Chapter 9: The Macroeconomy

Macroeconomy

Macroeconomy is the branch of economic that deals with structure, performance, behavior and decision making of whole or aggregate economy.

Economic growth, economic development and sustainability

Economic growth is an increase in an economy’s output and in long run an increase in country’s productive potential and the economic growth rate is annual percentage change in output.

Economic development is an increase in welfare and the quality of life.

Sustainable development is development that ensures that the needs of the present generation can be met without compromising the well-being of future generation.

Actual and Potential Economic Growth

Actual Economic Growth is an increase in real Gross Domestic Product (GDP). It occurs when the output increases.

Potential Economic Growth is an increase in the productive capacity of the economy.

Output gap is a gap between actual and potential output.

The factors contributing to economic growth

The following are the factors:

  1. Increase in quantity of resources
  2. Increase in quality of resources

 

National Income Statistics

National income is the total income of economy. National income statistics are used to compare countries’ economic performance of the country.

Gross domestic product, gross national product and gross national income

Gross National Income (GNI) is the total output produced by a country’s citizens wherever they produce it.

Gross national product (GNP) is an estimate of total value of all the final products and services turned out in a given period by the means of production owned by country’s residents.

Gross domestic product (GDP) is a measurement that seeks to capture a country’s economic output.

Money and real GDP

Money GDP is the total output measured in current prices.

Real GDP is the total output measured in constant prices.

Real GDP=(money GDP* price index in base year)/price index in current year

National Debt

National debt is the total amount of government debt.

Other indicators of living standards and economic development

Measurable Economic Welfare (MEW): a composite measure of living standards that adjust GDP for factors that reduce living standards and factors that impose living standard.

Human Development Index (HDI): A composite measure of living standards that include GNI per head, education and life expectancy.

Multidimensional Poverty Index (MPI): a composite measure of deprivation in terms of the proportion of household that lack the requirements for a reasonable standard of living.

Kuznets Curve

Kuznets curve is a curve that shows the relationship between economic growth and income inequality.

The characteristics of developed, developing and emerging economics

Developed economics are those economics with high GDP per head. They are high income countries.

Developing economy is and economy with a low GDP per head.

Emerging economies is economies with rapid growth rate and that provides good investment opportunities.

Labour Productivity

It is the quantity of goods and services that a worker is able to produce in a given time period.

Labour Force

Labour force is defined as the total number of workers who are available for work. The size of labour force depends on various factors, such as:

  • Total size of population of working age
  • The retirement age
  • The proportion of women who join the labour force.

 

Unemployment

Unemployment is when people are able and willing to work but are unable to find jobs. Unemployment can be divided into:

  1. Frictional unemployment: unemployment that is temporary and arises where people are in-between jobs.
  2. Structural Unemployment: Unemployment caused as a result of the changing structure of economic activity.
  3. Cynical Unemployment: unemployment that results from a lack of aggregate demand.

The consequences of unemployment

 There are many consequences of unemployment; the workers experience fall in income. They may also experience a decline in their physical and mental well-being. The economy will face an opportunity cost. The tax revenue received by government will be lower.

Policies to correct unemployment

To reduce cynical unemployment, a government will use reflationary fiscal or monetary policy. To reduce frictional and structural unemployment, a government will impose supply side policy.

The circular flow of income

It is a simple model of process by which income flows around economy.

Aggregate Expenditure

Aggregate expenditure is the total amount spent in the economy at different levels of income.

Consumption

Consumption or consumer expenditure is spending by household on goods and services.

Average propensity to consume (apc) =consumption/income

Marginal propensity to consume (mpc) = change in consumption/change in income

Investment is spending by firms on capital goods. The amount of investment is influenced by change in consumers demand, interest rate, cost of capital goods, etc.

Net export is the difference between exports and imports.

The quantity Theory of Money

The quantity theory of money is the theory that links inflation in an economy to change in the money supply. This theory is based on Fisher equation i.e. MV=PT, where; M is money, V is velocity of circulation, P is price level and T is transactions.

 Broad and Narrow Money

The money supply is the total amount of money in an economy. There are two main measures of money supply:

  1. Narrow money: The money that can be spent directly. This is sometimes referred as monetary base.
  2. Broad Money: The money that is used for spending and saving. Example is savings account.

Sources of money supply

Five main source of money supply are:

  1. An increase in commercial bank lending
  2. An increase in government spending financed by borrowing from commercial bank
  3. An increase in government spending by burrowing from central bank
  4. The sale of government bonds to private sector financial institutions
  5. More money entering than leaving country

Types of aid

Foreign aid: it is an assistance given to developing economics on favorable terms.

Dependence: It is a situation where the economic development of a developing economy is hindered by its relationships with developed economies.

International Monetary Fund (IMF): It is an international organization that promotes free trade and helps countries in balance of payments difficulties.

 

The role of trade, investment, multinationals and foreign direct investment

The governments of developing economics often argue for trade rather than aid. It can improve supply conditions and can reduce costs, which can lead to more efficient production as:

  • Economies of scale become possible because of the larger market.
  • Trade leads to a transfer of skills and technology from developed and developing economics.
  • Specialization and trade increases incomes and so provides the increased savings which can be used for investment.

 

Investment

Investment is spending by firms on capital goods.

 

 

Multinational corporations and foreign direct investment

A multinational corporation (MNC) is defined as a firm that operates in more than one country.

Foreign direct investment (FDI): It is the setting up of production units or the purchase of existing production units in other countries.

 

The role of the International Monetary Fund and the World Bank

The International Monetary Fund

The International Monetary Fund (IMF) was set up in 1945 after the Bretton Woods Conference, to help promote the health of the world economy after World War II. The purposes and responsibilities of the IMF include:

  • To promote international monetary cooperation
  • To facilitate the expansion and balanced growth of international trade
  • To provide exchange rate stability
  • To assist in setting up a multinational system of payments

The World Bank

Like the IMF, the World Bank was established at the Bretton Woods Conference. It is best described as the World Bank Group through the activities of its five constituent agencies. These are:

  • International Bank for Reconstruction and Development (IBRD)
  • International Finance Corporation(IFC)
  • International Development Association (IDA)
  • Multilateral Investment Guarantee Agency (MIGA)
  • International Centre for Settlement of Investment Disputes (ICSID)

 

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