7. Aggregate Demand and Supply and Macroeconomic Problems

Macroeconomic Objectives Distinction between microeconomics and macroeconomics The major macroeconomic issues –economic growth –unemployment –inflation –balance of payments and exchange rates balance of payments deficits and surpluses exchange rate movements Distinction between microeconomics and macroeconomics The major macroeconomic issues –economic growth –unemployment –inflation –balance of payments and exchange rates balance of payments deficits and surpluses exchange rate movements

Economic growth (average % per annum), Unemployment (average %), Inflation (average % per annum)

The Circular Flow of Income The inner flow

Factor payments Factor payments Consumption of domestically produced goods and services (C d ) Consumption of domestically produced goods and services (C d ) The circular flow of income Firms Households

The Circular Flow of Income Withdrawals –net saving –net taxes –import expenditure Injections –investment –government expenditure –export expenditure Withdrawals –net saving –net taxes –import expenditure Injections –investment –government expenditure –export expenditure

Factor payments Consumption of domestically produced goods and services (C d ) Investment (I) Government expenditure (G) Government Export expenditure (X) Export BANKS, etc Net saving (S) Net saving (S) GOV. Net taxes (T) Net ABROAD Import expenditure (M) Import The circular flow of income WITHDRAWALS INJECTIONS

The Circular Flow of Income The relationship between injections and withdrawals –the links between them The relationship between injections and withdrawals –the links between them

Factor payments Consumption of domestically produced goods and services (C d ) Investment (I) Government expenditure (G) Government Export expenditure (X) Export BANKS, etc Net saving (S) Net saving (S) GOV. Net taxes (T) Net ABROAD Import expenditure (M) Import The circular flow of income WITHDRAWALS INJECTIONS

The Circular Flow of Income The relationship between injections and withdrawals –the links between them –planned injections may not equal planned withdrawals The relationship between injections and withdrawals –the links between them –planned injections may not equal planned withdrawals

The Circular Flow of Income The relationship between injections and withdrawals –the links between them –planned injections may not equal planned withdrawals Equilibrium in the circular flow The relationship between injections and withdrawals –the links between them –planned injections may not equal planned withdrawals Equilibrium in the circular flow

Factor payments Consumption of domestically produced goods and services (C d ) Investment (I) Government expenditure (G) Government Export expenditure (X) Export BANKS, etc Net saving (S) Net saving (S) GOV. Net taxes (T) Net ABROAD Import expenditure (M) Import The circular flow of income WITHDRAWALS INJECTIONS

The Circular Flow of Income The relationship between injections and withdrawals –the links between them –planned injections may not equal planned withdrawals Equilibrium in the circular flow The circular flow and the four macroeconomic objectives The relationship between injections and withdrawals –the links between them –planned injections may not equal planned withdrawals Equilibrium in the circular flow The circular flow and the four macroeconomic objectives

Factor payments Consumption of domestically produced goods and services (C d ) Investment (I) Government expenditure (G) Government Export expenditure (X) Export BANKS, etc Net saving (S) Net saving (S) GOV. Net taxes (T) Net ABROAD Import expenditure (M) Import The circular flow of income WITHDRAWALS INJECTIONS

Measuring national income GDP: the measure of national income Methods of measuring GDP –the product approach –the income approach –the expenditure approach The product approach –measuring GVA GDP: the measure of national income Methods of measuring GDP –the product approach –the income approach –the expenditure approach The product approach –measuring GVA

Agriculture, forestry and fishing £9 656 m Mining, energy and water supply £ m Manufacturing £ m Construction £ m Wholesale and retail trade; repairs £ m Hotels and restaurants £23 678m Transport and communication £ m Banking, finance, insurance, etc. £ m Letting of property £ m Public administration and defence £ m Education, health and social work £ m Other services £ m Gross value added (GVA) at basic prices £ m Percentage of GVA UK GVA product-based measure: 1998

Measuring national income GDP: the measure of national income Methods of measuring GDP –the product approach –the income approach –the expenditure approach The product approach –measuring GVA The income approach GDP: the measure of national income Methods of measuring GDP –the product approach –the income approach –the expenditure approach The product approach –measuring GVA The income approach

Compensation of employees (wages and salaries) £ m Operating surplus (gross profit, rent and interest of firms government and other institutions) £ m Mixed incomes £ m Tax less subsidies on production (other than those on products) plus statistical discrepancy £ m Gross value added (GVA) at basic prices £ m UK GVA by category of income: 1998 Percentage of GVA

Measuring national income GDP: the measure of national income Methods of measuring GDP –the product approach –the income approach –the expenditure approach The product approach –measuring GVA The income approach –from GVA to GDP GDP: the measure of national income Methods of measuring GDP –the product approach –the income approach –the expenditure approach The product approach –measuring GVA The income approach –from GVA to GDP

Gross value added (GVA) at basic prices £ m UK GDP: 1998

Gross value added (GVA) at basic prices £ m plus Taxes on products£ m UK GDP: 1998

Gross value added (GVA) at basic prices £ m plus Taxes on products£ m less Subsidies on products £7 453m UK GDP: 1998

Gross value added (GVA) at basic prices £ m plus Taxes on products£ m less Subsidies on products £7 453m GDP (at market prices) £ m UK GDP: 1998

Measuring national income GDP: the measure of national income Methods of measuring GDP –the product approach –the income approach –the expenditure approach The product approach –measuring GVA The income approach The expenditure approach GDP: the measure of national income Methods of measuring GDP –the product approach –the income approach –the expenditure approach The product approach –measuring GVA The income approach The expenditure approach

UK GDP at market prices by category of expenditure: 1998

Measuring national income GDP: the measure of national income The product approach The income approach The expenditure approach From GDP to net national income (NNY) GDP: the measure of national income The product approach The income approach The expenditure approach From GDP to net national income (NNY)

UK GDP, GNY and NNY at market prices: 1998

Economic Growth and the Business Cycle Growth in actual and potential output Economic growth and the business cycle –fluctuations in actual growth Growth in actual and potential output Economic growth and the business cycle –fluctuations in actual growth

O National output Time Potential output Actual output The business cycle

Economic Growth and the Business Cycle Growth in actual and potential output Economic growth and the business cycle –fluctuations in actual growth –the phases of the business cycle Growth in actual and potential output Economic growth and the business cycle –fluctuations in actual growth –the phases of the business cycle

O National output Time Potential output Actual output The business cycle

Economic Growth and the Business Cycle Growth in actual and potential output Economic growth and the business cycle –fluctuations in actual growth –the phases of the business cycle –trend growth Growth in actual and potential output Economic growth and the business cycle –fluctuations in actual growth –the phases of the business cycle –trend growth

O National output Time Potential output Actual output Trend output The business cycle

Economic Growth and the Business Cycle Economic growth and the business cycle –fluctuations in actual growth –the phases of the business cycle –trend growth –the business cycle in practice Economic growth and the business cycle –fluctuations in actual growth –the phases of the business cycle –trend growth –the business cycle in practice

Economic Growth and the Business Cycle Economic growth and the business cycle –fluctuations in actual growth –the phases of the business cycle –trend growth –the business cycle in practice the irregularity of the cycle Economic growth and the business cycle –fluctuations in actual growth –the phases of the business cycle –trend growth –the business cycle in practice the irregularity of the cycle

Economic Growth and the Business Cycle Economic growth and the business cycle –fluctuations in actual growth –the phases of the business cycle –trend growth –the business cycle in practice the irregularity of the cycle the length of the phases Economic growth and the business cycle –fluctuations in actual growth –the phases of the business cycle –trend growth –the business cycle in practice the irregularity of the cycle the length of the phases

Economic Growth and the Business Cycle Economic growth and the business cycle –fluctuations in actual growth –the phases of the business cycle –trend growth –the business cycle in practice the irregularity of the cycle the length of the phases the magnitude of the phases Economic growth and the business cycle –fluctuations in actual growth –the phases of the business cycle –trend growth –the business cycle in practice the irregularity of the cycle the length of the phases the magnitude of the phases

Economic Growth and the Business Cycle Causes of actual growth –aggregate demand –aggregate demand relative to potential output Actual growth in practice –experience since 1970 Causes of actual growth –aggregate demand –aggregate demand relative to potential output Actual growth in practice –experience since 1970

Annual growth rate (%) UK Growth rates in selected industrial countries

Annual growth rate (%) UK Growth rates in selected industrial countries

Annual growth rate (%) UK France Growth rates in selected industrial countries

Annual growth rate (%) UK France Growth rates in selected industrial countries

Annual growth rate (%) UK France Germany Growth rates in selected industrial countries

Annual growth rate (%) UK France Germany Growth rates in selected industrial countries

Annual growth rate (%) UK France USA Germany Growth rates in selected industrial countries

Annual growth rate (%) UK France USA Germany Growth rates in selected industrial countries

Annual growth rate (%) UK France USA Germany Japan Growth rates in selected industrial countries

Annual growth rate (%) UK France USA Germany Japan Growth rates in selected industrial countries

Economic Growth and the Business Cycle Causes of potential growth –increases in the quantity of factors capital labour land and raw materials the problem of diminishing returns –increases in factor productivity Policies to achieve growth –demand-side and supply-side policies –market-orientated & interventionist policies Causes of potential growth –increases in the quantity of factors capital labour land and raw materials the problem of diminishing returns –increases in factor productivity Policies to achieve growth –demand-side and supply-side policies –market-orientated & interventionist policies

Unemployment The meaning of 'unemployment' Official measures of unemployment –claimant unemployment do claimant statistics give a true picture of unemployment? –standardised unemployment (ILO/OECD) The meaning of 'unemployment' Official measures of unemployment –claimant unemployment do claimant statistics give a true picture of unemployment? –standardised unemployment (ILO/OECD)

Unemployment rates in selected industrial countries UK

Unemployment rates in selected industrial countries

UK France Unemployment rates in selected industrial countries

UK France Unemployment rates in selected industrial countries

UK France Germany Unemployment rates in selected industrial countries

UK France Germany Unemployment rates in selected industrial countries

UK France USA Germany Unemployment rates in selected industrial countries

UK France USA Germany Unemployment rates in selected industrial countries

UK France USA Germany Japan Unemployment rates in selected industrial countries

UK France USA Germany Japan Unemployment rates in selected industrial countries

UK France USA Germany Japan OECD Unemployment rates in selected industrial countries

UK France USA Germany Japan OECD Unemployment rates in selected industrial countries

Unemployment Unemployment and the labour market –the aggregate demand and supply of labour –equilibrium in the model Unemployment and the labour market –the aggregate demand and supply of labour –equilibrium in the model

QeQe Aggregate demand and supply of labour O Average (real) wage rate No. of workers AS L AD L WeWe

Unemployment Unemployment and the labour market –the aggregate demand and supply of labour –equilibrium in the model –disequilibrium unemployment Unemployment and the labour market –the aggregate demand and supply of labour –equilibrium in the model –disequilibrium unemployment

O Average (real) wage rate No. of workers AS L AD L WeWe W2W2 BA Disequilibrium unemployment Q2Q2 Q1Q1

Unemployment Unemployment and the labour market –the aggregate demand and supply of labour –equilibrium in the model –disequilibrium unemployment –equilibrium unemployment Unemployment and the labour market –the aggregate demand and supply of labour –equilibrium in the model –disequilibrium unemployment –equilibrium unemployment

Equilibrium unemployment O Average (real) wage rate No. of workers AD L WeWe AS L e QeQe

Q2Q2 QeQe O Average (real) wage rate No. of workers AS L AD L WeWe N e d Equilibrium unemployment

Equilibrium and disequilibrium unemployment O Average (real) wage rate No. of workers AD L WeWe e QeQe AS L

O Average (real) wage rate No. of workers AS L AD L WeWe W2W2 ba e Disequilibrium unemployment Equilibrium and disequilibrium unemployment

O Average (real) wage rate No. of workers AS L AD L WeWe W2W2 ba e N c Equilibrium unemployment Disequilibrium unemployment Equilibrium and disequilibrium unemployment

Unemployment Disequilibrium unemployment –real-wage (classical) unemployment –demand-deficient (cyclical) unemployment –unemployment arising from a growth in the labour supply Disequilibrium unemployment –real-wage (classical) unemployment –demand-deficient (cyclical) unemployment –unemployment arising from a growth in the labour supply

Unemployment Equilibrium unemployment –frictional (search) unemployment –structural unemployment changing pattern of demand technological unemployment regional unemployment –seasonal unemployment Equilibrium unemployment –frictional (search) unemployment –structural unemployment changing pattern of demand technological unemployment regional unemployment –seasonal unemployment

Aggregate Demand and Supply The aggregate demand curve

O Price level National output AD Aggregate demand and aggregate supply

Aggregate Demand and Supply The aggregate demand curve –Why aggregate demand curves slope downwards import effect The aggregate demand curve –Why aggregate demand curves slope downwards import effect

O Price level National output AD Aggregate demand and aggregate supply

Aggregate Demand and Supply The aggregate demand curve –Why aggregate demand curves slope downwards import effect interest-rate effect The aggregate demand curve –Why aggregate demand curves slope downwards import effect interest-rate effect

O Price level National output AD Aggregate demand and aggregate supply

Aggregate Demand and Supply The aggregate demand curve –Why aggregate demand curves slope downwards import effect interest-rate effect savings effect The aggregate demand curve –Why aggregate demand curves slope downwards import effect interest-rate effect savings effect

O Price level National output AD Aggregate demand and aggregate supply

Aggregate Demand and Supply The aggregate demand curve –Why aggregate demand curves slope downwards import effect interest-rate effect savings effect The aggregate supply curve The aggregate demand curve –Why aggregate demand curves slope downwards import effect interest-rate effect savings effect The aggregate supply curve

O Price level National output AS AD Aggregate demand and aggregate supply

Aggregate Demand and Supply The aggregate demand curve –Why aggregate demand curves slope downwards import effect interest-rate effect savings effect The aggregate supply curve –Why aggregate supply curves generally slope upwards The aggregate demand curve –Why aggregate demand curves slope downwards import effect interest-rate effect savings effect The aggregate supply curve –Why aggregate supply curves generally slope upwards

O Price level National output AS AD Aggregate demand and aggregate supply

Aggregate Demand and Supply The aggregate demand curve –Why aggregate demand curves slope downwards import effect interest-rate effect savings effect The aggregate supply curve –Why aggregate supply curves generally slope upwards Equilibrium The aggregate demand curve –Why aggregate demand curves slope downwards import effect interest-rate effect savings effect The aggregate supply curve –Why aggregate supply curves generally slope upwards Equilibrium

O Price level National output AS AD PePe Aggregate demand and aggregate supply

O Price level National output AS AD PePe P2P2 a b Aggregate demand and aggregate supply

Aggregate Demand and Supply The aggregate demand curve –Why aggregate demand curves slope downwards import effect interest-rate effect savings effect The aggregate supply curve –Why AS curves generally slope upwards Equilibrium –Effect of a shift in the AD curve The aggregate demand curve –Why aggregate demand curves slope downwards import effect interest-rate effect savings effect The aggregate supply curve –Why AS curves generally slope upwards Equilibrium –Effect of a shift in the AD curve

Inflation Defining inflation The costs of inflation –redistribution –uncertainty –balance of payments –resources used to cope with inflation Experience of inflation since 1965 Defining inflation The costs of inflation –redistribution –uncertainty –balance of payments –resources used to cope with inflation Experience of inflation since 1965

UK Inflation rates in selected industrial countries

UK Inflation rates in selected industrial countries

UK EU 15 Inflation rates in selected industrial countries

UK EU 15 Inflation rates in selected industrial countries

UK EU 15 USA Inflation rates in selected industrial countries

UK EU 15 USA Inflation rates in selected industrial countries

UK EU 15 Japan USA Inflation rates in selected industrial countries

UK EU 15 Japan USA Inflation rates in selected industrial countries

UK EU 15 Japan USA OECD Inflation rates in selected industrial countries

UK EU 15 Japan USA OECD Inflation rates in selected industrial countries

Inflation Types of inflation –demand pull Types of inflation –demand pull

Demand-pull inflation O Price level National output AS AD 1 P1P1 Q1Q1

O Price level National output AS AD 1 P1P1 Q1Q1 AD 2 Demand-pull inflation

O Price level National output AS AD 1 P1P1 Q1Q1 AD 2 P2P2 Q2Q2 Demand-pull inflation

Inflation Types of inflation –demand pull –cost push Types of inflation –demand pull –cost push

Inflation Types of inflation –demand pull –cost push wage push Types of inflation –demand pull –cost push wage push

Inflation Types of inflation –demand pull –cost push wage push profit push Types of inflation –demand pull –cost push wage push profit push

Inflation Types of inflation –demand pull –cost push wage push profit push import-price push Types of inflation –demand pull –cost push wage push profit push import-price push

Cost-push inflation O Price level National output AS 1 AD P1P1 Q1Q1

O Price level National output AS 1 AD P1P1 Q1Q1 AS 2 Cost-push inflation

O Price level National output AS 1 AD P1P1 Q1Q1 AS 2 P2P2 Q2Q2 Cost-push inflation

Inflation Types of inflation –demand pull –cost push wage push profit push import-price push –the interaction of demand-pull and cost- push inflation Types of inflation –demand pull –cost push wage push profit push import-price push –the interaction of demand-pull and cost- push inflation

The interaction of demand-pull and cost-push inflation O Price level National output AS 1 AD 1 P1P1

O Price level National output AS 1 AD 1 P1P1 AS 2 AD 2 P2P2 The interaction of demand-pull and cost-push inflation

O Price level National output AS 1 AD 1 P1P1 AD 2 P2P2 AS 3 AD 3 P3P3 AS 2 The interaction of demand-pull and cost-push inflation

Inflation Types of inflation –demand pull –cost push wage push profit push import-price push –the interaction of demand-pull and cost- push inflation –structural (demand shift) Types of inflation –demand pull –cost push wage push profit push import-price push –the interaction of demand-pull and cost- push inflation –structural (demand shift)

Inflation Types of inflation –demand pull –cost push wage push profit push import-price push –the interaction of demand-pull and cost- push inflation –structural (demand shift) –expectations and inflation Types of inflation –demand pull –cost push wage push profit push import-price push –the interaction of demand-pull and cost- push inflation –structural (demand shift) –expectations and inflation

Inflation Policies to tackle inflation –demand-side policies –supply-side policies Policies to tackle inflation –demand-side policies –supply-side policies