Econ 152 Lecture 1 PDF

The National Economy The Scope of Macroeconomics  Macroeconomics Macroeconomics is the economics of the economy as a whole and microeconomics is the economics of the single market. Macroeconomics simplifies by ignoring differences among individual households. Macroeconomics is importa...

The National Economy The Scope of Macroeconomics  Macroeconomics Macroeconomics is the economics of the economy as a whole and microeconomics is the economics of the single market. Macroeconomics simplifies by ignoring differences among individual households. Macroeconomics is important — and even interesting — because it affects all of us.  Fathers of modern macroeconomics The foundation of macroeconomics was laid down by a British economist, John Maynard Keynes (1883 – 1946) in his revolutionary book “The General Theory of Employment, Interest and Money (1936)”. Milton Friedman James Tobin Paul Samuelson Robert E. Lucas Jr Robert Solow N. Gregory Mankiw etc. Important issues in macroeconomics Why does the cost of living keep rising? Why are millions of people unemployed, even when the economy is booming? Why are there recessions? Can the government do anything to combat recessions? Should it? Important issues in macroeconomics What is the government budget deficit? How does it affect the economy? Why does Ghana have such a huge trade deficit? Why are so many countries poor? What policies might help them grow out of poverty? THE SCOPE OF MACROECONOMICS Definitions Rate of economic growth: The percentage increase in national output over a 12-month period. Inflation: A persistent increase in the general price level over a given period of time. Rate of inflation is the percentage increase in prices over a 12-month period. Unemployment: those of working age who are without work, but who are available for work at current wage rates. THE SCOPE OF MACROECONOMICS Definitions Exchange rate: The rate at which one national currency exchanges for another. The rate is expressed as the amount of one currency that is necessary to purchase one unit of another currency (e.g. a Gh¢8 = $1) Balance of payments account: A record of the country’s transactions with the rest of the world. It shows the country’s payments to or deposits in other countries (debits) and its receipts or deposits from other countries (credits) THE SCOPE OF MACROECONOMICS The major macroeconomic issues/Goals of Macroeconomics (Rapid) economic growth: If output – real Gross Domestic Product (GDP)– grows faster than population, the average person can enjoy an improved standard of living High Employment (Unemployment): The main source of households’ incomes is labour earnings. When unemployment is high, many people are without jobs and must cut back their purchases of goods and services THE SCOPE OF MACROECONOMICS The major macroeconomic issues/Goals of Macroeconomics Inflation (Stable Prices): This goal is important because inflation imposes costs on society. Therefore keeping inflation rate low helps to reduce these costs. Balance of payments and stable exchange rates: A stable exchange rate will help reduce inflation, promote international trade and help the country achieve a favourable trade balance. Economic growth (average % per annum), Unemployment (average %), Inflation (average % per annum) France Germany Italy Japan UK USA EU(15) OECD Brazil Malaysia Singapore Growth 1960-9 7.5 4.4 5.3 10.9 2.9 4.3 3.5 4.6 5.4 6.5 8.8 1970-9 3.2 2.6 3.8 4.3 2.0 2.8 3.2 3.6 8.1 7.9 8.3 1980-9 2.2 1.8 2.4 4.0 2.4 2.5 2.2 2.6 3.0 5.8 6.1 1990-9 1.7 2.2 1.5 1.7 2.1 3.0 2.1 2.6 1.8 6.9 7.7 2000–5 2.0 1.0 1.5 1.9 2.7 2.9 2.0 2.6 2.8 5.2 4.6 Unemployment 1960-9 1.5 0.9 5.1 1.3 2.2 4.1 2.5 2.5 n/a n/a n/a 1970-9 3.7 2.3 6.4 1.7 4.5 6.1 4.0 4.3 n/a n/a n/a 1980-9 9.0 5.9 9.5 2.5 10.0 7.2 9.3 7.3 n/a 6.2 3.6 1990-9 10.6 7.7 10.4 3.7 8.1 5.8 9.2 6.9 9.3 3.4 2.8 2000–5 9.2 8.9 9.0 5.0 5.1 5.3 7.9 6.7 10.5 3.5 3.8 Inflation 1960-9 4.2 3.2 4.4 4.9 4.1 2.8 3.7 3.1 46.1 –0.3 1.1 1970-9 9.4 5.0 13.9 9.0 13.0 6.8 10.3 9.2 30.6 7.3 5.9 1980-9 7.3 2.9 11.2 2.5 7.4 5.5 7.4 8.9 332.2 2.2 2.5 1990-9 2.0 2.2 4.7 0.8 3.9 2.4 3.3 4.4 847.0 3.6 1.9 2000–5 1.8 1.4 2.7 –1.3 1.8 2.2 2.1 2.3 7.1 1.6 1.0 Economic growth (average % per annum), Unemployment (average %), Inflation (average % per annum) France Germany Italy Japan UK USA EU(15) OECD Brazil Malaysia Singapore Growth 1960-9 7.5 4.4 5.3 10.9 2.9 4.3 3.5 4.6 5.4 6.5 8.8 1970-9 3.2 2.6 3.8 4.3 2.0 2.8 3.2 3.6 8.1 7.9 8.3 1980-9 2.2 1.8 2.4 4.0 2.4 2.5 2.2 2.6 3.0 5.8 6.1 1990-9 1.7 2.2 1.5 1.7 2.1 3.0 2.1 2.6 1.8 6.9 7.7 2000–5 2.0 1.0 1.5 1.9 2.7 2.9 2.0 2.6 2.8 5.2 4.6 Unemployment 1960-9 1.5 0.9 5.1 1.3 2.2 4.1 2.5 2.5 n/a n/a n/a 1970-9 3.7 2.3 6.4 1.7 4.5 6.1 4.0 4.3 n/a n/a n/a 1980-9 9.0 5.9 9.5 2.5 10.0 7.2 9.3 7.3 n/a 6.2 3.6 1990-9 10.6 7.7 10.4 3.7 8.1 5.8 9.2 6.9 9.3 3.4 2.8 2000–5 9.2 8.9 9.0 5.0 5.1 5.3 7.9 6.7 10.5 3.5 3.8 Inflation 1960-9 4.2 3.2 4.4 4.9 4.1 2.8 3.7 3.1 46.1 –0.3 1.1 1970-9 9.4 5.0 13.9 9.0 13.0 6.8 10.3 9.2 30.6 7.3 5.9 1980-9 7.3 2.9 11.2 2.5 7.4 5.5 7.4 8.9 332.2 2.2 2.5 1990-9 2.0 2.2 4.7 0.8 3.9 2.4 3.3 4.4 847.0 3.6 1.9 2000–5 1.8 1.4 2.7 –1.3 1.8 2.2 2.1 2.3 7.1 1.6 1.0 Economic growth (average % per annum), Unemployment (average %), Inflation (average % per annum) France Germany Italy Japan UK USA EU(15) OECD Brazil Malaysia Singapore Growth 1960-9 7.5 4.4 5.3 10.9 2.9 4.3 3.5 4.6 5.4 6.5 8.8 1970-9 3.2 2.6 3.8 4.3 2.0 2.8 3.2 3.6 8.1 7.9 8.3 1980-9 2.2 1.8 2.4 4.0 2.4 2.5 2.2 2.6 3.0 5.8 6.1 1990-9 1.7 2.2 1.5 1.7 2.1 3.0 2.1 2.6 1.8 6.9 7.7 2000–5 2.0 1.0 1.5 1.9 2.7 2.9 2.0 2.6 2.8 5.2 4.6 Unemployment 1960-9 1.5 0.9 5.1 1.3 2.2 4.1 2.5 2.5 n/a n/a n/a 1970-9 3.7 2.3 6.4 1.7 4.5 6.1 4.0 4.3 n/a n/a n/a 1980-9 9.0 5.9 9.5 2.5 10.0 7.2 9.3 7.3 n/a 6.2 3.6 1990-9 10.6 7.7 10.4 3.7 8.1 5.8 9.2 6.9 9.3 3.4 2.8 2000–5 9.2 8.9 9.0 5.0 5.1 5.3 7.9 6.7 10.5 3.5 3.8 Inflation 1960-9 4.2 3.2 4.4 4.9 4.1 2.8 3.7 3.1 46.1 –0.3 1.1 1970-9 9.4 5.0 13.9 9.0 13.0 6.8 10.3 9.2 30.6 7.3 5.9 1980-9 7.3 2.9 11.2 2.5 7.4 5.5 7.4 8.9 332.2 2.2 2.5 1990-9 2.0 2.2 4.7 0.8 3.9 2.4 3.3 4.4 847.0 3.6 1.9 2000–5 1.8 1.4 2.7 –1.3 1.8 2.2 2.1 2.3 7.1 1.6 1.0 Ghana – Inflation Ghana –GDP growth (% annual) Unemployment -% of total laboure force (ILO modeled estimates) Ghana – Exchange rate (LCU/$) period average THE SCOPE OF MACROECONOMICS Microeconomics and macroeconomics The major macroeconomic issues economic growth unemployment inflation balance of payments and exchange rates Government macroeconomic policy THE SCOPE OF MACROECONOMICS Microeconomics and macroeconomics The major macroeconomic issues economic growth unemployment inflation balance of payments and exchange rates Government macroeconomic policy choosing between macroeconomic theories THE SCOPE OF MACROECONOMICS Microeconomics and macroeconomics The major macroeconomic issues economic growth unemployment inflation balance of payments and exchange rates Government macroeconomic policy choosing between macroeconomic theories choosing the order of priorities  Societies face trade-offs between economic objectives. The goal of faster growth may conflict with that of greater equality; The goal of lower unemployment may conflict with that of lower inflation. The existence of trade-offs means that policy-makers must make choices THE CIRCULAR FLOW OF INCOME Aggregate demand (AD). This is the total spending on goods and services made within the country. This spending consists of four elements. AD = C + I + G + X − M where, C= Household Consumption I =Investment G=Government expenditure X=Exports M=Imports The National Economy The Circular Flow of Income  National Income Accounting and The Circular Flow of Income National Income Accounting is the measurement of the annual output and income flows of an economy. It provides basis for assessing the economic performance, for designing public policy and for understanding how all the sectors of an economy interact.  National Income Accounting and The Circular Flow of Income It is an accounting framework used in measuring current economic activity in an economy over a period of time. The various approaches for measuring national income and their links can be explained by the Circular Flow of Income Model. The Circular Flow of Income  The Circular Flow of Income Figure: Circular Flow – Two – Sector Closed Economy Incomes to factors of Production Costs Factor services Factor market Goods market Receipts Goods and Services Household expenditure  The circular flow of income Firms Consumption of Factor domestically payments produced goods and services (Cd) Households  THE CIRCULAR FLOW OF INCOME Withdrawals (W): Only part of the incomes received by households will be spent on the goods and services of domestic firms. The remainder will be withdrawn from the inner flow. Likewise only part of the incomes generated by firms will be paid to the households. The remainder of this will also be withdrawn. There are three forms of withdraws (or ‘leakages’). Net savings (S): Saving is income that households choose not to spend but to put aside for the future. Savings are normally deposited in financial institutions such as banks  THE CIRCULAR FLOW OF INCOME Withdrawals (W): Net taxes (T): When people pay taxes (to either central or local government), this represents a withdrawal of money from the inner flow Import expenditure (M): Income spent on imported goods and services, or on goods and services using imported components.  THE CIRCULAR FLOW OF INCOME Injections (J) Only part of the demand for firms’ output arises from consumers’ expenditure. The remainder comes from other sources outside the inner flow. These additional components of aggregate demand are known as injections There are three types of injections. Investment (I): This is the money that firms spend after obtaining it from various financial institutions – either past savings or loans, or through a new issue of shares  THE CIRCULAR FLOW OF INCOME Injections (J) Government expenditure (G): When the government spends money on goods and services produced by firms, this counts as an injection Export expenditure (E): Money flows into the circular flow from abroad when residents abroad buy our exports of goods and services  The circular flow of income INJECTIONS Export expenditure (X) Investment (I) Government Consumption of expenditure (G) Factor domestically BANKS, etc GOV. ABROAD payments produced goods and services (Cd) Import Net expenditure (M) Net taxes (T) saving (S) WITHDRAWALS  THE CIRCULAR FLOW OF INCOME The links between injections and withdrawals There are indirect links between saving and investment, taxation and government expenditure, and imports and exports, via financial institutions, the government (central and local) and foreign countries respectively. Example: If more money is saved (S), there will be more available for banks and other financial institutions to lend out (I).  THE CIRCULAR FLOW OF INCOME The links between them (Example) If tax receipts are higher (T), the government may be more keen to increase its expenditure (G). If imports increase (M), incomes of people abroad will increase, which will enable them to purchase more of our exports (X). The circular flow and the four macroeconomic objectives However, Planned injections (J) may not equal planned withdrawals (W). If injections exceed withdrawals, the level of expenditure will rise and AD will rise Consequence on macroeconomic objectives Unemployment will fall Inflation will tend to rise The exports and imports part of the balance of payments will tend to deteriorate There will be economic growth  Equilibrium in the circular flow When injections do not equal withdrawals, a state of disequilibrium will exist This will set in train a process to bring the economy back to a state of equilibrium where injections are equal to withdrawals. Assume injections exceeds withdrawals : National income will increase People will save more (S), pay more taxes (T) and buy more imports (M). In other words, withdrawals will rise. This will continue until they have risen to equal injections The National Economy Measuring National Income  MEASURING NATIONAL INCOME The three ways of measuring GDP Gross domestic product (GDP): The value of output produced within the country over a 12-month period. the product method the income method the expenditure method The circular flow of national income and expenditure The circular flow of national income and expenditure (1) Production (2) Incomes (3) Expenditure  MEASURING NATIONAL INCOME The product (Output) method: This is the market value of final goods and services produced by countries’ own factors of production within a given period. That is adding up the monetary value of the physical goods and services in an economy within a given period, usually within a year. The final total output is called National Product of Output/GDP.  MEASURING NATIONAL INCOME The output approach involves adding up the market value of the total output (goods and services) of all firms in the various sectors of the economy (agriculture, mining, manufacturing, services, etc) in a year. This yields the GDP at market price  MEASURING NATIONAL INCOME The product (Output) method: Stages of Value of output Cost of Gross Value production (Cedis) intermediate Added (GVA) goods (Cedis) (Cedis) Farmer sells cassava 8,000 0 8,000 Miller turning cassava to 11,000 8,000 3,000 cassava dough Woman turning dough to gari 20,000 11,000 9,000 Gari delivered to retailer 30,000 20,000 10,000 Total 69,000 39,000 30,000  MEASURING NATIONAL INCOME The product (Output) method Net Factor Income from abroad: The difference between income earned by foreigners in the domestic country and income earned by the citizens residing abroad) GDP at market prices + Net Factor Income from abroad = Gross National Product (GNP) at market prices. GNP at market prices – Indirect taxes + subsidies = GNP at factor cost. GNP at factor cost – Depreciation = Net National Product (NNP) at factor cost.  MEASURING NATIONAL INCOME Problems of the product (Output) method The problem of double or multiple counting Non-marketed activities Underground activities Poor Statistics The valuation of public services  MEASURING NATIONAL INCOME The Income method/approach The National Income is arrived at by adding up all the money values of incomes earned (wages, rent, dividend, interest etc) by the factors of production employed in producing the output in an economy within a specified period of time like one year There are four factors of production. These are labour, land, capital and entrepreneurship.  MEASURING NATIONAL INCOME The Income method/approach Wages and salaries are paid to labour; Rent and interest are paid to land and capital respectively and profit o entrepreneurship. If all remunerations to factors of production are added up, the value should be equal to the total expenditure on total output.  MEASURING NATIONAL INCOME The Expenditure method/approach This approach measures the total expenditure needed to purchase output produced in the economy within a year. It is the expenditure of households, firms and government within a year. Total or Aggregate expenditure (AE) therefore is the sum of consumption expenditure on final goods and services and net exports (Exports minus Imports). MEASURING NATIONAL INCOME The Expenditure method/approach That is: AE = C + I + G + (X − M) where, C= Household Consumption I =Investment G=Government expenditure X=Exports M=Imports  MEASURING NATIONAL INCOME The Expenditure method/approach Problems with the expenditure approach The high illiteracy rate in developing countries including Ghana makes record keeping on expenditures very difficult to permit a reasonable assessment of expenditures. A large proportion of the national expenditure consists of private expenditures from the small-scale earners who are unwilling to give correct information on their expenditures for fear of high taxes. Subsistence production makes it difficult to compute subsistence consumption  Nominal versus real GDP Nominal GDP, measures GDP in the prices ruling at the time and thus takes no account of inflation. Real GDP measures GDP in the prices that ruled in the base year. Thus we could measure each year’s GDP in, say, 1990 prices. This would enable us to see how much real GDP had changed from one year to another. In other words, it would eliminate increases in money GDP that were merely due to an increase in prices.  Taking account of population: the use of per-capita measures Taking account of exchange rates: the use of PPP measures: For example, $1 may exchange for, say, Gh¢4.26. But will $1 in the US buy the same amount of goods as Gh¢4.26 in Ghana? The answer is almost certainly no  To compensate for this, GDP can be converted into a common currency at a purchasing power parity (PPP) rate. PPP rate is the rate of exchange rate that would allow a given amount of money in one country to buy the same amount of goods in another country after exchanging it into a currency of the other country.  MEASURING NATIONAL INCOME National income statistics: Suitable measures of living standards? Items that are excluded non-marketed items the underground economy Production: poor indicator of welfare? production does not equal consumption human costs of production Externalities (external costs) the production of 'regrettables' distribution of income The use of GDP per capita (GDP/Total population) Short-term Growth and the Business Cycle SHORT-TERM GROWTH & THE BUSINESS CYCLE Actual and potential national income Actual growth is the percentage annual increase in national output: the rate of growth in actual output Potential economic growth: It is the percentage annual increase in the economy’s capacity to produce: the rate of growth in potential output. Contributors to potential economic growth are: Discovery of natural resources Technological advances leading to efficiency Growth and the production possibility curve Growth in actual output Good X c b a O Good Y  Growth and the production possibility curve Growth in potential output Good X x I II O Good Y  Growth and the production possibility curve Growth in actual and potential output Good X y x I II O Good Y SHORT-TERM GROWTH & THE BUSINESS CYCLE Actual and potential national income actual and potential economic growth Economic growth & the business cycle SHORT-TERM GROWTH & THE BUSINESS CYCLE Actual and potential national income actual and potential economic growth Economic growth & the business cycle Business cycle is the periodic fluctuation of national output around its long-term trend. fluctuations in actual growth A business cycle may thus be defined as alternating periods of economic growth and contraction in an economy SHORT-TERM GROWTH & THE BUSINESS CYCLE Actual and potential national income actual and potential economic growth Economic growth & the business cycle When the actual GDP is above trend for a number of years in a row the economy is regarded as experiencing a boom or an expansion When the actual GDP is below trend for a number of years in a row we say that the economy is in contraction or recession.  SHORT-TERM GROWTH & THE BUSINESS CYCLE Actual and potential national income actual and potential economic growth Economic growth & the business cycle Phases of Business Cycle 1. Upturn: contracting or stagnant economy begins to recover 2. Expansion: there is rapid growth: the economy is booming 3. Peak: growth slows down or even ceases 4. Slow down or recession: there is little or no growth or even a decline in output  The business cycle Potential output National output 3 4 2 Actual 3 output 4 2 1 1 O Time SHORT-TERM GROWTH & THE BUSINESS CYCLE Actual and potential national income actual and potential economic growth Economic growth & the business cycle fluctuations in actual growth the phases of the business cycle upturn expansion peaking out slowdown or recession Long-term output trend sustainable national income  SHORT-TERM GROWTH & THE BUSINESS CYCLE Actual and potential national income actual and potential economic growth Economic growth & the business cycle fluctuations in actual growth the phases of the business cycle upturn expansion peaking out slowdown or recession Long-term output trend sustainable national income SHORT-TERM GROWTH & THE BUSINESS CYCLE Long-term Output Trend A line can be drawn showing the trend of national output over time (i.e. ignoring the cyclical fluctuations around the trend) If the average level of potential output that is unutilised stays constant from one cycle to another, the trend line will have the same slope as the potential output line. In other words, the trend rate of growth will be the same as the potential rate of growth.  The business cycle Potential output Trend National output output Actual output O Time SHORT-TERM GROWTH & THE BUSINESS CYCLE Causes of fluctuations in growth Changes in aggregate demand A rapid rise in aggregate demand will create shortages. This will tend to stimulate firms to increase output. The reverse holds Changes in aggregate demand relative to potential output Expansion of potential output in relation to increased aggregate demand The National Economy Long-term Economic Growth LONG-TERM ECONOMIC GROWTH  LONG-TERM ECONOMIC GROWTH Example: if GH¢100 million of extra capital yielded an annual income of ¢25 million, the marginal efficiency of capital would be ¢25 million/¢100 million=(1/4). Effects of actual growth on potential growth Actual growth stimulates investment and the development of new technology the importance of investment: Investment plays a twin role in economic growth (Think about it!!).  LONG-TERM ECONOMIC GROWTH Policies to achieve growth Demand-side policies Fiscal and monetary policies are intended to increase aggregate demand The principal policy instruments are government expenditure, taxation (fiscal policy); and the stock of money in circulation and interest rate (monetary policy)  LONG-TERM ECONOMIC GROWTH Policies to achieve growth Supply-side policies These policies are intended to increase the economy’s potential rate of output by increasing the supply of factor inputs and by increasing productivity Example: providing subsidies to firms Measures to encourage research and development, innovation and training  LONG-TERM ECONOMIC GROWTH The desirability of economic growth The benefits of economic growth increased consumption reduces other macro problems easier to redistribute incomes to the poor LONG-TERM ECONOMIC GROWTH The desirability of economic growth The costs of economic growth current opportunity costs Higher savings for investment would mean a cut in consumption may generate extra wants adverse social effects an excessive pursuit of material growth by a country can lead to a more greedy, more selfish and less caring society: suicides, divorce and other LONG-TERM ECONOMIC GROWTH The desirability of economic growth The costs of economic growth environmental costs pollution and waste depletion of resources Thank You