Introduction toMacroeconomics

Eren BALABAN

08.10.2019

Introduction

• In macro economics, not only the supply and demand for particularproduct in a particular market, but the supply and demand for allgoods and services produced in economy. Following properties arealso considered.• Average price of all products

• Overall consumption of all the people of families in the economy.

• Investments of all businesses in economy as a whole.

• Macroeconomic analysis deals with how macro variables of a nationaleconomy affect each other and how they are determined when theeconomy tends to achieve equilibrium.

Birth of Macroeconomics

• Classical supply and demand theory suggest that; when there is an unemploment, excessive supply of labor decreases wages andgenerates a new equilibrium point. However, during great depression, unemployment levels were extremely high and classical models couldnot explain that much lasting unemployment period.

• Therefore, Maynard Keynes developed the opinion that the aggregatedemand for goods and services produced in economy is the main factor determining the employment. He also argued that thegovernment may interfere to economy with various policies, thus mayaffect production and employment volume. His opinions has beencalled as Keynesian Revolution after 1936.

Birth of Macroeconomics

• According to Keynes; government should interfere when privatesector’s spending is insufficient; supporting aggregate demand, in order to prevent a reduction in output and employment in a period of inadequacy of special sector demands.

• Government can use tools like taxes and spending to achieve targetssuch as smoothing fluctuations in production and employment, realizing stable growth in production and employment becameincreasingly widespread.

Basic Concerns of Macroeconomics

• Threre are three basic indicators related to health of an economy;1. Unemployment Rate

2. Inflation Rate

3. Output Growth Rate

Employment and Unemployment

• Hired people and people actually seeking for a job together constitutethe total labor force.

• Employment is being hired the people deciding to work and earnincome in order to benefit their labor services.

• Unemployed is used for the person who is willing and able to work, but not finding a job even accepting the current wage rate.

• Unemployment rate is the percentage of unemployed people in thetotal labor force.

Types of Unemployment

• Cyclical Unemployment: It is the type of unemployment caused by therecession occasionally occured in economic life.

• Regional or Sectoral Unemployment: A region or sector might become lessfavorable which cause contraction in production and yields unemployment. This type of unemployment is partial but permanent.

• Structural Unemployment: Structural unemployment occurs when theoverall economy with its all sectors stays in a recession continuously.

• Hidden Unemployment: If there is no contraction in production in a specificsector of the economy when some of the employed workers are laid of, it means these laid off workers were hidden unemployed in that sector.

Inflation and General Price Level

• If there is an increase in a single good’s price, it is not correct toconsider this as inflation. If the prices of most of the goods andservices in an economy increase, then inflation occurs. Hyperinflationcan be defined as the very rapid increase in overall prices.

• General price level theoretically indicates the weighted average of allgoods and services in an economy within a period of time.

• Price levels in various years are explained in terms of increases anddecreases according to base year’s price level. Base year is not selected randomly, rather various economic, politic and social eventsare considered in selection.

Production Growth Rate

• Total production is the total of all goods andservices produced in an economy for a given periodof time.

• The rise in the capacity of economy to producegoods and services is called as economic growth. Inanother words, economic growth is the expansionof production possibilities of a country.

• Production capacity sometimes rises, sometimesdecreases. These fluctuation is known as businesscycle.

• When less products are produced in some period, this period is called as contraction or recessionperiod.

• When total production rises rapidly and more goodsand services are produced in the economy, thisperiod is named as recovery period.

Government and Macroeconomy

• Government can affect the macro economy by using following tools1. Fiscal Policy

2. Monetary Policy

3. Supply Side Policy

Fiscal Policy

• Fiscal policy is the decisions related to taxes that government collectsand expenditures that government makes.

• The scale and composition of these taxes and expenditures have a significant effect on the economy. Fiscal policy can be used to stabilize the fluctuations in production and employment.

• Government should decrease taxes and/or rise expenditures to avoidthe economic resession. This is called expansionary fiscal policy. Intimes of inflationary period, government should rise the taxes and/ordecrease expenditures to lower the inflation rate. This is called as thecontractionary fiscal policy.

Monetary Policy

• Monetary policy is the measures that the central bank takes tocontrol the quantity of money in the economy.

• The amount of money in an economy affects general price level, interest rate and exchange rate as well as its effects on unemployement and production.

Supply Side Policies

• Supply side policies aim to increase production instead of increasingaggregate demand.

• Supply side policies insist to accelerate economic growth rate is thetax system of the country. Economists who have this opinion suggestto reform the tax system in a way that it will encourage willingness towork, saving and investment.

Basic Components of Macroeconomics

• Macroeconomy consists of four groups as1. Households

2. Businesses

3. Government

4. Other Countries

• These four groups are in mutual relations with each other in variousways.

Basic Components of Macroeconomics

• Transfer payments are the payments thatgovernment and firms make tohouseholds without having in return forgood, service or labor.

National Income Accounting

• Economic performance of the particular country used to be measuredby its gold stocks in the past.

• Economic performance of a country is measured with respect to itsnational income accounting system today.

National Income Accounts

• Measuring the activities forming the income in a country is called as national income accounting.

• Figures issued in national income accounting system includeproduction data regarding the whole sectors of economy. Thosefigures are announced four times a year.

• These figures provide general summary of economic activities, showrelationships among production, income and total spending in country.

• Production level of a country can be measured by using prices of thegoods.

Gross Domestic Product • Total market value of finished (final) goods and services produced in a period of time in an economy is calledthe gross domestic product (GDP). GDP is the most widely used concept toevaluate the country’s general economic performance. Duringcalculation of GDP, double countingmust be avoided. Therefore, definitionof intermediate goods should be madeand they should be disregarded.

• Intermediate goods are used toproduce other goods and services in the economy.

• It is required to find and sum up thenet value added to GDP as a result of production of each businesses. Thisvalue is called the value added andcalculated by subtracting the value of intermediate goods from the value of production of related business.

Gross Domestic Product

• Final goods and services are the goods and services produced for ultimateusage for economic agents.

• It is difficult to determine the values of some goods and products such as security, justice, national defence or education provided by government.

• It is useful to exclude some products from GDP such as services providedby housewives due to it is difficult to estimate value of those products.

• Transactions which are totally financial are also excluded. Payments toeconomically weak people can be given as example.

• Second hand trade is also not counted in calculation of GDP.

Gross National Product

• GDP indicates the production realized within the borders of a country, but does not refer to the value of production made by a citizen of a country abroad. However, it includes production of foreigners in thatcountry. However, all foreigner’s would transfer their profit to theirhome country.

• Therefore, alternative definition is developed as gross nationalproduct (GNP). GNP shows the value of goods and services producedby the production factors belonging to that country.

• The difference between GDP and GNP is very low for many countries.

Calculation of GDP

• The GDP can be calculated in three different ways as;1. In terms of the total value of goods and services produced.2. In terms of the income obtained in return for producing goods and services3. In terms of expenditures made for goods and services produced.

• Total expenditures in an economy should be equal to the value of createdproduction.

• Value added for each sector is measured and added into each other tocalculate GDP. Those sectors can be named as• Agriculture• Industry• Transportation• Telecommunication• Trade and government services

Calculation of GDP

• When GDP is calculation is based on total income; it is necessary toknow the salaries and wages seen in payrolls of workers, officers andother employees, wage income paid in businesses and earningsshown other revenue groups’ income tax returns.If people do not pay their taxes accordingly, it is difficult to calculate GDP in terms of income earned.

• Total revenues obtained by production factors in a country is called as national income.

Calculation of GDP

• If we consider changes in stocks of businesses as a kind of expenditure, total expenditure amount for final goods and services should be equal to total production value of these final goods and services. Total expenditures for final goods and services can be divided into four groups

1. Consumption Expenditures: Expenditures made for goods and services which may directly meet the daily needs.

2. Investment Expenditures: Expenditures of businesses and government for new equipment, tools and buildings, increase in stocks and expenditures of individuals for building new houses. Investment amount calculated by summing those is said to be gross investment. In order to calculate net investment, costs of maintenances should be subtracted. If net investments are positive, due to increase in capital stock, productive capacity will rise.

Calculation of GDP

3. Third expenditure type is government expenditure and it is defined as total payments for purchasing goods and services by public organizations toperform the functions the government undertaken.

4. Fourth type of expenditure type is the net expenditure related to goodsand services. It is defined as the difference between export income andimport expenditure.

Other Concepts Related with GDP

• Equipment used during production will be worn off after sometime. In order to fix those equipment, some money should be saved. Therefore, GNP indicates the gross production power of a country. Inorder to take into account those wear into account, anotherdefinition is made as net national product (NNP).

• NNP and GNP are close to each other and always change in the samedirection.

• Indirect taxes are paid when a good or service is purchased. If wesubtract indirect taxes from NNP we get the value of national income. This obtained magnitude should be equal to total of incomepayments to the country’s production factors.

Other Concepts Related with GDP

• Personal income is the gross income obtained by subtracting theundistributed profit and social security contributions and addingprivate and public transfer payments. It differs from national incomein two ways.

1. Some production factors earning income in return for joining to productiondo not actually get this income.

2. Some individuals can earn income without participating into productionssuch as unemployment payments. Those payments should be added tonational income to obtain personal earning from all sources.

• Disposable income is the usable income obtained by subtractingdirect taxes from personal income such as income tax.

Price Changes and GDP

• If all the prices in the market increases; GDP also increases. Therefore, GDP valuecalculated by current market prices are called as GDP at current prices or nominal GDP.

• In order to eliminate price effects on GDP, a base year is selected and GDP is calculated according to market prices of selected year. Selected year is called as base year. Price effect is eliminated by doing so.

• GDP calculated by this way is called as real GDP or GDP at constant prices. Ifincrease in GDP will be used as an indicator of increasing wealth, then real GDP should be used, especially in high inflation periods.

• Ratio of value of a basket of goods and services with current prices to value of thesame basket with the base year’s prices is called as price index. Price index is used to convert nominal values to real values.

• If price index is used to convert nominal GDP to real GDP, it is called as GDP deflator.

Price Index

• Value of pen production at current prices decreased while real value of production increased at 2013. The reason for that situation is that theunit price of pen in 2013 decreased.

• The nominal value of pen production increased while the real valuedecreased due to rapid increase in pen price.

Limitations of GDP Usage

• Six important aspects should be kept in mind during using GDP as an indicator.

1. GDP does not make any sense if the population of country is unknown. In order toeliminate population effect GDP/capita should be used. In order to comparewealth of people from different countries, per capita national income should be used. Per capita national income is calculated by dividing dollar value of nationalincome to population and used.

2. Leisure time is not taken into consideration when GDP is calculated.3. GDP doesnt consider the quality changes of produced goods if improvement or

decline in quality is not reflected to prices.4. GDP doesn not provide detailed information about combination and distribution

of income created in country.5. GDP does not reflect social costs due to production of goods and services such as

pollution.6. There are many activities need to be added to GDP in principle but not included

actually. Illegal activities can be given as example.