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Lecture 1 - Introduction to MACROECONOMICS
Macroeconomics - is the study of how economy behaves in broad outline (business cycle, inflation &
GDP - measures the value of what is produced in one country
GNI (GNP) - measures the income accruing to residents
Consumer Price Index (CPI) - the average price of goods/services bought by a typical consumer
Productivity growth - can be achieved using more inputs (increasing the number of workers) or by getting more output for any given amount of inputs
Fiscal policy -governments increasing/decreasing their spending and/or taxes
Monetary policy - involves changing the interest rates in order to influence the economy. High interest rates are a symptom of a tight monetary policy. When interest rates are high, it is more costly for the firms to borrow and this makes them more reluctant to invest. Individuals are also hit by high interest payments on their loans. Hence high interest rates tend to reduce demand in the economy - firms invest less, and low interest rates stimulate the demand
Actual GDP - is what the economy actually produces
Potential GDP - is what the economy would produce if all resources (inputs) were fully employed
GDP gap - is the difference between actual GDP and potential GDP. When the actual GDP is below the potential GDP - is a negative output gap, called a recessionary gap. While in booms, actual GDP is higher than potential GDP, causing the output gap to become positive, and it is called an inflationary gap
The national output is related to the sum of all the outputs produced in the economy by individuals,
firms and governmental organizations. However, an error would arise in estimating the national output by adding all sales of all firms, called DOUBLE COUNTING. So to avoid double counting the concept of
The total value of a firm's output is the gross value of its output. The firm's value added is the net value of its output - it is this figure that is the firm's contribution to the nation's total output. The sum of all values added in an economy is a measure of the economy's total output. This measure of total output is called gross value added - a measure of all final output that is produced in the economy. (The gross value of the firm's output is the total output before making any deductions, while the net value deducts inputs made by other firms. In "gross value added" the usage is different, value added is already 1 defined as the firm's net output, and the word 'gross' refers to the fact that we are measuring currently produced outputs without taking account the depreciation of capital goods during their production.
thus, "gross value added" is the value added of the economy before any allowance for depreciation; and
"gross domestic product" refers to the total output produced before allowing for depreciation)
All output must be owned by someone. So whenever the national output is produced it must generate an equivalent amount of national income. There are two ways of measuring the national income: the value of what is produced and the value of income generated. Both measures yield the same total,
which is called the GDP. When it is calculated by adding up the all spending for each of the main components of final output, the result is called GDP-spending based. When it is calculated by adding up all incomes generated by production, it is called GDP-income based
GDP-SPENDING BASED for a given year is calculated by adding up the spending going to purchase the final output produced in that year. The total spending on final output is expressed as the sum of 3 categories: Consumption, Investment & Net Exports. Consumption is further divided into: private consumption spending & government consumption spending


1. Private consumption spending - includes spending by individuals (and non-profit institutions) on goods/services produced and sold to their final users during the year.
However, it excludes purchases of newly built houses these are counted as an investment (C)

2. Government consumption spending - when governments provide goods/services that their citizens want such as health care, defense, law & order. Only government spending on currently produced goods/services is included as part of GDP. So it does not include pension funds & unemployment benefits, income support, student grants, all such payments are called transfer payments (G)

Investment spending - is the spending on the goods not for the present consumption, but rather for future use. The goods that are created by this spending are called investment goods.
Investment spending is further divided into 3 categories: changes in inventories, fixed capital formation and the net acquisition of valuables (I)

1. Changes in inventories - an accumulation of stocks & unfinished goods count as the current investment because it represents goods produced that will be used in the future and they valued at their market price, rather than what they cost

2. Fixed capital formation - capital goods such as machines, computers & factory buildings
(hospitals, schools & offices). The economy's total quantity of capital goods is called the capital stock

3. Net acquisition of valuables - goods that are neither for consumption nor for production, rather they are held for their beauty or expected increase in value (e.g.
Net exports - (total exports) - (total imports) (X-IM)

2 The price paid by consumers for goods/services is not the same as the revenue received by the producer because of indirect taxes. Indirect Taxes - VAT. Thus, if you pay $100 for a meal in a restaurant, the restaurateur will receive only $85.10, and $14.90 will go to the government in the form of VAT. All spending categories are measured at market prices as these are what is spent by purchasers rather than what is received by producers
Market prices - prices paid by consumers
Basic Prices - market prices minus taxes on product plus subsidies on goods/services.

GDP-INCOME BASED - the production of output generates income. The 3 main categories of income are: operating surplus, mixed incomes and compensation for employees
Operating surplus - net business incomes after payment has been made to hired labor and inputs but before direct taxes have been paid. Direct Taxes are taxes that individuals and firms have to pay in relation to their income
Mixed incomes - people who are earning a living by selling their services or output but are not employed by any organization, and those who work on short contracts (not formally employees of an organization) - self employed people running sole-trader business. The reason why their incomes of this group are referred to as mixed incomes is that it is not clear what proportion of their earnings is equivalent to a wage/salary & what proportion is the profit of the business
Compensation of employees - is the wages and salaries (that payment for the services of labor)

The total income received by UK residents differs from GDP for 2 reasons:

1. Some domestic production creates earnings for non-UK residents who do some paid work. In this case, the income received by UK residents will be less than the GDP

2. Many UK residents earn income from work for overseas residents or overseas investments. In this case, the income received is greater than the GDP
The GDP measures the output and income produced in a particular country, while the GNI measures the income that is received by a particular country. To convert the GDP into GNI we need to add 3 terms in order to account for the difference between the income received and income produced:

1. Employee's compensation receipts from the rest of the world minus payments for the rest of the world (If a London-based consultant sells her services to a French firm, the income received will contribute to UK GNI but will be part of French GDP)

2. (Minus) net taxes on production paid to the rest of the world plus subsidies received from the rest of the world. The reasoning behind this is that we are measuring GNI at market prices

3 3. Property and entrepreneurial income receipts from the rest of the world minus payments to the rest of the world (If you live in Manchester and own a holiday home in Spain that you rent, the revenue earned will count as part of GDP in Spain, but income is received by a UK-resident so it adds to UK GNI), (A Japanese firm located in the UK contributes all its value added to UK GDP,
but profits remitted (sent) back to Japan are deducted from GDP in order to arrive at GNI)

4 Lecture 2 - A basic Model of the Determination of GDP in the SHORT-RUN
GDP can be deduced by: adding up the incomes of owners of inputs, adding up the values added of each sector & adding up the total final spending
Consumption spending depends on disposable income.
Investment spending depends on real interest rates & business confidence.
Total desired spending (or Aggregate spending (AE)) = desired private consumption, investment,
government consumption and exports
Desired spending - what people want to spend out of the resources that are available to them
Autonomous/Exogenous - components of aggregate spending that do not depend on current incomes
Induced/Endogenous - components of aggregate spending that do change in response to changes in income
People can either consume or save their disposable income. Saving is all disposable income that is left not consumed
What determines the division between the amount people decide to spend for consumption & the amount they decide to save? The factors that influence this decision are related with the consumption function and saving function
Consumption spending - is determined primarily by current personal disposable income
The underlying behavior of consumers depends on their disposable income which is equal to national income (Y)
Break-even level - the level of income at which desired consumption equals disposable income
Keynesian consumption function - people whose current consumption function depends only on current income
Average propensity to consume (APC) - is the total consumption spending divided by the total disposable income. APC = C/Y
Average propensity to save (APS) - is the proportion of disposable income that households want to save, and is deduced by dividing total desired spending by total disposable income. APS = S/Y
Marginal propensity to consume (MPC) - is the amount of extra consumption spending induced when the personal disposable income rises by $1. It is the change in consumption divided by the change in disposable income. MPC = CΔ / ΔY
Marginal propensity to save (MPS) - is the change in total desired saving divided by the change in disposable income. MPC = SΔ / ΔY
5 45° line - determines where the equilibrium is
APC + APS = 1


MPC + MPS = 1

Other things being equal the higher the interest rate, the higher is the cost of borrowing money for investment and the less is the amount of desired investment spending. This relationship is easily understood when investment is divided into 3 parts:
1) Inventory accumulation: the higher the interest rate, the lower is the desired inventory of goods & materials. Changes in interest rates cause temporary period of intense activity of investment/disinvestment as inventories are either increased or decreased 2) Residential housing construction (demand for new housing): when interest rates fall there is an increase in demand for housing and when interest rates rise the demand to purchase houses drops (house prices also fall). In general, spending for residential construction tends to vary negatively with interest rates 3) Business fixed capital formation: over 1.5 of investment by firms in fixed capital is financed though retained profits, which means the current profits are an important determinant of investment. The interest rate is thus major determinant of investment in fixed capital. High interest rates greatly reduce the volume of investment as their expected profit did not cover the interest on borrowed funds. Firms that have cash on their hand find that purchasing interestearning asset provide better return than investment in fixed capital. For them increase in interest rates mean that the opportunity cost of investing in fixed capital had risen
Marginal propensity to spend - is the amount of extra total spending induced when national income rises by $1. It is the fraction of any increment to national income (GDP) that will be spent on purchasing domestic output
Marginal propensity not to spend - it is the fraction of any increment to national income that does not add to desired aggregate spending, denoted by (1-c)
At any level of GDP at which aggregate desired spending exceeds total output, there will be pressure for
GDP to rise
At any level of GDP at which aggregate desired spending is less than total output, there will be pressure for GDP to fall
At GDP level where the aggregate desired spending is equal to national output, there is no incentive for firms to alter output
A change in GDP causes a movement along the aggregate spending function. An increased desire to spend at each level of GDP causes a shift in the aggregate spending. If the aggregates spending function shifts, the equilibrium will be disturbed and GDP will change
Multiplier - measures the change in equilibrium GDP in response to a change in expenditure/spending.
It is the change in GDP divided by the change in spending 6 The long run in macroeconomics is the period it takes the economy to return to the level of potential
GDP once it has been disturbed (хэм алдагдах)
Inflation - a persistent increase in the level of consumer prices or decline in the purchasing power of money, caused by an increase in available currency and credit beyond the proportion of available goods
& services. Income > Supply. Since supply is short, prices rise. More money leads to inflation and makes the value of money to drop


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