Macroeconomics Assignment Sample

Assignment
Exploring Macroeconomics
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EXPLORING MACROECONOMICS

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Table of Contents
Table of Figures .........................................................................................................................4
Introduction.................................................................................................................................1
Question: 1, the UK Recession...................................................................................................1
Solution.......................................................................................................................................1
Question: 2, Expansion of the US macro Economy ...................................................................5
Solution.......................................................................................................................................9
References...................................................................................................................................13

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Table of Figures
Figure 1 Relationship between Aggregate consumption expenditure and aggregate disposable
income........................................................................................................................................2
Figure 3 EYQ Graph..................................................................................................................4
Figure 4 Shifted EYQ Curve......................................................................................................5
Figure 5 Keynesian Cross Model...............................................................................................7
Figure 6 Equilibrium Curve.......................................................................................................7
Figure 7 Keynesian cross model at equilibrium (Intermediate Macroeconomics, 2012)..........7
Figure 8 Quantitative Easing Curve...........................................................................................8
Figure 10 Quantitative Easing Curve.........................................................................................9
Figure 11 Long run Phillips Curve ............................................................................................9
income....................................................................................................................10

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INTRODUCTION
With the collapse of US mortgage market due to sub-prime lending, the global financial system
is completely shattered. The UK financial markets were also not able to resist to this economy
fall-down. The combination of credit crunch and falling housing market resulted in a recession in the
UK market (Richardson, 2011). Recession can be defined as fall in real GDP of a country. Alternatively, it
can be defined as, for the two consecutive quarters, if economic growth shows negative trend; i.e. if there
is a fall in the real output of the country for consecutively six months (King and Cushman,
1997).
Question: 1, The UK Recession
Apply an appropriate theoretical framework to analyse how falling house prices and tighter consumer
credit conditions in the UK may cause the UK macro-economy to go into recession.
Solution:
The main reasons for the recession (2008-09) in UK are:
• Falling house prices – credit crunch and shortage of mortgage
• Credit crunch – shortage of finance
• People lost confidence in the financial sector which resulted in loss of confidence in the real economy
• Cost push inflation resulted in lowering the disposable income
The main factors that resulted in the recession of the UK economy were falling house prices and tighter
consumer credit. In order to analyse that how tighter consumer credit and falling prices of house impact
the economy of UK, we will apply Keynesian cross model (Economics Help, n.d).
Keynesian Cross Model is an important tool for understanding the macro-economic and the factors that
can impact the macro economics condition in negative ways. The most important outcome of Keynesian
Model was that, it tells that volume of national expenditure helps in determining the level of national
income and national product. Basically Keynesian Cross Model emphasised on the concept of national
expenditure and its components. Further, it tells that due to change in national expenditure, the aggregate
income and the output of the country changes (Benassy, 2011).
According to Keynesian cross model, two main components of National Expenditure are:
• Aggregate private investment spending by firms, and
• Aggregate private consumption expenditure by households
As in every economy, business sector generates revenue by sale of its goods and services, and
the sales of the goods and services happen when the consumers of the household sector purchase
them.

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income
The above diagram shows the relation between aggregate consumption expenditure on the Y axis and
aggregate disposable income on the X axis. This relation is referred to consumption function (CF).
Using the concept of consumption function we will try to understand the impact of falling prices
of house and tighter consumer credit on the UK economy.
According to the diagram,
C = a + c Yd
Where, C = aggregate private consumption expenditure
Yd = aggregate disposable income, and
c = community’s marginal propensity to consumer
So, if there will be no tax imposed by the government, the aggregate disposable income will
become equal to the national income. i.e., C = a + cY

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is rise in rate of interest, the consumption income will definitely fall. In the above diagram, the
consumption function shifts to CF2 from CF0 due to the above changes, while the marginal
propensity to consumer (c) remains stable.
Similarly, banks are coming with many schemes such as Equity Release Scheme and Cash Reversion Plan
that helps in financing the consumption. According to such schemes, the owner of the house can access
the finance to meet the consumption spending by keeping the asset as collateral. This has benefited the
owner in two ways; firstly, he will remain the owner of the house and secondly, he can access the
financial services of the financial institutes by keeping the asset as collateral. But in the present case of
falling in house price and tighter consumer credit, the consumers will find it difficult to keep the asset as
security, and will not get easy access to the finance so as to meet their expenses. So it will be difficult for
the owner to get the finance, to meet the consumption spending. So by this the consumption spending
will decline and will result in fall in national expenditure (Samuelson, 2010).
With the rise in interest rates, households with excess of money will enjoy higher income as
compared to the borrowers. But in the present economic scenario, borrowers are in excess as compared to
the net savers, so the combined impact of the rise in interest rate will negatively affect the consumption
spending and will result in lowering the consumption expenditure.
Figure 2 EYQ Graph

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The above diagram shows the level of national income (Y), national expenditure (E) and national product (Q),
which are always equal. When the prices of house remain same, the aggregate demand will intersect at 45
degree. This situation is called macro-economic equilibrium position (Macroeconomics Tutorials, n.d).
Figure 3 Shifted EYQ Curve
With the decline in the prises of house and tighter consumer credit will result in reduction of many
for expenditure. The above diagram shows the change by shifting the curve from AD0 to AD1. Hence
the equilibrium position shifts to F1 from F0. Hence the fall in prices of house will reduce the aggregate
demand and thus will result in fall in national product and national income (Macroeconomics Tutorials,
n.d).So by applying the Keynesian Cross Model, we have tried to explain that, the fall in house prices and
tighter consumer credit has resulted in the recession of the UK macro economy.
Question: 2, Expansion of the US macro Economy
Apply the Keynesian Cross model to analyse how rising consumer credit can stimulate an expansion
of the US macro economy. Carefully specify the starting position of your analysis in order to evaluate the
possible outcomes.

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Figure 4 Keynesian Cross Model
The other graph which shows the equilibrium condition is shown below:
Figure 6 Keynesian cross model at equilibrium (Intermediate Macroeconomics, 2012).

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References
 Barnes, R., n.d. Economic Indicators: Consumer Credit Report . [Online] Available through:<
http://www.investopedia.com/university/releases/consumercreditreport.asp#axzz2FfJHK1jk>
[Accessed on 20th
December 2012].
 Benassy, J. P., 2011. Macroeconomics Theory. New York: Oxford University Press.
 Bridges, J. and Thomas, R., 2012. The impact of QE on the UK economy — some supportive
monetarist arithmetic. [pdf] Available
through:<http://www.bankofengland.co.uk/publications/Documents/workingpapers/wp442.pdf
 [Accessed on 20th
December 2012].
 Economics Help. n.d. Causes of Recessions. [Online] Available
through:http://www.economicshelp.org/macroeconomics/economic-growth/cause-recession2.html
>[Accessed on 20th
December 2012].

Macroeconomics Assignment Sample

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