Macroeconomics

intro to macroeconomics-

An economic slowdown following covid19:

• How does an economic slowdown affect, say tourism businesses in NZ?
• What is the direct effect on the demand (and thus price) for their products?
• What is the indirect effect on the demand (and thus price) for their products?
• What will happen to the cost of their inputs?
• What will happen to the value of the NZ dollar and how will this impact on the profitability of the firm?
• What will happen to the cost of borrowing and how will this impact on the profitability of the firm?
• What will happen to wage demands from employees?
• Should the business expand or contract?
• Should the business try to develop new markets?

An international economic slowdown

• A negative shock to international demand for Tourism will:
• Decrease the price of tourism businesses and the quantity demand of tourism
• Decrease the incomes of Tourism businesses
• Decrease employment in the NZ tourism industry
• Decrease the value of tourism capital assets (land, buildings, etc.)
• Decrease the amount of spending by NZ tourism businesses in NZ
• Decrease the price of other goods and services
• Decrease incomes of NZ working in sectors supporting tourism
• Decrease employment
• Decrease spending
• Decrease incomes
• Decrease employment
• Decrease spending
• Repeat…

What is macroeconomics

• Macroeconomics is the study of the economy as a whole. It addresses many issues which impact our day-to-day lives.
• How much output does the country produce?
• What is inflation? Why does the cost of living keep rising?
• What is unemployment? How can it be reduced?
• Income Distribution: Why are so many countries poor? What policies might help them grow out of poverty?
• What is the trade deficit?

• GDP Defined

Gross domestic product or GDP

The market value of all the final goods and services produced within a country in a given time period.

Value Produced

• Use market prices to value production.

What Produced

Final good or service is a good or service that is produced for its final user and not as a component of another good or service.

Intermediate good or service is a good or service that is produced by one firm, bought by another firm, and used as a component of a final good or service.

GDP includes only those items that are traded in markets.

Where Produced

Within a country

When Produced

During a given time period

Value added:

The value of output minus the value of the intermediate goods used to produce that output

Gross domestic product: value added

1. A farmer grows rice and sells the rice to a miller for $100.

2. The miller turns the rice into flour and sells it to a noodle-factory for $300.

3. The noodle-factory uses the flour to make noodles which it sells to an economist for $600.

The economist eats the noodles.

What is the value-added at each step?

1. A farmer grows of rice and sells it to a miller for $100.

Value Added = $100

2. The miller turns the rice into flour and sells it to a noodle-factory for $300.

Value Added = $200

3. The noodle-factory uses the flour to make noodles which it sells to an economist for $600.

Value Added = $300

GDP = $100+$200+$300 = $600 = Value of the final good

GDP is    

   1. value of final goods produced

   2. sum of value added at all stages of production.

Should we include both 1. and 2.? 

The value of the final goods already includes the value of the intermediate goods, so including intermediate and final goods in GDP would be double counting. 

• Circular Flows in the NZ Economy

Consumption expenditure is the expenditure by households on consumption goods and services.

Investment is the purchase of new capital goods (tools, instruments, machines, buildings, and other constructions) and additions to inventories.

Consumption C

The value of all goods and services brought by households.

Consumption can be in the form of durable goods, non-durable goods, and services.

• Durable goods last a long time. E.g., cars, refrigerators, etc.
• Nondurable goods last a short time. E.g., food and clothing.
• Services are intangible items purchased by consumers. E.g., dry cleaning, taxi rides, visits to the doctor, etc.

Investment I

Spending on capital, a physical asset used in future production.

• Investment includes the following:

Business fixed investment

Spending on plant and equipment

Residential fixed investment

Spending by consumers and landlords on housing units

Inventory investment

The change in the value of all firms’ inventories

GDP, income and expenditure

Government expenditure on goods and services is the expenditure by all levels of government on goods and services.

Net exports of goods and services is the value of exports of goods and services minus the value of imports of goods and services.

Exports of goods and services are the items that firms in NZ for example produce and sell to the rest of the world.

Imports of goods and services are the items that households, firms, and governments in NZ buy from the rest of the world.

Which part of GDP

• A New Zealand Tourist’s Expenditure in Australia
• A Dairy farmer installs a new milking platform (built in NZ)
• I buy a new car
•  Christchurch hospital buys syringes

Total expenditure is the total amount received by producers of final goods and services.

Consumption expenditure: C

Investment: I

Government expenditure on goods and services: G

Net exports: NX

Total expenditure = C + I + G + NX

Income

• Labour earns wages.
• Capital earns interest.
• Land earns rent.
• Entrepreneurship earns profits.

Households receive these incomes.

• Expenditure Equals Income

Because firms pay out everything they receive as incomes to the factors of production (Y), total expenditure equals total income.

That is:

Y = C + I + G + NX

The value of production equals income equals expenditure.

Measuring the size of an economy

• Gross domestic product (GDP) is the market value of all final goods and services produced in a country in a given time period
• Market value depends on prices, which change over time
• Final goods and services (those bought by end users) do not include goods and services purchased as inputs into production
• Within a country
• In a given time period, normally a year or a quarter
• Nominal GDP values output in a particular period using the prices that prevailed during that period
• Real GDP values output in a particular period using the prices that prevailed during some historical reference base year
• Per capita GDP is GDP divided by the population

Components of GDP

Y = GDP = C + I + G + (X – M)

• C, consumption expenditure, is the total payment for consumer goods and services
• I, investment, is the total payment for new capital
• G, government expenditure, is the total payment for goods and services by the government
• (X – M), net exports, takes into account purchases of a country’s goods by foreigners (+) and purchases of foreign goods by domestic consumers (-)

Economic growth-

Economic growth is a sustained expansion of production possibilities measured as the increase in

real GDP over a given period.

• Calculating Growth Rates

Economic growth rate is the annual percentage change of real GDP.

Economic growth is a sustained expansion of production possibilities measured as the increase in

real GDP over a given period.

Maintained over decades, rapid economic growth can transform a poor nation into a rich one.

Such has been the experience of Hong Kong, South Korea, Taiwan and some other Asian economies.

Two features of our changing standard of living are

The growth of potential GDP per person

Fluctuations of real GDP per person around potential    GDP

Potential GDP is the value of real GDP when all the economy’s factors of production —labour, capital, land and entrepreneurial ability—are fully employed.

When some factors of production are unemployed, real GDP is less than potential GDP.

When some factors of production are over-employed and working hard, real GDP exceeds potential GDP.

In the short term, real GDP fluctuates around potential GDP.

To measure the trend in the standard of living, we remove the influence of short-term fluctuations and focus on potential GDP.    

• Tracking the Course of the Business Cycle

Fluctuations in the pace of expansion of real GDP is called the business cycle.

The business cycle is a periodic, but irregular, up- and down-movement of total production and other measures of economic activity.

The four stages of a business cycle are

expansion, peak, recession and trough.

• Economic Growth Versus Business Cycle Expansion

Real GDP can increase for two distinct reasons:

1. The economy might be returning to full employment    in an expansion phase of the business cycle.
2. Potential GDP might be increasing.

The return to full employment in an expansion phase of the business cycle isn’t economic growth.

The expansion of potential GDP is economic growth.

• The mechanics of economic growth

Potential GDP is the value of real GDP when all the economy’s factors of production are fully employed.

We produce the goods and services that make up real GDP by using factors of production: labour and human capital, physical capital, land and entrepreneurship.

At any given time, the quantities of human capital, physical capital, land, entrepreneurship and the state of technology are fixed.

But the quantity of labour is not fixed.

The quantity of labour employed depends on the choices of people and businesses.

So real GDP produced depends on the quantity of labour employed.

To describe the relationship between real GDP and the quantity of labour employed, we use a relationship called the production function. 

• The Production Function

Production function is a relationship that shows the maximum quantity of real GDP that can be produced as the quantity of labour employed changes and all other influences on production remain the same.

• What increases labour
• Workforce participation
• Female participation the workforce
• Maternity leave, child care, pay equity, etc.

• Delay retirement
• Mandatory retirement, superannuation policy, flexible work conditions, etc.

• Immigration and emigration
• Immigration policy, student loans policy, etc.

• General encouragement
• Income tax policy, income support policy, job training, etc.

• Sources of economic growth
• Productivity of labour
• Investment in physical capital (capital deepening)
• tax policy, direct subsidies, etc.

• Innovation and R&D
• Tax policy, direct subsidies, etc.

• Improved infrastructure
• Government spending on public goods, public/private partnerships, etc.

• Investment in human capital (education)
• Free and mandatory secondary school, subsidized tertiary education, student loans, etc.

Two components of labour productivity

• Capital deepening
• Increasing the amount of productive capital available to be used by workers tends to increase output per unit of labour

• Multi- or total-factor productivity
• Anything not accounted for by capital deepening
• Mostly attributed to technological change, innovation, etc. 

• What makes an economy grow?
• Preconditions for Productivity Growth

The fundamental precondition for labour productivity growth is the incentive system created by economic freedom, property rights, firms, markets and money.

Economic freedom is present when people are able to make personal choices, their private property is protected by the rule of law, and they are free to buy and sell in markets.

Property rights are the social arrangements that govern the protection of private property.

Economic freedom and property rights:

• Enable people to create firms—the organisations that enable labour and capital and ideas to cooperate in the wealth creation process.
• Enable free markets to function.
• Permit the creation of money and a system of monetary exchange, which facilitates the smooth functioning of markets that make specialisation and trade possible.

• The Pace of Productivity Growth

The growth of labour productivity depends on

• Physical capital growth
• Human capital growth
• Technological advances

Physical Capital Growth

The accumulation of new capital increases capital per worker and increases labour productivity.

Human Capital Growth

Human capital acquired through education, on-the-job training and learning-by-doing is the most fundamental source of labour productivity growth.

Technological Advances

The discovery and the application of new technologies and new goods has contributed immensely to increasing labour productivity.

• Policies to Achieve Faster Growth

To achieve faster economic growth, we must increase

• The growth rate of capital per hour of labour or
• The growth rate of human capital or
• The pace of technological advance.

• What makes an economy grow?

The main actions that governments can take to achieve these objectives are

• Create incentive mechanisms
• Encourage saving
• Encourage research and development
• Encourage international trade
• Improve the quality of education

Create Incentive Mechanisms

Economic growth occurs when the incentive to save, invest and innovate is strong enough. These incentives exist only when private property is protected.

Encourage Saving

Saving finances investment, which brings capital accumulation.

Tax incentives can encourage saving, increase the growth of capital and stimulate economic growth.

Encourage Research and Development

Everyone can use the fruits of basic research and development efforts.

Because basic inventions can be copied, the inventor’s profit is limited and so the market allocates too few resources to this activity.

Governments can direct public funds towards financing basic research, but it requires a mechanism for allocating public funds to their highest-valued use.

Encourage International Trade

Free international trade stimulates economic growth by extracting all the available gains from specialisation and trade.

Improve the Quality of Education

By funding basic education and by ensuring high standards in skills such as language, mathematics and science, governments can contribute enormously to a nation’s growth potential.

• How Much Difference Can Policy Make?

A well-intentioned government cannot dial up a big increase in the economic growth rate.

But it can pursue policies that will nudge the growth rate upward.

And over time, the benefits from these policies will be large.

Unemployment-

What makes an economy grow?

• Preconditions for Productivity Growth

The fundamental precondition for labour productivity growth is the incentive system created by economic freedom, property rights, firms, markets and money.

Economic freedom is present when people are able to make personal choices, their private property is protected by the rule of law, and they are free to buy and sell in markets.

Property rights are the social arrangements that govern the protection of private property.

Economic freedom and property rights:

• Enable people to create firms—the organisations that enable labour and capital and ideas to cooperate in the wealth creation process.
• Enable free markets to function.
• Permit the creation of money and a system of monetary exchange, which facilitates the smooth functioning of markets that make specialisation and trade possible.

• The Pace of Productivity Growth

The growth of labour productivity depends on

• Physical capital growth
• Human capital growth
• Technological advances

Physical Capital Growth

The accumulation of new capital increases capital per worker and increases labour productivity.

Human Capital Growth

Human capital acquired through education, on-the-job training and learning-by-doing is the most fundamental source of labour productivity growth.

Technological Advances

The discovery and the application of new technologies and new goods has contributed immensely to increasing labour productivity.

• Policies to Achieve Faster Growth

To achieve faster economic growth, we must increase

• The growth rate of capital per hour of labour or
• The growth rate of human capital or
• The pace of technological advance.

The main actions that governments can take to achieve these objectives are

• Create incentive mechanisms
• Encourage saving
• Encourage research and development
• Encourage international trade
• Improve the quality of education

Create Incentive Mechanisms

Economic growth occurs when the incentive to save, invest and innovate is strong enough. These incentives exist only when private property is protected.

Encourage Saving

Saving finances investment, which brings capital accumulation.

Tax incentives can encourage saving, increase the growth of capital and stimulate economic growth.

Encourage Research and Development

Everyone can use the fruits of basic research and development efforts.

Because basic inventions can be copied, the inventor’s profit is limited and so the market allocates too few resources to this activity.

Governments can direct public funds towards financing basic research, but it requires a mechanism for allocating public funds to their highest-valued use.

Encourage International Trade

Free international trade stimulates economic growth by extracting all the available gains from specialisation and trade.

Improve the Quality of Education

By funding basic education and by ensuring high standards in skills such as language, mathematics and science, governments can contribute enormously to a nation’s growth potential.

• How Much Difference Can Policy Make?

A well-intentioned government cannot dial up a big increase in the economic growth rate.

But it can pursue policies that will nudge the growth rate upward.

And over time, the benefits from these policies will be large.

What is unemployment?

• According to the international standard definition of unemployment (ILO, 2013), the unemployed comprises all individuals who in the reference week:
• were not in employment, and
• were available to work, and
• were actively seeking employment. 

Under utilisation

• Underutilisation is a measure of the potential labour supply and unmet need for work.
• An underutilised person may be unemployed, underemployed (wanting more hours), an unavailable jobseeker, or an available potential jobseeker.

Under employed

• The ILO guideline (ILO, 2013) defines the underemployed as employed individuals who:
• worked less than a specified threshold of hours (usually part-time), and
• would like to work more hours, and
• were available to do so in the reference week.
• If you are part-time are you underemployed?
• Most of the underemployed are part-time workers but not all part-time workers are underemployed

Potential labour force

• The potential labour force consists of people who are not in the labour force but can be considered to be ‘just outside it’. They meet two of the three criteria (listed above) needed to be considered unemployed. 

• Two main groups of individuals are in the potential labour force:
• unavailable jobseekers – people who were actively seeking work, were not available to have started work in the reference week, but would become available within a short subsequent period
• available potential jobseekers – people who are not actively seeking work but were available in the reference week and want a job (the ‘discouraged’ are included in this group). 

Why is unemployment a problem?

• Unemployment results in
• Lost income
• Which in turn drives down consumption
• Which in turn drives down GDP
• Which in turn drives down incomes, etc…
• Lost productivity
• Which in turns drives down GDP
• Which in turn drives down incomes, etc.
• Lost human capital (if unemployment is prolonged)
• Which in turn drives down productivity, etc…

Supply of labour

• Relationship between the quantity of labour supplied and the real wage rate
• Real wage is money wage divided by the price level
• Real wage rate is important because what matters is not the number of dollars that can earn but they can buy with it
• Quantity of labour increases as real wage increases

What causes unemployment?

• The demand for labour is determined by the needs and desires of firms to use labour as a factor of production
• When firms want to decrease production in the short-run, they decrease their demand for labour because it is the easiest factor of production to reduce in the short-run
• Unless wages and/or the supply of labour adjusts in line with this decreased demand for labour, there will be a labour surplus (unemployment)
• Typically wages and labour supply adjust with a lag, if at all

What causes unemployment?

• Natural unemployment is the sum of frictional and structural unemployment
• Full employment is defined as the situation in which the unemployment rate equals the natural unemployment rate

What causes natural unemployment?

• The natural unemployment rate is influenced by:
• The age distribution of the population
• The scale and pace of structural change
• Changes in technology can be particularly troublesome
• Unemployment and welfare benefits
• How motivated are unemployed people to find a job?

What is potential GDP?

• Remember that Potential GDP is the quantity of real GDP produced within an economy at full employment
• Potential GDP corresponds to the capacity of the economy to produce output on a sustained basis
• In particular without significant inflationary pressures
• Real GDP minus potential GDP is the output gap
• The output gap can be positive or negative
• If positive, the economy will be experiencing inflationary pressures

• How potential GDP grows
• Growth in the Supply of Labour
• Aggregate hours, the total number of hours worked by all the people employed, change as a result of changes in:
• 1. Average hours per worker
• 2. Employment-to-population ratio
• 3. The working-age population growth
• Population growth increases aggregate hours and real GDP, but to increase real GDP per person, labour must become more productive. 

How potential GDP grows?

• The Effects of Population Growth (Immigration)
• An increase in population increases the supply of labour.
• With no change in the demand for labour, the equilibrium real wage rate falls and the aggregate hours increase.
• The increase in the aggregate hours increases potential GDP.

Government policy

• Key objective is to increase L/N
• Increase labour force participation
• Lower frictional and structural unemployment
• Higher wages, lower taxes
• Lower benefits for people not in the workforce
• Job training, education
• Decrease the costs for firms of employing people
• Skilled immigration, discourage emigration of skilled graduates