Macroeconomics

Session 1

Goals of this session

What is macro and why is it important for business Measuring macro variables-output, inflation, unemployment plus stylised facts The circular flow of income

What is macroeconomics?
Macroeconomics is the study of economic aggregates
Total output of goods and services produced The average rate of price inflation The overall rate of employment and unemployment

Key questions include

What determines the rate of growth of total output? What are the causes of unemployment and its persistence? Why has it risen in the recent period? What causes inflation and does inflation matter? How can government policy impact on growth, unemployment and inflation?

Major macroeconomic events

The Great Depression of the 1930s The stagnation of the Japanese economy since the 1990s The collapse of growth in South East Asia in the late 1990s The current financial crisis

Key government macroeconomic objectives

High and stable rates of economic growth over the long term Low and stable inflation Low unemployment Balance of payments equilibrium

Why is macro important for business?

Macroeconomic developments (growth, inflation, exchange rates, government fiscal and monetary policy) are important influences on business performance:
Exchange rates impact on competitiveness in export markets and competition from imports with implications for sales and profitability Inflation of input prices (labour, materials, energy) impacts on company costs Government monetary policy determines bank borrowing costs and availability of finance for expansion and meeting cash flow needs

Macroeconomic developments important in business planning and strategy development. Discounted cash flow calculations require taking a view on future rates of inflation, interest rates and market demand. Leading macroeconomic indicators such as the purchasing managers indicator, forewarn senior management of possible turning points in the overall performance of the economy and the need for potential strategy adjustment to prepare for recovery or slowdown

Measuring national output

The measure of national output is called the Gross Domestic Product, GDP. GDP is the value of all final goods and services produced in an economy in a given time period.
It excludes intermediate purchases of goods and services e.g. the output of cars included but not the steel that goes into the production of a car

GDP is the sum of value added in the economy during a given time period i.e. it is the value of production minus the value of intermediate goods used in production GDP can also be looked at from the income rather than production side i.e. some of the value added goes to pay workers (labour income) and some of the value added goes to the firm (profit income). GDP can also be looked at from the expenditure side as the sum of private consumption (C), Investment (I), government expenditure excl. transfers (G) and net exports (X M) Nominal and real GDP:
Nominal GDP is GDP in current s or $s etc Real GDP is GDP is adjusted for any inflation that occurs over a period The change in Real GDP (2000 to 2010) = Nominal GDP(2010) Nominal GDP(2000) divided by the change in prices (GDP deflator) between 2000 and 2010

Not all the output of goods and services produced in a country is included in GDP and a substantial black or underground economy exists in many countries

The growth of world output (% p.a. at constant prices)

The growth of output in selected advanced economies (% p.a.)

The growth of output in Developing Asian countries (% p.a. constant prices)

GDP in 2009 (mUS$)

Constant 2006 Market Prices

LAB
Attlee

CON
Churchill, Eden, MacMillan, Douglas-Home 2.9%

LAB
Wilson 2.5%

CON LAB
Heath Wilson, 2.9% Callaghan
2.1%

CON
Thatcher, Major 2.2%

LAB
Blair, Brown 2.1%

GDP (m)

Constant 2006 Market Prices

Keynesian Policies
Managed Exchange Rates

Monetarist / Supply Side Policies

Flexible Exchange Rates

GDP Growth (% per annum)

Marshall Plan, Korean War

First Oil Crisis

ERM Crisis Second Oil Crisis

Global Financial Crisis

Inflation
Inflation is a sustained rise in the general level of prices-the price level. The inflation rate is the rate at which the price level increases Different measures of inflation
The GDP deflator gives the average price of GDP The consumer price index or cost of living is the average price of goods paid for by the consumer

Inflation (% p.a. price increases)

UK Inflation
30% 25% 20% 15% 10% 5% 0% 1958 -5% 1968 1978 1988 1998 2008
RPI Annual % Change
First Oil Crisis

Claimant Count (000s)

Second Oil Crisis

Money Targets Lawson Boom / Financial Liberation Fixed Exchange Rates

Global Financial Crisis

Inflation Targets

Unemployment
The unemployment rate is the ratio of the number of people unemployed to the number of people in the labour force
U=U/L

The problem in measuring the rate is that of determining who is unemployed.

In most labour force surveys an unemployed person defined as one who is out of work and who is actively searching for work Unemployment benefit claimants often used to calculate the rate but many not eligible for benefits In the UK persons on incapacity benefit (2.5m) not counted

Unemployment rates

Claimant Count (000s)

Claimant Count

The circular flow of income

Model 1 An economy with transactions between households and firms
HOUSEHOLDS Households provide labour and capital which they supply to firms Households receive income from firms in exchange for providing labour and capital Households spend their income on goods and services provided by firms

FIRMS Firms use labour and capital provided by households to provide goods and services
Firms pay households wages, dividends and interest for the labour and capital they provide Firms sell goods and services to households

A representation of Model 1
Spending on goods and services Goods and services

HOUSEHOLDS

FIRMS

Services of productive factors Factor incomes

Three ways of measuring aggregate economic activity-value of goods and services produced, the value of spending on goods and services and the income of factors of production

Flow of real resources Flow of payments

Introducing saving and investment: Model 2

Spending on goods and services = 5000 Goods and services
Saving = 2000

Investment = 2000

HOUSEHOLDS

FIRMS

Services of productive factors Factor incomes =7000

Value of GDP = Value of household income =Y = Household consumption C + Household saving S Y=C+S Value of GDP = Value of Final Expenditure = Household consumer expenditure C + Firms expenditure Investment I Y=C+I therefore S=I

Introducing a government sector: Model 3

I C C+I+G G Te
HOUSEHOLDS GOVERNMENT

C+I+G-Te
FIRMS

B-Td

Y+B-Td
GDP (at market prices) = Y=C + I + G GDP (at factor cost) Y= C + I + G Te Personal disposable income Yd= Y + B Td Saving S = (Y+B-Td) C and therefore Y=S-B+Td + C Therefore S-B+Td+C=C+I+G-Te S+Td+Te=I+G+B i.e. injections =leakages

Open economy: Model 4

Exports X Intermediate Goods/services Wages Rents Interest Profits Dividends

Government Spending G

Firms

Households

Investment I Financial institutions Firm saving Household saving

Government

Tax

Consumption C

Abroad

Imports M

Y=C+I+G+XM

or S + T + M = I + G +X

National Income accounting

Net property income Net property income from abroad from abroad

Depreciation Indirect taxes Net National Product at market prices NNP Rental income Profits National Income at factor cost
Income from employment

GNP at market prices

Government G Investment I

Net exports X-M

GDP at market prices

Consumption C

Wages

Questions
The following is information from the national income accounts for a hypothetical country: GDP (Y) = 6000 Personal disposable income Yd = 5,100 Government budget deficit (G-T) = 200 Consumption (C) = 3,800 Trade deficit (X-M) =100 How large is saving (S) ? How large is investment (I) ? How large is government spending (G) ? You are considering whether and when to invest your savings in starting a new business. How might a knowledge of key macroeconomic variables be of value in reaching your decision? GDP per capita is widely used as an indicator of national welfare and in making cross-country comparisons of the standard of living. What criticisms would you make of such measures?

A useful website http://en.wikipedia.org/wiki/Gross_domestic_product#Income_Approach

Compute the share of expenditure components for the US Q2 2009 from the data on this site