CHAPTER 1 INTRODUCTION TO MACROECONOMIC PB202 MACROECONOMICS CHAPTER 1 INTRODUCTION TO MACROECONOMIC Prepared by: Azlina bt Azmi Session of December 2010

Chapter objectives Learn macroeconomic in general To evaluate government policies and tools To know the Aggregate Demand and Aggregate Supply

Arrow Process Chapter Sneak Peak Why use graphics from PowerPointing.com? - Definition -AD curve - AS curve - What is macroeconomics? Macroeconomics versus microeconomics - Macroeconomic goal EFFECT ON UNEQUAL EQUILIBRIUM OF AD & AS AGGREGATE DEMAND & AGGREGATE SUPPLY GOVERNMENT POLICIES AND TOOLS MACROECONOMICS IN GENERAL SUMMARY Fiscal policy Monetary Policy How does it affects price level and real GDP? Factors that shift AD curve Factors shift AS curve This illustration is a part of ”Building Plan”. See the whole presentation at slideshop.com/value-chain

What is macroeconomics? The branch of economics that studies decision making for the economy as a whole (inflation, unemployment, economic growth, money supply, national incomes, business cycle)

Macroeconomics vs Microeconomics Studies individual income Studies national income Analyzes demand for and supply of labor Analyzes total employment in the economy Deals with households’ and firms’ decisions Deals with aggregate decisions Analyzes demand and supply of goods Analyzes aggregate demand and aggregate supply

Macroeconomic Goal Price stability Economic growth Full employment Distribution of income

Price stability A situation in which prices in an economy don’t change much over time Would mean that an economy would not experience inflation or deflation However, it is not common in economy to have price stability

Economic growth A positive change in the level of production of goods and services by a country over a certain period of time Nominal growth is defined as economic growth including inflation Real growth is nominal growth minus inflation Economic growth is usually brought about by technological innovation and positive external forces

Distribution of income

Inflation

Inflation An increase in the overall average price level of goods and services in the economy How do we know when it is inflation? By computing price level using CPI index Key measurement: Consumer Price Index (CPI) Types of inflation: Cost Push Inflation Demand Pull Inflation Imported Inflation

Cost – Push Inflation A phenomenon in which the price levels rise (inflation) due to increases in the cost of wages and raw materials Develops because the higher costs of production factors decreases in aggregate supply (the amount of total production) in the economy Fewer goods being produced and demand for these goods remains consistent, the prices of finished goods increase (inflation)

Demand Pull Inflation Economists will often say that demand – pull inflation is a result of too many dollars chasing too few goods Is a result of strong consumer demand. When individuals are trying to purchase the same good, the price will inevitably increase

Unemployment The growth of economy and unemployment are always “catching our eyes” Why? Affect our future GDP rises (economic in boom), full of jobs GDP falls, firms facing a bankruptcy and more workers lost their job

Business cycles Alternating periods of economic growth and contraction, which can be measured by changes in real GDP (Tucker. I.B, 2008) As a mirror of changes in unemployment and other key measures of macro economy 4 phases: Peak Recession Trough Recovery

Government Policies In order to stimulate economic growth, price level and aggregate demand (AD) To combat recession and inflation Two types: Fiscal Policy (tax and government spending) Monetary Policy (money supply)

Fiscal Policy The use of government spending and taxes to influence the nation’s spending, employment and price level Falls in to two types: Expansionary Fiscal Policy Contractionary Fiscal Policy

Expansionary Fiscal Policy In order to combat recession To increase aggregate demand Reduce tax, increase government spending or equally

Contractionary Fiscal Policy To combat inflation To increase aggregate demand Increase tax, reduce government spending

Monetary Policy The government tool to control level of money supply in the economy Changes in money supply can led changes in interest rate How Federal Reserve’s power to change money supply can also alter the interest rate Two types: Expansionary Monetary Policy Contractionary Monetary Policy

Expansionary Monetary Policy To combat recession Increasing money supply leads interest rate to fall How? Funds will be injected into the banking system to reduce interest rates Spending and borrowing would increase Resulting increase in consumption and investment to stimulate economic growth

Contractionary Monetary Policy To combat inflation Decreasing money supply leads an increase in interest rate How? Withdrawing funds from the banking system and raising interest rates The higher interest rates will encourage people to save more and spend less More expensive for people to borrow money

GDP growth and public expenditure share to GDP (%)

Aggregate Demand The total amount of goods and services demanded in the economy at a given time period. Describe relationship between price levels and aggregate output Negative relationship Also known as “total spending” Formula: AD = C+I+G+(X-M)

Aggregate Supply A total supply of goods and services produced in the economy at given overall price level at given time period Positive relationship between price and output Also known as “total output”

AD – AS curve

Shifts in AD Consumer expect a recessions Foreign income rises Foreign price levels fall Government spending increases

Shifts in AD Consumer expect a recessions They will not spend as much money today as to “save for a rainy day’ Thus, if spending has decreased, then AD must decrease Shown shift to the left

Consumer expect a recessions

Shifts in AD Foreign income rises We would expect that foreigners would spend more money – both in their home country and in ours A rise in foreign spending and exports – increase AD AD curve shift to the right

Foreign income rises

Shifts in AD Foreign price levels fall If foreign price fall, then foreign goods become cheaper We expect that consumers in our country are now more likely to buy foreign goods and less likely to buy domestic made goods Thus, fall in AD AD curve shift to the left

Foreign price levels fall

Government spending increases

Shifts in AS Size and quality of labor Technological innovations Increase in wages Increase in production costs Changes in producer taxes and subsidies

Technological improvements

Shift in AS Workers expect inflation and negotiate higher wages now If the cost of hiring workers has gone up, then companies will not want to hire as many workers AS would shrink, and AS curve shift to the left Reduction in real GDP as well as increase in the price level The expectation of future inflation has caused price level to increase today

Workers expect inflation and negotiate higher wages now

Lower costs of input