Unit one and two Flashcards
(31 cards)
What is macroeconomics?
The study of the determination of economic AGGREGATES and averages. It describes the behavior of ALL households, firms and the government in determining:
Why is it important?
Macroeconomics looks at the economy as a whole, dealing with such aggregate phenomena as growth in total output and living standards, commonly called ‘economic growth’, business cycles, inflation, unemployment and the balance of payments. It also asks how governments can use their monetary and fiscal policy instruments to help stabilize the economy
Concerns with macroeconomics
Employment,
Inflation,
Economic Growth- Gross Domestic Product,
Income Distribution,
Trade Balance.
An Open Economy with Government-Leakages
Leakages: Reduces the purchasing power of total incomes.
-Savings: Where some spending power ‘Leaks’ from the circular flow and is not passed back around the system.
Taxation: Direct Taxes (Income taxes and Corporation Taxes) Indirect Taxes (VAT). Some of the incomes created by productive activity are not passed back round as spending.
-Imports: trading with the rest of the world. As spending sometimes goes towards foreign goods and services, it is not passed back to domestic firms.
An Open Economy with Government-Injections
Injections: Compensates for leakages and are forms of spending on domestic output which come from outside the household sector. These increase purchasing power and demand.
-Investment: This is spending on capital goods such as machinery and equipment, undertaken by firms.
Government Spending: Government purchases of goods and services from firms- roads, buildings, computers etc. the government also spends on wages of civil servants and transfer payments*
Exports: sale of goods and services to foreign residents. Payments received for exports constitute another injection into the circular flow.
Formula for leakages and injections
Elements: Injections and Leakages.
Leakages= S + T+ M
Injections= I+ G + X
Income in an economy therefore arises from:
C + I + G + X – M.
C= Y - S - T
Calculation of National Accounts
Total Product/ National Product
Total / National Income
Total / National Expenditure
-describe essentially the same flow.
Therefore, NP = NY =NE, so long as leakages = Injections.
Three methods used in calculating national accounts: Output method, Income Method, and Expenditure Method.
GDP can be calculated in three ways
[1] as the sum of all values added by all producers of both intermediate and final goods
[2] as the income claims generated by the total production of goods and services; and
[3] as the expenditure needed to purchase all final goods and services produced during the period.
Output method
Factor Incomes arise from the sale of goods and services produced in the economy; one such way of calculating income is therefore to add up the value of all output created in the relevant period mainly for sale in the market. The value is measured by the supply price of output, i.e. the price a firm receives for its product. In this method the VALUE ADDED by firms at each stage of production is considered to avoid double counting.
Income method
This approach involves adding up the flows of Pre-tax incomes accruing to the owners of the factors of production- wages, salaries, rents, dividends, interest payment, undistributed profits- which are generated in a given year.
Expenditure Method
Adding up all that is spent on a country’s output gives expenditure on the national product. Figures for expenditure can be broken down into the components of:
: C + I + G + X – M.
Note: C refers to consumption expenditure
About Gross Domestic Product
The total output of the economy as a whole is the sum of the value added by each firm or enterprise
GDP can be measured as the sum of value added by all producers, as the sum of income claims generated in producing goods and services, or as the spending on all final goods and services produced
GDP is a specific measure of output in the market economy, and is not a measure of welfare or happiness
GDP vs GNP (Gross National Product)
GDP measures the value of what is produced in the country, while GNI (or GNP) measures the income accruing to residents, including net income from overseas.
Taxes are subtracted and subsidies added so that the values calculated are at FACTOR COST and not at MARKET PRICE.
Gross Domestic Product is the Value of total output actually produced in the whole economy over some period of time. GDP is spending based.
GDP = Gross National Product – Net Property incomes from abroad. The difference between gross and net is depreciation
Real GDP is calculated to reflect changes in real volumes of output and real income.
Nominal GDP reflects changes in both prices and quantities.
Any change in nominal GDP [or GNI] can be split into a change in real GDP and a change due to prices.
Interpreting National Income and Output
GDP and related measures of national income and output must be interpreted with their limitations in mind.
GDP excludes production that takes place in the underground economy or that does not pass through markets.
Limitations OF NATIONAL ACCOUNTS
It is necessary BUT not sufficient because:
-Hidden/ black Economy is not represented.
-Comparisons difficult because of differences in currencies.
-It does not reflect income distribution.
-It does not reflect living standards with regards to social, environmental standards.
Interpreting National Income and Output
Moreover, GDP does not measure everything that contributes to human welfare.
GDP is one of the best measures available of the total economic activity within a country.
It is particularly valuable when changes in GDP are used to indicate how economic activity has changed over time
What determines aggregate spending
C+ I + G + NX
Desired spending refers to what people want to spend out of the resources that are at their command.
Four main groups of decision makers to be considered are: Household, firms, governments and foreign purchasers of domestic output.
These groups’ desired spending: desired private consumption, desired investment, desired gov’t consumption and desired exports account for TOTAL DESIRED SPENDING which gives AGGREGATE SPENDING:
AE= C+ I + G + NX
Theory of GDP determination
The national accounts measures actual spending in each of the four categories: C + I + G + NX.
The theory of GDP determination deals with desired spending in each of these 4 categories.
Spending can be:
-AUTONOMOUS: independent of income changes
-INDUCED: dependent on income changes
Simple Keynesian Model- Consumption
C= Private consumption
Disposable income can be spent and saved therefore:
The consumption function determines the level of C and relates the total desired consumer spending of the personal sector to the variables that affect it.
Eg: C = A + b(Yd)
Yd= Y-T
A represents autonomous consumption
bY represent induced consumption.
What does this mean? C= 200 + 0.75 (Yd)
If Y= 1000
t-= 10%
Yd=1000 – 10%(1000) = 900; T= 100
A= 200 b(yd)= 0.75 (yd) ; C = 200+ 0.75(Yd); C= 200 + 0.75 (900); C= 200+675 = 875
MPC, APC vs MPS, APS
Because disposable income is either spent or saved then
APC + APS = 1.
MPC + MPS = 1.
APC is the total consumption spending divided by total disposable income (C/Yd).
MPC (or what was represented as b) is the percentage of each dollar change in income that is consumed. The MPC is therefore the slope of the consumption function. (∆C/ ∆Y)
The 45o Line
The 45 degree line shows all points where desired consumption equals disposable income. The line is a reference line that helps to locate the break even level at which CONSUMPTION SPENDING EQUALS DISPOSABLE INCOME. Consider the 45 degree line as Total or National Output.
More on 45o line
Both consumption and saving rise as disposable income rises.
Line C relates desired consumption to disposable income and is given by the consumption function.
Its slope is the marginal propensity to consume (MPC).
Saving is all disposable income that is not spent on consumption.
The relationship between disposable income and desired saving is shown by line S.
It slope is the marginal propensity to save (MPS).
Any given amount of disposable income must be accounted for by consumption plus saving.
Desired investment spending
It is the most volatile component of GDP.
Planned investment spending by firms is likely to be affected by a range of factors. The 2 most important are:-Interest Rate
:- Level of business profits.
The Keynesian model treats investment as autonomous, because Keynes saw that expectations were dominant in determining the level of investment and not so much current income.
Simple keynesian model: EQUILIBRIUM INCOME
The Equilibrium level of GDP occurs where aggregate desired spending equals total output.
By combining C and I the simple Keynesian aggregate demand function is determined.
In this simple model equilibrium can also be shown where leakage = injection, i.e. savings = investment.
At any level of GDP at which aggregate desired spending is greater than output, there will be a pressure for GDP to rise.
At any level of GDP for which aggregate desired spending is less than output there will be a pressure for GDP to fall
