employment Full Employment in macroeconomics can be defined as level of unemployment rate where there is no deficient unemployment. In Macroeconomics the main reason for considering Full Employment is because of the various disadvantages of high unemployment rate on the economy. High unemployment rate can cause the following: 1. Low consumption which is a direct result of low earning. 2. Low motivation of the unemployed and loss of skills which can cause un- employability. ECN 102 Principles of Economics II 3. High government spending on unemployment benefits 4. High social crime rate All these have a negative effect on the economy. In-Text Question _________________can be defined as the level of unemployment rate where there is no deficient unemployment. In-Text Answer Full Employment 1.2.1 Achieving Full Employment Full Employment is achievable. It involves the usage of all available resources (land, capital, labour and entrepreneurship) to produce goods and services. In any economy in recession, to achieve full employment, you need to: 1. Increase the aggregate demand (AD): This is the increase in totaldemand of goods and services at a specific time.This can be done by lowering the interest rate. 2. Use supply side policy which is the government personal effort in improving efficiency in the economy. For example training of unemployed youths. 3. Keep inflation low and maintain steady growth 4. Let productivity match wages. In-Text Question Full Employment is achievable. True or False In –Text Answer True 1.2.2 Disadvantages of Full Employment Full employment however has its own disadvantages. Some of which include: ECN 102 Principles of Economics II  Unsustainable growth  Labour shortage  Rejection of low paying jobs 1.3 Stability Economic stability happens when low inflation and constant growth are experienced. To achieve Stability in the economy:  Zigzag changes in price, production andemployment rate should be avoided or limited: Low unemployment is an indication of economic stability.  Progressive taxes could be introduced: This is a situation where the high income earners get the highest tax.  Floating exchange rate could be adopted: Here the government does not interfere with exchange rate. It is observed that it helps economic stability  There should beFlexible labour markets: This affords workers the opportunity to acquire new transferable skills and work on different task. Benefits of economic stability include: 1. Low unemployment 2. Increased productivity 3. Right atmosphere for job creation 4. High efficiency 5. High investments Attributes of economic instability include: 1. Rising inflation 2. Unstable currency exchange rate. 3. Little economic growth. 4. Low consumer patronage 5. Low international investments ECN 102 Principles of Economics II In-Text Question _________________is a benefit of economic stability except (a) Low unemployment (b) Increased Productivity (c) High tonic (d) High investment In-Text Answer (c) High tonic 1.4 Economic growth Economic growth happens when the economy has the ability to produce goods and services. When an economy produces more goods and services than previous occasion, it is said to have experienced economic growth. Economic growth occurs when there is an increase in capacities of the factors of production (Labour, land, capital and entrepreneurship) Economic growth means there is increase in national income and national output. Economics growth also means there is increase in GDP (gross domestic product). Gross domestic product is the market disposable value of the goods produces within the country. There are two types of economic growth. They are:  Actual economic growth  Potential economic growth Actual Economic growth Annual percentage increase in gross domestic product.(GDP) This is dependent of two major factors 1. Aggregate demand increase 2. Increase in potential output ECN 102 Principles of Economics II 1. Aggregate demand increase makes companies to produce more goods and services and make the potential output increase 2. Increase in Potential output is a direct result of aggregate demand increase Potential Economic growth This is how fast an economy could grow. It is determined by two factors 1. Amount of resources available 2. Productivity Economic growth has several benefits which include:  Increase in standard of living  Full employment  Redistribution of income  Good environmental conditions Economic growth has some disadvantages which include:  Low standard of living in the long run  Environmental pollution  High demand pull inflation if high aggregate demand is not well checked  Balance of payment deficit which is as a result of high import growth. Activity 1.1 Economic growth Time Allowed: 15Mins Your country is in a deep economic recession, what are the measures youwill take to reverse this as the new Finance Minister. ECN 102 Principles of Economics II Summary In study session 1 you have that: 1. Macroeconomics is a section of economics that studies the behavior and performance of the economy as whole 2. Macroeconomics has five major scopes which are:  Aggregates of National Income and its determination  Theory of income and employment  Theory of Money and Banking  Fiscal Theory  Balance of Payment 3. There are three major goals of macroeconomics which are  Full Employment  Stability  Economic growth 4. Full Employment in macroeconomics can be defined as level of unemployment rate where there is no deficient unemployment 5. Full Employment can be achieved by the using all available resources (land, capital, labour and entrepreneurship) to produce goods and services. 6. Unsustainable growths, Labour shortage, Rejection of low paying jobs are all disadvantages of full employment. 7. Economic stability happens when low inflation and constant growth are experienced. 8. Rising inflation, Unstable currency exchange rate are attributes of unstable economy ECN 102 Principles of Economics II 9. Progressive taxes and floating exchange rate are neededto achieve economic stability 10. Low unemployment and increased productivity are the advantages of economic stability. 11. Economic growth occurs when there is an increase in capacities of the factors of production (Labour, land, capital and entrepreneurship) 12. Actual economic growth and Potential economic growth are two types of economic growth. 13. Annual percentage increase in gross domestic product.(GDP) is actual growth 14. Potential growth is how fast an economy could grow. 15. Increases in standard of living and Full employment are benefits of economic growth. Self-Assessment Questions (SAQs) for Study Session 4 Now that you have completed this study session, you can assess how well you have achieved its Learning outcomes by answering the following questions. Write your answers in your study Diary and discuss them with your Tutor at the next study Support Meeting. You can check your answers with the Notes on the Self-Assessment questions at the end of this Module. SAQ 1.1 (Testing Learning outcomes 1.1) In your own words explain the concept of Macroeconomics ECN 102 Principles of Economics II SAQ 1.2 (Testing Learning outcomes 1.2) Discuss full employment as a goal in macroeconomics and how to achieve this SAQ 1.3 (Testing Learning outcomes 1.3) Explain the term “stability” in macroeconomics SAQ 1.4 (Testing Learning outcomes 1.4) Give basic solutions to slow economic growth in your country Notes on SAQs for study session 1 SAQ 1.1 Macroeconomics is a section of economics that studies the behavior and performance of the economy as whole. SAQ 1.2 Full Employment in macroeconomics can be defined as level of unemployment rate where there is no deficient unemployment. To achieve this you need to 1. Increase the aggregate demand (AD): This is the increase in total demand of goods and services at a specific time.This can be done by lowering the interest rate. 2. Use supply side policy which is the government personal effort in improving efficiency in the economy. For example training of unemployed youths. 3. Keep inflation low and maintain steady growth 4. Let productivity to match wages. ECN 102 Principles of Economics II SAQ 1.3 Economic stability happens when low inflation and constant growth are experienced. To achieve Stability in the economy:  Zigzag changes in price, production and employment rate should be avoided or limited: Low unemployment is an indication of economic stability.  Progressive taxes could be introduced: This is a situation where the high income earners get the highest tax.  Floating exchange rate could be adopted: Here the government does not interfere with exchange rate. It is observed that it helps economic stability  There should be Flexible labour markets: This affords workers the opportunity to acquire new transferable skills and work on different task. Benefits of economic stability include:  Low unemployment  Increased productivity  Right atmosphere for job creation  High efficiency  High investments. SAQ 1.4 Economic growth occurs when there is an increase in capacities of the factors of production (Labour, land, capital and entrepreneurship) This is achieved through: Actual economic growth Potential economic growth Actual Economic growth Annual percentage increase in gross domestic product.(GDP) ECN 102 Principles of Economics II This is dependent of two major factors 1. Aggregate demand increase 2. Increase in potential output 1. Aggregate demand increase makes companies to produce more goods and services and make the potential output increase 2. Increase in Potential output is a direct result of aggregate demand increase Potential Economic growth It is determined by two factors 1. Amount of resources available 2. Productivity References 1. http://www.economicshelp.org/blog/471/unemployment/supply-side-policies-for- reducing-unemployment/ 2. http://www.economicshelp.org/macroeconomics/macroessays/should-aim-govtbe-full- employment/ 3. http://www.amosweb.com/cgi-bin/awb_nav.pl?s=wpd&c=dsp&k=macroeconomic+goals 4. http://study.com/academy/lesson/full-employment-gdp-definition-and-examples.html 5. http://www.economicshelp.org/macroeconomics/economic-growth/causes-economic- growth/ 6. http://www.123helpme.com/discuss-the-causes-and-effects-of-economic-growth- view.asp?id=164627 7. http://www.answers.com/Q/What_is_macroeconomic_and_microeconomics ECN 102 Principles of Economics II Study Session 2: National Income Accounting Introduction It could be considered not a good way to live if you have all the money in the world and do not know how you spent it. Just like it is for individuals, it is for a country. It is important to keep records of transactions for record purpose and future references. National income accounting deals with keeping financial records of a country. In this study session will carefully look at national income accounting, its basic concepts, and various methods of computing national income, problems and its uses. Learning Outcomes for Study Session 2 At the end of this study, you should be able to 2.1.Define National Income Accounting 2.2.Explain the basic concepts of National Income Accounting 2.3.Mention the methods of National Income Accounting 2.4.Discuss the importance of National Income Accounting 2.5.Highlight the challenges of National Income Accounting 2.6.The circular flow of Income ECN 102 Principles of Economics II 2.1 National Income Accounting National Income Accounting is the monetary value flow of output of goods and services produced within the economy over a period of time. It is the bookkeeping system that government uses to determine the level of economic activities that take place in the country over a given period of time. National Income Accounting records the degree of dealings in accounts such as amount of taxes paid by individuals and corporations in the country, Wages paid to domestic and foreign workers and income of individuals and organizations. A pictorial money representation of national income accounting Figure 1.1:A pictorial money representation of national income accounting Source: http://s3.amazonaws.com/authorstream/content/327274_634019656564125000.jpg The national income or product or expenditure shows away of determining total value at factor cost of final goods and services, which are available either for consumption or for addition to wealth. This total is valued in terms of money and it is equal to the income adding to the factors of production, i.e. Land, Labour, Capital and Enterprise ECN 102 Principles of Economics II Box 2.1 Definition of National Accounting National Income Accounting is the monetary value flow of output of goods and services produced within the economy over a period of time. You can however define National income from income, expenditure or product angle National Income is a means of determining how money is being generated or spent in the country. It also shows the state of health of the country‟s economy. In-Text Question The monetary value flow of output of goods and services produced within the economy over a period of time is called________________ In-Text Answer National Income Accounting ECN 102 Principles of Economics II 2.2 National Income Accounting Concepts There are several basic National Accounting concepts that will help youunderstand some of the terminologies used in NationalIncome Accounting. Some of which are listed below: 1. Stock and flow variables 2. Gross Domestic products 3. Nominal GDP 4. Real GDP 5. Final Goods 6. Values Added 7. Current Outputs 8. Ex-post and Ex- ante Variable 9. Market prices 10. Factor Cost 11. Gross National Product 12. Personal income 13. Disposable Income 14. Transfer Income 15. Per Capital income 16. Net National Product Stock and Flow Variables This is a variable measured at a givenpoint time or at a particular period. National income Accounting is calculated for an accounting period or interval called flow variable. Gross Domestic products (GDP) This is the total monetary value of all the goods and services produced within the boundaries of a country at a given time. It also includes domestic goods produced by foreigncompanies. ECN 102 Principles of Economics II Nominal Gross Domestic products (NGDP) This is the monetary value of total goods and services made in an accounting period valued at the market prices of that period. For example GDP for 2014 measured the value of goods and services produces in 2014 at market prices that prevailed in 2014. Ex-post and Ex- ante Variable Ex post variables determine what actually happened in an accounting period. On the other hand ex- ante variable measures what is intended to happen. In national income accounting we are concerned in actual production of goods and services for an accounting period not what is expected to be produced.Therefore; in national income accounting we make use of ex-post variables. Market prices These are the prices that we pay for goods and services. These prices are affected mainly by indirect taxes and subsidies. These effects do not make market prices to reflect the through factor cost of goods and services. Indirect taxes imposed on goods make their prices to be higher than what they should have been. Conversely, subsidies paid to producers will make market prices lower than what they should have been. So we can say that market prices do not reflect the factor cost of production. Factor Cost This is considered as the net price. The factor cost is the market price of a product minus indirect taxes plus subsidies. It is also the can also refer to the unit cost of a particular factor of production. Real Gross Domestic Products (RGDP) It determines the value of total goods and service at constant prices. It shows the price change in the goods and services produced unlike Nominal Gross Domestic Product. It is said to give more accurate analysis. For example, GDP of Nigeria for 2014 in the first quarter is N20, 169,778.04 and real GDP is N15,438,679.50 ECN 102 Principles of Economics II Values Added This is the extra cost that a company or a producer acquires on a product in the course of its production. For example a chocolate factory bought the raw materials for their production at five million naira. After production, they sold their entire chocolate for eight million naira. The value added is three million naira. Current Outputs This is the quantity of goods and services produced in the country in a defined accounting period. For example the current output of 2014 in Nigeria. Final Goods These are goods bought for final use. They are not meant to be resold or further processed. In National Income Accounting the final product is valued to avoid multiple counting of product or expenditure. Gross National Product This is the value of goods and services produced by the nationals of the country whether currently residing in the country or living abroad. Personal Income This is the current income of households or persons from all sources which include receipts such as transfer payments from which no productive services are produced by recipients. Disposable Income This is calculated by deducting taxes from personal income.Disposable income = Personal income – Taxes. ECN 102 Principles of Economics II Transfer payment This is the money given by the government to its citizens. Example includes social security, unemployment compensation and welfare. Per Capital Income This is the total national income divided by the total population. Net National Product The net national product is defined as the Gross National Product (GNP) less capital allowance (Depreciation). That is NNP= GNP – Depreciation Net National Product (NNP) is derived by subtracting capital consumption allowance (Depreciation) from the value of Gross National Product (GNP) That is, NNP = GNP-D In-Text Question ________ the value of goods and services produced by the nationals of the country whether currently residing in the country or living abroad. In-Text Answer Gross National Product ECN 102 Principles of Economics II 2.3 Methods of National Income Accounting There are different methods of National Income Accounting. They are:  Out Put method  Expenditure method  Factor-income method Out Put Method This is achieved by adding the worth of all goods and services produced by all segments of the economy during the year. Only final goods and services are included. Intermediate (Unfinished) goods and services are excluded to avoid double counting.It can be determined by estimating only the net values of output (value-added) at every stage of production in the economy in the course of the year. Expenditure Method This is used to measure all the total expenditure of goods and services done by governments, individuals and private business people. All the goods and services expenditure done in the course of the year is added up. Unfinished (intermediate) goods are excluded to avoid double counting. It can be related in symbols as follows: Y = C + I + G + (X – M) 20 OR Y = C + I + G + Xn Where Y = The value of national income C = Aggregate consumption expenditure I = Private investment expenditure G = Government expenditure X = Exports expenditure M = Imports expenditure X= Net exports (Xn > 0) ECN 102 Principles of Economics II Factor-Income Method It is used to determine the worth of all factor inputs. This is achieved by adding up all the income paid out to the owners of factors of production such as rent for land, interest for capital, salaries and wages for employees and profit for management. Y = Yr + Yw + Yi + Y Where: Y = National Income Yπr = Income from rents Y w = Income from wages and salaries Y i = Income from Interest Y = Income from profits For example: Table 1.1.Calculate GDP using production method, Income method and expenditure approach? UAC PLC N Wages paid to UAC employees 15,000 Taxes paid to government 5,000 Revenue received from sale of Gala 35,000 Gala sold to public 10,000 Gala sold to retailers 25,000 Mr Biggs Wages paid to Mr Biggs employees 10,000 Taxes paid to government 2000 Sati‟s Beef purchased from UAC 25,000 Revenue received from sale of Sati‟s beef 40,000 What is the total value (in Naira) of the economic activity generated by these two firms? Solution: Production Method (value added: sales – intermediate goods): = 35,000 + (40,000-25, 0000) = N50, 000 ECN 102 Principles of Economics II Income Method (wages + profits+ Taxes) = 15,000+10,000+15,000+3,000+5,000+2000= N50, 000 Expenditure Method: (expenditure by final users) = 10,000+40,000 = N50, 000 In-Text Question _________is used to determine the worth of all factor inputs. In-Text Answer Factor-Income Method ECN 102 Principles of Economics II 2.4 Importance of National Income Accounting National Income Accounting has its importance or uses. They are discussed below 1. It measures the level of productivity of the economy at a given time 2. It measures the standard of living of countries using per capital income. 3. Planning and policy formulation is enhanced by national income accounting 4. It helps in determining per capital Income of countries. 5. It forecasts the economy; what to look out for in the future with regards to the economy 6. It is used for the redistribution of Income in the country 7. It aids foreign investments. In-Text Question National Income helps in the following except (a) Level of productivity ( b ) Standard of living ( c) Policy Planning and Formulation (d) Footballing and other sports activities In-Text Answer (d) Footballing and other Sports activities ECN 102 Principles of Economics II 2.5 Challenges of National Income Accounting However National Income Accounting has its peculiar challenges or problems. They are: 1. Exclusions of illegal income 2. Price level changes 3. Inadequate Statistical data 4. Inaccurate estimation of depreciation 5. Non recognition of changes in the environment 6. Confusing definition 7. Inaccurate Measurement 8. Problems of depreciation estimation 9. Double/multiple counting Exclusions of illegal income National income records legal incomes or goods and services.This may pose some practical problems to the national income accountants since some illegal incomes may find their way into the national income. Price Level Changes National income is measured in terms of money whose value changes from time to time. It is therefore, difficult to make a stable valuation of national income. This problem is dealt with by expressing national income estimates in real terms in constant prices. Inadequate statistical data. One basic problem of estimating national income is the lackstatistical data. This problem is more pronounced in developing countries like Ghana and Nigeria. Individuals, business firms and the government at times do not keep proper records of incomes, output and expenditure. ECN 102 Principles of Economics II Departments of governments given the responsibilities of collecting and collating vital statistical data do not keep up-to-date records. For example in Ghana because of lack of data on income the income method is not used in estimating national income. Inaccurate estimation of depreciation Capital stock wears and tears when used to produce goods or to render services. We account for this as depreciation or capital allowance. To arrive at GNP depreciation is subtracted from GNP. The problem here is how to accurately estimate depreciation. If the value of depreciation is over estimated or under estimated national income will be invariable affected. Non recognition of changes in the environment It does not accurately reflect changes in environment. For instance oil spills cleanup is measured as positive output but increased in pollution is not measured as negative. Confusing Definition Inclusion or exclusion of certain items in national income accounting can cause confusion Inaccurate Measurement National Income accounting understates social welfare-non-market transactions like home- makers service and do-it-yourself projects are not counted. It also fails to determine increase in leisure or work satisfaction and changes in product quality. Problem of depreciation estimation Capital stock wears and tears when used to produce goods or to render services. We account for this as depreciation or capital allowance. To arrive at GNP depreciation is subtracted from GNP. The problem here is how to accurately estimate depreciation. If the value of depreciation is over estimated or under estimated national income will be invariable affected Double/Multiple counting ECN 102 Principles of Economics II This has to do with intermediate goods, intermediate expenditure and transfer payment. There is the likelihood of valuing, for example, cassava and garri. If this happens, the value of total output will be grossly exaggerated. This problem is avoided to a very large degree by taking note of the value added or final expenditure and excluding transfer payments. Activity 2.5 Challenges of National Income Time: 15 Minutes Nigeria is a developing country, take some time to study some of the challenges of National income and state the one(s) that is peculiar to us and give the reasons for your answer. ECN 102 Principles of Economics II 2.6 The Circular Flow of Income It is the type of the economy in which the main exchange are shown as flows of money, goods and services etc. between economic agents like buyers and sellers. In National income accounting, output, and expenditure are generated by the activities of the two most vital parts of an economy, its households and firms, as they engage in jointly useful exchange. Households The primary economic function of households is to supply domestic firms with needed factors of production - land, human capital, real capital and enterprise. The factors are supplied by factor owners in return for a reward. Land is supplied by landowners, human capital by labour, real capital by capital owners (capitalists) and enterprise is provided by entrepreneurs. Entrepreneurs combine the other three factors, and bear the risks associated with production. Firms The function of firms is to supply private goods and services to domestic households and firms, and to households and firms abroad. To do this they use factors and pay for their services. The chart below shows the circular flow of income Figure 2.6 Circular Flow of income ECN 102 Principles of Economics II Source:http://upload.wikimedia.org/wikipedia/commons/thumb/b/b8/Circular_flo w_of_goods_income.png/360px-Circular_flow_of_goods_income.png Summary In this Study Session, you have learnt that: 1. National Income Accounting is the monetary value flow of output of goods and services produced within the economy over a period of time. 2. National Income Accounting has some basic concepts like: a. Stock and flow variables b. Gross Domestic products c. Nominal GDP d. Real GDP e. Final Goods f. Values Added g. Current Outputs 3. Stock and Flow variable is a variable measured at a givenpoint time or at a particular period. 4. Output,Expenditure, and Factor-income are all methods of National income Accounting 5. The output method is achieved by adding the worth of all goods and services produced by all segments of the economy during the year. 6. National income helps in measuring the level of productivity of the economy at a given time ECN 102 Principles of Economics II 7. Exclusions of illegal income, Price level changes and Inadequate Statistical data are all challenges of National Income Accounting. 8. The circular flow of income is the type of the economy in which the main exchange are shown as flows of money, goods and services etc. between economic agents like buyers and sellers. Self-Assessment Questions (SAQs) for Study Session 4 Now that you have completed this study session, you can assess how well you have achieved its Learning outcomes by answering the following questions. Write your answers in your study Diary and discuss them with your Tutor at the next study Support Meeting. You can check your answers with the Notes on the Self-Assessment questions at the end of this Module. SAQ 2.1 (Testing Learning outcomes 2.1) Describe National income accounting in your own words SAQ 2.2 (Testing Learning outcomes 2.2) Explain two concepts from National Income Accounting SAQ 2.3 (Testing Learning outcomes 2.3) Discuss the expenditure method of National Income accounting SAQ 2.4 (Testing Learning outcomes 2.4) Discuss how National Income could be beneficial to the country SAQ 2.5 (Testing Learning outcomes 2.5) How do you deal with Price level change in National Income Accounting? SAQ 2.6 (Testing Learning outcomes 2.6) Draw the chart to show circular flow of Income ECN 102 Principles of Economics II Notes on SAQs for study session 2 SAQ 2.1 National Income Accounting is the monetary value flow of output of goods and services produced within the economy over a period of time. It is the bookkeeping system that government uses to determine the level of economic activities that take place in the country over a given period of time. National Income Accounting records the degree of dealings in accounts such as amount of taxes paid by individuals and corporations in the country, Wages paid to domestic and foreign workers and income of individuals and organizations. SAQ 2.2 Stock and Flow Variables This is a variable measured at a givenpoint time or at a particular period. National income Accounting is calculated for an accounting period or interval called flow variable. Gross Domestic products (GDP) This is the total monetary value of all the goods and services produced within the boundaries of a country at a given time. It also includes domestic goods produced by foreign companies SAQ 2.3 Expenditure Method This is used to measure all the total expenditure of goods and services done by governments, individuals and private business people. All the goods and services expenditure done in the course of the year is added up. Unfinished (intermediate) goods are excluded to avoid double counting. It can be related in symbols as follows: Y = C + I + G + (X – M) 20 OR Y = C + I + G + Xn ECN 102 Principles of Economics II Where Y = The value of national income C = Aggregate consumption expenditure I = Private investment expenditure G = Government expenditure X = Exports expenditure M = Imports expenditure X= Net exports (Xn > 0) SAQ 2.4 1. It measures the level of productivity of the economy at a given time 2. It measures the standard of living of countries using per capital income. 3. Planning and policy formulation is enhanced by national income accounting SAQ 2.5 This problem is dealt with by expressing national income estimates in real terms in constant prices. SAQ 2.6 ECN 102 Principles of Economics II References  http://www.investopedia.com/terms/r/realgdp.asp  http://www.investopedia.com/terms/r/realgdp.asp  http://basiccollegeaccounting.com/2009/03/limitationschallengesproblems-in-the- measurement-of-national-incomes/ ECN 102 Principles of Economics II Study Session 3: Aggregate Demand and Supply Introduction Macroeconomics is a section of economics that studies the behavior and performance of the economy as whole. Macroeconomics is concerned with the determination of the aggregate demand and aggregate supply of output in the economy and the general price level. Therefore in this study you will understand aggregate demand and aggregate supply. Learning Outcomes for Study Session 3 At the end of this study, you should be able to: 3.1 Explain Aggregate Demand 3.2 Explain Aggregate Supply ECN 102 Principles of Economics II 3.1 Aggregate Demand Aggregate demand (AD) is the total demand for finished goods and services in an economy at a given time. It shows the amount of goods and services to be purchased at a given price level. Aggregate demand is the total level of demand for desired goods and services which make up the gross domestic product (GDP). It is the sum of consumption expenditure, net exports, government expenditureand investment expenditure. Box 3.1 Aggregate Demand Aggregate demand (AD) is the total demand for finished goods and services in an economy at a given time. Components of Aggregate Demand As a result of the proposed equation by the Mundell-Fleming model for a large open economy,the aggregate demand equation is Y =C(Y-T)+I(r) +G+NX(e ). From this we can deduce the four components of aggregate demand. The four components are:  Y=Output  C(Y-T) = Consumption as a function of disposable income  I(r )= investment spending as a function of real interest rate  G= Government expenditure  NX(e )= Net exports The first component Y This represents output or income. Y is the sum of goods and services bought by consumers, business, and the government. Output can be called income. That is the national income of the economy. The national income is national income divided by the population. This is the result of aggregate demand equation. ECN 102 Principles of Economics II Component C(Y-T) This express consumption as a function ofdisposableincome. Disposable money is the money available to consumers after removing tax. Consumption applies to income and taxes. Consumption reveals all the expenditure on all goods and services.For example, feeding, accommodation etc. Component I(r) This relates Investment spending as a function of real interest rate. The real interest rate is nominal rate revealed by the media for predicted inflation. Whenorganization wants to invest they take into consideration nominal interestrate, inflation and the real interest rate. Examples of such investments include buildings, education etc. Component G This represents any expenditure made by the government. Government expenditure is always high. It could constituter up to one-third of the gross domestic product. Examples of government spending include salaries payment, welfare programme, and expenditure on security. Component NX (e) This is the difference between imports and exports. Net exports are depended on real exchange rate. As real exchange rise, domestic currencies become valuable; exports fall and there areimports rise. A growth in domestic economic product brings low rate of export. Examples of export include cocoa, palm oil. Examples of importsinclude electronic, cars etc. The aggregate demand equation Y=c (Y-T) +I (r) + G + NX (e) ECN 102 Principles of Economics II 3.1.1 Aggregate demand Curve The graph below shows the aggregate demandsupply curve. Figure 1.1 Aggregate Demand Supply Curve The aggregate demand (AD) curve shows the total planned expenditure on goods and services in the economy as a function of the price level. A higher price level will reduce total planned expenditure. In-Text Question _____________is the total demand for finished goods and services in an economy at a given time In-Text Answer Aggregate demand (AD) ECN 102 Principles of Economics II 3.2 Aggregate Supply Aggregate Supply (AS) is the sum of the amounts of goods and services (real output) produced and supplied by the companies in an economy over a given oftime. Aggregate Supply has several components, they are:  Consumer goods  Capital goods  Public and Merit goods  Traded goods Consumer goods Consumer goods are supplied by the private sector and consumed by the households. This is the largest component of aggregate supply. Examples of such consumer goods and services include computers, phones, clothes etc. Capital goods These are goods such as machinery used in the production of commodities.They are used in the production of other goods.They help to increase the capacities of companies in the economy to supply consumer goods Public and Merit goods These are goods and services produced by private companies for the use of local or central government. Companies like pharmaceuticals, Engineering etc. depend on contracts to supply to the public sector. Traded goods Traded goods are goods and services meant for export such as chemicals, entertainment, etc. ECN 102 Principles of Economics II 3.2.1Aggregate Supply Curve The figure below shows the aggregate Supply Curve Figure 1.2 Aggregate Supply Curve The aggregate supply(AS) curve shows the quantity of output which firms are prepared to supply at various price levels. The aggregate supply curve in the Figure above suggests that firms are only prepared to supply more if the price level rises. This model will be in equilibrium where AD equals AS, at point E. In terms of the equations you saw in the earlier section, planned expenditure (C + I + G + NX) just equals output Y or Y = C + I + G + NXSuppose that the economy is not in equilibrium because the price level is at P1. At this price level planned expenditure (AD) is less than output (Y). However, the identity Y = C + I + G + NX will still hold because inventories equal to the distance AB will be added to firms‟ inventory holdings. ECN 102 Principles of Economics II There will be unintended investment of AB. Thus actual expenditure (including unintended inventory accumulation) will equal output. This cannot be an equilibrium position because firms will react to their lack of sales. As you will see in later units there are convincing reasons why these reactions will force the economy towards E. An increase in planned expenditure would shift the AD curve to the right. E would no longer be an equilibrium position. The increase in AD would cause an excess demand. Inventories will fall as firms satisfy the excess demand from their stocks. It is likely that firms will increase output (or prices) The extent to which firms will react, by increasing prices or output, depends upon the slope of the AS curve. The slope will depend crucially on the time period under consideration. DFS identify three models of aggregate supply – a short run model, a medium term model and a long run model. Short-run aggregate supply Let us start by examining the short-run model, where the AS curve is assumed to be flat. Equilibrium will be at the point where AD equals AS. Given a flat AS curve, the level of output in the economy is determined solely by the level of aggregate demand. Changes in aggregate demand will only affect output, with no impact on prices. Under what circumstances will firms be able to satisfy an increase in demand without this having any impact on the price level? If firms can increase output without increasing their prices, this means that they can increase output without increases in their average costs of production. This must mean that they can obtain additional resources, especially labour, without experiencing higher costs. This is most likely to be true in periods of high unemployment, or when there are barriers to costs increasing. ECN 102 Principles of Economics II This view of aggregate supply is sometimes referred to as the Keynesian view of aggregate supply because it is a view associated with John Maynard Keynes who argued that the deep economic recession which was experienced in the 1930s was the result of a lack of demand and that the way to boost output was to expand aggregate demand. This was based on the idea that spare resources were plentiful and that firms could easily increase output without this putting pressure on the price level. Keynesian economics came to be associated with policies aimed at boosting aggregate demand, and at heart they are based on the view that the AS curve is flat. This view of aggregate supply emphasizes the importance of aggregate demand in the determination of output in the economy. Long-run aggregate supply In the long run, the aggregate supply curve is vertical. This means that, in the long run, any change in aggregate demand will only affect the price level and will have no impact on output. If there was an increase in aggregate demand, what would Figure 1.2 predict would happen to the economy? The model predicts that output would not change, but that the price level would rise. A vertical AS curve means that output does not expand when there is an increase in aggregate demand. This is usually explained by saying that the economy is operating under some sort of capacity constraint and that firms are unable to increase output. The constraint that is usually assumed is the constraint of full employment. Y0 in Figure 1.2 is potential GDP, or the level of output associated with full employment. This view of aggregate supply is known as the Classical aggregate supply curve. Classical economics therefore is associated with the idea that changes in aggregate demand only affect the price level and have no impact on the level of output in the economy. Aggregate supply in the medium run ECN 102 Principles of Economics II Most economists accept that the short run AS curve is flat and the long run AS curve is vertical. However, this leaves open the question of how long is the short run, and what is the process by which the AS curve becomes vertical? If firms adjusted prices more rapidly what would happen to the slope of the AS curve? The faster prices adjust the steeper the AS curve will be. Since one of the major factors influencing prices will be the cost of labour, wages, the slope of the AS curve also depends upon how quickly wages adjust to an increase in output. If output in an economy expands because of increased expenditure, and prices fail to rise, what does this imply about the level of unemployment in the economy? If increased output can be produced without prices rising, firms must be able to secure extra workers without putting pressure on wages. Hence there must be unemployed resources available. Unemployment must exist in the economy. Output must be low and the economy is operating on the left hand portion of the AS curve. Activity 1.1 Aggregate Demand and Supply Time Allowed: 10 Minutes Considering the aggregate demand and supply curve discussed,what would be the nature of the disequilibrium if AD increased? ECN 102 Principles of Economics II Summary In Study Session 3, you have learnt that: 1. Aggregate demand (AD) is the total demand for finished goods and services in an economy at a given time. 2. The aggregate demand equation is Y =C(Y-T) +I(r) +G+NX (e ) and they make the four components. 3. The component G represents any expenditure made by the government. 4. Aggregate Supply (AS) is the sum of the amounts of goods and services (real output) produced and supplied by the companies in an economy over a given of time. 5. Aggregate Supply has several components, they are: Consumer goods, Capitalgoods, Public and Merit goods,tradedgoods. 6. Capital goods are goods such as machinery used in the production of commodities. 7. The aggregate supply (AS) curve shows the quantity of output which firms are prepared to supply at various price levels. ECN 102 Principles of Economics II Self-Assessment Questions (SAQs) for Study Session 4 Now that you have completed this study session, you can assess how well you have achieved its Learning outcomes by answering the following questions. Write your answers in your study Diary and discuss them with your Tutor at the next study Support Meeting. You can check your answers with the Notes on the Self-Assessment questions at the end of this Module. SAQ 3.1 (Testing Learning outcomes 3.1) Considering the aggregate demand and supply curve discussed, if AD increased, what would you expect to happen to inventories? SAQ 3.2 (Testing Learning outcomes 3.2) Considering the aggregate demand and supply curve discussed, if AD increased, How would you expect firms to respond? Notes on SAQs for study session 3 SAQ 3.1 Inventories will fall as firms satisfy the excess demand from their stocks. SAQ 3.2 It is likely that firms will increase output (or prices). The extent to which firms will react, by increasing prices or output, depends upon the slope of the AS curve. The slope will depend crucially on the time period under consideration. ECN 102 Principles of Economics II Reference http://www.investopedia.com/terms/a/aggregatedemand.asp ECN 102 Principles of Economics II Study Session 4: Consumption, Savings, Investments Introduction Consumption, Savings and Investments are three important terms in National Income Accounting that everybody can relate with. Everybody is a consumer. Some people have learnt the act of keeping part of their income for future use which you can relate to mean saving. In this study you will learn aboutconsumption,savings, propensity to save and consume, investments, exports and imports. Learning Outcomes for Study Session 4 At the end of this study, you should be able to: 4.1 Explain Consumption and its functions 4.2 Explain Savings and its functions 4.3 Discuss the average and Marginal Propensity to consume and Save 4.4 Explain Investments 4.5 Discuss the Investment Demand Curve 4.6 Explain Gross Exports and Gross Imports ECN 102 Principles of Economics II 4.1 Consumption Consumption can be defined as the act of using good and services to satisfy human wants.It can also be refers to households expenditure on good and services, which yields utility in the current period. Consumption is the amount a consumer spends in the purchase of goods and services Consumer spending could be autonomous (spending irrespective of receipt of income) or Induced (spending resulting from income increase). Box 1.1: Definition of Consumption Consumption can be defined as the act of using good and services to satisfy human wants There are several factors that determine consumption. They are: 1. Personal income 2. Income taxes 3. Consumer expectations 4. Wealth 5. Price level 6. Age 7. Savings Personal Income Personal Income is the current income of households or persons from all sources which include receipts such as transfer payments from which no productive services are produced by recipients. Consumption is impossible without one earning income either through employment or transfers from businesses or government. Income Taxes This is government‟s levy on the citizens‟ income.Income taxes reduce personal income which actually reduces the actual amount available for spending (disposable income). ECN 102 Principles of Economics II Consumer Expectation The expectation of consumers about future price and income can determine the consumption level at a particular time. If consumers foreseean increase in their income they buy things more. Wealth If a community inherits wealth, it increases their level of consumption. Wealth here could be either financial or housing wealth which has a direct relationship to the consumption level. Price level Increase in price can reduce the level of consumption. When there is increase in price level people that are rich and wealthy feel poorer and buy less. When there is reduction in price level , people buy more. Represented by C=1/p where C=consumption, p= price level Age The young are likely to consume more. If the population of the old people is more, consumption tends to be low. Savings When savings and investments increase consumption becomes low. On the other hand when savings and investments reduce, consumption increase automatically. The people will definitely spend more. In-Text Question _____________can be defined as the act of using good and services to satisfy human wants In-Text Answer Consumption ECN 102 Principles of Economics II 4.1.1 The Consumption Function The consumption function shows the relationship between consumption and disposable income. C = f (Yd.) Ceteris paribus. It is usually expressed as a positive and linear relationship when all other non-income determinants of consumption are held constant. The consumption function shifts when these non-income determinants change. C=consumption, f = function income, Yd. = disposable income. Table 1.1 Hypothetical Consumption Function for an Economy Disposable Income (Yd) Consumption (C) Savings (Million Naira) (Million Naira) (S = Yd – C) 500 500 10 550 540 20 600 580 30 650 620 40 700 660 50 750 700 60 800 740 70 The table can also be presented in a graphical form with consumption on the vertical axis and disposable income on the horizontal axis. The values of consumer saving (column 3) in Table1.1 is obtained by subtracting consumption from disposable income. The table initially shows that the consumer spends all his disposable income and as his disposable income increases he saves more. ECN 102 Principles of Economics II The graph below shows the income- consumption relationship Figure 1.1a graph showing income-consumer relationship Consumption function is a functional relationship existing between consumption expenditure and all its determinate. Activity 1.1: Factors affecting Consumption Time: 15minutes The Federal Government of Nigeria has just reduced the income tax of the civil servants. How does this affect the consumption level of the community? ECN 102 Principles of Economics II 4.2 Saving Saving can be defined as that part of income that is not consumed. It can also be said to be theamount of income per time that is not consumed by economic unit. Box 1.2 Definition of Saving Saving can be defined as that part of income that is not consumed. There are several factors thataffect savings. They are: 1. Income level 2. Interest rate 3. Availability of Saving Facilities 4. Inflation rate 5. Customs of people 6. Expectation of the people Income level 1. Income level affectssavings. The higher the income the higher will be the saving and lower the income the lower the saving S = f(y). The graph below shows the relationship between income and savings as explained in the study. Saving S = f(y) Income ECN 102 Principles of Economics II Figure1.2 a graph showing Income and Savings relationship Interest Rate The higher the interest rate, the higher people are willing to save. The lower the interestrate, the lower the saving rate. The graph below shows the relationship between Savings and interest S= Savings I= Interest Figure 1.3 Savings –Interest rate graph Availability of Saving Facilities The availability of saving facilities such as banks can affect the saving culture of the community. The efficiency of the banking system can aid effective savings. With the availability of appropriate saving schemes, savings thrive. Inflation rate Inflation which is the sustain increase in general price level in the society over a period of time affects saving rate. When inflation is high, saving is reduced as the value of money will drop. In-Text Question __________can be defined as the part of the income that is not consumed ECN 102 Principles of Economics II In-Text Answer Saving Custom of people Customs and conducts of the people towards saving also affect savings. Some individuals have the culture of saving toward ceremonies or projects like burial, naming ceremony, and buying of house. The picture below shows the typical African custom that could affect their conduct towards savings. They could actually save towards this Figure1.4 Lagos-Nigeria Eyofestival Source: https://farm5.staticflickr.com/4049/4244697656_7df8c9d409_o.jpg Expectations of the people The expectations of the people about the future value of some variables such as inflation, interest, income etc. could affect savings. 4.2.1 Saving Functions Saving function can be defined as a functional relationship connecting saving and all its determinants. Saving function can also be referred to as a linear relationship existing between disposable income and savings. ECN 102 Principles of Economics II Saving function can be represented mathematically as S=F(y) Where S= savings, y= National or disposable Income The graph Figure 1.5. below shows the saving function relationship with income ECN 102 Principles of Economics II 4.3 The average and Marginal Propensity to consume and Save The ratios used to express the relationship between consumption, Savings and disposable income include:  Average Propensity to Consume (APC)  Marginal Propensity to Consume (MPC)  Average Propensity to Save (APC)  Marginal Propensity to Save (MPS) Average Propensity to Consume (APC): This is the ratio of consumption to disposable income at a specific level of income. APC = C/Yd Marginal Propensity to Consume (MPC): This is the ratio of the change in consumption relative to the change in disposable income. MPC = ΔC/ΔYd Average Propensity to Save (APC): This is the ratio of saving to disposable income. APS = S/Yd Marginal Propensity to Save (MPS): This is the ratio of the change in saving relative to the change in disposable income. MPS = Δ S/ΔYd APC + APS = 1 MPC + MPS = 1 Table 1.2Ratios computed from the hypothetical example in Table 1.1 APC (C/Yd) APS Yd C MPC (ΔC/ΔYd) MPS 500/500 = 1.0 0 500 500 -- 540/550 = 0.98 0.02 550 540 40/50 = 0.80 0.20 580/600 = 0.97 0.03 600 580 40/50 = 0.80 0.20 620/650 = 0.95 0.05 650 620 40/50 = 0.80 0.20 660/700 = 0.94 0.06 700 660 40/50 = 0.80 0.20 700/750 = 0.93 0.07 750 700 40/50 = 0.80 0.20 ECN 102 Principles of Economics II 740/800 = 0.92 0.08 800 740 40/50 = 0.80 0.20 From the Table above, the APC decreases from 1.0 to 0.90 as disposable income Increases from N500b to N800b but save 8% of their income at N800b. The MPC is constant throughout at 0.8 while the MPS (1-MPC)is 0.2. Note also from the Table that APC + APS = 1 and MPC + MPS = 1 In-Text Question ______________the ratio of the change in consumption relative to the change in disposable income. In-Text Answer Average Propensity to Consume (APC) ECN 102 Principles of Economics II 4.4 Investments Investment can be defined as the production of goods and services which are not for current consumption but for future gains. Gross investmentis the sum of residential construction, non-residential construction, the purchase of producers‟ durable equipment by businesses, and the net change in business inventories. It is the least stable component of aggregate spending and a principal cause of the business cycle. In the national income accounts, investment consists of:  Residential construction  Nonresidential construction  Producers‟ durable equipment  Changes in business inventories. Residential construction It involves the purchase of housing units. It is influenced by demographics, buyer‟s level of indebtedness, wealth of buyers, current and expected income level, willingness to incur new debt, ability of buyers to obtain loan, cost of housing units, and mortgage rate of interest. Non-residential construction This includes offices, hotels and other commercial real estate. It is influenced by the rate of interest, the vacancy rate of existing units, needs for additional commercial space, ability of business units to meet increased rental costs. Producers’ durable equipment It is influenced by borrowing costs, utilization of existing productive capacity, availability of more efficient technology, current and expected sales, existing and future competition. ECN 102 Principles of Economics II Changes in business inventories This is the increase or reduction in the stocks of final goods, intermediate goods, raw materials, and other inputs used in production. These are linkedare linked to:  Rate of interest  Current and expected sales  Current and expected inventory prices  Certainty of inventory deliveries In-Text Question _____________can be defined as the production of goods and services which are not for current consumption but for future gains. In-Text Answer Investment 4.4.1 Factors affecting Investments There are several factors affecting investments. They are:  Level of National Income  Cost of Funds  Technical progress  Government Fiscal Policies  Business Climate Level of National Income: High income brings high investment. When the community experience low income there is low investment. Cost of Funds:This is the lending or interest rate. High lending rate lowers the rate of investment in the economy. ECN 102 Principles of Economics II Technical Progress:When technological changes increase, investment increase. Low pace in technology growth reduces investments Government Fiscal Policies:The volume of investments in the economy is directly related to the level of minimum wage, salaries and taxes. Business Climate:Thisis the business environment. An hostile environment will bring low investment. Activity 1.2 : Factors Affecting Investment Time: 16 Minutes Mr. Wada was the richest man in the country in 2014. His investments were worth 100 billion naira. But in year 2015, his investment dropped to 20 million naira. Consequently he was no longer the richest man in the country. What do you think could be responsible. ECN 102 Principles of Economics II 4.5 Investment Demand Curve It is a curve that shows the relationship between gross investment and the rate of interest, while other variables affecting investment spending are held constant. Investment spending is inversely related to the rate of interest. The higher the investment the lower the rate of interest and the lower the investment the higher the rate of interest. Figure 4.5 below shows Investment demand curve Figure 4.5 Investment demand Curve ECN 102 Principles of Economics II 4.6 Gross Exports and Gross Imports Gross Exportsare the value of goods and services produced in a home country and sold abroad. It is described as the value of flow of goods whether they were partially or fully manufactured in the country marketed to other countries. The picture shows an example of one of Nigeria‟s exports-cocoa Figure 4.6 cocoa as an export good Source:http://www.corporate-nigeria.com/index/agriculture/cocoa-growing.html Gross importsare the value of goods and services purchased by a home country from abroad. It is described as the value of flow of stock of material goods that enter the economic territory of a country. The picture below shows an electric generator, one of Nigeria‟s biggest imports ECN 102 Principles of Economics II Figure 4.6 An electric generator Source:http://kidsonroll.com/cservice/images/10,000%20Watt%20Portable%20Electric%20Gen erator.jpg Net Exports are the value of gross exports less gross imports.It the value of a country's total exports subtracting the value of its total imports. It is used to calculate a country's aggregate expenditures Net Importsare described difference between the values of imports as against exports in a country Imports usually lower the aggregate spending of a nation on domestically produced goods. There are several factors affecting imports and exports. They are:  Level of income  Foreign exchange rate  Import tariffs  Marketing ECN 102 Principles of Economics II Level of income If income rises at home more imports are bought. Companies may likely buy goods, services and raw materials imported. Individuals will buy more of imports if income increases. This will aid importation. If however there is reduction in income, companies in countries and individuals of such countries settle for domestic goods which will make them productive and increase export. Foreign exchange rate A collapse in a country‟s exchange rate will reduce export prices and increase import prices. This will be likely to increase the value of its exports and reduce the amount spent on imports. Import tariffs These are taxes placed on imports by the government. It is done for several reasons. It could be for consumer protection, national security, retaliation, domestic employment protection. These could affect the level of flow of imports and exports in the country. If the tarrif is too tight, imports goods may reduce. Marketing How much foreign companies invest in marketing could affect how much they sell to any country. In a similar way, the quantity domestic companies will sell is directly related to how much they put into marketing their products to the outside world. In-Text Question _____________are the value of goods and services produced in a home country and sold abroad In-Text Answer Gross Exports ECN 102 Principles of Economics II Summary In Study Session 4, you have learnt that: 1. Consumption is the act of using good and services to satisfy human wants. 2. Personal incomes, Income taxes, Consumer expectations, Wealth are some of the factors that determine consumption. 3. The consumption function shows the relationship between consumption and disposable income. C = f (Yd.) 4. Saving is that part of income that is not consumed 5. Income level, Interest rate, Availability of Saving Facilities etc. are all factors affecting saving 6. Saving function is the functional relationship connecting saving and all its determinants. 7. Average Propensity to Consume (APC) is the ratio of consumption to disposable income at a specific level of income. 8. Investment is the production of goods and services which are not for current consumption but for future gains. 9. Investment consists of Residential, construction, non-residentialconstruction, Producers‟ durable equipment and change in business directory. 10. Level of National Income, Cost of Funds, and Technical progress are all examples of factors affecting investments. 11. Gross Exportsare the value of goods and services produced in a home country and sold abroad. 12. Gross importsare the value of goods and services purchased by a home country from abroad. ECN 102 Principles of Economics II Self-Assessment Questions (SAQs) for Study Session 4 Now that you have completed this study session, you can assess how well you have achieved its Learning outcomes by answering the following questions. Write your answers in your study Diary and discuss them with your Tutor at the next study Support Meeting. You can check your answers with the Notes on the Self-Assessment questions at the end of this Module. SAQ 4.1 (Testing Learning outcomes 4.1) Consumption can be defined as the act of using good and services to satisfy human wants. Why do you think consumption level can drop in the society and give explanations on consumption function? SAQ 4.2 (Testing Learning outcomes 4.2) Give a brief description of saving and its function SAQ 4.3 (Testing Learning outcomes 4.3) Define the following terms.  Average Propensity to Consume (APC)  Marginal Propensity to Consume (MPC)  Average Propensity to Save (APC)  Marginal Propensity to Save (MPS) SAQ 4.4 (Testing Learning outcomes 4.4) Discuss the important components of Investments ECN 102 Principles of Economics II SAQ 4.5 (Testing Learning outcomes4.5) You‟ve learnt that Investment spending is inversely related to the rate of interest. Give a further explanation to this. SAQ 4.6(Testing Learning outcomes4.6) Give some explanation about gross export and imports Notes on SAQs for study session 4 SAQ 4.1 Consumption level could be affected because of the following: 1. Personal income 2. Income taxes 3. Consumer expectations 4. Wealth 5. Price level The consumption function shows the relationship between consumption anddisposable income. C = f (Yd.) Ceteris paribus. SAQ 4.2 Saving is that part of income that is not consumed. It can also be said to be the amount of income per time that is not consumed by economic unit. Saving function is the functional relationship connecting saving and all its determinants. Saving function can also be referred to as a linear relationship existing between and disposable income and savings. SAQ 4.3 Average Propensity to Consume (APC): This is the ratio of consumption to disposable income at a specific level of income. APC = C/Yd ECN 102 Principles of Economics II Marginal Propensity to Consume (MPC): This is the ratio of the change in consumption relative to the change in disposable income. MPC = ΔC/ΔYd Average Propensity to Save (APC): This is the ratio of saving to disposable income. APS = S/Yd Marginal Propensity to Save (MPS): This is the ratio of the change in saving relative to the change in disposable income. MPS = Δ S/ΔYd APC + APS = 1 MPC + MPS = 1 SAQ 4.4 In the national income accounts, investment consists of:  Residential construction  Nonresidential construction  Producers‟ durable equipment  Changes in business inventories. SAQ 4.5 This is explained with interest demand curve which shows that the relationship between gross investment and the rate of interest, while other variables affecting investment spending are held constant. It was inferred that the higher the investment the lower the rate of interest and the lower the investment the higher the rate of interest. SAQ 4.6 Gross Exportsare the value of goods and services produced in a home country and sold abroad. It is described as the value of flow of goods whether they were partially or fully manufactured in the country marketed to other countries Gross importsare the value of goods and services purchased by a home country from abroad. ECN 102 Principles of Economics II It is described as the value of flow of stock of material goods that enter the economic territory of a country. ECN 102 Principles of Economics II References 1. https://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp1050.pdf 2. http://www.amosweb.com/cgi- bin/awb_nav.pl?s=wpd&c=dsp&k=change+in+private+inventories 3. http://www.dictionarist.com/net+imports ECN 102 Principles of Economics II Study Session 5: Multiplier Analysis Introduction You would probably know that man reaps what he sows. Our actions today describe the reality of tomorrow. In macroeconomics, multiplier analysis speaks the same language. The multiplier effect comes to play because injections of demands of new goods and service into the circular flow of income affects further spending. And can affect the general output or employment.In this study, you will about multiplier, the types and the effects. Learning Outcomes for Study Session 5 At the end of this study you should be able to 5.1 Define Multiplier 5.2 Discuss the types of Multiplier 5.3 Explain the Multiplier effects ECN 102 Principles of Economics II 5.1 Multiplier Multiplier is a key concept in regional (and local) economic models. The basic idea is that the cumulative effect of an injection is greater than the initial impact. It is based on the notion of an internal feedback through input-output linkages between the main economic agents such as firms and households. Firms buy and sell goods and services to other firms. Households sell labour services to firms and buy goods from them. These linkages are found both within and between regions. If a new factory is to be set-up in a local area, it will require additional labour; this can be obtained from various sources; attracting existing workers from other industries; employing unemployed workers. Thus the impact of the new plant also spreads to other local industries through direct purchase from them and from purchases of locally produced goods and services, which arise from the income derived by the extra employment that is created. Further impacts occur due to feedback effects –where other local firms require more labour and inputs to meet rising demand for their output, which has been stimulated by the initial injection (the new Factory.) The multiplier process continues until the initial injection has worked its way through the local economy. Box 1.1: Definition of Multiplier It is based on the notion of an internal feedback through input-output linkages between the main economic agents such as firms and households. ECN 102 Principles of Economics II 5.2Types of Multipliers There are different types of multiplier. They are:  Balanced-budget multiplier  Expenditure Multiplier  Tax Multiplier The figure below shows the different types of Multiplier Balance-Budget Expenditure Tax Figure 5.2 Types of Multiplier Balanced-budget Multiplier Thisis the measure of the change in aggregate production caused by equal changes in government purchases and taxes. The balanced-budget multiplier is equal to one, meaning that the multiplier effect of a change in taxes offsets all but the initial production triggered by the change in government purchases. This multiplier is the combination of the expenditures multiplier, which measures the change in aggregate production caused by changes in an autonomous aggregate expenditure, and the tax multiplier which measures the change in aggregate production caused by changes in taxes. ECN 102 Principles of Economics II The balanced-budget multiplier measures the change in aggregate production triggered by an autonomous change in government taxes. This multiplier is useful in the analysis of fiscal policy changes that involves both government purchases and taxes. The logic behind this multiplier comes from the government's budget, which includes both spending and taxes. In general, a balanced budget has equality between spending and taxes. As such, the balanced-budget multiplier analyzes what happens when there is equality between changes in government purchases and taxes, that is, actions that keep the budget "balanced." In other words, the balanced-budget multiplier indicates the overall impact on aggregate production of a change in government purchases that is matched (that is, paid for) by an equivalent change in taxes. The balanced-budget multiplier, as such, is actually the sum of the expenditures multiplier (for government purchases) and the tax multiplier. The balanced-budget multiplier is equal to one. The "positive" impact on aggregate production caused by a change in government purchases is largely, but not completely, offset by the "negative" impact of the change in taxes. The only part of the impact of the change in government purchases NOT offset by the change in taxes is the purchase of aggregate production made by the initial injection. Hence, the change in aggregate production is equal to the initial change in government purchases. A Simple Formulation The balanced-budget multiplier, like the expenditures multiplier and tax multiplier can come in several different varieties based on assumptions concerning the structure of the economy and what components are induced by aggregate production. However, the value of the balanced-budget multiplier is the same whether consumption is the only induced expenditure or all components are assumed to be induced. The reason is that all of the "induced" changes in aggregate production caused by changes in government purchases are cancelled out by opposite changes in taxes. So it matters not what components are induced. ECN 102 Principles of Economics II As such, here is the balanced-budget multiplier (m[bb]) based on the combination of the simple expenditures multiplier and the simple tax multiplier. m(bb) = 1/mps + -(mpc/mps) = (1 - mpc/mps) = mps/mps = 1 Where MPC is the marginal propensity to consume and MPS is the marginal Propensity to save. Why One? The most obvious and most important point is that the balanced-budget multiplier has a value of 1. This value indicates that the change in aggregate production is caused by the initial injection of government purchases. The subsequent changes in aggregate production that might be result as government purchases trigger cumulatively reinforcing induced changes in factor payments, income, and consumption are cancelled out by an opposite impact from the change in taxes. Suppose, for example, that government purchases are increased by₦ 1 trillion using fiscal policy designed to correct a business-cycle contraction. By itself, this ₦1 trillion government purchases increase would be expected to trigger a ₦4 trillion increase in aggregate production. However, further suppose that this ₦1 trillion increase in government purchases is matched by, and paid for with, an equal ₦1 trillion increase in taxes. By itself, this ₦1 trillion increase in taxes is expected to trigger a ₦3 trillion decrease in aggregate production. The net impact on aggregate production of both changes is only ₦1 trillion, not₦ 4 trillion. If a₦ 4 trillion increases in aggregate production is needed to achieve full employment, then this strategy falls ₦3 trillion short. Why does this happen? Firstly, the increase in aggregate production triggered by the increase in government purchases is offset by a decrease in aggregate production triggered by the increase in taxes. ECN 102 Principles of Economics II Secondly, the increase in aggregate production stimulated by government purchases is only partially offset by the decrease aggregate production stimulated by taxes. The offset is only partial and there is a net impact on production due to the way taxes and government purchases affect aggregate expenditures. All ₦1 trillion of the government purchases act to increase aggregate expenditures. However, only ₦750 billion of the taxes (due to a marginal propensity to consume of 0.75) work their way through consumption to decrease aggregate expenditures. As such, there remains a net increase in aggregate expenditures of ₦250 billion. Evaluating this net increase of ₦250 billion using the simple expenditures multiplier of 4 identifies an increase in aggregate production of ₦1 trillion. Is it not a coincidence that this net increase in aggregate production is exactly equal to the original change in government purchases (and taxes). Only the initial ₦1 trillion government purchase triggers an increase in aggregate production. Each subsequent round of increased consumption that would be otherwise induced by the multiplier process is offset by decreased consumption resulting by higher taxes. The only expenditure that does not go through the household sector and is not cancelled by taxes is the original government purchase. Expenditures Multiplier The expenditures multiplier measures changes in aggregate production caused by changes in an autonomous expenditure. Like the tax multiplier this comes in several varieties, simple and complex, depending on which expenditures and other components are induced by aggregate production and income. It differs from the tax multiplier in that aggregate expenditures change by full amount of the autonomous change. ECN 102 Principles of Economics II The formular for simple expenditure for multiplier, m is M= 1/ (1-MPC) = 1/MPS Where MPC is the marginal propensity to consume and MPS =Marginal Propensity to Save Tax Multiplier The tax multiplier measures changes in aggregate production caused by changes in taxes. Like the expenditures multiplier this comes in several varieties, simple and complex, depending on which expenditures and other components are induced by aggregate production and income. It differs from the expenditures multiplier in that aggregate expenditures change by less than the change in taxes. The simple tax multiplier assumes that consumption is the only induced component. The formula for this simple tax multiplier is: M (tax) – MPC x 1/MPS= -MPC/MPS Where MPC is the marginal propensity to consume and MPS is the Marginal Propensity to save. In-Text Question _____________measures changes in aggregate production caused by changes in taxes. In-Text Answer The tax multiplier ECN 102 Principles of Economics II 5.3 Multiplier Effects Every time there is an addition of new demand into the circular flow there is a probability multiplier effect. Let‟s look at the multiplier process of a new export plant in the locality below and deduce the multiplier effect. Figure 1.1The multiplier process ECN 102 Principles of Economics II There are four effects: Direct: Increase in local income/output (wages) Increase in local employment Indirect: Increased demand for locally produced inputs: components, transport, and other services. These will also generate further demand for increased inputs by the supplying firms Induced Effects: Those people who are employed in the new plant will spend some of their income on locally produced goods and services. Feedback loop: Local producers of goods and services whose demand has increased because of the 1st round indirect and induced effects will also require more labour and other inputs Assumptions of Multiplier Effects The marginal propensity remains constant throughout as the income increases. There is net increase in investment over the preceding year There is no time gap between the increase in investments and the ultimate increase in income There is an excess capacity in consumer goods companies. Negative Multiplier Effect The multiplier effect can work in the opposite direction. If the government cut spending, many will loose their jobs. This will bring reduction in spending and therefore put further pressure on the economy. ECN 102 Principles of Economics II Applying the Multiplier effect. The multiplier effect can be applied in the following ways:  When the government finances the construction of new roads  When there is an rise in exports overseas  When there is a decrease in interest rates or tax rates, or when the exchange rate decreases In-Text Question The multiplier effect can be applied in the following ways except (a) When the government finances the construction of new roads (b) Rise in exports overseas (c) Decrease in interest rate (d) Decrease in borrowing In-Text Answer Decrease in borrowing. ECN 102 Principles of Economics II Summary At the end of study session 5, you have learnt that: 1. Multiplier is a key concept in regional (and local) economic models. The basic idea is that the cumulative effect of an injection is greater than the initial impact. It is based on the notion of an internal feedback through input-output linkages between the main economic agents such as firms and households. 2. Balanced-budget multiplier, Expenditure, and Tax are the different types of multipliers. 3. Balanced-budget Multiplier is the measure of the change in aggregate production caused by equal changes in government purchases and taxes. T 4. The multiplier effect can be applied in the following ways: When the government finances the construction of new roads When there is an rise in exports overseas When there is a decrease in interest rates or tax rates, or when the exchange rate decreases. ECN 102 Principles of Economics II Self-Assessment Questions (SAQs) for Study Session 5 Now that you have completed this study session, you can assess how well you have achieved its Learning outcomes by answering the following questions. Write your answers in your study Diary and discuss them with your Tutor at the next study Support Meeting. You can check your answers with the Notes on the Self-Assessment questions at the end of this Module. SAQ 5.1 (Testing Learning outcomes 5.1) Justify why Multiplier is a key concept in regional (and local) economic models SAQ 5.2 (Testing Learning outcomes 5.2) Explain the types of multipliers SAQ 5.3 (Testing Learning outcomes 5.3) Explain the multiplier effect Notes on SAQs for study session 5 SAQ 5.1 The basic idea is that the cumulative effect of an injection is greater than the initial impact. It is based on the notion of an internal feedback through input-output linkages between the main economic agents such as firms and households. SAQ 5.2 Balanced-budget Multiplier This is the measure of the change in aggregate production caused by equal changes in government purchases and taxes. The balanced-budget multiplier is equal to one, meaning that ECN 102 Principles of Economics II the multiplier effect of a change in taxes offsets all but the initial production triggered by the change in government purchases. Expenditures Multiplier The expenditures multiplier measures changes in aggregate production caused by changes in an autonomous expenditure Tax Multiplier The tax multiplier measures changes in aggregate production caused by changes in taxes. Like the expenditures multiplier this comes in several varieties, simple and complex, depending on which expenditures and other components are induced by aggregate production and income SAQ 5.3 Every time there is an addition of new demand into the circular flow there is a probability multiplier effect. References http://www.slideshare.net/khalid1173/multipliereffect ECN 102 Principles of Economics II Study Session 6: Unemployment Introduction Unemployment has become a global issue. Millions of people are roaming around the street with no job. This situation does not exclude our graduates and the educated. It is now very important to study this going by this ugly trend. In this study you will learn what unemployment is all about, the types, causes, effects and solutions. Learning Outcomes for Study Session 6 At the end of this study you should be able to 6.1 Define Unemployment 6.2 Highlight the types of unemployment 6.3 Explain the causes of unemployment 6.4 Highlight the effects of unemployment 6.5 Discuss the solution of unemployment ECN 102 Principles of Economics II 6.1Unemployment Unemployment is a situation whereby the factors of production (land, labour, capital) are not utilized in productive activities. Unemployment is said to occur when an individual is looking for work and could not find one. The failure of labour in the factors of production brings unemployment. The picture shows some unemployed men in an African community Figure 1.1Unemployed African men Source:http://www.brookings.edu/~/media/research/images/s/sk%20so/south_africa_unemploy ment001/south_africa_unemployment001_16x9.jpg Unemployment can be further explained as the economic situation characterized by individuals looking for jobs. Box 1.1 Define Unemployment ECN 102 Principles of Economics II Unemployment is a situation whereby the factors of production (land, labour, capital) are not utilized in productive activities. 6.1.1 Unemployment Rate Unemployment rate is measured in the percentage of the total available workforce. This is the total number of the unemployed divided by the employed. It is the percentage of the total labour force that is unemployed and willing to work but could get work. In-Text Question _______________is a situation whereby the factors of production (land, labour, capital) are not utilized in productive activities In-Text Answer Unemployment The unemployment rate shows the state of health of any economy. For instance Nigeria‟s unemployment rate in 2014 was around 85% which was not good for the country. ECN 102 Principles of Economics II 6.2 Types of Unemployment There are different types of unemployment. They are:  Frictional Unemployment  Structural Unemployment  Deficient demand Unemployment  Residual unemployment  Seasonal Unemployment The figure shows the types of unemployment Figure 1.2: Types of unemployment Frictional Unemployment This occurs when workers move from one job to another. It is the time gap that exists when you are looking for work. For example you were just laid off from work and you decided to look for ECN 102 Principles of Economics II another job. The time gap between this time and getting a new one is called frictional U

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