MacroEconomics:

Calculating National Income:

GDP = C + I + G + (X-M)

- C = Consumption
- I = Investment
- G = Government Spending
- X = Exports
- M = Imports

GNI = GDP + Net Income From Abroad

- A US Factory in Mexico contributes to Mexican GDP and US GNI.

GDP / GNI AS A MEASURE OF STANDARD OF LIVING:

(Slides)
Big Mac Index - an index used to measure the purchasing power parity (PPP) between two
currencies

Purchasing power parity - a theory that measures the average price level in different
countries and is widely used when comparing the GDP of different countries.

OECD better life index - an index which allows economists to compare well-being across
countries, based on 11 topics e.g. quality of housing, average income levels as well as
access to education and health services.

Happiness index - a landmark survey of the state of global happiness that ranks 156 by
how happy their citizens are.

Happy planet index - measures what matters; sustainable wellbeing for all. It tells us how
well nations are doing at achieving long, happy, sustainable lives

Limitations of GDP:
PIES:
P - Population
- Same amount of Pie split between more people.
I - Inequality
- Even if two countries have an identical GDP per Capita, not all households in that
country have the same income.
E - Environment
- Doesn’t include the value of the environment.
S - Shadow economy
 - Informal sector where people work and earn money that doesn’t go noticed.

Real GDP = Nominal GDP Adjusted for inflation

- You adjust for inflation by using a price deflator

Real GDP = Nominal GDP * Price Deflator

You can construct the price deflator using the Inflation Rate:
Price Deflator = 100 / (100 + Inflation Rate)

If you are comparing multiple years, you will select one year as the base year.

Normal GDP Growth Rate = ((Final - Initial) / (Initial)) * 100

Real GDP Growth = Nominal GDP Growth - Inflation Rate

Limitations of National income statistics:

(Slides)

Key Terms:
Calculation errors or incomplete statistics - particularly middle and low income nations
less so

The grey or unofficial economy - this sector which includes wages paid unofficially,
unofficial transactions such as between friends or family members, foreign migrant workers
employed without registration papers, as well as illegal activity such as the sale of bootleg
cigarettes

Military Output - many nations spend large proportions of their national output on building
up a vast army as well as diverting a significant proportion of their factors of production
towards the production of military goods, which do not improve standard of living.

Cost of economic growth - it does not necessarily tell you whether the growth is actually
good for its citizens or not. E.g., in recent decades China has experienced fantastic growth
rates. While there are many positives to such development this level of growth has also
come at a cost e.g. environmental costs, higher income inequalities and rapid (Largely
unplanned) urban development

Green GDP - a record of GDP after taking into account any damage to the environment.
This is calculated by the formulae: Nominal GDP minus environmental costs of production.

Why Collect National Income Statistics:

Governments collect national income statistics for a variety of reasons. Some of these
include the following:
 1. National income statistics are effectively a record of how successful an economy has
been over time.
2. Governments and other agencies also use national income statistics to compare the
performance of different countries as well as within a country between different time
periods.
3. National income statistics can also be used to predict future trends and develop
policies that form the basis of long term economic planning.

Real World Examples

Nigeria Rwanda
GDP 440.8 Billion USD (2021) 11.07 billion USD (2021)

Population 213.4 Million (2021) 13.46 million (2021)

GDP per Capita 2,065.75 USD (2021) 822.35 USD (2021)

Gini Coefficient 35.1% (2022) 47.3% (2016)

HDI Ranking 0.535 (2021) (Ranked 164) 0.534 (2021) (Ranked 165)

Happy Planet Index 34.1 (137th out of 152) (2019) 39.2

Happiness Index 4.98 (2022) 3.27 (2021)

Real Business cycles:

At Peak:
- Inflation is high
- Unemployment is low
At Trough:
- Inflation is low
- Unemployment is high

Aggregate Demand and Aggregate Supply Graph:

Aggregate Demand:
Basic Aggregate Demand -Aggregate Supply Model:

- AD = Aggregate Demand
- SPAS - Short Run Aggregate Supply
- PL - Price Level

Why is Aggregate Demand downward Sloping:

1. Real Wealth Effect: Behaviour of Consumers
2. Interest Rate Effect: Behaviour of Supplier
3. Exchange Rate Effect: Behaviour of foreign Factors.

Aggregate Demand = GDP

- C + I + G + (X-M)
- C = Consumption
- I = Investment
- G = Government Spending
- X = Exports
M = Imports

Aggregate Supply:
Shifter of Short Term Aggregate Supply:
 1. Resource Prices - Change in cost of availability if key resources
2. Actions by the Government - Change in Taxes, Subsidies, or regulations
3. Changes in Technology: - Change in technology or human capital.

Budget Deficit - when the total governments expenditure exceeds its revenue

Budget Surplus - when the government revenue exceeds its expenditure

LRAS: Neoclassical Model

- YFE = Full employment

- APL = Average Price Level
- AD = Aggregate Demand
- LRAS = Long Run Aggregate Supply
- SRAS = Short Run Aggregate Supply

The economy in the short run, can work beyond its Long Run Capacity.

In the Long Run, eventually wages and the price of resources would change, bringing the
SRAS to the LRAS.

Factors that affect Consumption:

- Income Tax Levels
- Cutting taxes leads to more real disposable income and consumption
- Inflation
- An increase in Inflation is a rise in prices, meaning people have less to spend.
- Interest Rates
- Asset Prices (e.g House, shares)
 - An increase in the price of your house makes you feel richer and more
confident to consume.
- Consumer Confidence
- How people feel the economy is going impacts confidence and consumption.
More confident = More Consumption

Investment:
- In macroeconomics, Investment refers to investment by firms in capital equipment. It
is often financed by borrowing from banks
- Investment is central to boosting productivity, the amount that can be produced per
unit of labour per hour.
- Higher productivity leads to stronger, long-term economic growth.

Factors that influence Investment:

- Interest rates
- High interest rates reduce levels of investment.
- Low interest rates can increase levels of investment (but only if businesses
are feeling confident)
- Business Confidence
- Low confidence means businesses invest less.
- High business confidence gives expectations of strong economic growth,
employment and overseas demand.
- Corporation tax rates:
- If corporations have their taxes cut they might invest more.

Government Spending:
- Governments can decide to increase or decrease their spending.
- When they spend more than budgeted for the year, they create a budget deficit.
- When they spend less than budgeted for the year, they create a budget surplus.
- Government finances budget deficits by borrowing, which increases public debt.

Net Exports
Exports - Imports

Factors that affect Net Exports:

- Exchange rates:
- A weak currency makes exports more expensive and exports cheaper.
Therefore, imports fall and exports increase.
 - A strong currency makes imports cheaper and exports more expensive.
Therefore, imports increase and exports fall.

Keynesian Model:
Aggregate Supply model:

Monetarist / Neoclassical: Economists believe that changes to the money supply

determine a country’s economic performance. Such a school of thoughts supports the view
that macroeconomic markets are self correcting and that any attempt to stimulate aggregate
demand through government interventions will be inflationary.

Keynesian economics: consists of a set of theories focused on total spending in the

economy and the effect

Sticky Wages:
One of Keynes' beliefs was that Wages were sticky and would not fall. This was due to
Unions that would strike if there were Wage cuts.

Differences: Neoclassical and Keynes:

The main difference between the two is how the economy stabilises itself.
- In the Neoclassical model, the economy stabilises itself by adjusting the price of
wages and Resources. Requiring no Government intervention
- In the Keynesian Model, the government must intervene to stabilise the economy.

LRAS: Long Run Aggregate Supply:

- In the Neoclassical model the LRAS is represented by a long straight vertical line that
is in the middle of the graph.
- In the Keynesian Model, there is no specific LRAS because Keynes believes that any
point could be the LRAS.
 - Since the economy will not change without outside intervention, it will remain
the way it currently is in the Long Run unless something is done.

Important Formulas:
GDP = C + I + G + (X-M)
- C = Consumption
- I = investment
- G = Government Spending
- X = Exports
- M = Imports.

GNI = GDP + Net Income From Abroad

- A US Factory in Mexico contributes to Mexican GDP and US GNI.

Real GDP = Nominal GDP Adjusted for inflation

- You adjust for inflation by using a price deflator
- Real GDP = Nominal GDP * Price Deflator

You can construct the price deflator using the Inflation Rate:
Price Deflator = 100 / (100 + Inflation Rate)

If you are comparing multiple years, you will select one year as the base year.

Normal GDP Growth Rate = ((Final - Initial) / (Initial)) * 100

Real GDP Growth = Nominal GDP Growth - Inflation Rate

Fiscal Policy:
Fiscal Policy - refers to the use of government spending and tax policies to influence
economic conditions, including demand for goods and services, employment, inflation and
economic growth.

Expansionary Fiscal Policy - examples of this would include decreasing taxes and / or
increasing government expenditures, implemented to fight recessionary pressures. A
decrease in taxes means that households have more disposable income to spend, while a
rise in government spending provides an injection into the circular flow of national income.

Contractionary Fiscal Policy - examples of this would include increasing taxes and / or
reducing government expenditures, implemented to fight inflationary pressures. Both policies
take money out of the circular flow of national income.

Spending multiplier - represents the multiple by which GDP increases or decreases in

response to an increase and decrease in government expenditures and investment.
Automatic stabilisers - so called because they act to stabilise economic cycles and are
automatically triggered without additional government action. Within fiscal policy this
includes personal income taxes, which automatically fall as the national income declines and
transfer payments such as unemployment insurance and welfare payments.

Expansionary Fiscal Policy Video: (Demand side policy)

a) In times of sluggish economic activity governments can manipulate aggregate
demand by what combination of taxation and / or government spending?
i) Tax cut:
1) Indirect injection into economy
2) Increases household disposable income to hopefully increase
consumption
3) But would also lead to an increase in savings and imports
4) Would result in less of an effect than direct government spending
ii) Fiscal Stimulus / Government Spending
1) Both tax cuts and increased government spending
2) Leads to budget deficit
3) Spending while cutting taxes would increase deficit

b) Explain the difference between expansionary and contractionary fiscal policy?

i) Contractionary fiscal policy is in response to an inflationary gap while
expansionary fiscal policy is in response to a recessionary gap.

c) When a government increases its spending on transfer payments, public services

and other spending items, how does this multiply throughout the economy?
i) As governments spend more money, the economy grows. (This can be seen
most clearly if you follow the GDP formula) This multiplies through the
economy by increasing the total amount of money in the system, thus
allowing for more economic growth.

d) When a government reduces tax rates, how does this multiply throughout the
economy?
i) A government reducing tax rates also increases the GDP, however it can also
have negative consequences. For example, if the taxes on demerit goods
were decreased, there would be a larger negative externality on society as a
whole.

Automatic Stabilizers:
● Key idea: Fiscal policies that happen without legislation
● Idea: in most economies, changes to the level of taxation and levels of government
spending happen automatically - without any government action
● This is because they are already in polkace
● Examples:
○ Make more money = pay higher taxes (progressive tax system)
○ Make less money = pay lower taxes (Progressive tax system)
○ Recession = increased unemployment = increased benefits.
Strengths of Fiscal policy:
- Pulling an economy out of recession
- Dealing with rapid and escalating inflation
- Ability to target sectors of the economy
- Direct impact of government spending on AD
- Ability to affect potential output

Limitations of Fiscal policy:

- Timing
- Recognition lag (Identifying a problem)
- Legislative lag (Policies needing to be approved)
- Implementation lag
- Effectiveness lag (Takes time for government spending to ripple through the
economy)
- Inflationary pressure
- Inability to tackle supply-side causes of instability
- Ina recession, tax cuts may not be effective in boosting AD (remember: consumer
and business confidence)
- Increased government debt
- Increased imports
- Crowding out
- Demand side policies are only effective when there is a spare capacity in the
economy. Without available unemployed resources any rise in aggregate demand is
likely to be inflationary only.
Crowding Out:
● Crowding out can occur when governments borrow money to finance deficit
spending.
● As can be seen in the graph below, this increases the demand for loanable funds.
● That in turn raises the interest rate.
● Higher interest rates “crowd out” private sector investment.

Raising AD through stimulus:

a) Why might the US government have wished to raise AD through stimulus measures
in 2011?
i) This was soon after the 2008 market crash. By raising AD, they could have
the economy grow again.
b) Why might the government now want to employ contractionary monetary policy to
reduce aggregate demand levels in 2016?
i) They may want to do this in order to reduce the effects of inflation.

Can fiscal policy promote long-term growth?

A) Can expansionary fiscal policy in the form of lower taxes and increases in
government spending increase both AD as well as AS?

Fiscal Policy’s positive supply-side effects:

- Infrastructure spending
- When the government supports modern infrastructure, including
transportation and communications, the private sector is given the resources
it needs to grow and succeed in the long run.
- Education spending
- Increased education levels is perhaps the most important source of a nation;s
ability for long-run growth - public schools improve skills in the labour force
- Research and development spending
 - Government funded research and development can lead to scientific,
technological, and medical breakthroughs that may spur new industries and
promote private sector growth.
- Incentives for private investments
- Creating tax policy that rewards innovation and entrepreneurship will
encourage private businesses to invest and thereby help the economy grow.

RWE Expansionary Fiscal Policy:

- In response to Covid-19, the UK economy shrank by 11% in 2020.
- The UK government borrowed 400 Billion pounds to finance a fiscal stimulus,
including wage subsidy schemes, grants and business loans, welfare benefits e.t.c.
- It also included the Eat out to help out scheme and cuts to VAT for hospitality and
tourism industries
- GDP growth recovered
- Unemployment levels were lower than in European countries
- But Public debt reached about 100% GDP, leading to contractionary fiscal policy in
the form of government cuts later on

RWE Contractionary fiscal policy:

- In response to the 2007 - 8 financial crisis, the UK government spent 137 billion
pounds to bail out the banks to avoid a financial meltdown.
- In 2009, the budget deficit was 10%, in 2020, it was 2%.
- In 2007-8 Government debt stood at 40.5% of GDP; in 2010-2011, government debt
stood at 74.45% of GDP.
- The conservative party cut government spending to reduce the budget deficit and
reduce public debt.
- Government departments, local councils, police, defence and welfare all suffered
cuts
- Although government finances recovered, the poor were particularly badly affected
by Welfare cuts.

Government Budgets:
Government budget - derived from government income from taxation and sales of public
assets minus total expenditures, including debt interest payments.

Fiscal policy - refers to the use of government spending and tax policies to influence
economic conditions, including demand for goods and services, employment, inflation and
economic growth.

Budget deficit - when government income from taxation and sales of public assets is lower
than its total expenditure, including debt interest payments, within a fiscal year.

Budget surplus - when government income from taxation and sales of public assets is
greater than its total expenditure, including debt interest payments, within a fiscal year.

Budget balance - when government income from taxation and sales of public assets is
equal to its total expenditure, including debt interest payments, within a fiscal year.
Public (National) Debt - the cumulative level of debt measured at a specific point in time
and is the accumulation of all prior deficits.

Direct taxation - tax paid directly by an individual or organisation to the government, e.g.
property tax, personal property tax, income tax or taxes on assets.

Indirect taxation - taxes collected by an intermediary (such as a retail store) from the
person who bears the ultimate economic burden of the tax e.g. the consumer.

Government expenditure - government or public spending can be classified into current

expenditures, capital expenditures and transfer payments.

Transfer payments - a payment made to a person with no service or good provided in

exchange e.g. pensions, student grants or unemployment benefits. Transfer payments are
used by governments to redistribute money to those in society most in need.

Surpluses and deficits:

Key idea: “Net AD depends on balanced budget”
Balanced budget:
- Expenditures = revenues
- Leakages = injection
- No net effect on ad
Budget surplus:
- Revenues > expenditures
- Leakages > injections
- Net effect on AD is negative
- Reduce national debt
Budget deficit:
- Revenues < expenditures
- Leakages < injection
- Net effect on AD is positive
- Increases national debt

Sustainable level of government (National) Debt: (HL Only)

- Government debt is measured as a percentage of GDP.
𝐷𝑒𝑏𝑡
- Debt-to-GDP Ratio = 𝐺𝐷𝑃

- A high debt-to-GDP ratio is bad as it means that the country is more likely to default
on (or stop paying) its loans to international financial institutions
- The ratio for Greece as of 2017 was 182%. Greece had to be bailed out by Germany,
the reason being that foreign governments and banks held a lot of Greece’s debt.
- When the returns on government bonds are low, it shows that investors are confident
in demand for the government debt.
 - When the return on bonds get high, this means that the investors avoid the debt
because it is risky and so the government is ready to promise higher returns to raise
money.

Costs of Government debt:

- High debt servicing costs
- In recent years the US government has spent more than USD 1 billion per
day on interest payments.
- Credit Ratings:
- If a government’s credit rating worsens because of high debt, it will be even
more expensive to pay back its debt.
- Impacts on future taxation and government spending:
- Government debt will have to be serviced by future increases in national
income, or GDP, and possibly a future increase in taxes or a diversion of
spending from one programme to another.
- Increases in debt will mean increased taxes in the future and less ability for
the government to spend on areas such as education and health care, which
are important for society.