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The Nature of Macroeconomics

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Introduction

1. The Nature of Macroeconomics Macroeconomics * Macroeconomics deals with the economy as a whole * To gain an overview of the whole economy and relationships between its parts --> allow policy makers to develop policies to achieve stable, sustainable economic growth and maximise human welfare * 3 interrelated measures of economic activity or aggregates o Total output --> (production) of goods and services o Total spending --> on goods and services o Total income --> paid to owners of all factors of production * John Maynard Keynes challenged mainstream (neoclassical) --> Say's Law = supply creates its own demand * Neoclassical = all markets work by themselves through a flexible price mechanism which automatically adjusts in response to market forces and guarantees full employment of resources = assumes perfectly flexible prices, therefore no need for government intervention. * Keynes = no such automatic mechanism and markets are imperfect, therefore equilibrium could exist at a level below full employment of resources * Demand management = government should intervene by raising aggregate demand of aggregate expenditure to shift the economy back towards full employment Measurement of Macroeconomic Activity * Measuring Gross Domestic Product (GDP), 3 methods: o Income approach = summing up all incomes paid to factors of production o Expenditure approach = summing up all spending on final goods and services. (exports are added, imports subtracted : X - M) o Production approach = summing up the market value of final goods and services : gross output of firms minus the costs of intermediate goods and services (goods and services used in production) Microeconomics * Microeconomics deals with single economics agents or units * 4 questions: o What determines the relative prices of goods and services? o What determines an individual's consumption pattern? o How decisions are made by firms : what, how, how much and for whom to produce o How can individual units be made to work more efficiently * Total output of an economy is made up of the production of many individual units, both public and private sectors 2. ...read more.

Middle

full employment of resources * Called a deflationary gap and an increase in the level of total spending in the economy is needed * Y2 = income and output is above full employment, excessive aggregate expenditure in the economy * All resources are utilised thus no more output is possible in the short term, prices rise * Difference between Yfe and Y2 thru rising prices not increased output * Called an inflationary gap where excess AD over and above needed to achieve full employment * Yfe = just right to fully utilise all existing resources and produce enough goods and services to meet demand * No inflation or unemployment Pg 67 Policy Solutions Deflationary Gaps * To raise AD1 to AD2 government uses a combination of fiscal policy and monetary policy measures G � T v r v Pg 69 Inflationary Gaps * To lower AD1 to AD2 government uses FP and MP G v T � r � Pg 69 * Consumers and businesses may take time to respond to changes in r and taxes * Changing the level of G is more direct in affecting the level of demand but may have political and social consequences, limits FP Inflation * Inflation = sustained rise in general level of prices * Demand pull (demand inflation) = AD increases at a rate faster than the capacity of the economy to produce goods and services * AD > AS * Increase in competition for goods and services drives up their prices * Cost push (cost inflation) = prices pushed up by rising cost to producers who compete for increasingly scare resources, pass on cost increases to consumers Sources of Inflation Demand Inflation * Increase in C, I, G or X - M as the economy approaches FE * Full employment causes labour shortages --> employers bid up wages to attract labour --> Y � --> AD rises * High levels of foreign investment --> AD rises * High export earnings --> income rise --> AD rises * Inflationary expectations, expectation that prices � --> ? ...read more.

Conclusion

services, shorter working hours thus more recreation * Economic growth impedes price stability and external stability * Price stability = econ growth too rapid, AD > AS then prices in product and factor markets � * External stability = rapid growth then inflation occurs, reduced international competivietss, CAD �, foreign debt �, imports �, resources are diverted into producing output for domestic consumption rather than export The Phillips curve * Inverse relationship between rate of growth in price inflation and unemployment * A trade-off between inflation and unemployment must be made Pg 104 Reasons for trade-off * Economy moves toward FE due to fiscal stimulus, labour markets tighten and wage rise, cost �, price � * Incomes rise, spending rises thus price rises * Firms in less competitive industries put up prices up to protect profits rather than look for ways to reduce cots Stagflation * PC shift to the right Pg 104 The role of expectations Pg 105 * NO long run trade off between UE and inflation will by unable to achieve lower UE and inflation * Using microeconomic can alter supply side to shift PC to the left, not demand side 5. Why Nations Trade Reasons for trade Pg 107 Reasons for international trade * No country is capable of being self sufficient, lack of resources to satisfy all needs and wants * Nations rely on each other to supplement domestic production, countries produce surplus for trade * Resources unevenly distributed due to climatic and topographical differences, minerals and soils, technology and labour * Factor endowments determine what exports and imports are needed * All countries are better off if they trade, due to specialisation and allocation of resources = cost advantage Absolute and comparative advantage * Absolute advantage = economy produces more of a product than another economy, using resources more efficiently (productivity higher) * Comparative advantage = Relatively more efficient at producing a commodity than another country, lower opportunity cost in production of a particular commodity than another country ...read more.

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