7. Aggregate Demand and Supply and Macroeconomic Problems

7. Aggregate Demand and Supplyand Macroeconomic Problems

Macroeconomic ObjectivesMacroeconomic Objectives

• Distinction between microeconomics and macroeconomics

• The major macroeconomic issues

– economic growth

– unemployment

– inflation

– balance of payments and exchange rates

• balance of payments deficits and surpluses

• exchange rate movements

• Distinction between microeconomics and macroeconomics

• The major macroeconomic issues

– economic growth

– unemployment

– inflation

– balance of payments and exchange rates

• balance of payments deficits and surpluses

• exchange rate movements

Economic growth (average % per annum), Unemployment (average %), Inflation (average % per annum)

The Circular Flow of IncomeThe Circular Flow of Income

• The inner flow• The inner flow

Factorpayments

Factorpayments

Consumption ofdomestically

produced goodsand services (Cd)



The circular flow of income

Firms

Households


• Withdrawals

– net saving

– net taxes

– import expenditure

• Injections

– investment

– government expenditure

– export expenditure

• Withdrawals

– net saving

– net taxes

– import expenditure

• Injections

– investment

– government expenditure

– export expenditure

Factorpayments



Investment (Investment (II))Investment (Investment (II))

GovernmentGovernmentexpenditure (expenditure (GG))


ExportExportexpenditure (expenditure (XX))


BANKS, etcBANKS, etc

Netsaving (S)

Netsaving (S)

GOV.GOV.

NetNettaxes (taxes (TT))


ABROAD

ImportImportexpenditure (expenditure (MM))


The circular flow of incomeThe circular flow of income

WITHDRAWALS

INJECTIONS


• The relationship between injections and withdrawals– the links between them

• The relationship between injections and withdrawals– the links between them

Factorpayments









Netsaving (S)

Netsaving (S)

GOV.GOV.



ABROAD




WITHDRAWALS

INJECTIONS


• The relationship between injections and withdrawals

– the links between them

– planned injections may not equal planned withdrawals








• Equilibrium in the circular flow





Factorpayments









Netsaving (S)

Netsaving (S)

GOV.GOV.



ABROAD




WITHDRAWALS

INJECTIONS






• The circular flow and the four macroeconomic objectives





• The circular flow and the four macroeconomic objectives

Factorpayments









Netsaving (S)

Netsaving (S)

GOV.GOV.



ABROAD




WITHDRAWALS

INJECTIONS

Measuring national incomeMeasuring national income

• GDP: the measure of national income

• Methods of measuring GDP– the product approach

– the income approach

– the expenditure approach

• The product approach– measuring GVA






Agriculture, forestry and fishing £9 656 mMining, energy and water supply £29 485 m

Manufacturing£147 306 m

Construction £39 262 m

Wholesale and retail trade; repairs £89 392 m

Hotels and restaurants £23 678m

Transport and communication £63 340 m

Banking, finance, insurance, etc.£17 737 m

Letting of property £159 240 m

Public administration and defence £40 495 m

Education, health and social work £89 041 m

Other services £38 912 m

Gross value added (GVA) at basic prices£747 544 m

1.33.9

19.7

5.3

12.0

3.2

8.4

2.4

21.3

5.4

11.9

5.2

100.0

Percen

tage o

f GV

A

UK GVA product-based measure: 1998







• The income approach







62.0

29.9

5.8

2.3

100.0

Compensation of employees (wages and salaries)

£463 398 m

Operating surplus(gross profit, rent and interest of firms

government and other institutions)£223 212 m

Mixed incomes£43 379 m

Tax less subsidies on production(other than those on products) plusstatistical discrepancy £17 555 m

Gross value added (GVA) at basic prices £747 544m

UK GVA by category of income: 1998

Percen

tage o

f GV

A







• The income approach– from GVA to GDP






• The income approach– from GVA to GDP


UK GDP: 1998


plus Taxes on products £103 634m

UK GDP: 1998



less Subsidies on products £7 453m

UK GDP: 1998



less Subsidies on products £7 453m

GDP (at market prices) £843 725m

UK GDP: 1998








• The expenditure approach








UK GDP at market prices by category of expenditure: 1998








• The product approach



• From GDP to net national income (NNY)


• The product approach



• From GDP to net national income (NNY)

UK GDP, GNY and NNY at market prices: 1998

UK GDP, GNY and NNY at market prices: 1998

Economic Growth andthe Business Cycle


• Growth in actual and potential output

• Economic growth and the business cycle

– fluctuations in actual growth




O

Nat

iona

l out

put

Time

Potential output

Actualoutput

The business cycle






– the phases of the business cycle





O

Nat

iona

l out

put

Time

Potential output

Actualoutput

1

2

3

4

1

2

34

The business cycle







– trend growth





– trend growth

O

Nat

iona

l out

put

Time

Potential output

Actualoutput

Trendoutput

The business cycle






– trend growth

– the business cycle in practice




– trend growth







– trend growth


• the irregularity of the cycle




– trend growth








– trend growth



• the length of the phases




– trend growth









– trend growth




• the magnitude of the phases




– trend growth




• the magnitude of the phases



• Causes of actual growth

– aggregate demand

– aggregate demand relative to potential output

• Actual growth in practice

– experience since 1970

• Causes of actual growth

– aggregate demand

– aggregate demand relative to potential output

• Actual growth in practice

– experience since 1970

-3

-2

-1

0

1

2

3

4

5

6

7

8

9

10

1970 1975 1980 1985 1990 1995 2000

Ann

ual g

row

th r

ate

(%)

UK

Growth rates in selected industrial countries

-3

-2

-1

0

1

2

3

4

5

6

7

8

9

10

1970 1975 1980 1985 1990 1995 2000

Ann

ual g

row

th r

ate

(%)

UK

Growth rates in selected industrial countriesGrowth rates in selected industrial countriesGrowth rates in selected industrial countriesGrowth rates in selected industrial countries

-3

-2

-1

0

1

2

3

4

5

6

7

8

9

10

1970 1975 1980 1985 1990 1995 2000

Ann

ual g

row

th r

ate

(%)

UK

France


-3

-2

-1

0

1

2

3

4

5

6

7

8

9

10

1970 1975 1980 1985 1990 1995 2000

Ann

ual g

row

th r

ate

(%)

UK

France


-3

-2

-1

0

1

2

3

4

5

6

7

8

9

10

1970 1975 1980 1985 1990 1995 2000

Ann

ual g

row

th r

ate

(%)

UK

France

Germany


-3

-2

-1

0

1

2

3

4

5

6

7

8

9

10

1970 1975 1980 1985 1990 1995 2000

Ann

ual g

row

th r

ate

(%)

UK

France

Germany


-3

-2

-1

0

1

2

3

4

5

6

7

8

9

10

1970 1975 1980 1985 1990 1995 2000

Ann

ual g

row

th r

ate

(%)

UK

France USA

Germany


-3

-2

-1

0

1

2

3

4

5

6

7

8

9

10

1970 1975 1980 1985 1990 1995 2000

Ann

ual g

row

th r

ate

(%)

UK

France USA

Germany


-3

-2

-1

0

1

2

3

4

5

6

7

8

9

10

1970 1975 1980 1985 1990 1995 2000

Ann

ual g

row

th r

ate

(%)

UK

France USA

GermanyJapan


-3

-2

-1

0

1

2

3

4

5

6

7

8

9

10

1970 1975 1980 1985 1990 1995 2000

Ann

ual g

row

th r

ate

(%)

UK

France USA

GermanyJapan




• Causes of potential growth– increases in the quantity of factors

• capital

• labour

• land and raw materials

• the problem of diminishing returns

– increases in factor productivity

• Policies to achieve growth– demand-side and supply-side policies

– market-orientated & interventionist policies

• Causes of potential growth– increases in the quantity of factors

• capital

• labour

• land and raw materials

• the problem of diminishing returns

– increases in factor productivity

• Policies to achieve growth– demand-side and supply-side policies

– market-orientated & interventionist policies

UnemploymentUnemployment

• The meaning of 'unemployment'

• Official measures of unemployment

– claimant unemployment

• do claimant statistics give a true picture of unemployment?

– standardised unemployment (ILO/OECD)

• The meaning of 'unemployment'

• Official measures of unemployment

– claimant unemployment

• do claimant statistics give a true picture of unemployment?

– standardised unemployment (ILO/OECD)

0

2

4

6

8

10

12

14

1970 1975 1980 1985 1990 1995 2000

Une

mpl

oym

ent (

% o

f wor

kfor

ce)

Unemployment rates in selected industrial countries

UK

0

2

4

6

8

10

12

14

1970 1975 1980 1985 1990 1995 2000

Une

mpl

oym

ent (

% o

f wor

kfor

ce)

UK


0

2

4

6

8

10

12

14

1970 1975 1980 1985 1990 1995 2000

Une

mpl

oym

ent (

% o

f wor

kfor

ce)

UK

France


0

2

4

6

8

10

12

14

1970 1975 1980 1985 1990 1995 2000

Une

mpl

oym

ent (

% o

f wor

kfor

ce)

UK

France


0

2

4

6

8

10

12

14

1970 1975 1980 1985 1990 1995 2000

Une

mpl

oym

ent (

% o

f wor

kfor

ce)

UK

France

Germany


0

2

4

6

8

10

12

14

1970 1975 1980 1985 1990 1995 2000

Une

mpl

oym

ent (

% o

f wor

kfor

ce)

UK

France

Germany


0

2

4

6

8

10

12

14

1970 1975 1980 1985 1990 1995 2000

Une

mpl

oym

ent (

% o

f wor

kfor

ce)

UK

France USA

Germany


0

2

4

6

8

10

12

14

1970 1975 1980 1985 1990 1995 2000

Une

mpl

oym

ent (

% o

f wor

kfor

ce)

UK

France USA

Germany


0

2

4

6

8

10

12

14

1970 1975 1980 1985 1990 1995 2000

Une

mpl

oym

ent (

% o

f wor

kfor

ce)

UK

France USA

Germany Japan


0

2

4

6

8

10

12

14

1970 1975 1980 1985 1990 1995 2000

Une

mpl

oym

ent (

% o

f wor

kfor

ce)

UK

France USA

Germany Japan


0

2

4

6

8

10

12

14

1970 1975 1980 1985 1990 1995 2000

Une

mpl

oym

ent (

% o

f wor

kfor

ce)

UK

France USA

Germany Japan

OECD


0

2

4

6

8

10

12

14

1970 1975 1980 1985 1990 1995 2000

Une

mpl

oym

ent (

% o

f wor

kfor

ce)

UK

France USA

Germany Japan

OECD



• Unemployment and the labour market

– the aggregate demand and supply of labour

– equilibrium in the model




Qe

Aggregate demand and supply of labour

O

Ave

rag

e (r

ea

l) w

ag

e ra

te

No. of workers

ASL

ADL

We





– disequilibrium unemployment





O

Ave

rag

e (r

ea

l) w

ag

e ra

te

No. of workers

ASL

ADL

We

W2

B A

Disequilibrium unemployment

Q2 Q1






– equilibrium unemployment





– equilibrium unemployment

Equilibrium unemployment

O

Ave

rag

e (r

ea

l) w

ag

e ra

te

No. of workers

ADL

We

ASL

e

Qe

Q2QeO

Ave

rag

e (r

ea

l) w

ag

e ra

te

No. of workers

ASL

ADL

We

N

e d

Equilibrium unemployment

Equilibrium and disequilibrium unemployment

O

Ave

rag

e (r

ea

l) w

ag

e ra

te

No. of workers

ADL

We

e

Qe

ASL

O

Ave

rag

e (r

ea

l) w

ag

e ra

te

No. of workers

ASL

ADL

We

W2

b a

e

Disequilibriumunemployment


O

Ave

rag

e (r

ea

l) w

ag

e ra

te

No. of workers

ASL

ADL

We

W2

b a

e

N

c

Equilibriumunemployment

Disequilibriumunemployment



• Disequilibrium unemployment

– real-wage (classical) unemployment

– demand-deficient (cyclical) unemployment

– unemployment arising from a growth in the labour supply

• Disequilibrium unemployment

– real-wage (classical) unemployment

– demand-deficient (cyclical) unemployment

– unemployment arising from a growth in the labour supply


• Equilibrium unemployment

– frictional (search) unemployment

– structural unemployment

• changing pattern of demand

• technological unemployment

• regional unemployment

– seasonal unemployment

• Equilibrium unemployment

– frictional (search) unemployment

– structural unemployment

• changing pattern of demand

• technological unemployment

• regional unemployment

– seasonal unemployment

Aggregate Demand and SupplyAggregate Demand and Supply

• The aggregate demand curve• The aggregate demand curve

O

Pri

ce le

vel

National output

AD

Aggregate demand and aggregate supply


• The aggregate demand curve

– Why aggregate demand curves slope downwards

• import effect



• import effect

O

Pri

ce le

vel

National output

AD





• import effect

• interest-rate effect



• import effect


O

Pri

ce le

vel

National output

AD





• import effect


• savings effect



• import effect


• savings effect

O

Pri

ce le

vel

National output

AD





• import effect


• savings effect

• The aggregate supply curve



• import effect


• savings effect


O

Pri

ce le

vel

National output

AS

AD





• import effect


• savings effect


– Why aggregate supply curves generally slope upwards



• import effect


• savings effect



O

Pri

ce le

vel

National output

AS

AD




– Why aggregate demand curves slope downwards• import effect


• savings effect



• Equilibrium


– Why aggregate demand curves slope downwards• import effect


• savings effect



• Equilibrium

O

Pri

ce le

vel

National output

AS

AD

Pe


O

Pri

ce le

vel

National output

AS

AD

Pe

P2

ab



• The aggregate demand curve– Why aggregate demand curves slope

downwards• import effect


• savings effect

• The aggregate supply curve– Why AS curves generally slope upwards

• Equilibrium– Effect of a shift in the AD curve

• The aggregate demand curve– Why aggregate demand curves slope

downwards• import effect


• savings effect

• The aggregate supply curve– Why AS curves generally slope upwards

• Equilibrium– Effect of a shift in the AD curve

InflationInflation

• Defining inflation

• The costs of inflation

– redistribution

– uncertainty

– balance of payments

– resources used to cope with inflation

• Experience of inflation since 1965

• Defining inflation

• The costs of inflation

– redistribution

– uncertainty

– balance of payments

– resources used to cope with inflation

• Experience of inflation since 1965

-2

0

2

4

6

8

10

12

14

16

18

20

22

24

26

1965 1970 1975 1980 1985 1990 1995 2000

Infla

tion

(% in

crea

se in

ret

ail p

rices

)

UK

Inflation rates in selected industrial countries

-2

0

2

4

6

8

10

12

14

16

18

20

22

24

26

1965 1970 1975 1980 1985 1990 1995 2000

Infla

tion

(% in

crea

se in

ret

ail p

rices

)

UK


-2

0

2

4

6

8

10

12

14

16

18

20

22

24

26

1965 1970 1975 1980 1985 1990 1995 2000

Infla

tion

(% in

crea

se in

ret

ail p

rices

)

UK

EU 15


-2

0

2

4

6

8

10

12

14

16

18

20

22

24

26

1965 1970 1975 1980 1985 1990 1995 2000

Infla

tion

(% in

crea

se in

ret

ail p

rices

)

UK

EU 15


-2

0

2

4

6

8

10

12

14

16

18

20

22

24

26

1965 1970 1975 1980 1985 1990 1995 2000

Infla

tion

(% in

crea

se in

ret

ail p

rices

)

UK

EU 15

USA


-2

0

2

4

6

8

10

12

14

16

18

20

22

24

26

1965 1970 1975 1980 1985 1990 1995 2000

Infla

tion

(% in

crea

se in

ret

ail p

rices

)

UK

EU 15

USA


-2

0

2

4

6

8

10

12

14

16

18

20

22

24

26

1965 1970 1975 1980 1985 1990 1995 2000

Infla

tion

(% in

crea

se in

ret

ail p

rices

)

UK

EU 15 Japan

USA


-2

0

2

4

6

8

10

12

14

16

18

20

22

24

26

1965 1970 1975 1980 1985 1990 1995 2000

Infla

tion

(% in

crea

se in

ret

ail p

rices

)

UK

EU 15 Japan

USA


-2

0

2

4

6

8

10

12

14

16

18

20

22

24

26

1965 1970 1975 1980 1985 1990 1995 2000

Infla

tion

(% in

crea

se in

ret

ail p

rices

)

UK

EU 15 Japan

USAOECD


-2

0

2

4

6

8

10

12

14

16

18

20

22

24

26

1965 1970 1975 1980 1985 1990 1995 2000

Infla

tion

(% in

crea

se in

ret

ail p

rices

)

UK

EU 15 Japan

USAOECD


InflationInflation

• Types of inflation– demand pull


Demand-pull inflation

O

Pri

ce le

vel

National output

AS

AD1

P1

Q1

O

Pri

ce le

vel

National output

AS

AD1

P1

Q1

AD2


O

Pri

ce le

vel

National output

AS

AD1

P1

Q1

AD2

P2

Q2


InflationInflation


– cost push


– cost push

InflationInflation


– cost push• wage push



InflationInflation



• profit push



• profit push

InflationInflation



• profit push

• import-price push



• profit push


Cost-push inflation

O

Pri

ce le

vel

National output

AS1

AD

P1

Q1

O

Pri

ce le

vel

National output

AS1

AD

P1

Q1

AS2

Cost-push inflation

O

Pri

ce le

vel

National output

AS1

AD

P1

Q1

AS2

P2

Q2

Cost-push inflation

InflationInflation

• Types of inflation

– demand pull

– cost push

• wage push

• profit push


– the interaction of demand-pull and cost-push inflation

• Types of inflation

– demand pull

– cost push

• wage push

• profit push



The interaction of demand-pull and cost-push inflation

O

Pri

ce le

vel

National output

AS1

AD1

P1

O

Pri

ce le

vel

National output

AS1

AD1

P1

AS2

AD2

P2


O

Pri

ce le

vel

National output

AS1

AD1

P1

AD2

P2

AS3

AD3

P3

AS2


InflationInflation



• profit push



– structural (demand shift)



• profit push




InflationInflation



• profit push




– expectations and inflation



• profit push




– expectations and inflation

InflationInflation

• Policies to tackle inflation– demand-side policies

– supply-side policies

• Policies to tackle inflation– demand-side policies

– supply-side policies

Documents

7. Aggregate Demand and Supply and Macroeconomic Problems