basics of macroeconomics training course material for e-library on system of national accounts march...
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Basics of Macroeconomics
Training Course Material for e-Library onSystem of National Accounts
March 2009
Module-I: PP1
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Topics To Be Covered
• Introduction• Circular flow of income and expenditure• Measuring economy• Macroeconomic objectives• Macroeconomic policy
– Monetary policy– Fiscal policy
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Introduction• People have unlimited wants and needs• The wants and needs are satisfied by
consuming goods and services (commodities)
• Commodities are produced by using resources
• Income gets generated to owners of resources who get income (factor) shares in the process of production of goods and services
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Introduction (Contd.)
• The resources are factors of production
Resource Factor Income (Factor) share
Natural Land Rent
Human Labour Salaries/Wages
Financial Capital Interest
Managerial skill Enterprise Profit /Loss
Produced M&E Depreciation
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INPUTS:
RESOURCES /FACTORS OF PRODUCTION
PRODUCTION PROCESS
OUTPUT: GOODS AND SERVICES
INTERMEDIATE USE and FINAL USE
•DISTRIBUTION
•CONSUMPTION
Economic Activities
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Key Economic Issues • Scarce resources in relation to unlimited wants
and needs• How nations use their scarce resources -
results in future development• Scarcity is the gap between human desires
and available resources.
• Scarcity forces people to make economic choices.
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Opportunity Costs
The Opportunity Cost of using resources for a certain purpose is the benefit given up by not using them in an alternative way
It is what is given up in order to get something else
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Key Economic Problems
• WHAT goods and services to produce?
• HOW to produce those goods and services?
• Labour intensive? Capital intensive?
• WHO should get the goods and services produced?
• Rich? Poor who works hard?
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Two Complementary Ways of Viewing the Economy
• Microeconomics is the behavior in the economy of
– individual markets (eg. for wheat, coal)– individual decision makers (eg. firms, households)
• Macroeconomics is the study of aggregate economic behavior. National, global economies and choices– Total economy output– Unemployment– Productivity– Inflation
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Circular Flow of Income and Expenditure
• The concept of a circularity in economic relations is a critical one.
• It helps to understand how the separate parts of the economy are related to each other in a system of mutual interaction.
• Circular flow of Income and Expenditure is a simplified model for understanding of economic relations.
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The Circular Flow of Income & Expenditure
Producers
Consumers
Factor Markets
Goods Markets
Consumption Expenditure
Sales receipt
Wages, rent, and profit
Income
Goods & Services sold
Goods & Services bought
Labor, land, and capital
Inputs for production
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The Circular Flow of Income & Expenditure (Contd.)
• Two kinds of markets:Goods markets: Goods and services that are
produced by firms are sold in these markets. Factor markets: The services of factors of production
(land, labour, and capital) are sold in these markets
• The interactions involve flows going in two directions:
• Flows in goods and services, called real flows. • Flows of payments for these goods and services,
called money flows
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Govtern-ment
Households
Consumption
Income
Govt. Expenditure
FinancialMarket
Saving
Investment Rest of the World
Imports
Exports
Circular Flow of Income and Expenditure[Showing also Leakages: Saving, Taxes, Imports; and Injections: Investment, Govt. Expenditure, Exports]
Taxes
Firms
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The Circular Flow
1.Three Markets
a) Labor Market
b) Goods Market
c) Financial Market
2.Four Economic Agents
a) Households
b) Firms/Businesses
c) Government
d) Rest of the World
The Circular Flow of Income & Expenditure (Contd.)
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The Circular Flow of Income & Expenditure (Contd.)
• Firms produce goods and services, they create through factor payments the incomes for households
• Households buy consumption goods and services, so there is consumption coming out of Households’ box
• Government collects taxes in order to cover its expenditure
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The Circular Flow of Income & Expenditure (Contd.)
• Households devote part of their income (after tax) to savings, which flows into capital/financial market that in turn makes investment for businesses
• There are several leakages from and injections to the flow around the main circuit
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The Circular Flow of Income & Expenditure (Contd.)Leakages and Injections
• Leakages: [Out from the Households]
– Saving– Taxes– Imports
• Injections: [In to the Firms]
– Investment– Government Expenditure– Exports
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Final Demand of Goods / Services
Y = C + G + I + X- M Where,
C is Household Final Consumption Expenditure
G is Government Final Consumption Expenditure
I is Gross Domestic Investment
X is exports
M is Imports
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Consumption
Consumption is the value of goods and services bought by people
It is a large part of aggregate demand (??)
The economic performance of the country can be judged by the level and dynamics of consumption
Three categories of consumption:
•Spending for consumer durables
•Spending for consumer non-durables
•Spending for consumer services
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Saving• People save, avoiding to consume all their income,
is called “ Personal Saving”• People deposit Saving in bank accounts or in bonds,
shares and other financial instruments (Financial Saving). It can also be invested in acquiring Houses (Physical Assets)
• Consumption is the key determinant (complementary) for the amount of Personal Saving.
• Domestic Saving = Personal Saving + Business Saving + Public/ Government Saving
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• Investment is the net value of machinery, equipment, plants, and buildings/sheds that are acquired by business firms for production purposes.
• All spending by business firms for acquiring new machinery and equipment and business plants/ structures.
• All changes in business inventories of raw materials, semi-finished goods, and finished goods.
• All spending by households for acquiring newly constructed residential housing
Investment
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Government Consumption Expenditure on Goods and Services (G)
(a) Central government
(i) Defense
(ii) Non-defense
(b) State government
(c) Local Bodies
Net Exports (X-M)(a) Exports
(b) Imports
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Measuring the Flow of Income and Expenditure
• There are three possible ways of measuring the flow of income
• Each of the ways looks at a different part of circular flow
• All three should give the same results
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Measuring the Flow of Income and Expenditure (Contd.)
Three approaches of measuring circular flow:
Production Approach: total amount of goods and services produced in one year.
Expenditure Approach : total amount of households final consumption expenditure, government final consumption expenditure, gross investments and net exports in one year.
Income Approach : total incomes earned by the factors of production involved in the production of goods and services in one year.
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Objectives of Government’s
Macroeconomic Policy • Full employment • Keep low inflation• Economic growth • Equitable distribution of income• Low government budget, deficit and
international debt
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Policy Instruments
Fiscal Policies Monetary Policy
Government income
Interest rates
Money in circulation
Government expenditure
How to Achieve These Objectives?
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Fiscal PolicyFiscal Policy
• Fiscal policy: Government spending and Taxation (government income) decisions.
• Government can affect aggregate demand by:– Purchasing more or fewer goods and services.– Increasing or reducing taxes.– Changing the level of income transfer.
• Fiscal policy:– Expansionary– Contractionary
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Fiscal Policy (Contd.)
• Expansionary fiscal policy: • Increase in government spending• Reduction in Taxes
• Contractionary fiscal policy: • Reduction in government spending • Increase in Taxes
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Fiscal Policy (Contd.)
• Tax regime, as a Fiscal measure, influences− Consumption− Investment− Government Spending
• Fiscal Policy also does influence • Education, Health, Poverty Reduction, • Welfare Reforms, Investment, • Regional Imbalances, Promotion of Enterprise,
etc.
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Reduction of Taxes
• The government increases the disposable income of the households by reducing taxes.
• Disposable income is the after-tax income of consumers or personal income less personal taxes.
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Tax Cuts and Investment
• A tax cut may also be an effective mechanism for increasing investment spending.
• Tax cuts have been used to stimulate the economy.
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Transfer Payments
• Increasing transfer payments such as– social security– welfare benefits– unemployment benefits– and veterans’ benefits
Often stimulate the economy
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Monetary PolicyMonetary Policy
• Influences the level of economic activity through – changes of the amount of money in circulation
(Money Supply) – short-term interest rates
• Central bank controls country’s monetary conditions through– Money in circulation– Interest rates
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How do Interest Rates affect Consumption, Saving & Investment
Interest Rates Borrowing
Individuals Firms
Consumption Investment
SavingInterest Rates
Consumption
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How do Interest Rates affect Export and Import Prices
Interest Rates Exchange Rates
Appreciation
Import price down
Depreciation
Import price up
Export price up
Export price down
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THANKSTHANKS