INTRODUCTION TO ECONOMICS<br /><ul><li>Economics is a study of social science.
Developed out of the broader field of political economy owing to a desire to use an empirical approach.
Aim to explain “how” economics work and economic agent “interact”.
Analysis is applied throughout society, business finance and government, etc.</li></li></ul><li>Contd….<br /><ul><li>Expanding domain in the social science has been described as “economics imperialism”.
Common distinctions are drawn between various dimensions of economics.
The textbook distinction are drawn between micro and macro concepts.
Defines as “the science which studies human behaviour as a relationship between end users and means which have alternative uses”.</li></li></ul><li>ECONOMICS<br />MICROECONOMICS<br />MACROECONOMICS<br />
MICROECONOMICS<br /><ul><li>Microeconomic examines the economic behaviour of agents.
Microeconomics focus on “What” and “For whom”.
Explores how various system of incentives and way of making decisions work.
Examines whether the production meet the highest value and if not what change would increase that value.</li></li></ul><li>MACROECONOMICS<br /><ul><li>Macroeconomics considers the performance of a country as a whole.
Deals with situation/condition with a long run effect.
We try to understand changes in-</li></ul> rate of economics growth.<br /> rate of inflation.<br /> unemployment.<br /> our trade performance with other countries.<br /><ul><li>Help to evaluate the relative success or failure of government economic policies.</li></li></ul><li>Macroeconomics<br />Macroeconomics is the study of aggregates or averages covering the entire economy, such as Total Employment, National Income, National Output, Total Investment, Total Consumption, Total Savings, Aggregate Demand, Aggregate Supply and General price level, Wage level, and Cost structure.<br />
DIFFERENCE BETWEEN MICROECONOMICS AND MACROECONOMICS<br />
AGGREGATE-DEMAND<br />In economics aggregate demand is the total demand for final goods and services in the economy at a given time and price level.<br />Aggregate demand is the gross domestic product of a country when inventory levels are static.<br />
Aggregate Demand<br />The sum of all expenditure in the economy over a period of time<br />Macro concept – WHOLE economy<br />Formula:<br />AD = C+I+G+(X-M)<br />C= Consumption Spending<br />I = Investment Spending<br />G = Government Spending<br />(X-M) = difference between spending on imports and receipts from exports (Balance of Payments)<br />
Consumption Expenditure<br />Exogenous factors affecting consumption:<br />Tax rates<br />Incomes – short term and expected income over lifetime<br />Wage increases<br />Credit<br />Interest rates<br />Wealth<br />Property<br />Shares<br />Savings<br />Bonds<br />
Investment Expenditure<br />Spending on:<br />Machinery<br />Equipment<br />Buildings<br />Infrastructure<br />Influenced by:<br />Expected rates of return<br />Interest rates<br />Expectations of future sales<br />Expectations of future inflation rates<br />
Government Spending<br />Defence<br />Health<br />Social Welfare<br />Education<br />Foreign Aid<br />Regions<br />Industry<br />Law and Order<br />
Import Spending (negative)<br />Goods and services bought from abroad – represents an outflow of funds from the country (reduces AD)<br />
Export Earnings (Positive)<br />Goods and services sold abroad – represents a flow of funds into the country (raises AD)<br />
Aggregate Demand Curve<br />The aggregate demand (AD) curve is a curve that shows the negative relationship between aggregate output (income) and the price level<br />
Deriving the Aggregate Demand Curve<br />To derive the aggregate demand curve, we examine what happens to aggregate output (income) (Y) when the price level (P) changes, assuming no changes in government spending (G), net taxes (T), or the monetary policy variable (Ms).<br />
Deriving the Aggregate Demand Curve<br />The AD curve is not a market demand curve, and it is not the sum of all market demand curves in the economy. It is a more complex concept.<br />
Aggregate Demand Curve <br />Aggregate demand falls when the price level increases because the higher price level causes the demand for money to rise, which causes the interest rate to rise.<br />It is the higher interest rate that causes aggregate output to fall.<br />At all points along the AD curve, both the goods market and the money market are in equilibrium.<br />
Reasons why AD is downward sloping<br />The consumption link: The decrease in consumption brought about by an increase in the interest rate contributes to the overall decrease in output.<br />The real wealth effect, or real balance, effect: When the price level rises, there is a decrease in consumption brought about by a change in real wealth.<br />
Shifts in AD<br />Changes in Governmental Policies<br />Changes in Monetary Policy<br />Changes in Expectations of Households and Firms<br />
AGGREGATE SUPPLY<br /><ul><li>Aggregate supply is the total supply of goods and services in an economy.</li></li></ul><li>AGGREGATE SUPPLY CURVE<br /><ul><li>Curve shows relation between aggregate quantity of output supplied by all the firms in an economy and overall price level.
It is not a market supply curve ,and it is not simple sum of all individual supply curves.
Rather than an aggregate supply curve, what does exist is a “price/output response” curve</li></li></ul><li>AGGREGATE SUPPLY IN THE SHORT RUN<br /><ul><li>In the short run, the aggregate supply curve (the price/output response curve) has a positive slope</li></li></ul><li>AGGREGATE SUPPLY IN THE SHORT RUN<br /><ul><li>Macroeconomists focus on whether or not the economy as a whole is operating at full capacity.
As the economy approaches maximum capacity, firms respond to further increases in demand only by raising prices.</li></li></ul><li>AGGREGATE SUPPLY IN THE SHORT RUN<br /><ul><li>At low levels of aggregate output the curve is fairly flat.
As economy approaches capacity, the curve becomes nearly vertical.
At capacity, the curve is vertical.</li></li></ul><li>The Response of Input Prices to Changes in the Overall Price Level<br /><ul><li>There must be a lag between changes in input prices and changes in output prices, otherwise the aggregate supply (price/output response) curve would be vertical.
Wage rates may increase at exactly the same rate as the overall price level if the price-level increase is fully anticipated. Most input prices, however, tend to lag increases in output prices.</li></li></ul><li>WHY IS THE SHORT RUN CURVE UPWARD SLOPING?<br />Short-run aggregate supply curve slopes upward because:<br /><ul><li> Contracts make some wages and prices “sticky.”
Menu costs make some prices sticky</li></li></ul><li>Shifts of the Short-RunAggregate Supply Curve<br />
Factors That Shift the Aggregate Supply Curve<br />Shifts to the LeftDecreases in Aggregate Supply<br />Shifts to the RightIncreases in Aggregate Supply<br />Higher costshigher input prices higher wage rates<br />Lower costs lower input prices lower wage rates<br />Stagnationcapital deterioration<br />Economic growth more capital more labor technological change<br />Public policywaste and inefficiency over-regulation<br />Public policysupply-side policies<br />tax cuts<br />deregulation<br />Bad weather, natural disasters, destruction from wars<br />Good weather<br />Shifts of the Short-RunAggregate Supply Curve<br />
The Equilibrium Price Level<br /><ul><li>AD represents money and goods market in equilibrium.
AS represents price/output decisions of all firms in ecomony.
P0 and Y0 correspond to equilibrium in the goods market and the money market and a set of price/output decisions on the part of all the firms in the economy.</li></li></ul><li>The Long-RunAggregate Supply Curve<br /><ul><li>Costs lag behind price-level changes in the short run, resulting in an upward-sloping AS curve.
Costs and the price level move in tandem in the long run, and the AS curve is vertical.</li></li></ul><li>The Long-RunAggregate Supply Curve<br /><ul><li>Output can be pushed above potential GDP by higher aggregate demand. The aggregate price level also rises.</li></li></ul><li>The Long-RunAggregate Supply Curve<br /><ul><li>When output is pushed above potential, there is upward pressure on costs, and this causes the short-run AS curve to the left.
Costs ultimately increase by the same percentage as the price level, and the quantity supplied ends up back at Y0.</li></li></ul><li>The Long-RunAggregate Supply Curve<br /><ul><li>Y0 represents the level of output that can be sustained in the long run without inflation. It is also called potential output or potential GDP.</li></li></ul><li>Macroeconomic Model Building<br />Model Building Overview<br />Much of the work of economists is model building.<br />Models help to explain the relationship between economic variables and help to answer why economic problems or conditions occur.<br />Model building consists of:<br />Identifying variables<br />Establishing assumptions<br />Collecting and analyzing data<br />Interpreting conclusions<br />
Classical Economics<br />Popularly accepted theory prior to the Great Depression of the 1930s.<br />Says the economy will automatically adjust to full employment.<br />Classical economics is mainly based upon:<br />Barter economy<br />Supply creates its own demand in a macro economy.<br />Wages and prices are flexible and increase or decrease to ensure that the economy operates at full employment.<br />Savings always equals investment, because changes in the interest rate bring savings and investment into equality.<br />
Keynesian Economics<br />Based on the work of John Maynard Keynes, who focused on the role of aggregate spending in determining the level of macroeconomic activity.<br />Introduced the idea that a macro economy seeks an equilibrium output level.<br /> Keynesian theories -<br /> The labour market <br /> The market for loanable funds (money market) <br /> The Multiplier <br /> Keynesian inflation theory <br />
THE LABOUR MARKET –<br /><ul><li>Keynes didn't have the same confidence in the labour market as Classical economists
Wages would be 'sticky downwards‘ ( mean that wages would not necessarily fall enough to clear the market and unemployment would linger) </li></ul>MARKET FOR LOANABLE FUNDS (MONEY MARKET) <br /><ul><li>Any increase in savings would mean that people spent less. This would mean a decrease in aggregate demand
Firms would be even less inclined to invest because they would find the demand for their products decreasing.</li></ul>MULTIPLIER EFFECT-<br />
KEYNESIAN VIEW ON INFLATION<br />DEMAND-PULL INFLATION -.As aggregate demand grows so does the level of output <br /><ul><li> Full employment- leads to inflation</li></ul>COST-PUSH INFLATION<br /><ul><li>Increased pressure on the labour market (as nearly everyone has a job)
This in turn will cause costs to increase.</li></li></ul><li>KEYNESIAN POLICIES-<br />Reflationary policies<br /> Reflationary policies which boost the level of economic activity might include: <br /> Increasing the level of government expenditure<br /> Cutting taxation (either direct or indirect) to encourage spending<br /> Cutting interest rates to encourage saving <br />Allowing some money supply growth<br />
KEYNESIAN POLICIES<br /> Deflationary policies<br />Deflationary policies which dampen down the level of economic activity might include: <br /><ul><li>Reducing the level of government expenditure
Increasing taxation (either direct or indirect) to discourage spending
Increasing interest rates to discourage saving