This document provides an overview of macroeconomics and the macroeconomic environment. It discusses key topics such as the components of the economy, economic growth, productivity, and macroeconomic performance measures. The circular flow model and factors that influence economic growth like savings, investment, expectations and shocks are also examined. Macroeconomic objectives and how performance is measured using indicators like GDP, unemployment and inflation are outlined.

1. Go Global !Go Global !
Managerial Economics :Managerial Economics :
The Macroeconomic
Environment
By
Stephen OngStephen Ong
Visiting Fellow, Birmingham City UniversityVisiting Fellow, Birmingham City University
Visiting Professor, College of Management,Visiting Professor, College of Management,
Shenzhen UniversityShenzhen University
April 2013April 2013

2. Learning Objectives
• To identify the componentTo identify the component
parts of the economyparts of the economy
• To explain the Circular FlowTo explain the Circular Flow
ModelModel
• To define the fiveTo define the five
macroeconomic objectivesmacroeconomic objectives
• To explain howTo explain how
macroeconomic performancesmacroeconomic performances
are measuredare measured

3. AgendaAgenda
1. Components of the Economy
2. The Circular Flow Model
3. Macroeconomic objectives
4. Macroeconomic performance
measures

4. 1. The Macroeconomics Environment

5. 1. Components of the Economy
1.Firms
2.Households
3.Government
4.Banking sector
5.External (overseas) sector

6. 6
1. Economic Growth1. Economic Growth
• Increase in real GDP or real GDP perIncrease in real GDP or real GDP per
capita over some time periodcapita over some time period
• Percentage rate of growthPercentage rate of growth
• Growth as a goalGrowth as a goal
• Arithmetic of growth:Arithmetic of growth: Rule of 70Rule of 70
Approximate
number of years
required to double
real GDP
=
70
annual percentage rate
of growth

7. 7
1.1 Economic Growth1.1 Economic Growth
• Growth U.S. real GDP 1950-2005Growth U.S. real GDP 1950-2005
– Increased 6 foldIncreased 6 fold
– 3.5% per year3.5% per year
• Growth in U.S. real GDP per capitaGrowth in U.S. real GDP per capita
– Increased more than 3 foldIncreased more than 3 fold
– 2.3% per year2.3% per year
• QualificationsQualifications
– Improved products and servicesImproved products and services
– Added leisureAdded leisure
– Other impactsOther impacts

8. 8
1.2 Modern Economic Growth1.2 Modern Economic Growth
• Began with the IndustrialBegan with the Industrial
Revolution in late 1700’sRevolution in late 1700’s
• Ongoing increases in livingOngoing increases in living
standardsstandards
• Time for leisureTime for leisure
• Social changeSocial change
• DemocracyDemocracy
• Human lifespan doubledHuman lifespan doubled

9. 9
1.3 Modern Economic Growth1.3 Modern Economic Growth
• Began in BritainBegan in Britain
• Has spread slowlyHas spread slowly
• Starting date main cause ofStarting date main cause of
worldwide differences in livingworldwide differences in living
standardsstandards
• Catching up is possibleCatching up is possible
• Leader countries invent technologyLeader countries invent technology
• Follower countries adopt technologyFollower countries adopt technology
– Can grow fasterCan grow faster

10. 10
1.4 Real GDP Per Capita1.4 Real GDP Per Capita
Real GDPReal GDP Real GDPReal GDP AverageAverage
annualannual
per capita,per capita, per capita,per capita, growthgrowth
rate,rate,
CountryCountry 19601960 20042004 1960-20041960-2004United States $12,892 $36,098 2.3%
United Kingdom 10,323 26,762 2.2
France 8,531 26,168 2.5
Ireland 5,294 28,957 3.9
Japan 4,509 24,661 3.9
Singapore 4,219 29,404 4.4
Hong Kong 3,322 29,642 5.0
South Korea 1,458 18,424 5.8
Figures are in 1996 dollars Source: Penn World Table

11. 11
1.5 Modern Economic Growth1.5 Modern Economic Growth
• Growth-promotingGrowth-promoting
institutional structuresinstitutional structures
– Strong property rightsStrong property rights
– Patents and copyrightsPatents and copyrights
– Efficient financial institutionsEfficient financial institutions
– Literacy and widespread educationLiteracy and widespread education
– Free tradeFree trade
– Competitive market systemCompetitive market system

12. 12
1.6 Ingredients of Growth1.6 Ingredients of Growth
• Supply factorsSupply factors
– Increases in quantity andIncreases in quantity and
quality of natural resourcesquality of natural resources
– Increases in quality andIncreases in quality and
quantity of human resourcesquantity of human resources
– Increases in the supply (orIncreases in the supply (or
stock) of capital goodsstock) of capital goods
– Improvements in technologyImprovements in technology

13. 13
1.7 Ingredients of Growth1.7 Ingredients of Growth
• Demand factorDemand factor
– Households, businesses, andHouseholds, businesses, and
government must purchasegovernment must purchase
the economy’s expandingthe economy’s expanding
outputoutput
• Efficiency factorEfficiency factor
– Must achieve economicMust achieve economic
efficiency and full employmentefficiency and full employment

14. 14
1.8 Production Possibilities1.8 Production Possibilities
Consumer Goods
CapitalGoods
a
Economic
Growth
b
A
C
B D
c

15. 15
1.9 Labour and Productivity1.9 Labour and Productivity
• Size of
employed
labour force
• Average
hours of
work
Labour
Inputs
(hours of
work)
• Quantity of
capital
• Education and
training
• Technological
advance
• Allocative
efficiency
• Other
Labour
Productivity
(average
output per
hour)
Real
GDP
Real GDP = hours of work x labour productivity
x
=

16. 1.10 U.S. Economic Growth1.10 U.S. Economic Growth
Annual Averages for Five Decades
0
1
2
3
4
5
1950-1959 1960-1969 1970-1979 1980-1989 1990-1999 2000-2005
Year
AverageAnnualIncrease(Percent)
Real GDP
Real GDP Per Capita
Source: Bureau of Economic Analysis

17. 17
1.11 Accounting for Growth1.11 Accounting for Growth
Accounting for Growth of U.S. Real GDP,
1953-2013 (average annual percentage changes)
Item
1953 Q2
to
1973 Q4
1973 Q4
to
1995 Q2
1995 Q2
to
2001 Q1
2001 Q1
to
2007 Q3
2007 Q3
to
2013 Q4*
Increases in Real GDP
Increases in
Quantity of Labour
Increases in
Labour Productivity
3.6
1.1
2.5
2.8
1.3
1.5
3.8
1.4
2.4
2.6
-0.1
2.7
2.8
0.3
2.5
Source: Economic Report of the President, 2008*Beyond 2007 are Projections

18. 18
• Factors affecting productivityFactors affecting productivity
growthgrowth
– Technological advance (40%)Technological advance (40%)
– Quantity of capital (30%)Quantity of capital (30%)
– Education and training (15%)Education and training (15%)
– Economies of scale andEconomies of scale and
resource allocation (15%)resource allocation (15%)
1.12 Accounting for Growth

19. 19
Average Test Scores of Eighth Grade
Students in Math and Science, Top 10
Countries and the United States, 2003
Singapore
South Korea
Hong Kong
Taiwan
Japan
Belgium
Netherlands
Estonia
Hungary
Malaysia
United States
1
2
3
4
5
6
7
8
9
10
15
605
589
586
585
570
537
536
531
529
508
504
Singapore
Taiwan
South Korea
Hong Kong
Estonia
Japan
Hungary
Netherlands
United States
Australia
1
2
3
4
5
6
7
8
9
10
578
571
558
556
552
552
543
536
527
527
Mathematics Science
1.13 Accounting for Growth

20. 20
1.14 Productivity Growth1.14 Productivity Growth
• Accelerated rate of growthAccelerated rate of growth
– 1.4% per year 1973-19951.4% per year 1973-1995
– 2.9% per year 1995-20052.9% per year 1995-2005
• Affects real output, real income,Affects real output, real income,
and real wagesand real wages
• Pay higher wages withoutPay higher wages without
lowering profitlowering profit

21. 21
1.15 Accelerated Productivity1.15 Accelerated Productivity
GrowthGrowth
• Microchip/informationMicrochip/information
technologytechnology
• New firms and increasingNew firms and increasing
returnsreturns
• Sources of increasing returnsSources of increasing returns
– More specialized inputsMore specialized inputs
– Spreading of development costsSpreading of development costs
– Simultaneous consumptionSimultaneous consumption
– Network effectsNetwork effects
– Learning by doingLearning by doing
• GGlobal competitionlobal competition

22. 22
1.16 Economic Growth1.16 Economic Growth
• Is accelerated productivity growthIs accelerated productivity growth
sustainable?sustainable?
• Is economic growth desirable andIs economic growth desirable and
sustainable?sustainable?
• The antigrowth viewThe antigrowth view
– Environmental and resource issuesEnvironmental and resource issues
• In defense of economic growthIn defense of economic growth
– Higher standard of livingHigher standard of living
– Human imagination can solveHuman imagination can solve
environmental and resource issuesenvironmental and resource issues

23. 23
1.17 Economic Growth in China1.17 Economic Growth in China
• Growth averages past 25 years:Growth averages past 25 years:
– 9% annual growth output9% annual growth output
– 8% annual growth output per capita8% annual growth output per capita
• Labour more productiveLabour more productive
• More international tradeMore international trade
• Transition to market economyTransition to market economy
• Joined WTO 2001Joined WTO 2001
• Financial system remains weakFinancial system remains weak
• Income inequality acrossIncome inequality across
geographic areasgeographic areas

24. 2. The Circular Flow Model

25. 2. Performance and Policy2. Performance and Policy
• Real GDPReal GDP
– Corrects for price changesCorrects for price changes
• Nominal GDPNominal GDP
– Uses current pricesUses current prices
• UnemploymentUnemployment
• InflationInflation
– Increase in overall level ofIncrease in overall level of
pricesprices

26. 26
2.1 Economic Performance2.1 Economic Performance
• Output growthOutput growth
– 3.1% per year 1995-20053.1% per year 1995-2005
• Unemployment rateUnemployment rate
– 4.6% in 20074.6% in 2007
• Inflation rateInflation rate
– 2.7% in 20072.7% in 2007

27. 27
2.2 Economic Growth2.2 Economic Growth
• Standard of living measuredStandard of living measured
by output per personby output per person
• No growth in living standardsNo growth in living standards
prior to Industrial Revolutionprior to Industrial Revolution
• Modern economic growthModern economic growth
– Output per person risesOutput per person rises
– Not experienced by allNot experienced by all
countriescountries

28. 28
2.3 GDP Per Person 20072.3 GDP Per Person 2007
ZimbabweZimbabwe $188$188
United States $45,845
Canada $38,345
Japan $33,576
United Kingdom $35,134
South Korea $24,782
France $33,187
Russia $14,692
Saudi Arabia $23,243
Burundi $371
Tanzania $1,256
North Korea $1,900
India $2,659
China $5,292
Mexico $12,774
U.S. dollars based on purchasing power parity (PPP)

29. 29
2.4 Savings and Investment2.4 Savings and Investment
• SavingSaving
– Tradeoff current for futureTradeoff current for future
consumptionconsumption
• InvestmentInvestment
– Financial investmentFinancial investment
– Economic investmentEconomic investment
• Banks and financialBanks and financial
institutionsinstitutions

30. 30
2.5 Shocks2.5 Shocks
• Demand shocks and flexibleDemand shocks and flexible
pricesprices
– Price falls if demand lowPrice falls if demand low
– Sales unchangedSales unchanged
• Demand shocks and stickyDemand shocks and sticky
pricesprices
– Maintain inventoryMaintain inventory
– Sales changeSales change
– Business cyclesBusiness cycles

31. 31
2.6 Expectations2.6 Expectations
• The future is uncertainThe future is uncertain
• Expectations affectExpectations affect
investmentinvestment
• ShocksShocks
– What happens is not what youWhat happens is not what you
expectedexpected
• Demand shocksDemand shocks
• Supply shocksSupply shocks

32. 32
2.7.1 Demand Shocks2.7.1 Demand Shocks
Cars per week
Price
DM
DL
DH
900
$40,000
$37,000
$35,000
Flexible Prices

33. 33
2.7.2 Demand Shocks2.7.2 Demand Shocks
Cars per week
DM
DL
DH
700 900 1150
$37,000
Fixed Prices
Price

34. How sticky is
How long ago since
the price changed ?
Months Months
Dry cleaning McDonald’s
Meal
Newspaper Small Car
Haircut Milk
Taxi fare Electricity
Medical services Airfare
Magazine Petrol
Personal Computer Teh tarik

35. 35
2.8.1 Sticky Prices2.8.1 Sticky Prices
• Explain fluctuations in GDPExplain fluctuations in GDP
• Average months between price changesAverage months between price changes
Months Months
Coin-operated Laundry
Machine
46.4 Beer 4.3
Newspaper 29.9 Microwave
Ovens
3.0
Haircut 25.5 Milk 2.4
Taxi fare 19.7 Electricity 1.8
Vet services 14.9 Airfare 1.0
Magazine 11.2 Gasoline 0.6
PC Software 5.5

36. 36
2.8.1 Sticky Prices2.8.1 Sticky Prices
• Many prices sticky in shortMany prices sticky in short
runrun
– Consumers prefer stable pricesConsumers prefer stable prices
– Firms want to avoid price warsFirms want to avoid price wars
• All prices flexible in long runAll prices flexible in long run
– Firms adjust to unexpected,Firms adjust to unexpected,
but permanent changes inbut permanent changes in
demanddemand

37. 37
2.9 Inventory Management2.9 Inventory Management
• Computerized inventory trackingComputerized inventory tracking
• Unexpected changes in demandUnexpected changes in demand
easier to observeeasier to observe
• Firms make better output andFirms make better output and
employment decisionsemployment decisions
• Less severe business cyclesLess severe business cycles
• Only two mild recessions sinceOnly two mild recessions since
adoptionadoption
– Possible explanationPossible explanation

38. 3. Macroeconomics Policy3. Macroeconomics Policy

39. 3.1 Macroeconomic Policy

40. 3.1 GDP Growth Rates

41. 3.2 Actual vs Potential GDP

42. 3.3 Unemployment

43. 3.4 Inflation

45. 3.5 Aggregate Supply & Demand

46. 3.6 Impact of Increase in AD

47. 3.7 Long run Growth

48. 3.8 GDP

49. 3.8.1 Real GDP Growth

50. 3.8.2 Long
run GDP
Growth

51. 3.9 Consumption

52. 3.10 Consumption & Disposal
Income

53. 3.11 Savings

54. 3.12 USA Consumption & DI

55. 3.13 USA Consumption Function

56. 3.14 USA Savings rate

57. 3.15 Investment vs Interest Rates

58. 3.16 Investment Shifts

59. 4. Macroeconomic Performance4. Macroeconomic Performance
MeasuresMeasures
Economic growth – GDP vs GNI
 Inflation
Unemployment
Balance of Payments
 Exchange rate

60. 60
4.1 Gross Domestic Product4.1 Gross Domestic Product
• Measure of aggregate outputMeasure of aggregate output
• Monetary measureMonetary measure
• Avoid multiple countingAvoid multiple counting
– Market value final goodsMarket value final goods
– Ignore intermediate goodsIgnore intermediate goods
– Count value addedCount value added

61. 61
4.1 Gross Domestic Product4.1 Gross Domestic Product
• Exclude financialExclude financial
transactionstransactions
– Public transfer paymentsPublic transfer payments
– Private transfer paymentsPrivate transfer payments
– Stock (and bond) marketStock (and bond) market
transactionstransactions
• Second hand salesSecond hand sales
– Sell used car to a friendSell used car to a friend

62. 62
4.2 Two Approaches to GDP4.2 Two Approaches to GDP
• Income approachIncome approach
– Count income derived fromCount income derived from
productionproduction
– Wages, rental income, interestWages, rental income, interest
income, profitincome, profit
• Expenditure approachExpenditure approach
– Count sum of money spentCount sum of money spent
buying the final goodsbuying the final goods
– Who buys the goods?Who buys the goods?

63. 4.2.1 Product vs Earnings Approach

64. 64
G
D
P
= =
+
Consumption by
Households
Investment by
Businesses
Government
Purchases
Expenditures
By Foreigners
+
+
+
+
+
Wages
Rents
Interest
Profits
Statistical
Adjustments
+
4.3 Two Approaches to GDP

65. 65
4.4.1 Expenditure Approach4.4.1 Expenditure Approach
• Personal consumptionPersonal consumption
expenditures (C)expenditures (C)
– Durable consumer goodsDurable consumer goods
– Nondurable consumer goodsNondurable consumer goods
– Consumer expenditures forConsumer expenditures for
servicesservices
– Domestic plus foreignDomestic plus foreign
producedproduced

66. 4.4.1.1 Share of Consumption

67. 67
4.4.2 Expenditure Approach4.4.2 Expenditure Approach
• Gross private domesticGross private domestic
investment (I)investment (I)
– Machinery, equipment, andMachinery, equipment, and
toolstools
– All constructionAll construction
– Changes in inventoriesChanges in inventories
• Creation of new capital assetCreation of new capital asset
• Noninvestment transactionsNoninvestment transactions

68. 68
4.4.3 Expenditure Approach4.4.3 Expenditure Approach
January 1 Year’s GDP December 31
Consumption
& Government
Spending
Depreciation
Net
Investment
Gross
Investment
Stock of
Capital
Increase
Stock of
Capital
Gross Investment
Depreciation
Net Investment
-
=

69. 69
4.4.4 Expenditure Approach4.4.4 Expenditure Approach
• Government purchases (G)Government purchases (G)
– Expenditures for goods and servicesExpenditures for goods and services
– Expenditures for social capitalExpenditures for social capital
– Excludes transfer paymentsExcludes transfer payments
• Net exports (XNet exports (Xnn))
– Add exported goodsAdd exported goods
– Subtract imported goodsSubtract imported goods
– NX = exports - importsNX = exports - imports
• GDP = C+IGDP = C+Ig+G+X+G+Xn

70. 70
Compensation
Rents
Interest
Proprietor’s Income
Corporate Profits
Taxes on Production and
Imports
National Income
Net Foreign Factor Income (-)
Statistical Discrepancy (+)
Consumption of Fixed
Capital (+)
Gross Domestic Product
$ 7874
65
603
1043
1627
1009
$12,221
96
29
1687
$ 13,841
Personal Consumption (C)
Gross Private Domestic
Investment (Ig)
Government Purchases (G)
Net Exports (Xn)
Gross Domestic Product
in Billions
Receipts
Expenditures Approach
Allocations
Income Approach
$ 9734
2125
2690
-708
$ 13,841
4.4.5 U.S. Economy 20074.4.5 U.S. Economy 2007

71. 71
4.4.6 C4.4.6 Comparative GDPomparative GDP
Source: World Bank
Selected Nations GDPs, 2007
United States
Japan
Germany
China
United Kingdom
France
Italy
Canada
Spain
Brazil
Russia
India
South Korea
Mexico
Australia
0 1 2 3 4 5 6 7 8 9 10 12 13
GDP in Trillions of Dollars

72. 72
4.5 Components of National4.5 Components of National
IncomeIncome
• Compensation of employeesCompensation of employees
• RentsRents
• InterestInterest
• Proprietor’s incomeProprietor’s income
• Corporate profitsCorporate profits
– Corporate income taxesCorporate income taxes
– DividendsDividends
– Undistributed corporate profitsUndistributed corporate profits
• Taxes on production and importsTaxes on production and imports

73. 73
4.5.1 Income Approach4.5.1 Income Approach
• From national income to GDPFrom national income to GDP
– Net foreign factor incomeNet foreign factor income
– Statistical discrepancyStatistical discrepancy
– Consumption of fixed capitalConsumption of fixed capital
• Other national accountsOther national accounts
– Net domestic product (NDP)Net domestic product (NDP)
– National income (NI)National income (NI)
– Personal income (PI)Personal income (PI)
– Disposable income (DI)Disposable income (DI)
– DI = C + SDI = C + S

74. 74
4.5.2 U.S. Income Relationships4.5.2 U.S. Income Relationships
20072007
Gross Domestic Product (GDP)
Less: Consumption of Fixed Capital
Equals: Net Domestic Product (NDP)
Less: Statistical Discrepancy
Plus: Net Foreign Factor Income
Equals: National Income (NI)
Less: Taxes on Production and Imports
Less: Social Security Contributions
Less: Corporate Income Taxes
Less: Undistributed Corporate Profits
Plus: Transfer Payments
Equals: Personal Income (PI)
Less: Personal Taxes
Equals: Disposable Income (DI)
$ 13,841
1687
$ 12,154
29
96
$ 12,221
1009
979
467
344
2237
$ 11,659
1482
$ 10,177

75. 4.5.3 GDP vs DI

76. 76
4.6 Nominal vs. Real GDP4.6 Nominal vs. Real GDP
• GDP is a dollar measure ofGDP is a dollar measure of
productionproduction
• Using dollar values createsUsing dollar values creates
problemsproblems
• Nominal GDPNominal GDP
– Use prevailing priceUse prevailing price
• Real GDPReal GDP
– Reflect changes in priceReflect changes in price
– Use base year priceUse base year price

77. 4.6.1 Real vs Nominal GDP

78. 78
4.6.2 GDP Price Index4.6.2 GDP Price Index
• Use price index to determine realUse price index to determine real
GDPGDP
Price
Index
In Given
Year
= x100
Price of Market Basket
In Specific Year
Price of Same Basket
In Base Year
Real
GDP =
Nominal GDP
Price Index (in hundredths)

79. 79
4.7 Shortcomings of GDP4.7 Shortcomings of GDP
• Nonmarket activitiesNonmarket activities
• LeisureLeisure
• Improved product qualityImproved product quality
• The underground economyThe underground economy
• GDP and the environmentGDP and the environment
• Composition and distribution of theComposition and distribution of the
outputoutput
• Noneconomic sources of well-beingNoneconomic sources of well-being

80. 80
4.7.1 Und4.7.1 Underground Economyerground Economy
Source: Open Assessment, E-Journal
As a percentage of GDP, Selected
Nations, 2007
Mexico
South Korea
India
Italy
Spain
China
Sweden
Germany
France
United Kingdom
Japan
Switzerland
United States
0 5 10 15 20 25 30
Percentage of GDP

81. 81
4.8.1 Sources of Data4.8.1 Sources of Data
• ConsumptionConsumption
– Census Bureau’s Retail Trade SurveyCensus Bureau’s Retail Trade Survey
– Census Bureau’s Survey ofCensus Bureau’s Survey of
ManufacturersManufacturers
– Census Bureau’s Service SurveyCensus Bureau’s Service Survey
• InvestmentInvestment
– All Consumption data sourcesAll Consumption data sources
– Census Bureau’s Housing Starts SurveyCensus Bureau’s Housing Starts Survey
and Housing Sales Surveyand Housing Sales Survey
– Retail Trade SurveyRetail Trade Survey
– Wholesale Trade SurveyWholesale Trade Survey
– Survey of ManufacturingSurvey of Manufacturing

82. 82
• Government PurchasesGovernment Purchases
– Office of Personnel ManagementOffice of Personnel Management
– Construction SurveysConstruction Surveys
– Census Bureau’s Survey ofCensus Bureau’s Survey of
Government FinanceGovernment Finance
• Net ExportsNet Exports
– U.S. Customs ServiceU.S. Customs Service
– BEA Surveys and AnalysisBEA Surveys and Analysis
4.8.2 Sources of Data

83. 5. Economic Growth Models

84. 5.1 Technology Diffusion

85. 5.2 Growth factors

86. 5.21 Four Wheels of Growth
 Human resources (L)Human resources (L)
 Natural Resources (R)Natural Resources (R)
 Capital (K)Capital (K)
Technological change &Technological change &
innovation (A)innovation (A)
Output (Q) = Af (K, L, R)Output (Q) = Af (K, L, R)
where f=Production functionwhere f=Production function
 L=(labour supply, education, skills,
discipline, motivation)
 R=(land, minerals, fuels, environmental
quality)
 K=(factories, machinery, roads, IP)
 A=(science, engineering, management,
entrepreneurship)

87. 5.3 Smith vs Malthus

88. 5.4 Growth vs Capital

89. 5.5 Technological advance

91. 5.7 Factors in GDP Growth

92. 5.8 Labour Productivity

93. 5.9 Wages & productivity

94. ConclusionConclusion
“Economic growth is the single mostEconomic growth is the single most
important factor in the success ofimportant factor in the success of
nations in the long run. Economicnations in the long run. Economic
growth involves the growth of potentialgrowth involves the growth of potential
output over the long run. The growth inoutput over the long run. The growth in
output per capita is an importantoutput per capita is an important
objective of government because it isobjective of government because it is
associated with rising average realassociated with rising average real
incomes and rising living standardsincomes and rising living standards”
Paul Samuelson

95. Questions?Questions?

96. Go Global !Go Global !
Managerial Economics :Managerial Economics :
The Macroeconomic
Environment 2:
The Business Cycle

97. Learning Objectives
 To analyse the key macroeconomic
indicators
 To explain how the business cycle works
 To critically assess the relationship
between the business cycle and company
performance

98. AgendaAgenda
1. Business
Cycles &
Business
Performance
2. Unemployment
3. Inflation

99. The Macroeconomics Environment

100. 1.1 Components of the Economy
1.Firms
2.Households
3.Government
4.Banking sector
5.External (overseas) sector

101. The Circular Flow Model

102. 1.1. The Business CycleThe Business Cycle

103. 1.1 Long term Business Cycle

104. 1.2 Causes of Business1.2 Causes of Business
CyclesCycles
• Shocks and price stickinessShocks and price stickiness
• Supply and productivity shocksSupply and productivity shocks
• Monetary shocksMonetary shocks
• Financial bursts and bubblesFinancial bursts and bubbles
• Unexpected political eventsUnexpected political events
• Common linkCommon link
• Unexpected changes inUnexpected changes in
spendingspending

105. 1.3 Impact of Policy1.3 Impact of Policy

106. 1.4 Effects on Business1.4 Effects on Business
PerformancePerformance
1.Profitability
2.Share prices and Dividend Policies
3.Investment and Return on Capital
Employed
4.Cash Flow

107. Key Business Performance IndicatorsKey Business Performance Indicators
& Stage of Business Cycle :& Stage of Business Cycle : RecessionRecession
Indicator
(Rise/Fall)
Profits
Share prices
Dividends
Investment
Return on
Capital
Cash flow
Sales revenue
Costs
Bankruptcies

108. Key Business Performance IndicatorsKey Business Performance Indicators
& Stage of Business Cycle :& Stage of Business Cycle : BOOMBOOM
Indicator
(Rise/Fall)
Profits
Share prices
Dividends
Investment
Return on
Capital
Cash flow
Sales revenue
Costs
Bankruptcies

109. 2. Unemployment2. Unemployment
• Twin problems of the business cycleTwin problems of the business cycle
• UnemploymentUnemployment
• InflationInflation
• Measurement of unemploymentMeasurement of unemployment
• Who’s in the labour forceWho’s in the labour force
• Problems with the unemploymentProblems with the unemployment
raterate
• Part-time employmentPart-time employment
• Discouraged workersDiscouraged workers
Unemployment Rate
Unemployed
Labour Force
= x 100

110. 2.1 Unemployment2.1 Unemployment
Under 16
And/or
Institutionalized
(71.8 Million)
2007 data
Total
Population
(303.6 Million)
Not in
Labor Force
(78.7 Million)
Employed
(146.0 Million)
Labor
Force
(153.1 Million)
Unemployed
(7.1 Million) Source: Bureau of Labor Statistics

111. 2.1.1 USA Labour force 2007

112. 2.2 Unemployment2.2 Unemployment
• Types of unemploymentTypes of unemployment
• FrictionalFrictional
• StructuralStructural
• CyclicalCyclical
• Full employment definedFull employment defined
• No cyclical unemploymentNo cyclical unemployment
• Natural rate ofNatural rate of
unemploymentunemployment
• Full employment rateFull employment rate

113. 2.3 Unemployment2.3 Unemployment
• Natural rate of unemploymentNatural rate of unemployment
• 1980’s 6%1980’s 6%
• Today 4-5%Today 4-5%
• Aging labour forceAging labour force
• Temp agencies and the internetTemp agencies and the internet
• New welfare laws and workNew welfare laws and work
requirementsrequirements
• Prison population has doubledPrison population has doubled

114. 2.4 Cost of Unemployment2.4 Cost of Unemployment
• Foregone outputForegone output
• Potential outputPotential output
• GDP gapGDP gap
• (Actual output – potential(Actual output – potential
output)output)
• Okun’s LawOkun’s Law
• Each 1% above NRU createsEach 1% above NRU creates
negative 2% output gapnegative 2% output gap

115. 2.4.1 Costs of Unemployment

116. 2.4.2 Okun's Law

117. 2.5 Unemployment2.5 Unemployment
5,000
6,000
7,000
8,000
9,000
10,000
11,000
12,000
1 985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005
1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005
The GDP Gap
12,000
11,000
10,000
9,000
8,000
7,000
6,000
5,000
GDP(billionsof1996dollars)
0
2
4
6
8
10
1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005
1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005
The Unemployment Rate
10
8
6
4
2
0
Unemployment
(percentofcivilian
Laborforce)
Source: Congressional Budget Office & Bureau of Economic Analysis
GDP gap
(positive)
GDP gap
(negative)
Potential GDP
Actual GDP

118. 2.6 Unemployment2.6 Unemployment
• Unequal burdensUnequal burdens
• OccupationOccupation
• AgeAge
• Race and ethnicityRace and ethnicity
• GenderGender
• EducationEducation
• DurationDuration
• Noneconomic costsNoneconomic costs

119. 2.7 Unemployment Rate2.7 Unemployment Rate
Source: Bureau of Labor Statistics
Unemployment Rates in Five Industrial
Nations,1995-2005

120. 2.7.1 Unemployment & Labour
Markets

121. 2.7.2 Vacancy & Unemployment
Rates

122. 2.7.3 Unemployment by Demographics

123. 2.7.4 Duration of Unemployment

124. 2.7.5 Unemployment Distribution

125. 2.7.6 USA vs EU

126. 3. Inflation3. Inflation
• Rise in general level ofRise in general level of
pricesprices
• Consumer price index (CPI)Consumer price index (CPI)
• Market basketMarket basket
• 300 goods and services300 goods and services
• Typical urban consumerTypical urban consumer
• 2 year updates2 year updates
CPI
Price of the Most Recent Market
Basket in the Particular Year
Price estimate of the Market
Basket in 1982-1984
= x 100

127. 3.01 Historic UK Inflation

128. 3.02 USA CPI

129. 3.03 Recent CPI

130. 3.04 Hyperinflation Germany

131. 3.1 Inflation3.1 Inflation
Annual Inflation Rates in the United States,
1960-2007
0
5
10
15
1960 1970 1980 1990 2000
InflationRate(percent)
Source: Bureau of Labor Statistics

132. 3.2 Inflation3.2 Inflation
Source: Bureau of Labor Statistics
Inflation Rates in Five Industrial Nations,
1995-2005

133. 3.3 Inflation3.3 Inflation
• Types of InflationTypes of Inflation
• Demand pullDemand pull
• Cost-pushCost-push
• Redistributive EffectsRedistributive Effects
• Nominal and real incomeNominal and real income
• Growth in nominal income vs.Growth in nominal income vs.
inflation rateinflation rate
• Anticipated vs. unanticipatedAnticipated vs. unanticipated
inflationinflation

134. 3.4 Inflation3.4 Inflation
• Who is hurt by inflation?Who is hurt by inflation?
• Fixed-income receiversFixed-income receivers
• SaversSavers
• CreditorsCreditors
• Who is unaffected or not hurt byWho is unaffected or not hurt by
inflation?inflation?
• Flexible-income receiversFlexible-income receivers
• Cost-of-living adjustments (COLAs)Cost-of-living adjustments (COLAs)
• DebtorsDebtors

135. 3.5 Anticipated Inflation3.5 Anticipated Inflation
• Nominal Interest RateNominal Interest Rate
• Real Interest RateReal Interest Rate
• Inflation PremiumInflation Premium
Nominal
Interest
Rate
Real
Interest
Rate
Inflation
Premium
11%
5%
6%
= +

136. 3.6 Inflation & Economic Growth

137. 3.7 Other Inflation Issues3.7 Other Inflation Issues
• DeflationDeflation
• Mixed effectsMixed effects
• ArbitrarinessArbitrariness
• Cost-push inflation and realCost-push inflation and real
outputoutput
• Demand-pull inflation andDemand-pull inflation and
real outputreal output
• HyperinflationHyperinflation

138. 3.7.1 Demand Pull

139. 3.7.2 Stagflation

140. 3.7.3 Upward Spiral of Prices & Wages

141. 3.7.4 Phillips Curve:
Inflation vs Unemployment

142. 3.7.5 Phillip Curve Shifts

143. 3.7.6 Unemployment & NAIRU

144. 3.7.7 Costs of Disinflation

145. 3.7.8 USA Inflation & Unemployment

146. ConclusionConclusion
“High unemployment is a central flaw
in modern capitalism... Unemployment
must sometimes be kept above its
socially optimal level to ensure price
stability, and the tension between price
stability and low unemployment is one
of the cruelest dilemmas of modern
society.” Paul Samuelson

147. Core ReadingCore Reading
• Keat, Paul G. and Young, Philip KY (2009)
Managerial Economics, 6th
edition, Pearson
• Samuelson, William F. and Marks, Stephen G.
(2010) Managerial Economics, 6th
edition, John
Wiley
• Pindyck, Robert S. and Rubinfeld, Daniel L.(2013)
Microeconomics, 8th
edition, Pearson
• Samuelson, P.A. and Nordhaus, W. D.Samuelson, P.A. and Nordhaus, W. D.
(2010)(2010)“Economics”“Economics” Irwin/McGraw-Hill, 19Irwin/McGraw-Hill, 19thth
EditionEdition
• Porter, Michael E. (2004)Porter, Michael E. (2004)“Competitive Strategy –“Competitive Strategy –
Techniques for Analyzing Industries and Competitors”Techniques for Analyzing Industries and Competitors”
Free PressFree Press

148. Questions?Questions?