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Lecture notes EC1009 Introduction to Macroeconomics (EC1009)
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Lecture notes of 17 pages for the course EC1009 Introduction to Macroeconomics at City (a)
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EC1009 Introduction to Macroeconomics notesMacroeconomic objectives
Economic growth:
The main benefit of this is the expanded consumption possibilities as well as better
healthcare, quality of life, living standards, Research and Development and better
environment.
The costs are a rapid depletion of non-renewable resources as well as more frequent
job changes.
Inflation:
A process of rising the general level of prices in an economy.
This is measured in % change in the average level of prices. RPI is a common
measure. This usually fluctuates but is almost always positive.
A falling price rate is called deflation (this is being suffered in Japan since 1996).
The UK inflation target is 2% but has fluctuated between 0-5% in recent years.
High inflation is a problem as it reduces the value of money, therefore savers don’t
get real return on their money. As there’s a time lag with wages, goods seem more
expensive.
Unemployment:
This is when a person is willing and able to work yet does not have a job.
The ONS publishes claimant count data based on who claims JSA, however not all
unemployed people are on JSA (either due to stigma against it or they’re ineligible).
This is a large problem as there is a loss of human capital, lost production potential,
more money spent by the government on benefits and of course a devastating
impact for the individual and their family.
The UK target is to keep unemployment as low as possible as 0 is impossible.
Balance of Payments on the Current Account:
If a country exports more than it imports, it has a current account surplus (i.e. Kuwait
and China).
If a country imports more than it exports, it has a current account deficit (i.e. UK and
Mongolia).
GDP
What is GDP?
GDP is the market value of the final goods and services produced in a country in
a given time period.
, A final good/service is an item bought by its final user during a specified time
period. This contrasts with intermediate goods which are items produced by a
firm and bought by another firm to use as a component of a final good/service.
Gross means before accounting the depreciation of capital. The opposite of gross
is net.
Circular flow of Expenditure and Income
There are 3 ways to measure GDP.
Expenditure Method; GDP = Y = C+I+G+(X-M)
Income Method; GDP = Y = wages + profits + rental income + cost of capital
Output Method; GDP = Y = Gross value added to output of various sectors of
the economy
GNY
Gross National Income measures the total income earned by domestic citizens
(formerly known as Gross National Product).
GNY = GDP + Net Property Income from abroad.
Flows, Stocks and Investment
A flow is a quantity per unit of time while a stock is the quantity that exists at a point
in time. GDP, savings and investment are flow variables while wealth is a stock.
Investment is defined as production today dedicated towards production of other
goods or services in the future such as plants, buildings and machinery.
This is an annual flow that changes the stock of capital, used for calculating GDP rises
and falls is stocks of goods.
Investment plays a central role in the economy as capital stock growth causes GDP
growth while investment fluctuation causes GDP fluctuation.
However, investment can depend on many things such as business confidence, tax,
FDI, political stability, long term interest rates, macroeconomic performance and
global events such as Brexit.
Net investment = Gross investment – Depreciation (decrease in the stock of capital
that results from wear and tear and obsolescence).
Keynesian Economics
Key Assumptions
We have a simple closed economy with no government sector.
Both wages and prices are fixed in the short run. An increase in AD leads to an
increase in output and not to a rise in aggregate price level or wages.
As firms set their prices and hold them fixed in the short term, the quantities they
sell depend on demand not supply. AD determines the quantity of goods sold, which
is real GDP.
Modelling Consumption
, To model consumption we need to assume that it’s determined by 2 factors;
autonomous consumption (A) and income induced consumption (cY where c =
change in C/change in Y).
C = A + cY
Since income can be spent or saved, the savings function can be given by S = -A + sY
where s is marginal propensity to save (change in S-change in Y)
Equilibrium GDP
This is when AD equals national output. At this level, purchasers wish to buy exactly
the amount of national output being produced.
When GDP is above equilibrium, desired expenditure falls short of national output
and output will be curtailed.
When GDP is below equilibrium, desired expenditure exceeds national output and
output will be increased.
In a closed economy with no government, desired saving = investment at equilibrium
GDP.
Keynes’ insight and the Multiplier
Keynes showed that the economy may be in equilibrium but at less than the full
employment level of income because there’s an insufficient AD at the full
employment level of income.
Keynes argued that there is no reason to expect the planned investment to equal the
planned savings at full employment as they’re carried out by 2 distinct groups. They
coincide at an income of 1000 well below full employment.
To get the multiplier you differentiate Y=A+cY+dI to get dY = 1/1-c (dA+dI)
The simple multiplier is given as 1/1-c but as 1-c=s it is 1/s.
An increase in investment increases AD and real GDP which increases induced
expenditure which increases aggregate expenditure increasing real GDP again.
Therefore real GDP increases by more than the initial increase in autonomous
expenditure.
The Paradox of Thrift
If we could get economic agents to consume more and save less, it would be possible
to get to the full employment level and the level of aggregate savings would be
exactly equal at less than full employment.
Keynes’ response to the Classical School of Thought on Unemployment
According to classical economists, if there was unemployment then the appropriate
solution would be to lower wages as it leads to a higher demand of labour to solve
the unemployment problem.
Keynes had 2 responses to this – Most wages are sticky downwards, they’d fall
eventually but it would take a lot of time.
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