Transcript Macroeconomics Chamberlin and Yueh

Macroeconomics
Chamberlin and Yueh
Chapter 1
Lecture slides
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by Graeme Chamberlin and Linda Yueh ISBN 1-84480-042-1
© 2006 Cengage Learning
Macroeconomics and the Circular
Flow of Income
–
The Circular Flow of Income
–
National Income Accounting and the
Circular Flow of Income
–
Macroeconomic Modelling and the Circular
Flow of Income
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by Graeme Chamberlin and Linda Yueh ISBN 1-84480-042-1
© 2006 Cengage Learning
Learning Objectives
• To understand what macroeconomics is about
• Representing the macroeconomy by the circular flow of income
• Using the circular flow of income to measure national
income/output
• Understanding the usefulness of macroeconomic models in
analysing the economy and forming economic policy
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by Graeme Chamberlin and Linda Yueh ISBN 1-84480-042-1
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The Circular Flow of Income
• The economy can be viewed as a system
where there are actions and interactions
between households, firms, the government,
financial institutions and the foreign sector.
This system has come to be known as the
circular flow of income.
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by Graeme Chamberlin and Linda Yueh ISBN 1-84480-042-1
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Government policy
• An important aspect of macroeconomics is
the role of government policies. As the
government is part of the circular flow of
income, it is in a position to take measures
to try and influence parts of it to achieve
certain goals. These objectives are usually
the promotion of economic growth, low
unemployment, the control of inflation and
trade balance.
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by Graeme Chamberlin and Linda Yueh ISBN 1-84480-042-1
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The analogy of a hot water system
• If we think of the economy as a central heating system that pumps hot
water around a house, then the use of government policy can be viewed
as the thermostat. If it is too cold, then action must be taken to make
things warmer, more hot water must circulate. Likewise, if it is too
warm action must be taken to cool things down. Policy making at the
macro level is mainly about influencing the circular flow of income.
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by Graeme Chamberlin and Linda Yueh ISBN 1-84480-042-1
© 2006 Cengage Learning
Circular Flow of Income
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Five main players
•
•
•
•
•
Households
Firms
Financial sector
Government
External (foreign) sector
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© 2006 Cengage Learning
Injections and Leakages
• Injections are items which add to the
circular flow of income. These are
investment (I), government spending (G) and
exports (X).
• Leakages from the circular flow are those
items which lead to lower income flows;
these are saving (S), taxes (T) and imports
(M).
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by Graeme Chamberlin and Linda Yueh ISBN 1-84480-042-1
© 2006 Cengage Learning
Equilibrium in the Economy
• When injections exceed leakages the circular
flow of income will increase, and likewise
will fall when leakages exceed injections.
The economy will be in equilibrium when
leakages are equal to injections.
• I+G+X=S+T+M
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by Graeme Chamberlin and Linda Yueh ISBN 1-84480-042-1
© 2006 Cengage Learning
National Income Accounting and the
Circular Flow of Income
• Gross Domestic Product (GDP) is a measure of the total output
produced by an economy. There are three different ways of calculating
the level of national output; these are the expenditure method, income
method and output method.
• National income accounting has a direct relationship to the circular
flow of income. First of all, the level of GDP is an indicator of the
strength of the circular flow of income. Secondly, due to the circular
flow, the three methods of calculating GDP should all produce the same
measure.
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© 2006 Cengage Learning
Three measures of GDP
• (1) Expenditure Method
• Y=C+G+I+X–M
• Adjustment: GDP (factor cost) = GDP
(market prices) – Taxes + Subsidies
• Example: Expenditure method for the UK
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Components of Expenditure in UK
GDP
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UK GDP, adjusted from market
prices to factor cost
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by Graeme Chamberlin and Linda Yueh ISBN 1-84480-042-1
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Three measures of GDP
• (2) Income Method:
• Y = Other Income + Corporate Profits +
Wages and Salaries
• Example: Income measure for the UK
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by Graeme Chamberlin and Linda Yueh ISBN 1-84480-042-1
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Components of Income in UK GDP
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Three measures of GDP
• (3) Output method
• The output method avoids double-counting
by totalling the value-added by each firm at
each state of the production process.
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by Graeme Chamberlin and Linda Yueh ISBN 1-84480-042-1
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Three measures of UK GDP: Figure
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GDP and GDP per capita
• Gross Domestic Product basically refers to
the income generated by an economy in a
year.
• GDP per capita is the level of GDP divided
by the country’s population, and is a widely
used indicator of the material standard of
living in a country.
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by Graeme Chamberlin and Linda Yueh ISBN 1-84480-042-1
© 2006 Cengage Learning
Economic Growth
• Economic growth is the change in GDP and
is the main concern for governments and
policy makers. High and sustained economic
growth means that a nation’s economy is
generating more and more income, which
allows the continual improvement of living
standards.
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by Graeme Chamberlin and Linda Yueh ISBN 1-84480-042-1
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UK Output and Trend GDP
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Output and Trend Growth of GDP
• First, in the UK, GDP grows consistently over time,
implying that people become increasingly richer and enjoy
improving living standards. There is a positive trend.
• Second, GDP does not grow steadily. In fact, the actual
level of GDP fluctuates quite considerably around the trend
path, which is a sign that the rate of economic growth is not
constant in the short run. There is output fluctuation, such
as booms and recessions.
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Annual UK GDP growth rate
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Open Economies
• Openness can be seen in two ways:
• Trade of goods and services. Exports are injections, and
imports are leakages from the circular flow.
• The second is capital flows to and from the financial sector,
which reflects the globalisation of financial markets, e.g.,
foreign direct investment and portfolio capital, which
represents purchases of financial assets, such as bonds and
equities.
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by Graeme Chamberlin and Linda Yueh ISBN 1-84480-042-1
© 2006 Cengage Learning
Exports and imports as a percentage
of GDP, UK
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External assets and liabilities as a
percentage of GDP, UK
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by Graeme Chamberlin and Linda Yueh ISBN 1-84480-042-1
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Macroeconomic Modelling and the
Circular Flow of Income
• General equilibrium type models, which are
designed to find equilibrium for the
economy as a whole, and takes into account
the actions and interactions among sectors of
the economy.
• E.g., The Phillips machine, Bank of England
Quarterly Model
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by Graeme Chamberlin and Linda Yueh ISBN 1-84480-042-1
© 2006 Cengage Learning
Summary
• The workings of the macroeconomy can be neatly
summarised by the circular flow of income, which
describes how the various players in an economy such as
households, firms etc. are linked together. These linkages
and interactions suggest that the economy can be
considered to be more than the sum of its parts.
• The relevance of the circular flow is demonstrated in
national income accounting where the expenditure, income
and output methods should each produce the same measure
of national income/output.
• Macroeconomic policy making has largely focussed on
promoting high and stable economic growth. High growth
over the long run produces sustained improvements in
material living standards.
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by Graeme Chamberlin and Linda Yueh ISBN 1-84480-042-1
© 2006 Cengage Learning
Summary
• In the short run, the goal of policy makers is to smooth out
cyclical movements in the economy to avoid episodes of
high unemployment or inflation. To this end, the
government through its central position in the circular flow
of income can use monetary and fiscal policies to influence
the economy.
• Over the last four decades economies have become
increasingly open to each other through international trade
and capital flows. This has meant that the study of open
economies is increasingly relevant.
• The formulation of policy is greatly aided by the use of
macroeconomic models. These are heavily based on the
circular flow of income and can be used to analyse the
effects of policies or shocks on the economy.
Use with Macroeconomics
by Graeme Chamberlin and Linda Yueh ISBN 1-84480-042-1
© 2006 Cengage Learning