1

Mr Sydney Armstrong

Week 1

Lecture 1

Economics is the study of how society uses scarce productive resources to produce valuable commodities

and distribute them among different people.

The study of economics is divided into two fields: Microeconomics and Macroeconomics.

Macroeconomics analyses the behaviour of the entire economy and major spending sector: Household

Consumption, Business Investment, Government Expenditure and Net Export (export less import) the

study of the economy as a whole. The field focuses primarily on the level of output for the entire

economy, the general level of prices, the rate of unemployment and the economys balance of payments.

The roots of Macroeconomics: Macroeconomics did not exist in its modern form until 1936 when John

Maynard Keynes published his revolutionary General Theory of Employment, Interest and Money. At

the time England and the United States were still stuck in the Great Depression of the 1930s, with over a

quarter of the American labour force unemployed. In his new theory Keynes developed an analysis of

what causes business cycle, with alternating spells of high unemployment and inflation. Today,

macroeconomics examines a wide variety of areas, such as how total investment and consumption are

determined, how central banks manage money and interest rates what causes international financial crises

etc. Although macroeconomics has progressed far since his first insights, the issues addressed by Keynes

still define the study of macroeconomics today.

Macroeconomic Issues

The macroeconomic issues that will be examined during this course are:

1) Economic Growth (change in the level of output) a) An outward shift in the PPC (production possibilities curve) due to an increase in the quantity or

quality resources.

b) An increase of real output (gross domestic product) or real output per capita.

NB: Gross domestic product is the market value of all final goods and services produced within an

economy for a given period.

2) Unemployment: The failure of an economy to fully utilise its entire labour force.

3) Inflation: A rise in the general level of prices in an economy.

4) The Balance of Payments: A summary of all the transactions that took place between the individuals, firms and government units of one nation and those of all other nations during a year.

5) Exchange Rates: The rate of exchange of one nations currency for another nations currency.

A foreign firm would look at some key macroeconomic indicators so as to inform its decision as to

whether or not it should invest in a particular country.

Some key macroeconomic indicators are:

1. Real Gross Domestic Product (Real GDP) 2. The unemployment rate 3. The inflation rate 4. The interest rate 5. The exchange rate 6. The level of the stock market

Some Macroeconomics goals include

1. High but controllable levels of economic growth 2. Stable inflation rate 3. Low rate of unemployment 4. Stable exchange rate 5. Balanced balance of payment

2

Economic Growth and Business Cycles

Economic Growth

Economic growth has been defined generally as an increase in real GDP or real GDP per capita for a

given time period. While both of the foregoing variables are important in giving an idea of an economys

economic soundness they serve different purposes. The level of real GDP of an economy represents the

economic, political and in some cases the military stature of a country, the United States which happens to

be the worlds largest economy is a good example. On the other hand real GDP per capita real GDP

divided by the total population serves as an indicator of a countrys standard of living.

It is important to note that GDP was modified by the word real as opposed to nominal.

It is conventional in economics that real variables be used so as to take out any illusory effects that

nominal variables might readily present.

Real GDP: The total amount of goods and services produced in a given time period, adjusted for price

level changes.

Nominal GDP: The total amount of goods and services produced in a given time period, measured at

current prices.

Factors that determine economic growth

Natural Resources A large amount of resources is not sufficient to guarantee economic growth. People must devise the methods to convert natural resources into usable forms. LDCs require this

type of human resource before they are able to exploit the natural resources they possess.

Capital Accumulation The more machines a nation has the more goods and services and therefore income it will be able to produce.

Rate of Saving Without savings we cannot have investment, and without investment into capital stock there can be little hope of much economic growth. On a national level this means that

higher savings rates eventually mean higher living standard, all other things held constant.

Technological Progress Technology makes it possible to obtain more output from the same amount of inputs as before. The ability of a nation to initiate and sustain technology change

depends on:

1. The scientific capabilities of the population 2. The quality and size of the nations educational and training system and 3. The % of income that goes into basic research and development each year.

Factors to Promote Growth

Promote Savings

Promote Mobility Factors of production needs to be reallocated from industrial sectors that are declining into those that are expanding.

Promote Education and Training We need specialize labour to operate and develop specializes machinery.

Promote Research & Development -

Promote the Supply side Increase the AS (Aggregate Supply)

Business Cycles are recurrent fluctuations of economic activity or real GDP that occurs relative to the

long-term growth trend of the economy. These cycles vary in duration and intensity however economists

have identified four phases of a business cycle.

TREND LINE

D A

B

C

O

U

T

P

U

T

YEARS

3

Key: A Peak B Recession C Trough D Recovery 1Q;

Peak: At this point economic activity is at a temporary maximum. The economy is at the full employment

level and real output is at or very close to the economys capacity. The price level is likely to rise during

this phase. A peak is followed by a period of recession.

Recession: A period of decline in an economys total output usually lasting at least six months and

marked by contractions in many sectors of the economy. The price level shows little or no change but if

the recession is long enough turns into a depression- then prices will start to fall. A recession is

followed by a trough.

Trough: In this phase the recession or depression is at its lowest level, and can be short-lived or last very

long. The trough is followed by the recovery or expansionary phase.

Recovery (expansion): As the word suggests the economy is on the road to growth. In this phase output

and employment start to rise, as a result the price level will start to rise. This phase will continue until it

reaches the plateau or peak and a new cycle will begin.

Actual vs. Potential growth.

Potential growth (potential GDP) represents the maximum sustainable level of output that the economy

can produce. When an economy is operating at its potential, there are high levels of utilization of the

labour force and the capital stock. Potential output is determined by the economys productive capacity,

which depends upon the inputs available (capital, labour, land, etc.) and the economys technological

efficiency. Potential growth tends to grow steadily because inputs like labour and capital and the level of

technology change quite slowly overtime. By contrast actual growth (actual GDP) is subject to large

business cycle swings if spending pattern change sharply.

4

Mr Sydney Armstrong

Week 2

Lecture 1

Circular flow of income

Definition: The circular flow model, describes the interactions between the two basic agents in an

economy, consumers and producers. This model shows the flow of resources, products, income and

revenues between these two basic economic agents.

The circular flow of income is one of the most useful economic models. Universities and governments

use a more complicated version in order to make economic forecasts. The model is simple to start with

but is made more complex by adding additional sectors to it. The first version has only two sectors,

households and firms.

The basic circular flow of income model consists of six assumptions:

1. The economy consists of two sectors: households and firms. 2. Households spend all of their income (Y) on goods and services or consumption (C). There is no

saving (S).

3. All output (O) produced by firms is purchased by households through their expenditure (E). 4. There is no financial sector. 5. There is no government sector. 6. There is no overseas sector.

In fig.1, firms use factors of production provided by households. Land, labour, capital and

entrepreneurship are used by firms to produce a good or service. The firms pay households a reward for

using these factors. Rent for land, wages for labour, interest f