Macroeconomics Introduction Frederick University 2014

Economic Agents households firms government L, N, K Final goods and services

Factors Generating Economic Problems Scarcity of resources Technological changes Changes in tastes and preferences

Main Economic Questions Generators Scarcity of resources Technological changes Changes in tastes and preferences Questions What (and how much) How For whom

Main Economic problems Questions What and how much How For Whom Problems Efficiency in allocation Efficiency in motivation Efficiency in distribution

Economics Economics is the study of how economic agents make decisions what to produce, how to produce, and for whom to produce

Microeconomics vs. Macroeconomics Microeconomics – studies how economic agents make decisions what, how and for whom to produce from the point of view of individual households and firms Macroeconomics - studies how economic agents make decisions what, how and for whom to produce from the perspective of the impact of these decisions on the national economy as a whole.

Major Macroeconomic Issues Output Employment and Unemployment Price Level

Macroeconomic objectives Issues Output Employment and Unemployment Price level Objectives High level and rapid growth of output High level of employment and low level of involuntary unemployment Price level stability

Production Possibilities Frontier winemovies choices 200A 166B 1210C 813D 415E 016F A W B C F M Production Possibilities Curve

Physical and Institutional PPF w M Physical PPF Institutional PPF Physical PPF – indicates the potential of the economy to produce, constrained by the physical availability of resources Institutional PPF – indicates the potential of the economy to produce, constrained by the physical availability of resources and by the rules and traditions followed by the decision makers

Institutional PPF and Potential Output Potential Output – the maximum sustainable level of output that the economy can produce, given the productive capacity, the economy’s technological efficiency, and the rules and traditions, followed in the economy When actual output exceeds potential output, price inflation tends to rise When actual output falls below the potential, unemployment tend to increase

The Rate of Employment and The Rate of Unemployment Employment Rate – reflects the fraction of working population over 16 and below 64 years Unemployment rate – reflects the percentage of unemployed in the labor force Labor force = employed + unemployed Unemployment rate = [unemployed : (employed + unemployed)] x 100% Natural rate of Unemployment – the rate of unemployment, determined by the institutional PPF and potential output.

Price Stability and the Rate of Inflation Price stability – the price level is unchanged or rises very slowly The Consumer Price Index (CPI) - measures the average price of goods and services bought by consumers Rate of Inflation – the percentage change in the overall price level from one year to the next Inflation 2012 = [(CPI – CPI 2011 ) : CPI 2011 ] x 100%

Aggregate Demand AD – the quantity of GDP, which the economic agents are planning to buy at every price level, ceteris paribus Price level output AD AD depends on: The willingness of households to buy output The willingness of firms to buy output Government fiscal and monetary policies

Aggregate Supply Aggregate supply (AS) - the total quantity of goods and services that the firms in the country are willing to produce and sell at every price level, ceteris paribus. Price level Output AS AS depends on: Physical PPF – resources and technology Potential output determined by institutions, shaping costs, efficient use of resources

Macroeconomic Equilibrium P AS and AD determine: equilibrium output the level of employment and unemployment the price level and the rate of inflation the balance of payments Output ADAS E

FIRMS HOUSEHOLDS Expenditures on final goods and services Primary Income Production factors Final goods and services The Circular Flow

GDP Gross Domestic Product – value of final goods and services produced in the economy within a year  Final goods and services – produced during the current period and not used in the production of other goods and services  Intermediate goods The double counting problem

Value Added Stages of the production process of 1/2 kilo of bread: 1. Wheat from the farmer – € Flour from the miller – € Bread from the backer – €0.84 Value added 1. Wheat – € Flour – € Bread – € Total Value added = = = 0.84

Expenditure Approach Economic Agents households firms government foreigners Expenditures C + I + G + X - M

Expenditure approach GDP = C + I + G + X – M = АЕ Aggregate Expenditures

Income approach GDP = ∑ primary income = Wages and salaries + proprietors’ income + interests + rents + dividends + retained earnings + depreciation

Expenditure approach vs. Income approach АЕ - Indirect taxes - + subsidies = Primary income

Three approaches to GDP calculation The value added approach The expenditure approach The income approach

GDP vs. GNP GDP – created on the national territory GNP – created by the citizens of the country

Net Domestic Product GDP (АЕ) – depreciation allowances = NDP

Domestic Income, Personal Income and Disposable Income GDP (income approach) - Depreciation = NDP (income approach) = Domestic income Domestic income - Retained earnings - Corporate taxes - Social security + Transfer payments to the households _________________________________ = Personal income - households’ income taxes = Disposable income

GDP Shortcomings underground activities income distribution leisure time demerit activities market prices public goods production at factor prices quantity vs. quality net exports might not contribute to the growth of welfare

Real vs. Nominal GDP Nominal GDP – GDP at current prices Real GDP – GDP at constant prices (base year prices – chosen year) Index – the change in the value of an indicator compared to its previous level, taken as a base (= 100) GDP deflator = (Nominal GDP : Real GDP) х 100