Economics Unit 3 Macroeconomics

UNIT 3: Macroeconomics WHAT IT IS ➔ The study of how the economy function as a whole, on a much larger scale ➔ Looks at specific resource and product markets, and how people behave ➔ We study the total rather than each individual stakeholder alone Main Objectives: - Stable rising price level - - Full employment Economics growth Equitable income distribution Economic Activity Overall Economic Activity Circular flow of income simple model (in a closed economy and no government): 12 - Shows the concepts and relationships of the macroeconomy - *Shows that the value of output = total income generating in producing the output 22 - 4 factors of production and their payment methods: 1. Rent (for land) 2. Wages (for labour) 3. Interest (for capital) 4. Profit (for entrepreneurship) Income flow: from firms to households Expenditure flow: from households to firms Leakages and Injections (withdrawals) - Paired together, so whatever leaks out can come back through injections Leakages include: saving, taxes, imports Injections include: investment, government spending, exports Saving: consumer income that isn’t spent Investment: spending of firms in order to produce capital goods Taxes: paid by households to the government Government Spending: funds that go towards government expenditures and go back into the expenditure flow Imports: goods and services produced in other countries, purchased by domestic buyers Exports: goods and services produced domestically, purchased by foreign buyers Circular flow of income, including leakages and injections: 23 13 Measuring Economic Activity ● Assesses economic performance overtime ● Compares income and output with other economies ● Creates a basis for developing policies to deal with economic issues 3 ways of measuring aggregate output (all within a country, over a given period of time): 1. Expenditure approach - All the spending to buy final goods and services produced within a country is added up. 2. Income approach - All income earned by factors of production that lead to production of all goods and services. 3. Output approach - The value of all final goods and services produced. 4 components of total spending: Consumption (C): spending/purchases by a household in a year, except housing 24 Investment (I): spending by firms on capital goods Government spending (G): spending by government of factors of production Net Exports (X-M): exports (X) - imports (M) * { Adding the 4 components, you get GDP: C + I + G + (X-M) = GDP } * GDP: The market value of all final goods and services produced in a country, in a given time period. (usually a year) GNI: A form of aggregate output, which is the value of all final goods and services produced by a country’s residents. (regardless of where it came from) Nominal value: A measure of money value in terms of the price at the time it was measured. Nominal GDP: current prices, doesn’t account for price changes Real value: A measure of value that looks at changes in price over time, rather than at the time. Real GDP: price change overtime *Green GDP = GDP = value of environmental degradation Variations in Economic Activity: Aggregate Demand and Aggregate Supply 25 Aggregate Demand and Curve: Aggregate demand (AD): The total amount of aggregate output/real GDP that output buyers (consumers, firms, government and foreigners) want to buy at each of economy's price levels. AD Curve: The relationship between total real output demanded by the 4 components and the economy’s price level. 14 Reasons for negative slope: - Wealth effect: changes in price level affecting people’s wealth, price level decrease = more output demanded, leading to downward movement along curve - Interest rate effect: changes in price level affecting interest rates and then aggregate demand, price level increase = higher demand for money = increased interest rates = decreased consumer borrowing and investments, leading to downward movement along curve - International trade effect: increase in domestic price level while other countries’ stays the same = exports to become more expense = less quantity demand, leading to downward movement along curve 26 Aggregate Supply Curves and Changes Long-run aggregate supply (LRAS): The long-run relationship between price level and aggregate output, shown with LRAS Curve. Short-run aggregate supply: The short-run relationship between price level and aggregate output, shown with SRAS Curve. 15 - The LRAS and SRAS curve intersect, occurring at the GDP Inflationary gap: output gap, actual equilibrium output is greater than potential output Deflationary gap: output gap, actual equilibrium output is less than potential output Inflation and Deflation Inflation: sustained increase in the overall price level Deflation: sustained decrease in the overall price level Disinflation: when inflation occurs at a lower rate, from one year to the other 27 Consumer Price Index (CPI): measures the cost of living for a household compared to a hypothetical basket of goods, measured through consumers Problems: - Different households experience different inflation rates due to different levels of income and consumption of goods and services. - Different inflation rates depend on cultural and regional factors. - There are changes in.. - the quality of the goods and services - the consumption as a result of discounts, sales, deals - the consumption as a result of new products - the comparison to other countries around the world Producer Price Index (PPI): The indices of prices that producers receive at a number of different stages in the production process, and measures level changes through producers not consumers. Consequences of Inflation: - A rise in inflation rates leads to risks and uncertainties with certain stakeholders: - People with fixed income/wages -- as inflation rises, they become worse off - People with income/wages that increases at a lower rate than inflation -- when it doesn’t keep up, their income will fall - Cash holders -- as inflation rises, cash value and purchasing power decreases - Money savers -- when rate of interest is lower than rate of inflation, their money goes down in value and results in less savings An appropriate rate of inflation: - A low and stable rate, in the rage of 2-3% each year - Not a zero rate, because this is too close to deflation 28 Causes and Consequences of Deflation: - Deflation (like inflation) creates uncertainties for firms because of the decreasing price levels, making it difficult for them to make changes in their prices - Wages of workers don’t easily fall -- difficult for firms to lower prices and wages since profit would decrease, so they keep them high - Oligopolistic firms fear price wars -- when one lowers price, the other follows, so firms avoid lowering their prices - Firms want to avoid lowering menu costs -- believe deflation is only for short period of time, and so they keep prices the same Economics of Inequality and Poverty Issue of Equity and Income Distribution: - Because of unequal distribution in areas of factors of distribution, there is inequity when it comes to how income is distributed. - Example: People may want to work, but lack skills that firms look for when hiring. Issue of Poverty - The inability to satisfy minimal needs of consumption due to a lack of basic financial and other essential resources. Absolute poverty: defines minimum income level (poverty line) to sustain a family’s basic needs Relative poverty: compares income of households and individuals to median incomes and related to how equally incomes are distributed among the population Causes: - Low income - Unemployment 29 - Low levels of ownership - of capital and land - Discrimination - Age - Demographics - Inaccessibility of social services Consequences: - Low standards of living - High infant/child mortality rate - Lack of access to healthcare, aid, and education - Higher risk of preventable diseases - due to lack of resources and aid - Unable to reach full potential - in terms of talent, education, career Demand-Side Policies: Monetary and Fiscal Policy Fiscal Policy: Fiscal Policy: The manipulation by the government of its own expenditures, taxes, and spending to influence economic conditions. Expansionary fiscal policy: for eliminating a deflationary/recessionary gap, works to expand aggregate demand Contractionary fiscal policy: for eliminating an inflationary gap, works to contract aggregate demand These policies can: - Increases government spending - Decreases business taxes 30 - Decreased personal income taxes Strengths: - Pulls an economy out of a severe recession/deflation - Spending of the government directly impacts aggregate demand and is made certain that changes in spending will be made - Affects long-term growth of the economy in terms of potential output Weaknesses: - Time lags - Political pressure and constraints - Deficit spending - Unable to deal with instability in terms of supply - Tax cuts may not increase aggregate demand (risk) Monetary Policy: Monetary policy: A policy carried out by banks and regulates money supply, interest and exchange rates, and borrowing in order to achieve macroeconomic goals. The role central banks play (in every country): - Bankers for the government -- (for the government) They hold cash deposits, receive payments, make payments, and manage government borrowing. - Bankers for commercial banks -- (for commercial banks) They hold cash deposits and loans. - Conductor of the monetary policy -- Responsible for this policy, which involves making changes to money supply, interest and exchange rates, and borrowing. Chart: Demand-side policies for recessionary and inflationary gaps 31 16 Supply-Side Policies Supply-side policy: The production and supply side of the economy, specifically to aggregate supply. Two categories: 1. Interventionist: relies on government involvement to achieve economic goals 2. Market-based: relies on competitive markets to achieve economic goals Interventionist supply-side policies include.. - Investments in human capital (education and healthcare), infrastructure, new technology, industrial policies, and improving the accessibility to healthcare Market-based supply-side policies include.. 1. Encouraging competition - Privatisation -- transfer of ownership from public to private sector - Deregulation -- eliminating or reducing government regulation of private activities - Private financing of public activities 32 2. Labour market reforms - Eliminating or reducing minimum wage legislation - Weakening power of labour unions - Reducing unemployment benefits - Reducing job security 3. Incentive-related policies - Lowering personal income taxes - Lowering business taxes - Lowering taxes on capital investments