Introduction to economics “Introduction to macroeconomics”

Introduction to economics“Introduction to macroeconomics”

Lecturer: Alberto Romero Ania

Export-Oriented Management

Introduction to Economics Lecturer: Alberto Romero Ania

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Macroeconomics:

• The branch of economics that studies the entire economy, especially such topics as aggregate production, unemployment, inflation, and business cycles.

• It can be thought of as the study of the economic forest, as compared to microeconomics, which is the study of the economic trees.

• The aggregate, or national economy is the prime focus of the study of macroeconomics.


• The three goals of economy that are most relevant to the study of macroeconomics are

– Full employment.

– Stability.

– Economic growth.


Macroeconomic goals:

• Full employment is the condition in which all of the economy's available resources are engaged in the production of goods and services. (Full employment of all resources, not only labor ones ! )

• Stability is the condition in which the economy avoids large changes in production, employment, and especially prices.


Macroeconomic goals:

• Economic growth is the condition in which the economy's production possibilities are expanding over time.

• The GDP is the total market value of all goods and services produced within an economy during a given period of time, usually one year.

• This is the government's official measure of how much output our economy produces.


Gross Domestic Product: GDP

• The general condition in which resources are willing and able to produce goods and services but are not engaged in productive activities.

• While unemployment is most commonly thought of in terms of labor, any of the other factors of production (capital, land, and entrepreneurship) can be unemployed as well.

• The analysis of unemployment, especially labor unemployment, goes hand-in-hand with the study of macroeconomics.


Unemployment:

• A persistent increase in the average price level in the economy.

• Inflation occurs when the AVERAGE price level (which is prices IN GENERAL) increases over time.

• This does NEITHER mean that ALL prices increase the same, nor that ALL prices necessarily increase.


Inflation:

• Some prices might increase a lot, others a little, and still other prices decrease or remain unchanged.

• Inflation results when the AVERAGE of these assorted prices follows an upward trend.

• Inflation is the most common phenomenon associated with the price level.


Inflation:

• It depends on expansions and contractions of the national economy (measured by gross domestic product, GDP).

• Unemployment inevitably rises during contractions.

• A complete cycle typically lasts from three to five years, but could also last ten years or more.


Business cycle and the Economy cycle:

• Economic cycles are predictable long-term pattern changes in national income. Traditional business cycles undergo four stages: expansion, prosperity, contraction, and recession. After a recessionary phase, the expansionary phase can start again. The phases of the business cycle are characterized by changing employment, industrial production, and interest rates


Economic Cycles:

• It is divided into four phases:1. Expansion2. Prosperity3. Contraction4. Recession

• For further information about the economy cycles click here !


Economy cycle:

http://academic.udayton.edu/JohnRapp/new_page_3.htm

• Unemployment rises during contractions and inflation tends to decrease during expansions.

• To avoid the inflation and unemployment problems of business cycles, the government frequently undertakes various fiscal and monetary policies.


Business cycle:

• 1.- A country´s standard of living depends on its ability to produce goods and services

– What explains the large differences in living standards among countries and over time?

Productivity: The quantity of goods and services produced from each hour of a worker´s time, as well as outputs from resources units used during the production.


3 Principles of Macroeconomics

• 2.- Prices rise when the government prints too much money

– Inflation is an increase in the overall level of prices in the economy

– Keeping inflation at a low level is what economic policymakers around the world must do.

– What causes inflation ? Answer: The growth in the quantity of money, because the value of the money falls.



• 3.- Society faces a short-run tradeoff between inflation and unemployment.

– When the government increases the amount of money there are two results: Inflation in the long-run and a lower level of unemployment in the short-run.

– The Phillips curve shows the short-run tradeoff between inflation and unemployment.

– For further information about the Philips Curve click here or here !



http://www.businessbookmall.com/Economics_16_Stagflation_and_the_Rise_of_Supply-Side_Economics.htm

http://www.rh.edu/~stodder/BE/MACRONOTES1.htm

• 3.- Society faces a short-run tradeoff between inflation and unemployment.



Macroeconomics is the study of the aggregate economy, including the topics of inflation, unemployment, business cycles, gross domestic product, money, fiscal policy, and

monetary policy.


Macroeconomics:

An economy is an interactive system of:

– Production– Distribution– Consumption

of resources, goods, and services that addresses

the basic economic problem of scarcity.


Macroeconomics:

• Economic functions are divided into four basic macroeconomic sectors:

1. Household: the consumers.

2. Business: the producers.

3. Government: the regulators and taxers.

4. Foreign: the others.


Macroeconomics:

• The household sector of macroeconomics is everyone in an economy, who consumes goods and services.

• Consumption is the use of natural resources, goods, or services to satisfy wants and needs.


The household sector:

• In a complex economy, consumption is expenditures by the household sector for the purchase of final goods and services.

• Household sector is a term that indicates the population´s consumption and the satisfaction of its wants and needs.

Everyone in society is included in the household sector.


The household sector:

• Produces the goods and services that are consumed by the household sector.

• The business sector is responsible for production by combining the four basic resources: – Labor– Capital– Land,– Entrepreneurship.


The business sector:

• A business is a method of combining resources for production.

• While the business sector buys raw materials, intermediate goods, and other things, the most important purchase of the business sector is capital goods, or investment in capital.


The business sector:

The government sector• Affects resource allocation and production by imposing

laws and regulations that force decisions which otherwise would not be made.

• There are different levels of government: Federal, State, Autonomous Region, and Local.

• The government sector collects taxes and buys a share of the economy's production, termed “government purchases”.

• These are goods such as national defense, highway and street construction, education, and police protection.


The government sector and the public goods• Government should provide public goods.• Public good is a good that is non-rivaled and non-excludable.

This means that the consumption of the good by one individual does not reduce availability of the good for consumption by others; and that no one can be effectively excluded from using the good.

• Terminology, and types of goods:


Economic activity

• It is divided into domestic and foreign.

• Any citizen of Austria, any firm owned by an Austrian citizen, and the government of any Austrian city are part of the Austrian domestic economy.

• Any resident, business or government of another country is part of the foreign sector.


Economic activity

• Exports are goods purchased by the foreign sector that are produced by the domestic economy.

• Imports are goods purchased by the domestic economy that are produced by the foreign sector.

• Net exports are the difference between exports and imports, or exports minus imports.

What happens if Euro increases its value versus Dollar ?


Case of study: Euro increases its value vs Dollar

What happens if Euro increases its value versus Dollar ?Is it good or bad for the domestic economic activity ?


Case of study: Euro increases its value vs Dollar

What happens if Euro increases its value versus Dollar ?Is it good or bad for the domestic economic activity ?

• Exports point of view: It is good to reduce exports and bad to support exports, because the goods and services from United States and other no-euro countries become more expensive.

• Imports point of view: It is good to support imports and bad to reduce imports, because the goods and services from United States and other no-euro countries become cheaper.


Macroeconomics / Microeconomics

• Macroeconomics is the study of the entire economy, the aggregate economy.

• Microeconomics is the study of parts of the economy.• Economists first studied parts of the economy (markets,

demand, supply, and prices), what we now call microeconomics.

• The Great Depression of the 1930´s motivated economists led by John Maynard Keynes to study macroeconomics.

Macroeconomics affects microeconomic decisions and microeconomic decisions affect Macroeconomics.


Three Macroeconomic Goals:

• Full employment: Using all available resources for production.

• Stability: Avoiding inflation and/or fluctuations in the economy.

• Growth: Lessening the problem of scarcity by increasing production capabilities.


Three Macroeconomic Goals:

• We always pursue these goals but conflicts mean we cannot reach them at the same time.

Macroeconomic problems from not reaching this goals are: production, unemployment, and inflation.


Unemployment

• Unemployment exists when resources, especially labor, are willing and able to produce goods but are not employed because no one is buying production.

• Voluntary unemployment occurs when people choose not to work. (Would you continue working if you made lottery winnigs?)

• Involuntary unemployment occurs when people are willing to work, but can't find employment.


Unemployment problems:

• The economy suffers because unemployed resources are not producing goods to lessen the scarcity problem.

• The unemployed suffer personal hardships and a lower living standard.


Inflation problems:

• It is a stability problem

• It typically emerges if the four macro sectors of the economy demand more goods that the economy can produce.

• In future prices will increase much more.


Inflation problems:

• Financial assets like money, bank accounts, stocks and bonds decrease in value because of higher prices. (Same quantity of Euros could not buy the same quantity of products)

• Income and wealth are haphazardly redistributed because prices change at different rates.


The macroeconomy is unstable

• It has periods of falling production, rising inflation, and/or high unemployment.

• Business cycles are recurring expansions and contractions of the aggregate economy.


The macroeconomy is unstable.

• Expansion is a general period of increasing economic activity or rising production, which is associated with low or falling unemployment and high or rising inflation.

• Contraction is a general period of decreasing economic activity or falling production, which is associated with high or rising unemployment and low or falling inflation.


To understand business cycles: Causes

• Consumption: If households decide to buy more or less, the rest of the economy follows it.

• Capital Investment: Big investment movements can set in upward or downward spirals of total production.

• Government Purchases and Taxes: – Government purchases (contractionary or expansionary) effect over

the economy. – Taxes affect both the ability of the household to buy production and the

ability of the business sector to make investments.


To understand business cycles: Causes

• Net Exports: Changes in imports/exports can involve expansions and contractions of the domestic economy. (Example: clothes from Asia)

• Circulating Money: Too much money produces inflationary expansion, and too little money produces contraction and unemployment.

• Resource Supply: Resource supply changes (energy prices, technology, wages, etc.) can produce expansions and contractions. (Example: Oil supply affects economy)


Government

• Government tries to bring the economy closer to the macro goals of full employment, stability and growth, and to lessen the scarcity problem.

• Economic policies are government actions designed to affect the economy to pursue the economic goals.

• Stabilization policies are designed to limit economic instability and business cycles and avoid high rates of unemployment and inflation.


Key macroeconomic stabilization policies:

• Fiscal policy is the use of governmental spending and taxes to stabilize the economy.

• Monetary policy is the use of the amount of money in circulation to stabilize the economy.


Different views of government and economic• People can take different views of government and economic

polices, which depend on political philosophies.

• Liberal Democrat: The view that government is the only way to keep the economy running smoothly, using paternalistic, hands-on policies.

If a problem arises, then government is the answer.


Different views of government and economic

People can take different views of government and economic polic, which depend on political philosophies.

• Conservative Republican: The view that government is the problem, not the solution. The best government is the smallest government because it is a tyrannical oppressor of individual rights and freedoms.

Free markets should run the economy


Politics and Economy:

Reasons for differing views of the 'best' economic policies:

• First: Human beings are different, with different likes, dislikes, tastes, preferences, values, beliefs, ideologies and opinions. This is the source of differences on what is considered the 'best' for the economy.

• Second: Human beings often have vested interests in the consequences of the policies. They personally benefit from a policy. While self-interest is okay, the question is whether self-interests of the few prevent greater welfare of the many.


Theories

• Using the scientific method to test macroeconomic theories is an evolving process. Over time, more hypotheses are tested and macroeconomic theories grow, expand and improve.

• The result of combining different political philosophies and vested interests with the inability to provide definitive explanations, creates alternative, competing theories that seek to explain the world.


The veil of ignorance theory• Rawls argued that the representative parties in the original

position would select two principles of justice:1. Each citizen is guaranteed a fully adequate set of basic

liberties, which is compatible with the same set of liberties for all others;

2. Social and economic inequalities must satisfy two conditions: – Provide the greatest benefit of the least advantaged – Nobody knows its final position in society. The reason that the

least well off member gets benefited is that it is assumed that under the veil of ignorance, which is the original position, people will be risk averse. This implies that everyone is afraid of being part of the poor members of society, so the social contract is constructed to help the least well off members.


Business Cycles

• It's a fact of life that the economy is unstable.

• The economy expands and contracts.

• In general, we prefer the good that comes with a rising, expanding economy and don't like the bad that comes with a falling, contracting one. (But others prefer the contrary, example: Businesses focused on recovering debtors accounts & unpaid bills )


Business Cycles

• The fluctuations in economy never stop.

• It is difficult for economy to run full speed at all times.

• Economic fluctuations go by the term business cycles.


Business cycles are irregular

• Business cycles are irregular. (Life is good, then it's bad.)

• For example, the Great Depression in the 1930´s was the worst economic period in the previous century.

– Unemployment reached 25%.

– Total production declined by about 40%.

– Investment declined by 90%.


Business cycles are irregular

• During the 1920´s, production was up, unemployment was down, life was good, then it got bad.

• Although we use the term 'cycle', we don't know how long an expansion or a contraction will last.

– The economy might expand for a year or it might expand for a decade before it declines.

– It is unpredictable because it depends on very many variables.


Expansionary Good Times

• The good side: The economy is growing, more goods are produced, living standards rise, businesses are profitable, and scarcity problems are lessened.

• The bad side: Inflation and inefficiency.


Expansionary Good Times

• Inflation tends to worsen when the economy expands too rapidly. Inflation is usually a bigger problem for some than for others, including those on fixed incomes and with financial wealth.

• Inefficiency is likely during an expansion. With the expansion of the entire economy and by everyone becoming better off, the incentive to be efficient is reduced.


Contractionary Bad Times Problems

• First: Real GDP declines during a contraction. This means less production for the four sectors to buy.

• Second: Unemployment increases. Resources, especially labor, produce less and receive less income.

• Third: The incomes of employed resources also tend to fall, or at least do not rise as much as during an expansion.


Contractionary Bad Times Problems

• Fourth: Business profits decline and bankruptcies increase, as a consequence we have more unemployment.

• Fifth: Social problems worsen, including crime, poverty, and alcoholism.

• But contractions have some positive aspects, too ! ! !

– Inflation remains low or declines – Resources are allocated more efficiently .


A business cycle is a combination of two periods• In general, as real GDP has a long term upward trend, it

generally increases overtime.• The business cycle is a combination of the two periods,

– (1) expanding economic activity moves the economy up to and above the long-run trend

– (2) declining activity that drops it below this trend.


GDP Over time• The red line represents the pattern of actual real GDP over

time.• The gray line is the long-run trend (Example: the historical

average of real GDP growth, about 3% each year).


A contraction

A contraction is officially designated as a period of at least six months of economic decline.


Contractions:• A contraction takes the economy from above the long-run

trend to below the long-run trend.• Contractions don't last forever. The end of a contraction is

the trough, the turning point to an expansion.


A recovery:• An expansion recovery period is a period of aggregate

economic increase, indicated by the growth of real GDP from B to C.

• Whenever the economy approaches point C above the long-run trend, inflation is most likely to become a problem, as we try to buy more output than our resources can produce.


Anticipating a peak turning point helps !• Anticipating a peak turning point helps to avoid the

problems of unemployment, a bankrupt business, or lower income.


Indicators• Since the 1930s´ Great Depression, when the modern study

of economics was prompted, economists have been searching for indicators of business cycles.

• Some indicators that are useful measures are:– Real GDP– Unemployment rate– Inflation rate

But they measure only specific aspects of the economy.

These may not be the only indicators of overall business cycle activity.


Other Indicators:• Economists have identified three sets of indicators that lead

the business cycles changes:

1. Leading indicators.

2. Coincident indicators.

3. Delay or lagging indicators.


Leading economic indicators

• Indicate business-cycle activity 3 or 12 months ahead.

• If leading indicators decline now, then the economy is very likely to decline in 3 to 12 months.

• Leading indicators are eleven statistics indicators that precede changes in the economy.


Leading economic indicators• Three notable leading indicators are stock market prices,

the money supply, and consumer confidence.• The Composite Index of Leading Indicators, displayed in

this chart, combines all eleven into a single number.• The Composite Index works better than individual indicators

do, but it is not perfect. Some declines are not followed by a contraction.


Coincident economic indicators

• Coincident economic indicators move along with the aggregate economy. They mark the business cycle.

• The four coincident indicators are measures of:

– Production.– Employment.– Income.– Sales.


Coincident economic indicators• The Composite Index of Coincident Indicators, displayed

in the graph, combines all four. Turns in this index mark business cycles´ peaks and troughs.


Coincident economic indicators

Leading and coincident indicators work together. Leading indicators forecast turning points. Coincident indicators

turn 3 to 12 months later.


Lagging economic indicators

• Lagging economic indicators lag the turning points of business cycles after 3 to 12 months.

• Lagging indicators certify that a contraction or an expansion is over.

The next turning point usually doesn't begin until lagging indicators confirm that the last one has happened.


Lagging economic indicators• Seven statistics are used as lagging indicators, including the

inflation rate, consumer debt, and the prime interest rate. (The Prime Interest Rate is the interest rate charged by banks to their most creditworthy customers (usually the most prominent and stable business customers))

• The Composite Index of Lagging Indicators, displayed in this graph, combines all seven into a single number. This index turns after the official business cycle.


Summary

• Several types are of measurements are used to indicate business cycle activity.

• It is possible to make use of leading economic indicators that reach turning points 3 to 12 months before the business cycle reaches these turning points.


Summary

• Coincident economic indicators mark and show the actual business cycle turning points.

• Lagging economic indicators, that reach turning points 3 to 12 months after official business cycle turning points, provide valuable information.


Introduction to economics“Introduction to macroeconomics”

Lecturer: Alberto Romero Ania

Export-Oriented Management


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Introduction to economics “Introduction to macroeconomics”

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