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What is macroeconomics?

Extracts from this document...

Introduction

Macroeconomics 1.1 What is macroeconomics? * Macroeconomics = economy as a whole, economic aggregates & relationships between them * Concerned with total levels of production, expenditure & income * Microeconomics = individual section of economy Reasons for studying microeconomics * Describe & explain economic events and trends * Predict direction of economy for the future * Described & measure economic welfare * Determine standard of living * Develop & apply policies to improve economic performance Three types of economics indicators * Leading indicator = predict change in economic activity before trend becomes evident - expectations of households and firms * Coincident indicator = move in line with level of economic activity * Lagging indicators = not expected to show any change until after trends - indicate how people reacted after changes in the economy 1.2 Output, income & expenditure aggregates Pg 7, 1.3 the circular flow model * Real flow = goods & services * Monetary flow = money * Resources exchanged for Income (Y) * Income earned spent on Consumption (C) of goods & services * Households Saving (S) lent to firms for Investment (I), which adds to further productive capacity * Taxation (T) used for Government Spending (G), to provide goods & services for community - current or capital * Imports (M) and Exports (X) Withdrawals & injections * Leakages = Savings, Taxation & Imports * Injections = Investment, Government spending & Exports Measuring GDP * GDP = Gross Domestic Product - total market value of goods & services produced * GDP (P) = value of production, final values of goods & services produced in economy * GDP (E) = expenditure, final expenditures, changes in stocks held in firms and net exports * GDP (I) = income, total income, allowing deprecation of capital and net indirect taxes Macroeconomic equilibrium * Equilibrium = desired level of expenditure equals level of output produces, and incomes earned from the production * At equilibrium no tendency to change levels of income, output or expenditure * ?E = ? ...read more.

Middle

Direct investment, portfolio investment, other investment, reserve assets * Direct investment = objective of obtaining a lasting interest, 10% or more of shares or voting stock * Portfolio investment = international equity and debt securities * Other investment = no direct or portfolio, trade credits, loans, currency and deposits * Reserve assets = financial assets controlled by a monetary authority * Balance on current account + balance on capital and financial account + net errors and omissions = 0 The current account deficit CAD increases if * Fall in terms of trade, export prices relative to import prices decline, exports receipts decline while import payment increase --> BOP falls * Decline in international competitiveness, productivity levels decline or real wages rise more than productivity, exports will be less competitive in overseas * High rate of economic growth, lead to an increase in aggregate demand, excess spending in consumption and investment lead to surge in imports * Foreign investment into Australia, an increase in CAD = increase in capital and financial account surplus, rate of return on investment is higher in Australia than rest of the world --> large capital inflow * Decline in national savings, savings may fall when economy in recession, households draw on savings to maintain consumption, profits fall and government's budget surplus shrinks * Increase in national investment, economy undergoing structural changes may require increases in capital, MER Interpreting the current account balance * Current account balance = balance of goods & services and income * Absorption approach = country is living beyond its means = CAD * National investment > national savings = CAD * CAD must be financed by capital and financial surplus * Financial account 1) equity, capital inflow - investment 2) debt, capital inflow - borrowing Pg 107, 2.14 The CAD and the national accounts Pg109, 2.16 Te income deficit 2.4 Australia's foreign debt * Foreign debt / external debt = amount of money that Australians owe to the rest of the world * Gross foreign debt ...read more.

Conclusion

Fall in interest rates will reduce capital inflow, reduce demand for currency --> currency depreciation Pg 199, 3.22 The transmission mechanism Pg 200, 3.23 The effect of monetary policy The effect of market operations The quantity method * RBA buys back securities in market = increase in money supply * Increases liquidity as financial institutions have more to lend * RBA sells securities, money is drawn out of public and amount of credit in banks is reduced, reduced demand for securities --> interest rates rise The price method * Tighten monetary policy = create a shortage of cash * Raise the cash rate = borrowing cost rises thus demand for credit falls * Ease monetary policy = create a surplus of cash * Lower the cash rate = borrowing cost falls thus demand for credit rises Inflation targeting * RBA and government determine a level of inflation to aim for 2-3% * RBA announce and explain policy decisions = transparent Strengths of monetary policy Monetary policy is very flexible * Policy decisions are made very day * No specific authorisation by Parliament Monetary policy has greater political neutrality * Transmission route is subtle * Policy is aimed across the board thus not target a specific group Monetary policy is very effective during boom periods * More effective to control high levels of aggregate demand and inflation Monetary policy is most effective under floating exchange rates * Changes in interest rates are different than other countries * Alter capital inflow into Australia, exports and imports Weakness of monetary policy Monetary policy I not very effective during a recession * Interest rates are low other factors are more important Time lags * Recognition lag, action lag, implementation lag, effect lag Monetary policy can be circumvented * Companies can raise finance by floating shares rather than direct borrowing Monetary policy is not effective under a fixed exchange rate * Cut in interest will reduce capital inflow, imbalance of BOP deficit and money supply --> interest rates rise ...read more.

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