AS Economics Introductory Macroeconomics Sixth Form pre-reading
National income National income (Y) = money value of goods and services produced in an economy over a period of time, usually one year. National income is the main measure of macroeconomic performance the goods and services produced provide economic welfare/satisfy wants, thus dealing with the economic problem of scarcity. Measuring national income in reality is quite difficult so the government uses a series of approximations, the most common of which is: Gross Domestic Product (GDP) = money value of total output produced by factors of production based in the UK over a period of time, usually a year. You will learn other measures of National Income in your classes, but for now learn the definition of GDP. Circular flow of income A simple model of the macroeconomy designed to help economists understand how the level of national income is determined. In its simplest form, there are two groups active in the economy Households = owners of factors of production who supply these factors to the firms so that the firms can produce goods and services. The factors are paid (rent, wages, interest & profit) for their work providing income to the households, which they use to buy goods and services from the firms to satisfy their wants. Firms = organisations (companies, partnerships, etc) that hire the services of factors of production to produce goods and services for sale to the households. The two groups are linked to create a production line of factor inputs and product outputs (dotted lines on diagram). The flow of money that accompanies this production is comprised of household income and expenditure (solid lines on diagram).
rent, wages, interest & profit (Y) (2) land, labour, capital & enterprise HOUSEHOLDS FIRMS goods & services (1) (3) expenditure on goods & services (C) The value of output produced in this economy can be measured in three ways National output = value of goods and services flowing from the firms (measure at point 1) National income = value of rent, wages, interest and profit paid to households (measure at point 2) National expenditure = value of spending by households on goods and services (measure at point 3) The value obtained should be the same for each method so national output = national income = national expenditure This very simple model of the economy will always be in equilibrium with a constant level of national income circulating between the households and firms. To make the model more realistic and useful, it is necessary to introduce injections and leakages, which are accompanied by an increase in the number of active groups in the economy. This will be covered in your classes.
The objectives of macroeconomic policy There are four main objectives of macroeconomic policy Full employment/low unemployment unemployment is a waste of scarce resources so the more people working, the higher the economy s output and the better living standards will be. Stable prices/low inflation inflation generates undesirable effects like a loss of international competitiveness, income redistribution, etc. Low inflation (eg 2.0% pa) is generally felt to be desirable as it promotes economic confidence, without producing the damage associated with high inflation. Economic growth growth generates more output to satisfy more wants to boost welfare, but rapid growth carries possible problems like resource depletion and resource degradation. Balance of payments equilibrium the government aims for the total value of money coming into the economy from things like exports to be at or around the total value of money leaving the economy to pay for imports. A sustained balance of payments deficits (where the cost of imports exceeds the income from exports) need to be avoided to prevent the accumulation of debt to other nations. The country needs to live within its means internationally. Governments have placed different emphasis on these objectives. Keynesians (1950 s and 1960 s) full employment was main objective. Monetarists (1979 2010) stable prices were the main focus. Since 2010 the coalition government has prioritised the reduction in government debt over the four main macroeconomic policy objectives. In addition, because the economy has been in a period of low growth since 2008, most economists would argue that the government is now more concerned about growth than stable prices / inflation. In addition to the above four objectives, governments also strive to improve aspects of the domestic economy, such as labour productivity. Conflicts of policy Policy conflict = when two or more objectives are mutually exclusive. Common policy conflicts Growth and stable prices. When the economy is growing strongly, it is likely that prices will rise.
Full employment and stable prices increasing aggregate demand (the total level of demand for goods and services) in the economy is likely to raise employment, but also prices Balance of payments equilibrium and stable prices reducing the value of our currency will make exports cheaper and therefore raise the level of exports. However, it will also increase import prices, putting pressures on inflation to rise. Policy trade-offs are necessary the government may have to compromise and seek satisfactory performances in the conflicting policy objectives rather than setting out to attain the best possible outcome for one objective. The environment is an additional source of policy conflict eg measures to protect the environment (taxes on fuel, pollution permits, etc) could clash with stable prices and economic growth. Policies to create more fuel efficiency could lead to job losses. Objectives can be complementary eg promoting economic growth should help achieve full employment. Constraints on policy In seeking to achieve its objectives, the government faces various constraints that limit its freedom. They include Limited number of policy instruments there are four main objectives, but only three main policy areas o fiscal policy = the manipulation of government spending and taxes in the budget o monetary policy = setting the base interest rate, and control of the money supply such as through Quantitative Easing o supply side policy = measures to increase efficiency of companies in the economy, by encouraging competitiveness through incentives and de-regulation.