BFELecture 7 Intro to Macroeconomics

8/6/2019 BFELecture 7 Intro to Macroeconomics

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INTRODUCING MACRO ECONOMICS

Macroeconomics considers the

performance of the economy as a whole.

Increasing global aspect as events in one

economy affect many others.


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Concerned with:

Economic Growth - trends in national output and

living standards

Unemployment - the causes and consequences ofunemployment and the reasons for the changingstructure of the work force

Inflation - the economics of price inflation - wholoses and who gains and what can we do aboutinflation?


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Concerned with:

International trade - does the UK pay its way intrading with other countries?

Interest rates - should interest rates rise or fall?How do changes in interest rates affect

consumers and businesses in the economy?


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The Government has several current objectives:

Stable low inflation with prices rising at a rate within thetarget range of 1.5% - 2.5% per year.

Sustainable growth - as measured by the rate of growth ofreal Gross Domestic Product.

Higher levels of investment and productivity - to improveinternational competitiveness.


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High employment - the government wants to achieve full-employment.

Rising living standards and a fall in relative poverty

Sound government finances (including control overgovernment borrowing and the national debt)

The key point is that Government through its economicpolicies, aims to improve the economic welfare of thecountry as a whole.


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What are the major objectives of macroeconomic policy?

The four major objectives are

full employment,

price stability,

a high, but sustainable, rate of economic growth, and

keeping the Balance of Payments in equilibrium.


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If one had to pick the most important objectivetoday, it would have to be :

inflation. [July 2008]

If one had to pick the most important objectivetoday, [Feb 2009] what would it be ?


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INTRODUCING MACRO ECONOMICSAre there any conflicts between these objectives?

Unfortunately, it is virtually impossible for a government toscore in all these goals at once.

Healthy growth and low inflation

If an economy grows too quickly, especially if it is due toexcessive consumer spending as it tends to be in the UK,then demand will outstrip supply and prices will rise.Equally, the steps taken to keep inflation low, like relatively

high interest rates, can often restrict growth via reducedconsumer spending and investment. It is difficult toachieve both aims.


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Healthy growth and a Balance of Paymentsequilibrium

When an economy is growing quickly, consumer

spending tends to be high. Import growth picksup relative to exports, leading to a worseningtrade deficit.

Either the exchange rate will give, or importcontrols will be used (not easily possible these

days with theW

orldT

rade Organisation), or The government has to deflate the economy,

implying a low rate of growth.


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Low unemployment (or full employment) and low inflation

These two variables have, in theory, an inverse relationship.If a government tries to reduce unemployment throughreflationary measures, such as lower interest rates orincreased public spending, then the resulting reduction inunemployment will push wages, and then prices, higher.

On the other hand, when the government tries to controlhigh inflation with higher interest rates and reduced

spending, the resulting reduced consumer spending andlower investment will result in job losses.


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Healthy growth and the environment

Quite simply, the faster the rate of growth, the

higher the level of production, and so the level ofpollution from factories, cars, etc. rises. Also,vital rain forests tend to disappear, not justbecause we consume the wood; new factories,towns and housing are built on the resulting land.


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INTRODUCING MACRO ECONOMICSHealthy growth and equality

Equality was an objective of socialistgovernments. Although it is true to say thatforcing equality throughout a country can lead toinefficiencies (where are the incentives?), thoseon the left wing feel that it is an admirable andimportant aim.

The 'trickle down' effect. As an economy growsthe poor may well get a smaller slice of the cake,

but the cake gets so large that the poor man stillgets more cake. Of course this does overlook thefact that the rich man is getting a larger slice of abigger cake!


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Healthy growth and equality

The developed world has grown hugely since the

SecondWorld War, but even with the creation ofwelfare states it is the wealth creators that havebenefited hugely whilst those at the bottom of thepile have seen their standard of living just plodalong.


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Measuring National Income

To measure how much output, spending andincome has been generated we use national

income accounts. These accounts measure the:1. Total value of the output of goods and services

produced in the UK2. Total amount of expenditure taking place in the

economy

3. Total amount of income generated throughproduction of goods and services


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National Income is a term used to measure themonetary value of the flow of output of goods andservices produced within the economy over a period

of time.M

easuring the level and rate of growth ofnational income (Y) is important to economists whenthey are considering:

1. The rate of economic growth and where theeconomy is in the business cycle

2. Changes to overall living standards of the population3. Looking at the distribution of national income (i.e.

measuring income and wealth inequalities)


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INTRODUCING MACRO ECONOMICSGDP is also known as Gross Valued Added.

i) The Expenditure Method (Aggregate Demand)

This is the sum of the final expenditure on UK

produced goods and services measured atcurrent market prices. The full equation for GDPusing this approach is

GDP = C + I + G + (X-M)

C: Household spending (consumption)

I: Capital Investment spendingG: General Government spendingX: Exports of Goods and ServicesM: Imports of Goods and Services


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ii) The Income Method (Sum of Factor Incomes)Here GDP is the sum of the final incomes earned

through the production of goods and services. Main Factor Incomes

Income from employment and self-employmentAdded to Profits of companiesAdded to Rent income

= Gross Domestic product [by factor income]


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What is a recession?

A technical recession occurs when the level of

real national output declines over two successivequarters causing a contraction in the total volumeof production in the economy.

But often a sharp slowdown in the rate of growthof output, spending and income can feel like arecession!


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WHATMIGHT CAUSE A RECESSION?

Recessions have a variety of causes and a wide

range of symptoms.

Some causes are domestic in origin, stemmingfrom policy mistakes on behalf of the economicauthorities.


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WHATMIGHT CAUSE A RECESSION?

External shocks can also bring about recession.

E.g.1973-74 the large jump in world oil pricescaused a sharp rise in cost push inflation and anacceleration in wages. Falling real purchasingpower of consumers and a deflationary fiscal andmonetary policy from the government sent the

economy into reverse.

2008 oil prices rose to over $140 barrel


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SOME CHARACTERISTICS OF A RECESSION

Declining demand for output leading to higher

levels of spare productive capacity

Contracting employment / rising unemploymentas firms lay-off workers to control their costs (seethe chart below)

A

sharp fall in business confidence & profits


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SOME CHARACTERISTICS OF A RECESSION

A decrease in fixed capital investment spendingbecause there is insufficient demand to justify

new capital projects De-stocking and heavy price discounting - this

leads to lower inflation

Reduced inflationary pressure in the labourmarket as unemployment rises

Falling demand for imports

Increased government borrowing

.


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INTRODUCING MACRO ECONOMICS Investment is spending on capital goods by firms and

government, which will allow increased production ofconsumer goods and services in future time periods.

Investment demand is quite volatile from year to year.

Indeed in years of economic recession, the real value ofinvestment spending can fall quite sharply becausebusinesses decide to postpone or cancel investmentprojects.

Investment spending across the UK economy hasincreased (in real terms) Service industries have enjoyedthe lion's share of this spending on capital goods, but therehave also seen large scale increases in capital expenditurein new economy sectors such as information technologyand communication industries.


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INTRODUCING MACRO ECONOMICSGross and Net Investment An import distinction to make is between gross and net

capital investment spending Net investment is positive when gross investment is higher

than depreciation or capital consumption. Then there willbe an increase in the nation's stock of capital.

Fixed Investment - is spending on new capital machineryand plant, construction, housing, vehicles, etc.

Working Capital - is spending on stocks/inventories offinished goods and raw materials. The accumulation ofstocks by firms, whether voluntary or involuntary, iscounted as investment.

Gross Domestic Fixed Capital Formation (GDFCF) - isexpenditure on fixed assets (buildings, vehicles and plant)either for replacing or adding to the stock of fixed assets.

BFELecture 7 Intro to Macroeconomics

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