# Macroeconomics IB Assignment

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What is Macroeconomics? Macroeconomics studies the behavior of the entire economy, and how resources are allocated. It examines economy – wide phenomena such as changes in unemployment, national income, rate of growth, gross domestic product, inflation and price levels. Macroeconomics deals with 5 variables: Variable Macroeconomic objective Economic growth A steady rate of increase of national output Employment A low level of unemployment price stability A low and stable rate of inflation External stability A favorable balance of payments position Income distribution

An equitable distribution of income Circular flow of income model Figure 1 Two sector circular flow of income model This is the basis for the circular flow of income ;o-sector model shown above. Households provide the factors of production, and receive income. They buy the goods and services, produced by the firms using the income received, and in this way the income circulates throughout the economy. The factors of production provided and income received are shown in the table below: Factor of production (provided by firms) Payment to the factor (provided by households) Land Rent Labor Wages Capital

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Interest Entrepreneurship Profits Leakages and Injections Figure 2 Four-sector circular flow with leakages and injections Even the four-sector model remains a simplification of a complex economy, but it serves to illustrate some important conclusions. The economy is in equilibrium where leakages are equal to injections. If the leakages rise, without a corresponding increase in injections, then national output will fall to a new equilibrium, as there will be less income circulating. If injections rise with no corresponding rise in leakages, then the economy will move to a new equilibrium.

National Income National income is most commonly measured by the Gross Domestic Product (GAP). There are 3 different methods that are all used to calculate this figure: The Output Method: This measures the actual value of the goods and services produced. This is calculated by summing all of the value added by all the firms in an economy. When we say value added it means that at each stage of a production process we deduct the costs of inputs, so as not to ‘double count’ the inputs.

The data is usually grouped according to the different production sectors in the economy: Agriculture and mining (primary sector), manufacturing (secondary sector) and services (tertiary sector). The Income Method: This measures the value of all the incomes earned in the economy. The Expenditure Method: This measures the value of all spending on goods and services in the economy. This is calculated by summing up the spending by all the different sectors in the economy.

These include: Spending by households, known as consumption (C) Spending by firms, known as investment (I) Spending by governments (G) National income measured, 3 different methods used. GAP= C+l+ G+(X-M) Explain this formula Working 13. 1 page 160 Macro-economic activity concerns the production, income and expenditure that takes place in an economy when goods and services are produced and sold. This is distinct from an economy’s (or government’s) macro-economic goals. These typically are: 1 . Full employment: the lowest unemployment rate possible. . Price stability: a low rate of inflation Inflation is an increase in the general level of prices or an increase in an average price level. 3. Strong and sustainable rates of economic growth 4. External stability 5. Equity in the distribution of income Equity differs from equality in that CEQ laity infers everybody has access to the name resources -?? equity means everybody can buy In a closed economy (no trade with overseas) then: Production = income = expenditure Simple model of economy In the real world, we have: 1 .

Trade with overseas 2. Government activity 3. Some people save The total demand (aggregate demand) for this economy’s goods and services is determined by adding up all Of the demand placed on the business sector less the demand place on the business sectors overseas…. AD = C (consumption demand) + I (investment demand) + G (government demand) + (X (export demand) – M (import demand)) GAP vs.. Gross National Product (IN) GAP – GAP is the final market value of Goods and services produced in an economy over a period of time.

This can also be defined as the income earned on production of goods and services within Australia GNP (Gross National Product) – Gross national product is the total income that is earned by a country’s factor of production regardless of where the assets are located. The gross national income is GAP + net income earned by Australian factors of productions overseas (net property income from abroad). Income earned by Australians overseas minus income earned by overseas residents on production they generate in Australia.

Property Income -> income earned on assets such as properties, businesses etc. (includes rents, profits, etc. ) IN vs.. IN IN – the deprecation of assets = the Net National Income (IN) GAP as a measure of Living standards – Limitations Growth in GAP may not accurately reflect growth in production because the growth in the value of production may have occurred because of inflation. GAP fails to distinguish between monetary transactions that actually improve our welfare (such as money spent on good food) and those that detract from our welfare (such as money spent on tobacco).

GAP doesn’t measure changes n the quality of goods and services from one quarter to the next. GAP figures do not take into account the depletion of the nation’s stock of capital (e. G. Using up natural resources) or the costs associate with other negative externalities. GAP figures do not take into account the value of ‘leisure time’ that may be sacrificed when there are increases in GAP. GAP is inaccurate because it excludes some non-marketed goods and services where it is too difficult to get accurate values, such as home-based production (including home maintenance).

GAP is inaccurate because it does not record production f goods and services that have been sold in black (or informal) markets (such as sale of goods in the cash economy or the sale of illegal goods). Real GAP per capita is an inaccurate indicator of living standards because it reveals nothing about how the income or production is distributed in the economy. GAP is inaccurate because the figures are based on estimates of production, income and expenditure that will rarely be 100% accurate. Green GAP Green GAP GAP -?? environmental costs Of production.

These environmental costs of production may include: Health, agricultural, industrial costs caused by air pollution and water illusion. Waste disposal and cleaning up environmental damage Business (Economic) Cycle If the trough last longer than 6 months, it can be identified as a recession. If the recession is prolonged (e. G. More than 2 years, then we have a depression) The economic cycle is characterized by periods of strong growth in Aggregated Demand and Real GAP. We will typically see: High real GAP growth (+4%) Low unemployment (tight labor market) High inflation High interest rates High growth in wages High growth in asset prices (e. . Shares, property etc. ) Confidence levels are extremely high At the boom, eventually the higher inflation, interest rates, excessive wage growth etc. Starts to result in lower levels of Aggregate Demand. This then intensifies and the economy enters a downturn, such as: Prices decrease Wages decrease Confidence decreases Asset prices decrease Interest rates decrease All of these reach their lowest point in the trough. Eventually people start spending because Of the lower interest rates, lower inflation. And then the economy once more enters the recovery.

Aggregate Demand Aggregate demand is the total demand for goods and services. Durable vs.. Non-durable Durable – e. . Equipment, vehicles, etc. (items that are not immediately consumed and last some time) Non-durable -?? e. G. Food, stationary etc. (items used once and not long lasting) AD is downward sloping because lower prices in the economy (or low inflation) will tend to increase AD. This will lead to: International competitiveness results in an increase in X and a decrease in M Consumers spend more, and save less.

Factors causing changes in Aggregate Demand Consumption: Size of population If population increases the demand for consumption goods increases. ( E. G. Food, clothing, shelter) Disposable Income If it increases then there will be an income in Consumption Customer confidence Lower interest rates This will increase consumption for several reasons; including: Decreasing interest rates will decrease the cost of borrowing which therefore increases the incentives to borrow to fund the purchase of consumer durables (e. G. A new car) Decrease interest rates decrease the incentive to save, and increase the incentive to spend.

Decrease in interest rates, decrease the cost to service debt (paying the interest on owed debt), which therefore increases cash available for spending. (I. E. Increases discretionary income) Wealth The value of an entity’s net assets (assets – debt). Not to be confused with income. Income is a flow variable, it is measured over a period of time. Wealth is a stock variable, and is measured ATA point in time. An increase In wealth (e. G. Increase in the value of property of shared portfolio) will tend to increase consumption. Indebtedness The extent to which households or businesses have net debt.

The higher the indebtedness, the higher the household is in debt, the less likely they are to spend. Government actions influencing consumption Taxes (direct taxes – individual income tax) Consumer rebates or subsidies Laws or regulations Investment: Two types of investment: 1 Financial Investment = putting money into a bank or asset 2. Refers to the purchase of capital items. That is when businesses for example purchase machinery or equipment. This spending results in benefits that are expected to be enjoyed over a relatively longer period. This is the most volatile component of Aggregate Demand.

It is highly sensitive to changes in factors such as: Interest rates National income Real GAP in the economy is increasing at a fast rate. (E. G. 5%) Technological change Government policy initiatives Tax changes (e. G. Carbon tax, MART) Government subsidies (e. G. To Ford and Holder Australia) Laws and regulations (e. G. Zoning laws) Government Spending: The amount and nature of government spending depends on a vast range of factors and the goals of the government. If the government has made a commitment to financially support a given industry, then government spending will rise.

If governments are obliged to spend to correct market failure, then government spending will rise. A new education or health policy might require increased public spending on schools or hospitals. This is really comprised of two types of government spending, within Aggregate Demand. (GIG +GO) GIG = Government consumption demand (Non-durable) (e. G. Wages, stationary items) GO Government investment demand (durable) (e. G. Infrastructure such as roads, equipment) Factors affecting Government spending include: Politics (e. G. N election will impact on the direction and volume of some government spending) The perceived needs of the citizens, households and regions. Levels of government indebtedness Net Exports Factors affecting Net Exports: Wealth of other countries Economic growth overseas Exchange rate Higher exchange rate is bad, a low exchange rate is good Trade policies in the domestic economy (e. G. Australia) compared to the trade policies existing elsewhere (e. G. A decrease in protection such as quotas and tariffs) Overseas vs.. Domestic rates of inflation Relative rates of productivity between domestic and overseas economies Other government factors (e. . Government procurement policies) Budgetary (fiscal) Policy The government’s manipulation of its receipts (revenue) and expenditure (expense or outlays) in order to assist with the achievement of is economic + social objectives, which are: Low unemployment Low I inflation Strong and sustainable economic growth Equity in the distribution of income A direct tax is on income, whereas an indirect tax is on production and/or expenditure. When the economy is in the upward phase of the business cycle, the budget will automatically move towards a surplus (revenue greater than expenditure).

In addition, the government is also likely to adopt a more contraction fiscal policy stance by increasing the size of the surplus even further. They do this because they want to insure that growth does not come urn-sustainable and the high surplus works to restrict aggregate demand and minimize the capacity constraints that emerge in the economy. When the economy is in the trough phase, the budget outcome will automatically move towards a deficit (expenses greater than revenue). In addition the government is also likely to implement a more expansionary budgetary policy Stance via the delivery Of a bigger budget deficit.

They do this because they want to stimulate aggregate demand and protect against the negative effects of a possible recession (high unemployment, increased poverty). What is Monetary Policy? Monetary policy involves the manipulation of key financial variables in the economy, (in particular interest rates and exchange rates) in order to assist with the achievement of the government’s key economic goals – in particular the focus is on achieving a low rate of inflation (price stability) Who is responsible for Monetary Policies?

The government charges the central bank (ARAB in Australia) with the responsibility of conducting monetary policy. Note that most central banks, including Australia, around the world are set up to be independent of the government of the day. This means that their decisions are made on the basis of what is in the best interest of the economy, and not for political votes/ reasons. Distinguish between a contraction or expansionary (accommodating stance) monetary policy: A contraction monetary policy is one where the ARAB sets interest rates at a high enough level to be exerting a restrictive or constraining influence On the economy.

Typically this means that the ARAB sets the cash rate above approximately 4. 25%. The main steps involved in achieving a tighter monetary policy DON’T SAY: Tightening of monetary means that monetary policy is restrictive The ARAB announces a new higher target cash rate It then enters the cash market and seeks to restrict supply of cash. It does this by selling bonds to cash market participants, which are primarily the banks This causes the cash rate to move up towards the new target cash rate This causes all other interest rates in the economy to move by ‘roughly’ the same magnitude.

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