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Macroeconomics
Session 1
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Goals of this session
What is macro and why is it important forbusiness
Measuring macro variables-output,inflation, unemployment plus stylised facts
The circular flow of income
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What is macroeconomics?
Macroeconomics is the study of economic aggregates Total output of goods and services produced The average rate of price inflation The overall rate of employment and unemployment
Key questions include
What determines the rate of growth of total output? What are the causes of unemployment and its persistence? Why has it
risen in the recent period? What causes inflation and does inflation matter? How can government policy impact on growth, unemployment and
inflation?
Major macroeconomic events The Great Depression of the 1930s The stagnation of the Japanese economy since the 1990s The collapse of growth in South East Asia in the late 1990s The current financial crisis
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Key government macroeconomicobjectives
High and stable rates of economic growthover the long term
Low and stable inflation
Low unemployment
Balance of payments equilibrium
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Why is macro important forbusiness?
Macroeconomic developments (growth, inflation, exchange rates,government fiscal and monetary policy) are important influences onbusiness performance: Exchange rates impact on competitiveness in export markets and
competition from imports with implications for sales and profitability Inflation of input prices (labour, materials, energy) impacts on company
costs Government monetary policy determines bank borrowing costsand availability of finance for expansion and meeting cash flow needs
Macroeconomic developments important in business planning andstrategy development. Discounted cash flow calculations requiretaking a view on future rates of inflation, interest rates and marketdemand.
Leading macroeconomic indicators such as the purchasingmanagers indicator, forewarn senior management of possibleturning points in the overall performance of the economy and theneed for potential strategy adjustment to prepare for recovery orslowdown
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Measuring national output
The measure of national output is called the Gross Domestic Product, GDP. GDP is the value of all finalgoods and services produced in an economy in a given time period.
It excludes intermediate purchases of goods and services e.g. the output of cars included but not the steelthat goes into the production of a car
GDP is the sum of value addedin the economy during a given time period i.e. it is the value ofproduction minus the value of intermediate goods used in production
GDP can also be looked at from the incomerather than production side i.e. some of the valueadded goes to pay workers (labour income) and some of the value added goes to the firm (profit
income). GDP can also be looked at from the expenditure side as the sum of private consumption (C),
Investment (I), government expenditure excl. transfers (G) and net exports (XM)
Nominal and real GDP: Nominal GDP is GDP in current s or $s etc Real GDP is GDP is adjusted for any inflation that occurs over a period The change in Real GDP (2000 to 2010)
= Nominal GDP(2010)Nominal GDP(2000) divided by the change in prices (GDP deflator) between 2000and 2010
Not all the output of goods and services produced in a country is included in GDP and asubstantial black or underground economy exists in many countries
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The growth of world output (% p.a.at constant prices)
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The growth of output in selectedadvanced economies (% p.a.)
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The growth of output in DevelopingAsian countries (% p.a. constant
prices)
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GDP in 2009 (mUS$)
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Constant 2006 Market Prices
LAB LAB LABCONCONCONHeath Thatcher,
Major
Blair, BrownWilsonChurchill, Eden,
MacMillan,Douglas-Home
Attlee
2.9%
2.5%
2.9%
LABWilson,
Callaghan2.1% 2.2%
2.1%
GDP
(m)
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Constant 2006 Market Prices
GDPGrowth(%
perannum)
Keynesian Policies Monetarist / Supply Side PoliciesManaged Exchange Rates Flexible Exchange Rates
Marshall Plan,
Korean War
First Oil
Crisis Second Oil
Crisis
ERM Crisis
Global Financial
Crisis
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Inflation
Inflation is a sustained rise in the generallevel of prices-the price level. Theinflation rateis the rate at which the price
level increases Different measures of inflation
The GDP deflator gives the average price ofGDP
The consumer price index or cost of living isthe average price of goods paid for by theconsumer
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Inflation (% p.a. price increases)
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UK Inflation
-5%
0%
5%
10%
15%
20%
25%
30%
1958 1968 1978 1988 1998 2008
Global Financial
CrisisClaimantCount(000s)
RPI Annual % Change
Fixed Exchange Rates
First Oil
Crisis
Second Oil
Crisis
MoneyTargets
Lawson Boom /
Financial Liberation
Inflation Targets
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Unemployment
The unemployment rate is the ratio of thenumber of people unemployed to the number ofpeople in the labour force U=U/L
The problem in measuring the rate is that ofdetermining who is unemployed. In most labour force surveys an unemployed person
defined as one who is out of work and who is activelysearching for work
Unemployment benefit claimants often used tocalculate the rate but many not eligible for benefits
In the UK persons on incapacity benefit (2.5m) notcounted
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Unemployment rates
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Claimant Count
ClaimantCount(000s)
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The circular flow of income
Model 1 An economy with transactionsbetween households and firms
HOUSEHOLDS FIRMS
Households provide labour andcapital which they supply to firms
Households receive income fromfirms in exchange for providinglabour and capital
Households spend their income ongoods and services provided by firms
Firms use labour and capital providedby households to provide goods andservices
Firms pay households wages,dividends and interest for the labourand capital they provide
Firms sell goods and services tohouseholds
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A representation of Model 1
HOUSEHOLDS
Spending on goods and services
FIRMS
Factor incomes
Goods and services
Services of productive
factors
Flow of real resourcesFlow of payments
Three ways of measuring aggregate economicactivity-value of goods and services produced,the value of spending on goods and services and
the income of factors of production
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Introducing saving and investment:Model 2
HOUSEHOLDS
Spending on goods and services= 5000
FIRMS
Factor incomes=7000
Goods and services
Services of productive
factors
Saving = 2000
Investment= 2000
Value of GDP = Value of household income =Y = Household consumption C + Household saving SY = C + S
Value of GDP = Value of Final Expenditure = Household consumer expenditure C + Firms expenditure Investment IY = C + I
therefore S = I
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Introducing a government sector:Model 3
HOUSEHOLDS GOVERNMENT FIRMS
S
C
I
G
Te
C+I+G
Y+B-Td
C+I+G-Te
B-Td Y
GDP (at market prices) = Y=C + I + GGDP (at factor cost) Y= C + I + G TePersonal disposable income Y
d= Y + B Td
Saving S = (Y+B-Td)C and therefore Y=S-B+Td + CTherefore S-B+Td+C=C+I+G-TeS+Td+Te=I+G+B i.e. injections =leakages
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Open economy: Model 4
GovernmentSpending
Firms Households
Exports
Imports
Government
Investment
Consumption
Abroad
Financialinstitutions
Intermediate
Goods/services
WagesRentsInterest
Profits Dividends
Firm savingHousehold saving
Tax
X
G
I
C
M
Y = C + I + G + XM or S + T + M = I + G +X
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National Income accounting
GNPat
marketprices
ConsumptionC
Net exportsX-M
InvestmentI
GovernmentG
Net property incomefrom abroad
GDPat
market
prices
Net property incomefrom abroad
NetNationalProduct
atmarketpricesNNP
Depreciation
NationalIncome
atfactorcost
Indirecttaxes
Wages
Income fromemployment
Profits
Rentalincome
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Questions
The following is information from the national income accounts for a hypothetical country:GDP (Y) = 6000
Personal disposable income Yd= 5,100Government budget deficit (G-T) = 200Consumption (C) = 3,800Trade deficit (X-M) =100
How large is saving (S) ?
How large is investment (I) ?How large is government spending (G) ?
You are considering whether and when to invest your savings in starting a new business. Howmight a knowledge of key macroeconomic variables be of value in reaching your decision?
GDP per capita is widely used as an indicator of national welfare and in making cross-countrycomparisons of the standard of living. What criticisms would you make of such measures?
A useful website http://en.wikipedia.org/wiki/Gross_domestic_product#Income_Approach Compute the share of expenditure components for the US Q2 2009 from the data on this site
http://en.wikipedia.org/wiki/Gross_domestic_producthttp://en.wikipedia.org/wiki/Gross_domestic_product