Macroeconomic problems

lecture outline
? Introduction to macroeconomics
? Circular flow model
? GDP and business cycles

Drawing a Line Between Macro and Micro
Microeconomics
How individual decision-making units behave
Macroeconomics
Behavior of entire economies
Study economic aggregates such as price level, production, unemployment

? Economic growth
? Low Unemployment
? Low inflation
Three macroeconomic concerns

Gross Domestic Product (GDP)
GDP is the sum of the value of new, final goods produced within the domestic borders of an economy.
Final goods are goods sold to their end-users

Intermediate goods which are sold from one firm to another for immediate transformation into other goods.
financial transactions like buying stocks.
purchases of used goods which have been sold before.
goods produced overseas by domestic firms.
GDP does not include:

Gross Domestic Product
? Limitations of GDP
Not a measure of the nation’s economic well-being
Includes only market activity
Creates a problem when making international comparisons
Ignores the underground economy
Do people in poor countries really live on $5/week?
Places no value on leisure

The Circular Flow of National Income
Closed economy with no government
The inner flow
Firms
Households

fig
Factor
payments
Consumption of
domestically
produced goods
and services (Cd)
The circular flow of income

Factor
payments
Consumption of
domestically
produced goods
and services (Cd)
The circular flow of income
WITHDRAWALS
INJECTIONS

The Circular Flow of Income
W = S + T + M
J = I + G + X
W = J
(S+T+M) = (I+G+X)
But it does NOT guarantee that
S = I
G = T
M = X

The Circular Flow of Income
W = S + T + M
J = I + G + X
W = J
(S+T+M) = (I+G+X)
But it does NOT guarantee that
S = I
G = T
M = X

aggregate demand
Aggregate demand – total spending on the goods and services made within the country
AD = C + I + G + X – M
or
AD = Cd + I + G + X

Rise in AD will lead to:
Output
Unemployment
Inflation
Import (M)
Balance of payments will deteriorate
Circular flow of income and
macroeconomic objectives
↑
or Economic growth
↓
↑
↑

Economic Growth

Economic Growth and the Business Cycle
Economic growth
Output gap = Actual output – Potential output
Actual
Potential
Trend growth line

economic growth and the business cycle
Business cycle – the periodic fluctuations of national output round its long-term trend
‘Phases’ of the business cycle:
The upturn
The rapid expansion
The peaking out
The slowdown, recession or slump

fig
O
National output
Time
Potential output
Actual
output
1
2
3
4
The Business Cycle

Business Cycle Theories
? Endogenous theories
Innovation theory
Psychological theory
Inventory cycle theory
Monetary theory
Under-consumption theory
? Exogenous theories
Sunspot theory
War theory

UPTURN
? During a period of expansion:
Wages increase
Low unemployment
People are optimistic and spending money
High demand for goods
Businesses start
Easy to get a bank loan
Businesses make profits and stock prices increase

Peak
? When the economic cycle peaks:
The economy stops growing (reached the top)
GDP reaches maximum
Businesses can’t produce any more or hire more people
Cycle begins to contract

Contraction
? During a period of contraction:
Businesses cut back production and layoff people
Unemployment increases
Number of jobs decline
People are pessimistic (negative) and stop spending money
Banks stop lending money

Trough
? When the economic cycle reaches a trough:
Economy “bottoms-out” (reaches lowest point)
High unemployment and low spending
Stock prices drop
But,
when we hit bottom, no where to go but up!
UNLESS….

READINGS
Sloman J. (2016), Essentials of Economics, 7th edition, Prentice Hall, Chapter 8.
Mankiw E. (2018), Principles of Economics, 8th edition, Cengage learning. Chapter 8