MGMT 510 Macroeconomics for Managers Presented By Prof

MGMT 510 – Macroeconomics for Managers Presented By: Prof. Dr. Serhan Çiftçioğlu

OUTLINE FOR TODAY 1. What does Macroeconomics study in general? A. B. Short-run Fluctuations in total production or output of the economy Sources of long-run economic growth

n In general the output of an economy grows over time at a certain trend rate but from time to time there may be higher or slower growth than this trend (average) rate n In other words there is a positive upward trend in output in the long-run. However around this positive upward trend there are fluctuations in the short-run called business cycles

Cycles in Output a. Expansions- Increase in output above the b. c. d. e. f. g. previous PEAK! Recessions (contractions in output that lasts for at least 2 consecutive quarters) Recovery (increases in output again) Contraction (decrease in output) Depression (usually characterized by at least 10% decreas in Y and at least 20% unemployment rate) Peak point of a cycle! Trough point of one cycle!

n Macroeconomics is also interested in analysing the short-run fluctuations in not only output but also fluctuations in other macroeconomic variables such as; a. b. c. d. e. f. g. h. Unemployment Interest rates Trade balance (net exports [exports-imports]) Budget balance of government Exchange rates Consumer spending called consumption Investment spending Inflation Rate

How do we measure output (or national income) of an Economy? n The most important measure is called Real GDP (Real Gross Domestic Product) n Real GDP or national income is the monetary value of all final goods and services produced in one year in a given country after taking into account the inflation rate from previous year to the current year (this is done by using CONSTANT PRICES that prevailed in a selected base year in calculating the monetary value of final goods and services produced in the current year)

How do we measure output (or national income) of an Economy? n Another alternative measure of total output of an economy is real GNP(gross national product) n Real GNP is the monetary value of all final goods and services produced by the citizens of a country (either inside or outside the country) in 1 year after taking into account the inflation rate from previous year to this year. Again to do this we need to use constant prices.

How do we measure output (or national income) of an Economy? n NOMINAL GDP AND NOMINAL GNP n In this case GDP or GNP figures are calculated using CURRENT PRICES; these are the prices that prevailed in the current year. n Real GDP (or real GNP) is the much more accurate measure of the true output performance of an economy relative to nominal GDP (or real GNP)

Example to show: how real GDP and nominal GDP are calculated! (using constant and current prices) Suppose that North Cyprus produces 2 types of final goods: EDUCATION and TOURISM. The following table reports prices and quantities of each good produced in the last 5 years. We consider the year 2015 as the base year. Year Prices of TOURISM Quantities of TOURISM Nominal GDP Real GDP EDUCATION Quantities of EDUCATION 2013 100 TL 70 50 TL 100 (100× 70) + (50× 100) = 12000 (120× 70) + (60× 100)= 14400 2014 120 TL 60 50 TL 110 12700 13800 2015 120 TL 80 60 TL 100 15600 2016 150 TL 70 70 TL 120 18900 15600 2017 140 TL 90 80 TL 80 19000 15600

GDP Can be measured using alternative approaches such as: 1 - Expenditures Approach 2 -Incomes (or Factor. Payments) Approach 3 - Value Added Approach

1. Expenditures Approach n Total expenditures on output produced within a country in a year =C + I + G + E – M C Total Consumer spending on durables, nondurables and services I Total investment spending: Includes not only spending of firms on new capital goods such as tools, equipment, machinery, and plants but also spending of households on new houses plus the changes the values of inventories of firms.

Expenditure Approach (Cont. d) G Spending of Government E Exports M Imports

2. Incomes Approach n Total incomes earned as a result of production in one year = GDP=Wages + Salaries + Profits + Rents + Dividends +Interest Income+ Indirect Business Taxes (Such as Sales Taxes)

3. VALUE ADDED Approach n GDP= Total Value Added of all firms (producers) in one year n Value Added of a firm= MARKET VALUE of its production - COST OF INTERMEDIATE PRODUCTS used in production

Sources of long-run economic growth A. Accumulation of physical capital B. Population growth which increases total labour force C. Technological progress D. Accumulation of human capital E. Growth of efficiency of firms and governments in using available resources together with a given level of technology.

DETAILED ANALYSIS OF FACTORS AFFECTING LONG-RUN ECONOMIC GROWTH Y= A F(K, L) This is the GENERAL FORM of PRODUCTION FUNCTION. A= Total Factor Productivity K= Stock of Physical Capital L= Quantity of Labor Supply

This general form of PRODUCTION FUNCTION implies that GROWTH RATE OF REAL GDP (ΔY/Y) depends on The Growth Rates of A, K and L: GROWTH RATE OF A = ΔA/A (%Δ in A) GROWTH RATE OF K = ΔK/K (%Δ in K) GROWTH RATE OF L = ΔL/L (%Δ in L)

Therefore, to understand the FACTORS THAT ARE LIKELY TO AFFECT LONG-RUN GROWTH RATE OF AN ECONOMY WE NEED TO UNDERSTAND THE FACTORS THAT CAN AFFECT THE RESPECTIVE GROWTH RATES OF A, K and L:

FACTORS AFFECTING GROWTH RATE OF L (Quantity of Labor Supply) L depends on two parameters: (a) Number of LABOR FORCE Available for Work which depends on POPULATION. So GROWTH RATE of POPULATION is one factor that is likely to affect the GROWTH RATE of L.

(b) QUALITY of LABOR FORCE which is called HUMAN CAPITAL. Average Stock of HUMAN CAPITAL per worker in the economy determines the PRODUCTIVE CAPACITY and Quantity of Labor Supply for each worker.

FACTORS AFFECTING STOCK OF HUMAN CAPITAL OF EACH WORKER (a) LEVEL OF EDUCATION (years of (b) (c) (d) (e) schooling) Amount of Experience Amount of Training Amount and Quality of Health Care received Amount and Quality of Nourishment (Food)

THEREFORE LONG-RUN GROWTH RATE OF L DEPENDS NOT ONLY ON GROWTH RATE OF POPULATION BUT ALSO ON THE GROWTH RATE OF HUMAN CAPITAL (H). And growth of H will depend on the IMPROVEMENTS in the factors affecting H (listed before). NOTE: Some economists believe that REDUCTION IN INCOME TAX RATE MAY GIVE INCENTIVES TO INDIVIDUAL WORKERS TO INCREASE THEIR LABOR SUPPLY. However empirical evidence suggests that this effect is very small.

FACTORS AFFECTING GROWTH RATE OF K (= Rate of Accumulation of K) a) High Rate of Domestic Investment (I/Y) b) High Rate of Domestic Savings (S/Y) S= Spr + Sgov (pr= private; gov= government) c) Macroeconomic Stability (Usually it means low interest rates, low inflation and low budget deficits)

d) Trade Openness ( E+M/ Y) Y=GDP, E=Exports, M=Imports, Why? 1) Relatively bigger market potential and sales in Global Markets leads to higher volume of investment 2) Availability of imported capital goods makes investment in certain projects possible 3) Availability of new imported products gives new ideas to domestic producers for producing wider range of new products.

e) Financial Development Usually it means (1) Easier entry conditions for the new banks and a corresponding increase in the number and quality of private banks and other financial intermediaries in the financial sector. (2) Increased market share of private (domestic and foreign) banks in the financial sector (3) Relatively more competitive structure in financial sector (4) An increase in the quantity and quality of financial services with lower transaction costs

f) Cultural Values (1) Savings Propensity (2) Openness to New Ideas (3) Degree of Trust between individuals (4) Risk Taking/entrepreneurship

FACTORS AFFECTING GROWTH RATE OF TOTAL FACTOR PRODUCTIVITY Growth Rate of Productivity = Annual %Δ in A A= T X E >>% Δ in A= % Δ in T + % Δ in E T= Level of Technology E= Level of Efficiency

FACTORS AFFECTING EFFICIENCY GROWTH (a) Macroeconomic Stability (b) Financial Development (c) Trade Openness (Competition in global markets can lead firms to improve cost efficiency and Economies of Scale can bring about further reduction in Unit Costs) (d) Quality of Institutions (1) Justice System (2) Bureaucracy (corruption) (3) Security (e) Democracy - Accountability Transparency

FACTORS AFFECTING GROWTH OF TECHNOLOGY ( % Δ in T ) (a) Amount of Resources (L and K) allocated for R&D. (b) Openness to Capital Flows (FDI may bring new technologies) (c) Trade Openness (Availability of new capital goods which embody new technologies)

n One important goal of macroeconomics is n to develop macroeconomic policies ( such as monetary and fiscal policies) that will A. B. Minimise the amount of short-run fluctuations in output and keep the economy grow steadily at a sustainable rate so that unemployment remains low and wellfare of people steadily increases Increase the long run growth rate of economy

n In this class, we will particularly focus on developing a macroeconomic model to analyse the factors responsible for short-run fluctuations in economies and fiscal and monetary policies that can be used to deal with these fluctuations

n Our model is based on Keynesian theory which assumes that in the short-run: A. B. C. D. Prices are fixed (price rigidity) Wages are fixed (wage rigidity) Economy operates below full-employment level of output (or potential output) so that there are idle resources As a corollary of (A), (B), and (C); in the short-run output is solely and only determined by the level of the aggregate demand ( or total expenditures) for domestic output

Are these assumptions of Keynesian model realistic?