Macroeconomics Review: Mr. Remigio G. Tiambeng

MACROECONOMICS REVIEW MR. REMIGIO G. TIAMBENG

MACROECONOMICS  the study economic aggregates and an overview of the economy. FOCUS: • Economic Growth and GDP • Unemployment, Inflation, and the Government • The Circular Flow Model • National Income Accounting • Business Cycles • Keynesian (Fiscal) Economics

THE CIRCULAR FLOW MODEL Also called as: The circular flow of goods and services The circular flow of economic activity

“What comes around goes around” Example: Juan spends (purchased) a final good P10,000 the market value is P10,000 the income to the factors is P10,000.

FISCAL AND MONETARY POLICIES Monetary policy and Fiscal policy refer to the two most widely recognized "tools" used to influence a nation's economic activity. Monetary policy is primarily concerned with the management of interest rates and the total supply of money in circulation and is generally carried out by central banks such as the Bangko Sentral ng Pilipinas. Fiscal policy is the collective term for the taxing and spending actions of governments. Here in the Philippines, the national fiscal policy is determined by the Executive and Legislative Branches.

Types of Fiscal Policy 1. Expansionary Fiscal Policy -> involves decreasing taxes, increasing government expenditures or both in order to fight recessionary pressures. A decrease in taxes means that households have more disposal income to spend. Higher disposal income increases consumption which increases GDP. 2. Contractionary Fiscal Policy -> involves increasing taxes, decreasing government expenditures or both in order to fight inflationary pressures. Due to an increase in taxes, households have less disposal income to spend. Lower disposal income decreases consumption.

Purpose EFP: • The purpose of expansionary fiscal policy is to boost growth to a healthy economic level. • This is needed during the contractionary phase of the business cycle. The government wants to reduce unemployment, increase consumer demand and avoid a recession. If a recession has already occurred, then it seeks to end the recession and prevent a depression.

How It Works: • Expansionary fiscal policy expands the amount of money in an economy. It puts more money into consumers' hands to give them more purchasing power. It uses subsidies, transfers payments including welfare programs, and income tax cuts. It reduces unemployment by contracting public works or hiring new government workers. All these measures increase demand. That spurs consumer spending, which drives almost seventy percent of the economy. The other three components of gross domestic product are government spending, net exports and business investment. • Corporate tax cuts put more money into businesses' hands. They use it for new investment and employees.

Contractionary fiscal policy is a form of fiscal policy that involves increasing taxes, decreasing government expenditures or both in order to fight inflationary pressures. Due to an increase in taxes, households have less disposal income to spend. Lower disposal income decreases consumption.

Purpose • The purpose of contractionary fiscal policy is to slow growth to a healthy economic level. That's between 2 percent to 3 percent a year. An economy that grows more than 3 percent creates four negative consequences. • It creates inflation. That's when prices rise too fast in clothing, food and other necessities. Higher prices quickly gobble up savings and destroy the standard of living. • It drives up prices in investments. That's called an asset bubble. It's happened in stocks, gold and oil. An example of its devastating effects is the 2006 housing bubble. By 2005, the cost of housing became unaffordable for most families. Banks lowered their terms to entice subprime borrowers, creating a crisis in 2008. • It's unsustainable. Growth at 4 percent or more leads to a recession. That especially occurs with asset bubbles. For more, see Business Cycle. • It lowers unemployment to below the natural rate of unemployment. Employers struggle to find enough workers to meet market demand. That slows growth from the production side.

How It Works • When governments cut spending or increase taxes, it takes money out of consumers' hands. • That also happens when the government cuts subsidies, transfer payments including welfare programs, contracts for public works or the number of government employees. • Shrinking the money supply decreases demand. It gives consumers less purchasing power. That reduces business profit, forcing companies to cut employment.

BUSINESS CYCLE The upward and downward movements of levels of GDP (gross domestic product) and refers to the period of expansions and contractions in the level of economic activities (business fluctuations) around a long-term growth trend .

BUSINESS/ECONOMIC CYCLE

PHASES OF BUSINESS CYCLE 1. In the expansion phase, there is an increase in various economic factors, such as production, employment, output, wages, profits, demand and supply of products, and sales. 2. In peak phase, the economic factors, such as production, profit, sales, and employment, are higher, but do not increase further. 3. In recession phase, all the economic factors, such as production, prices, saving and investment, starts decreasing. 4. During the trough phase, the economic activities of a country decline below the normal level. In this phase, the growth rate of an economy becomes negative. In addition, in trough phase, there is a rapid decline in national income and expenditure. 5. In recovery phase, consumers increase their rate of consumption, as they assume that there would be no further reduction in the prices of products. As a result, the demand for consumer products increases.

The business cycle goes through 4 phases: Economic Expansion: Real GDP is increasing Economic Contraction: Real GDP is declining Peak: The economy reverses from expansion to contraction Trough: The economy reverses from contraction to expansion

Economic Recession: When the economy is in a downturn for at least six months. Growth rate is negative, unemployment increases, and price level is most likely to rise. Economic Depression: A prolonged recession declared when the unemployment rate is 12% or more.

NATIONAL INCOME ACCOUNTING • National income accounting is a bookkeeping system that a national government uses to measure the level of the country's economic activity in a given time period. National income accounting provides the statistics to determine if the economy is encountering difficulties. • GROSS NATIONAL PRODUCT. The gross national product is the sum total of all final goods and services produced by the people of one country in one year. • Gross domestic product (GDP) is the total value of output in an economy and is used to measure change in economic activity. GDP includes the output of foreign owned businesses that are located in a country following foreign direct investment.

Three Approaches to Measuring GDP EXPENDITURE APPROACH = PRODUCT APPROACH = INCOME APPROACH

1. EXPENDITURE APPROACH -> It measures the total amount spent on the goods produced by a country in a year.

GDP = C + I + G + (X-M) • C= Private Consumption Expenditures • I= Investment Expenditures • G= Government Consumption Expenditures and Investments • X= Value of Exports • M= Value of Imports

2. INCOME APPROACH It measures the total incomes earned by households in a nation in a year. GDP = W + R + I + BP + IBT + SA + d + F • W= Wages, Salaries, Benefits, Pensions, and SSS Contributions • R= Rental Income • I= Interest Income • BP= Business Profits (of business owners) – P, P, C • IBT= Indirect Business Taxes (sales tax, business property tax, license fees) • d= Depreciation (this is the decrease in value of goods) • F= Foreign Income(To calculate this, take the total payments received by domestic citizens from foreign entities and subtract the total payments sent to foreign entities for domestic production.)

3. PRODUCTION APPROACH It sums up the market value of the total production of all the major economic sectors of the country. GDP = AS + IS + SS • AS= Agricultural Sector (fishery, forestry, piggery, poultry, etc.) • IS= Industrial Sector (manufacturing and production) • SS = Service Sector

UNEMPLOYMENT Represents the number of people in the labor force who want to work but do not have a job. It is generally stated as a percentage and calculated by dividing the number of people who are unemployed by the total work force. The formula for calculating the labor force participation rate is pretty straightforward:

LFPR = LF / P where: • P = total eligible population (both the economically inactive and active populations) • LF = labor force The labor force is made up of those people who want to work; it excludes people who are retired, disabled, and able to work but not currently looking for a position; for instance, they may be taking care of children or going to college.

Causes of Unemployment • The government defines those who want to work as people who have actively looked for work within the past four weeks and determines the number of people currently unemployed through a monthly survey called the Current Population Survey. • People can be unemployed for many reasons: • They quit their position and are looking for a new one. • They were laid off due to lack of work and haven't yet been rehired. • Their company reduced the work force, and they are seeking a new position. This can be due to a local condition, when the company closes a plant or division, or a national condition, when the economy slows and many companies reduce their work force. • They have recently returned to the work force - perhaps from pregnancy or attending school - and haven't yet located a position. • The need for their skill set has gone down, and there are limited positions available, which may lead to unemployment until they train for a new position. • Technology has reduced the need for their type of position.

Three Types of Unemployment 1. Cyclical Unemployment -> a factor of overall unemployment that relates to the cyclical trends in growth and production that occur within the business cycle. When business cycles are at their peak, cyclical unemployment will be low because total economic output is being maximized. 2. Structural Unemployment -> caused by a mismatch between the skills that workers in the economy can offer, and the skills demanded of workers by employers (also known as the skills gap). It is often brought about by technological changes that make the job skills of many of today's workers obsolete. 3. Frictional Unemployment -> exists in any economy due to people being in the process of moving from one job to another.

INFLATION The rate at which the general level of prices for goods and services is rising and, consequently, the purchasing power of currency is falling.