Enu macroecon environment 040812

Go Global !Global Economic Environment :Global Economic Environment :The Macroeconomic Environment

By

Stephen OngStephen OngEdinburgh Napier University Business School

[email protected] Professor, College of Management, Shenzhen

University4 August 2012

Learning Objectives

To identify the component parts of the economy

To explain the Circular Flow Model To define the five macroeconomic

objectives To explain how macroeconomic

performances are measured

AgendaAgenda

1. Components of the Economy2. The Circular Flow Model3. Macroeconomic objectives4. Macroeconomic performance

measures

1. The Macroeconomics Environment

1. Components of the Economy

1.Firms

2.Households

3.Government

4.Banking sector

5.External (overseas) sector

6

1. Economic Growth1. Economic Growth

• Increase in real GDP or real GDP Increase in real GDP or real GDP per capita over some time periodper capita over some time period

• Percentage rate of growthPercentage rate of growth• Growth as a goalGrowth as a goal• Arithmetic of growth: Arithmetic of growth: Rule of 70Rule of 70

Approximatenumber of yearsrequired to doublereal GDP

=70

annual percentage rateof growth

7

1.1 Economic Growth1.1 Economic Growth• Growth U.S. real GDP 1950-2005Growth U.S. real GDP 1950-2005– Increased 6 fold Increased 6 fold – 3.5% per year 3.5% per year

• Growth in U.S. real GDP per capitaGrowth in U.S. real GDP per capita– Increased more than 3 foldIncreased more than 3 fold– 2.3% per year2.3% per year

• Qualifications Qualifications – Improved products and servicesImproved products and services– Added leisureAdded leisure– Other impactsOther impacts

8

1.2 Modern Economic 1.2 Modern Economic GrowthGrowth

• Began with the Industrial Began with the Industrial Revolution in late 1700’sRevolution in late 1700’s

• Ongoing increases in living Ongoing increases in living standardsstandards

• Time for leisureTime for leisure• Social changeSocial change• DemocracyDemocracy• Human lifespan doubledHuman lifespan doubled

9


• Began in BritainBegan in Britain• Has spread slowlyHas spread slowly• Starting date main cause of Starting date main cause of

worldwide differences in living worldwide differences in living standardsstandards

• Catching up is possibleCatching up is possible• Leader countries invent technologyLeader countries invent technology• Follower countries adopt technologyFollower countries adopt technology– Can grow fasterCan grow faster

10

1.4 Real GDP Per Capita1.4 Real GDP Per Capita

Real GDPReal GDP Real GDPReal GDP Average Average annualannual

per capita,per capita, per capita,per capita, growth growth rate,rate, CountryCountry 19601960 2004 2004 1960-2004 1960-2004United States $12,892 $36,098 2.3%

United Kingdom 10,323 26,762 2.2France 8,531 26,168 2.5Ireland 5,294 28,957 3.9Japan 4,509 24,661 3.9Singapore 4,219 29,404 4.4Hong Kong 3,322 29,642 5.0South Korea 1,458 18,424 5.8

Figures are in 1996 dollarsSource: Penn World Table

11


• Growth-promoting Growth-promoting institutional structuresinstitutional structures– Strong property rightsStrong property rights

– Patents and copyrightsPatents and copyrights

– Efficient financial institutionsEfficient financial institutions

– Literacy and widespread educationLiteracy and widespread education

– Free tradeFree trade

– Competitive market systemCompetitive market system

12

1.6 Ingredients of Growth1.6 Ingredients of Growth

• Supply factorsSupply factors– Increases in quantity and Increases in quantity and

quality of natural resources quality of natural resources – Increases in quality and Increases in quality and

quantity of human resourcesquantity of human resources– Increases in the supply (or Increases in the supply (or

stock) of capital goodsstock) of capital goods– Improvements in technologyImprovements in technology

13

1.7 Ingredients of Growth1.7 Ingredients of Growth

• Demand factorDemand factor–Households, businesses, and Households, businesses, and

government must purchase government must purchase the economy’s expanding the economy’s expanding output output

• Efficiency factorEfficiency factor–Must achieve economic Must achieve economic

efficiency and full employmentefficiency and full employment

14

1.8 Production Possibilities1.8 Production Possibilities

Consumer Goods

Ca

pit

al G

oo

ds

a

EconomicGrowth

b

A

C

B D

c

15

1.9 Labour and 1.9 Labour and ProductivityProductivity

• Size of employed labour force

• Average hours of work

LabourInputs(hours ofwork)

• Quantity of capital

• Education and training

• Technological advance

• Allocative efficiency

• Other

LabourProductivity(average output per hour)

RealGDP

Real GDP = hours of work x labour productivity

x=

16

1.10 U.S. Economic Growth1.10 U.S. Economic Growth

Annual Averages for Five Decades

0

1

2

3

4

5

1950-1959 1960-1969 1970-1979 1980-1989 1990-1999 2000-2005Year

Ave

rag

e A

nn

ual

Incr

ease

(P

erce

nt) Real GDP

Real GDP Per Capita

Source: Bureau of Economic Analysis

17

1.11 Accounting for 1.11 Accounting for GrowthGrowth

Accounting for Growth of U.S. Real GDP, 1953-2013 (average annual percentage changes)

Item

1953 Q2to

1973 Q4

1973 Q4to

1995 Q2

1995 Q2to

2001 Q1

2001 Q1to

2007 Q3

2007 Q3to

2013 Q4*

Increases in Real GDP

Increases in Quantity of Labor

Increases in Labor Productivity

3.6

1.1

2.5

2.8

1.3

1.5

3.8

1.4

2.4

2.6

-0.1

2.7

2.8

0.3

2.5Source: Economic Report of the President, 2008*Beyond 2007 are Projections

18

• Factors affecting productivity Factors affecting productivity growthgrowth–Technological advance (40%)Technological advance (40%)–Quantity of capital (30%)Quantity of capital (30%)–Education and training (15%)Education and training (15%)–Economies of scale and Economies of scale and

resource allocation (15%)resource allocation (15%)

1.12 Accounting for Growth

19

Average Test Scores of Eighth Grade Students in Math and Science, Top 10 Countries and the United States, 2003

SingaporeSouth KoreaHong KongTaiwanJapanBelgiumNetherlandsEstoniaHungaryMalaysiaUnited States

123456789

1015

605589586585570537536531529508504

SingaporeTaiwanSouth KoreaHong KongEstoniaJapanHungaryNetherlandsUnited StatesAustralia

123456789

10

578571558556552552543536527527

Mathematics Science

1.13 Accounting for Growth

20

1.14 Productivity Growth1.14 Productivity Growth

• Accelerated rate of growthAccelerated rate of growth–1.4% per year 1973-19951.4% per year 1973-1995–2.9% per year 1995-20052.9% per year 1995-2005

• Affects real output, real Affects real output, real income, and real wagesincome, and real wages• Pay higher wages without Pay higher wages without

lowering profitlowering profit

21

1.15 Accelerated Productivity 1.15 Accelerated Productivity GrowthGrowth

• Microchip/information Microchip/information technologytechnology• New firms and increasing New firms and increasing

returnsreturns• Sources of increasing returnsSources of increasing returns

– More specialized inputsMore specialized inputs– Spreading of development costsSpreading of development costs– Simultaneous consumptionSimultaneous consumption– Network effectsNetwork effects– Learning by doingLearning by doing

• GGlobal competitionlobal competition

22

1.16 Economic Growth1.16 Economic Growth

• Is accelerated productivity growth Is accelerated productivity growth sustainable?sustainable?

• Is economic growth desirable and Is economic growth desirable and sustainable?sustainable?

• The antigrowth viewThe antigrowth view– Environmental and resource issuesEnvironmental and resource issues

• In defense of economic growthIn defense of economic growth– Higher standard of livingHigher standard of living– Human imagination can solve Human imagination can solve

environmental and resource issuesenvironmental and resource issues

23

1.17 Economic Growth in 1.17 Economic Growth in ChinaChina

• Growth averages past 25 years:Growth averages past 25 years:– 9% annual growth output9% annual growth output– 8% annual growth output per capita8% annual growth output per capita

• Labour more productiveLabour more productive• More international tradeMore international trade• Transition to market economyTransition to market economy• Joined WTO 2001Joined WTO 2001• Financial system remains weakFinancial system remains weak• Income inequality across Income inequality across

geographic areasgeographic areas

2. The Circular Flow Model

25

2. Performance and Policy2. Performance and Policy

• Real GDPReal GDP–Corrects for price changesCorrects for price changes

• Nominal GDPNominal GDP–Uses current prices Uses current prices

• UnemploymentUnemployment• Inflation Inflation – Increase in overall level of Increase in overall level of

pricesprices

26

2.1 Economic Performance2.1 Economic Performance

• Output growthOutput growth–3.1% per year 1995-20053.1% per year 1995-2005

• Unemployment rateUnemployment rate–4.6% in 20074.6% in 2007

• Inflation rateInflation rate–2.7% in 20072.7% in 2007

27

2.2 Economic Growth2.2 Economic Growth

• Standard of living measured Standard of living measured by output per personby output per person• No growth in living standards No growth in living standards

prior to Industrial Revolutionprior to Industrial Revolution• Modern economic growthModern economic growth–Output per person risesOutput per person rises–Not experienced by all Not experienced by all

countriescountries

28

2.3 GDP Per Person 20072.3 GDP Per Person 2007

ZimbabweZimbabwe $188$188

United States $45,845Canada $38,345

Japan $33,576United Kingdom $35,134

South Korea $24,782France $33,187

Russia $14,692Saudi Arabia $23,243

Burundi $371Tanzania $1,256North Korea $1,900India $2,659China $5,292Mexico $12,774

U.S. dollars based on purchasing power parity (PPP)

29

2.4 Savings and Investment2.4 Savings and Investment

• SavingSaving–Tradeoff current for future Tradeoff current for future

consumption consumption

• InvestmentInvestment–Financial investmentFinancial investment–Economic investment Economic investment

• Banks and financial Banks and financial institutionsinstitutions

30

2.5 Shocks2.5 Shocks• Demand shocks and flexible Demand shocks and flexible

pricesprices– Price falls if demand lowPrice falls if demand low– Sales unchangedSales unchanged

• Demand shocks and sticky Demand shocks and sticky pricesprices–Maintain inventoryMaintain inventory– Sales changeSales change– Business cyclesBusiness cycles

31

2.6 Expectations2.6 Expectations

• The future is uncertainThe future is uncertain• Expectations affect Expectations affect

investmentinvestment• Shocks Shocks –What happens is not what you What happens is not what you

expectedexpected

• Demand shocksDemand shocks• Supply shocksSupply shocks

32

2.7.1 Demand Shocks2.7.1 Demand Shocks

Cars per week

Pri

ce

DM

DL

DH

900

$40,000

$37,000

$35,000

Flexible Prices

33

2.7.2 Demand Shocks2.7.2 Demand Shocks

Cars per week

DMDL

DH

700 900 1150

$37,000

Fixed Prices

Pri

ce

How sticky is

How long ago since the price changed ?

Months Months

Dry cleaning McDonald’s Meal

Newspaper Small Car

Haircut Milk

Taxi fare Electricity

Medical services Airfare

Magazine Petrol

Personal Computer Teh tarik

35

2.8.1 Sticky Prices2.8.1 Sticky Prices

• Explain fluctuations in GDPExplain fluctuations in GDP• Average months between price changesAverage months between price changes

Months Months

Coin-operated Laundry Machine

46.4 Beer 4.3

Newspaper 29.9 Microwave Ovens

3.0

Haircut 25.5 Milk 2.4

Taxi fare 19.7 Electricity 1.8

Vet services 14.9 Airfare 1.0

Magazine 11.2 Gasoline 0.6

PC Software 5.5

36

2.8.1 Sticky Prices2.8.1 Sticky Prices

• Many prices sticky in short Many prices sticky in short runrun–Consumers prefer stable pricesConsumers prefer stable prices–Firms want to avoid price warsFirms want to avoid price wars

• All prices flexible in long runAll prices flexible in long run–Firms adjust to unexpected, Firms adjust to unexpected,

but permanent changes in but permanent changes in demanddemand

37

2.9 Inventory Management 2.9 Inventory Management

• Computerized inventory trackingComputerized inventory tracking• Unexpected changes in demand Unexpected changes in demand

easier to observeeasier to observe• Firms make better output and Firms make better output and

employment decisionsemployment decisions• Less severe business cyclesLess severe business cycles• Only two mild recessions since Only two mild recessions since

adoption adoption – Possible explanationPossible explanation

3. Macroeconomics Policy3. Macroeconomics Policy

3.1 Macroeconomic Policy

3.1 GDP Growth Rates

3.2 Actual vs Potential GDP

3.3 Unemployment

3.4 Inflation

3.5 Aggregate Supply & Demand

3.6 Impact of Increase in AD

3.7 Long run Growth

3.8 GDP

3.8.1 Real GDP Growth

3.8.2 Long run GDP Growth

3.9 Consumption

3.10 Consumption & Disposal Income

3.11 Savings

3.12 USA Consumption & DI

3.13 USA Consumption Function

3.14 USA Savings rate

3.15 Investment vs Interest Rates

3.16 Investment Shifts

4. Macroeconomic 4. Macroeconomic Performance MeasuresPerformance Measures

Economic growth – GDP vs GNI

Inflation

Unemployment

Balance of Payments

Exchange rate

60

4.1 Gross Domestic Product4.1 Gross Domestic Product

• Measure of aggregate outputMeasure of aggregate output• Monetary measureMonetary measure• Avoid multiple countingAvoid multiple counting–Market value final goodsMarket value final goods– Ignore intermediate goodsIgnore intermediate goods–Count value addedCount value added

61

4.1 Gross Domestic Product4.1 Gross Domestic Product

• Exclude financial Exclude financial transactionstransactions–Public transfer paymentsPublic transfer payments–Private transfer paymentsPrivate transfer payments–Stock (and bond) market Stock (and bond) market

transactionstransactions• Second hand salesSecond hand sales–Sell used car to a friendSell used car to a friend

62

4.2 Two Approaches to GDP4.2 Two Approaches to GDP

• Income approachIncome approach–Count income derived from Count income derived from

productionproduction–Wages, rental income, interest Wages, rental income, interest

income, profitincome, profit• Expenditure approachExpenditure approach–Count sum of money spent Count sum of money spent

buying the final goodsbuying the final goods–Who buys the goods?Who buys the goods?

4.2.1 Product vs Earnings Approach

64

GDP

= =

+Consumption by

Households

Investment byBusinesses

GovernmentPurchases

ExpendituresBy Foreigners

+

+

+++

Wages

Rents

Interest

Profits

StatisticalAdjustments

+

4.3 Two Approaches to GDP

65

4.4.1 Expenditure Approach4.4.1 Expenditure Approach

• Personal consumption Personal consumption expenditures (C)expenditures (C)–Durable consumer goodsDurable consumer goods–Nondurable consumer goodsNondurable consumer goods–Consumer expenditures for Consumer expenditures for

servicesservices–Domestic plus foreign Domestic plus foreign

producedproduced

4.4.1.1 Share of Consumption

67


• Gross private domestic Gross private domestic investment (I)investment (I)–Machinery, equipment, and Machinery, equipment, and

toolstools–All constructionAll construction–Changes in inventoriesChanges in inventories

• Creation of new capital assetCreation of new capital asset• Noninvestment transactionsNoninvestment transactions

68


January 1 Year’s GDP December 31

Consumption& Government

Spending

Depreciation

NetInvestment

GrossInvestment

Stock ofCapital

Increase

Stock ofCapital

Gross InvestmentDepreciationNet Investment

-=

69


• Government purchases (G)Government purchases (G)– Expenditures for goods and servicesExpenditures for goods and services– Expenditures for social capitalExpenditures for social capital– Excludes transfer paymentsExcludes transfer payments

• Net exports (XNet exports (Xnn))– Add exported goodsAdd exported goods– Subtract imported goodsSubtract imported goods– NX = exports - importsNX = exports - imports

• GDP = C+IGDP = C+Igg+G+X+G+Xnn

70

Compensation

Rents

Interest

Proprietor’s Income

Corporate Profits

Taxes on Production and

Imports

National Income

Net Foreign Factor Income (-)

Statistical Discrepancy (+)

Consumption of Fixed

Capital (+)

Gross Domestic Product

$ 7874

65

603

1043

1627

1009

$12,221

96

29

1687

$ 13,841

Personal Consumption (C)

Gross Private Domestic

Investment (Ig)

Government Purchases (G)

Net Exports (Xn)

Gross Domestic Product

in Billions ReceiptsExpenditures Approach

AllocationsIncome Approach

$ 9734

2125

2690

-708

$ 13,841

4.4.5 U.S. Economy 20074.4.5 U.S. Economy 2007

71

4.4.6 C4.4.6 Comparative GDPomparative GDP

Source: World Bank

Selected Nations GDPs, 2007

United StatesJapan

GermanyChina

United KingdomFrance

ItalyCanada

SpainBrazil

RussiaIndia

South KoreaMexico

Australia

0 1 2 3 4 5 6 7 8 9 10 12 13GDP in Trillions of Dollars

72

4.5 Components of National 4.5 Components of National IncomeIncome

• Compensation of employeesCompensation of employees• RentsRents• InterestInterest• Proprietor’s incomeProprietor’s income• Corporate profitsCorporate profits– Corporate income taxesCorporate income taxes– DividendsDividends– Undistributed corporate profitsUndistributed corporate profits

• Taxes on production and importsTaxes on production and imports

73

4.5.1 Income Approach4.5.1 Income Approach

• From national income to GDPFrom national income to GDP– Net foreign factor incomeNet foreign factor income– Statistical discrepancyStatistical discrepancy– Consumption of fixed capitalConsumption of fixed capital

• Other national accountsOther national accounts– Net domestic product (NDP)Net domestic product (NDP)– National income (NI)National income (NI)– Personal income (PI)Personal income (PI)– Disposable income (DI)Disposable income (DI)– DI = C + SDI = C + S

74

4.5.2 U.S. Income 4.5.2 U.S. Income Relationships 2007Relationships 2007

Gross Domestic Product (GDP)Less: Consumption of Fixed CapitalEquals: Net Domestic Product (NDP)Less: Statistical DiscrepancyPlus: Net Foreign Factor IncomeEquals: National Income (NI)Less: Taxes on Production and ImportsLess: Social Security ContributionsLess: Corporate Income TaxesLess: Undistributed Corporate ProfitsPlus: Transfer PaymentsEquals: Personal Income (PI)Less: Personal TaxesEquals: Disposable Income (DI)

$ 13,8411687

$ 12,1542996

$ 12,2211009

979467344

2237$ 11,659

1482$ 10,177

4.5.3 GDP vs DI

76

4.6 Nominal vs. Real GDP4.6 Nominal vs. Real GDP

• GDP is a dollar measure of GDP is a dollar measure of productionproduction• Using dollar values creates Using dollar values creates

problemsproblems• Nominal GDPNominal GDP–Use prevailing priceUse prevailing price

• Real GDPReal GDP–Reflect changes in priceReflect changes in price–Use base year priceUse base year price

4.6.1 Real vs Nominal GDP

78

4.6.2 GDP Price Index4.6.2 GDP Price Index

• Use price index to determine real Use price index to determine real GDPGDP

PriceIndexIn GivenYear = x100

Price of Market BasketIn Specific Year

Price of Same BasketIn Base Year

RealGDP =

Nominal GDP

Price Index (in hundredths)

79

4.7 Shortcomings of GDP4.7 Shortcomings of GDP

• Nonmarket activitiesNonmarket activities• LeisureLeisure• Improved product qualityImproved product quality• The underground economyThe underground economy• GDP and the environmentGDP and the environment• Composition and distribution of the Composition and distribution of the

outputoutput• Noneconomic sources of well-beingNoneconomic sources of well-being

80

4.7.1 Und4.7.1 Underground erground EconomyEconomy

Source: Open Assessment, E-Journal

As a percentage of GDP, Selected Nations, 2007

MexicoSouth Korea

IndiaItaly

SpainChina

SwedenGermany

FranceUnited Kingdom

JapanSwitzerland

United States

0 5 10 15 20 25 30 Percentage of GDP

81

4.8.1 Sources of Data4.8.1 Sources of Data

• ConsumptionConsumption– Census Bureau’s Retail Trade SurveyCensus Bureau’s Retail Trade Survey– Census Bureau’s Survey of Census Bureau’s Survey of

ManufacturersManufacturers– Census Bureau’s Service SurveyCensus Bureau’s Service Survey

• InvestmentInvestment– All Consumption data sourcesAll Consumption data sources– Census Bureau’s Housing Starts Survey Census Bureau’s Housing Starts Survey

and Housing Sales Surveyand Housing Sales Survey– Retail Trade SurveyRetail Trade Survey– Wholesale Trade SurveyWholesale Trade Survey– Survey of ManufacturingSurvey of Manufacturing

82

• Government PurchasesGovernment Purchases– Office of Personnel ManagementOffice of Personnel Management– Construction SurveysConstruction Surveys– Census Bureau’s Survey of Census Bureau’s Survey of

Government FinanceGovernment Finance

• Net ExportsNet Exports– U.S. Customs ServiceU.S. Customs Service– BEA Surveys and AnalysisBEA Surveys and Analysis

4.8.2 Sources of Data

5. Economic Growth Models

5.1 Technology Diffusion

5.2 Growth factors

5.21 Four Wheels of Growth

Human resources (L)Human resources (L)

Natural Resources (R)Natural Resources (R)

Capital (K)Capital (K)

Technological change & Technological change & innovation (A)innovation (A)

Output (Q) = Af (K, L, R)Output (Q) = Af (K, L, R) where f=Production functionwhere f=Production function

L=(labour supply, education, skills, discipline, motivation)

R=(land, minerals, fuels, environmental quality)

K=(factories, machinery, roads, IP)

A=(science, engineering, management, entrepreneurship)

5.3 Smith vs Malthus

5.4 Growth vs Capital

5.5 Technological advance

5.7 Factors in GDP Growth

5.8 Labour Productivity

5.9 Wages & productivity

ConclusionConclusion

“Economic growth is the single most Economic growth is the single most important factor in the success of important factor in the success of nations in the long run. Economic nations in the long run. Economic growth involves the growth of growth involves the growth of potential output over the long run. The potential output over the long run. The growth in output per capita is an growth in output per capita is an important objective of government important objective of government because it is associated with rising because it is associated with rising average real incomes and rising living average real incomes and rising living standardsstandards” Paul Samuelson

Core ReadingCore Reading

Juleff, L, Chalmers, A.. and Harte, P. (2008) Business Economics in a Global Juleff, L, Chalmers, A.. and Harte, P. (2008) Business Economics in a Global Environment, Napier University EdinburghEnvironment, Napier University Edinburgh

Daniels, J.D., Radebaugh, L.H. and Sullivan, D.P. (2012) International Daniels, J.D., Radebaugh, L.H. and Sullivan, D.P. (2012) International Business: Environments and Operations. 14Business: Environments and Operations. 14thth edition, Pearson edition, Pearson

Samuelson, P.A. and Nordhaus, W. D. (2010)Samuelson, P.A. and Nordhaus, W. D. (2010)“Economics”“Economics” Irwin/McGraw-Hill, 19Irwin/McGraw-Hill, 19thth Edition Edition

Porter, Michael E. (2004)Porter, Michael E. (2004)“Competitive Strategy – Techniques for Analyzing “Competitive Strategy – Techniques for Analyzing Industries and Competitors”Industries and Competitors” Free Press Free Press

Questions?Questions?