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Week 7: TheNational Economy
Key termsmacroeconomic issuesmacroeconomic objectiveseconomic growthemployment / unemploymentinflationBalance of Pay...
4 Key Macroeconomic Issues1. Economic growth2. Employment3. Inflation4. Balance of Payments and the exchange rate
Macroeconomic issues1.Economic growth‘the growing ability of the economy to produce goodsand services’government objecti...
Macroeconomic Issues2. Employmentemployment is thetotal number of people currently employedunemployment is the total num...
Macroeconomic Issues3. Inflationthe general rise in pricesthe rate of inflation measures the annual percentageincrease ...
Macroeconomic Issues4. Balance of Paymentsall payments made to other countries (importpurchases, outward spending, inter...
Macroeconomic IssuesKey problem: policy conflicteg goal of high economic growth may conflictwith goal of low inflationSo...
Economic AggregatesAggregate Demand (AD) =* total spending on goods and services made within thecountry over a given perio...
Aggregate Demand4 components1. Consumption (C)2. Investment (I)3. Government Spending (G)4. Net Exports (X-M)AD = C + I + ...
The Circular Flow of IncomeThe inner flowFirms and Households
FactorpaymentsConsumption ofdomesticallyproduced goodsand services (Cd)The circular flow of incomeFirmsHouseholds
Beyond the inner flowWithdrawals (W)net saving (S)net taxes (T)import expenditure (M)Total withdrawals are the total ...
FactorpaymentsConsumption ofdomesticallyproduced goodsand services (Cd)BANKS, etcBANKS, etcNetsaving (S)GOV.GOV.NetNettaxe...
Beyond the inner flowInjections (J)Investment (I)Government expenditure (G)Export expenditure (X)Total injections are...
FactorpaymentsConsumption ofdomesticallyproduced goodsand services (Cd)Investment (Investment (II))GovernmentGovernmentexp...
The Circular Flow of IncomeThe relationship between injections and withdrawalsthe links between them are complex due to ...
The Circular Flow of IncomeThe relationship between injections and withdrawals Disequilibrium when J ≠ WThis will set i...
Relationship between W and JIf J > W then the level of expenditure will rise; a risein ADExtra spending will increase fi...
Effect of rise in AD on 4 macro objectives1. Economic growthThe greater the excess of J over W, the bigger the rise inna...
Effect of rise in aggregate demand on 4macroeconomic objections - continued3. InflationWill tend to rise. The greater ri...
Disequilibrium and a chain reaction‘automatic stabilisers’J W˃ As national income rises:Households will spend more [Cd]...
QuestionThis time: J < WStep 1: What will be the effect on each of the four objectives ifplanned injections are less than...
 If planned injections are less than withdrawals, national income will fall.Other things being equal, this will have the ...
If J < W National income will rise / fall Ceteris paribus, this will have the following effects on the four macro-econom...
Aggregate Demand – components1. Consumption (C)The amount of consumer spending on goods andservices produced in the count...
Aggregate Demand – components2. Investment (I)Expenditure by firms in the country on ‘capital goods’(eg buildings, equipm...
Aggregate Demand – components3. Government spending (G)on goods and services (eg defence, education, health,housing etc)...
Aggregate Demand – components3. Government spending (G) - continuedG directly increases/decreases ADeg consider wartime s...
Aggregate Demand – components3. Government Spending (G) - continuedBudget deficit (G > T):expansionary fiscal policy = in...
Aggregate Demand – components4. Net Exports [X - M)Net exports is the difference between the value ofexports and the val...
Aggregate Demand – components4. Net exports (X -M) continuedSpending on X depends on Level of income in other countries...
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  1. 1. Week 7: TheNational Economy
  2. 2. Key termsmacroeconomic issuesmacroeconomic objectiveseconomic growthemployment / unemploymentinflationBalance of Paymentsexchange ratepolicy conflictcircular flow of incomewithdrawals savings, taxation, importsinjections Investment, governmentspending, exportsaggregate demand
  3. 3. 4 Key Macroeconomic Issues1. Economic growth2. Employment3. Inflation4. Balance of Payments and the exchange rate
  4. 4. Macroeconomic issues1.Economic growth‘the growing ability of the economy to produce goodsand services’government objective Achieve high but stable growth rates over a sustained periodof time[UK = up from -0.4% to 1% but mostly due to the 2012Olympics]
  5. 5. Macroeconomic Issues2. Employmentemployment is thetotal number of people currently employedunemployment is the total number of peopleactively looking for work but who are notcurrently employedgovernment objective: full employment (reducing unemployment) such that there isno waste of human resources[UK = down from 8.1% to 7.9%]
  6. 6. Macroeconomic Issues3. Inflationthe general rise in pricesthe rate of inflation measures the annual percentageincrease in pricesgovernment objective: control inflation such that it is low and stable[UK CPI = down from 2.5% to 2.2% - target is 2%]
  7. 7. Macroeconomic Issues4. Balance of Paymentsall payments made to other countries (importpurchases, outward spending, interest paid)all payments received from other countries (exportsales, inward investment, interest earned)if a country spends more foreign currency than it earns,there will be a BofP deficit (currency surplus, exchangerate falls)government objective: achieve balance of country’s trade and capital flows over aperiod of years – BofP equilibrium [UK = deficit £49b]
  8. 8. Macroeconomic IssuesKey problem: policy conflicteg goal of high economic growth may conflictwith goal of low inflationSolution: trade-offs(opportunity costs, rational choices, and cost-benefit analyses)
  9. 9. Economic AggregatesAggregate Demand (AD) =* total spending on goods and services made within thecountry over a given period of time (planned spending)
  10. 10. Aggregate Demand4 components1. Consumption (C)2. Investment (I)3. Government Spending (G)4. Net Exports (X-M)AD = C + I + G + X-MRelationship between 4 macro objectives and AD – seecircular flow of income
  11. 11. The Circular Flow of IncomeThe inner flowFirms and Households
  12. 12. FactorpaymentsConsumption ofdomesticallyproduced goodsand services (Cd)The circular flow of incomeFirmsHouseholds
  13. 13. Beyond the inner flowWithdrawals (W)net saving (S)net taxes (T)import expenditure (M)Total withdrawals are the total of net saving, nettaxes and expenditure on importsW = S + T + M
  14. 14. FactorpaymentsConsumption ofdomesticallyproduced goodsand services (Cd)BANKS, etcBANKS, etcNetsaving (S)GOV.GOV.NetNettaxes (taxes (TT))ABROADImportImportexpenditure (expenditure (MM))The circular flow of incomeWITHDRAWALS
  15. 15. Beyond the inner flowInjections (J)Investment (I)Government expenditure (G)Export expenditure (X)Total injections are the sum of investment,government expenditure, and exportsJ = I + G + XAggregate demand (total spending on output) is Cd + J
  16. 16. FactorpaymentsConsumption ofdomesticallyproduced goodsand services (Cd)Investment (Investment (II))GovernmentGovernmentexpenditure (expenditure (GG))ExportExportexpenditure (expenditure (XX))BANKS, etcBANKS, etcNetsaving (S)GOV.GOV.NetNettaxes (taxes (TT))ABROADImportImportexpenditure (expenditure (MM))The circular flow of incomeWITHDRAWALSINJECTIONS
  17. 17. The Circular Flow of IncomeThe relationship between injections and withdrawalsthe links between them are complex due to manydifferent decisions made by many different peopleplanned injections may not equal planned withdrawalsegS ≠ I, T ≠ G, X ≠ M
  18. 18. The Circular Flow of IncomeThe relationship between injections and withdrawals Disequilibrium when J ≠ WThis will set in motion a process to bring economyback to state of equilibrium where J = W
  19. 19. Relationship between W and JIf J > W then the level of expenditure will rise; a risein ADExtra spending will increase firms’ sales, encouragethem to produce moreTotal output in the economy will riseFirms pay out more in wages, profits, rents, interestNational income will rise
  20. 20. Effect of rise in AD on 4 macro objectives1. Economic growthThe greater the excess of J over W, the bigger the rise innational income2. UnemploymentWill fall as firms take on more workers to meet theextra demand in outputcontinued
  21. 21. Effect of rise in aggregate demand on 4macroeconomic objections - continued3. InflationWill tend to rise. The greater rise in AD relative tocapacity of firms to produce, the more firms struggle tomeet demand so likely to raise prices4. Balance of PaymentsWill tend to deteriorate. Higher demand means moreM and higher inflation means X less competitive andimports relatively cheaper. So M tend to rise and X tendto fall
  22. 22. Disequilibrium and a chain reaction‘automatic stabilisers’J W˃ As national income rises:Households will spend more [Cd]Households will save more [S]Households will pay more taxes [T] [and governmentwill spend less on welfare benefits]Households will buy more imports [M]So withdrawals increaseEventually, equilibrium: J = W[ie automatic stabilisers can avoid unsustainable growth,high inflation]
  23. 23. QuestionThis time: J < WStep 1: What will be the effect on each of the four objectives ifplanned injections are less than planned withdrawals?Step 2: Explain how the chain reaction returns the economyto equilibrium [J = W] [ie how the automatic stabiliserswork to limit the fall in growth to avoid high inflation]
  24. 24.  If planned injections are less than withdrawals, national income will fall.Other things being equal, this will have the following effects on the fourobjectives: Growth will be negative. Unemployment will rise. The rate of inflation will fall. Exports will tend to rise (as their relative prices fall) and imports will tend tofall (as they become less competitive with home-produced goods and asincomes at home fall and thus people cannot afford to buy so many imports).These effects are collectively known as the international substitution effect As national income falls Households will spend less (Cd) Households will save less (S) Households will pay less taxes (T)[government will pay more welfare benefits] Households will buy fewer imports (M) Demand from abroad for X tends to increase. So withdrawals decrease
  25. 25. If J < W National income will rise / fall Ceteris paribus, this will have the following effects on the four macro-economic objectives: Growth will be negative / positive Unemployment will rise / fall The rate of inflation will rise / fall Exports will tend to rise / fall Imports will tend to rise / fall So the balance of payments will improve / deteroriateAutomatic stabilisers can limit fall in growth by:
  26. 26. Aggregate Demand – components1. Consumption (C)The amount of consumer spending on goods andservices produced in the country (the largest part ofAD)It is influenced by: Disposable income (the largest part of C) Expected future incomes/consumer confidence Household wealth The financial system/interest rates New technology
  27. 27. Aggregate Demand – components2. Investment (I)Expenditure by firms in the country on ‘capital goods’(eg buildings, equipment NOT stocks, bonds)It is influenced by: Increased consumer demand Expectations and business confidence Financial system/interest rates Technological advances Cost of capital goods Level of company profits
  28. 28. Aggregate Demand – components3. Government spending (G)on goods and services (eg defence, education, health,housing etc)it is influenced by: Government policy (political issue) National income – short-term National income – long-term (includes issue of tax revenue) Demographic changes Demand for merit and public goods
  29. 29. Aggregate Demand – components3. Government spending (G) - continuedG directly increases/decreases ADeg consider wartime spendingT indirectly increases/decreases ADeg lower tax rate = consumers keep more of what they earnthereby increasing their disposable income
  30. 30. Aggregate Demand – components3. Government Spending (G) - continuedBudget deficit (G > T):expansionary fiscal policy = increase ADBudget Surplus (G < T):contractionary fiscal policy + decrease ADBalanced Budget (G = T):neutral effect on AD
  31. 31. Aggregate Demand – components4. Net Exports [X - M)Net exports is the difference between the value ofexports and the value of imports[M subtracted from X because M not part of the country’sproduction]Export sales lead to flow of funds into country so ADincreasesImport purchases lead to flow of funds out of countryso AD is reduced
  32. 32. Aggregate Demand – components4. Net exports (X -M) continuedSpending on X depends on Level of income in other countries Exchange rateSpending on M depends on Level of income in own country Exchange rate
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