How the macroeconomy works

How the macroeconomy works

1. National Income, national output and national product

   • Economists use the terms national income and national output interchangeably
   • To produce the flow on national output, the economy must possess a stock of physical capital goods and a stock of human capital, together with stocks of the other factors of production: land and entrepreneurship
   • National capital stock- the stock of capital goods, such as buildings and machinery, in the economy that has accumulated over time and is measured at a point in time
   • Wealth- The stack of assets which have value at a point in time, as distinct from income which is a flow generated over a period of time
   • National wealth- the stock of all goods that exist at a point in time that have value in the economy
   • National income- the flow of new output produced by the economy in a particular period (e.g. a year)
   • National Output- The same as national income, namely the flow of new output produced by the economy in a particular period (e.g. a year)
   • National product- another name for national income and national output
   • The national capital stock is part of the stock of national wealth, which compromises all physical assets owned by the nation's residents that have value
   • The national capital stock is part of the stock of national wealth, which comprises all physical assets owned by the nation's residents that have value. This includes capital goods and social capital such as roads, schools and hospitals which are owned by the state
   • The national capital stock excludes consumer goods, which are a part of national wealth but not part of national capital. All capital is wealth, but not all wealth is capital
   • Consumption- Total planned spending b households on consumer goods and services produced within the economy
   • In the short term, the easiest way to increase living standards is to boost current consumption
   • National Income=National Output=National Expenditure

2. Circular Flow of Income

   • Closed Economy- An economy with no international trade
   • Saving- Income which is not spent
   • Withdrawal- A leakage of spending power out of the circular flow of income into saving, taxation or imports
   • Investment- Total planned spending by firms on capital goods produced within the economy
   • Injection- Spending entering the circular flow of income as a result of investment, government spending and exports
   • If planned spending equals planned investment, national income is in equilibrium, tending neither to rise nor to fall
   • If withdrawals exceed injections, output and income falls. If injections exceed withdrawals, output and income rises
   • Open economy- An economy open to international trade
   • S+T+M = G+I+X This in in equilibrium
   • S+T+M > I+G+X This causes the equilibrium price to fall
   • S+T+M ,< I+G+X Equilibrium price to rise

3. Aggregate demand and supply Analysis

   • The AD/AS supply model is particularly useful for analysing the effect of an increase in aggregate demand in the economy
   • The following question is addressed- Will expansionary fiscal policy and expansionary monetary policy be reflationary policies, increasing real output and jobs, or will the price level increase instead (i.e. will the policy result in price inflation?)
   • Equilibrium national income occurs when the aggregate demand for real output equals the aggregate supply of real output
   • If either the AD curve or the AS curve shifts to a new position, the point of equilibrium national income will change
   • An economic shock is a sudden unexpected event hitting the economy, disturbing either aggregate demand for aggregate supply. In some cases, outside shocks may affect both aggregate demand and aggregate supply

4. The determinants of aggregate demand

   • AD= C+I+G+(X-M)
     • Consumption
     • Investment
     • Government Spending
     • Exports
     • Imports
   • Consumption
     • This is spending by all the households in the economy on goods and services
     • A determinant of consumption is also a determinant of household saving
     • If we assume a closed economy with no taxation, households can do either 2 things: spend or save
     • There are many factors which can influence consumption
       • Interest Rates- The higher the rate of interest, the more households are likely to save
       • Level of income- This is often called the Keynesian theory of consumption and saving. His view is that as income rises, although consumption rises, consumption falls as a fraction of real income
       • Expected future income- People plan savings of the view of their expected lifetime income
       • Wealth- As people become wealthier, consumption tends to rise
       • Consumer confidence- As confidence increases, consumption is likely to increase
       • Availability of credit- If credit is available easily and cheaply, consumption is likely to increase.
       • Distribution of income- Rich people save a geater proportion of their income than poorer people. Redistribution of income from rich to poor will increase consumption and reduce saving
       • Expectations of future inflation- Fears of rising inflation are likely to increase saving
   • Personal and household's saving ratio
     • Personal Savings ratio: This measures the actual or realised saving of the personal sector as a ratio of total personal sector disposable income
     • The household savings ratio measures household's realised saving as a ratio of their disposable income
     • This provides information about what lies ahead for aggregate demand
   • Investment
     • Investment is planned demand for capital goods
     • A country's gross investment include 2 parts, replacement investment and net investment

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