The National

Economy
 Macroeconomic Objectives

• Distinction between microeconomics

and macroeconomics
• The major macroeconomic issues
–– economic
economic growth
growth
–– unemployment
unemployment
–– inflation
inflation
–– balance
balance of
of payments
payments and
and exchange
exchange rates
rates
•• balance
balance of
of payments
payments deficits
deficits and
and surpluses
surpluses
•• exchange
exchange rate
rate movements
movements
 The Circular Flow of Income

• The inner flow

 The circular flow of income

Firms

Consumption of
Factor domestically
payments produced goods
and services (Cd)

Households
 The Circular Flow of Income

• Withdrawals
–– net
net saving
saving
–– net
net taxes
taxes
–– import
import expenditure
expenditure
• Injections
–– investment
investment
–– government
government expenditure
expenditure
–– export
export expenditure
expenditure
 The circular flow of income

INJECTIONS

Export
expenditure
expenditure (X)
Investment
Investment ((I))
Government
Government
Consumption of expenditure
expenditure ((G))

Factor domestically
BANKS, etc GOV. ABROAD
payments produced goods
and services (Cd)
Import
Import
Net
Net expenditure
Net expenditure (M
M))
taxes
taxes (T
T))
saving (S)

WITHDRAWALS
 The Circular Flow of Income

• The relationship between injections and

withdrawals
–– the
the links
links between
between them
them
 The circular flow of income

INJECTIONS

Export
expenditure
expenditure (X)
Investment
Investment ((I))
Government
Government
Consumption of expenditure
expenditure ((G))

Factor domestically
BANKS, etc GOV. ABROAD
payments produced goods
and services (Cd)
Import
Import
Net
Net expenditure
Net expenditure (M
M))
taxes
taxes (T
T))
saving (S)

WITHDRAWALS
 The Circular Flow of Income

• The relationship between injections and

withdrawals
–– the
the links
links between
between them
them
–– planned
planned injections
injections may
may not
not equal
equal planned
planned
withdrawals
withdrawals
 The Circular Flow of Income

• The relationship between injections and

withdrawals
–– the
the links
links between
between them
them
–– planned
planned injections
injections may
may not
not equal
equal planned
planned
withdrawals
withdrawals

• Equilibrium in the circular flow

 The circular flow of income

INJECTIONS

Export
expenditure
expenditure (X)
Investment
Investment ((I))
Government
Government
Consumption of expenditure
expenditure ((G))

Factor domestically
BANKS, etc GOV. ABROAD
payments produced goods
and services (Cd)
Import
Import
Net
Net expenditure
Net expenditure (M
M))
taxes
taxes (T
T))
saving (S)

WITHDRAWALS
 The Circular Flow of Income

• The relationship between injections and

withdrawals
–– the
the links
links between
between them
them
–– planned
planned injections
injections may
may not
not equal
equal planned
planned
withdrawals
withdrawals

• Equilibrium in the circular flow

• The circular flow and the four

macroeconomic objectives
 The circular flow of income

INJECTIONS

Export
expenditure
expenditure (X)
Investment
Investment ((I))
Government
Government
Consumption of expenditure
expenditure ((G))

Factor domestically
BANKS, etc GOV. ABROAD
payments produced goods
and services (Cd)
Import
Import
Net
Net expenditure
Net expenditure (M
M))
taxes
taxes (T
T))
saving (S)

WITHDRAWALS
Economic Growth and the Business Cycle

• Actual and potential growth

–– Economic
Economic growth
growth and
and the
the production
production
possibility
possibility curve
curve
 Growth and the production possibility curve
Good X

b
Growth in
actual output

I
O
Good Y
 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

• Economic growth and the business

cycle
–– fluctuations
fluctuations in
in actual
actual growth
growth
 The business cycle

Full-capacity
output
National output

Actual
output

O
Time
Economic Growth and the Business Cycle

• Economic growth and the business

cycle
–– fluctuations
fluctuations in
in actual
actual growth
growth
–– the
the phases
phases of
of the
the business
business cycle
cycle
•• upturn
upturn
•• rapid
rapid expansion
expansion
•• peaking
peaking out
out
•• slowdown
slowdown oror recession
recession
 The business cycle

Full-capacity
output
National output

3
4
2 Actual
3
output
4
2 1

O
Time
Economic Growth and the Business Cycle

• Economic growth and the business

cycle
–– fluctuations
fluctuations in
in actual
actual growth
growth
–– the
the phases
phases of
of the
the business
business cycle
cycle
•• upturn
upturn
•• rapid
rapid expansion
expansion
•• peaking
peaking out
out
•• slowdown
slowdown oror recession
recession
–– long-term
long-term output
output trend
trend
 The business cycle

Full-capacity
output

Trend
National output

output

Actual
output

O
Time
Economic Growth and the Business Cycle

• Economic growth and the business

cycle
–– fluctuations
fluctuations in
in actual
actual growth
growth
–– the
the phases
phases of
of the
the business
business cycle
cycle
–– long-term
long-term output
output trend
trend
–– the
the business
business cycle
cycle in
in practice
practice
•• the
the irregularity
irregularity of
of the
the cycle
cycle
•• the
the length
length of
of the
the phases
phases
•• the
the magnitude
magnitude of
of the
the phases
phases
Economic Growth and the Business Cycle

• Causes of potential growth

–– increases
increases in
in the
the quantity
quantity of
of factors
factors
•• capital
capital
•• labour
labour
•• land
land and
and raw
raw materials
materials
–– the
the problem
problem of
of diminishing
diminishing returns
returns
–– increases
increases in
in factor
factor productivity
productivity
• Policies to achieve growth
–– demand-side
demand-side and
and supply-side
supply-side policies
policies
–– market-orientated
market-orientated and
and interventionist
interventionist
policies
policies
Equilibrium Level of National Income

• The circular flow of income

The circular flow of income
The circular flow of income

Cd
 The circular flow of income

Incomes Cd
 The circular flow of income

Incomes Cd

W=S+T+M
 The circular flow of income

J=I+G+X

Incomes Cd

W=S+T+M
Equilibrium Level of National Income

• Effect on national income of a change in

injections and/or withdrawals
–– JJ >> W
W :: national
national income
income rises
rises
–– WW >> JJ :: national
national income
income falls
falls
• The Keynesian diagram: the withdrawals
and injections approach
–– the
the withdrawals
withdrawals curve
curve
–– the
the injections
injections curve
curve
–– equilibrium
equilibrium
 Deriving equilibrium national income
Cd, W, J

If injections exceed withdrawals,

national income will rise.

a
J
b
O Y1 Y
 Deriving equilibrium national income
Cd, W, J

If withdrawals exceed injections,

national income will fall.

W
c

d J

O Y2 Y
 Deriving equilibrium national income
Cd, W, J

Equilibrium national income

is where W = J.

x
J

O
Ye Y
Equilibrium Level of National Income

• The Keynesian diagram: the income and

expenditure approach
–– the
the 45°
45° line
line
 Deriving equilibrium national income
Cd, W, J

Y = Cd + W

O
Y
Equilibrium Level of National Income

• The Keynesian diagram: the income and

expenditure approach
–– the
the 45°
45° line
line
–– the
the expenditure
expenditure curve
curve
 Deriving equilibrium national income
Cd, W, J

Y = Cd + W
E = Cd + J

Cd
J

O
Y
Equilibrium Level of National Income

• The Keynesian diagram: the income and

expenditure approach
–– the
the 45°
45° line
line
–– the
the expenditure
expenditure curve
curve
–– equilibrium
equilibrium
 Deriving equilibrium national income
Cd, W, J

If aggregate expenditure Y = Cd + W
exceeds national income, E = Cd + J
national income will rise.

Cd

e
W
f

O Y1 Y
 Deriving equilibrium national income
Cd, W, J

If national income exceeds Y = Cd + W

aggregate expenditure, E = Cd + J
national income will fall. g

h Cd

O Y2 Y
 Deriving equilibrium national income
Cd, W, J

Y = Cd + W
Equilibrium national income is
where Y = E (and W = J). E = Cd + J

Cd
z

x
J

O
Ye Y
 Aggregate demand and aggregate supply

Why
Why the
the AD
AD curve
curve slopes
slopes downwards
downwards
•• foreign
foreign trade
trade effect
effect
•• real
real balance
balance effect
effect
Price level

•• interest
interest rate
rate effect
effect

The
The shape
shape of
of the
the AD
AD curve
curve
Shifts
Shifts in
in the
the AD
AD curve
curve

AD

National output
 Aggregate Demand and Supply

• The aggregate demand curve

• The aggregate supply curve

 Aggregate demand and aggregate supply

AS
Price level

•• short-run
short-run and
and long-run
long-run AS
AS
curves
curves
•• the
the shape
shape of
of the
the AS
AS curve
curve
•• shift
shift in
in the
the AS
AS curve
curve

National output
 Aggregate Demand and Supply

• The aggregate demand curve

• The aggregate supply curve

• Equilibrium
 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

National output
 Aggregate Demand and Supply

• The aggregate demand curve

• The aggregate supply curve

• Equilibrium
–– shifts
shifts in
in the
the AD
AD curve
curve
 Aggregate Demand and Supply

• The aggregate demand curve

• The aggregate supply curve

• Equilibrium
–– shifts
shifts in
in the
the AD
AD curve
curve
–– shifts
shifts in
in the
the AS
AS curve
curve
 Aggregate Demand and Supply

• Relationship between the AD/AS and

Keynesian diagrams
–– effect
effect of
of aa change
change in
in aggregate
aggregate demand
demand
•• effect
effect with
with no
no price
price change
change
Allowing for inflation in the 45 line and AD / AS diagrams
P
AS

An upward-
sloping AS curve
P1

AD1
Y
Y1
Cd, W, J, E

Y
Allowing for inflation in the 45 line and AD / AS diagrams
P
AS

An upward-
sloping AS curve
P1

AD1
Y
Cd, W, J, E Y

E1

Y
Y
Allowing for inflation in the 45 line and AD / AS diagrams
P
AS
A rise in aggregate
demand shown in
both diagrams A rise in the
price level to P2
P2
P1
AD2
AD1
Y
Cd, W, J, E Y
E2

E1

Y
Y Y
 Aggregate Demand and Supply

• Relationship between the AD/AS and

Keynesian diagrams
–– effect
effect of
of aa change
change in
in aggregate
aggregate demand
demand
•• effect
effect with
with no
no price
price change
change
•• effect
effect with
with price
price change
change
Allowing for inflation in the 45 line and AD / AS diagrams
P
AS

A rise in the
price level to P2
P2
P1
AD2
AD1
Y
Cd, W, J, E Y
E2
E3
E1

This reduces real

aggregate
expenditure to E3

Y
Y1 Y3 Y2
 Measuring national income

• GDP: the measure of national income

• Methods of measuring GDP
–– the
the product
product approach
approach
–– the
the income
income approach
approach
–– the
the expenditure
expenditure approach
approach
The circular flow of national income and expenditure
The circular flow of national income and expenditure
(1) Production

(2) Incomes (3) Expenditure

 Measuring national income

• GDP: the measure of national income

• Methods of measuring GDP
–– the
the product
product approach
approach
–– the
the income
income approach
approach
–– the
the expenditure
expenditure approach
approach
• The product approach
 Measuring national income

• GDP: the measure of national income

• Methods of measuring GDP
–– the
the product
product approach
approach
–– the
the income
income approach
approach
–– the
the expenditure
expenditure approach
approach
• The product approach
–– measuring
measuring GVA
GVA
 Measuring national income

• GDP: the measure of national income

• Methods of measuring GDP
–– the
the product
product approach
approach
–– the
the income
income approach
approach
–– the
the expenditure
expenditure approach
approach
• The product approach
–– measuring
measuring GVA
GVA
• The income approach
UK GVA by category of income: 2005

Compensation of employees
(wages and salaries)
£684 618 m

Operating surplus
(gross profit, rent and interest of firms
government and other institutions)
£312 026 m

Mixed incomes
£76 112 m
Tax less subsidies on production
(other than those on products) plus
statistical discrepancy £14 103 m
 Measuring national income

• GDP: the measure of national income

• Methods of measuring GDP
–– the
the product
product approach
approach
–– the
the income
income approach
approach
–– the
the expenditure
expenditure approach
approach
• The product approach
–– measuring
measuring GVA
GVA
• The income approach
• From GVA to GDP
 Measuring national income

• GDP: the measure of national income

• Methods of measuring GDP
–– the
the product
product approach
approach
–– the
the income
income approach
approach
–– the
the expenditure
expenditure approach
approach
• The product approach
–– measuring
measuring GVA
GVA
• The income approach
• The expenditure approach
UK
UK GDP
GDP by
by category
category of
of expenditure,
expenditure, GNY
GNY and
and NNY:
NNY: 2005
2005
£million

Consumption expenditure of households and NPISH (C) 791 302

Government final consumption (G) 267 530
Gross capital formation (I) 209 187
Exports of goods and services (X) 322 298
less Imports of goods and services (M) 366 540
Statistical discrepancy 938

Gross domestic product (GDP) (at market prices) 1 224 715

 Measuring national income

• GDP: the measure of national income

• Methods of measuring GDP
–– the
the product
product approach
approach
–– the
the income
income approach
approach
–– the
the expenditure
expenditure approach
approach
• The product approach
• The income approach
• From GDP to net national income (NNY)
UK
UK GDP
GDP by
by category
category of
of expenditure,
expenditure, GNY
GNY and
and NNY:
NNY: 2005
2005
£million

Consumption expenditure of households and NPISH (C) 791 302

Government final consumption (G) 267 530
Gross capital formation (I) 209 187
Exports of goods and services (X) 322 298
less Imports of goods and services (M) 366 540
Statistical discrepancy 938

Gross domestic product (GDP) (at market prices) 1 224 715

plus Net income from abroad 28 846

Gross national income (GNY) 1 253 561

UK
UK GDP
GDP by
by category
category of
of expenditure,
expenditure, GNY
GNY and
and NNY:
NNY: 2005
2005
£million

Consumption expenditure of households and NPISH (C) 791 302

Government final consumption (G) 267 530
Gross capital formation (I) 209 187
Exports of goods and services (X) 322 298
less Imports of goods and services (M) 366 540
Statistical discrepancy 938

Gross domestic product (GDP) (at market prices) 1 224 715

plus Net income from abroad 28 846

Gross national income (GNY) 1 253 561

less Capital consumption (depreciation) 131 093

Net national income (NNY) 1 122 468