lecture 3 - micro and macro economics
lecture 3 - micro and macro economics
Macro economics - The larger Economic environment influences managerial decisions. eg changes in the overall level of economic activity, interest rates, unemployment, exchange raters at home and abroad create challenges and opportunities.
Circular flow - model portraysnthe level of economic actiity in a country as a flow of expenditure from the household sector to firms as consumers purchase goods and services currently produced and sold in output markets
The flow then returns to consumers as income received for supplying firms with inputs
Overall macro environment is influenced by aggregare soebdubf decicisons of consumers, governments etc
The interaction between these factors such as lack of consumer conidence and decerases in government employment for example can influence economic recovery.
There are various indicators of economic activity The divergence makes it difficult to predict
Equlibrium is the stble level of output and income
Managers need to be aware of the price level and the level of unemployment is going as changes in these can affect the demand and customer base for products and costs.
Large chages in these variables will inevitably mean the government stepping in for policy changes.
Price level and unemployment:
Prices and wages determint te value of employment to workers and firms
Understanding macro must be built on microeconomic foundations
Not only the price of goods and services important but also wages paid and the price of debt all has a major effect
Over time wage ad debt agreements price will have different values in the future due to inflation
Inflations as enormous impications
Wage growth - if less thatn inflation then workers become cheaper to hire and their value increases. In contrast when inflation falls behind wage growth then workers are more expensive and firms reduce employment and output.
Understanding of how inflation and wages inpact on output is crucial for companies to understand the future math of the macr environment
In short run enexpected changes in inflation result in imacted revenues and costs
Worsening progit results in falling output whereas rising profit results in increased output
Manaers need to undersnd the adjustment process to understand how the economy works
The Phillips Curve:
Lower unemployment is associated with hugher inflation
Trade off between unemployment and inflation
Problems when relatuonship broke down as we had unemployment rising whilst inflation was rising
Trade off only existed in the short run.
AMerican eonomists Fridament and Phelps stepped in and offered explanation - there is not one curve but lots of short run curves which build the long term curve. In thelong term there is no trade off between unemployment and inflation
Natural rate of unemployment - cvan be achieved without inflation rise
One aim is to promote full employment
Policy does not seek zero unemployment asn some will always exist
According to the new classical view, what happens depends on where the price inflation has been understood and expected, in which case there is no money illusion.
If workers have bd up wages they have suffered from money illusions, falsely believing they would be better off. In that case inflation would be a temporary phenomena.
Does the trade off stil exist?
UK between 1993 and 2008 there was record lows of employment and inflation did not rise. This is claimed to be due to successful supply side policies.
UK inflation 1993 - 2017:
Stats on iflationand unemployment supports this view however in 2017 we found that the relationship had returned as an inverse statistical relationship returning. Many argue however is that the rise in inflation is more cost cutting inflation due to post brexit and falls in Sterling
Impact of Macro changes on decisions:
Changes in the macro affect firms and infustries through the micro factos of demand, prod, cost and profit
Managers need to be able to address how much demand and supply are changing in the economy
Need to ndestand consumption, investment, government spending and exports
Aggregate supply is influenced by costs faced by firms
When price of key inputs incerase such aas oil, then firms are less willing to supply and aggregate supply will fall
Managers need to be able to react to both policy changes and other affregate spending changes in order to determine the optimal strategies for their firms
Circular Flow of Income.
consumers and producers interact in two broad types of market
Market for goods and services - output of firms
2 market for resources - the firms inputs. this includes labour, which we as workers effectively 'sell' to firms
This generates a flow of goods and services from households to firms and vice versa
Managers need to understand and may purchase services of consultants
Managers also need to recognise different effects
FIrms in internaitonl ,arkets afected by exchange rates
All firms affected bu changes in overall levels of GDP
Plocy makers use taxes and government expenitures as tools to influence the grouwth of GDP
These tools include policies tat influence aggregate expenditure
The Central bank uses control over money suppley to change interest rates and credit to influence consumer and business spending
All of these institutuions must respond to changes in a country's currency exchange rate, the trade balance and capital flows
We can think of this like flying a plane, where the piot can change an input to influence the flight path. Governments do the same with their economies. Different variables like inflation or unemployment
We focus on short run macro issues as these tend to be the most affecting.
Managers competitice strartegues are influenced by macro environ changes over the next dew months, quarters and years and not the distant future because most business plans are three and five years
Personal Consumptive expenditure:
AMount of spending by households on durable, nondurable goods and services in a given period
Consumption function - fundamnetal relationship in macro that assumes that household consumptuon spending is primary on the level of disposalbe income in the economy, if all other variables are constant.
Marginal propensity to consume the additional consumptions depending on real income
The impact of changes in overall real income on individual firms and managers strats deoends on the factors that affect the demand for that firm's prducts and in teur reactions to changes in income.
Interest rates -
This is a detemrminant of business spending.
However interest rates can also influence consumer spending on durale goods such as cars and appliances.
The real interest rate is the nominal rate adusted for expected inglation that influences spending decisions.
The nominal rate is the reported rate
Wealth - households can finance consumption expenditure out of their existing stoc of wealth
Eealth effect of the stock market has a significant effect on household spending
Several studies have reoirted that there is a greater wealth effect on consumer expenditure from the capital gains in housing rather than the stock market.
Availability of credit also influences personal spending
Gross private domestic investment - total amount of spending on business structures, equipment and software, residential structures and business inventory
Firms invest in structures and equipment etc to provide the capacity to proudce increased amounst of goods as the economy grows or to replace items
Resdidential is investement in housing etc
Investment on structures is related to the level of real invcome and output
The portion of investment spending related to the replacement of existing facilities tends to be stale over time
However business do not want excess capacity
Investment spending can be deferred and firms can sustain production with existing infrastructure
Real interest rate affects the cost of new capital goos.
The rate of return of an invest must be greater than the cost of financing
The response to interest rate changes differs between consumption and the various components of investment. Studies have shown that an unexpected tightening of monetary policy impacts final demand whihc falls soon after. Residential investment experiences the quickest and declines on spending