2. Key terms
macroeconomic issues
macroeconomic objectives
economic growth
employment / unemployment
inflation
Balance of Payments
exchange rate
policy conflict
circular flow of income
withdrawals
savings, taxation, imports
injections
Investment, government
spending, exports
aggregate demand
3. 4 Key Macroeconomic Issues
1. Economic growth
2. Employment
3. Inflation
4. Balance of Payments and the exchange rate
4. Macroeconomic issues
1.Economic growth
‘the growing ability of the economy to produce goods
and services’
government objective
Achieve high but stable growth rates over a sustained period
of time
[UK = up from -0.4% to 1% but mostly due to the 2012
Olympics]
5. Macroeconomic Issues
2. Employment
employment is the
total number of people currently employed
unemployment is the total number of people
actively looking for work but who are not
currently employed
government objective:
full employment (reducing unemployment) such that there is
no waste of human resources
[UK = down from 8.1% to 7.9%]
6. Macroeconomic Issues
3. Inflation
the general rise in prices
the rate of inflation measures the annual percentage
increase in prices
government objective:
control inflation such that it is low and stable
[UK CPI = down from 2.5% to 2.2% - target is 2%]
7. Macroeconomic Issues
4. Balance of Payments
all payments made to other countries (import
purchases, outward spending, interest paid)
all payments received from other countries (export
sales, inward investment, interest earned)
if a country spends more foreign currency than it earns,
there will be a BofP deficit (currency surplus, exchange
rate falls)
government objective:
achieve balance of country’s trade and capital flows over a
period of years – BofP equilibrium [UK = deficit £49b]
8. Macroeconomic Issues
Key problem: policy conflict
eg goal of high economic growth may conflict
with goal of low inflation
Solution: trade-offs
(opportunity costs, rational choices, and cost-
benefit analyses)
9. Economic Aggregates
Aggregate Demand (AD) =
* total spending on goods and services made within the
country over a given period of time (planned spending)
10. Aggregate Demand
4 components
1. Consumption (C)
2. Investment (I)
3. Government Spending (G)
4. Net Exports (X-M)
AD = C + I + G + X-M
Relationship between 4 macro objectives and AD – see
circular flow of income
13. Beyond the inner flow
Withdrawals (W)
net saving (S)
net taxes (T)
import expenditure (M)
Total withdrawals are the total of net saving, net
taxes and expenditure on imports
W = S + T + M
15. Beyond the inner flow
Injections (J)
Investment (I)
Government expenditure (G)
Export expenditure (X)
Total injections are the sum of investment,
government expenditure, and exports
J = I + G + X
Aggregate demand (total spending on output) is Cd + J
16. Factor
payments
Consumption of
domestically
produced goods
and services (Cd)
Investment (Investment (II))
GovernmentGovernment
expenditure (expenditure (GG))
ExportExport
expenditure (expenditure (XX))
BANKS, etcBANKS, etc
Net
saving (S)
GOV.GOV.
NetNet
taxes (taxes (TT))
ABROAD
ImportImport
expenditure (expenditure (MM))
The circular flow of income
WITHDRAWALS
INJECTIONS
17. The Circular Flow of Income
The relationship between injections and withdrawals
the links between them are complex due to many
different decisions made by many different people
planned injections may not equal planned withdrawals
eg
S ≠ I, T ≠ G, X ≠ M
18. The Circular Flow of Income
The relationship between injections and withdrawals
Disequilibrium when J ≠ W
This will set in motion a process to bring economy
back to state of equilibrium where J = W
19. Relationship between W and J
If J > W then the level of expenditure will rise; a rise
in AD
Extra spending will increase firms’ sales, encourage
them to produce more
Total output in the economy will rise
Firms pay out more in wages, profits, rents, interest
National income will rise
20. Effect of rise in AD on 4 macro objectives
1. Economic growth
The greater the excess of J over W, the bigger the rise in
national income
2. Unemployment
Will fall as firms take on more workers to meet the
extra demand in output
continued
21. Effect of rise in aggregate demand on 4
macroeconomic objections - continued
3. Inflation
Will tend to rise. The greater rise in AD relative to
capacity of firms to produce, the more firms struggle to
meet demand so likely to raise prices
4. Balance of Payments
Will tend to deteriorate. Higher demand means more
M and higher inflation means X less competitive and
imports relatively cheaper. So M tend to rise and X tend
to fall
22. Disequilibrium and a chain reaction
‘automatic stabilisers’
J W˃ As national income rises:
Households will spend more [Cd]
Households will save more [S]
Households will pay more taxes [T] [and government
will spend less on welfare benefits]
Households will buy more imports [M]
So withdrawals increase
Eventually, equilibrium: J = W
[ie automatic stabilisers can avoid unsustainable growth,
high inflation]
23. Question
This time: J < W
Step 1: What will be the effect on each of the four objectives if
planned injections are less than planned withdrawals?
Step 2: Explain how the chain reaction returns the economy
to equilibrium [J = W] [ie how the automatic stabilisers
work to limit the fall in growth to avoid high inflation]
24. If planned injections are less than withdrawals, national income will fall.
Other things being equal, this will have the following effects on the four
objectives:
Growth will be negative.
Unemployment will rise.
The rate of inflation will fall.
Exports will tend to rise (as their relative prices fall) and imports will tend to
fall (as they become less competitive with home-produced goods and as
incomes at home fall and thus people cannot afford to buy so many imports).
These effects are collectively known as the international substitution effect
As national income falls
Households will spend less (Cd)
Households will save less (S)
Households will pay less taxes (T)[government will pay more welfare benefits]
Households will buy fewer imports (M)
Demand from abroad for X tends to increase. So withdrawals decrease
25. If J < W
National income will rise / fall
Ceteris paribus, this will have the following effects on the four macro-
economic objectives:
Growth will be negative / positive
Unemployment will rise / fall
The rate of inflation will rise / fall
Exports will tend to rise / fall
Imports will tend to rise / fall
So the balance of payments will improve / deteroriate
Automatic stabilisers can limit fall in growth by:
26. Aggregate Demand – components
1. Consumption (C)
The amount of consumer spending on goods and
services produced in the country (the largest part of
AD)
It is influenced by:
Disposable income (the largest part of C)
Expected future incomes/consumer confidence
Household wealth
The financial system/interest rates
New technology
27. Aggregate Demand – components
2. Investment (I)
Expenditure by firms in the country on ‘capital goods’
(eg buildings, equipment NOT stocks, bonds)
It is influenced by:
Increased consumer demand
Expectations and business confidence
Financial system/interest rates
Technological advances
Cost of capital goods
Level of company profits
28. Aggregate Demand – components
3. Government spending (G)
on goods and services (eg defence, education, health,
housing etc)
it is influenced by:
Government policy (political issue)
National income – short-term
National income – long-term (includes issue of tax revenue)
Demographic changes
Demand for merit and public goods
29. Aggregate Demand – components
3. Government spending (G) - continued
G directly increases/decreases AD
eg consider wartime spending
T indirectly increases/decreases AD
eg lower tax rate = consumers keep more of what they earn
thereby increasing their disposable income
30. Aggregate Demand – components
3. Government Spending (G) - continued
Budget deficit (G > T):
expansionary fiscal policy = increase AD
Budget Surplus (G < T):
contractionary fiscal policy + decrease AD
Balanced Budget (G = T):
neutral effect on AD
31. Aggregate Demand – components
4. Net Exports [X - M)
Net exports is the difference between the value of
exports and the value of imports
[M subtracted from X because M not part of the country’s
production]
Export sales lead to flow of funds into country so AD
increases
Import purchases lead to flow of funds out of country
so AD is reduced
32. Aggregate Demand – components
4. Net exports (X -M) continued
Spending on X depends on
Level of income in other countries
Exchange rate
Spending on M depends on
Level of income in own country
Exchange rate
