INTRODUCTION TO MACROECONOMICS Modified1

8/7/2019 INTRODUCTION TO MACROECONOMICS Modified1

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INTRODUCTION TO MACROECONOMICS

OBJECTIVE OF THE SERVICE COURSE INMACROEOCONIMCS:

TO BRUSH UP YOUR KNOWLEDGE IN

MACROECONOMICS.

TO IDENTIFY THE LEVEL OF THEKNOWLEDGE AQUIRED BY YOU

TO SET THE GROUND FOR THELAUNCHING THE ADVANCED COURSE INMACROEOCONOMICS


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WHAT IS MACROEOCONOMICS?

IT VIEWS ECONOMICS ISSUES USING ATELESCOPE!

PUT IT DIFFERENTLY,

MACROEOCONOMICS PROVIDES A BIRDSEYE VIEW ON ECONOMIC ISSUES.


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MACROECNOMICS concern with theeconomy as a whole

It analyses the causes of major problems:

High unemployment

Rampant inflation

Low wages

Low economic growth

It analyses the

Short term fluctuations [output, employment,price]

Long term increases [output, living standard]


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MACROECNOMICS concern with theeconomy as a whole

It analyses the causes of major problems:

High unemployment

Rampant inflation

Low wages

Low economic growth

It analyses the

Short term fluctuations [output, employment,price]

Long term increases [output, living standard]


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MACROECNOMIC objectives of aneconomy: Achieving

High level of output [GDP]Full employment

Price stability

Sustainable balance ofpayments

Raid economic growth


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Gross Domestic Product [GDP] GDP is the market value of all goods

and services produced by factorslocated within the Boundaries of acountry, during a specified period oftime usually a year

Nominal and real GDP:Nominal GDP when adjusted for pricechanges [inflation] gives the real GDP


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POTENTIAL GDP AND ACTUAL GDP

Potential GDP is the maximum outputan economy can produce when all its

resources are fully employed [alsoknown as full employment output]

At potential GDP level an economyenjoys:

Low unemployment rates

High production levels


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POTENTIAL GDP is determined by

Availability of inputs:

Land

Labor

Capital

Entrepreneurship

The countrys technological competence

Potential GDP tends to grow veryslowly but steadily


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Actual GDP is influenced by businesscycles and changes sharply fromyear to year

Macroeconomic policies affect actualGDP quickly but slowly on potentialoutput

Actual GDP diverges from potentialGDP during business cycles

The gap between potential GDP andActual GDP is the GDP gap


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The GDP gap indicates the intensityof business cycle

If actual GDP > potential GDP

inflationary output gap If actual GDP < potential GDP

deflationary [recessionary] outputgap

The objective of macroeconomicpolicies is to minimize such gaps andincrease potential output in the long

run


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Macro objectives: Full employment:

Gainful employment will reduce poverty During a recession unemployment rises

Price stability: Prices determine the purchasing power of

money During inflation PP of money will erode

Inflation is calculated by WPI, CPI Extreme form of inflation is hyper-inflation High inflation disturbs decision-making During high inflation people prefer to have

real assets

People lose confidence on currency


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Macro objectives: Sustainable Balance of PaymentsBOP is a systematic record of alltransactions of a country with the restof the world

Transactions consist of Exports imports of goods and services Lending borrowing and investment in

foreign countries An important indicator of foreign trade

is net exports [export less imports] alsoknown as the Trade Balance


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Macro objectives: Export >imports Positive trade balance Export


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Macro objectives: Economic growth usually refers to:

An increase in PPF curve A growth in real output [GDP] or real per

capita output [per capita GDP] The per capita GDP is also determined

by a third factor: the population growth If real GDP grows at g% and population

grows at p% per annum, per capita GDPmust grow at% growth Per capita GDP=([1+g]/[1+p])-1


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INSTRUMENTS OF ECONOMIC POLICY

Fiscal policy

Monetary policyExchange rate policyInternational trade policyEmployment policyPrices and income policy


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Instruments of macroeconomic policy

Objective Instrument /Tool

High output level

Low unemploymentrate

Stable price level

Maintenance of the BOP

Steady economicgrowth

Monetary policy

Fiscal policyExchange rate policy

International trade

policy

Prices and incomepolicies

Employment policy


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Fiscal policy This refers to the government policy on

its revenue and expenditure

Government expenditures:

Purchases [spending of goods andservices, investment] Transfer payments [samurdhi etc] Government spending has a +veeffect on overall spending of theeconomy which influences the GDP

Government spending is used as atool to control the level of economicactivity


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Fiscal policy This refers to the government policy on

its revenue and expenditure

Government Revenue:

Taxation is the main form ofgovernment revenue Taxation affects the economy in twoways: Changes in taxation affect the disposable

income of people. A fall in tax canincrease consumption It affects the prices of goods and

services. A fall in taxes may increaseinvestment which can spur growth


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Monetary policy The monetary system of a country

consist of institutions that createsfinancial assets with a high degree ofliquidity

This system is guided and controlled bythe central bank of a country

The central bank, commercial banks andother non banking financial institutions

constitute the financial system The monetary policy of a country is

formulated and implemented by thecentral bank.

It controls the money supply interest

rates and the quantity of credit.


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International Trade policy Trade policies relate to tariff and non

tariff regulations that limit or promotethe exports and imports of a country

East Asian countries used theirtrade policies strategically toincrease economic growth.

Sri Lanka after a 7 year period ofdirigiste regime opened itsinternational trade

Sri Lanka has a limited number ofinstruments to control trade


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Exchange Rate Policy These policies are also closely related totrade policies, since ER affects bothimports and exports

Foreign exchange rate management

play a crucial role in international trade. ER is the price of one currency in terms

of another currency The ER policy forms apart of a countrys

monetary policy Some countries use a fixed ER against

other currencies Others allow market forces to determine

the ER

INTRODUCTION TO MACROECONOMICS Modified1

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