#principles of micro economics

1. PRINCIPLES OF MACROECONOMICS
BY MARSHAL NANGATI @KAYZ HIGH
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2. DEFINITION & SCOPE OF
MACROECONOMICS
• Macroeconomics: the study of the economy as
a whole. This branch of economics adopts a
global approach in grappling with economic
issues.
• The study is done through theories
underpinned by empirical evidence or
concrete examples of economic situations,
agents, events, policies and institutions.
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3. DEFINITION AND SCOPE CONT’D
• Macroeconomics is very relevant to policy
makers, scholars, non-governmental
organizations and multi-lateral institutions
such as the United Nations, IMF, World Bank,
ADB and SADC to mention just a few.
• There are many schools of thought that have
evolved over the past 200 years in a bid to
better explain economic issues.
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4. KEY TOPICS OF MACROECONOMICS
1. National income concepts and measurement
2. National income determination
3. International trade & BOPs
4. Money and the price level
5. Macroeconomic problems:
- Inflation
- Unemployment
- BOPs deficits and surpluses
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5. KEY TOPICS CONT’D
- Underdevelopment or development related
problems
6. Macroeconomic policies:
- Fiscal policy
- Monetary policy
- Trade policy
- Exchange rate policy
- Incomes and pricing policies
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6. KEY TOPICS CONT’D
7. Industrialization strategies:
-export-oriented industrialization
-import-substitution industrialization
-technology-driven strategies
-mixed strategies
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7. GOALS OF MACROECONOMIC POLICY
1. To ensure price stability
2. To create employment
3. To attract and retain investment
4. To ensure exchange rate stability
5. To maintain or to attain Balance of Payments
(BOPs) balance.
6. To achieve a balanced budget
7. To ensure sustainable economic growth and
development
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8. National income accounting concepts
• National Income: the total level of production
within a given economy or by resources of a
given economy over a specified period of time
usually 1 year.
• In economics national income is viewed as a
flow studied through the three-pronged
circular flow model of national income:
- Two sector model
- Three sector model
- Open economy model
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9. The two sector model of national income
• Key players are:
1. Households – they provide land, labour, capital
and enterprise. Households obtain rent, wages,
interest and profit.
2. Firms – they transform factors of production plus
materials from the economy into goods and
services in an economy.
Firms obtain payment for commodities when
members of households purchase goods and
services.
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10. The two sector model cont’d
• Assumptions:
• The basic circular flow of income model consists
of six assumptions:
• The economy consists of two sectors: households
and firms.
• Households spend all of their income (Y)
on goods and services or consumption(C).
• All output (O) produced by firms is purchased by
households through their expenditure(E).
• There is no financial sector.
• There is no govt sector.
• There is no overseas sector.
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11. The two sector model cont’d
Simple model:
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HOUSEHOLDS
FIRMS
(MASHTECH WORLD)
Land
Labour
Capital
Enterprise
Rent
Wages
Interest
Profit
Goods &
Services
Payment
for goods
&
services

12. The two sector model cont’d
At equilibrium W = J or Withdrawals equals Injections
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FIRMS HOUSEHOLDS
RESOURCE
MARKET
RESOURCES INPUTS
PRODUCT
MARKET
GOODS &
SERVICES
GOODS &
SERVICES
Savings
(W)
Investment
(J)

13. The two sector model cont’d
• What if W>J?
– This means that with the passage of time more
income is lost from the economy than is created
or generated within the economy.
– Economic activity declines leading to increased
unemployment in the economy.
– This situation can be remedied through an
appropriate mix of macroeconomic and
microeconomic policies.
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14. The two sector model cont’d
• What if W<J?
– This implies that there is more investment (or
capital creation) in the economy.
– Increased creation of capital or investment has
multiplier and accelerator effects on economic
activity leading to increases in national income.
– A sustained rise in national income leads to
economic growth and an improvement in living
standards or welfare, ceteris paribus.
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15. The three sector model
• This is a closed economy with government.
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16. The three sector model cont’d
• It includes household sector, producing sector
and government sector.
• It will study a circular flow income in these
sectors excluding rest of the world i.e. closed
economy income. Here flows from household
sector and producing sector to government
sector are in the form of taxes.
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17. The three sector model cont’d
• The income received from the government
sector flows to producing and household
sector in the form of payments for
government purchases of goods and services
as well as payment of subsides and transfer
payments.
• Every payment has a receipt in response of it
by which aggregate expenditure of an
economy becomes identical to aggregate
income and makes this circular flow and
unending.
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18. The four sector model
• A modern monetary economy comprises a
network of four sector economy these are-
1.Household sector 2.Firms or Producing
sector 3.Government sector 4.Rest of the
world sector.
• Each of the above sectors receives some
payments from the other in lieu of goods and
services which makes a regular flow of goods
and physical services.
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19. The four sector model cont’d
• Money facilitates such an exchange smoothly.
A residual of each market comes in capital
market as saving which in turn is invested in
firms and government sector.
• Technically speaking, so long as lending is
equal to the borrowing i.e. leakage is equal to
injections, the circular flow will continue
indefinitely.
• However this job is done by financial
institutions in the economy.
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20. The four sector model cont’d
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21. The five sector model
• The five sector model of the circular flow of
income is a more realistic representation of the
economy.
• Unlike the two sector model where there are six
assumptions the five sector circular flow relaxes
all six assumptions. Since the first assumption is
relaxed there are three more sectors introduced.
• The first is the Financial Sector that consists of
banks and non-bank intermediaries who engage
in the borrowing (savings from households) and
lending of money.
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22. The five sector model cont’d
• In terms of the circular flow of income model the
leakage that financial institutions provide in the
economy is the option for households to save
their money.
• This is a leakage because the saved money can
not be spent in the economy and thus is an idle
asset that means not all output will be
purchased.
• The injection that the financial sector provides
into the economy is investment (I) into the
business/firms sector.
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23. The five sector model cont’d
• The next sector introduced into the circular flow
of income is the Government Sector that consists
of the economic activities of local, state and
federal governments.
• The leakage that the Government sector provides
is through the collection of revenue through
Taxes (T) that is provided by households and firms
to the government.
• For this reason they are a leakage because it is a
leakage out of the current income thus reducing
the expenditure on current goods and services.
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24. The five sector model cont’d
• The final sector in the circular flow of income
model is the overseas sector which
transforms the model from a closed
economy to an open economy.
• The main leakage from this sector are
imports (M), which represent spending by
residents into the rest of the world.
• The main injection provided by this sector is
the exports (X) of goods and services which
generate income for the exporters from
overseas residents.
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25. The five sector model cont’d
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26. The five sector model cont’d
• In the five sector model there are three
injections and three withdrawals:
• Injections:
1. Investment (I)
2. Govt expenditure (G)
3. Exports (X)
• Withdrawals:
1. Savings (S)
2. Taxes (T)
3. Imports (M)
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27. The five sector model cont’d
• In the steady state: W = J implying that:
• I+G+X = S+T+M
• The foreign sector introduces those goods and
services into an economy which are not
immediately available in the economy.
• Taxes in international trade include the various
import tariffs and export taxes which may be
levied on goods and services.
• It is important to imagine relationships or
interactions in international trade in terms of net
exports, that is, (X-M or Exports minus Imports).
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28. MARSHTECH DESIGNS 28