1. The Macroeconomic Environment By the end of this class you should be able to: 1)Define macroeconomics 2)Explain the flow of income in an economy 3)Recognise some problems in measuring the value of an economy

2. Macroeconomics is... the study of the economy as a whole the study of the economy as a whole it deals with broad aggregates it deals with broad aggregates uses the same positivist thinking as in microeconomics. uses the same positivist thinking as in microeconomics.

3. Some key issues in macroeconomics Inflation Inflation the rate of change of the general price level the rate of change of the general price level Unemployment Unemployment a measure of the number of people looking for work, but who are without jobs a measure of the number of people looking for work, but who are without jobs Output Output real gross national product (GNP) measures total income of an economy real gross national product (GNP) measures total income of an economy

4. More key issues in macroeconomics Economic growth Economic growth increases in real GNP, an indication of the expansion of the economy’s total output increases in real GNP, an indication of the expansion of the economy’s total output Macroeconomic policy Macroeconomic policy a variety of policy measures used to improve overall performance of the economy a variety of policy measures used to improve overall performance of the economy

5. fig 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

6. 5 THE CIRCULAR FLOW OF INCOME Withdrawals Withdrawals net saving net saving net taxes net taxes import expenditure import expenditure Injections Injections investment investment government expenditure government expenditure export expenditure export expenditure

7. fig 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

8. Three measures of national worth (£) Expenditure Expenditure the sum of expenditures in the economy the sum of expenditures in the economy Y = C + I + G + X - M Y = C + I + G + X - M Income Income the sum of incomes paid for factor services the sum of incomes paid for factor services Output Output the sum of output (value added) produced in the economy the sum of output (value added) produced in the economy

9. fig INCOME PRODUCTION EXPENDITURE National Product (output) = National Expenditure = National Income

10. Aggregate output in the short run Potential output Potential output the output produced if all factors of production were fully employed the output produced if all factors of production were fully employed Actual output Actual output actual production may diverge from the potential level actual production may diverge from the potential level Formal Economic Models: Keynsian Model

11. Some assumptions Prices and wages are fixed Prices and wages are fixed Actual output is demand-determined Actual output is demand-determined

12. Aggregate Demand (AD) AD has five components: AD has five components: Investment [ I ] Investment [ I ] firms’ planned additions to physical capital & inventories firms’ planned additions to physical capital & inventories for now, assume this is autonomous for now, assume this is autonomous Consumption [C] Consumption [C] households’ demand for goods and services households’ demand for goods and services Government Spending [ G ] (autonomous) Government Spending [ G ] (autonomous) Exports [ X ] (autonomous) Exports [ X ] (autonomous) Imports [ M ] (autonomous) Imports [ M ] (autonomous)

13. The consumption function National Income Consumption C = 8 + 0.7 Y The consumption function shows desired aggregate consumption at each level of aggregate income 0 With zero income, desired consumption is 8 (“autonomous consumption”).{ 8 The marginal propensity to consume (the slope of the function) is 0.7 – i.e. for each additional £1 of income, 70p is consumed.

14. The aggregate demand schedule National Income Planned Spending C AD = C + I + G + X - M The AD function is the vertical addition of C, I, G, X & M

15. Equilibrium output: Y = C + I + G + X - M Output, Income Planned spending 45 o line This the point at which planned spending equals actual output and income. EAD

16. Student Activity Using the Keynesian income – expenditure diagram shown previously, adapt it to show what happens if: A) Investment decreases B) Fiscal Policy changes, e.g. Government spending rises

17. Readings: Begg, D. et al, (2008), Economics, Chapters 19 & 20 Griffiths, A. & Wall, S., (2005) Economics for Business & Management, Chapter 9 McDowell, M. et al, (2006), Principles of Economics, Chapters 17 & 18 16