Introduction to Economics - LEC 10 (Macroecoeconomics and Economic Growth) PDF

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Introduction to EconomicsLecture 10Macroeconomics and Economic Growth :Economic analysis of the whole economy is called 'macroeconomics'. Earlier topics examined 'microeconomic' issues, such as demand and supply in individual markets; competition levels in particular industries, and firms' pricing a...

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Introduction to Economics Lecture 10 Macroeconomics and Economic Growth: Economic analysis of the whole economy is called 'macroeconomics'. Earlier topics examined 'microeconomic' issues, such as demand and supply in individual markets; competition levels in particular industries, and firms' pricing and output behaviour. This topic studies issues that affect the whole economy. When studying the whole economy, it is necessary to revisit the concepts of demand and supply and learn how these are applied in macroeconomics. The concepts of aggregate demand and aggregate supply are introduced and studied. Learning Objectives:        

Understand the distinction between Macroeconomics and Microeconomics. Define GDP and understand the different methods of measuring GDP. Understand the difference between Nominal and Real GDP. Understand the limitations of GDP as a measure of wellbeing. explain the slopes of the aggregate demand (AD) and aggregate supply (AS) curves. understand the main factors that cause shifts in the aggregate demand curve and the aggregate supply curve explain why the long run aggregate supply curve becomes vertical at the potential GDP (full employment). Explain fluctuations in economic activity using AD and AS model.

Microeconomics/Macroeconomics: Microeconomics: The study of how households and firms make choices, how they interact in markets, and how the government attempts to influence their choices. Macroeconomics: The study of the national economy and the global economy as a whole.

Macroeconomics: Main objects of explanation are: -

Aggregate Output (Growth over time) General Level of Prices (I.e. Inflation Rate) Unemployment Interest Rates Foreign Exchange Rates Balance of Payments Position

Gross Domestic Product: -

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Measuring Total Production: o Gross Domestic Product (GDP) Definition: o The market value of all final goods and services produced in a country during a period of time. GDP is measured using market values, not quantities GDP includes only the market value of final goods and services

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Final Good or Service: o A new good or service which is the end product of the production process that is purchased by the final user.

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Intermediate Good or Service: o A good or service that is an input into another good or service.

Calculating Gross Domestic Product: Three ways of Calculating GDP: -

The Production Method The Expenditure Method The Income Method

The Production Method: •

The sum of the value of all goods and services produced by industries in the economy in a year minus the cost of goods and services used in the productive process, leaving the valueadded by the industries Value of all goods and services produced in Economy – Cost of Goods used to produce = Value Added by Industries  Measures GDP by adding up the value added to products at each stage of their production up until final consumption.  Value-added equals the value of a firm’s production minus the value of the intermediate goods it uses in production.  The value-added of all industries in the economy gives GDP at market prices.

Expenditure Method: •

Measures GDP at market prices by collecting data on all final expenditures on goods and services, adding the contribution by exports and subtracting the value of imports.

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Important: Measures final goods and services newly produced (excludes second-hand products) over accounting period.

Components of GDP:  Consumption (C): Spending by households on goods and services, not including spending on new houses.  Investment (I): Spending by firms on new factories, office buildings, machinery, and inventories, and spending by households on new houses.  Government purchases (G): Spending by federal, state, and local governments on goods and services  Net exports (NX): The value of exports minus the value of imports GDP = C + I + G + NX

Income Method: The sum of the income generated in the production of goods and services; or wages, salaries and supplements plus rent, interest, profit and dividends

The Simple Circular Flow: 2 Sector Economy

Nominal Vs. Real GDP: •

Nominal GDP is total production valued at current prices.

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Real GDP is total production valued at constant base year prices.

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Nominal GDP is affected by changes in prices and thus could be misleading when comparing GDP over time.

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Real GDP is not affected by changes in prices. Thus, it is a better measure of the economy’s production of goods and services.

Example: 2 Years: -

Nominal GDP 2015 = 10*$10 + 15*$5 = $175 Nominal GDP 2019 = 8*$15 + 10*$10 = $220 Real GDP 2015 (in base year 2015 prices)=10*$10 + 15*$5 = $175 Real GDP 2019 (in base year 2015 prices) = 8*$10 + 10*$5 = $130

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Shortcomings of GDP as a Measure of Total Production: •

GDP does not include the non-observed economy.  Household production: Goods and services people produce for themselves.

Examples: home-cooking, cleaning, childcare, gardening, home maintenance.  The underground economy: Buying and selling of goods and services that is concealed from the government to avoid taxes or regulations or because the goods and services are illegal.

Shortcomings of GDP as a Measure of Well-Being: 1. Health, life-expectancy, education levels 2. Economic equality and social justice 3. Environmental quality 4. Leisure time

Aggregate Demand & Aggregate Supply: •

In the long run, real GDP for most countries grows steadily

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However, the short run is characterised by more volatile contractions and expansions in growth of real GDP

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The name given to this tendency for growth in real GDP to fluctuate in the short term is the business cycle

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Aggregate demand and aggregate supply model: •

A model that explains short-run fluctuations in real GDP and the price level

The Business Cycle: •

The Expansion Phase: •

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The Contraction Phase: •

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Production, employment and income are falling below trend growth

Recession: •

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Production, employment and income are increasing above trend growth

Defined as a significant decline in economic activity spread across the economy, lasting more than a few months, visible in industrial production, employment, real income and wholesale-retail trade

Technical Definition of Recession: •

Two successive quarters of negative economic growth

Aggregate Demand: •

Aggregate Demand shows the relationship between the price level and the quantity of real GDP demanded in the economy.

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Real GDP = C + I + G + NX Where C = consumption I = investment G = government spending NX = (X - M) = exports minus imports

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The AD curve is downward sloping from left to right.

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Changes in the price level are depicted as movements up or down a stationary aggregate demand curve.

Why is the aggregate demand curve downward sloping? 1) The Wealth Effect a. How a change in the price level affects consumption 2) The Interest-rate Effect a. How a change in the price level affects investment 3) The International-trade Effect a. How a change in the price level affects net exports The Variables that Shift the Aggregate Demand Curve? 1) Changes in Government Policies i. Examples: Taxes, government purchases 2) Changes in the Expectations of Households and Firms 3) Changes in Foreign Variables i. Examples: Exchange rates, relative income levels between countries

Short Run Aggregate Supply: •

Short Run Aggregate Supply shows the relationship in short run between the price level and the quantity of real GDP supplied in an economy (i.e. quantity of goods and services firms are willing to supply)

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SRAS curve slopes upward from left to right

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SRAS curve is upward sloping, showing that, in the short run, firms will produce more in response to higher prices.

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Changes in the price level are depicted as movements up or down a stationary short-run aggregate supply curve.

Variables that Shift the Short Run Aggregate Supply Curve: 1. Expected changes in the future price level 2. Adjustments of workers and firms to errors in past expectations about the price level. 3. Unexpected changes in the price of an important natural resource 4. Increases in the labour force and/or in the capital stock, and/or in resources 5. Technological change

Aggregate and Short Run Aggregate Supply:

Long Run Aggregate Supply Curve: •

A curve that shows the relationship in the long run between the price level and the quantity of real GDP supplied

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The long-run aggregate supply curve shows that in the long run, increases in the price level do not affect the level of real GDP

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The long-run aggregate supply curve is a vertical line at potential GDP

Shifts in the Long Run Aggregate Supply Curve: The Long Run Aggregate Supply curve shifts because potential GDP increases over time. Increases in potential GDP (or economic growth) are due to:  An increase in resources  An increase in machinery and equipment  New technology

The Short Run and Long Run Effects of a Decrease In Aggregate Demand:

Recessionary Gap: -

A recessionary gap occurs when real GDP equilibrium occurs at a point less than the potential GDP Deficiency in aggregate demand or a supply side shock/shift Economic policy may be required to reduce the size of the recessionary gap

The Short Run and Long Run Effects of an Increase In Aggregate Demand:

Inflationary Gap: •

An inflationary gap occurs when actual GDP equilibrium exceeds the potential GDP.

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This can occur in times of an economic boom - very strong aggregate demand, and inflation results.

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Economic policy may be required to reduce the gap....