The Macroeconomic The Macroeconomic EnvironmentEnvironment

By the end of this class you should be able to:

1) Define macroeconomics2) Explain the flow of income in an

economy3) Recognise some problems in

measuring the value of an economy

Macroeconomics is ...Macroeconomics is ...

the study of the economy as a wholethe study of the economy as a whole

it deals with broad aggregatesit deals with broad aggregates

uses the same positivist thinking as uses the same positivist thinking as in microeconomics.in microeconomics.

Some key issues in Some key issues in macroeconomicsmacroeconomics

InflationInflation the rate of change of the general price levelthe rate of change of the general price level

UnemploymentUnemployment a measure of the number of people looking a measure of the number of people looking

for work, but who are without jobsfor work, but who are without jobs

OutputOutput real gross national product (GNP) measures real gross national product (GNP) measures

total income of an economytotal income of an economy

More key issues in More key issues in macroeconomicsmacroeconomics

Economic growthEconomic growth increases in real GNP, an indication of increases in real GNP, an indication of

the expansion of the economy’s total the expansion of the economy’s total outputoutput

Macroeconomic policyMacroeconomic policy a variety of policy measures used to a variety of policy measures used to

improve overall performance of the improve overall performance of the economyeconomy

figfig

Factorpayments

Factorpayments

Consumption ofdomestically

produced goodsand services (Cd)

Consumption ofdomestically

produced goodsand services (Cd)

The circular flow of income

Firms

Households

66

THE CIRCULAR FLOW OF INCOMETHE CIRCULAR FLOW OF INCOMETHE CIRCULAR FLOW OF INCOMETHE CIRCULAR FLOW OF INCOME

WithdrawalsWithdrawals net savingnet saving

net taxesnet taxes

import expenditureimport expenditure

InjectionsInjections investmentinvestment

government expendituregovernment expenditure

export expenditureexport expenditure

figfig

Factorpayments

Consumption ofdomestically

produced goodsand services (Cd)

Investment (Investment (II))Investment (Investment (II))

GovernmentGovernmentexpenditure (expenditure (GG))

GovernmentGovernmentexpenditure (expenditure (GG))

ExportExportexpenditure (expenditure (XX))

ExportExportexpenditure (expenditure (XX))

BANKS, etcBANKS, etc

Netsaving (S)

Netsaving (S)

GOV.GOV.

NetNettaxes (taxes (TT))

NetNettaxes (taxes (TT))

ABROAD

ImportImportexpenditure (expenditure (MM))

ImportImportexpenditure (expenditure (MM))

The circular flow of incomeThe circular flow of income

WITHDRAWALS

INJECTIONS

Three measures of national Three measures of national worth (£)worth (£)

ExpenditureExpenditure the sum of expenditures in the economythe sum of expenditures in the economy Y = C + I + G + X - MY = C + I + G + X - M

IncomeIncome the sum of incomes paid for factor the sum of incomes paid for factor

servicesservices OutputOutput

the sum of output (value added) produced the sum of output (value added) produced in the economyin the economy

figfig

INCOME INCOME

PRODUCTION

EXPENDITURE

National Product (output) = National Expenditure = National Income

Aggregate output in the short runAggregate output in the short run

Potential outputPotential output the output produced if all factors of the output produced if all factors of

production were fully employedproduction were fully employed Actual outputActual output

actual production may diverge from the actual production may diverge from the potential level potential level

Formal Economic Models: Keynsian Model

Some assumptionsSome assumptions

Prices and wages are fixedPrices and wages are fixed Actual output is Actual output is demand-determineddemand-determined

Aggregate Demand (AD)Aggregate Demand (AD)

AD has five components:AD has five components: Investment [ I ]Investment [ I ]

firms’ planned additions to physical capital & inventoriesfirms’ planned additions to physical capital & inventories for now, assume this is autonomousfor now, assume this is autonomous

Consumption [C]Consumption [C] households’ demand for goods and serviceshouseholds’ demand for goods and services

Government Spending [ G ] (autonomous)Government Spending [ G ] (autonomous)

Exports [ X ] (autonomous)Exports [ X ] (autonomous)

Imports [ M ] (autonomous)Imports [ M ] (autonomous)

The consumption The consumption functionfunction

National IncomeNational Income

Con

su

mp

tion

Con

su

mp

tion

C = 8 + 0.7 YC = 8 + 0.7 Y

The consumption function shows desired aggregateThe consumption function shows desired aggregateconsumption at each level of aggregate incomeconsumption at each level of aggregate income

00

With zero income,With zero income,desired consumptiondesired consumptionis 8 (“autonomousis 8 (“autonomousconsumption”).consumption”).

{{88The The marginal propensitymarginal propensityto consumeto consume (the slope of (the slope ofthe function) is 0.7 – i.e.the function) is 0.7 – i.e.for each additional £1 of for each additional £1 of income, 70p is consumedincome, 70p is consumed..

The aggregate demand The aggregate demand scheduleschedule

National IncomeNational Income

Pla

nn

ed

Sp

en

din

gP

lan

ned

Sp

en

din

g

CC

AD = C + I + G + X - MAD = C + I + G + X - M

The AD function is The AD function is the vertical additionthe vertical additionof C, I, G, X & Mof C, I, G, X & M

Equilibrium output: Y = C + I + G + X Equilibrium output: Y = C + I + G + X - M- M

Output, IncomeOutput, Income

Pla

nn

ed

sp

en

din

gP

lan

ned

sp

en

din

g

4545oo line line

This the point at whichThis the point at whichplanned spending equalsplanned spending equalsactual output and income.actual output and income.

E ADAD

Student ActivityStudent Activity

Using the Keynesian income – Using the Keynesian income – expenditure diagram shown expenditure diagram shown previously, adapt it to show what previously, adapt it to show what happens if:happens if:

A)A) Investment decreasesInvestment decreases

B) Fiscal Policy changes, e.g. B) Fiscal Policy changes, e.g. Government spending risesGovernment spending rises

Readings:Readings:

Begg, D. et al, (2008), Begg, D. et al, (2008), EconomicsEconomics, Chapters, Chapters

19 & 2019 & 20

Griffiths, A. & Wall, S., (2005) Griffiths, A. & Wall, S., (2005) Economics for Economics for Business & ManagementBusiness & Management, Chapter 9, Chapter 9

McDowell, M. et al, (2006), McDowell, M. et al, (2006), Principles of Principles of EconomicsEconomics, Chapters 17 & 18, Chapters 17 & 18

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