1
Mr Sydney Armstrong
Week 1
Lecture 1
Economics is the study of how society uses scarce productive resources to produce valuable commodities
and distribute them among different people.
The study of economics is divided into two fields: Microeconomics and Macroeconomics.
Macroeconomics analyses the behaviour of the entire economy and major spending sector: Household
Consumption, Business Investment, Government Expenditure and Net Export (export less import) the
study of the economy as a whole. The field focuses primarily on the level of output for the entire
economy, the general level of prices, the rate of unemployment and the economys balance of payments.
The roots of Macroeconomics: Macroeconomics did not exist in its modern form until 1936 when John
Maynard Keynes published his revolutionary General Theory of Employment, Interest and Money. At
the time England and the United States were still stuck in the Great Depression of the 1930s, with over a
quarter of the American labour force unemployed. In his new theory Keynes developed an analysis of
what causes business cycle, with alternating spells of high unemployment and inflation. Today,
macroeconomics examines a wide variety of areas, such as how total investment and consumption are
determined, how central banks manage money and interest rates what causes international financial crises
etc. Although macroeconomics has progressed far since his first insights, the issues addressed by Keynes
still define the study of macroeconomics today.
Macroeconomic Issues
The macroeconomic issues that will be examined during this course are:
1) Economic Growth (change in the level of output) a) An outward shift in the PPC (production possibilities curve) due to an increase in the quantity or
quality resources.
b) An increase of real output (gross domestic product) or real output per capita.
NB: Gross domestic product is the market value of all final goods and services produced within an
economy for a given period.
2) Unemployment: The failure of an economy to fully utilise its entire labour force.
3) Inflation: A rise in the general level of prices in an economy.
4) The Balance of Payments: A summary of all the transactions that took place between the individuals, firms and government units of one nation and those of all other nations during a year.
5) Exchange Rates: The rate of exchange of one nations currency for another nations currency.
A foreign firm would look at some key macroeconomic indicators so as to inform its decision as to
whether or not it should invest in a particular country.
Some key macroeconomic indicators are:
1. Real Gross Domestic Product (Real GDP) 2. The unemployment rate 3. The inflation rate 4. The interest rate 5. The exchange rate 6. The level of the stock market
Some Macroeconomics goals include
1. High but controllable levels of economic growth 2. Stable inflation rate 3. Low rate of unemployment 4. Stable exchange rate 5. Balanced balance of payment
2
Economic Growth and Business Cycles
Economic Growth
Economic growth has been defined generally as an increase in real GDP or real GDP per capita for a
given time period. While both of the foregoing variables are important in giving an idea of an economys
economic soundness they serve different purposes. The level of real GDP of an economy represents the
economic, political and in some cases the military stature of a country, the United States which happens to
be the worlds largest economy is a good example. On the other hand real GDP per capita real GDP
divided by the total population serves as an indicator of a countrys standard of living.
It is important to note that GDP was modified by the word real as opposed to nominal.
It is conventional in economics that real variables be used so as to take out any illusory effects that
nominal variables might readily present.
Real GDP: The total amount of goods and services produced in a given time period, adjusted for price
level changes.
Nominal GDP: The total amount of goods and services produced in a given time period, measured at
current prices.
Factors that determine economic growth
Natural Resources A large amount of resources is not sufficient to guarantee economic growth. People must devise the methods to convert natural resources into usable forms. LDCs require this
type of human resource before they are able to exploit the natural resources they possess.
Capital Accumulation The more machines a nation has the more goods and services and therefore income it will be able to produce.
Rate of Saving Without savings we cannot have investment, and without investment into capital stock there can be little hope of much economic growth. On a national level this means that
higher savings rates eventually mean higher living standard, all other things held constant.
Technological Progress Technology makes it possible to obtain more output from the same amount of inputs as before. The ability of a nation to initiate and sustain technology change
depends on:
1. The scientific capabilities of the population 2. The quality and size of the nations educational and training system and 3. The % of income that goes into basic research and development each year.
Factors to Promote Growth
Promote Savings
Promote Mobility Factors of production needs to be reallocated from industrial sectors that are declining into those that are expanding.
Promote Education and Training We need specialize labour to operate and develop specializes machinery.
Promote Research & Development -
Promote the Supply side Increase the AS (Aggregate Supply)
Business Cycles are recurrent fluctuations of economic activity or real GDP that occurs relative to the
long-term growth trend of the economy. These cycles vary in duration and intensity however economists
have identified four phases of a business cycle.
TREND LINE
D A
B
C
O
U
T
P
U
T
YEARS
3
Key: A Peak B Recession C Trough D Recovery 1Q;
Peak: At this point economic activity is at a temporary maximum. The economy is at the full employment
level and real output is at or very close to the economys capacity. The price level is likely to rise during
this phase. A peak is followed by a period of recession.
Recession: A period of decline in an economys total output usually lasting at least six months and
marked by contractions in many sectors of the economy. The price level shows little or no change but if
the recession is long enough turns into a depression- then prices will start to fall. A recession is
followed by a trough.
Trough: In this phase the recession or depression is at its lowest level, and can be short-lived or last very
long. The trough is followed by the recovery or expansionary phase.
Recovery (expansion): As the word suggests the economy is on the road to growth. In this phase output
and employment start to rise, as a result the price level will start to rise. This phase will continue until it
reaches the plateau or peak and a new cycle will begin.
Actual vs. Potential growth.
Potential growth (potential GDP) represents the maximum sustainable level of output that the economy
can produce. When an economy is operating at its potential, there are high levels of utilization of the
labour force and the capital stock. Potential output is determined by the economys productive capacity,
which depends upon the inputs available (capital, labour, land, etc.) and the economys technological
efficiency. Potential growth tends to grow steadily because inputs like labour and capital and the level of
technology change quite slowly overtime. By contrast actual growth (actual GDP) is subject to large
business cycle swings if spending pattern change sharply.
4
Mr Sydney Armstrong
Week 2
Lecture 1
Circular flow of income
Definition: The circular flow model, describes the interactions between the two basic agents in an
economy, consumers and producers. This model shows the flow of resources, products, income and
revenues between these two basic economic agents.
The circular flow of income is one of the most useful economic models. Universities and governments
use a more complicated version in order to make economic forecasts. The model is simple to start with
but is made more complex by adding additional sectors to it. The first version has only two sectors,
households and firms.
The basic circular flow of income model consists of six assumptions:
1. The economy consists of two sectors: households and firms. 2. Households spend all of their income (Y) on goods and services or consumption (C). There is no
saving (S).
3. All output (O) produced by firms is purchased by households through their expenditure (E). 4. There is no financial sector. 5. There is no government sector. 6. There is no overseas sector.
In fig.1, firms use factors of production provided by households. Land, labour, capital and
entrepreneurship are used by firms to produce a good or service. The firms pay households a reward for
using these factors. Rent for land, wages for labour, interest f