Economics
Chapter 14: The National Economy
14.1 The scope of macroeconomics
MACROECONOMIC D E B AT E S
Economics can take different views on the importance of macroeconomic issues.
It is difficult to forecast what will happen. It is relatively easy to explain things once they have happened.
A crucial element in macroeconomic activity is people’s expectations. If people are optimistic about the
future, consumers may be more inclined to spend and firms more inclined to invest.
THE M A J O R M A C R O E C O N O M I C I SS U E S
Economic growth
Rate of economic growth = The percentage increase in national output, normally expressed over a 12-
month period.
Governments try to achieve high rates of economic growth over the long term – in other words, growth
that is sustained over the years and is not just a temporary phenomenon. To this end, governments
ordinarily try to achieve stable growth, avoiding both recessions and excessive short-term growth that
cannot be sustained.
Unemployment
Reducing unemployment is another major macroeconomic aim of governments, not only for the sake of
the unemployed themselves, but also because it represents a waste of human resources and because
unemployment benefits are a drain on government revenues.
Inflation
By inflation we mean a general rise in prices throughout the economy. Government policy here is to keep
inflation both low and stable. One of the most important reasons for this is that it will aid the process of
economic decision making.
Rate of inflation = The percentage increase in prices over a 12-month period.
The balance of payments and the exchange rate
We are concerned here with a country’s foreign trade and its economic relationships with other countries.
Balance of payments account = A record of the country’s transactions with the rest of the world. It shows
the country’s payments to or deposits in other countries (debits) and its receipts or deposits from other
countries (credits). It also shows the balance between these debits and credits under various headings.
The debit items include all payments to other countries: these include the country’s purchases of imports,
the investments it makes abroad and the interest and dividends paid to people abroad who have invested
in the country. The credit items include all receipts from other countries: these include the sales of
exports, inflows of investment into the country and earnings of interest and dividends from abroad.
The sale of exports and any other receipts earn foreign currency. The purchase of imports or any other
payments abroad requires foreign currency. If we start to spend more foreign currency than we earn, then
the balance of payments will go into deficit. If the government does nothing to correct the balance of
payments deficit, the exchange rate must fall.
Exchange rate = The rate at which one national currency exchanges for another. The rate is expressed as
the amount of one currency that is necessary to purchase one unit of another currency (e.g. €1.2 = £1).
, A falling exchange rate is a problem because it pushes up the price of imports and may fuel inflation. Also,
if the exchange rate fluctuates, this can cause great uncertainty for traders and can damage international
trade and economic growth.
Sector accounts
- Income and expenditure account or profit and loss account = A record of the flows of incomes,
expenditure and saving of an individual or institution.
- Balance sheet = A record of the stock of assets and liabilities of an individual or institution.
o Asset = Possessions of an individual or institution or claims held on others.
o Liability = Claims by others on an individual or institution; debts of that individual or
institution.
There are three key accounts which are compiled for the main sectors of the economy: the household,
corporate and government sectors and the economy as whole.
- First, there is the income account which record the various flows of income alongside the
amounts either spent or saved.
- Second, there is the financial account. The financial balance sheet gives a complete record of the
stocks of financial assets (arising from saving) and financial liabilities (arising from borrowing) of a
sector, and include things such as currency, bank deposits, loans, bonds and shares.
- Third, there is the capital account, which records the stock of non-financial (physical) wealth,
arising from acquiring or disposing of physical assets, such as property and machinery.
The national balance sheet is a measure of the wealth of a country. It can be presented so as to show the
contribution of each sector and/or the composition of wealth. The balance of a sector’s or country’s stock
of both financial and non-financial wealth is referred to as its net worth.
Net worth = The market value of a sector’s stock of financial and non-financial wealth.
Financial stability
A core aim of policy makers is to ensure the stability of the financial system.
A model of the macroeconomy is incomplete if it does not just incorporate financial markets and
institutions but also capture the interaction between the financial system and the macroeconomy.
G OV E R N M E N T MACROECONOMIC POLICY
From the above issues we can identify a series of macroeconomic policy objectives that governments
might typically pursue:
- High and stable economic growth
- Low unemployment
- Low inflation
- The avoidance of balance of payments deficits and excessive exchange rate fluctuations
- The avoidance of excessively financially distresses sectors of the economy, including government
- A stable financial system
These policy objectives may conflict.
Governments are thus often faced with awkward policy choices.
14.2: The circular flow of income
Aggregate demand = Total spending on goods and services produced in the economy. It consists of four
elements: consumer expenditure (C), investment (I), government expenditure (G), and the expenditure on
exports (X), less any expenditure on foreign goods and services (M). Thus AD = C + I + G + X – M or Cd + I +
G + X.
Consumption of domestically produced goods and services (Cd) = The direct flow of money payments
from households to firms.
Chapter 14: The National Economy
14.1 The scope of macroeconomics
MACROECONOMIC D E B AT E S
Economics can take different views on the importance of macroeconomic issues.
It is difficult to forecast what will happen. It is relatively easy to explain things once they have happened.
A crucial element in macroeconomic activity is people’s expectations. If people are optimistic about the
future, consumers may be more inclined to spend and firms more inclined to invest.
THE M A J O R M A C R O E C O N O M I C I SS U E S
Economic growth
Rate of economic growth = The percentage increase in national output, normally expressed over a 12-
month period.
Governments try to achieve high rates of economic growth over the long term – in other words, growth
that is sustained over the years and is not just a temporary phenomenon. To this end, governments
ordinarily try to achieve stable growth, avoiding both recessions and excessive short-term growth that
cannot be sustained.
Unemployment
Reducing unemployment is another major macroeconomic aim of governments, not only for the sake of
the unemployed themselves, but also because it represents a waste of human resources and because
unemployment benefits are a drain on government revenues.
Inflation
By inflation we mean a general rise in prices throughout the economy. Government policy here is to keep
inflation both low and stable. One of the most important reasons for this is that it will aid the process of
economic decision making.
Rate of inflation = The percentage increase in prices over a 12-month period.
The balance of payments and the exchange rate
We are concerned here with a country’s foreign trade and its economic relationships with other countries.
Balance of payments account = A record of the country’s transactions with the rest of the world. It shows
the country’s payments to or deposits in other countries (debits) and its receipts or deposits from other
countries (credits). It also shows the balance between these debits and credits under various headings.
The debit items include all payments to other countries: these include the country’s purchases of imports,
the investments it makes abroad and the interest and dividends paid to people abroad who have invested
in the country. The credit items include all receipts from other countries: these include the sales of
exports, inflows of investment into the country and earnings of interest and dividends from abroad.
The sale of exports and any other receipts earn foreign currency. The purchase of imports or any other
payments abroad requires foreign currency. If we start to spend more foreign currency than we earn, then
the balance of payments will go into deficit. If the government does nothing to correct the balance of
payments deficit, the exchange rate must fall.
Exchange rate = The rate at which one national currency exchanges for another. The rate is expressed as
the amount of one currency that is necessary to purchase one unit of another currency (e.g. €1.2 = £1).
, A falling exchange rate is a problem because it pushes up the price of imports and may fuel inflation. Also,
if the exchange rate fluctuates, this can cause great uncertainty for traders and can damage international
trade and economic growth.
Sector accounts
- Income and expenditure account or profit and loss account = A record of the flows of incomes,
expenditure and saving of an individual or institution.
- Balance sheet = A record of the stock of assets and liabilities of an individual or institution.
o Asset = Possessions of an individual or institution or claims held on others.
o Liability = Claims by others on an individual or institution; debts of that individual or
institution.
There are three key accounts which are compiled for the main sectors of the economy: the household,
corporate and government sectors and the economy as whole.
- First, there is the income account which record the various flows of income alongside the
amounts either spent or saved.
- Second, there is the financial account. The financial balance sheet gives a complete record of the
stocks of financial assets (arising from saving) and financial liabilities (arising from borrowing) of a
sector, and include things such as currency, bank deposits, loans, bonds and shares.
- Third, there is the capital account, which records the stock of non-financial (physical) wealth,
arising from acquiring or disposing of physical assets, such as property and machinery.
The national balance sheet is a measure of the wealth of a country. It can be presented so as to show the
contribution of each sector and/or the composition of wealth. The balance of a sector’s or country’s stock
of both financial and non-financial wealth is referred to as its net worth.
Net worth = The market value of a sector’s stock of financial and non-financial wealth.
Financial stability
A core aim of policy makers is to ensure the stability of the financial system.
A model of the macroeconomy is incomplete if it does not just incorporate financial markets and
institutions but also capture the interaction between the financial system and the macroeconomy.
G OV E R N M E N T MACROECONOMIC POLICY
From the above issues we can identify a series of macroeconomic policy objectives that governments
might typically pursue:
- High and stable economic growth
- Low unemployment
- Low inflation
- The avoidance of balance of payments deficits and excessive exchange rate fluctuations
- The avoidance of excessively financially distresses sectors of the economy, including government
- A stable financial system
These policy objectives may conflict.
Governments are thus often faced with awkward policy choices.
14.2: The circular flow of income
Aggregate demand = Total spending on goods and services produced in the economy. It consists of four
elements: consumer expenditure (C), investment (I), government expenditure (G), and the expenditure on
exports (X), less any expenditure on foreign goods and services (M). Thus AD = C + I + G + X – M or Cd + I +
G + X.
Consumption of domestically produced goods and services (Cd) = The direct flow of money payments
from households to firms.
