How Macroeconomics differ from Microeconomics

how macroeconomics is related to microeconomics.what are macroeconomics objectives and what are macroeconomics policies pdf free download
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CharlieNixon,United Kingdom,Researcher
Published Date:13-07-2017
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Introduction to Macroeconomics Lecture Notes Robert M. Kunst March 20061 Macroeconomics Macroeconomics (Greek makro = ‘big’) describes and explains economic processes that concern aggregates. An aggregate is a multitude of economic subjects that share some common features. By contrast, microeconomics treats economic processes that concern individuals. Example: Thedecisionofafirmtopurchaseanewofficechairfromcom- pany X is not a macroeconomic problem. The reaction of Austrian house- holds to an increased rate of capital taxation is a macroeconomic problem. Why macroeconomics and not only microeconomics? The whole is more complex than the sum of independent parts. It is not possible to de- scribe an economy by forming models for all firms and persons and all their cross-effects. Macroeconomics investigates aggregate behavior by imposing simplifying assumptions (“assume there are many identical firms that pro- duce the same good”) but without abstracting from the essential features. These assumptions are used in order to build macroeconomic models.Typi- cally, such models have three aspects: the ‘story’, the mathematical model, and a graphical representation. Macroeconomics is ‘non-experimental’: like, e.g., history, macro- economics cannot conduct controlled scientific experiments (people would complain about such experiments, and with a good reason) and focuses on pure observation. Because historical episodes allow diverse interpretations, many conclusions of macroeconomics are not coercive. Classical motivation of macroeconomics: politicians should be ad- vised how to control the economy, such that specified targets can be met optimally. policy targets: traditionally, the ‘magical pentagon’ of good economic growth,stableprices,fullemployment,externalequilibrium,justdistribution 1of income; according to the EMU criteria, focus on inflation (around 2%), public debt, and a balanced budget; according toBlanchard,focusonlow unemployment (around 5%), good economic growth, and inflation (0—3%). Inallspecifications,aimismeetingseveralconflictingtargetssimultaneously. Examplesforfurthertypicalquestionstomacroeconomics:what causes business cycles (episodes of stronger and weaker economic growth)? cananincreaseinthemonetarysupplybythecentralbankcauserealeffects? what is responsible for long-run economic growth? should the exchange rate ofacurrencybekeptata fixed level? can one decrease unemployment, if one accepts an increase in inflation? A survey of world economics: three large economic blocks (Eu- rope, USA+Canada, Japan+Far East) with different problems, the remain- der mostly developing countries. 1. USA:goodgrowth,lowinflation, tolerable unemployment rate, per- sistent external deficit, increasing income inequality. 2. EU:moderategrowth,lowinflation, in some countries high unem- ployment, inconspicuous external balance (total EU active, in Austria recently turned active), for some countries large public debt, currently important unification process, convergence and heterogeneity of indi- vidual countries. ‘Richest’ EU countries Luxembourg, Denmark, then ‘mid-field’ with Austria, IRL, B, NL, UK, D, F, FIN, I, S; slightly be- low E, GR, SLO, P. Last come most ‘new’ (2004 accession) countries (from Malta down to Latvia). Very ‘rich’ non-EU countries Norway, Iceland, and Switzerland. 3. Japan: recently weak growth, large external surplus, deflationary ten- dencies. 22SystemofNationalAccounts Basic idea (not the definition): Summary of all economic activities within a country’s territory and within a given time range (e.g., a year or quarter) yields thegross domestic product (GDP). The value of all goods andser- vicesisdeterminedatmarketprices(finalprices,purchasers’ prices). System for compilation of data and bookkeeping of all positions is called the System of National Accounts (SNA). In Europe, compilation of the SNA conforms to the ESA (European System of Accounts)standard. Economic activity is mainly measured by transactions. Phrases from text books: diversification of labor (not complete self-subsistence) causes transactions, exchange of money for goods or services, exchange of an asset orliabilityforadifferentassetorliability,etc. Thetransactionstakeplaceon markets. Money makes transactions easier than direct exchange of goods for goods, which may require ‘double coincidence’ (hungry tailor meets freezing baker). Purpose of money: apart from payment and storage of value primarily unit of measurement (numeraire). In economic text books, usually dollar (), monetary unit (MU), or euro. gross: many activities serve to repair or replace worn or damaged ma- chines and objects (‘depreciation’), therefore it is not the total GDP that contributes to the accumulation of aggregate wealth. In the SNA, ‘gross’ usually means ‘inclusive of depreciation’, ‘net’ often contains taxes, though no depreciation. Consumption of fixed capital (in economics, depreciation)ofSNAisthe estimatedwearandtearofproducedmeansofproduction(this‘depreciation’ should not be confused with positions in tax declarations or with changes in the currency exchange rate). 3Capital stock is the stock of fixed capital (machines, buildings, ...) in enterprisesandinthegeneralgovernmentsector. Thismustbedistinguished carefully from the informal usage of the word ‘capital’ as ‘money, liquid wealth’. By definition, capital contains all produced means of production. The separation of capital such as machinery from intermediate consumption such as raw materials can be difficult. economic activities: only market activities can be fully accounted for. Therefore, privateexchangeanddomesticservicespassbyunnoticed. Byde- finition, however, legitimacy of a transaction should not play a role. There- fore, the shadow economy (moonlighting) and illegal drug production are part of the GDP, but such activities are difficult to measure. A consequence of this measurement problem is an exaggerated wedge between developing countries andOECDcountries (withthe per capita GDPof Angola you can- notsurviveinAustria). Interestfocusesontransactions–bilateral(requited) transactions (purchase etc.) and unilateral (unrequited) transactions (trans- fers)–while value changes of existing objects are not accounted fully. value added:definitionofGDPasthesumofvaluesaddedintheproduc- tion process (ore→ metal→ screw→ motor part→ video recorder) avoids multiple counts. Problems in the valuation of public services. market prices: in principle, all goods and services are valued at market prices, that is, inclusive of all taxes. If data is collected at the net value (without taxes), taxes must be added. economic agents: Resident ‘institutional units’ are classified with regard to their distinctive characteristics. Types of institutional units are: pri- vate households, general government, financial and non-financial corpora- tions (comprises most so called firms or enterprises), non-profit institutions servinghouseholds. Foreign(non-resident) units are summarized as the ‘rest 4of the world’, provided there are transactions with resident units. The same personcanbepartofaprivatehouseholdandofanenterprise(rentsoutan apartment, or even only uses his/her own condo but is assumed to rent it out to him/herself). resident is an institutional unit that is situated on a country’s territory. Citizenship is not the criterion for residence. However, foreign students or short-term foreign workers are not viewed as resident. private households: produce and invest relatively little, consume, obtain wage and profit income from corporations and from the government. As self-employed persons, they obtain ‘mixed income’, though the separation of households fromcorporations is occasionallydifficult. Small(non-corporate) firms and farms are counted as private households. general government (‘public sector’): receives taxes from enterprises and from private households, provides public goods (‘consumes them by itself’ according to SNA), no intention of profit. corporations: produce and invest, do not consume, intention of profit. Corporations, not the government sector, comprise also firms in public prop- erty, if they cover 50% of their costs from sales. Because depreciation is now called ‘consumption of fixed capital’, it represents a kind of consumption of corporations. Corporationsareeitherfinancial (banksetc.) ornon-financial. non-profit institutions serving households (NPIsH): institutions (such as schools, churches) that cover less than 50% of their production costs from sales; idea: no intention of profit. A small sector, for simplification often added to households. rest of the world: consumes goods and services produced by residents (exports) and produces goods and services consumed by residents (imports). imports of services: includes travels abroad by residents 5exports of services: includes consumption of foreign tourists on the terri- tory of the economy (imputed based on valuta purchases etc.) sectors: the activities of individuals of a similar kind are added up (ag- gregated). The aggregate of all households forms the household sector etc., whereby transactions within the sector disappear. This ‘consolidation’ elim- inates the exchange between households, as it does not increase collective wealth. Recorded are the production of capital within the firms, the pro- duction by private households, public consumption, which by definition is produced and consumed by the general government itself. ex post: SNA records only after the economic processes have already occurred,thereforeonlylimitedvalidityfortheassessmentoffuture reactions in the economy. ex ante would be a task for economic theory. flows andstocks: SNAmainlyrecordsflowsofgoodsandserviceswithina timeperiod(forexample,theconsumptionofAustrianhouseholdsinthefirst half-year of 1996). Sometimes, also stocks are of interest (wealth, number of unemployed persons, central bank money, capital stock on July 31, 1996) at a fixed time point. Changes of stocks are flows (bath tub: water level at timepoint1=waterlevelattimepoint0+inflow — outflow; inflow and outflow are flows;waterlevelisa stock) stocks: also short for ‘common stocks’ (shares) and occasionally for ‘in- ventories’ (beware of the possibility of confusion) 2.1 Matrix of transactions between sectors ThenewSNAconventionaffectsthistraditionalpresentation(followingHas- linger), though it remains instructive and valid in principle. The NPIsH sectorisomittedhere,anartificialsector‘valuechanges’completesthetrans- action matrix. 6Diagramofmonetaryflows(payments)fromtherowsectorstothecolumn sectors, grossly simplified, goods flows partly in the opposite direction: non- value → firms government households residents changes firms T +T W +Π ImΠ dir,F ind F d und,net H government subv+I C W +tr S P P P P households C T S dir,H H non-residents X Im−X value changes I I F,net P,net names (notation as used in economics, not necessarily in SNA): C...(private) consumption of households C ...public consumption P I ...investment of corporations (enterprises, firms) F I ...investment of general government (public investment) P (‘investment’ always concerns means of production, not purchases of as- sets) I ...investment without depreciation (wear and tear of the capital net stock) W ...wage payments of firms to households F W ...wage payments in the public sector P H tr ...transfers to households (pensions, benefits, superscript indicates direction ‘to households’; ‘transfers’=unilateral transactions without coun- terpart) S ,S ...saving (public sector often negative) H P subv....subsidies to enterprises T...taxes etc. T ...indirect taxes are deductions before the calculation of income ind 7(mainly value added tax) including customs, officially production taxes. T ...directtaxesaredeductionsfromearnedincome(wagetax, income dir tax etc.), including contributions to social security Π ...undistributed profits und Π ...distributed profits (dividends etc.) d X...exports Im...imports Economic circuit:rowsums=columnsums(inflow=outflow), nothing is lost, often graphical presentation with arrows. (metaphorical analogy wa- ter: sectorAtmospherewithinputevaporationandoutputrain,sectorConti- nents with input rain and output evaporation frominland water and outflow at estuaries, sector Oceans with input at estuaries and output evaporation from seas; earth is a closed circuit, amount of water is globally preserved) openandclosedcircuit: without value changes, the economic circuit is open, for example atX Im more payments would flow to Austria than fromAustriatonon-residents. Thehypotheticalvaluechangessector(global bank?) loses X−Im and closes the circuit. 2.2 Accounts of the SNA The new SNA consists of a sequence of several accounts, in which many single positions are recorded, while others result as balancing items (bold typeintheaccounts). Theseaccountsarecalculatedforall sectors(financial and non-financial corporations, public households, private households and NPIsH, rest of the world) and for the total economy. 82.2.1 Sectorial accounting The accounts that are decomposed according to sectors (financial and non- financialcorporations,publichouseholds,privatehouseholdsandNPIsH)are primarily income accounts, which focus on the contributions of individual sectors to national income. Point of departure is the production account. Gross output (allproductionat basic prices,i.e. withoutvalueaddedtaxand customs) is booked on the credit side of this account. To this correspond, as uses, the intermediate consumption and the depreciation (consumption of fixedcapital). Thebalancingitemisnetvalueadded.Thecolumns‘resources’ and ‘uses’ correspond to the bookkeeping terms ‘credit’ and ‘debit’. Uses Resources intermediate consumption gross output depreciation net value added In the generation of income account, the balancing item of the production account is transferred to the Resources. From the net value added, salaries and wages (workers’ compensation) and some (so called ‘other’) production taxes (e.g. payroll tax) are paid. The position ‘other subsidies received’ represents negative taxes, only the difference is of concern. The balancing itemofthisaccountiscalled‘operatingsurplusandmixedincome’,wherethe households and NPIsH earn mixed income, while the firms and government 9receive an operating surplus: Uses Resources wages paid net value added other taxes on production paid — other subsidies received operating surplus, net mixed income, net In the account of primary income allocation, the generation of income is turned on its head. It yields, as a balancing item, the income of the sector. For the total economy, the net value is slightly modified relative to the sum of single sectors, as primary income may also cross borders and also because of the hypothetical position ‘financial services indirectly measured’ (FISIM). Therelativecontributionsbythepositionsdifferwidelyacrosssectors. Thus, onlythegeneralgovernmentreceivesproductiontaxes,whileonlyhouseholds receive wages. The meaning of a primary income is that it is generated completely in the production process. By contrast, the secondary income is incomeafteritsredistributionthroughunilateraltransfers. Correspondingly, production taxes (indirect taxes) show up in the primary account, but not the ‘direct’ taxes. Uses Resources property income paid operating surplus, net mixed income, net wages received production taxes received — subsidies paid property income received primary income, net FISIM 10In the account of secondary income distribution, fiscal authorities show their power. Neither corporations nor private households receive direct taxes, while other transfers re-distribute income flows among all sectors. As a bal- ancing item, this account yields the so called disposable income, i.e. the amount of income that is actually disposable for the sector’s expenditures (or to the economy’s expenditures for the aggregate account) Uses Resources currenttaxesonincomeandwealth primary income, net paid currenttaxesonincomeandwealth social contributions paid received monetary social benefits paid social contributions received other current transfers paid monetary social benefits received disposable income, net other current transfers received In the use of income account, all sectors except the corporations consume out of their disposable income. The balancing item is the saving of the sector, with a small correction because of contributions to pension funds, whichwewouldliketoignore. Thequotientof savinganddisposableincome in the household sector is called the household saving rate and represents an important economic quantity. In Austria, this saving rate has dropped in recent years from double-digit percentages to around 8%. Occasionally, also thetotal savingrateisreported, whichratherisabalancingitemagainstthe non-resident sector. Uses Resources consumer expenditures disposable income, net saving, net 11In the capital account, saving serves as a resource for investment. After deduction of a few lesser items, the net position of lending and borrowing evolvesasabalancingitem. Gross fixed investment is called ‘gross’, as it comprises depreciation. It is called fixed investment to distinguish it from inventory investment, which is also seen as an investment. Fixed investment canbebrokenupintoresidentialconstruction,otherconstruction investment (buildings and structures, i.e. factories, streets, tunnels, ...), and equipment investment (machines, vehicles, ...). Gross fixed investment minus deprecia- tion is called net fixed investment. Uses Resources gross fixed investment net saving — depreciation capital transfers received, net changes in inventories net acquisition of valuables net acquisition of non-produced assets net position of lending and borrowing 2.2.2 SNA for the total economy Parallel to sectorial SNA, there is an accounting for the total economy, in which the main emphasis is on production accounts rather than on income. In these total accounts, we find the primary target variable of SNA, the gross domestic product (GDP). The GDP is distinct from the income items, as it relates to the production by resident units rather than to the income of residents. For production, all activities count that are performed on the territory of an economy. For income, we are rather interested in activities that are exercised by residents with permanent residence on this territory, 12whethertheseactivitiestakeplaceathomeorabroad. Fordisposableincome, one is more interested in the persons who earn the income. For the GDP, it is more important, where production occurs. Even for disposable income, however, residents are not defined by their citizenship. Longer-term guest workers in Austria are counted as Austrians, while some border workers, foreign students etc. are not counted as residents. Againthereisaproductionaccount, whichdepartsfromgrossoutput, which is recorded without goods taxes. Goods taxes are those indirect taxes that depend on the quantity of production, i.e. primarily value added tax (VAT) and customs. GDP should however also include these, thus they are added,beforeintermediateconsumptionissubtracted. Thebalancingitemis GDP.Netofdepreciation,thisvariableiscallednet domestic product (NDP). GDP and NDP should correspond to the row sums across the values added of all sectors. Uses Resources intermediate consumption gross output gross domestic product goods taxes — goods subsidies depreciation net domestic product In the sequence of accounts, the balancing item of exports and imports ac- cordingtoSNAisrecordedinaseparateaccountas external balance of goods and services. Otherwise, the generation of income account follows, whose balancing item is again the operating surplus and mixed income. Note that the previously added goods taxes are subtracted here just like other taxes, such that the sectorial income accounts are comparable to the total. All subsidies are minus positions (minus items), what really matters is the net 13position of taxes minus subsidies. Uses Resources wages paid net domestic product goods taxes paid other production taxes paid goods subsidies received other subsidies received operating surplus and mixed income, net In analogy to the sectorial account, anaccountofprimaryincomealloca- tion follows here, which yields the so-called net national income (NNI) as a balancing item. The NNI should correspond to the sum of primary in- comes net across all resident sectors. In the sequence of corrections in the lasttwoaccounts(generationofincomeandprimarydistribution),thediffer- ence between resident production and resident income disappears, such that the resulting NNI again expresses the income of residents, which is indicated by the word ‘national’. Before all, the net position of border-crossing prop- erty income can be sizeable, while the net position of border-crossing wages and subsidies is comparatively small. In order to calculate ‘gross national income’ (GNI), one must add depreciation to net national income. GNI ap- proximately corresponds to the historical ‘gross national product’ (GNP). The name ‘income’ for this item is better than ‘product’, as it describes the income of residential population and not their production. 14Uses Resources operating surplus and property income paid mixed income, net wages received production taxes received — subsidies paid net national income property income received Bywayoftheaccount ofsecondaryincomedistribution,weobtainthedispos- ableincomeofthetotaleconomy. Thepositionsinthisaccountarerelatively small,asonlyfewdirecttaxesandsocialcontributionscrossbordersandtheir net position is even smaller: Uses Resources income and property taxes paid net national income social contributions paid income and property taxes received monetary social benefits paid social contributions received other current transfers paid monetary social benefits received disposable income net other current transfers received Like households, also the total economy consumes out of its disposable in- come. Mainly, the household and the government sectors contribute to this consumption. After an above mentioned small correction due to the change in pension funds, the saving of the economy results as a balancing item. In a parallel account for the non-resident sector, thisuseofincomeaccount also shows the external position ‘external balance of current transactions’. This is important insofar, as this ‘SNA current balance’ is available to an open 15economy to finance its investment, apart from its saving. Uses Resources consumption expenditure disposable income net saving net The capital account has again the form that was described above. Finally, the net position of lending and borrowing should correspond to the current external balance. Due to measurement errors, there is no exact correspon- dence. Therefore, there is the possibility of a ‘statistical difference’ on the debit side. In total, however, the net position of lending and borrowing for the total economy should be the negative value of the external balance. Uses Resources gross fixed investment net saving — depreciation capital transfers net inventory changes net acquisition of valuables net acquisition of non-produced assets net lending/borrowing 2.3 Variants of GDP Once more the most important current and historical (partly still used) def- initions • Gross national income (GNI, formerly ‘gross national product’): GDPplusprimaryincomeofresidentsfromtherestoftheworldminus primary income of non-residents from the economy; a GDP according to the concept of residency of income earners instead of residency of production units. International mobility (work abroad) confuses the 16concept (extreme examples Luxemburg, Kuwait). Persons with per- manent residence in Austria are always counted as residents • Gross social product: obsolete expression for gross national income (GNI). • Net domestic product: GDP minus depreciation. • Netdomesticproductatfactorcosts: Netdomesticproductwith- out all production taxes (minus T plus subv). ind • Net national income (formerly ‘net national product’): gross na- tional income minus depreciation. • Net disposable income of the economy: net national income (at market prices, i.e. including all production taxes) plus balancing item of border-crossing transfers. Should be a future main indicator of the economy. • GDP (etc.) at basic prices: Intermediate stage between the calcu- lation at market prices (i.e. including all production taxes) and the calculation at producer prices (i.e. excluding all production taxes). Here,onlygoodstaxes(comprisesasitsmostimportantpartsthevalue added tax and customs) minus goods subsidies are subtracted. Only after the further subtraction of ‘other production taxes minus other subsidies’ (e.g., payroll tax), the value at producer prices is obtained. Accordingtoconvention, theoriginalgrossoutputiscompiledat‘basic prices’, GDP and NNI are then shown at market prices. Factor costs: the compensation paid to the production factors capital (machinery and buildings) and labor, by profits and wages, without taxes (net minus subsidies). 17Primary income:defined as income earned by direct participation in the production process. Labor and property income. Formerly ‘factor in- come’. 2.4 SNA=3 national accounts In many countries, GDP was formerly calculated three times • from production • from its final uses • from income Particularly in the UK, three slightly different GDP variants were com- puted. According to SNA convention today, the first of the three defines the proper GDP. As already described, GDP is computed by adding ‘goods taxes minus goods subsidies’ to gross output and subtracting intermediate consumption. There is also a break-down according to different production sectors (mining, agriculture, manufacturing etc.), which is not of central in- terest in macroeconomics. An important component of this break-down is industrial production, which is computed on a monthly basis and serves as a fast business indicator. Of fundamental interest in macroeconomics is the break-down of GDP according to final uses GDP =C +C +I +X−Im . (1) P which is collected in a separate SNA account (Account 0, in economics GDP is denoted by the letter Y and government consumption by the letter G). Note that, from the outlined sequence of accounts you obtain C from 18the consumer expenditure of households (including NPIsH), C from the p consumer expenditure of general government, I from the capital account, X−Im from the external account as an external balance. In order to obtain an exact match of the left side (from production) and the right side (from uses), one should observe: • the changes in inventories (conceptually seen as investment: inventory investment) • the change in the stock of valuables (purchases of objects of art etc.) and similar small positions • astatisticaldifference (formerly often added to the smaller aggregates as ‘inventory changes and statistical difference’) Sometimes, the private consumption C is broken down in: • consumption of durable goods (cars, video recorders, ...) • consumptionof non-durablegoods (clothing, food, books andjournals, ...): proximity of purchase and utilization • consumption of services (dining out, fitness studio, ...): not storable Public consumption C is broken down into: P • Collective consumption: indivisible utilization (e.g., street lighting) • Individual consumption: can be allocated to individual persons (e.g., free education) According to the concept of the new SNA, individual public consump- tion and private consumption are summarized in the aggregate ‘individual consumption’. The economic meaning of this convention is questionable. 19

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