Macroeconomics

1. Macroeconomics 2.1 Economic Activity

2. Readings • McGee textbook • Pages 249-264 • Pages267-271 • Pages 299-303 • Mankiw textbook • Read Chapter 23 2.1 Economic Activity

3. Online resources • http://www.dineshbakshi.com/ib-economics • www.Econclassroom.com • Khan Academy 2.1 Economic Activity

4. Vocab 2.1 Economic Activity

5. Learning Objectives • Describe using a diagram, the circular flow of income between households and firms in a closed economy with no government • Identify the four factors of production and their respective payments and explain why these constitute the income flow in the model. • Describe, using a diagram, the circular flow of income • Explain how the size of the circular flow will change depending on the relative size of injections and leakages. • Outline that the income flow is numerically equivalent to the expenditure flow and the value of output flow. • Distinguish between GDP and GNP/GNI as measures of economic activity. • Distinguish between the nominal value of GDP and GNP/GNI and the real value of GDP and GNP/GNI. • Distinguish between total GDP and GNP/GNI and per capita GDP and GNP/GNI. 2.1 Economic Activity

6. Continued • Examine the output approach, the income approach and the expenditure approach when measuring national income. • Evaluate the use of national income statistics, including their use for making comparisons over time, their use for making comparisons between countries and their use for making conclusions about standards of living. • Explain the meaning and significance of “green GDP”, a measure of GDP that accounts for environmental destruction • Explain, using a business cycle diagram, that economies typically tend to go through a cyclical pattern characterized by the phases of the business cycle. • Explain the long-term growth trend in the business cycle diagram as the potential output of the economy. • Distinguish between a decrease in GDP and a decrease in GDP growth. • Calculate nominal GDP from sets of national income data, using the expenditure approach., Calculate GNP/GNI from data, Calculate real GDP, using a price deflator. (HL ONLY) 2.1 Economic Activity

7. Links to ToK • Do you think the in ability to observe some variables makes the social scientific methods less ‘scientific’? • What kinds of difficulties might be created for the policy makers who use the concept of ‘potential output’ to determine appropriate policies for the economy. • What is the empirical evidence for the existence of the business cycle? How do we decide whether this evidence is sufficient? 2.1 Economic Activity

8. Intro to Macro 2.1 Economic Activity

9. Macroeconomics • In contrast to micro, macro[large]economics, is the study of economics as a whole • Throughout our studies of Microeconomics, we learned several key concepts, most for which there is a similar concept which we will study in Macroeconomics. • The table below shows several of the Micro concepts we studied and their Macro equivalents. 2.1 Economic Activity

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11. Macro Circular Model 2.1 Economic Activity

12. Circular Flow • Just like scientists in other fields, economists use models to represent something from the real world. • A model of the solar system: Allows astronomers to illustrate in a simplified model the relationships between solar bodies. • A Circular Flow Model: Allows economists to illustrate in a simplified model the relationships between households and firms in a market economy. 2.1 Economic Activity

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14. REMEMBER • Ceteris Paribus: Like in other scientists, when using economic models we must assume “all else equal”. This allows us to observe how one variable in an economy will affect another, without considering all the other factors that may affect the variable in question. 2.1 Economic Activity

15. Open economy vs. Closed economy 2.1 Economic Activity

16. Open Economy vs. Closed Economy • In a nutshell, closed economy/autarky, is a sel-sufficient economy • closed economy does not enter into any one of the following activities. • It neither exports goods and services to the foreign countries nor imports goods and services from the foreign countries. • It neither buys shares, debentures, bonds etc. from foreign countries nor sells shares, debentures, bonds etc. to foreign countries 2.1 Economic Activity

17. It neither borrows from the foreign countries nor lends to the foreign countries. • It neither receives gifts from foreigners nor sends gifts to foreigners. • Normal residents of a closed economy cannot go to other countries to work in their domestic territoryand vice versa. • Therefore GDP and GNP [to be discussed later in the section] are the same 2.1 Economic Activity

18. Open economy • open economy is not only involved in the process of production within its domestic territory but also can participate in production anywhere in the rest of the world. • An open economy involves itself in the following activities. • It buys shares, debentures, bonds etc. from foreign countries and sells shares, debentures, bonds etc. to foreign countries. 2.1 Economic Activity

19. It borrows from foreign countries and lends to foreign countries. • It can send gifts and remittances to foreigners and can receive the same from them. • Normal residents of an open economy can move or be employed and are allowed to work in the domestic territory of other economies. • Due to these reasons, GDP and GNP are not same in an open economy. • It is to be noted that at present all economies of the world are open economies. 2.1 Economic Activity

20. This is what you know Closed economy 2.1 Economic Activity

21. Let’s add more macro features: 2.1 Economic Activity

22. A government sector: • The government collects taxes from households and firms (these are a leakage from the circular flow) • and contributes government expenditures on public goods (these are injections into the flow). 2.1 Economic Activity

23. A foreign sector: • A nation spends money on foreign goods (imports, this is a leakage) • and earns money by selling goods to foreigners (exports, an injection). 2.1 Economic Activity

24. The banking sector: • Households and firms save money in the banking sector (a leakage) and banks provide households and firms with funds for investment (an injection) 2.1 Economic Activity

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26. Test your knowledge • In your groups, discuss • What are the four factors of production and what are the four respective payments? • Use the circular flow to show: • Circular flow of income 2.1 Economic Activity

27. Leakage and Injections in the Circular Flow 2.1 Economic Activity

28. Referring to the circular flow • In the circular flow model on the previous slide there were red arrows and green arrows, • indicating leakages from and injections to the circular flow. 2.1 Economic Activity

29. Leakages • Taxes paid to the government, • spending on imports from abroad, • and money saved in banks • are all considered leakages from the circular flow of income. • Any income earned but NOT spent on goods and services does not contribute to the nation’s total output, and is therefore leaked from the nation’s economy. • However, these three leakages allow for the three following injections. 2.1 Economic Activity

30. Injections • Government spending • export revenues • investments • are all enabled by the three leakages mentioned previously. 2.1 Economic Activity

31. 1-Tax • Because households and firms pay taxes, • government has money to provide the nation with valuable infrastructure, education, defense, support for health care and so on • all public or quasi-public goods that would be under-provided by the free market. • These contribute to national output and are thus injections into the circular flow. 2.1 Economic Activity

32. 2-Imports • Because domestic households buy imports, • foreigners have access to the money they need to buy the nation’s exports. • The spending by foreigners on domestically produced goods contributes to national output and is therefore an injection. 2.1 Economic Activity

33. 3-Savings • Because households save some percentage of their income, • capital is available for others to borrow and spend. • Spending on capital goods by firms or on homes by households (both considered investments) contributes to the nation’s output and is thus an injection into the circular flow. 2.1 Economic Activity

34. Keep in mind! • The total output of a nation’s economy will either increase or decrease based on the relative size of leakages and injections! 2.1 Economic Activity

35. Test your understanding • in your groups, discuss • What happens to the size of the income flow when: • Leakages are larger than injections • Injections are larger than leakages 2.1 Economic Activity

36. Answer • If the Injections < leakages, the income flow becomes smaller • How? Part of the household income that leaks as savings into the financial market, does not come back into the flow as investment. • Fewer G&S are purchased, firms cut back, output decreases, they buy fewer factors of production, unemployment increases and household income reduces. • If the injections > leakages, the income flow becomes larger • How? Suppose spending on exports > imports, expenditure flow increases since injection is larger than leakage. • Foreigners demand more, firms produce more and acquire more FoP, unemployment falls and household income increases. 2.1 Economic Activity

37. Test your knowledge • In your groups, • Illustrate using the CFI model, how the three points of leakages and injections are linked together. • Draw your final chart on the provided poster. 2.1 Economic Activity

38. Three Approaches to Measuring Output 2.1 Economic Activity

39. The Income approach • Measures GDP by recording the income of household in the resource market side of the circular flow of income. • Income includes payments households receive in the resource market in exchange for providing firms with the factors of production, • including the total sum of each of the following earned by a nation’s households in a year: • Wages for labor, Interest for capital, Rent for land and Profits for entrepreneurship. • National Income = W+I+R+P 2.1 Economic Activity

40. The Output approach • Measures the value of the total output produced in the different sectors of the economy. When the total output of every sector of the nation’s economy is summed, total output is found. • National output = Outputs of the primary sector + the secondary sector the tertiary sector 2.1 Economic Activity

41. The Expenditure approach • Counts the total spending on final new goods and services in a given year. • "Final" goods are ready for consumption and do not includes goods that will be input goods or are raw materials for other production. • This approach distinguishes between four types of spending on a nation’s output. • These include households consumption (C), investment in capital by firms (I), government spending (G) and net exports (Xn). • Total expenditures =C+I+G+Xn 2.1 Economic Activity

42. Test your knowledge • Discuss with your partner the different approaches to measuring economy’s output. 2.1 Economic Activity

43. Video • Watch the video and answer the following questions: • http://www.econclassroom.com/?p=2632 2.1 Economic Activity

44. Apply your knowledge • Examine the different approaches when measuring national income. 2.1 Economic Activity

45. Intro to GDP 2.1 Economic Activity

46. Gross Domestic Product • The sum of all officially recognized final goods and services produced within a country in a given period of time • GDP can be measured using the income approach, the output approach and expenditure approach 2.1 Economic Activity

47. The formula 2.1 Economic Activity

48. Included in GDP • GDP includes only final products and services • GDP is the value of what has been produced within the borders of a nation over one year, not what was actually sold. 2.1 Economic Activity

49. Excluded in the GDP • Purely financial transactions are excluded. • Public transfer payments, like social security or cash welfare benefits. • Private transfer payments, like student allowances or alimony payments. • The sale of stocks and bonds represent a transfer of existing assets (However, the brokers’ fees are included for services rendered.) • Secondhand sales: If I buy a used car in 2008, that sale does not count towards 2008's GDP, because the car was not made in 2008! The price of the car was originally included in the year's GDP when it was produced. 2.1 Economic Activity

50. The Components of GDP 2.1 Economic Activity