Chap8

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Chap8

  1. 1. CHAPTER 8: INTRODUCTION TO MACROECONOMICS
  2. 2. 8.1 Introduction 8.2 Concern of Macroeconomics 8.3 Government policy 8.4 Component of Macroeconomics 8.5 Aggregate Demand & Aggregate Supply
  3. 3. <ul><li>Microeconomics </li></ul><ul><ul><li>examines the behavior of individual decision-making-units business firms and households. </li></ul></ul><ul><li>Macroeconomics </li></ul><ul><ul><li>deals with the economy as a whole; it examines the behavior of economic aggregates such as aggregate income, consumption, investment, and the overall level of prices. </li></ul></ul><ul><ul><ul><li>Aggregate behavior refers to the behavior of all households and firms together. </li></ul></ul></ul><ul><ul><ul><li>Connection to microeconomics: </li></ul></ul></ul><ul><ul><ul><ul><li>Macroeconomic behavior is the sum of all the microeconomic decision made by individual households & firms </li></ul></ul></ul></ul>8.1 INTRODUCTION TO MACROECONOMICS
  4. 4. <ul><li>Four major concerns: </li></ul><ul><ul><li>Inflation </li></ul></ul><ul><ul><li>Output growth </li></ul></ul><ul><ul><li>Unemployment </li></ul></ul><ul><ul><li>Distribution of income </li></ul></ul><ul><li>Goals for policy maker: </li></ul><ul><ul><li>Price stability </li></ul></ul><ul><ul><li>Economic growth </li></ul></ul><ul><ul><li>Full employment </li></ul></ul><ul><ul><li>Equitable distribution of income </li></ul></ul>8.2 CONCERNS OF MACROECONOMICS
  5. 5. If the inflation rate is 2% annually, theoretically a RM1 pack of candy will cost???
  6. 6. <ul><ul><li>INFLATION </li></ul></ul><ul><ul><li>A continuous increase in the general price level of goods and services in the economy. </li></ul></ul><ul><li>Deflation </li></ul><ul><ul><li>Decrease in the overall price level. Prolonged periods of deflation can be just as damaging for the economy as sustained inflation. </li></ul></ul><ul><li>Stagflation </li></ul><ul><ul><li>Refers to a situation in an economy when there is high unemployment and rapid inflation simultaneously. </li></ul></ul>
  7. 7. <ul><ul><li>There are various degree of inflation such as: </li></ul></ul><ul><ul><li>Creeping inflation – a sustained rise in price i.e. about 2% per year </li></ul></ul><ul><ul><li>Mild inflation – a sustained rise in price of about 8% to 10% per year </li></ul></ul><ul><ul><li>Hyperinflation – occurs when monthly prices rise to 50% to 60% or more. </li></ul></ul><ul><ul><li>Hyperinflation was witnessed in Germany in 1923, Hungary in 1947 and China in 1949. </li></ul></ul>
  8. 8. Measures of Inflation: <ul><li>(1) GDP Deflator: </li></ul><ul><ul><li>A comprehensive inflation measure of all goods and services included in the GDP. </li></ul></ul><ul><ul><li>GDP deflator = (nominal GDP / real GDP) x 100 </li></ul></ul><ul><ul><li>Nominal GDP is dollar value of GDP in a particular year measured in prices of that same year. </li></ul></ul><ul><ul><li>Real GDP is dollar value of GDP in a particular year measured in base year prices. </li></ul></ul>
  9. 9. Measures of Inflation (continue..) <ul><li>(2) Consumer Price Index (CPI) </li></ul><ul><li>The CPI is the most popular used to measure the rate of inflation. </li></ul><ul><li>CPI is an index that measures changes in the average price of consumer goods and services. </li></ul><ul><li>The formula below shows how the rate of inflation is computed: </li></ul><ul><li>Inflation rate = CPI this year – CPI previous year </li></ul><ul><li>CPI previous year </li></ul>
  10. 10. Measures of Inflation (continue..) <ul><li>(3) Producer Price Index (PPI) </li></ul><ul><li>These are indexes of prices that producers receive for products at all stages in the production process, not just the final stage. </li></ul><ul><li>The three main categories are finished goods, intermediate materials and crude materials. </li></ul>
  11. 11. Causes of Inflation <ul><li>(1) Demand-Pull Inflation : </li></ul><ul><ul><li>Inflation that is initiated by an increase in aggregate demand (AD curve shift rightward). </li></ul></ul><ul><ul><li>AD increases may be due to a rise in consumer demand, or an increase in the level of government expenditure etc. </li></ul></ul><ul><li>(2) Cost-Push Inflation : </li></ul><ul><ul><li>Inflation that is initiated by a decrease in aggregate supply (AS curve shift leftward). </li></ul></ul><ul><ul><li>AS decreases may be due to increase in the cost shock, natural disaster and so on. </li></ul></ul><ul><ul><li>Will be discussed more detail in Topic 12 </li></ul></ul>
  12. 12. Effects of Inflation <ul><li>Distribution of Income </li></ul><ul><ul><li>Inflation changes the existing pattern of distribution of income and wealth in society where some groups are relatively better off than others. </li></ul></ul><ul><ul><li>E.g. businessman will earn higher profits from rising prices (gain) and people who depend on fixed income will tend to lose because of inflation. </li></ul></ul><ul><li>Savings </li></ul><ul><ul><li>The value of fixed deposits, bonds, life insurance policies and money would depreciate in terms of real income. </li></ul></ul><ul><ul><li>Since inflation depreciates the value of fixed deposits, people will save less and invest in non-financial sectors such as house and land. </li></ul></ul>
  13. 13. Effects of Inflation (continue..) <ul><li>(3) Production </li></ul><ul><ul><li>During inflation, general level of prices rises and producers make higher profits. </li></ul></ul><ul><ul><li>This will lead producers to increase their level of production and investment and will create more job opportunities and reduce unemployment. </li></ul></ul><ul><li>Balance of Trade </li></ul><ul><ul><li>During inflation, many countries face a deficit balance of trade since imports are greater than exports. </li></ul></ul><ul><ul><li>When price of domestic products rise, foreigners will reduce the demand for domestic products. </li></ul></ul><ul><ul><li>At the same time, imports increase because the imported products are now cheaper than domestic products. </li></ul></ul>
  14. 14. <ul><li>(5) Effects on debtors/ borrowers (owes a debt) </li></ul><ul><li> & creditors </li></ul><ul><ul><li>Inflation that is lower than expected benefits creditors and hurt the debtor and vice versa . </li></ul></ul><ul><ul><li>For example: If I loan you RM100 to be paid back in a year, and prices increase 10%, I get back 10% less in real terms than what I loaned you. </li></ul></ul><ul><li>(6) Investment risk </li></ul><ul><ul><li>investor could be reluctant to invest and make long-term commitment. </li></ul></ul><ul><ul><li>slow down the economic growth. </li></ul></ul>Effects of Inflation (continue..)
  15. 15. <ul><li>OUTPUT GROWTH </li></ul><ul><li>Output growth is the growth rate of the output for the entire economy. </li></ul><ul><li>It can be measured using the rate of GDP of that country. </li></ul><ul><li>Business cycle: </li></ul><ul><ul><li>Refer to the regular fluctuations in economic activity particularly with regard to national income, employment and output. </li></ul></ul><ul><ul><li>4 phases of the business cycle: </li></ul></ul><ul><ul><li>(1) Peak or Boom (3) Trough </li></ul></ul><ul><ul><li>(2) Recession (4) Expansion </li></ul></ul>
  16. 16. <ul><li>Expansion/ boom </li></ul><ul><ul><li>The period in the business cycle from a trough up to a peak, during which output and employment rise. </li></ul></ul><ul><li>Contraction /recession/ slump </li></ul><ul><ul><li>The period in the business cycle from a peak down to a trough, during which output and employment fall. </li></ul></ul>
  17. 17. No job, no $$$$..... How to survive???? Take it easy, relax….
  18. 18. <ul><li>UNEMPLOYMENT </li></ul><ul><li>Definition: </li></ul><ul><ul><li>A situation where labour force participations are available and willing to work but are unable to find jobs. </li></ul></ul><ul><ul><li>key indicator of the economy’s health. </li></ul></ul><ul><li>Unemployment rate: </li></ul><ul><ul><li>It can be measured using this unemployment rate indicator. </li></ul></ul><ul><ul><li>The ration of the number of people unemployed to the total number of people in the labor force. </li></ul></ul><ul><ul><li>Unemployment rate = Number of Unemployed x 100 </li></ul></ul><ul><ul><li>(%) Labour Force </li></ul></ul>
  19. 19. <ul><li>Total labor force in Malaysia is 11,420.7 (‘000), 11,025.6 (‘000) people employed and total population is 15,021(‘000). What is the unemployment rate? </li></ul><ul><ul><li>Hints: Fourth quarter of 2009 </li></ul></ul>
  20. 20. Population Labor force Not in labor force Employed Unemployed < 16 > 55 Discourage workers
  21. 21. <ul><li>Labor Force </li></ul><ul><ul><li>All persons above the age of 16 and older who are employed or are actively seeking employment. </li></ul></ul><ul><li>Not in the labor force </li></ul><ul><ul><li>A person who is not looking for work, either because he or she does not want a job or has given up looking. </li></ul></ul><ul><li>Discouraged workers </li></ul><ul><ul><li>The people who want to work but cannot find jobs. </li></ul></ul><ul><ul><li>They grow discourage and stop looking for jobs in the short-term. </li></ul></ul>
  22. 22. <ul><li>Total labor force in Malaysia is 11,420.7 (‘000), 11,025.6 (‘000) people employed and 39.51 (‘000) people looking for work. What is the unemployment rate? </li></ul><ul><ul><li>Hints: Fourth quarter of 2009 </li></ul></ul>
  23. 23. <ul><li>(1) Frictional unemployment </li></ul><ul><ul><li>Definition : Occurs when people are in between jobs, entering and reentering the labour force; used to denote short-run job/skill matching problems. </li></ul></ul><ul><ul><li>Example : Employers need time to learn about the talent available while the job seekers need time to learn about employment opportunities. </li></ul></ul><ul><ul><li>Generally happen in short-term and voluntary. </li></ul></ul>Types of Unemployment
  24. 24. <ul><li>(2) Structural unemployment </li></ul><ul><ul><li>Definition : The portion of unemployment that is due to changes in the structure of the economy that result in a significant loss of jobs in certain industries. </li></ul></ul><ul><ul><li>Example : W orkers do not have the skills demanded by employers. </li></ul></ul><ul><ul><li>Occurs because changes in tastes, technology, taxes, or competition reduce the demand for certain skills and increase the demand for other skills. </li></ul></ul>
  25. 25. <ul><li>(3) Cyclical unemployment </li></ul><ul><ul><li>Definition : The increase in unemployment that occurs during recessions and depressions . </li></ul></ul><ul><ul><li>Example: Worker laid off because recessions and gets rehired some monthly later. </li></ul></ul><ul><li>(4) Seasonal unemployment </li></ul><ul><ul><li>Definition : The unemployment that arises because of seasonal changes in labor demand during the year. </li></ul></ul><ul><ul><li>Example : A fisherman which is unable to catch fish in winter or in rainy weather. </li></ul></ul>
  26. 26. <ul><li>Natural Rate of Unemployment </li></ul><ul><ul><li>The unemployment that occurs as a normal part of the functioning of the economy. </li></ul></ul><ul><ul><li>Sometimes taken as the sum of frictional unemployment and structural unemployment. </li></ul></ul><ul><ul><li>Does not mean zero unemployment but low unemployment, with estimates ranging from 4% to 6% of the unemployment rate. </li></ul></ul>
  27. 27. <ul><li>Productivity inefficient </li></ul><ul><ul><li>Less goods and services are being produced then it is possible to produce. </li></ul></ul><ul><li>Lower living standard </li></ul><ul><ul><li>Less income in a given region as people are working. </li></ul></ul><ul><ul><li>Less spending on goods and services. </li></ul></ul><ul><li>Social and political problem </li></ul><ul><ul><li>People have more free time and lower incomes. </li></ul></ul><ul><ul><li>May engage in troublesome social and political activities. </li></ul></ul><ul><ul><li>Lead to more crimes </li></ul></ul>Effects of Unemployment
  28. 28. <ul><li>Government tax </li></ul><ul><ul><li>The government will earn less from direct taxation because people are not earning and indirect taxation revenue will also fall because people are not spending as well. </li></ul></ul><ul><ul><li>Government budget will also be affected because less income and higher spending by government. </li></ul></ul><ul><li>Investment </li></ul><ul><ul><li>Firm lose confidence in the economy and do not put money into longer-term projects. </li></ul></ul>Effects of Unemployment
  29. 29. DISTRIBUTION OF INCOME <ul><li>Income distribution is how a nation’s total economy is distributed amongst its population. </li></ul><ul><li>It has always been a central concern of economic theory and economic policy. </li></ul><ul><li>Government need to consider policies to improve the distribution of income and wealth because the benefit s of growth for the poor may be diminished if the distribution of income worsens. </li></ul>
  30. 30. <ul><li>Three kinds of policies: </li></ul><ul><ul><li>Fiscal policy </li></ul></ul><ul><ul><ul><li>Refer to government policies concerning taxes and spending </li></ul></ul></ul><ul><ul><li>Monetary policy </li></ul></ul><ul><ul><ul><li>Consist of tools used by the central bank to control the quantity of money in the economy </li></ul></ul></ul><ul><ul><li>Supply-side policy </li></ul></ul><ul><ul><ul><li>Government policies that focus on stimulating aggregate supply . </li></ul></ul></ul>8.3 GOVERNMENT POLICIES
  31. 31. <ul><li>Macroeconomics focuses on four groups: </li></ul><ul><li>Households </li></ul><ul><li>Firms </li></ul><ul><li>Government </li></ul><ul><li>Rest of the world (International sector) </li></ul>8.4 THE COMPONENTS OF MACROECONOMICS
  32. 32. <ul><li>Circular Flow Diagram </li></ul><ul><ul><li>Definition : shows the economic interaction between the four sectors in the economy. </li></ul></ul><ul><ul><li>Everyone’s expenditure is someone else’s receipt. Every transaction must have 2 sides. </li></ul></ul>
  33. 33. The Circular Flow Diagram
  34. 34. <ul><li>Household: </li></ul><ul><ul><li>Owns/sell all the factors of production. </li></ul></ul><ul><ul><li>Work in the firm and for the government where they receive wages for their services. </li></ul></ul><ul><ul><li>Also receive other payment from government such as transfer payment and subsidies. </li></ul></ul><ul><ul><li>Spends income by buying goods and services produced by firms and also pay tax for government. </li></ul></ul><ul><li>Firm: </li></ul><ul><ul><li>Buy the factors of production from household. </li></ul></ul><ul><ul><li>Produce and sell goods and services to household and government – earn income. </li></ul></ul><ul><ul><li>Firms pay for services of factors of production; wages, rent, interest and profit. </li></ul></ul>
  35. 35. <ul><li>Government: </li></ul><ul><ul><li>Collect taxes from households and firms. </li></ul></ul><ul><ul><li>Government revenues will use to spend on welfare activities, provision of public utility services, and so on. </li></ul></ul><ul><ul><li>Will make payments to households in the form wages, interest and transfer payment and buy goods and services from firms. </li></ul></ul><ul><li>Rest of the World: </li></ul><ul><ul><li>Households will buy goods and services from rest of the world. </li></ul></ul><ul><ul><li>People from foreign country will also buy exported goods from domestic firms. </li></ul></ul>
  36. 36. <ul><li>Households, firms, the government, & the rest of the world all interact in 3 different market arenas: </li></ul><ul><ul><li>Input Market </li></ul></ul><ul><ul><li>Output Market </li></ul></ul><ul><ul><li>Financial market </li></ul></ul><ul><li>(1) Input Market </li></ul><ul><ul><li>Households are sellers; sell factors of production. </li></ul></ul><ul><ul><li>Firms and government are buyers; buy the factors of production from household. </li></ul></ul>Market Arenas
  37. 37. <ul><li>(2) Output Market </li></ul><ul><ul><li>Firms are sellers; sell goods and services produces </li></ul></ul><ul><ul><li>Households & the government are buyers; buy goods and services from firms. </li></ul></ul><ul><li>(3) Financial Market </li></ul><ul><ul><li>Households buy stocks & bonds from firms. </li></ul></ul><ul><ul><li>Households s upply funds to this market in the expectation of earning income, & also demand (borrow) funds from this market. </li></ul></ul><ul><ul><li>Firms, government, & the rest of the world also engage in borrowing & lending, coordinated by financial institutions. </li></ul></ul>
  38. 38. <ul><li>AD is the total DD for goods & services in an economy. </li></ul><ul><li>AS is the total SS of goods and services in an economy. </li></ul><ul><li>AD & AS curves are more complex than simple market DD & market SS curves. </li></ul>8.5 AGGREGATE DEMAND & AGGREGATE SUPPLY
  39. 39. THANK YOU

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