MACROECONOMIC OBJECTIVES by izCmry25

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									          AGGREGATE DEMAND AND SUPPLY
•   Just as the intersection of demand and supply for a product determines price in a
    single market, the intersection of aggregate demand and aggregate supply
    determines the overall price level in the economy

•   The AD curve slopes down from left to right due to:
    - international substitution effect: if prices in economy fall people will be
      encouraged to buy more domestically produced goods (and less imports)
    - the inter-temporal substitution effect: if prices fall people will need less
      money leading to lower interest rates and higher levels of expenditure
    - the real balance effect: if prices fall people’s real savings will increase
      leading to further expenditure

•   The AS curve slopes up from left to right due to:
    - greater profits to be made at higher prices (while real wage rates remain the
      same; however the curve tend to eventually become inelastic due to
      diminishing returns and growing shortages (as economy nears full production)
              Aggregate demand and aggregate supply

                                          AS
Price level




                                               If the price level is initially P2,
                                                   the excess demand will
                                               cause price level to rise to Pe
              Pe
                         b              a
              P2

                                                        AD

               O

                             National output
ECONOMIC GROWTH AND THE BUSINESS CYCLE

 • Distinction between actual and potential growth

   - Actual growth is the percentage increase in national output:
   the rate of growth in actual output.
   - Potential growth is the rate at which an economy could grow if
   working at full capacity.

   An economy can easily under perform. Thus for example in a
   recession the actual rate of growth may be well below the
   potential level.
   Short-run concerns in economies often relate to the actual rate
   of growth (and the desire to maintain it at a high level).
   Long run concerns are more with factors of production in the
   economy that can potentially influence the rate of growth.
         Growth and the production possibility curve
Good X




                                  b
               Growth in
                                                   Growth in
              actual output
                                                   potential
                                                    output
                              a




                                               I       II
         O
                                      Good Y
ECONOMIC GROWTH AND THE BUSINESS CYCLE
  • There are four phases that are identified in terms of the business
    cycle

     1 The upturn
     2. The expansion
     3. the peaking out
     4. The slowdown

     - In practice this are not fully regular as diagrams would
     suggest. For example sometimes the expansion phase
     (boom) might be very short. In other cases the slowdown
     (recession) might extend over a decade..
     - Also a recession could vary significantly from mild to
     extremely severe.
     - Fluctuations in output are usually caused in the short-term by
     variations in the overall level of aggregate demand (i.e. the total
     expenditure in the economy).
     - In the long-run changes in the potential of the economy to
     produce output are more important.
                                       Real GDP in France and the UK
                           500
                                           France
                           450             UK

                           400
 Real GDP, 1960 = 100 ..




                           350

                           300

                           250

                           200

                           150

                           100
                             1960   1965   1970   1975   1980   1985   1990   1995   2000   2005   2010

Source: AMECO database (European Commission) and OECD Economic Outlook (OECD)
Note: 2009 and 2010 figures based on forecasts
                                             Economic growth in the UK
                                 400                                                          6.0
                                                                    Quarterly growth rate
                                 350                                GDP                       5.0

                                                                                              4.0
 £ billions (in 2005 prices) .




                                 300
                                                                                              3.0
                                 250




                                                                                                     % change
                                                                                              2.0
                                 200
                                                                                              1.0
                                 150
                                                                                              0.0
                                 100
                                                                                              -1.0

                                  50                                                          -2.0

                                   0                                                         -3.0
                                   1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
Source: National Statistics times series data
                          The business cycle

                                                 Potential output
National output




                                                   3
                                                          4
                                             2             Actual
                              3
                                                           output
                                  4
                          2              1


                      1



                  O
                                  Time
   POTENTIAL CONTRIBUTION TO GROWTH
Increases in Quantity of Resources

• Capital

   - Output depends on stock of capital invested in economy e.g. roads,
   factories, machinery, buildings etc.
   - A major factor in the growth of the Celtic Tiger (1994 - 2001) was a
   huge increase in multinational investment in Ireland (especially by US
   firms).
   - By contrast very poor nations (as in Africa) are unable to set aside
   sufficient resources for investment and therefore find it hard to achieve
   economic growth.
   - Investment needs to be financed out of savings (or borrowing) and
   understandably poor countries find it hard to save.
POTENTIAL CONTRIBUTION TO GROWTH (con)
 • Labour

   - Clearly if the numbers working increases, the level of output
   should also increase.

   This was also a major factor in the boom in the Irish economies
   in the late 90's. the work force effectively doubled in 10 years
   enabling a very large increase in output.

   - However as well as the numbers working, the quality of labour
   employed (e.g. in terms of education and skills is very
   important).

   - Ireland can no longer compete with lower cost countries (such
   as in Eastern Europe) in terms of unskilled production. Thus it
   makes greater sense for us to concentrate on more skilled areas
   such as information technology.
POTENTIAL CONTRIBUTION TO GROWTH (con)
•    Land and Raw Materials

      Ireland is well endowed with agricultural land (with agriculture and
      the food industry important sectors of the economy).
       Unfortunately we are not well endowed with important raw materials
       such as oil and gas.
    - However though helpful these are not vital for economic growth (as
      the success of Japan after the 2nd World War demonstrated).

•    Enterprise

     - This is the 4th factor of production. If an economy is to thrive, people
       must be willing to undertake the risks of setting up business.
      In the past there was a great lack of an enterprise culture in Ireland
      which inhibited growth.
      This is why we began to rely so much on importing enterprise from
      abroad by attracting multinational companies through tax breaks and
      grants.
POTENTIAL CONTRIBUTION TO GROWTH (con)
 • Increases in Productivity

   - Changes in technology are very important to prevent the law of
   diminishing returns setting in with respect to investment.
   So for example the rise of computer and internet technology has
   greatly increased the possibilities for new types of investment
   thus enhancing growth prospects.

 • Policies to achieve Growth

   - The policies of the Government can greatly affect the capacity
   of an economy to grow.
   During the 1980's there was very little growth in the Irish
   economy largely because of the past effects of reckless
   Government borrowing. In recent years the determination of the
   Government to reduce income tax initially contributed
   considerably to our growth prospects. However subsequent
   reliance on a massive property bubble has created much of our
   present problems
       Explanations of Long-term Growth

• Neoclassical or ‘Solow’ growth model
  – diminishing returns to capital

  – need for replacement investment

  – steady-state national income

  – effect of an increase in the saving rate
– human capital and education

– technological progress
                 CAPITAL ACCUMULATION
•   The rate of growth of capital accumulation depends on two factors:
    1. the marginal capital output ratio; this is the amount of extra capital
      ΔK divided by the extra amount of output that it produces divided ΔY
      So k = ΔK/ΔY
     The lower the value of k the higher is the productivity of capital

    2. the proportion of national income that is invested (i) which assuming that
       all savings are invested is the proportion that is saved (s)

    The formula for growth becomes

     g = i/k (or g = s/k)

    Thus if 20% of national income went into new investment with the marginal
    capital output ratio k = 4, then the growth rate = 20/4 = 5
Output (Y), Investment (I), Depreciation (D)            Steady-state output

                                                                                        Output (Y)


                                                                  f
                                               Y1

                                                    a                            Depreciation (D)
                                               Y0


                                                                                      Investment (I)
                                                                g
                                               I0
                                                    b
                                                    c                   Equilibrium
                                               D0
                                                                         at point g


                                               O    K0           K1
                                                            Capital stock (K)
     Effect of an increase in the rate of saving and investment
Output (Y), Investment (I), Depreciation (D)



                                                                         m               Y
                                               Y2
                                                          f
                                               Y1


                                                                                           D

                                                                        n                  I2
                                                        h
                                                                                           I1
                                                        g


                                                              Initial equilibrium New equilibrium

                                                         K1               K2
                                                    Capital stock (K)
Output (Y), Investment (I), Depreciation (D)        Effect of a technological advance

                                                                                   p    Y2
                                               Y2
                                                                                        Y1

                                                                     f
                                               Y1
                                                                                         D

                                                                                   n     I2
                                                                   h
                                                                                         I1
                                                                   g




                                                                    K1             K2
                                                               Capital stock (K)
     Explanations of Long-term Growth (con)

• Endogenous growth theory
 – when technological progress is not a ‘given’
 – determinants of technological progress
   • importance of institutional factors & policies
   • research and development
   • training and education
   • incentives
 – impact on production function?
   • move upwards over time
   • become steeper
              REASONS FOR IRELAND’S BOOM
•   Continued investment in education since 1960’s with more emphasis in recent years
    on technical education

•   Considerable foreign direct investment (FDI) - especially from US - in Ireland due
    to following reasons

    - generous grant support and tax concessions by Government
    - Ireland a member of EU since 1973
    - only English speaking country in Eurozone
    - availability of skilled labour
    - political stability

•   Generous structural funding by EU during late 80’s and 90’s providing funds for
    infrastructural development

•   Availability of labour supply both in quantitative and qualitative terms through

    - unemployed, significant increase in female participation, open approach to
      immigration etc.
      REASONS FOR IRELAND’S BOOM (con)

• Government Policy
  - promotion of a more enterprise oriented approach
  - responsible management of fiscal policy
  - emphasis on continuing tax reductions as a way of stimulating
    incentives

• Pay Constraints
  - in view of the high productivity levels attained, growth in incomes
    were very moderate during the 90’s
  - significant improvement in industrial relationships

• International Conditions
  - as Ireland is a very open economy, favourable conditions in major
    markets are very important (with rapid increase in exports up till
   2001)
      REASONS FOR IRELAND’S BOOM (con)
•   After temporary downturn in’01 and ’02 return to substantial economic growth
    (03 -07) though at a lower rate than in first phase

•   However a significant change in the reasons for growth was at work:

    - continued foreign investment in Ireland under threat from cheaper
     countries in Eastern Europe and elsewhere

    - exports which had grown very rapidly until 2001 had been stagnant since
      2001

    - later boom very much driven by massive growth in construction

    - demand for property largely dependent on the extension of increased credit
      So in a sense we were borrowing from future to pay for today’s activities

    - wage rates and other expenses had risen considerably making Ireland an
     increasingly expensive country within which to do business
                    PRESENT SITUATION
• A sharp downturn in Irish economy has taken place due to a number of
  reasons

   - substantial drop in activity in construction sector (which had been
    the recent engine of growth)
   - continuing fall in stock markets around the world (and especially in
    Ireland) further damaging business confidence
   - severe worldwide financial crisis directly impacting on construction
    activity and on economy in general
   - reckless lending by Irish banking sector has damaged our credit
    worthiness abroad
   - recession in US and other markets (of great importance to Irish
    economy)
   - despite recent fall in inflation, cost basis still very high in Ireland
   making us vulnerable to competition and movement of multinational
   firms elsewhere
                     GROWTH IN CHINA
• Capital
  - high savings rate is then efficiently channelled by government into
    key infrastructure projects
  - clever concentration on showcase investment in key areas which
    helps to attract foreign investment
  - creation of specific investment zones, free trade and tax incentives
  - quick approval of investment projects
  - strong industrial tradition with China now seen as the world’s
    leading manufacturing base

• Labour
  - China benefits from a vast pool of potential cheap labour with many
   of the 40% of the population still working for very low returns in
   agriculture eager to move to other sectors
  - benefit from a vast diaspora abroad who increasingly are being
    encouraged home to aid the economic effort
  - increasing emphasis on educational and technical skills with many
   going abroad to achieve their objectives
                   GROWTH IN CHINA (con)
•   Land and Raw Materials
    - China has an abundance of natural resources e.g. coal, iron ore,
      oil, natural gas and minerals (such as lead aluminium and zinc)
    - because of the demands of domestic growth, China has invested
      heavily in Africa and other countries with a view to exploiting its rich
      natural resources such as oil and copper

•   Enterprise
    - liberalisation measures by ruling party has greatly increased
      opportunities for domestic enterprise
    - multinational investment - which is at present welcomed – increases
     access to enterprise in the higher tech industries

•   Other
    - huge domestic market
    - strong business attitude
    - authoritarian government (preserving political and social cohesion) with a
      desire to promote growth
         COSTS OF ECONOMIC GROWTH
• The benefits of economic growth are obvious. The standard of
  living increases with people in general having more money to
  spend on consumer goods and services. Also it enables the
  Government to improve services such as health and education
  and spend more on improving the infrastructure e.g. roads.

However there are costs

• Higher growth in the short run could require more investment
  thus lessening resources for consumption. This happened in a
  dramatic fashion in the Soviet Union under Stalin!
• Growth can generate extra demands and social pressures to
  keep up so that people still feel that they have too little.
• There may be adverse social effects as people become more
  materialistic and less caring in society.
• There can also be environmental consequences e.g. terrible
  traffic congestion in major cities.
• Non-renewable resources e.g. oil and gas can be run down and
  finally the benefits may not be distributed equally.
                     UNEMPLOYMENT
• Meaning of Unemployment
  - measurement by live register
  - QNHS measurement by ILO and PES methods

• Standardised Unemployment
  - ILO measurement which requires that no payment for
  even I hrs work in previous week made, or that no search
  was made in previous four weeks or that person not
  available to take up employment in next two weeks

• Labour force made up of those in employment or seeking employment;
  excludes many students still in full-time education and married women
  who opt to stay at home
Unemployment rates in selected industrialised countries
                  14
                           UK                  France
                  12       USA                 Japan


                  10
 % of workforce




                   8


                   6


                   4


                   2


                   0
                   1965   1970    1975          1980    1985   1990   1995   2000   2005   2010
Source: AMECO database (European Commission)
2009 and 2010 based on forecast
            Standardised unemployment rates
  in different sections of the labour market: 2008 (Q2)
                                            Total under Women         Men
              Total (all Women Men (all
  Country                                    25 years   under 25    under 25
               ages)     (all ages) ages)
                                                old     years old   years old

Belgium          6.6       7.2       6.1       15.7       17.2         14.5
Germany          7.5       7.4       7.5       10.3        9.5         11.0
France           7.2       7.6       6.8       16.7       16.0         17.3
Ireland          5.5       4.4       6.4       11.1        8.4         13.5
Japan            5.0       3.9       4.1        7.1        6.4          7.8
Netherlands      2.8       3.0       2.6        5.2        5.2          5.1
Spain           10.4      12.3       9.1       23.9       25.9         22.2
UK               5.1       4.7       5.5       13.3       10.8         15.4
USA              5.2       5.1       5.4       12.7       11.6         13.8
EU15             6.8       7.4       6.3       14.5       14.4         14.9
                TYPES OF UNEMPLOYMENT
•   Classical - arises from artificial restrictions on market forces e.g. by trade
    unions

•   Involuntary (Keynesian) - due to business cycle e.g. a fall in aggregate demand
    leading to recession

•   Structural - applies to special groups of workers or regions of the economy;
    requires special measures

•   Frictional (short-term) - can reflect a healthy jobs market leading to
    considerable job mobility

•   Cyclical - due to variations in economic activity

•   Technological e.g. application of IT systems

•   Seasonal e.g. changing availability of work in tourist sector

•   Wholetime, part-time and temporary

•   Hidden

•   Discouraged and marginalised workers
                                Classical unemployment


                                                 ASL
Average (real) wage rate




                                 B         A
                           W2

                           We



                                                         ADL

                            O     Q         Q
                                  2         1
                                      No. of workers
                                Equilibrium and disequilibrium unemployment


                                                           ASL
                                          Disequilibrium
                                                                 N
Average (real) wage rate




                                          unemployment


                                            b         a    c
                           W2
                                                  e
                           We                                     Equilibrium
                                                                 unemployment


                                                                     ADL

                            O

                                                No. of workers
             COSTS OF UNEMPLOYMENT

• Losses to unemployed themselves in terms of lower earnings than
  possible from social welfare payments

• Losses to economy and economic growth through waste of valuable
  productive resource

• Costs to government and tax payers (less tax raised and higher social
  spending required)

• Workers who stay unemployed for long periods may lose valuable
  skills

• Other costs - higher rates of crime and domestic problems

• Can be very demoralising for those affected and community as a whole
MEASURES TO DEAL WITH UNEMPLOYMENT
 • Achieving and maintaining higher levels of economic growth in
   economy

 • Adopting specific measures to deal with problem areas - e.g. retraining
   for workers made unemployed, special job schemes for young
   workers, infrastructural investment in disadvantaged regions etc.

 • Improving job information services

 • Matching educational programmes to future job needs in economy

 • Job sharing schemes

 • Incentives for those with enterprising ideas

 • Lower tax rates on employed
                             INFLATION
• Inflation refers to the general rise in prices in economy

• Main measurement is Consumer Price Index (CPI) which is perhaps the
  best known of all indices. It is now measured on a monthly basis in
  Ireland

• Level of inflation in Ireland had been higher than other EU countries
  prior to the recession but fell from 4.1% for 2008 to – 4.5% for 2009

• The degree of inflation can vary as between

   - mild
   - creeping
   - rampant
   - hyper

• Fast rising inflation undermines the value of money
                 CAUSES OF INFLATION

• Demand pull
  - when overall demand exceeds supply (e.g. in a boom)

• Cost push
  - when costs push up demand e.g. wages through trade union pressure,
  - profits of monopoly firms and imported inflation

• Sectoral inflation
  - e.g. when excess demand in certain labour markets pushes up price

• Monetarism
  - where inflation is due to excess money supply
                   Demand-pull inflation


                                    AS
Price level




              P2

              P1
                                                 AD2

                                           AD1

              O         Q1 Q2
                       National output
                   Cost-push inflation

                              AS2
                                    AS1
Price level




              P2
              P1



                                          AD

              O    Q2    Q1
                        National output
                 EFFECTS OF INFLATION
• Reduces the value of money creating a wage price spiral

• Can redistribute money away from those on fixed incomes

• Encourages speculation in the economy
  - property market in Ireland during Celtic Tiger
  - investments in stock market

• Penalises savers and rewards borrowers
  - higher inflation in Ireland than EU contributed to credit boom

• Causes uncertainty which is bad for planning

• Can have damaging effect on international confidence affecting
  exchange rates, interest rates, foreign investment etc.

								
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