INTRODUCTION TO MACROECONOMICS

B.Sc. In Financial Engineering

Diploma Level
Ms.C.L.D Amaratunga,
Bsc. Economics and Management, University of London, LSE and
Masters in Accounting and Finance , University of Adelaide.

Course content

Syllabus: Macroeconomic objectives and policies The

determination of national income and measuring GDP, Aggregate
demand, Aggregate Supply, the price level and the speed of
adjustment, consumption and savings, aggregate expenditure and
equilibrium, fiscal policy and monetary policies, foreign trade
and exchange rates, Money and banking, Central banking and
the monetary system, Unemployment, Inflation, Open economy
macroeconomics, Economic growth, The business cycle.

Assessment: Assignments (In-class Exams- 40%) and end of

semester written examination 60%.

Learning Outcome
By the end of the lecture series you should be able to:
Interpret the working of an economy by identifying macroeconomic
objectives and policies.
Compute
and
interpret
national
production,
income
and
expenditure. Understand different concepts of production approach
Interpret the working of aggregate and aggregate supply in
determining the price level. Understand the process of adjustment
in the short and long run.
Compute
and interpret consumption and savings and other
components of aggregate expenditure. Identify inflationary and
deflationary gaps. .
Interpret the use of fiscal and monetary policies. Money supply and
money demand and the conduct of monetary policy by the Central
bank.
Interpret trade theories and understand the balance of payments
and the exchange rate s .
Examine the determinants of inflation and unemployment.
Interpret economic growth and its determinants, and understand
the reasons for business cycles .

Microeconomics Vs
Macroeconomics

Introduction to Economics

Macroeconomics considers aggregates

and averages
Aggregates: GDP, Labor Force,
Averages: price level, interest rate

Macroeconomic variables
Stock variable: stock of capital, money
supply
Flow variable: investment, depreciation

Introduction to Economics

Macroeconomic objectives

Economic growth- A steady rate of increase of

national output.
Employment- A low level of unemployment
Price stability- A low and stable rate of inflation

Internal stability controlling inflation

External stability maintaining a stable exchange
rate
Maintaining a favorable balance of payments

Income distribution- An equitable distribution

of income

Macroeconomic policies

Monetary policy
Fiscal policy
Exchange rate policy
Employment (labor market) policy
Income distribution policy
International trade policy

What is Macroeconomics?

The Circular flow of incomeFour sector model

Households own factors of production and

they would supply factor services to firms.
They would receive factor incomes from firms.
Households spend the factor incomes to buy
the output of firms.

The firms use the factor inputs that are

rented from the households to make the
output. The output is sold to the households
and the income is used by the firms to pay
factor incomes to the households.

The Circular flow of incomeFour sector model

The Government sector taxes the households and the firms

and the revenue will be used for government spending.

The Foreign sector Import represents expenditure of

income which does not return to the firms. Exports accrue an
income not directly coming from households.

Leakages ( A leakage from the circular flow is no longer

recycled from households to firms)
Savings+ Imports+Taxes

Injections( An injection is money that flows to firms without

being recycled through households)- Investment+
Exports+ Government spending

The Circular flow of incomeFour sector model

At the equilibrium level of output Leakages

would equate Injections.
S+T+M=I + E+ G

If leakages rise without a corresponding

increase in injections then national output will
fall to a new equilibrium level of output.

If injections rise with no corresponding

increase in leakages then national output will
rise to a new equilibrium level of output.

National income measures

The output method- This measures the

actual value of goods and services produced.
This is calculated by summing all the value
added by all the firms in an economy. At each
stage of production the input cost is deducted
in order to avoid double counting.

Output is calculated by adding the total output

of the agriculture and mining (primary) sector,
the manufacturing sector(secondary) and the
services (tertiary) sector.

National income measures

The income method measures the value of all the incomes earned in
the economy.

The expenditure method measures the real value of all spending on

goods and services in the economy. This is calculated by adding up the
spending by all the different sectors in the economy.
Spending by households (C)
Spending by firms (I)
Spending by governments (G)
Spending by foreigners on exports minus spending on imports- Net
exports ( X-M)
The GDP at market prices ( Total spending of the
economy)=C=I+G+(X-M)

Regardless of the method used accounting will result in the same final
figure. National output, national income or national expenditure.

GDP per capita- International

Comparison

It is the total GDP divided by the size of the

population. The economic activity in a
county is measured by the GDP.

In order to compare the GDP between

countries in terms of raising living standards
the GDP per capita figure is the most
appropriate.

Reasons for the use of National

Income Statistics
National income statistics are used to judge
whether or not a government has been
successful in achieving its macroeconomic
objective of increased growth.
Governments use statistics to develop
policies.
Economists use statistics to develop models
to forecasts the future.
GDP is used to evaluate the standard of
living between different countries.

Limitations of GDP Three ways

of measuring national income

Errors/omissions from the data gathered-the task of

gathering the data is so large that it is inevitable that
mistakes and omissions occur.

Time- It takes a long time to gather all of the information so

revisions to provisional figures will be made over time.
Cash economy- some transactions are paid for in cash to
avoid paying taxation and are subsequently not recorded.

Unrecorded and under-recorded economic activityGDP values are undervalued because of hidden economic
activity.
External costs- GDP figures do not take into account the
costs of resource depletion.

Limitations of GDP

Distribution of income- two countries may have

similar GDP per capita, the distribution of income in
each country may be very different.
Double counting- it is difficult to avoid double
counting items that may go through several
production processes e.g. counting the value of
flour when it leaves the mill, and again when bread
is produced would lead to the flour being included
in the national figures twice.
Quality of life- whilst national income provides an
indication of wealth it does not measure quality of
life.

Difficulties in comparing national

income between countries.

Other quality of life concerns- GDP accounting does not include

free activities such as volunteer work or people caring for the elderly.
Different methods of calculating national income figures may
differ from one country to another.
Accuracy of figures- some countries may be more accurate than
others in their collection of raw data.
Currency fluctuations-some currencies may fluctuate wildly over a
year making it difficult to make direct comparisons.
Population size-unless the national income figures are per capita it
is difficult to judge the wealth per person, and comparisons can be
misleading.
Composition of output-Different countries will have different ways
of spending their wealth. Some countries will spend large proportions
on armaments which may provide little actual direct benefits to the
general public.