MacroeconomicsKanako Nakagawa

Introduction to development Circular flow of income: simplified model of the economy that

shows the flow of money through the economy. Gross Domestic Product (GDP): total money value of all final

goods and services produced in an economy in one year. Gross National Product (GNP): total money value of all final

goods and services produced in an economy in one year, plus net property income from abroad.

Real GDP: GDP, not adjusted for inflation Per capita GDP: total money value of all final goods and

services produced in an economy in one year per head of the population.

Circular Flow DiagramHouseholds

Firms

Exports

Government Spending

Investment

Imports

Taxes

Savings

Expenditure

Income

Aggregate Demand (AD)

AD: total spending in an economy consisting of consumption, investment, government spending and net exports. Consumption: spending by households on consumer

goods and services over a period of time Investment: addition to the capital stock of the economy

in the form of factories, offices, machinery, and equipment which is used to produce goods and services.

Aggregate demand curvePr

ice L

evel

Real GDP

P1

P2

Y1 Y2

AD

Figure 1: AD curve

0

Aggregate Supply (AS) AS: total amount of domestic goods and services

supplied by businesses and the government, including both consumer goods and capital goods.

Short-run aggregate supply (SRAS): AS that varies with the level of demand for goods and services and that is shifted by changes in the costs of factors of production.

Long-run aggregate supply (LRAS): AS that is dependent upon the resources in the economy and that can only be increased by improvements in the quantity and/or quality of factors of production.

Short-run aggregate supply curve

Price

Lev

el

Real GDP

P2

P1

Y1 Y2

SRAS

Figure 1: SRAS curve

0

Macroeconomic Models

Inflationary gap: situation where total spending (AD) is greater than the full employment level of output, thus causing inflation.

Deflationary gap: situation where total spending (AD) is less that the full employment level of output, thus causing unemployment.

Policies Demand-side policies: any government policies designed to

influence AD in the economy, thus affecting the average price level and real national output.

Supply-side policies: any government policies designed to shift the LRAS curve to the right, thus increasing potential output in the economy.

Fiscal policy: policy using changes in government spending and/or direct taxation to achieve economic objectives.

Monetary policy: policy using changes in the money supply or interest rates to achieve economic objectives.

Demand-side policyPr

ice L

evel

Real GDP

P1P2

Y1 Y2

AD

Figure 1: effect of demand-side policy

AD’

AS

0

Supply-side policyPr

ice L

evel

Real GDP

P1

P2

Y1 Y2

AD

Figure 1: AD curve

LRAS1LRAS2

Unemployment Unemployment: situation that exists when people who are

willing and able to work cannot get a job. Unemployment rate: number of unemployed workers

expressed as a percentage of the total workforce.

Full employment: when the number of jobs available in an economy is equal to or greater than the number of people actively seeking work.

Underemployment: when workers are carrying out jobs for which they are over-qualified, or when workers are employed part-time even when they can work full-time.

Real wage unemployment; exists when real wages in the economy get pushed up above their equilibrium

Unemployment Cont. Structural unemployment; exists when in the long term the

pattern of demand and production methods change and there is a permanent fall in the demand for a particular type of labor.

Frictional (search) unemployment: exists when people have left a job and are in the process of searching for another job.

Seasonal unemployment: exists when people are out of work because their usual job is out of season.

Demand deficient (cyclical) unemployment: exists when there is insufficient AD in the economy and real wages do not fall to compensate for this.

Real wage unemployment

0

Aver

age

wage

rate

Number of workers

ASL

ADL

a bW1

We

Q1 Q2

Demand deficient unemployment

0

Aver

age

wage

rate

Number of workers

ASL

ADLT

a bWe

W1

Q1

ADL

Qe

c

Inflation

Inflation: sustained increase in the general (or average) level of prices and a fall in the value of money.

Demand-pull inflation: inflation that is caused by increasing AD in an economy that shifts the AD curve to the right.

Cost-push inflation: inflation that is caused by an increase in the costs of production in an economy that shifts the SRAS curve to the left.

Demand-pull inflationPr

ice L

evel

Real GDP

P1

P2

Y1 Y2

AD

0

SRAS

AD’

Cost-push inflationPr

ice L

evel

Real GDP

P2

P1

Y2 Y1

AD

0

SRAS’SRAS

Deflation

Persistent fall in the average level of prices in an economy

Taxes

Direct taxation: imposed on people’s income or wealth, and on firms’ profit.

Indirect taxation: tax on expenditure, added to the selling price of a good or service.

Progressive taxation: system of direct taxation where tax is levied at an increasing rate for successive bands of income.

Regressive taxation: system of taxation in which tax is levied at a decreasing average rate as income rises.