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Macroeconomics Introduction Frederick University 2014 Economic Agents government Final goods and services L, N, K households firms 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 Problems What and how much How For Whom 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 Production Possibilities Curve W 20 A wine 20 16 12 8 4 0 movies 0 6 10 13 15 16 choices A B C D E F 16 B C 12 16 0 6 10 F M Physical and Institutional PPF w Physical PPF Physical PPF – indicates the potential of the economy to produce, constrained by the physical availability of resources Institutional PPF M 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 = [(CPI20012 – CPI2011) : CPI2011] 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 AD depends on: AD The willingness of households to buy output The willingness of firms to buy output Government fiscal and monetary policies output 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. AS depends on: Price level AS Physical PPF – resources and technology Potential output determined by institutions, shaping costs, efficient use of resources Output Macroeconomic Equilibrium P AD AS E Output AS and AD determine: equilibrium output the level of employment and unemployment the price level and the rate of inflation the balance of payments Expenditures on final goods and services Final goods and services FIRMS HOUSEHOLDS Production factors Primary Income 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: Value added 1. 2. 1. 2. 3. Wheat from the farmer – € 0.15 Flour from the miller – €0.43 Bread from the backer – €0.84 3. 4. Wheat – €0.15 Flour – €0.28 Bread – €0.41 Total Value added = = 0.15 + 0.28 + 0.41 = 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