Macro Economics Aggregates and Concepts 1
Introduction to MacroEconomics
Introduction Economics is divided into two parts (1) Microeconomics examines the behavior of individual decision-making units business firms and households. (2) Macroeconomics deals with the economy as a whole; it examines the behavior of economic aggregates such as aggregate income, consumption, investment, and the overall level of prices. Aggregate behavior refers to the behavior of all households and firms together. 3
Contd Microeconomists generally conclude that markets work well. Macroeconomists, however, observe that some important prices often seem sticky. Sticky prices are prices that do not always adjust rapidly to maintain the equality between quantity supplied and quantity demanded. 4
Contd Macroeconomists often reflect on the microeconomic principles underlying macroeconomic analysis, or the microeconomic foundations of macroeconomics. 5
Roots of Macroeconomics The Roots of MacroeconomicsThe Great Depression was a period of severe economic contraction and high unemployment that began in 1929 and continued throughout the 1930s. Classical economists applied microeconomic models, or market clearing models, to economy-wide problems. However, simple classical models failed to explain the prolonged existence of high unemployment during the Great Depression. This provided the impetus for the development of 6 macroeconomics.
Circular Flow of Income Production and Consumption is carried out by two different economic identities called households and firms in a modern economy. The households supply factor services namely :land, labour,capital and enterprise to the firms and are paid in return factor rewards in the form of rent,wages,interest and profit. When the household sector receives their payments, they spend it on the goods and services produced by the firms. In this way, the total income generated in an economy flows in a circular manner from the firms to the households and from the households back to the firms. 7
Contd. The circular flow of income shows that national output=national income=national expenditure. National output refer to the real flow of goods and services, National income is the money value of the goods and services produced which is the sum of factor rewards (r+i+w+r) and national expenditure is the disposal of national income for the consumption of goods and services produced. 8
Circular flow of Income in a closed economy Two Sector Model (without savings): A two sector simple economy consists of households and firms. It is thus free from government and the external sector. This model is based on the following assumptions: (1) There are only two sectors, namely :households and firms (2) Households own factor services, namely: land, labor, capital and enterprise and firms use these services. (3) Household sector receive factor rewards in the form of rent, wages, interest and profits. 9
Contd. (4) Both households and firms have zero savings. (5) There is no foreign trade or the government sector. Since there are no savings, the financial sector does not exist. (6) Supply of factor services and the state of technology are given Two Sector Model (with savings)-savings are a leakage from the circular flow of income. It is injected back into the economy in the form of investment. 10
Contd. Three sector model (Firms, Households and Government): Government is introduced in the three sector model. Leakages from and injections into the circular flow of income is also caused by the financial operations of the government. 11
Contd. Circular Flow of Income in an open economy: The Four Sector Model: The circular flow of income in an open economy is economy with international trade.when a country exports, it receives monetary flows from abroad and such flows will be considered as injections into the economy. 12
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