Chapter:4

Macroeconomic
Environment

Economic Systems
The concept of economic scarcity:
Like politics , the term economic tends to be used in
a variety of ways and contexts to describe certain
aspects of human behavior, ranging from activities
such as producing , distributing and consuming , to the
idea of frugality in the use of a resource.
The economists idea of scarcity centers around the
relationship between societys needs and wants and the
resources available to satisfy them . In essence , needs
and wants tend to be unlimited , the resources which
can be used to meet those needs and wants are finite
and accordingly no society at any time has the capacity
to provide for all its actual and potential requirements.

 From a societal point of view, the existence of

economic scarcity poses 3 serious problems
concerning the use of resources:
1. What to use the available resources for?
2. How best to use those resources?
3. How best to distribute the goods and services
produced with them?
In practice, these problems tend to be solved in a
variety of ways.
Different types of economic systems have been
approached.

 1. The centrally planned economy:

Here, most of the key decisions on production are taken by
a central planning authority, normally the state and its
agencies.
Under this arrangement, the state typically:
Owns and/or controls the main economic resources;
Establishes priorities in the use of those resources;
Sets output targets for businesses which are largely under
state ownership and/or control;
Directs resources in an effort to achieve these
predetermined targets; and
Seeks to coordinate production in such a way as to ensure
consistency between output and input demands.

 The fact that an economy is centrally planned

does not necessarily imply that all economic
decisions are taken at central level, in many
cases decision making may be devolved to
subordinate agencies. However, these agencies
are responsible to the centre which retains overall
control of the economy and directs the use of
scarce productive resources.
The problem of coordinating inputs and outputs in
a modern planned economy is a daunting task
and involves and array of state planners and a
central plan or blueprint normally covering a
number of years (e.g. 5 year plan).

 In such an environment , the traditional

entrepreneurial skills of efficient resources
management, price setting and risk taking have
little, if any, scope for development and
managers behave essentially as technicians and
bureaucrats, administering decisions largely
made elsewhere.

 The free market economy:

It stands in direct contrast to the centrally planned
system. Here, the key economic agencies are private
individuals and firms and these interact in free
markets, through a system of prices to determine the
allocation of resources.
The key features of this type of economic system are
as follows :
Resources are in private ownership and the individuals
owning them are free to use tem as they wish.
Firms , also in private ownership , equally able to make
decisions on production , free from state interference.

 No blueprint (or master plan) exists to direct

production and consumption.
Decisions on resource allocation are the results a
decentralized system of markets and prices , in which
the decisions of millions of consumes and hundreds
of thousands of firms are automatically co-ordinated.
The consumer is sovereign, i.e. dictates the pattern of
supply and hence the pattern of resource allocation.
In short, the three problems of what to produce, how
to produce and how to distribute are solved by market
forces.
Figure 4.1 the market economy

Politico-economic synthesis
The economic problem of resource allocation,
described above, clearly has a political
dimension, given its focus on the ownership,
control and use of wealth-producing assets within
society. This allows links to be made between a
countrys chosen economic
Political system and its
political regime.
system
1

Economic
system

Freemarket
4

Democrati
c
2

Planne
d
3
Authoritaria
n

 In applying this model to specific cases, it is clear that

free-market approaches to resource allocation are
predominantly associated with democratic states.
A link between authoritarian regimes and planned
economic systems can equally be rationalized, in that
government control over the political system is
considerably facilitated if it also directs the economy
through the ownership and/ or control of the means of
production, distribution and exchange.
In practice, of course, this picture is much more
complicated than suggested by this simple dichotomy.

The Macroeconomy
Levels of analysis:
Economists typically distinguishes between 2
types of analysis:
1. Microeconomic analysis, which is concerned
with the study of economic decision taking by
both individuals and firms.
2. Macroeconomic analysis, which is concerned
with interactions in the economy as a whole (i.e.
with economic aggregates)
The flows of economic activity:
Figure: 4.3, 4.4 and 4.5

Real flows in the economy

Income flows in the economy

A simplified model of real flows

and income flows

 Changes in economic activity:

The circular flow of income with leakages (figure:
4.6)
The circular flow of income with injections added
(figure: 4.7)

Government and The

Macroeconomy: Objectives
Most governments have a number of key
economic objectives, such as:
Controlling inflation:
Inflation is usually defined as an upward and
persistent movement in the general level of
prices over a given period of time. It can be
characterized as a fall in value of money.
For governments of all political complexions,
reducing such movements to a minimum is seen
as a primary economic objective.

 Economic growth:
Growth is an objective shared by governments and
organizations alike.
The aim is usually to achieve steady and sustained
levels of non-inflationary growth, preferably led by
exports.
Such growth is normally indicated by annual
increase in real national income or gross domestic
product where real = allowing for inflation , and
gross domestic product (GDP) = the economys
annual output of goods and services measured in
monetary terms)

 Reducing unemployment:
In most democratic states, the goal of full
employment is no longer part of the political
agenda; instead government pronouncements on
employment tend to focus on job creation and
maintenance and on developing the skills
appropriate to future demands.
The consensus seems to be that in technologically
advanced market-based economies, some
unemployment is inevitable and that the basic aim
should be to reduce unemployment to a both
politically and socially acceptable.

 A favorable balance of payment:

A countrys balance of payments is essentially the net
balance of credits (earnings) and debits (payments)
arising from its international trade over a given period of
time.
Where credit exceed debits a balance of payment surplus
exists; the opposite is described as a deficit.
Governments prefer either equilibrium in the balance of
payments or surpluses, rather than deficits.
However, it would be fair to say that for some
government facing persistent balance of payment deficit,
a sustained reduction in the size of the deficit may be
regarded as significant.

 Controlling public borrowing:

Governments raise large amount of revenue
annually, mainly through taxation, and use this
income to spend on a wide variety of public goods
and services.
Where annual revenue exceeds government
spending, a budget surplus occurs and the excess
is often used to repay past debt. The
accumulated debt of past and present
governments represents a countrys national
debt.

 A stable exchange rate:

A countrys currency has 2 values: an internal
value and an external value.
Internally, its value is expressed in terms of the
goods and services it can buy and hence it is
affected by changes in domestic prices.
Externally, its value is expressed as exchange
rate which governs how much of another
countrys currency it can purchase ( e.g. $1 = 80
Tk).

 Since foreign trade normally involves an

exchange of currencies, fluctuations in the
external value of a currency will influence the
price of imports and exports and hence can affect
the trading prospects of business as well as a
countrys balance of payments and its rate of
inflation.
Governments and businesses involved in
international trade prefer relatively stable
exchange rates.

Government and The

Macroeconomy: Policies
Government intervention usually takes 3 main forms:
Fiscal policy:
Fiscal policy involves the use of changes in government
spending and taxation to influence the level and
composition of aggregate demand in the economy and,
given the amounts involved, this clearly has important
implications for business.
Monetary policy:
Monetary policy seeks to influence monetary variables
such as the money supply or rates of interest in order to
regulate the economy. While the supply of money and
interest rates are interrelated, it is convenient to
consider then separately.

 Direct controls:
Income policies: which seek to control inflationary
pressures by influencing the rate which wages and
salaries rise.
Import controls: which attempts to improve a
countrys balance of payments situation, by
reducing either the supply of, or the demand for,
imported goods and services.
Regional and urban policies: which are aimed at
alleviating urban and regional problems,
particularly differences in income, output,
employment and local and regional
decline.

The Role of Financial

Institutions
Elements of financial system
1. lenders and borrowers- these may be
individuals, organizations and governments.
2. financial institutions, of various kinds, which act
as intermediaries between lenders and borrowers
and which manage their own asset portfolios in the
interest of their shareholders and/ or depositors.
3. financial markets, in which lending and
borrowing takes place through the transfer of
money and/ or other types of asset, including
paper assets such as shares and stock.

The role of central bank:

Banker to the government
Banker to the clearing banks
Manager of the countrys foreign reserves
Manager of the national debt
Manager of the issue of notes and coins
Supervisor of the monetary sector; and
Implementer of the governments
monetary policy

International economic institutions

and organizations
The International Monetary Fund
(IMF)
The Organization for Economic Cooperation And Development (OECD)
The European Bank for
Reconstruction and Development
(EBRD)
The World Trade Organization (WTO)
The World Bank (IBRD)
The European Investment Bank (EIB)