Lecture Notes-3

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Lesson 3.1

Macroeconomics


Disclaimer


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They
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are advised to use to supplement knowledge and understanding of the
module.


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Learning Outcomes

The following areas will be covered
in this lecture note:

L 03
-

Explain core macroeconomic concepts

Contents




Economic Indicators


National Income Determination



Overview of key economic indicators



“A

regularly published statistics that give an indication of current and future
trends in the economy. Among key indicators are the data for inflation,
unemployment, gross domestic product, and the trade balance.” (1)



“A piece of economic data, usually of macroeconomic scale, that is used by
investors to interpret current or future investment possibilities and judge the
overall health of an economy.” (2)


Under this section, the following economic indicators will be considered:

1.
Inflation

2.
Unemployment

3.
Economic Growth



Overview of key Economic Indicators

Overview of key economic indicators



Inflation




“An increase in the overall level of prices in the
Economy” (3 : P 13)




“An increase in the overall price level.” (4 : P 412)

Overview of key economic indicators


Inflation


Inflation is measured using the following formula (3)


Rate of Inflation=
Price level (year t)
-
Price level (year t
-
1)




Price level (year t
-
1)


Where,
t

is referred to the current year and
t
-
1
referred to the previous year.


In England, Consumer Price Index is used to measure the inflation.



Unemployment



“Those who were available for work, and had tried to find employment
during the previous 4 weeks. It also includes those waiting to be recalled
to a job from which they had been laid off.

(3 : P 310)




A person
16 years old or older who is not working, is available for work,
and has made specific efforts to find work during the
previous 4 weeks
.”
(4 : P 442)


Unemployment Rate



Unemployment Rate is measured using the following formula (3)


Unemployment Rate=
Number of unemployed
x 100




Labor Force




“The percentage of the labour force that is unemployed” (3 : P 311)





The ratio of the number of people unemployed to the total number of
people in the labor force.”
(4: P 442)


Economic Growth





“An
increase in the total output of
an economy”.(4 : P 14)



“The positive rate of change of national output
” (5: P 414)


Economic Growth contd.



An economy can grow over time as a result of the:

1.
changes in available amount of resources in the economy

2.
changes in the efficiency of factors of production.


National Income Determination


National Income



“The total income earned by the factors of production owned by a
country’s
citizens”. (4 : P 429)




A measure of the value of the output of the goods and services produced
by an economy over a period of time, usually one year
”. (5 : P 318)

The national income statisticians divide the demand for the total output
into four main categories: (3)


1.
Consumption spending by households (C)

2.
Investment spending by business and households (I)

3.
Government spending on purchasing goods and services (G)

4.
Foreign demand

National Income Determination contd.


“Spending by households on goods and services, with the exception of
purchases of new housing
”. (3 : P 209)




Expenditures by consumers on goods and services
”. (4 : P 426)



Consumption


The
C
onsumption Function

The

term

consumption

function

describes

the

relationship

between

consumption

and

the

variables

that

influence

it
;

in

the

simplest

theory,

consumption

is

determined

primarily

by


current

disposable

income
.

(
4
)


C=
C+cY





“The total income in the economy that remains after paying for
consumption and government purchases
”. (3 : P 278)




The amount of disposable income that is left after total personal
spending in a given period
”. (4 : P 431)



Savings


It

assumes

that

individuals

either

spend

their

income

or

save

it
.

Individuals

decide

how

to

divide

disposable

income

between

consumption

and

savings
.

Hence,

savings

is

equal

to

income

minus

consumption
.


S=
-
C + (1
-
c) Y





Savings Function



“Spending on capital equipment, inventories, and structures, including
household purchases of new housing
”. (3 : P 209)




Total investment in capital
-
that is, the purchase of new housing, plants,
equipment, and inventory by the private (or nongovernment) sector
”. (4 :
P 427)



Investment



Both

firms

and

households

purchase

investment

goods
.

Firms

buy

investment

goods

to

add

to

their

stock

of

capital

and

to

replace

existing

capital

as

it

wears

out
.




Households

also

invest
.

For

example

they

may

buy

new

houses,

which

are

also

part

of

investment
.



Investment contd.



“Spending on goods and services by local, state, and federal
governments
”. (3 : P 210)




Expenditures by federal, state, and local governments for final goods and
services.
”. (4 : P 431)

Government Expenditure

Basically government imposes two main types of tax:



Lump
-
Sum tax
-

A tax that collects the same amount of tax revenue at each
level. it affects the consumers disposable income directly.


Income

tax

-

it

is

an

endogenous

variable
.

This

changes

in

responsive

to

changes

in

National

Income
.

Hence

income

tax

=

tY

where

t

refers

to

the

rate

of

tax

and

Y

refers

to

the

income

of

households
.



Tx
=
T+tY


Tax



Transfer Payments

These

are

the

expenses

which

are

not

made

in

return

for

any

contribution

to

current

output
.

These

payments

do

affect

the

demand

for

goods

and

services

indirectly
.

It

is

assumed

to

be

autonomous

since

it

is

not

affected

by

the

income

of

households
.



Net Tax Function

Net Tax is defined as tax minus transfer payments.



T=
Tx
-
Tr



Transfer Payments and Net Tax Function




“Spending on domestically produced goods by foreigners (exports) minus
spending on foreign goods by domestic residents (imports)
”. (3 : P 210)




The difference between exports (sales to foreigners of U.S.
-

produced
goods and services) and imports (U.S. purchases of goods and services
from abroad). The figure can be positive or negative.
”. (4 : P 427)


Net Exports


Exports depend on spending decisions made by foreign consumers therefore
it will not change as a result of change in our national income. They are
autonomous. (X)


Imports however depend on the spending decisions of domestic residents.



M=My


Net exports = NX=X
-
mY



Net Exports contd.


National Income can be accounted using three approaches:

1.
Expenditure Approach

2.
Income Approach

3.
Value added approach



National Income Measurements

This approach measures National Income as the sum of expenditures on final
goods and services. With the assumption that they can sell anything
produced, it can be shown as,

Y = AE, where
Y

is the income and
AE

is the aggregate expenditure



Expenditure Approach

It

is

a

line

that

is

constructed

by

connecting

all

points

where

desired

aggregate

expenditure

(measured

on

the

vertical

axis)
.

Because

both

axes

are

given

in

the

same

units,

this

line

has

a

positive

slope

of

unity,

that

is,

it

forms

an

angle

of

45



with

the

axes
.





The 45 Degree Line

The equilibrium level of GDP is determined where the aggregate expenditure
line intersects the 45 degree line.





Graphical Analysis

Aggregate expenditure = Income



AE = Y


In a two sector economy,



Yd = Y (no government intervention)



AE = C+ I



AE = C+
Cy+I



AE =
A+Cy

where A = C+I



AE=Y



Y=
C+I+Cy



Y
-
Cy=C+I



Y(1
-
C)=C+I



Y=

A



1
-
c





Mathematical Approach

Leakages are the income received either by firms or households that is not
passed on to the other group by buying goods or services from it.


Injections are the income received either by domestic firms or households
that does not rise from the spending of the other group.






Leakages


Injections Approach


leakages

injections

2 sector economy

savings

Investment

3 sector economy

Savings

Tax

Investment ,Government
expenditure

4 sector economy

Savings

Tax

Imports

Investment ,Government
expenditure

Exports


Income Approach

This

approach

measures

National

Income

as

the

sum

of

incomes

of

factors

of

production

i
.
e
.

the

sum

of

wages,

rent,

interest

and

profit
.



Value Added Approach

This

approach

measures

National

Income

as

the

sum

of

value

added

at

each

stage

of

production

(from

initial

to

final

stage)



Income Approach and Value Added Approach


1.
financialtimeslexicon
. [homepage on the Internet]. No Date [cited
2012.10.28]. Available from
http://lexicon.ft.com/Term?term=economic
-
indicators


2.
econguru
.

[homepage on the Internet]. No Date [cited 2012.10.28].
Available from
http://glossary.econguru.com/economic
-
term/

3.
Mankiw

NG.
Principles of Macroeconomics. 5
th

Ed. Mason, OH: South
-

Western
Cengage

Learning; 2008

References

4.
Case KE, Fair RC,
Oster

SM. Principles of Economics. 10th Ed. London:
Pearson Education; 2012

5.
Griffiths A , Wall S (ed.) Economics for Business and Management.
London: Pearson Education
; 2005

References contd.