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The economy and business activity

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    • 1. The Economy and Business Activity
    • 2. Macroeconomic Objectives• Microeconomics and macroeconomics• The major macroeconomic issues – economic growth – unemployment – inflation – balance of payments and exchange rates• Government macroeconomic policy – controlling various intermediate variables • interest rates, money supply, taxes, government expenditure, etc.
    • 3. The Circular Flow of Income• The inner flow
    • 4. The circular flow of income Firms Consumption of Factor domesticallypayments produced goods and services (Cd) Households
    • 5. The Circular Flow of Income• Withdrawals – net saving (S) – net taxes (T) – import expenditure (M)• Injections – investment (I) – government expenditure (G) – export expenditure (X)
    • 6. The circular flow of income INJECTIONS Export expenditure (X) Investment (I) Government Consumption of expenditure (G) Factor domestically BANKS, etc GOV. ABROADpayments produced goods and services (Cd) Import Net expenditure (M) Net taxes (T) saving (S) WITHDRAWALS
    • 7. The Circular Flow of Income• The relationship between withdrawals and injections – the links between them – planned injections may not equal planned withdrawals • effect of J > W • effect of W > J – equilibrium in the circular flow
    • 8. The circular flow of income INJECTIONS Export expenditure (X) Investment (I) Government Consumption of expenditure (G) Factor domestically BANKS, etc GOV. ABROADpayments produced goods and services (Cd) Import Net expenditure (M) Net taxes (T) saving (S) WITHDRAWALS
    • 9. The Circular Flow of Income• The relationship between withdrawals and injections – the links between them – planned injections may not equal planned withdrawals • effect of J > W • effect of W > J – equilibrium in the circular flow• The circular flow and the four macroeconomic objectives
    • 10. The Determination of Business Activity• The importance of aggregate demand – effects of J > W – effects of W > J• Identifying the equilibrium level of GDP – the 45o line diagram
    • 11. Equilibrium GDPCd, E, W, J (£bn) GDP = Cd + W 45° O GDP (£bn)
    • 12. The Determination of Business Activity• The importance of aggregate demand – effects of J > W – effects of W > J• Identifying the equilibrium level of GDP – the 45o line diagram – the GDP and E lines
    • 13. Equilibrium GDPCd, E, W, J (£bn) GDP = Cd + W E = Cd + J Cd J 45° O GDP (£bn)
    • 14. The Determination of Business Activity• The importance of aggregate demand – effects of J > W – effects of W > J• Identifying the equilibrium level of GDP – the 45o line diagram – the GDP and E lines • effects of E > GDP • effects of GDP > E
    • 15. Equilibrium GDPCd, E, W, J (£bn) GDP = Cd + W c E = Cd + J d Cd a b 45° O GDP1 GDP2 GDP (£bn)
    • 16. The Determination of Business Activity• The importance of aggregate demand – effects of J > W – effects of W > J• Identifying the equilibrium level of GDP – the 45o line diagram – the GDP and E lines • effects of GDP > E • effects of E > GDP – finding the equilibrium point
    • 17. Equilibrium GDPCd, E, W, J (£bn) GDP = Cd + W c E = Cd + J d Cd e a b 45° O GDP1 GDPe GDP2 GDP (£bn)
    • 18. The Determination of Business Activity• The multiplier – the multiplier process – definition of the multiplier • ∆GDP / ∆J – the marginal propensity to consume domestic goods and services • mpcd = ∆Cd / ∆GDP
    • 19. The multiplier: a rise in aggregate expenditureCd, E, W, J (£bn) GDP Multiplier = ∆GDP / ∆ J E2 = 60/20 = 3 E1 160∆GDP Cd 120∆J 100 ∆Cd = 40 O 100 160 GDP (£bn) ∆GDP = 60
    • 20. The Determination of Business Activity• The multiplier – the multiplier process – definition of the multiplier • ∆GDP / ∆J – the marginal propensity to consume domestic goods and services • mpcd = ∆Cd / ∆GDP – formula for the multiplier • 1 / (1–mpcd)
    • 21. The multiplier: a rise in aggregate expenditureCd, E, W, J (£bn) GDP Multiplier = ∆GDP / ∆ E E2 = 60/20 = 3 E1 160∆GDP Cd 120∆J 100 ∆Cd = 40 O 100 160 GDP (£bn) ∆GDP = 60
    • 22. The Business Cycle• Growth in actual and potential output• Economic growth & the business cycle – fluctuations in actual growth – the phases of the business cycle • the upturn • the expansion • the peaking out • the slowdown or recession
    • 23. The business cycle Potential outputNational output 3 4 2 Actual 3 output 4 2 1 1 O Time
    • 24. The Business Cycle• Growth in actual and potential output• Economic growth & the business cycle – fluctuations in actual growth – the phases of the business cycle • the upturn • the expansion • the peaking out • the slowdown or recession – long-term output trend
    • 25. The business cycle Potential output TrendNational output output Actual output O Time
    • 26. The Business Cycle• Growth in actual and potential output• Economic growth & the business cycle – fluctuations in actual growth – the phases of the business cycle • the upturn • the expansion • the peaking out • the slowdown or recession – long-term output trend – the business cycle in practice
    • 27. The Business Cycle• Growth in actual and potential output• Economic growth & the business cycle – fluctuations in actual growth – the phases of the business cycle • the upturn • the expansion • the peaking out • the slowdown or recession – long-term output trend – the business cycle in practice • the length of the phases
    • 28. The Business Cycle• Growth in actual and potential output• Economic growth & the business cycle – fluctuations in actual growth – the phases of the business cycle • the upturn • the expansion • the peaking out • the slowdown or recession – long-term output trend – the business cycle in practice • the length of the phases • the magnitude of the phases
    • 29. Growth rates in selected industrial countries 10 9 UK 8Annual growth rate (%) 7 6 5 4 3 2 1 0 -1 -2 -3 1970 1975 1980 1985 1990 1995 2000 2005
    • 30. Growth rates in selected industrial countries 10 9 UK 8Annual growth rate (%) 7 6 5 4 3 2 1 0 -1 -2 -3 1970 1975 1980 1985 1990 1995 2000 2005
    • 31. Growth rates in selected industrial countries 10 9 UK 8 EU15Annual growth rate (%) 7 6 5 4 3 2 1 0 -1 -2 -3 1970 1975 1980 1985 1990 1995 2000 2005
    • 32. Growth rates in selected industrial countries 10 9 UK 8 EU15Annual growth rate (%) 7 6 5 4 3 2 1 0 -1 -2 -3 1970 1975 1980 1985 1990 1995 2000 2005
    • 33. Growth rates in selected industrial countries 10 9 UK USA 8 EU15Annual growth rate (%) 7 6 5 4 3 2 1 0 -1 -2 -3 1970 1975 1980 1985 1990 1995 2000 2005
    • 34. Growth rates in selected industrial countries 10 9 UK USA 8 EU15Annual growth rate (%) 7 6 5 4 3 2 1 0 -1 -2 -3 1970 1975 1980 1985 1990 1995 2000 2005
    • 35. Growth rates in selected industrial countries 10 9 UK USA 8 EU15 JapanAnnual growth rate (%) 7 6 5 4 3 2 1 0 -1 -2 -3 1970 1975 1980 1985 1990 1995 2000 2005
    • 36. Growth rates in selected industrial countries 10 9 UK USA 8 EU15 JapanAnnual growth rate (%) 7 6 5 4 3 2 1 0 -1 -2 -3 1970 1975 1980 1985 1990 1995 2000 2005
    • 37. The Business Cycle• Causes of cyclical fluctuations – Why does AD change in the first place? – Why do booms and recessions persist? • time lags • bandwagon effects – the accelerator – Why do booms and recessions end? • ceilings and floors • echo effects • the accelerator • random shocks • changes in government policy
    • 38. Money, Interest Rates and Business Activity• The meaning of money – narrow definitions of money (M0 in the UK) – broad definitions of money (M4 in the UK)• The supply of money – banks and the creation of credit • simple illustration
    • 39. Credit creation: Banks original balance sheet
    • 40. Credit creation: Effect of a new deposit of £10bn
    • 41. Credit creation: Full effect of a new deposit of £10bn
    • 42. Money, Interest Rates and Business Activity• The meaning of money – narrow definitions of money (M0 in the UK) – broad definitions of money (M4 in the UK)• The supply of money – banks and the creation of credit • simple illustration • the deposits multiplier
    • 43. Money, Interest Rates and Business Activity• The meaning of money – narrow definitions of money (M0 in the UK) – broad definitions of money (M4 in the UK)• The supply of money – banks and the creation of credit • simple illustration • the deposits multiplier – creation of credit: the real world
    • 44. Money, Interest Rates and Business Activity• The meaning of money – narrow definitions of money (M0 in the UK) – broad definitions of money (M4 in the UK)• The supply of money – banks and the creation of credit • simple illustration • the deposits multiplier – creation of credit: the real world • banks liquidity ratio may vary
    • 45. Money, Interest Rates and Business Activity• The meaning of money – narrow definitions of money (M0 in the UK) – broad definitions of money (M4 in the UK)• The supply of money – banks and the creation of credit • simple illustration • the deposits multiplier – creation of credit: the real world • banks liquidity ratio may vary • banks respond to the demand for money
    • 46. Money, Interest Rates and Business Activity• Causes of increases in money supply – increased demand for money • banks reduce liquidity ratio – inflow of funds from abroad – a public-sector deficit (PSNCR) • depends on how it is financed – from banking sector: money supply expands – from outside the banking sector: money supply does not expand
    • 47. Money, Interest Rates and Business Activity• The demand for money – reasons for holding money • transactions and precautionary motive • assets or speculative motive – determinants of demand for money • money national income • speculation about future return on assets • rate of interest
    • 48. Money, Interest Rates and Business Activity• Equilibrium rate of interest – where demand for money equals supply
    • 49. Equilibrium in the money market MSRate of interest re Md O Money
    • 50. Money, Interest Rates and Business Activity• Equilibrium rate of interest – where demand for money equals supply – if supply of money rises or demand for money falls, the rate of interest will fall
    • 51. Equilibrium in the money market MSRate of interest re Md O Money
    • 52. Money, Interest Rates and Business Activity• Effects of changes in money supply on national income – rise in money supply causes interest rate to fall – fall in interest rate causes investment to rise – rise in investment causes GDP to rise• Determinants of the size of these effects
    • 53. Unemployment• Measuring unemployment – defining the unemployment rate – claimant unemployment • do claimant statistics give a true picture of unemployment? – standardised unemployment (ILO/OECD) • use of labour force surveys
    • 54. Unemployment• Unemployment and the labour market – the aggregate demand and supply of labour
    • 55. Aggregate demand and supply of labour ASLAverage (real) wage rate ADL O No. of workers
    • 56. Unemployment• Unemployment and the labour market – the aggregate demand and supply of labour • equilibrium in the model
    • 57. Aggregate demand and supply of labour ASLAverage (real) wage rate We ADL O Qe No. of workers
    • 58. Unemployment• Unemployment and the labour market – the aggregate demand and supply of labour • equilibrium in the model – disequilibrium unemployment
    • 59. Disequilibrium unemployment ASLAverage (real) wage rate B A W2 We ADL O Q2 Q1 No. of workers
    • 60. Unemployment• Unemployment and the labour market – the aggregate demand and supply of labour • equilibrium in the model – disequilibrium unemployment – equilibrium unemployment
    • 61. Equilibrium unemployment ASLAverage (real) wage rate e We ADL O Qe No. of workers
    • 62. Equilibrium unemployment ASL NAverage (real) wage rate e d We ADL O Qe Q2 No. of workers
    • 63. Equilibrium and disequilibrium unemployment ASLAverage (real) wage rate e We ADL O Qe No. of workers
    • 64. Equilibrium and disequilibrium unemployment ASLAverage (real) wage rate Disequilibrium unemployment b a W2 e We ADL O No. of workers
    • 65. Equilibrium and disequilibrium unemployment ASL NAverage (real) wage rate Disequilibrium unemployment b a c W2 e We Equilibrium unemployment ADL O No. of workers
    • 66. Unemployment• Unemployment and the labour market – the aggregate demand and supply of labour • equilibrium in the model – disequilibrium unemployment – equilibrium unemployment• Disequilibrium unemployment
    • 67. Unemployment• Unemployment and the labour market – the aggregate demand and supply of labour • equilibrium in the model – disequilibrium unemployment – equilibrium unemployment• Disequilibrium unemployment – real-wage unemployment
    • 68. Unemployment• Unemployment and the labour market – the aggregate demand and supply of labour • equilibrium in the model – disequilibrium unemployment – equilibrium unemployment• Disequilibrium unemployment – real-wage unemployment – demand-deficient (cyclical) unemployment
    • 69. Unemployment rates in selected industrial countries 14 UKAnnual growth rate (%) 12 10 8 6 4 2 0 1970 1975 1980 1985 1990 1995 2000 2005
    • 70. Unemployment rates in selected industrial countries 14 UKAnnual growth rate (%) 12 10 8 6 4 2 0 1970 1975 1980 1985 1990 1995 2000 2005
    • 71. Unemployment rates in selected industrial countries 14 UK EU15Annual growth rate (%) 12 10 8 6 4 2 0 1970 1975 1980 1985 1990 1995 2000 2005
    • 72. Unemployment rates in selected industrial countries 14 UK EU15Annual growth rate (%) 12 10 8 6 4 2 0 1970 1975 1980 1985 1990 1995 2000 2005
    • 73. Unemployment rates in selected industrial countries 14 UK USA EU15Annual growth rate (%) 12 10 8 6 4 2 0 1970 1975 1980 1985 1990 1995 2000 2005
    • 74. Unemployment rates in selected industrial countries 14 UK USA EU15Annual growth rate (%) 12 10 8 6 4 2 0 1970 1975 1980 1985 1990 1995 2000 2005
    • 75. Unemployment rates in selected industrial countries 14 UK USA EU15 JapanAnnual growth rate (%) 12 10 8 6 4 2 0 1970 1975 1980 1985 1990 1995 2000 2005
    • 76. Unemployment rates in selected industrial countries 14 UK USA EU15 JapanAnnual growth rate (%) 12 10 8 6 4 2 0 1970 1975 1980 1985 1990 1995 2000 2005
    • 77. Unemployment• Equilibrium unemployment – frictional (search) unemployment – structural unemployment • changing pattern of demand • technological unemployment • regional unemployment – seasonal unemployment
    • 78. Inflation• Defining inflation – consumer price inflation – other categories of inflation• Inflation in historical perspective – low inflation in 1950s and 60s – high inflation in 1970s and 80s – low inflation since mid 1990s • most developed countries gear monetary policy to achieving a low target rate of inflation
    • 79. Inflation rates in selected industrial countries 26 24 UK 22Annual growth rate (%) 20 18 16 14 12 10 8 6 4 2 0 -2 1965 1970 1975 1980 1985 1990 1995 2000 2005
    • 80. Inflation rates in selected industrial countries 26 24 UK 22Annual growth rate (%) 20 18 16 14 12 10 8 6 4 2 0 -2 1965 1970 1975 1980 1985 1990 1995 2000 2005
    • 81. Inflation rates in selected industrial countries 26 24 UK 22 EU15Annual growth rate (%) 20 18 16 14 12 10 8 6 4 2 0 -2 1965 1970 1975 1980 1985 1990 1995 2000 2005
    • 82. Inflation rates in selected industrial countries 26 24 UK 22 EU15Annual growth rate (%) 20 18 16 14 12 10 8 6 4 2 0 -2 1965 1970 1975 1980 1985 1990 1995 2000 2005
    • 83. Inflation rates in selected industrial countries 26 24 UK USA 22 EU15Annual growth rate (%) 20 18 16 14 12 10 8 6 4 2 0 -2 1965 1970 1975 1980 1985 1990 1995 2000 2005
    • 84. Inflation rates in selected industrial countries 26 24 UK USA 22 EU15Annual growth rate (%) 20 18 16 14 12 10 8 6 4 2 0 -2 1965 1970 1975 1980 1985 1990 1995 2000 2005
    • 85. Inflation rates in selected industrial countries 26 24 UK USA 22 EU15 JapanAnnual growth rate (%) 20 18 16 14 12 10 8 6 4 2 0 -2 1965 1970 1975 1980 1985 1990 1995 2000 2005
    • 86. Inflation rates in selected industrial countries 26 24 UK USA 22 EU15 JapanAnnual growth rate (%) 20 18 16 14 12 10 8 6 4 2 0 -2 1965 1970 1975 1980 1985 1990 1995 2000 2005
    • 87. Inflation• Aggregate demand & supply and prices – aggregate demand curve
    • 88. Price level Aggregate demand and aggregate supply AD O National output
    • 89. Inflation• Aggregate demand & supply and prices – aggregate demand curve • why AD curves slope downwards
    • 90. Inflation• Aggregate demand & supply and prices – aggregate demand curve • why AD curves slope downwards – lower price level leads to fewer imports – lower price level tends to cause interest rates to fall – lower price level increases value of peoples savings
    • 91. Inflation• Aggregate demand & supply and prices – aggregate demand curve • why AD curves slope downwards – lower price level leads to fewer imports – lower price level tends to cause interest rates to fall – lower price level increases value of peoples savings – aggregate supply curve
    • 92. Aggregate demand and aggregate supply ASPrice level AD O National output
    • 93. Inflation• Aggregate demand & supply and prices – aggregate demand curve • why AD curves slope downwards – lower price level leads to fewer imports – lower price level tends to cause interest rates to fall – lower price level increases value of peoples savings – aggregate supply curve • why AS curves generally slope upwards
    • 94. Inflation• Aggregate demand & supply and prices – aggregate demand curve • why AD curves slope downwards – lower price level leads to fewer imports – lower price level tends to cause interest rates to fall – lower price level increases value of peoples savings – aggregate supply curve • why AS curves generally slope upwards – equilibrium
    • 95. Aggregate demand and aggregate supply ASPrice level Pe AD O National output
    • 96. Aggregate demand and aggregate supply ASPrice level Pe b a P2 AD O National output
    • 97. Inflation• Aggregate demand & supply and prices – aggregate demand curve • why AD curves slope downwards – lower price level leads to fewer imports – lower price level tends to cause interest rates to fall – lower price level increases value of peoples savings – aggregate supply curve • why AS curves generally slope upwards – equilibrium – shifts in AD and AS curves
    • 98. Inflation• Causes of inflation – demand pull
    • 99. Demand-pull inflation ASPrice level P1 AD1 O Q1 National output
    • 100. Demand-pull inflation ASPrice level P1 AD2 AD1 O Q1 National output
    • 101. Demand-pull inflation ASPrice level P2 P1 AD2 AD1 O Q1 Q2 National output
    • 102. Inflation• Causes of inflation – demand pull – cost push • wage push • profit push • import-price push
    • 103. Cost-push inflation AS1Price level P1 AD O Q1 National output
    • 104. Cost-push inflation AS2 AS1Price level P1 AD O Q1 National output
    • 105. Cost-push inflation AS2 AS1Price level P2 P1 AD O Q2 Q1 National output
    • 106. Inflation• Causes of inflation – demand pull – cost push • wage push • profit push • import-price push – the interaction of demand-pull and cost-push inflation
    • 107. The interaction of demand-pull and cost-push inflation AS1Price level P1 AD1 O National output
    • 108. The interaction of demand-pull and cost-push inflation AS2 AS1Price level P2 P1 AD2 AD1 O National output
    • 109. The interaction of demand-pull and cost-push inflation AS3 AS 2 AS1 P3Price level P2 P1 AD3 AD2 AD1 O National output
    • 110. Inflation• Causes of inflation – demand pull – cost push • wage push • profit push • import-price push – expectations and inflation
    • 111. Inflation• Causes of inflation – demand pull – cost push • wage push • profit push • import-price push – expectations and inflation• Policies to tackle inflation
    • 112. Inflation• Causes of inflation – demand pull – cost push • wage push • profit push • import-price push – expectations and inflation• Policies to tackle inflation – demand-side policies
    • 113. Inflation• Causes of inflation – demand pull – cost push • wage push • profit push • import-price push – expectations and inflation• Policies to tackle inflation – demand-side policies – supply-side policies