7.1 Macroeconomic Objectives
Economic Growth
Governments try to achieve high rates of growth which can maintained in the long run. Also it is important to achieve stable rates that can be maintained and thus avoid both booms (when the rate is too high) and recessions (when the rate is too low).
Ireland has performed exceptionally well in recent years in what is referred to as the Celtic Tiger.
Unemployment
Governments aim to keep unemployment as low as possible. Unemployment is now quite low in Ireland (about 4.5%) but still very high in the EU (about 9%).
Inflation
Again Governments try to keep the figure low so as to enhance competitiveness. Inflation has been worryingly higher than our neighbours in Ireland in recent years (around 4%).
The Balance of Payments
This relates to trade transactions with other countries. If we export more in value terms than we import, then we have a balance of payments surplus.
The Balance of Payments bears a close relationship to the exchange rate. In general a favourable balance of payments tends to be associated with a strong currency.
Governments can pursue other intermediate objectives in pursuit of the above primary goals. These could include control of interest rates, taxation, money supply and government expenditure.
7.2 The Circular Flow of Income
The Circular Flow of Income provides a simple model of the economy made up of two groups that shows how firms (producers) and households (consumers) are interconnected.
Each group plays two roles.
The firms are the producers of all the goods and services in the economy. However they equally are the employers of all the factors of production (such as labour).
The households are the consumers of all the goods and services. Equally they are the suppliers of the factors of production.
The households receive income (for supply of the factors of production to the firms). In turn they generate expenditure (in payment for goods and services purchased).
Thus there is continual flow of income and expenditure in the economy. The firms keep paying out income; in turn they receive back expenditure (when the goods produced are purchased).
An economy is in equilibrium when
Income = expenditure (or aggregate demand).
If you think about it, you will see that this is quite logical.
Imagine during the year that all the firms in the economy pay out €100 bl. income to household. Now if all this money is disposed of as expenditure then the firms will receive back exactly €100 bl. and be in the position to pay out the same amount in income the following year.
Therefore when Income = Expenditure, the overall level of economic activity remains unchanged.
However in practice there can be withdrawals from and injections into the income-expenditure flow.
The main withdrawals (W) are
Savings (S). A person can opt to save some money (e.g. in a bank) rather than spend it.
Taxation (T). The government can legally take money off citzens thus reducing their capacity to spend.
Imports (M). When we buy imports e.g. a Japanese car the money goes abroad (out of the domestic economy).
Likewise there are 3 corresponding injections (J)
Investment (I). People can borrow money from banks (e.g. for a new house) thus increasing spending power
Government Expenditure (G). Money that is raised in tax revenue is largely on health, education, social welfare etc.
Exports (X). When we export goods e.g. food, additional money comes into economy.
So therefore when we allow for all these withdrawals and injections, equilibrium in economy entails that
W = J
i.e. S + T + M = I + G + X
Imagine a bath that is full of water with the stopper out at the bottom and the tap running.
Now if the amount going out through the bottom (withdrawals) is exactly matched by the amount coming in through the taps (injections), then the bath will remain full with the level of water unchanged.
Likewise with the economy! When withdrawals (money going out) are exactly matched by money coming in (injections), then it remains in equilibrium (i.e. with level of activity unchanged).
However if W > J then the level of economic activity will fall causing recession.
If J > W then the level of activity will rise in money terms causing inflation. It is important to realise that too much money coming into economy will lead to a rise in the general price level. Ultimately this could lead to income falling (as competitiveness with other countries could be eroded).
7.3 Economic growth and the business cycle
Distinction between actual and potential growth
Actual growth is the percentage increase in national output: the rate of growth in actual output.
Potential growth is the rate at which an economy could grow if working at full capacity.
An economy can easily under perform. Thus for example in a recession the actual rate of growth may be well below the potential level.
Short-run concerns in economies tend to be with the actual rate of growth (and the desire to maintain it at a high level).
Long run concerns are more with factors in the economy that can potentially influence the rate of growth.
Economic Growth and the Business Cycle
There are four phases that are identified in terms of the business cycle
1 The upturn
2. The expansion
3. the peaking out
4. The slowdown
In practice this are not fully regular as diagrams would suggest. For example sometimes the expansion phase (boom) might be very short. In other cases the slowdown (recession) might extend over a decade..
Also the severity of a recession could vary significantly from mild to extremely severe.
Fluctuations in output are usually caused in the short-term by variations in the overall level of aggregate demand (i.e. the total expenditure in the economy).
In the long-run changes in the potential of the economy to produce output are more important.
We look at these factors in the next section.
Causes of Potential Growth
1. Increases in quantity of resources
Capital
Output depends on stock of capital invested in economy e.g. roads, factories, machinery, buildings etc.
A major factor in the growth of the Celtic Tiger (1994 - 2001) was a huge increase in multinational investment in Ireland (especially by US firms).
By contrast very poor nations (as in Africa) are unable to set aside sufficient resouces for investment and therefore find it hard to achieve economic growth.
Investment needs to be financed out of savings (or borrowing) and understandably poor countries find it hard to save.Labour
Clearly if the numbers working increases, the level of output should also increase.
This was also a major factor in the boom in the Irish economies in the late 90's. the work force effectively doubled in 10 years enabling a very large increase in output.However as well as the numbers working the quality of labour employed (e.g. in terms of education and skills is very important).
Ireland can no longer compete with lower cost countries (such as in Eastern Europe) in terms of unskilled production. Thus it makes greater sense for us to concentrate on areas for example like information technology.
Land and Raw Materials
Ireland is well endowed with agricultural land (with agriculture and the food industry important sectors of the economy).
We are not well endowed with important raw materials such as oil.However though helpful these are not vital for economic growth (as the success of Japan after the 2nd World War demonstarted).
Enterprise
This is the 4th factor of production. If an economy is to thrive people must be willing to take the risks of business. In the past there was a great lack of an enterprise culture in Ireland which inhibited growth.
This is why we began to rely so much on importing enterprise from abroad through attracting multinational companies through tax breaks and grants.
Increases in Productivity
Changes in technology are very important to prevent the law of diminishing returns setting in with respect to investment.
So for example the rise of computer and internet technology has graetly increased the possibilities for new types of investment thus enhancing growth prospects.
Policies to achieve Growth
The policies of the Government can greatly affect the capacity of an economy to grow.
During the 1980's there was very little growth in teh Irish economy largely because of the past effects of reckless Government borrowing. In recent years the determination of teh Government to reduce income tax has contributed considerably to our growth prospects.
Measurement of National Income
National Income represents the value in money terms of what is produced in an economy on an annual basis. When divided by population to obtain income per capita it provides the conventional measurement of the standard of living. Economic growth then represents the real change in National Income from year to year.
There are three ways of measuring National Income
1. Income Approach
This is the attempt to measure the total amount paid out in income during the year. There are problems with this approach.
For example farming income is difficult to measure accurately. Also activity in the black economy will not be assessed.2. Expenditure Approach
This is the measurement of the total amount spent in an economy during the year. Again there can be problems. Capital expenditure in teh private sector is hard to assess. Also smuggling activity (between countries) would distort figures.
3. Output Approach
This is the measurement of the value added at each stage of production which is measured accurately would also provide a valid measurement of economic activity. However the main difficulty here is the problem of double counting.
There are different National Income concepts.
The one that is officially used in Europe is GDP (Gross Domestic Product) at market prices.
However this is not very valid for Ireland as it does not take account of outflows of money that have been generated in the country (especially the profits of multinational companies).
So a more accurate figure for Ireland is GNP (Gross National Product) at market prices.
Net measurements can also be taken (i.e. that do not include depreciation).
Also measurements can be at market prices (as for expenditure) or factor cost (for income).
An alternative measurement of human welfare is provided through the United Nations Human Development Index (HDI).
This includes three componenets
1. Life Expectancy at birth
2. Education based on literacy levels and years of schooling
3. GDP per capita.
Costs of Economic Growth
The benefits of economic growth are obvious. The standard of living increases with people in general having more money to spend on consumer goods and services. Also it enables the Goverenement to improve services such as health and education and spend more on improving the infrastructure e.g. roads.
However there are costs.
Higher growth in the short run could require more investment thus lessening resources for consumption. This happened in the Soviet Union under Stalin!
Growth can generate extra demands so that people still feel that they have too little.
There may be adverse social effects as people become more materialistic and less caring in society.
There can also be environmental consequences e.g. terrible traffic congestion in major cities.
Valuable resources e.g. oil and gas can be run down and finally the benefits may not be distributed equally.
7.4 Unemployment
Meaning of Unemployment
Employment can be measured in terms of numbers or as a rate (of the the overall labour force.
The labour force - by definition - is made up of those working (i.e. employed) and those not working but wishing to do so (i.e. unemployed).
Measures of Unemployment
Ireland - QHNS (Quarterly Household National Survey)
This is based on a quarterly survey of respondents taken randomly around the country.
The unemployment rate in Ireland on this basis is currently 4.5%.The Live Register (those registered to claim unemployment benefits) is also used.
It gives a much higher figure for unemployment. However it is not relaible as many claiming benefit might not be actually seeking employment.
Types of Unemployment
Real-Wage Unemployment
This arises when market forces are not allowed to operate properly. For example if a trade union insists on keeping wages above the market rate then a surplus of labour (i.e. unemployment) will arise at this wage rate.
Demand-Deficient Unemployment
This is due to a lack of sufficient overall demand in the economy as for example happens during a recession. Economic activity falls off and thus the demand for labour likewise falls.
Frictional Unemployment
This represents a temporary form of unempolyment as workers move between jobs.
It can even be a good sign if it indicates that workers are confident of finding a new job.Structural Unemployment
This represents a specific "structural" problem which requires specific attention
e.g. if unemployment is much higher in certain regions, or for a certain age group, or in a certain industry then special measures will be necessary to address the problem.
Seasonal Unemployment
In certain occupations e.g. tourism employment can vary during the year
7.5 Aggregate Demand and Supply
Level of output and prices in the economy
Just as price and quantity of a product are determined in a single market by supply and demand, in like manner the general price level and national output are determined in the overall economy through the interaction of aggregate supply and aggregate demand.
So for example if teh aggregate demand curve increases (i.e. shifts to the right) there will a higher level of output and the general price level will rise.
7.6 Inflation
Measurement of Inflation
Inflation refers to the overall change in the price level in the economy. It is commonly measured by the Consumer Price Index (CPI) with new figures produced on a monthly basis. The current level of inflation in Ireland is around 3% pa (and presently dropping).
Causes of inflation
Demand-pull inflation
Just as in an individual market (say housing) prices rise when demand is excessive (in relation to supply), likewise for the economy as a whole the price level will rise if demand increases at a faster rate than supply.
For example if demand increases this year by 15% but the supply of goods only goes up by 5%, then clearly people are not going to be able to buy 15% more goods (in real terms). Therefore the price level will go up by the difference (i.e. 10%).
This type of inflation usually occurs when the economy is in a boom and consumer expenditure rises rapidly.Cost-push inflation
Sometimes the price level can rise even when demand in the economy is sluggish. This is due to market imperfections which enables monopoly firms to push up prices (even in the absence of demand).
This can also arise due strong trade unions pushing up wage demands (again the absence of overall growth in the economy).Structural inflation
This can arise due to a shortage of workers in a particular region (or industry). Let’s say par rates for computer personnel rise sharply in Dublin (due to a shortage). Then this could lead to a general rise countrywide (even though a shortage may not exist elsewhere).
Costs of inflation
Some people can lose out badly e.g. those on fixed incomes.
Inflation causes uncertainty and lack of investment
It can lead to undue emphasis on speculative activity (e.g. buying and selling shares)
It can damage competitiveness with other economies