MacroeconomicsIntroduction

Frederick University

2014

Economic Agents

households firms

government

L, N, K

Final goods and services

Factors Generating Economic Problems

Scarcity of resources Technological changes Changes in tastes and preferences

Main Economic Questions

Generators

Scarcity of resources

Technological changes

Changes in tastes and preferences

Questions

What (and how much)

How For whom

Main Economic problems

Questions What and how

much

How

For Whom

Problems Efficiency in

allocation Efficiency in

motivation Efficiency in

distribution

Economics

Economics is the study of how economic agents make decisions what to produce, how to produce, and for whom to produce

Microeconomics vs. Macroeconomics Microeconomics – studies how economic

agents make decisions what, how and for whom to produce from the point of view of individual households and firms

Macroeconomics - studies how economic agents make decisions what, how and for whom to produce from the perspective of the impact of these decisions on the national economy as a whole.

Major Macroeconomic Issues

Output Employment and Unemployment Price Level

Macroeconomic objectives

Issues Output

Employment and Unemployment

Price level

Objectives High level and rapid

growth of output High level of

employment and low level of involuntary unemployment

Price level stability

Production Possibilities Frontier

wine movies choices

20 0 A

16 6 B

12 10 C

8 13 D

4 15 E

0 16 F

A

W

B

C

F

M

Production Possibilities Curve

20

0

16

6

12

10

16

Physical and Institutional PPF

w

M

Physical PPF

Institutional PPF

Physical PPF – indicates the potential of theeconomy to produce, constrained by thephysical availability of resources

Institutional PPF – indicates the potential of the economy to produce,constrained by the physical availability of resources and by the rulesand traditions followed by the decision makers

Institutional PPF and Potential Output Potential Output – the maximum sustainable

level of output that the economy can produce, given the productive capacity, the economy’s technological efficiency, and the rules and traditions, followed in the economy

When actual output exceeds potential output, price inflation tends to rise

When actual output falls below the potential, unemployment tend to increase

The Rate of Employment and The Rate of Unemployment Employment Rate – reflects the fraction of

working population over 16 and below 64 years

Unemployment rate – reflects the percentage of unemployed in the labor force

Labor force = employed + unemployed Unemployment rate = [unemployed :

(employed + unemployed)] x 100% Natural rate of Unemployment – the rate of

unemployment, determined by the institutional PPF and potential output.

Price Stability and the Rate of Inflation Price stability – the price level is

unchanged or rises very slowly The Consumer Price Index (CPI) -

measures the average price of goods and services bought by consumers

Rate of Inflation – the percentage change in the overall price level from one year to the next

Inflation 2012 = [(CPI20012 – CPI2011) : CPI2011] x 100%

Aggregate Demand AD – the quantity of GDP, which the economic agents are

planning to buy at every price level, ceteris paribus

Price level

output

AD AD depends on:

The willingness of households to buy output

The willingness of firms to buy output

Government fiscal and monetary policies

Aggregate Supply Aggregate supply (AS) - the total quantity of goods and services that

the firms in the country are willing to produce and sell at every price level, ceteris paribus.

Price level

Output

AS

AS depends on:

Physical PPF – resources and technology

Potential output determined by institutions,shaping costs, efficient use of resources

Macroeconomic Equilibrium

P AS and AD determine:

equilibrium output the level of

employment and unemployment

the price level and the rate of inflation

the balance of payments

Output

AD AS

E

FIRMSHOUSEHOLDS

Expenditures on final goods and services

Primary Income

Production factors

Final goods and services

The Circular Flow

GDP Gross Domestic Product – value of final

goods and services produced in the economy within a year

Final goods and services – produced during the current period and not used in the production of other goods and services

Intermediate goods The double counting problem

Value Added

Stages of the production process of 1/2 kilo of bread:

1. Wheat from the farmer – € 0.15

2. Flour from the miller – €0.43

3. Bread from the backer – €0.84

Value added

1. Wheat – €0.152. Flour – €0.283. Bread – €0.414. Total Value added =

= 0.15 + 0.28 + 0.41 = 0.84

Expenditure Approach

Economic Agents

households firms government foreigners

Expenditures

C + I + G + X - M

Expenditure approach

GDP = C + I + G + X – M = АЕ

Aggregate Expenditures

Income approach

GDP = ∑ primary income = Wages and salaries + proprietors’ income + interests + rents + dividends + retained earnings + depreciation

Expenditure approach vs. Income approach

АЕ- Indirect taxes- + subsidies

= Primary income

Three approaches to GDP calculation

The value added approach The expenditure approach The income approach

GDP vs. GNP

GDP – created on the national territory

GNP – created by the citizens of the country

Net Domestic Product

GDP (АЕ) – depreciation allowances = NDP

Domestic Income, Personal Income and Disposable IncomeGDP (income approach) - Depreciation = NDP (income approach) = Domestic

income

Domestic income- Retained earnings- Corporate taxes- Social security+ Transfer payments to the households_________________________________= Personal income- households’ income taxes

= Disposable income

GDP Shortcomings underground activities income distribution leisure time demerit activities market prices public goods production at factor prices quantity vs. quality net exports might not contribute to the

growth of welfare

Real vs. Nominal GDP Nominal GDP – GDP at current prices Real GDP – GDP at constant prices

(base year prices – chosen year) Index – the change in the value of an

indicator compared to its previous level, taken as a base (= 100)

GDP deflator =(Nominal GDP : Real GDP) х 100