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Chapter:4Macroeconomic EnvironmentEconomic SystemsThe concept of economic scarcity:Like politics , the term economic tends to be used in a variety of ways and contexts to describe certain aspects of human behavior, ranging from activities such as producing , distributing and consuming , to the idea of frugality in the use of a resource.The economists idea of scarcity centers around the relationship between societys needs and wants and the resources available to satisfy them . In essence , needs and wants tend to be unlimited , the resources which can be used to meet those needs and wants are finite and accordingly no society at any time has the capacity to provide for all its actual and potential requirements.From a societal point of view, the existence of economic scarcity poses 3 serious problems concerning the use of resources:1. What to use the available resources for?2. How best to use those resources?3. How best to distribute the goods and services produced with them?In practice, these problems tend to be solved in a variety of ways. Different types of economic systems have been approached. 1. The centrally planned economy:Here, most of the key decisions on production are taken by a central planning authority, normally the state and its agencies.Under this arrangement, the state typically:Owns and/or controls the main economic resources;Establishes priorities in the use of those resources;Sets output targets for businesses which are largely under state ownership and/or control;Directs resources in an effort to achieve these predetermined targets; andSeeks to coordinate production in such a way as to ensure consistency between output and input demands.

The fact that an economy is centrally planned does not necessarily imply that all economic decisions are taken at central level, in many cases decision making may be devolved to subordinate agencies. However, these agencies are responsible to the centre which retains overall control of the economy and directs the use of scarce productive resources.The problem of coordinating inputs and outputs in a modern planned economy is a daunting task and involves and array of state planners and a central plan or blueprint normally covering a number of years (e.g. 5 year plan).In such an environment , the traditional entrepreneurial skills of efficient resources management, price setting and risk taking have little, if any, scope for development and managers behave essentially as technicians and bureaucrats, administering decisions largely made elsewhere.

The free market economy:It stands in direct contrast to the centrally planned system. Here, the key economic agencies are private individuals and firms and these interact in free markets, through a system of prices to determine the allocation of resources.The key features of this type of economic system are as follows :Resources are in private ownership and the individuals owning them are free to use tem as they wish.Firms , also in private ownership , equally able to make decisions on production , free from state interference.

No blueprint (or master plan) exists to direct production and consumption.Decisions on resource allocation are the results a decentralized system of markets and prices , in which the decisions of millions of consumes and hundreds of thousands of firms are automatically co-ordinated.The consumer is sovereign, i.e. dictates the pattern of supply and hence the pattern of resource allocation.In short, the three problems of what to produce, how to produce and how to distribute are solved by market forces.Figure 4.1 the market economy

Politico-economic synthesisThe economic problem of resource allocation, described above, clearly has a political dimension, given its focus on the ownership, control and use of wealth-producing assets within society. This allows links to be made between a countrys chosen economic system and its political regime.

PoliticalsystemDemocraticAuthoritarianPlannedFree-marketEconomicsystem1423In applying this model to specific cases, it is clear that free-market approaches to resource allocation are predominantly associated with democratic states. A link between authoritarian regimes and planned economic systems can equally be rationalized, in that government control over the political system is considerably facilitated if it also directs the economy through the ownership and/ or control of the means of production, distribution and exchange.In practice, of course, this picture is much more complicated than suggested by this simple dichotomy.The MacroeconomyLevels of analysis:Economists typically distinguishes between 2 types of analysis:1. Microeconomic analysis, which is concerned with the study of economic decision taking by both individuals and firms.2. Macroeconomic analysis, which is concerned with interactions in the economy as a whole (i.e. with economic aggregates)The flows of economic activity:Figure: 4.3, 4.4 and 4.5

Real flows in the economyIncome flows in the economy

A simplified model of real flows and income flows

Changes in economic activity:The circular flow of income with leakages (figure: 4.6)The circular flow of income with injections added (figure: 4.7)

Government and The Macroeconomy: ObjectivesMost governments have a number of key economic objectives, such as:Controlling inflation:Inflation is usually defined as an upward and persistent movement in the general level of prices over a given period of time. It can be characterized as a fall in value of money.For governments of all political complexions, reducing such movements to a minimum is seen as a primary economic objective.

Economic growth:Growth is an objective shared by governments and organizations alike. The aim is usually to achieve steady and sustained levels of non-inflationary growth, preferably led by exports. Such growth is normally indicated by annual increase in real national income or gross domestic product where real = allowing for inflation , and gross domestic product (GDP) = the economys annual output of goods and services measured in monetary terms)Reducing unemployment:In most democratic states, the goal of full employment is no longer part of the political agenda; instead government pronouncements on employment tend to focus on job creation and maintenance and on developing the skills appropriate to future demands.The consensus seems to be that in technologically advanced market-based economies, some unemployment is inevitable and that the basic aim should be to reduce unemployment to a both politically and socially acceptable.

A favorable balance of payment:A countrys balance of payments is essentially the net balance of credits (earnings) and debits (payments) arising from its international trade over a given period of time. Where credit exceed debits a balance of payment surplus exists; the opposite is described as a deficit.Governments prefer either equilibrium in the balance of payments or surpluses, rather than deficits.However, it would be fair to say that for some government facing persistent balance of payment deficit, a sustained reduction in the size of the deficit may be regarded as significant.

Controlling public borrowing:Governments raise large amount of revenue annually, mainly through taxation, and use this income to spend on a wide variety of public goods and services. Where annual revenue exceeds government spending, a budget surplus occurs and the excess is often used to repay past debt. The accumulated debt of past and present governments represents a countrys national debt.

A stable exchange rate:A countrys currency has 2 values: an internal value and an external value.Internally, its value is expressed in terms of the goods and services it can buy and hence it is affected by changes in domestic prices.Externally, its value is expressed as exchange rate which governs how much of another countrys currency it can purchase ( e.g. $1 = 80 Tk).

Since foreign trade normally involves an exchange of currencies, fluctuations in the external value of a currency will influence the price of imports and exports and hence can affect the trading prospects of business as well as a countrys balance of payments and its rate of inflation.Governments and businesses involved in international trade prefer relatively stable exchange rates.Government and The Macroeconomy: PoliciesGovernment intervention usually takes 3 main forms: Fiscal policy:Fiscal policy involves the use of changes in government spending and taxation to influence the level and composition of aggregate demand in the economy and, given the amounts involved, this clearly has important implications for business.Monetary policy:Monetary policy seeks to influence monetary variables such as the money supply or rates of interest in order to regulate the economy. While the supply of money and interest rates are interrelated, it is convenient to consider then separately.Direct controls:Income policies: which seek to control inflationary pressures by influencing the rate which wages and salaries rise.Import controls: which attempts to improve a countrys balance of payments situation, by reducing either the supply of, or the demand for, imported goods and services.Regional and urban policies: which are aimed at alleviating urban and regional problems, particularly differences in income, output, employment and local and regional decline.The Role of Financial InstitutionsElements of financial system1. lenders and borrowers- these may be individuals, organizations and governments.2. financial institutions, of various kinds, which act as intermediaries between lenders and borrowers and which manage their own asset portfolios in the interest of their shareholders and/ or depositors.3. financial markets, in which lending and borrowing takes place through the transfer of money and/ or other types of asset, including paper assets such as shares and stock.The role of central bank:Banker to the governmentBanker to the clearing banksManager of the countrys foreign reservesManager of the national debtManager of the issue of notes and coinsSupervisor of the monetary sector; andImplementer of the governments monetary policyInternational economic institutions and organizationsThe International Monetary Fund (IMF)The Organization for Economic Co-operation And Development (OECD)The European Bank for Reconstruction and Development (EBRD)The World Trade Organization (WTO)The World Bank (IBRD)The European Investment Bank (EIB)