Economics for business (third
edition) – Begg and Ward
Economics II – summary
Chapter 9 – Introduction to the macroeconomy
9.1 Business problem: business cycles and economic uncertainty
- Process of buying a new house and buying a new production facility the same
- Two issues: How much should you offer for the new house and how much can you afford to
borrow?
- Business cycle will affect the success of the investment
- Business cycle = the background to the business investment decision is a recognition of the
business cycle, where, over time, any economy can grow at a faster rate, a so-called
‘economic boom’, and then move into a period of slower growth, an ‘economic recession’
- Box 9.1: collapse of the service and manufacturing sectors in many leading EU economies, by
cuts in consumption, leading to a reduction in exports, factors: levels of debt and fears of
unemployment, can be balanced by increased government spending and cuts in interest
rates making the debt repayments more affordable
- Therefore, business problems are: business cycles (variations in economic activity), economic
uncertainty and problems relating to business confidence, investment and product planning
9.2 Macroeconomic issues
Key Macroeconomic outputs
- GDP = gross domestic product, a measure of the total output produced by an economy in a
given year
- Inflation = is the rate of change in the average price level. Inflation of 2 per cent indicates
that prices have risen by 2 per cent during the previous 12 months
- Unemployment = is the number of individuals seeking work that do not currently have a job
- Current account = the difference between exported and imported goods and services
- For an economy to be functioning well, each of these outputs needs to be controlled and
managed, with governments targeting higher economic growth, improved price stability, low
unemployment and growing, but balanced, international trade
Key macroeconomic inputs
- Key policy inputs controlled by government or the central bank are:
- Interest rates = are the price of money and are set by the central bank
1
, - Government deficit = is the difference between government spending and tax receipts. Just
as students run up overdrafts, spending more than they earn, so too does the government
- Governments look at the outputs of the economy and examine the performance of the
economy; if they don’t like it, they change the inputs
The circular flow of income
- Circular flow of income = shows the flow of inputs, outputs and payments between
households and firms within an economy
2
, - Households are assumed to own the factors of production – land, labour, capital and
enterprise
- Firms need to use the factors of production -> financial reward for using them, e.g. labour ->
wages
- Households use this money to buy the finished goods and services (returning cash to firms)
- The inner loop captures the flow of resources
- The outer loop captures the corresponding financial flows
- The faster the flow the higher the level of economic output
- The level of income activity within an economy is measured as GDP
Leakages and injections
- Broaden the circular flow to take account of saving by households, investment by firms,
government spending and taxation, and international trade
- Leakage = from the circular flow is income not spent on goods and services within the
economy. Leakages can be savings, taxation and imports
- Injection = into the circular flow is additional spending on goods and services that does not
come from the income earned by households in the inner loop. Injections can be investment,
government spending and exports
Savings and investments
- Savings are taken from the circular flow and represent a leakage
- Investments are an injection of financial resources
- In equilibrium, savings will equal investments, because banks will set an interest rate where
the supply of funds from savers equals the demand for funds by investing firms
Taxes and government spending
- Represents a leakage from the circular flow as they reduce the ability of households to spend
on goods and services
- Government undertakes also a number of injections, e.g. buying hospitals and schools,
employing nurses and teachers, paying social benefits to the needy
Exports and imports
- Import (buying car of another economy) represents a leakage
3
, - Export (if anyone buys cars from your economy) represents an injection
Total expenditure
- Total expenditure = is equal to consumption, plus investment, plus government spending,
plus net exports (exports minus imports) -> is simply all the separate sources of spending
within the economy
- Components of total expenditure provide an understanding of which expenditures lead to an
increase or decrease in economic activity
- Increasing expenditure -> flow of inner loop increases to match increased demand
9. 4 National income determination and business cycles
- Total expenditure is in fact aggregate demand = is the total demand in the economy
- Relationship between aggregate demand and the change in the price level
- Aggregate demand is calculated by adding up all demand changes in the economy, the price
level is calculated by adding all price changes together -> a basket of commonly purchased
goods and services is defined
- Price level = is the average change in the price of goods and services in an economy. The
change in the average price level is a measure of inflation, where 5 per cent inflation means
that prices on average have change, i.e. increased, by 5 per cent
- Inflation a key aspect of modern macroeconomic policy
Aggregate demand and inflation
- Relationship between aggregate demand an inflation also negative
- The higher the rate of inflation, the higher the central bank has to raise interest rates in
order to stem (eindämmen) inflation; as interest rates increase, consumers and firms are less
4
edition) – Begg and Ward
Economics II – summary
Chapter 9 – Introduction to the macroeconomy
9.1 Business problem: business cycles and economic uncertainty
- Process of buying a new house and buying a new production facility the same
- Two issues: How much should you offer for the new house and how much can you afford to
borrow?
- Business cycle will affect the success of the investment
- Business cycle = the background to the business investment decision is a recognition of the
business cycle, where, over time, any economy can grow at a faster rate, a so-called
‘economic boom’, and then move into a period of slower growth, an ‘economic recession’
- Box 9.1: collapse of the service and manufacturing sectors in many leading EU economies, by
cuts in consumption, leading to a reduction in exports, factors: levels of debt and fears of
unemployment, can be balanced by increased government spending and cuts in interest
rates making the debt repayments more affordable
- Therefore, business problems are: business cycles (variations in economic activity), economic
uncertainty and problems relating to business confidence, investment and product planning
9.2 Macroeconomic issues
Key Macroeconomic outputs
- GDP = gross domestic product, a measure of the total output produced by an economy in a
given year
- Inflation = is the rate of change in the average price level. Inflation of 2 per cent indicates
that prices have risen by 2 per cent during the previous 12 months
- Unemployment = is the number of individuals seeking work that do not currently have a job
- Current account = the difference between exported and imported goods and services
- For an economy to be functioning well, each of these outputs needs to be controlled and
managed, with governments targeting higher economic growth, improved price stability, low
unemployment and growing, but balanced, international trade
Key macroeconomic inputs
- Key policy inputs controlled by government or the central bank are:
- Interest rates = are the price of money and are set by the central bank
1
, - Government deficit = is the difference between government spending and tax receipts. Just
as students run up overdrafts, spending more than they earn, so too does the government
- Governments look at the outputs of the economy and examine the performance of the
economy; if they don’t like it, they change the inputs
The circular flow of income
- Circular flow of income = shows the flow of inputs, outputs and payments between
households and firms within an economy
2
, - Households are assumed to own the factors of production – land, labour, capital and
enterprise
- Firms need to use the factors of production -> financial reward for using them, e.g. labour ->
wages
- Households use this money to buy the finished goods and services (returning cash to firms)
- The inner loop captures the flow of resources
- The outer loop captures the corresponding financial flows
- The faster the flow the higher the level of economic output
- The level of income activity within an economy is measured as GDP
Leakages and injections
- Broaden the circular flow to take account of saving by households, investment by firms,
government spending and taxation, and international trade
- Leakage = from the circular flow is income not spent on goods and services within the
economy. Leakages can be savings, taxation and imports
- Injection = into the circular flow is additional spending on goods and services that does not
come from the income earned by households in the inner loop. Injections can be investment,
government spending and exports
Savings and investments
- Savings are taken from the circular flow and represent a leakage
- Investments are an injection of financial resources
- In equilibrium, savings will equal investments, because banks will set an interest rate where
the supply of funds from savers equals the demand for funds by investing firms
Taxes and government spending
- Represents a leakage from the circular flow as they reduce the ability of households to spend
on goods and services
- Government undertakes also a number of injections, e.g. buying hospitals and schools,
employing nurses and teachers, paying social benefits to the needy
Exports and imports
- Import (buying car of another economy) represents a leakage
3
, - Export (if anyone buys cars from your economy) represents an injection
Total expenditure
- Total expenditure = is equal to consumption, plus investment, plus government spending,
plus net exports (exports minus imports) -> is simply all the separate sources of spending
within the economy
- Components of total expenditure provide an understanding of which expenditures lead to an
increase or decrease in economic activity
- Increasing expenditure -> flow of inner loop increases to match increased demand
9. 4 National income determination and business cycles
- Total expenditure is in fact aggregate demand = is the total demand in the economy
- Relationship between aggregate demand and the change in the price level
- Aggregate demand is calculated by adding up all demand changes in the economy, the price
level is calculated by adding all price changes together -> a basket of commonly purchased
goods and services is defined
- Price level = is the average change in the price of goods and services in an economy. The
change in the average price level is a measure of inflation, where 5 per cent inflation means
that prices on average have change, i.e. increased, by 5 per cent
- Inflation a key aspect of modern macroeconomic policy
Aggregate demand and inflation
- Relationship between aggregate demand an inflation also negative
- The higher the rate of inflation, the higher the central bank has to raise interest rates in
order to stem (eindämmen) inflation; as interest rates increase, consumers and firms are less
4
