Chapter 2

Determinants of demand (with examples)

Demand is what drives economic growth. Businesses want to increase demand so
they can increase their profits. Governments and central banks boost demand to
end recessions, or slow it during the expansion phase of the business cycle.
What drives demand? 1. Price of the good or service, 2. Prices of related goods or
services (substitutes), 3. Income of those with the demand, 4. Tastes or preferences,
5. Expectations (about future price changes)
Demand is determined as ceteris paribus all other things being equal.
If price falls, demand raises. Also with substitute goods, if one company creates
cheaper butter than the other, the demand of the cheaper one will rise and the
demand of the expensive butter will fall.

Equilibrium price
The price where the quantity supplied meets the quantity demanded. Price where
there are no surpluses or shortages.

Chapter 3
Time dimension
The longer the time period that it takes for producers and consumers to respond to
a change in price, the greater the elasticity of supply and demand.
Price expectations and speculation: If prices are likely to change in the foreseeable
future, this will affect the behavior of buyers and sellers now. Actions of people are
influenced by their expectations. This is called speculation where people make
buying or selling decisions based on their anticipations of future prices.

Chapter 14
Major ME issues (know concepts)
Economic growth
The goal of governments is to achieve high rates of economic growth over the
long term. In other words a growth that is fixed and sustained, not just temporary.
They try to avoid recessions and excessive short-term growth that cannot be
sustained. Economies suffer from casual instability. As a result, economic growth
and other macroeconomic indicator tend to fluctuate.
Rate of economic growth represents the percentage increase in national output,
normally expressed over a 12-month period.

Unemployment
Another major macroeconomic aim of governments. I also represents a waste of
human resources and because unemployment benefits are a drain on government
revenues.

Unemployment shows ratio of people who have a job in an economy to those who
do not have a job, but are still in the labor marked and are actively searching for
work. People who are not looking for a job are not considered in the labor market
and therefore are not included in the measure of unemployment.

Inflation
By general it means a general rise in prices throughout economy. It is the
government policy to keep inflation both low and stable. Of of the most important
reason for this is that t will aid the process orf economic decision making. For
example, businesses will be able to set prices and wage rates, and amake
investment decisions with far more confidence.
The target is around 2 percent.
Inflation is the rate at which prices in an economy increase over time. In other
words, inflation is the rate at which currency is depreciating in value over time.

The balance of payments and the exchange rate

A countrys balance of payments account records all transactions between the
resident of that country and the rest of the world. These transactions enter as either
debit items or credit items.
It is important to keep the balance of payments stable. We cannot spend more
foreign currency than we earn. In other words, there will be a shortfall of foreign
currencies and the government will have to borrow money from abroad, or draw on
its foreign currency reserves to make up the shortfall.

Government macroeconomic policy

Government pursues all of the issues. Objectives that governments typically pursue
are:
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High and stable economic growth

Low unemployment
Low inflation
The avoidance of balance of payments deficits and excessive exchange rate
fluctuations

All of these might conflict with each other. For example, a policy designed to
accelerate the rate of economic growth may result in a higher rate of inflation and a
balance of payments deficit.

The circular flow of income

INN
E
R
FLO
W

Firms pay money to households

in the form of wages and
salaries, dividens on shares,
interest and rent. These
payments are in return for the

services of the factors of production labour, capital and land that are supplied by
household.

Injections
Only part of the demand for firms output arises from customers expenditure. The
remainder comes from other sources outside the inner flow. These additional
components of aggregate demand are known as injections (J).
There are three types of injection
Investment (I) This is the money that firms spend after obtaining it from various
financial institutions either past savings or loans,, or through a new issue of
shares.
Government expenditure (G) When the government spends money on goods and
services produces by the firms, this counts as an injection. Examples: spending on
roads, hospitals and schools.
Export expenditure (X) Money flows into the circular flow from abroad when
residents abroad buy our exports of goods and services.
Total investments = J = I + G +X

GDP
An important distinction her is between nominal GDP and real GDP

Nominal GDP
Sometimes called money GDP, measures GDP in the prices ruling at the time and
thus takes no account of inflation.; GDP measured at current prices.

Real GDP
GDP after allowing for inflation: GDP measured in constant prices (i.e in terms of the
prices ruling in some base year) Thus we could measure GDP in the prices that ruled
in some particular year the base year. This would enable us to see how much real
GDP has changed from one year to another.
In other words, it would eliminate increases in money GDP that were merely due to
an increase in prices.

Problems of using GDP

The figures do give quite a good indication of the level of production of goods and
the incomes generated from it, provided we are clear about the distinctions
between the different measures. However, id doesnt give the welfare or happiness
of the countrys citizens, then there are serious problems in relying exclusively on
GDP statistics.

Some of the goods and services goes unrecorded and thus the GDP figures will
understate the nations output.
Non marketed items
If you employ a decorator to paint your living room, this will be recorder in GDP
statistics; If however you decide to paint the room by yourself, it will not. If parents
take a nanny to look after their children, this childcare will form part of GDP. If,
however, a parent stays home, it will not. It means that the true production is
understated in the economy.

The underground economy

Illegal and hence undeclared transactions. Used either for goods or services that are
illegal themselves, as with drugs, guns and prostitution. Alternatively, they could be
transactions that are illegal only n that they are not declared for tax purposes. For
example, to avoid paying VAT, a garage may be prepared to repair your car slightly
more cheap if you pay cash.
Another example is that of moonlighting , where people do extra work outside their
normal job and do not declare the income for tax purposed.

Faces of Business Cycle (or trade cycle)

Shows the periodic fluctuations of national output round its long-term trend.
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Long term output trend

A line can be drawn showing the trend of

national output over time (i.e ignoring
the cyclical fluctuations around the
trend). This is shown as the dashed line.

The business cycle in practice

-

Length of the phases

Some booms are short lived, lasting only

a few months or so. Others are much
longer, lasting perhaps several years.
Likewise, some recessions are short
while others are
-

long.

The magnitude of the phases

Sometimes in Expansion phase, there is a very high rate of economic growth,

perhaps 4 per cent per annum or more. On other occasions , Expansion phase
growth is much gentler. Sometimes in Recession phase theres an actual decline in
output. In other cases, Recession pause is merely a pause, with growth simply
being low.