Principles of Macro-Economics AGEC 114 Dr J Mutambara

Introduction Economics is a social science that deals with how consumers, producers, and society chooses among the alternative uses of scarce resources in the processes of consuming, producing and exchange of goods and services to satisfy their objectives. Two branches exist Micro economics Macro economics

Micro economics Micro economics Concerned with economic actions of individuals or specific groups of individuals such as individual consumers and producers and their determination of prices of goods and services. Consumers Producers

Macro Economics Macro Economics Macro Economics focus on broad aggregates such as growth of the nation’s Gross Domestic Product (GDP), Gross National Product (GNP), unemployment, inflation and macro economic policies. Micro economics explicitly accounts for the interrelationship between the nation’s labour, product and money market and the economic decisions of foreign governments and individuals.

Macro-economics and micro-economics Despite the differences between the two branches, there is no conflict between them; the aggregate economy is certainly affected by events taking place at individual level.

The fallacy of composition That which is true at individual situation is not necessarily true at aggregate. Suppose an individual farmer adopts a technology and his income doubles, it does not mean that if all farmers adopts the same technology their incomes will also double. There are a series of events that will happen at aggregate level that may not happen at individual level hence outcome are not the same.

Macro-economics Looks at the behavior of the economy as a whole. Aggregate variable considered are-: Total output Aggregate price level Employment Interest rates Wage rate Foreign exchange rate. etc The subject of macro-economics looks at factors that influences these variables and the trends in variables over time. Macro-economics is policy oriented- To what degree can gvt policy influences economic outcomes. The analysis of macro –economics is guided by different schools of thoughts Keynesian economics Classical economics Monetarism New classical economics The real business cycle theory New Keynesian theory

National Economic goals Full employment Price stability Rising standards of living Fair distribution of income Economic stability Resilience to shocks and disturbances Good international relations

Circular flow of economic activity

Key Macro-Terms Output-GNP and GDP A measure of all currently produced final goods and services. GDP=An estimated value of the total worth of a country’s production and services, within its boundary, by its nationals and foreigners, calculated over the course on one year. GDP = consumption + investment + (government spending) + (exports − imports). Used to see the strength of a country’s local economy. GNP=An estimated value of the total worth of production and services, by citizens of a country, on its land or on foreign land, calculated over the course on one year. GNP = GDP + NR (Net income inflow from assets abroad or Net Income Receipts) - NP (Net payment outflow to foreign assets). To see how the nationals of a country are doing economically.

Price index  

Price index  

Examples of price index Consumer price index- fixed basket of consumer goods (personal consumption) Producer price index- is a price index that measures the average changes in prices received by domestic producers for their output. GDP deflator-: the GDP deflator (implicit price deflator) is a measure of the level of prices of all new, domestically produced, final goods and services in an economy. GDP stands for gross domestic product, the total value of all final goods and services produced within that economy during a specified period.

Inflation: In economics, inflation is a sustained increase in the general price level of goods and services in an economy over a period of time.  When the price level rises, each unit of currency buys fewer goods and services; consequently, inflation reflects a reduction in the purchasing power per unit of money – a loss of real value in the medium of exchange and unit of account within the economy. A chief measure of price inflation is the inflation rate, the annualized percentage change in a general price index, usually the consumer price index, over time. The rate of inflation is the % change in the price index from one year to another. Inflation affects economies in various positive and negative ways. The negative effects of inflation include an increase in the opportunity cost of holding money, uncertainty over future inflation which may discourage investment and savings, and if inflation were rapid enough, shortages of goods as consumers begin hoarding out of concern that prices will increase in the future. Positive effects include reducing the real burden of public and private debt, keeping nominal interest rates above zero so that central banks can adjust interest rates to stabilize the economy, and reducing unemployment due to nominal wage rigidity

Inflation Different types of inflation depending on causes and rate of inflation. Demand-pull inflation is caused by increases in aggregate demand due to increased private and government spending, etc. Demand inflation encourages economic growth since the excess demand and favourable market conditions will stimulate investment and expansion. Cost-push inflation, also called "supply shock inflation," is caused by a drop in aggregate supply (potential output). This may be due to natural disasters, or increased prices of inputs. For example, a sudden decrease in the supply of oil, leading to increased oil prices, can cause cost-push inflation. Producers for whom oil is a part of their costs could then pass this on to consumers in the form of increased prices. Another example stems from unexpectedly high Insured losses, either legitimate (catastrophes) or fraudulent (which might be particularly prevalent in times of recession). Built-in inflation is induced by adaptive expectations, and is often linked to the "price/wage spiral". It involves workers trying to keep their wages up with prices (above the rate of inflation), and firms passing these higher labor costs on to their customers as higher prices, leading to a 'vicious circle'. Built-in inflation reflects events in the past, and so might be seen as hangover inflation.

Inflation Creeping - Creeping or mild inflation is when prices rise 3% a year or less. When prices increase 2% or less it benefits economic growth. This kind of mild inflation makes consumers expect that prices will keep going up. That boosts demand. Consumers buy now to beat higher future prices. That's how mild inflation drives economic expansion. For that reason, this level of inflation is desirable. Walking- This type of strong inflation is between 3-10 % a year. It is harmful to the economy because it heats up economic growth too fast. People start to buy more than they need, just to avoid tomorrow's much higher prices. This drives demand even further, so that suppliers can't keep up. More important, neither can wages. As a result, common goods and services are priced out of the reach of most people. Galloping- When inflation rises to 10 % or more, it wreaks absolute havoc on the economy. Money loses value so fast that business and employee income can't keep up with costs and prices. Foreign investors avoid the country, depriving it of needed capital. The economy becomes unstable, and government leaders lose credibility. Galloping inflation must be prevented at all costs. Hyperinflation- Hyperinflation is when prices skyrocket more than 50 % a month. It is very rare. In fact, most examples of hyperinflation have occurred only when governments printed money to pay for wars .

Employment Percentage of labor force who are employed. Unemployment : Unemployment rate is the number of unemployed persons expressed as a percentage of labor force. Three types of unemployment Frictional – associated with changing jobs, people constantly leaving and entering jobs. Cyclical – Associated with downturns in the economy Structural- associated with decline in industry activity Full employment difficult to define and employment can be satisfactory at certain levels, some quote 96%

Other measures Budget deficit: Government tax revenue minus expenditure. Trade Deficit: Exports-imports (value terms). Aggregate demand: The sum of demands for current output by each of the buying sectors of the economy: households, businesses, gvt, foreign sector. Aggregate supply: The sum of supplies for current output by each of the supplying sectors of the economy: businesses, gvt, foreign sector.

Business cycles Cycles in business activities of the economy Downturn/recession/depression Trough Expansion/ recovery Peak