A2 MACROECONOMICS NOTES
Tayyaba Sami Khan
,Contents
CHAPTER 1: CIRCULAR FLOW OF INCOME ........................................................................................ 2
Chapter 2: Money and Banking .................................................................................................................. 67
Chapter 3: Economic Growth and Sustainability ...................................................................................... 105
Chapter 4: Employment/Unemployment .................................................................................................. 117
Chapter 5: Government Macroeconomic intervention .............................................................................. 127
Chapter 6: International Economic Issues ................................................................................................ 140
1|Page
,CHAPTER 1: CIRCULAR FLOW OF INCOME
Governments’ macro economic aims include maintenance of high and stable economic growth, low
unemployment, low inflation, avoidance of balance of payments deficit and exchange rate stability. One
way these four objectives are linked is through their relationship with aggregate expenditure (AE) which
is also called aggregate demand. This is the total spending on goods ans services made within the country
(domestically produced goods and services). This spending consists of four elements:
1- Consumer spending on domestically produced goods [Total consumer spending on all goods (C)
minus spending on imports (m)]
2- Investment expenditure by firms (I)
3- Government spending (G)
4- Expendture by residents abroad on this country’s exports (X)
Therefore:
Since Cd=C-M, we can say that:
To show how the four macroeconomic objectives are related in an economy, we make use of the ciruclar
flow of income. In the diagram 5.1, the economy is divided into two major groups: firms and households.
Each group has two roles. Firms are producers of goods and services, and are also employers of labor and
other factors of production. Households are consumers of goods and services; they are also suppliers of
labor and various other factors of production. In the diagram, there is inner flow and various outer flows
of income between these two groups.
Before we look at the various parts of the diagram, we need to make the distinction between money and
income. Money is a stock concept. At any given time, there is a certain quantity of money in an economy
(for example $1 billion at the beginning of 2018). But national income is a flow concept, therefore is
measured over a period of time.
2|Page
, Figure 5.1:
The inner flow, withdrawals and Injections
The inner flow
Firms pay money to households in form of wages, salaries, dividends on shares, interest and rent. These
payments are in return for the services of factors of production (labor, capital and land) that are supplied
by households. Therefore, on the left hand side of the diagram, money flows directly from firms to
households in form of factor payments.
Households in return pay money to domestic firms when they consume domestically produced goods and
services. This is shown in the right hand side of the inner flow. There is a circular flow of payments from
firms to households to firms and so on.
If households spend all their incomes on buying domestic goods and services, and if firms pay out all this
income they receive as factor payments, money just goes round and round between households and firms
and income remains unchanged.
In the real world, not all the income gets passed on round the inner flow; some is withdrawn. At the same
time, incomes are injected into the flow from outside. Let us examine these withdrawals and injections.
3|Page
Tayyaba Sami Khan
,Contents
CHAPTER 1: CIRCULAR FLOW OF INCOME ........................................................................................ 2
Chapter 2: Money and Banking .................................................................................................................. 67
Chapter 3: Economic Growth and Sustainability ...................................................................................... 105
Chapter 4: Employment/Unemployment .................................................................................................. 117
Chapter 5: Government Macroeconomic intervention .............................................................................. 127
Chapter 6: International Economic Issues ................................................................................................ 140
1|Page
,CHAPTER 1: CIRCULAR FLOW OF INCOME
Governments’ macro economic aims include maintenance of high and stable economic growth, low
unemployment, low inflation, avoidance of balance of payments deficit and exchange rate stability. One
way these four objectives are linked is through their relationship with aggregate expenditure (AE) which
is also called aggregate demand. This is the total spending on goods ans services made within the country
(domestically produced goods and services). This spending consists of four elements:
1- Consumer spending on domestically produced goods [Total consumer spending on all goods (C)
minus spending on imports (m)]
2- Investment expenditure by firms (I)
3- Government spending (G)
4- Expendture by residents abroad on this country’s exports (X)
Therefore:
Since Cd=C-M, we can say that:
To show how the four macroeconomic objectives are related in an economy, we make use of the ciruclar
flow of income. In the diagram 5.1, the economy is divided into two major groups: firms and households.
Each group has two roles. Firms are producers of goods and services, and are also employers of labor and
other factors of production. Households are consumers of goods and services; they are also suppliers of
labor and various other factors of production. In the diagram, there is inner flow and various outer flows
of income between these two groups.
Before we look at the various parts of the diagram, we need to make the distinction between money and
income. Money is a stock concept. At any given time, there is a certain quantity of money in an economy
(for example $1 billion at the beginning of 2018). But national income is a flow concept, therefore is
measured over a period of time.
2|Page
, Figure 5.1:
The inner flow, withdrawals and Injections
The inner flow
Firms pay money to households in form of wages, salaries, dividends on shares, interest and rent. These
payments are in return for the services of factors of production (labor, capital and land) that are supplied
by households. Therefore, on the left hand side of the diagram, money flows directly from firms to
households in form of factor payments.
Households in return pay money to domestic firms when they consume domestically produced goods and
services. This is shown in the right hand side of the inner flow. There is a circular flow of payments from
firms to households to firms and so on.
If households spend all their incomes on buying domestic goods and services, and if firms pay out all this
income they receive as factor payments, money just goes round and round between households and firms
and income remains unchanged.
In the real world, not all the income gets passed on round the inner flow; some is withdrawn. At the same
time, incomes are injected into the flow from outside. Let us examine these withdrawals and injections.
3|Page
