Basics in Macroeconomics

1. Course: Basics in Macroeconomics • NDU University • Faculty of Business and Finance • Suggested Study Books: • Case and fair Prepared by Wissam Zgheib - NDU University

2. Chapter 1: The Fundamentalsof Economics Prepared by Wissam Zgheib - NDU University

3. What Is Economics? • Economics is the study of how societies use scarce resources to produce valuable commodities and distribute them among different people. • Goods are scarce because people desire much more than what is available of the economic goods. Prepared by Wissam Zgheib - NDU University

4. Difference Between Microeconomics and Macroeconomics • Microeconomics: founded by Adam Smith (1776). It is concerned with the behavior of individual entities such as markets and firms. • Macroeconomics: founded by John Maynard Keynes (1935). It is concerned with the overall performance of the economy. Key words: business cycle, employment, inflation, interest rate. Prepared by Wissam Zgheib - NDU University

5. The Three Fundamental Questions of Economic Organizations • Whatcommodities are produced? In what quantities are they produced? • Howare goods produced? • With What resources are they produced? • Who will do the production? • What are the production techniques? • For whom are goods produced? How is the national product divided among the different households? Prepared by Wissam Zgheib - NDU University

6. Types of Economies • Market Economy: in which individuals and private firms make the major decisions about production and consumption. • Command Economy: in which the government makes the major decisions about production and consumption. The government owns most of the means of production. • Mixed Economy: lies between market economy and command economy. Prepared by Wissam Zgheib - NDU University

7. Society’s Technological Possibilities • Inputs: also called factors of production; used to produce goods and services. • Land • Labor • Capital • Outputs: goods that result from the production process. • The Production-Possibility Frontier (PPF): shows the maximum amount of output given an economy’s technological capability and its available inputs. Prepared by Wissam Zgheib - NDU University

8. A smooth curve connects the plotted points of the numerical production possibilities Prepared by Wissam Zgheib - NDU University

9. More on PPF… • Societies are sometimes inside their PPF when unemployment is high and when the government is inefficient. • The economy is on its PPF when it is producing efficiently i.e. when it cannot produce more of one good without producing less of another. Prepared by Wissam Zgheib - NDU University

10. Economic growth shifts the PPF outward Prepared by Wissam Zgheib - NDU University

11. Basic Elements of Supply, Demand, and Equilibrium Prepared by Wissam Zgheib - NDU University

12. The Demand Schedule • It is the relationship between price and quantity bought, ceteris paribus • The Demand curve is downward-sloping because the buyers tend to buy less of a commodity when its price is raised. • Substitution effect • Income effect • The market demand curve: is the sum total of all individual curves. Prepared by Wissam Zgheib - NDU University

13. Forces Behind the Demand Curve • Average income of consumers • Size of the market (population) • Prices and availability of related goods • Tastes or preferences • Special influences: seasonality, expectations about the future… Prepared by Wissam Zgheib - NDU University

14. Example of a Demand Curve Prepared by Wissam Zgheib - NDU University

15. Factors Shifting the Demand Curve • The demand curve shifts because influences other than the good’s price change, such as: • Average Income • Population or size of the market • Prices and availability of related goods • Tastes • Special Influences Prepared by Wissam Zgheib - NDU University

16. Factors Leading to Movements along the Demand Curve • Change in the price of the good Prepared by Wissam Zgheib - NDU University

17. The Supply Schedule • It is the relationship between the price of a commodity and the amount of that commodity that producers are willing to produce, ceteris paribus. • The supply curve is upward-sloping because producers are willing to produce and sell more of the commodity as its price increases. Prepared by Wissam Zgheib - NDU University

18. Example of a Supply Curve Prepared by Wissam Zgheib - NDU University

19. Forces Behind the Supply Curve • Technological advances • Input prices • Prices of related goods • Government policy: quotas and tariffs • Special influences: weather, innovation, structure of the market… Prepared by Wissam Zgheib - NDU University

20. Factors Shifting the Supply Curve • The supply curve shifts when changes in factors other than a good’s price affect the quantity supplied, such as: • Technological advances • Input prices • Prices of related goods • Government policy: quotas and tariffs • Special influences: weather, innovation, structure of the market… Prepared by Wissam Zgheib - NDU University

21. Factors Leading to Movements along the Supply Curve • Change in the price of the good produced Prepared by Wissam Zgheib - NDU University

22. Equilibrium of Supply and Demand • A market equilibrium comes at the price at which quantity demanded equals quantity supplied. • The equilibrium price is also called the market-clearing price. Prepared by Wissam Zgheib - NDU University

23. Equilibrium With Supply and Demand Curves Prepared by Wissam Zgheib - NDU University

24. Effect of a Shift in Supply or Demand Prepared by Wissam Zgheib - NDU University

25. Shifts of and Movements along Curves Prepared by Wissam Zgheib - NDU University

26. Introduction to Macroeconomics and National Income Accounting Prepared by Wissam Zgheib - NDU University

27. Macroeconomics is ... • the study of the economy as a whole • It deals with broad aggregates: AS and AD • but uses the same style of thinking about economic issues as in microeconomics. Prepared by Wissam Zgheib - NDU University

28. Aggregate Supply & Aggregate Demand • The level of aggregate supply (AS) is the quantity of output the economy can produce or is willing to produce given the resources available. • The aggregate supply tradeoff between prices and output represents firms’ decisions to lower or raise prices when the demand for output falls or rises. • The level of aggregate demand (AD) is the total demand: for goods to consume, for new investment, for goods purchased by the government, and for net goods to be exported abroad. Prepared by Wissam Zgheib - NDU University

29. Equilibrium between AS and AD • The intersection of the AS curve and the AD curve determines the equilibrium point. • The equilibrium point determines the level of output Y on the horizontal axis, and the price level on the vertical axis. • The output level Y refers to GDP, the total physical output produced in the economy. • The price level P refers to the general level of prices in the economy, not any specific price. Prepared by Wissam Zgheib - NDU University

30. Models in Macroeconomics • Models are simplified representations of the real world. A good model tries to explain the behaviors that are most important to us, and omits the details that are unimportant. • In economics, the complex behavior of millions of individuals, firms, and markets is represented by a certain number of models that are based on a set of assumptions considered reasonable in a real-world example. Prepared by Wissam Zgheib - NDU University

31. The Three Models in Macroeconomics • Long Run Growth Theory: (more than 10 years) • Focuses on the growth of productive capacity as fluctuations in the economy tend to average out over the years • We assume that labor, capital, and raw materials are fully employed • The AS curve is vertical (called the classical AS curve) • The AD curve is downward sloping. Thus, output is determined by AS alone, and prices are determined by both AD and AS. Prepared by Wissam Zgheib - NDU University

32. The Three Models in Macroeconomics • The Medium Run Model (btw 1 year and ten years): • AD is downward sloping • AS is upward sloping • The Short Run Model (less than 1 year): • AS is horizontal (called Keynesian AS curve) • AD is downward sloping • Changes in output are due to shifts in the AD curve • Prices are unaffected by the level of output and/or AD Prepared by Wissam Zgheib - NDU University

33. Why did Keynes assume fixed product prices and wages? • During a deep recession, there are many idle resources in the economy. Producers are willing to sell additional output at current prices because there is plenty of resources to go around for everyone who wants them. In addition, the supply of unemployed workers willing to work for the prevailing wage rate diminishes the power of workers to increase their wages. • A horizontal supply curve would explain fixed prices and wages. Prepared by Wissam Zgheib - NDU University

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35. The Effect of an Increase in Government Spending Prepared by Wissam Zgheib - NDU University

36. According to Keynes, what will a shift in aggregate demand do? • It will restore a depressed economy to full employment Prepared by Wissam Zgheib - NDU University

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38. Some Key Issues in Macroeconomics • Business Cycles: recurring patterns of economic expansion, then contraction, then expansion again. Business cycles are characterized by: • Peak: point at which an expansionary phase ends and a contractionary phase begins. • Contractionary Phase: a period in which GDP is declining. Also associated with declining inflation rates and increasing unemployment rates. • Trough: point at which a contractionary phase ends and an expansionary phase begins. • Expansionary Phase: a period in which GDP is growing. Also associated with increasing inflation rates and declining unemployment rates. Prepared by Wissam Zgheib - NDU University

39. Business Cycles Prepared by Wissam Zgheib - NDU University

40. Inflation = (Pt - Pt-1) / Pt-1 => Pt = Pt-1 + infl * Pt-1 • Inflation is the rate of change of the general price level over time. • The price level Pt is the accumulation of past inflations • Deflation: is a decrease in the average level of prices of goods and services. It occurs when the inflation rate is negative. • Disinflation: a "planned reduction" in the general price level. It is described as benign. Being destructive, both inflation and deflation are described as "sudden", laying off any blame upon misguided consumers. Prepared by Wissam Zgheib - NDU University

41. Unemployment • a measure of the number of people looking for work, but who are without jobs. The unemployment rate is the % of the labour force that is unemployed = Unemployed / Labor force • Rate of Activity: labor force / total population • Labor force: Employed + Unemployed • Output • real gross national product (GNP) measures total income of an economy • it is closely related to the economy's total output Prepared by Wissam Zgheib - NDU University

42. Defining GDP and GNP • GDP: is the market value of all final goods and services produced in the country within a given period. • GNP: is GDP to which is added receipts from abroad made as factor payments to domestically owned factors of production. • In the U.S., the two notions are used interchangeably because the difference between GDP and GNP is only about 1%. Therefore, it can be ignored. But the difference can be more significant for other countries. Prepared by Wissam Zgheib - NDU University

43. Definition of Nominal & Real • Nominal: The value of an economic variable in terms of the price level at the time of its measurement, i.e. unadjusted for price movements. To compute Nominal GDP, we multiply quantities produced Q by the price P at which they sold on a given year. • Real: measures “real” production i.e. quantities produced, eliminating the effect of changing prices. To eliminate the effect of changing prices, we pretend that prices did not change, by fixing a year as a base. • Deflator: A numeric pricing measure used to change nominal values into real values. Prepared by Wissam Zgheib - NDU University

44. The Problem… • If prices rise between two years, does a higher GDP necessarily mean that we produced more? Prepared by Wissam Zgheib - NDU University

45. No. All the observed increase in GDP may be due to increasing prices, even though quantities remain the same or even decrease. Prepared by Wissam Zgheib - NDU University

46. From Nominal Values to Real values • With nominal economic variables on hand, the key issue becomes how to remove the price effect from a data series i.e. change nominal data to real values. • To transform a nominal series into real terms, two things are needed: the nominal data and an appropriate price index. The appropriate price index can come from any number of sources. Among the more prominent price indexes are the Consumer Price Index (CPI), the Producer Price Index (PPI), and the GDP deflator. Prepared by Wissam Zgheib - NDU University

47. Price Indexes • The three main price indexes are: • The GDP deflator: measures inflation or the change in prices that occurred between the base year and the current year. It involves all goods produced in the economy. The GDP deflator = (Nominal GDP / Real GDP)*100 • The consumer price index (CPI): measures the cost of buying a FIXED basket of goods and services representative of the purchases of urban consumers. It is used to measure prices at the retail level. • The producer price index (PPI): measures the cost of a fixed basket of raw materials and semi finished goods. It is used to measure prices at an early stage of the distribution level. Prepared by Wissam Zgheib - NDU University

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49. Price Indexes Cont’d • Price indexes measure the value of a basket of goods in a certain time period, relative to the value of the same basket in a base period. They are calculated by dividing the value of the basket of goods in the year of interest by the value in the base year. By convention, this ratio is then multiplied by 100. • Generally speaking, statisticians set price indexes equal to 100 in a given base year for convenience and reference. To use a price index to deflate a nominal series, the index must be divided by 100 (decimal form). The formula for obtaining a real series is given by dividing nominal values by the price index (decimal form) for that same time period: • Nominal Value / price index (in decimal form) = Real Value Prepared by Wissam Zgheib - NDU University

50. But how does this simple formula remove price fluctuations from actual changes in a variable’s overall value? • Economic variables measured in dollar values like GDP, exports, construction contract values, and sales are calculated from the product of the quantity sold and the selling price (P*Q). Analysts want to get their hands around the changes in quantity sold and disregard changes in prices because it’s the quantity of goods and services consumed by households that affects well-being, not the prices. In effect, the percentage change in real values over a given time period should mirror the percentage change in quantity. Prepared by Wissam Zgheib - NDU University