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9The Economy and
Business Activity
9The Economy and
Business Activity
Macroeconomic ObjectivesMacroeconomic Objectives
• Microeconomics and macroeconomics
• The major macroeconomic issues– economic growth
– unemployment
– inflation
– balance of payments and exchange rates
• Government macroeconomic policy– controlling various intermediate variables
• interest rates, money supply, taxes, government expenditure, etc.
• Microeconomics and macroeconomics
• The major macroeconomic issues– economic growth
– unemployment
– inflation
– balance of payments and exchange rates
• Government macroeconomic policy– controlling various intermediate variables
• interest rates, money supply, taxes, government expenditure, etc.
The Circular Flow of IncomeThe Circular Flow of Income
• The inner flow• The inner flow
Factorpayments
Factorpayments
Consumption ofdomestically
produced goodsand services (Cd)
Consumption ofdomestically
produced goodsand services (Cd)
The circular flow of incomeThe circular flow of income
Firms
Households
The Circular Flow of IncomeThe Circular Flow of Income
• Withdrawals
– net saving (S)
– net taxes (T)
– import expenditure (M)
• Injections
– investment (I)
– government expenditure (G)
– export expenditure (X)
• Withdrawals
– net saving (S)
– net taxes (T)
– import expenditure (M)
• Injections
– investment (I)
– government expenditure (G)
– export expenditure (X)
Factorpayments
Factorpayments
Consumption ofdomestically
produced goodsand services (Cd)
Consumption ofdomestically
produced goodsand services (Cd)
Investment (I)Investment (I)
Governmentexpenditure (G)
Governmentexpenditure (G)
Exportexpenditure (X)
Exportexpenditure (X)
BANKS, etc
Netsaving (S)
Netsaving (S)
GOV.
Nettaxes (T)
Nettaxes (T)
ABROAD
Importexpenditure (M)
Importexpenditure (M)
The circular flow of incomeThe circular flow of income
WITHDRAWALS
INJECTIONS
The Circular Flow of IncomeThe Circular Flow of Income
• The relationship between withdrawals and injections
– the links between them
– planned injections may not equal planned withdrawals
• effect of J > W
• effect of W > J
– equilibrium in the circular flow
• The relationship between withdrawals and injections
– the links between them
– planned injections may not equal planned withdrawals
• effect of J > W
• effect of W > J
– equilibrium in the circular flow
Factorpayments
Factorpayments
Consumption ofdomestically
produced goodsand services (Cd)
Consumption ofdomestically
produced goodsand services (Cd)
Investment (I)Investment (I)
Governmentexpenditure (G)
Governmentexpenditure (G)
Exportexpenditure (X)
Exportexpenditure (X)
BANKS, etc
Netsaving (S)
Netsaving (S)
GOV.
Nettaxes (T)
Nettaxes (T)
ABROAD
Importexpenditure (M)
Importexpenditure (M)
The circular flow of incomeThe circular flow of income
WITHDRAWALS
INJECTIONS
The Circular Flow of IncomeThe Circular Flow of Income
• The relationship between withdrawals and injections
– the links between them
– planned injections may not equal planned withdrawals
• effect of J > W
• effect of W > J
– equilibrium in the circular flow
• The circular flow and the four macroeconomic objectives
• The relationship between withdrawals and injections
– the links between them
– planned injections may not equal planned withdrawals
• effect of J > W
• effect of W > J
– equilibrium in the circular flow
• The circular flow and the four macroeconomic objectives
The Determination of Business ActivityThe Determination of Business Activity
• The importance of aggregate demand
– effects of J > W
– effects of W > J
• Identifying the equilibrium level of GDP
– the 45o line diagram
• The importance of aggregate demand
– effects of J > W
– effects of W > J
• Identifying the equilibrium level of GDP
– the 45o line diagram
45°
O GDP (£bn)
GDP = Cd + W
Cd, E, W, J (£bn)
Equilibrium GDPEquilibrium GDP
The Determination of Business ActivityThe Determination of Business Activity
• The importance of aggregate demand
– effects of J > W
– effects of W > J
• Identifying the equilibrium level of GDP
– the 45o line diagram
– the GDP and E lines
• The importance of aggregate demand
– effects of J > W
– effects of W > J
• Identifying the equilibrium level of GDP
– the 45o line diagram
– the GDP and E lines
45°
O GDP (£bn)
GDP = Cd + W
E = Cd + J
Cd, E, W, J (£bn)
Cd
JJ
Equilibrium GDPEquilibrium GDP
The Determination of Business ActivityThe Determination of Business Activity
• The importance of aggregate demand
– effects of J > W
– effects of W > J
• Identifying the equilibrium level of GDP
– the 45o line diagram
– the GDP and E lines
• effects of E > GDP
• effects of GDP > E
• The importance of aggregate demand
– effects of J > W
– effects of W > J
• Identifying the equilibrium level of GDP
– the 45o line diagram
– the GDP and E lines
• effects of E > GDP
• effects of GDP > E
45°
O GDP (£bn)
GDP = Cd + W
E = Cd + J
Cd, E, W, J (£bn)
Cd
GDP1 GDP2
a
b
c
d
Equilibrium GDPEquilibrium GDP
The Determination of Business ActivityThe Determination of Business Activity
• The importance of aggregate demand
– effects of J > W
– effects of W > J
• Identifying the equilibrium level of GDP
– the 45o line diagram
– the GDP and E lines
• effects of GDP > E
• effects of E > GDP
– finding the equilibrium point
• The importance of aggregate demand
– effects of J > W
– effects of W > J
• Identifying the equilibrium level of GDP
– the 45o line diagram
– the GDP and E lines
• effects of GDP > E
• effects of E > GDP
– finding the equilibrium point
45°
O GDP (£bn)
GDP = Cd + W
E = Cd + J
Cd, E, W, J (£bn)
Cd
GDP1 GDP2GDPe
a
b
c
de
Equilibrium GDPEquilibrium GDP
The Determination of Business ActivityThe Determination of Business Activity
• The multiplier
– the multiplier process
– definition of the multiplierGDP / J
– the marginal propensity to consume domestic goods and services
• mpcd = Cd / GDP
• The multiplier
– the multiplier process
– definition of the multiplierGDP / J
– the marginal propensity to consume domestic goods and services
• mpcd = Cd / GDP
GDP
E1
O GDP (£bn)100
E2
160
Multiplier = GDP / J= 60/20 = 3
100
120
160
Cd, E, W, J (£bn)
The multiplier: a rise in aggregate expenditureThe multiplier: a rise in aggregate expenditure
Cd
J
Cd = 40
GDP = 60
GDP
The Determination of Business ActivityThe Determination of Business Activity
• The multiplier
– the multiplier process
– definition of the multiplierGDP / J
– the marginal propensity to consume domestic goods and services
• mpcd = Cd / GDP
– formula for the multiplier
• 1 / (1–mpcd)
• The multiplier
– the multiplier process
– definition of the multiplierGDP / J
– the marginal propensity to consume domestic goods and services
• mpcd = Cd / GDP
– formula for the multiplier
• 1 / (1–mpcd)
GDP
E1
O GDP (£bn)100
E2
160
Multiplier = GDP / E= 60/20 = 3
100
120
160
Cd, E, W, J (£bn)
Cd
J
Cd = 40
GDP = 60
GDP
The multiplier: a rise in aggregate expenditureThe multiplier: a rise in aggregate expenditure
The Business CycleThe Business Cycle
• Growth in actual and potential output
• Economic growth & the business cycle
– fluctuations in actual growth
– the phases of the business cycle
• the upturn
• the expansion
• the peaking out
• the slowdown or recession
• Growth in actual and potential output
• Economic growth & the business cycle
– fluctuations in actual growth
– the phases of the business cycle
• the upturn
• the expansion
• the peaking out
• the slowdown or recession
O
Nat
iona
l out
put
Time
Potential output
1
2
3
4
1
2
34Actualoutput
The business cycleThe business cycle
The Business CycleThe Business Cycle
• Growth in actual and potential output
• Economic growth & the business cycle– fluctuations in actual growth
– the phases of the business cycle• the upturn
• the expansion
• the peaking out
• the slowdown or recession
– long-term output trend
• Growth in actual and potential output
• Economic growth & the business cycle– fluctuations in actual growth
– the phases of the business cycle• the upturn
• the expansion
• the peaking out
• the slowdown or recession
– long-term output trend
O
Nat
iona
l out
put
Time
Potential output
Actualoutput
Trendoutput
The business cycleThe business cycle
The Business CycleThe Business Cycle
• Growth in actual and potential output• Economic growth & the business cycle
– fluctuations in actual growth– the phases of the business cycle
• the upturn• the expansion• the peaking out• the slowdown or recession
– long-term output trend– the business cycle in practice
• Growth in actual and potential output• Economic growth & the business cycle
– fluctuations in actual growth– the phases of the business cycle
• the upturn• the expansion• the peaking out• the slowdown or recession
– long-term output trend– the business cycle in practice
The Business CycleThe Business Cycle
• Growth in actual and potential output• Economic growth & the business cycle
– fluctuations in actual growth– the phases of the business cycle
• the upturn• the expansion• the peaking out• the slowdown or recession
– long-term output trend– the business cycle in practice
• the length of the phases
• Growth in actual and potential output• Economic growth & the business cycle
– fluctuations in actual growth– the phases of the business cycle
• the upturn• the expansion• the peaking out• the slowdown or recession
– long-term output trend– the business cycle in practice
• the length of the phases
The Business CycleThe Business Cycle
• Growth in actual and potential output• Economic growth & the business cycle
– fluctuations in actual growth– the phases of the business cycle
• the upturn• the expansion• the peaking out• the slowdown or recession
– long-term output trend– the business cycle in practice
• the length of the phases• the magnitude of the phases
• Growth in actual and potential output• Economic growth & the business cycle
– fluctuations in actual growth– the phases of the business cycle
• the upturn• the expansion• the peaking out• the slowdown or recession
– long-term output trend– the business cycle in practice
• the length of the phases• the magnitude of the phases
Ann
ual g
row
th r
ate
(%)
UK
Growth rates in selected industrial countriesGrowth rates in selected industrial countries
-3
-2
-1
0
1
2
3
4
5
6
7
8
9
10
1970 1975 1980 1985 1990 1995 2000 2005
Ann
ual g
row
th r
ate
(%)
UK
Growth rates in selected industrial countriesGrowth rates in selected industrial countries
-3
-2
-1
0
1
2
3
4
5
6
7
8
9
10
1970 1975 1980 1985 1990 1995 2000 2005
Ann
ual g
row
th r
ate
(%)
Growth rates in selected industrial countriesGrowth rates in selected industrial countries
-3
-2
-1
0
1
2
3
4
5
6
7
8
9
10
1970 1975 1980 1985 1990 1995 2000 2005
UK
EU15
Ann
ual g
row
th r
ate
(%)
Growth rates in selected industrial countriesGrowth rates in selected industrial countries
-3
-2
-1
0
1
2
3
4
5
6
7
8
9
10
1970 1975 1980 1985 1990 1995 2000 2005
UK
EU15
Ann
ual g
row
th r
ate
(%)
Growth rates in selected industrial countriesGrowth rates in selected industrial countries
-3
-2
-1
0
1
2
3
4
5
6
7
8
9
10
1970 1975 1980 1985 1990 1995 2000 2005
UK
EU15
USA
Ann
ual g
row
th r
ate
(%)
Growth rates in selected industrial countriesGrowth rates in selected industrial countries
-3
-2
-1
0
1
2
3
4
5
6
7
8
9
10
1970 1975 1980 1985 1990 1995 2000 2005
UK
EU15
USA
Ann
ual g
row
th r
ate
(%)
Growth rates in selected industrial countriesGrowth rates in selected industrial countries
-3
-2
-1
0
1
2
3
4
5
6
7
8
9
10
1970 1975 1980 1985 1990 1995 2000 2005
UK
EU15 Japan
USA
Ann
ual g
row
th r
ate
(%)
Growth rates in selected industrial countriesGrowth rates in selected industrial countries
-3
-2
-1
0
1
2
3
4
5
6
7
8
9
10
1970 1975 1980 1985 1990 1995 2000 2005
UK
EU15 Japan
USA
The Business CycleThe Business Cycle
• Causes of cyclical fluctuations– Why does AD change in the first place?– Why do booms and recessions persist?
• time lags• bandwagon effects
– the accelerator
– Why do booms and recessions end?• ceilings and floors• echo effects• the accelerator• random shocks• changes in government policy
• Causes of cyclical fluctuations– Why does AD change in the first place?– Why do booms and recessions persist?
• time lags• bandwagon effects
– the accelerator
– Why do booms and recessions end?• ceilings and floors• echo effects• the accelerator• random shocks• changes in government policy
Money, Interest Rates and Business ActivityMoney, Interest Rates and Business Activity
• The meaning of money– narrow definitions of money (M0 in the UK)
– broad definitions of money (M4 in the UK)
• The supply of money– banks and the creation of credit
• simple illustration
• The meaning of money– narrow definitions of money (M0 in the UK)
– broad definitions of money (M4 in the UK)
• The supply of money– banks and the creation of credit
• simple illustration
Credit creation: Banks' original balance sheetCredit creation: Banks' original balance sheet
Credit creation: Effect of a new deposit of £10bn Credit creation: Effect of a new deposit of £10bn
Credit creation: Full effect of a new deposit of £10bn Credit creation: Full effect of a new deposit of £10bn
Money, Interest Rates and Business ActivityMoney, Interest Rates and Business Activity
• The meaning of money– narrow definitions of money (M0 in the UK)
– broad definitions of money (M4 in the UK)
• The supply of money– banks and the creation of credit
• simple illustration
• the deposits multiplier
• The meaning of money– narrow definitions of money (M0 in the UK)
– broad definitions of money (M4 in the UK)
• The supply of money– banks and the creation of credit
• simple illustration
• the deposits multiplier
Money, Interest Rates and Business ActivityMoney, Interest Rates and Business Activity
• The meaning of money– narrow definitions of money (M0 in the UK)
– broad definitions of money (M4 in the UK)
• The supply of money– banks and the creation of credit
• simple illustration
• the deposits multiplier
– creation of credit: the real world
• The meaning of money– narrow definitions of money (M0 in the UK)
– broad definitions of money (M4 in the UK)
• The supply of money– banks and the creation of credit
• simple illustration
• the deposits multiplier
– creation of credit: the real world
Money, Interest Rates and Business ActivityMoney, Interest Rates and Business Activity
• The meaning of money– narrow definitions of money (M0 in the UK)
– broad definitions of money (M4 in the UK)
• The supply of money– banks and the creation of credit
• simple illustration
• the deposits multiplier
– creation of credit: the real world• banks' liquidity ratio may vary
• The meaning of money– narrow definitions of money (M0 in the UK)
– broad definitions of money (M4 in the UK)
• The supply of money– banks and the creation of credit
• simple illustration
• the deposits multiplier
– creation of credit: the real world• banks' liquidity ratio may vary
Money, Interest Rates and Business ActivityMoney, Interest Rates and Business Activity
• The meaning of money– narrow definitions of money (M0 in the UK)
– broad definitions of money (M4 in the UK)
• The supply of money– banks and the creation of credit
• simple illustration
• the deposits multiplier
– creation of credit: the real world• banks' liquidity ratio may vary
• banks respond to the demand for money
• The meaning of money– narrow definitions of money (M0 in the UK)
– broad definitions of money (M4 in the UK)
• The supply of money– banks and the creation of credit
• simple illustration
• the deposits multiplier
– creation of credit: the real world• banks' liquidity ratio may vary
• banks respond to the demand for money
• Causes of increases in money supply
– increased demand for money
• banks reduce liquidity ratio
– inflow of funds from abroad
– a public-sector deficit (PSNCR)
• depends on how it is financed
– from banking sector: money supply expands
– from outside the banking sector: money supply does not expand
• Causes of increases in money supply
– increased demand for money
• banks reduce liquidity ratio
– inflow of funds from abroad
– a public-sector deficit (PSNCR)
• depends on how it is financed
– from banking sector: money supply expands
– from outside the banking sector: money supply does not expand
Money, Interest Rates and Business ActivityMoney, Interest Rates and Business Activity
• The demand for money
– reasons for holding money
• transactions and precautionary motive
• assets or speculative motive
– determinants of demand for money
• money national income
• speculation about future return on assets
• rate of interest
• The demand for money
– reasons for holding money
• transactions and precautionary motive
• assets or speculative motive
– determinants of demand for money
• money national income
• speculation about future return on assets
• rate of interest
Money, Interest Rates and Business ActivityMoney, Interest Rates and Business Activity
• Equilibrium rate of interest
– where demand for money equals supply
• Equilibrium rate of interest
– where demand for money equals supply
Money, Interest Rates and Business ActivityMoney, Interest Rates and Business Activity
OMoney
Ra
te o
f in
tere
st
Md
re
Equilibrium in the money marketEquilibrium in the money market
MS
• Equilibrium rate of interest
– where demand for money equals supply
– if supply of money rises or demand for money falls, the rate of interest will fall
• Equilibrium rate of interest
– where demand for money equals supply
– if supply of money rises or demand for money falls, the rate of interest will fall
Money, Interest Rates and Business ActivityMoney, Interest Rates and Business Activity
OMoney
Ra
te o
f in
tere
st
Md
re
Equilibrium in the money marketEquilibrium in the money market
MS
• Effects of changes in money supply on national income
– rise in money supply causes interest rate to fall
– fall in interest rate causes investment to rise
– rise in investment causes GDP to rise
• Determinants of the size of these effects
• Effects of changes in money supply on national income
– rise in money supply causes interest rate to fall
– fall in interest rate causes investment to rise
– rise in investment causes GDP to rise
• Determinants of the size of these effects
Money, Interest Rates and Business ActivityMoney, Interest Rates and Business Activity
UnemploymentUnemployment
• Measuring unemployment
– defining the unemployment rate
– claimant unemployment
• do claimant statistics give a true picture of unemployment?
– standardised unemployment (ILO/OECD)
• use of labour force surveys
• Measuring unemployment
– defining the unemployment rate
– claimant unemployment
• do claimant statistics give a true picture of unemployment?
– standardised unemployment (ILO/OECD)
• use of labour force surveys
UnemploymentUnemployment
• Unemployment and the labour market
– the aggregate demand and supply of labour
• Unemployment and the labour market
– the aggregate demand and supply of labour
Aggregate demand and supply of labourAggregate demand and supply of labour
O
Ave
rag
e (r
ea
l) w
ag
e ra
te
No. of workers
ASL
ADL
UnemploymentUnemployment
• Unemployment and the labour market
– the aggregate demand and supply of labour
• equilibrium in the model
• Unemployment and the labour market
– the aggregate demand and supply of labour
• equilibrium in the model
QeO
Ave
rag
e (r
ea
l) w
ag
e ra
te
No. of workers
ASL
ADL
We
Aggregate demand and supply of labourAggregate demand and supply of labour
UnemploymentUnemployment
• Unemployment and the labour market
– the aggregate demand and supply of labour
• equilibrium in the model
– disequilibrium unemployment
• Unemployment and the labour market
– the aggregate demand and supply of labour
• equilibrium in the model
– disequilibrium unemployment
O
Ave
rag
e (r
ea
l) w
ag
e ra
te
No. of workers
ASL
ADL
We
W2
Disequilibrium unemploymentDisequilibrium unemployment
Q2 Q1
B A
UnemploymentUnemployment
• Unemployment and the labour market
– the aggregate demand and supply of labour
• equilibrium in the model
– disequilibrium unemployment
– equilibrium unemployment
• Unemployment and the labour market
– the aggregate demand and supply of labour
• equilibrium in the model
– disequilibrium unemployment
– equilibrium unemployment
Equilibrium unemploymentEquilibrium unemployment
O
Ave
rag
e (r
ea
l) w
ag
e ra
te
No. of workers
ADL
We
ASL
e
Qe
Q2QeO
Ave
rag
e (r
ea
l) w
ag
e ra
te
No. of workers
ASL
ADL
We
N
e d
Equilibrium unemploymentEquilibrium unemployment
Equilibrium and disequilibrium unemploymentEquilibrium and disequilibrium unemployment
O
Ave
rag
e (r
ea
l) w
ag
e ra
te
No. of workers
ADL
We
e
Qe
ASL
O
Ave
rag
e (r
ea
l) w
ag
e ra
te
No. of workers
ASL
ADL
We
W2
b a
e
Disequilibriumunemployment
Equilibrium and disequilibrium unemploymentEquilibrium and disequilibrium unemployment
O
Ave
rag
e (r
ea
l) w
ag
e ra
te
No. of workers
ASL
ADL
We
W2
b a
e
N
c
Equilibriumunemployment
Disequilibriumunemployment
Equilibrium and disequilibrium unemploymentEquilibrium and disequilibrium unemployment
UnemploymentUnemployment
• Unemployment and the labour market
– the aggregate demand and supply of labour
• equilibrium in the model
– disequilibrium unemployment
– equilibrium unemployment
• Disequilibrium unemployment
• Unemployment and the labour market
– the aggregate demand and supply of labour
• equilibrium in the model
– disequilibrium unemployment
– equilibrium unemployment
• Disequilibrium unemployment
UnemploymentUnemployment
• Unemployment and the labour market
– the aggregate demand and supply of labour
• equilibrium in the model
– disequilibrium unemployment
– equilibrium unemployment
• Disequilibrium unemployment
– real-wage unemployment
• Unemployment and the labour market
– the aggregate demand and supply of labour
• equilibrium in the model
– disequilibrium unemployment
– equilibrium unemployment
• Disequilibrium unemployment
– real-wage unemployment
UnemploymentUnemployment
• Unemployment and the labour market
– the aggregate demand and supply of labour
• equilibrium in the model
– disequilibrium unemployment
– equilibrium unemployment
• Disequilibrium unemployment
– real-wage unemployment
– demand-deficient (cyclical) unemployment
• Unemployment and the labour market
– the aggregate demand and supply of labour
• equilibrium in the model
– disequilibrium unemployment
– equilibrium unemployment
• Disequilibrium unemployment
– real-wage unemployment
– demand-deficient (cyclical) unemployment
Ann
ual g
row
th r
ate
(%)
UK
Unemployment rates in selected industrial countriesUnemployment rates in selected industrial countries
0
2
4
6
8
10
12
14
1970 1975 1980 1985 1990 1995 2000 2005
Ann
ual g
row
th r
ate
(%)
UK
0
2
4
6
8
10
12
14
1970 1975 1980 1985 1990 1995 2000 2005
Unemployment rates in selected industrial countriesUnemployment rates in selected industrial countries
0
2
4
6
8
10
12
14
1970 1975 1980 1985 1990 1995 2000 2005
Ann
ual g
row
th r
ate
(%)
UK
EU15
Unemployment rates in selected industrial countriesUnemployment rates in selected industrial countries
0
2
4
6
8
10
12
14
1970 1975 1980 1985 1990 1995 2000 2005
Ann
ual g
row
th r
ate
(%)
UK
EU15
Unemployment rates in selected industrial countriesUnemployment rates in selected industrial countries
0
2
4
6
8
10
12
14
1970 1975 1980 1985 1990 1995 2000 2005
Ann
ual g
row
th r
ate
(%)
UK
EU15
USA
Unemployment rates in selected industrial countriesUnemployment rates in selected industrial countries
0
2
4
6
8
10
12
14
1970 1975 1980 1985 1990 1995 2000 2005
Ann
ual g
row
th r
ate
(%)
UK
EU15
USA
Unemployment rates in selected industrial countriesUnemployment rates in selected industrial countries
0
2
4
6
8
10
12
14
1970 1975 1980 1985 1990 1995 2000 2005
Ann
ual g
row
th r
ate
(%)
UK
EU15 Japan
USA
Unemployment rates in selected industrial countriesUnemployment rates in selected industrial countries
0
2
4
6
8
10
12
14
1970 1975 1980 1985 1990 1995 2000 2005
Ann
ual g
row
th r
ate
(%)
UK
EU15 Japan
USA
Unemployment rates in selected industrial countriesUnemployment rates in selected industrial countries
UnemploymentUnemployment
• Equilibrium unemployment
– frictional (search) unemployment
– structural unemployment
• changing pattern of demand
• technological unemployment
• regional unemployment
– seasonal unemployment
• Equilibrium unemployment
– frictional (search) unemployment
– structural unemployment
• changing pattern of demand
• technological unemployment
• regional unemployment
– seasonal unemployment
InflationInflation
• Defining inflation
– consumer price inflation
– other categories of inflation
• Inflation in historical perspective
– low inflation in 1950s and 60s
– high inflation in 1970s and 80s
– low inflation since mid 1990s
• most developed countries gear monetary policy to achieving a low target rate of inflation
• Defining inflation
– consumer price inflation
– other categories of inflation
• Inflation in historical perspective
– low inflation in 1950s and 60s
– high inflation in 1970s and 80s
– low inflation since mid 1990s
• most developed countries gear monetary policy to achieving a low target rate of inflation
Ann
ual g
row
th r
ate
(%)
UK
Inflation rates in selected industrial countriesInflation rates in selected industrial countries
-2
0
2
4
6
8
10
12
14
16
18
20
22
24
26
1965 1970 1975 1980 1985 1990 1995 2000 2005
Ann
ual g
row
th r
ate
(%)
UK
-2
0
2
4
6
8
10
12
14
16
18
20
22
24
26
1965 1970 1975 1980 1985 1990 1995 2000 2005
Inflation rates in selected industrial countriesInflation rates in selected industrial countries
-2
0
2
4
6
8
10
12
14
16
18
20
22
24
26
1965 1970 1975 1980 1985 1990 1995 2000 2005
Ann
ual g
row
th r
ate
(%)
UK
EU15
Inflation rates in selected industrial countriesInflation rates in selected industrial countries
-2
0
2
4
6
8
10
12
14
16
18
20
22
24
26
1965 1970 1975 1980 1985 1990 1995 2000 2005
Ann
ual g
row
th r
ate
(%)
UK
EU15
Inflation rates in selected industrial countriesInflation rates in selected industrial countries
-2
0
2
4
6
8
10
12
14
16
18
20
22
24
26
1965 1970 1975 1980 1985 1990 1995 2000 2005
Ann
ual g
row
th r
ate
(%)
UK
EU15
USA
Inflation rates in selected industrial countriesInflation rates in selected industrial countries
-2
0
2
4
6
8
10
12
14
16
18
20
22
24
26
1965 1970 1975 1980 1985 1990 1995 2000 2005
Ann
ual g
row
th r
ate
(%)
UK
EU15
USA
Inflation rates in selected industrial countriesInflation rates in selected industrial countries
-2
0
2
4
6
8
10
12
14
16
18
20
22
24
26
1965 1970 1975 1980 1985 1990 1995 2000 2005
Ann
ual g
row
th r
ate
(%)
UK
EU15 Japan
USA
Inflation rates in selected industrial countriesInflation rates in selected industrial countries
-2
0
2
4
6
8
10
12
14
16
18
20
22
24
26
1965 1970 1975 1980 1985 1990 1995 2000 2005
Ann
ual g
row
th r
ate
(%)
UK
EU15 Japan
USA
Inflation rates in selected industrial countriesInflation rates in selected industrial countries
InflationInflation
• Aggregate demand & supply and prices
– aggregate demand curve
• Aggregate demand & supply and prices
– aggregate demand curve
O
Pri
ce le
vel
National output
AD
Aggregate demand and aggregate supplyAggregate demand and aggregate supply
InflationInflation
• Aggregate demand & supply and prices
– aggregate demand curve
• why AD curves slope downwards
• Aggregate demand & supply and prices
– aggregate demand curve
• why AD curves slope downwards
InflationInflation
• Aggregate demand & supply and prices
– aggregate demand curve
• why AD curves slope downwards– lower price level leads to fewer imports
– lower price level tends to cause interest rates to fall
– lower price level increases value of people's savings
• Aggregate demand & supply and prices
– aggregate demand curve
• why AD curves slope downwards– lower price level leads to fewer imports
– lower price level tends to cause interest rates to fall
– lower price level increases value of people's savings
InflationInflation
• Aggregate demand & supply and prices
– aggregate demand curve
• why AD curves slope downwards– lower price level leads to fewer imports
– lower price level tends to cause interest rates to fall
– lower price level increases value of people's savings
– aggregate supply curve
• Aggregate demand & supply and prices
– aggregate demand curve
• why AD curves slope downwards– lower price level leads to fewer imports
– lower price level tends to cause interest rates to fall
– lower price level increases value of people's savings
– aggregate supply curve
O
Pri
ce le
vel
National output
AS
AD
Aggregate demand and aggregate supplyAggregate demand and aggregate supply
InflationInflation
• Aggregate demand & supply and prices
– aggregate demand curve
• why AD curves slope downwards– lower price level leads to fewer imports
– lower price level tends to cause interest rates to fall
– lower price level increases value of people's savings
– aggregate supply curve
• why AS curves generally slope upwards
• Aggregate demand & supply and prices
– aggregate demand curve
• why AD curves slope downwards– lower price level leads to fewer imports
– lower price level tends to cause interest rates to fall
– lower price level increases value of people's savings
– aggregate supply curve
• why AS curves generally slope upwards
InflationInflation
• Aggregate demand & supply and prices
– aggregate demand curve
• why AD curves slope downwards– lower price level leads to fewer imports
– lower price level tends to cause interest rates to fall
– lower price level increases value of people's savings
– aggregate supply curve
• why AS curves generally slope upwards
– equilibrium
• Aggregate demand & supply and prices
– aggregate demand curve
• why AD curves slope downwards– lower price level leads to fewer imports
– lower price level tends to cause interest rates to fall
– lower price level increases value of people's savings
– aggregate supply curve
• why AS curves generally slope upwards
– equilibrium
O
Pri
ce le
vel
National output
AS
AD
Pe
Aggregate demand and aggregate supplyAggregate demand and aggregate supply
O
Pri
ce le
vel
National output
AS
AD
Pe
P2
ab
Aggregate demand and aggregate supplyAggregate demand and aggregate supply
InflationInflation
• Aggregate demand & supply and prices
– aggregate demand curve
• why AD curves slope downwards– lower price level leads to fewer imports
– lower price level tends to cause interest rates to fall
– lower price level increases value of people's savings
– aggregate supply curve
• why AS curves generally slope upwards
– equilibrium
– shifts in AD and AS curves
• Aggregate demand & supply and prices
– aggregate demand curve
• why AD curves slope downwards– lower price level leads to fewer imports
– lower price level tends to cause interest rates to fall
– lower price level increases value of people's savings
– aggregate supply curve
• why AS curves generally slope upwards
– equilibrium
– shifts in AD and AS curves
InflationInflation
• Causes of inflation– demand pull
• Causes of inflation– demand pull
Demand-pull inflationDemand-pull inflation
O
Pri
ce le
vel
National output
AS
AD1
P1
Q1
O
Pri
ce le
vel
National output
AS
AD1
P1
Q1
AD2
Demand-pull inflationDemand-pull inflation
O
Pri
ce le
vel
National output
AS
AD1
P1
Q1
AD2
P2
Q2
Demand-pull inflationDemand-pull inflation
InflationInflation
• Causes of inflation– demand pull
– cost push• wage push
• profit push
• import-price push
• Causes of inflation– demand pull
– cost push• wage push
• profit push
• import-price push
Cost-push inflationCost-push inflation
O
Pri
ce le
vel
National output
AS1
AD
P1
Q1
O
Pri
ce le
vel
National output
AS1
AD
P1
Q1
AS2
Cost-push inflationCost-push inflation
O
Pri
ce le
vel
National output
AS1
AD
P1
Q1
AS2
P2
Q2
Cost-push inflationCost-push inflation
InflationInflation
• Causes of inflation– demand pull
– cost push• wage push
• profit push
• import-price push
– the interaction of demand-pull and cost-push inflation
• Causes of inflation– demand pull
– cost push• wage push
• profit push
• import-price push
– the interaction of demand-pull and cost-push inflation
The interaction of demand-pull and cost-push inflationThe interaction of demand-pull and cost-push inflation
O
Pri
ce le
vel
National output
AS1
AD1
P1
O
Pri
ce le
vel
National output
AS1
AD1
P1
AS2
AD2
P2
The interaction of demand-pull and cost-push inflationThe interaction of demand-pull and cost-push inflation
O
Pri
ce le
vel
National output
AS1
AD1
P1
AD2
P2
AS3
AD3
P3
AS2
The interaction of demand-pull and cost-push inflationThe interaction of demand-pull and cost-push inflation
InflationInflation
• Causes of inflation– demand pull
– cost push• wage push
• profit push
• import-price push
– expectations and inflation
• Causes of inflation– demand pull
– cost push• wage push
• profit push
• import-price push
– expectations and inflation
InflationInflation
• Causes of inflation– demand pull
– cost push• wage push
• profit push
• import-price push
– expectations and inflation
• Policies to tackle inflation
• Causes of inflation– demand pull
– cost push• wage push
• profit push
• import-price push
– expectations and inflation
• Policies to tackle inflation
InflationInflation
• Causes of inflation– demand pull
– cost push• wage push
• profit push
• import-price push
– expectations and inflation
• Policies to tackle inflation– demand-side policies
• Causes of inflation– demand pull
– cost push• wage push
• profit push
• import-price push
– expectations and inflation
• Policies to tackle inflation– demand-side policies
InflationInflation
• Causes of inflation– demand pull
– cost push• wage push
• profit push
• import-price push
– expectations and inflation
• Policies to tackle inflation– demand-side policies
– supply-side policies
• Causes of inflation– demand pull
– cost push• wage push
• profit push
• import-price push
– expectations and inflation
• Policies to tackle inflation– demand-side policies
– supply-side policies