Download - Section 3 student version
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Macroeconomics
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2
What is macroeconomics?
What are macroeconomic goals?
How is national income measured?
How can economic growth be achieved?
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What is macroeconomics?
Macroeconomics is the study of a national economy.
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Macroeconom
ic Goals
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National Income
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Two Sector Circular Flow of Income
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Wages, Rent and Profits(Y)
Factors of Production
Expenditure on Goods and Services(E)
Good and Services = Output (O)
Households
FirmsE = O = Y
Monetary Flow
Real Flow
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Four Sector Circular Flow of Income
7
Expenditure
Income
Households
Firms
Leakages (L)
Saving (S)
Taxes(T)
Imports (M)
Injections (J)
Exports(X)
Investments(I)
GovernmentSpending (G)
O = E = Y Sum J = Sum L
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Measuring National Income
8
Wages, Rent and Profits
Factors of Production
Expenditure on Goods and Services
Good and Services
Households
Firms
Output Method Income Method
Expenditure Method
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9 How is national income measured?
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10 How is national output measured?
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11How is national expenditure measured?
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12 What is GDP?
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13 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)
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14 GNP
GNP = Gross National Product = Total Income Earned by a nation’s factors of production regardless of where the assets are located
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15 Real GDP
Real GDP = Nominal GDP adjusted for inflation
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16 Calculating Real GDP
Real GDP = Nominal GDP of year measuredGDP Deflator
X 100
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17 The Uses of National Statistics
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18 Limitations of the Data
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Introduction to Development
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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.
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Why GDP fails to accurately measure welfare21
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Why GDP may understate improvements in welfare22
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Why GDP may overstate welfare23
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How can development be measured?
GDP per capita
Human Development Index
Aims to stress the human dimension of economic growth
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How can development be measured?25
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How is the HDI determined?26
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27How can development be measured?
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Developing and Developed 28
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How can development be measured?
Important Indicators of development
① Infant mortality rate
② Maternal mortality ratio
③ Enrolment in each level of education
④ Literacy
⑤ Internet users per 1000
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Macroeconomic Models
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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.
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Click icon to add picture
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33 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
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What causes shifts in AD?34
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What causes Changes in
Consumption?
35
AD AD
ADAD
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What causes Changes in Consumption?
36
AD
AD AD
AD
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What causes Changes in Consumption?
37
AD
AD AD
AD
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What causes Changes in Investment?
38
AD
AD
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Demand for investment funds?39
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What causes Changes in Investment?
40
AD
AD AD
AD
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What causes Changes in Investment?
41
AD
ADAD
AD
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What causes Changes in Investment?
42
AD
AD
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What causes Changes in Government Spending?
43
AD
ADAD
AD
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What causes Changes in Export and
iMport spending?
44
AD
AD
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What causes Changes in Export and
iMport spending?
45
AD
ADAD
AD
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What is aggregate supply (AS)?
Aggregate (total) Supply is amount of goods and services that all industries will produce at a given price level.
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What is aggregate supply in the short run (SRAS)?47
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What are the components of AS?48
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What causes shifts in SRAS?49
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What causes shifts in SRAS?
50
AS
AS AS
AS
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What causes shifts in SRAS?
51
ASAS
ASAS
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What causes supply shocks?
52
AS
AS
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Macroeconomic Equilibrium53
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Shifts in AD54
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Shifts in SRAS55
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The Business Cycle
Fluctuations in the growth of real output, consisting of periods of expansion and contraction called business cycles or trade cycles.
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Business Cycle57
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Business Cycle: Expansion
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Business Cycle: Peak
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Business Cycle: Contraction
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Business Cycle: Trough
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Relationship between real GDP and Employment
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Using Diagrams to Illustrate Macroeconomic Goals
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Using Diagrams to Illustrate Macroeconomic Goals
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Changes in SR Equilibrium 65
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Changes in AD 66
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Changes in SRAS 67
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Economic Scenarios 68
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Deflationary (recessionary) gap 69
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Recession
A recession is when the economy experiences two consecutive quarters of falling GDP.
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Inflationary gap 71
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Full employment level of output 72
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Causes of Business Cycle 73
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Changes in AD 74
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Changes in AS 75
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76
Wh
at is th
e n
eo
classica
l p
ersp
ective
?
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77 The Neoclassical LRAS
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78Neoclassical (Free Market) LRAS
LRAS perfectly inelastic at Full Employment Level of Output (Ymax)Potential Output = Quantity and Quality of FOPs not Price
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79 Why is the LRAS vertical?
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80Implications of the neoclassical LRAS?
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81Long-run equilibrium
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82Long-run equilibrium and Decline in AD
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83Return to Long-run equilibrium
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84Long-run equilibrium
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85Long-run equilibrium and Increase in AD
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86Return to Long-run equilibrium
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87
What is the Keynesian perspective?
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88 The Keynesian SR/LRAS?
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89 Keynesian SR/LRAS
Segment 1: Spare capacity in the economy, LRAS perfectly elastic
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90 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
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91
Inflationary Gap in the Keynesian Perspective
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Full Employment Equilibrium in the Keynesian Perspective
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Economic Growth: Improved Quantity & Quality of FOPs
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Economic Growth: Neoclassical Perspective
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Economic Growth: Keynesian Perspective
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Demand-side and Supply-side policies
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Policy Alternatives to Manage the Economy97
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Expansionary Policies (in recession)
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99Contractionary Policies (in inflation)
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100Strengths of Fiscal Policy
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101Weaknesses of Fiscal Policy
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102Strengths of Monetary Policy
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103Weaknesses of Monetary Policy
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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
1. Ensure steady supply of money
2. Ensure price and wage flexibility
3. Focus on supply-side policies to achieve economic growth
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Supply-side Policies
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Market-orientated Policies
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Market-orientated Supply-side Policies: Objectives107
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Reduce Government Sector: Pros and Cons109
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Improving incentives : Pros and Cons111
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Make labor more responsive to supply and demand : Pros and Cons
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Government policies to improve industry: Pros and Cons
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Shifting the SRAS and the LRAS in the AS-AD Model116
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The multiplier, accelerator and crowding-out effect
HL Topics
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The Multiplier Effect118
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Marginal Propensity
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Example of the Multiplier in Effect
Initial Spending by government $100m
2nd Round of Spending $60m
3rd Round of Spending $36m
4th Round of Spending $21.6m
5th Round of Spending $12.96m
And So On
Last Round $0.01m
Total Spending, including initial spending by government
$249.99m
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Assumption 60% of additional income spent on Consumption (MPC = 0.6)
The Multiplier = 1/1-MPC
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The Multiplier Effect
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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.
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Crowding-out Effect123
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Crowding-out Effect
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Crowding-out Effect
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Unemployment and Inflation
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Unem
ployment
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Economy at Potential
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Types of Unemployment
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Keynesian Remedy for Unemployment During a Recession
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Neoclassical Remedy for Unemployment During a Recession
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Real Wage Unemployment
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Eliminating Cyclical (Demand-deficient) Unemployment
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Inflation and Deflation136
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Inflation & D
eflation
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Demand-pull Inflation
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Cost-push Inflation
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Stakeholders and Inflation
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“Good” Deflation
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Macroeconomics
Section 3.5
HL Topics
Measuring Inflation
The Phillips Curve
NRU & NAIRU
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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.
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Problems Measuring Inflation146
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The Phillips Curve147
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NRU = NAIRU
If governments avoid demand-side expansionary policies Non-accelerating inflation rate of unemployment is achieved (NAIRU)
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Long-run Phillips Curve149
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Phillips Curve
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Phillips Curve
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No-classical challenge to the Phillips Curve
a = Labor Market at equilibrium
6% = NRU
Wages set to rise by at least 2% as workers expect this rate of inflation
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LR Phillips Curve
If expansionary policies adopted, inflation would increase to 4% or more. Real wages have fallen and firms hire additional labor.
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LR Phillips CurveUnemployment 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%.
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LR Phillips CurveOnce 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)
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LR Phillips CurveAny attempt to to increase AD will only result in temporary changes to unemployment but increasingly high rates of inflation
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LR Phillips CurveFriedman argued that no trade off exists if governments do not use demand side policies.
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Income Distribution
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Income Distribution and Equity
Horizontal Equity = people should be treated the same e.g. people who have the same income should pay the same tax
Vertical Equity = treating people differently to achieve greater fairness e.g. people on low incomes pay less tax than people on high incomes
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Progressive, Proportional and Regressive Taxation
Progressive: as income increases, the fraction paid in tax increasesProportional: as income increases the fraction paid in taxes remains constantRegressive: as income increases, the fraction paid in taxes decreases
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Progressive, Proportional and Regressive Taxation
Income $ Proportional Tax Rate
Tax Paid
Progressive Tax Rate
Tax paid Regressive Tax
Tax Paid
10,000 15% 1500 15% 1500 15% 1500
50,000 15% 6500 20% 10000 10% 5000
100,000 15% 15000 40% 40000 5% 5000
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Lorenz Curve
Perfect income equality
Inequality of income
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Calculating G
ini Coefficient
Gini Coefficient = A/A+B
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A
B
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Gini Coefficient
Gini Coefficient = areas between diagonal and Lorenz Curve/entire area under diagonal
Values closer to 0 = greater income equality
Values closer to 1 = greater income inequality
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Laffer Curve (HL Extension)168
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Laffer Curve
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170 Activity
Select one of the OECD economies to study in detail over Section 3
Undertake research to find the following:
1.Real GDP for the last decade
2.Real GDP per Capita for the last decade
3.Real GDP growth for the last decade
What conclusions can you draw?
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171 Activity
Visit www.nationmaster.com or any reputable site and gather data on the various measure of development for your OECD country of focus and compare it with the developing nation you chose early in the course.
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Typical Examination Questions
172
These questions focus on Measuring National Income and Macroeconomics Models.
1. Explain the possible limitations of using GDP as a measure to
compare welfare between countries.
2. Using the circular flow of income diagram, explain the link between
saving and investment.
3. Use AS/AD diagrams to explain the causes of inflation (or deflation).
4. Identify the components of aggregate demand (or aggregate supply)
and briefly explain factors which might determine these components.
5. Evaluate the likely impact on an economy of a substantial rise (or fall)
in the level of interest rates (or other components of AD)
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Typical Examination Questions
These questions focus on inflation and deflation:
1. What are the problems associated with measuring inflation?
2. Explain the possible causes of a rise (or fall) in the rate of inflation in
an economy.
3. Evaluate the likely effects of a rising (or falling) rate of inflation on the
performance of an economy.
4. Explain the costs of inflation and deflation.
5. Evaluate the view that governments should make the control of
inflation their highest priority
6. Evaluate the possible impact on economic performance that may
result from a government decision to bring inflation under control.
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Typical Examination Questions
These questions focus on unemployment:
1. Explain the different types of unemployment.
2. Evaluate polices aimed at achieving full employment in an economy.
3. Explain the costs of unemployment.
4. Discuss the reasons why government find the goal of full employment difficult to achieve.
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Typical Examination Questions
These questions focus on monetary and fiscal policy:
1. Discuss the strengths and weaknesses of demand-side policies.
2. Discuss the strengths and weakness of supply-side policies.
3. Explain the purpose of various demand-side (or supply-side) policies.
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Typical Examination Questions
These questions focus on income distribution:
1. With the use of examples, explain the difference between a progressive tax and a regressive tax.
2. With the use of examples, explain the difference between direct and indirect taxes.
3. Explain the possible impact on the distribution of income of a government shifting its main source of tax revenue from progressive direct taxes to regressive indirect taxes.
4. Evaluate the methods government use to redistribute income in an economy.
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Typical HL Examination Questions
In addition to the questions above, HL students need to prepare for the following:
1. Explain the relationship between the Lorenz Curve and the Gini coefficient.
2. Explain how increasing government spending can lead to crowding out.
3. Use the Phillips curve to explain the concepts of Natural Rate of Unemployment and outline its usefulness.
4. Explain the multiplier and the accelerator effects.
5. Use the Laffer Curve to explain the likely impact of progressive and regressive tax systems.
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178 On-Line Resources (1)
1. Keynes and Hayek Rap
2. Nationmater is a massive central data source and a handy way to graphically compare nations that compiles data from such sources as the CIA World Factbook, UN, and OECD.
3. CIA Factbook The World Factbook provides information on the history, people, government, economy, geography, communications, transportation, military, and transnational issues for 266 world entities.
4. Gapminder, an excellent way to visual information
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179 On-Line Resources (2)
5. International Monetary Fund also provides international data.
6. National Council on Economics Education is another excellent source of information. The organization also has worksheets to help student analyze current GDP data.
7. The Economist Debates
8. Commanding Heights
9. Triple A Learning Economics Blog