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MacroEconomics Diagrams and Definitions
What is macroeconomics? Macroeconomics is the study of a national economy.
Macroeconomic Goals
Two Sector Circular Flow of Income Monetary Flow Households RealFlow Good and Services =  Output (O) Expenditure  on Goods and Services (E) Wages, Rent and Profits (Y) Factors of Production Firms E = O = Y 4
Four Sector Circular Flow of Income Leakages (L) Injections (J) Saving  (S) Households Investments (I) Income Exports (X) Imports  (M) Government Spending (G) Expenditure Taxes (T) Firms O = E = Y 5 Sum J = Sum L
Measuring National Income Income Method Output Method Households Good and Services Wages, Rent and Profits Expenditure  on Goods and Services Factors of Production Firms Expenditure Method 6
How is national income measured?
How is national output measured?
How is national expenditure measured?
What is GDP?
GDP GDP = Gross Domestic Product = Total Value of all Spending in an Economy = The Total Value of all final Goods and Services in an Economy regardless of who owns the productive assets. GDP = C + I + G + (X – M)
GNP GNP = Gross National Product = Total Income Earned by a nation’s factors of production regardless of where the assets are located
Real GDP Real GDP = Nominal GDP adjusted for inflation
Calculating Real GDP Real GDP = Nominal GDP of year measured
The Uses of National Statistics
Limitations of the Data
What is economic development? Economic Development is a multidimensional concept that includes poverty reduction, provision of education, health care and law and order, civil liberties and civic participation.
Why GDP fails to accurately measure welfare
Why GDP may understate improvements in welfare
Why GDP may overstate welfare
How can development be measured? GDP per capita Human Development Index 	Aims to stress the human dimension of economic growth
How can development be measured?
How is the HDI determined?
How can development be measured?
Developing and Developed
How can development be measured? Important Indicators of development Infant mortality rate Maternal mortality ratio Enrolment in each level of education Literacy  Internet users per 1000
Macroeconomic Models
What is aggregate demand (AD)? Aggregate Demand is the aggregate (total) spending on goods and service in a period of time at a given price level.
What are the components of AD? C =	all household consumption on durables, non-durables and services I =  firm’s replacement investment(spending on capital to maintain productivity) or induced investment to increase production G = all government spending  X-M = spending by foreigners on exports less domestic spending on imports
What causes shifts in AD?
What causes Changes in Consumption? AD AD AD AD 32
What causes Changes in Consumption?   AD AD AD AD 33
What causes Changes in Consumption?  AD AD AD AD 34
What causes Changes in Investment? AD AD 35
Demand for investment funds?
What causes Changes in Investment?  AD AD AD AD 37
What causes Changes in Investment?   AD AD AD AD 38
What causes Changes in Investment? AD AD 39
What causes Changes in Government Spending?  AD AD AD AD 40
What causes Changes in Export and iMport spending? AD AD 41
What causes Changes in Export and iMport spending? AD AD AD AD 42
What is aggregate supply (AS)? Aggregate(total) Supply isamount of goods and services that all industries will produce at a given price level.
What is aggregate supply in the short run (SRAS)?
What are the components of AS?
What causes shifts in SRAS?
What causes shifts in SRAS?  AS AS AS AS 47
What causes shifts in SRAS?  AS AS AS AS 48
What causes supply shocks?  AS AS 49
Macroeconomic Equilibrium
Shifts in AD
Shifts in SRAS
The Business Cycle Fluctuations in the growth of real output, consisting of periods of expansion and contraction called business cycles or trade cycles.
Business Cycle
Business Cycle: Expansion
Business Cycle: Peak
Business Cycle: Contraction
Business Cycle: Trough
Relationship between real GDP and Employment 59
Using Diagrams to Illustrate Macroeconomic Goals
Using Diagrams to Illustrate Macroeconomic Goals
Changes in SR Equilibrium
Changes in AD
Changes in SRAS
Economic  Scenarios
Deflationary (recessionary) gap
Recession  A recession is when the economy experiences two consecutive quarters of falling GDP.
Inflationary gap
Full employment level of output
Causes of  Business Cycle
Changes in AD
Changes in AS
What is the neoclassical perspective?
The Neoclassical LRAS
Neoclassical (Free Market)  LRAS  LRAS perfectly inelastic at Full Employment Level of Output (Ymax) Potential Output = Quantity and Quality of FOPs not Price
Why is the LRAS vertical?
Implications of the neoclassical LRAS?
Long-run equilibrium
Long-run equilibrium and Decline in AD
Return to Long-run equilibrium
Long-run equilibrium
Long-run equilibrium and Increase in AD
Return to Long-run equilibrium
What is the Keynesian perspective?
The Keynesian SR/LRAS?
 Keynesian SR/LRAS
 Keynesian SR/LRAS Keynes argued that as there is nothing inherent in the economy to move the SR into the LR, then SRAS = LRAS NB  In diagrams taking a Keynesian you may see the AS curve labeled Keynesian AS or simply LRAS as long as the diagram’s title makes clear which perspective is being adopted
Inflationary Gap in the Keynesian Perspective
Full Employment Equilibrium in the Keynesian Perspective
Economic Growth: Improved Quantity & Quality of FOPs
Economic Growth: Neoclassical Perspective
Economic Growth: Keynesian Perspective
Policy Alternatives to Manage the Economy
Expansionary Policies (in recession)
Contractionary  Policies (in inflation)
Strengths of Fiscal Policy
Weaknesses of Fiscal Policy
Strengths of Monetary Policy
Weaknesses of Monetary Policy
The Neoclassical/Monetarist Challenge Argument that discretionary fiscal polices that try to stabilize the economy are so flawed that they actually cause instability Alternative policies Ensure steady supply of money Ensure price and wage flexibility Focus on supply-side policies to achieve economic growth
Supply-side Policies
Market-orientated Policies
Market-orientated Supply-side Policies: Objectives
Reduce Government Sector: Pros and Cons
Make labor more responsive to supply and demand : Pros and Cons
Government policies to improve industry: Pros and Cons
Shifting the SRAS and the LRAS in the AS-AD Model
The Multiplier Effect
Marginal Propensity
Example of the Multiplier in Effect Assumption 60% of additional income spent on Consumption (MPC = 0.6) The Multiplier = 1/1-MPC
The Multiplier Effect
The Accelerator Theory & the Combined multiplier/accelerator effect Argues that small changes in GDP produces larger changes in investment spending.  These fluctuations interact with the Multiplier effect to increase the momentum of business cycle.
Crowding-out Effect
Crowding-out Effect
Crowding-out Effect
Unemployment and Inflation
Unemployment
Economy at Potential
Types of Unemployment
Keynesian Remedy for Unemployment During a Recession
Neoclassical Remedy for Unemployment During a Recession
Real Wage Unemployment
Eliminating Cyclical (Demand-deficient) Unemployment
Inflation and Deflation
Inflation & Deflation
Demand-pull Inflation
Cost-push Inflation
Stakeholders and Inflation
“Good” Deflation
Measuring Inflation The consumer price index (CPI)  compares the value of a basket of goods and services in one year with a same basket in the base year.
Problems Measuring Inflation
The Phillips Curve
NRU = NAIRU If governments avoid demand-side expansionary policies Non-accelerating inflation rate of unemployment is achieved (NAIRU)
Long-run Phillips Curve
Phillips Curve
Phillips Curve
Neo-classical challenge to the Phillips Curve
LR Phillips Curve If expansionary policies adopted, inflation would  increase to 4% or more.  Real wages have fallen and firms hire additional labor.
LR Phillips Curve Unemployment is now below NRU at 4%. (b) Workers have fallen for the “money illusion” and slow to realize that real wages have fallen because inflation is actually over 4%.
LR Phillips Curve Unemployment is now below NRU at 4%. (b) Workers have fallen for the “money illusion” and slow to realize that real wages have fallen because inflation is actually over 4%.
LR Phillips Curve Once workers realize real wages have fallen they will demand at least a 4% pay rise.  Real wages will return to previous levels and firm will fire workers. Unemployment has returned to (c)
LR Phillips Curve Any attempt to to increase AD will only result in temporary changes to unemployment but increasingly high rates of inflation
LR Phillips Curve Friedman argued that no trade off exists if governments do not use demand side policies.

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