Title: Week 8 Introduction to macroeconomics
1Week 8Introduction to macroeconomics
2Macroeconomics is ...
- the study of the economy as a whole
- it deals with broad aggregates
- but uses the same style of thinking about
economic issues as in microeconomics.
3Some key issues in macroeconomics
- Inflation
- the rate of increase of the general price level
- Unemployment
- a measure of the number of people looking for
work, but who are without jobs - Output
- real gross national product (GNP) measures total
income of an economy - it is closely related to the economy's total
output
4More key issues in macroeconomics
- Economic growth
- increases in real GNP, an indication of the
expansion of the economys total output - Macroeconomic policy
- a variety of policy measures used by the
government to affect the overall performance of
the economy
5(No Transcript)
6Inflation in UK, USA and Germany1960 - 2001
7Unemploymentin UK, USA and Germany
8Economic growthin UK, USA and Germany
9The circular flow of income, expenditure and
output
10Government in the circular flow
11Adding the foreign sector
- To incorporate the foreign sector into the
circular flow - we must recognize that residents of a country
will buy imports from abroad - and that domestic firms will sell (export) goods
and services abroad.
12GDP and GNP
- Gross domestic product (GDP)
- measures the output produced by factors of
production located in the domestic economy - Gross national product (GNP)
- measures the total income earned by domestic
citizens - GNP GDP net income from abroad
13Three measures of national output
- Expenditure
- the sum of expenditures in the economy
- Y C I G X - Z
- Income
- the sum of incomes paid for factor services
- wages, profits, etc.
- Output
- the sum of output (value added) produced in the
economy
14What GNP does and does not measure
- Some care is needed
- to distinguish between real and nominal
measurements - to take account of population changes
- to remember that GNP is not a comprehensive
measure of everything that contributes to
economic welfare
15Output and aggregate demand
16Aggregate output in the short run
- Potential output
- the output the economy would produce if all
factors of production were fully employed - Actual output
- what is actually produced in a period
- which may diverge from the potential level
17Some simplifying assumptions
- Prices and wages are fixed
- The actual quantity of total output is
demand-determined - this will be a Keynesian model
- For now, also assume
- no government
- no foreign trade
- Later chapters relax these assumptions
18Aggregate demand
- Given no government and no international trade,
aggregate demand has two components - Investment
- firms desired or planned additions to physical
capital inventories - for now, assume this is autonomous
- Consumption
- households demand for goods and services
- so, AD C I
19Consumption demand
- Households allocate their income between
CONSUMPTION and SAVING - Personal Disposable Income
- income that households have for spending or
saving - income from their supply of factor services (plus
transfers less taxes)
20The consumption function
The consumption function shows desired
aggregate consumption at each level of aggregate
income
C 8 0.7 Y
Consumption
0
Income
21 The saving function
The saving function shows desired saving at
each income level.
Saving
S -8 0.3 Y
Since all income is either saved or spent on
consumption, the saving function can be
derived from the consumption function or vice
versa.
0
Income
22The aggregate demand schedule
Aggregate demand is what households plan to spend
on consumption and what firms plan to spend on
investment.
Aggregate demand
C
Income
23Equilibrium output
45o line
The 45o line shows the points at which
desired spending equals output or income.
Desired spending
This the point at which planned spending
equals actual output and income.
Output, Income
24Effects of a fall in aggregate demand
45o line
Suppose the economy starts in equilibrium at Y0.
AD0
Desired spending
Y0
Output, Income
Notice that the change in equilibrium output
is larger than the original change in AD.
25The multiplier
- The multiplier is the ratio of the change in
equilibrium output to the change in autonomous
spending that causes the change in output. - The larger the marginal propensity to consume,
the larger is the multiplier. - The higher is the marginal propensity to save,
the more of each extra unit of income leaks out
of the circular flow.
26Fiscal policy and foreign trade
27Some key terms
- Fiscal policy
- the governments decisions about spending and
taxes - Stabilization policy
- government actions to try to keep output close to
its potential level - Budget deficit
- the excess of government outlays over government
receipts - National debt
- the stock of outstanding government debt
28Government in the income-expenditure model
- YCIG (assumption no foreign trade)
- Direct taxes
- affect the slope of the consumption function
- and hence the slope of the AD schedule.
- Government expenditure affects the position of
the AD schedule
29Fiscal policy?
45o line
Aggregate demand
AD0
But this ignores some important issues prices,
interest rates, and the need to fund the
government spending.
Y0
Income, output
30The government budget
The budget deficit equals total government
spending minus total tax revenue.
G, NT
Income, output
31Foreign tradeand income determination
- Introducing exports (X) imports (Z)
- TRADE BALANCE
- the value of net exports (X - Z)
- TRADE DEFICIT
- when imports exceed exports
- TRADE SURPLUS
- when exports exceed imports
- Equilibrium is now where
- Y C I G X - Z
32Exports, imports and the trade balance
X, Z
Income
33Foreign trade and the multiplier
- The marginal propensity to import
- is the fraction of additional income that
domestic residents wish to spend on additional
imports. - The effect of foreign trade is to reduce the size
of the multiplier - the higher the value of the marginal propensity
to import, the lower the value of the multiplier.