Variables of Macroeconomics & Circular Flow of Income and Expenditure - Macroeconomics | Macro Economics - B Com PDF Download

The macroeconomy is an aggregate picture of an entire economic environment, such as the economy of a country. It includes data on proprietary activities, including consumer spending and the hiring rates of employees by private sector businesses. Compiling this data into averages and analyzing them helps determine the economy's overall financial health. There are several key variables in a macroeconomic analysis.

Economic Output

Economic output or income is measured in terms of the gross domestic product. A higher rate tends to indicate a more economically solvent nation. Analysts measure GDP income by adding consumer spending, private investment, government spending and net exports. They calculate net exports by subtracting total imports from total exports. GDP reflects the total income earned from internal factors of production. It is also important to note that GDP calculations take into account the market value of the goods and services produced.

Unemployment Rate

The unemployment rate is the percentage of the working population that is not currently employed. The percentage only takes into account the number of people who are actively seeking employment. Those who are unemployed and not seeking jobs are "voluntarily" unemployed. Many governments set benchmark unemployment rates since they are aware that a zero rate is next to impossible. If the actual aggregate unemployment rate is at or below the benchmark rate, the economy is considered to be fully employed.

Inflation Rate

The inflation rate measures changes in the average price level based on a price index. The most commonly known index in the United States is the consumer price index. This index measures average retail prices that consumers pay. A high or increasing CPI indicates the existence of inflation. Higher prices tend to reduce overall consumer spending, which in turn leads to a decrease in GDP. While inflation itself is not negative, rapidly increasing rates of inflation signal the possibility of poor macroeconomic health.

Interest Rate

Interest rates are a reflection of the risk of borrowing. In terms of macroeconomic reporting, the interest rate is the nominal rate. Nominal rates are not adjusted for inflation. Some of the more widely known interest rates are those for a new car loan, a used car loan, a 15- or 30-year fixed mortgage and the treasury bond rate. Lower interest rates typically occur when there is a need to stimulate consumer spending. For example, if the housing market has an excess of inventory and a decline in the number of buyers, lenders might reduce mortgage interest rates to stimulate demand.

What is the circular flow?

The circular flow of income and spending shows connections between different sectors of an economy

• It shows flows of goods and services and factors of production between firms and households
• The circular flow shows how national income or Gross Domestic Product is calculated

Businesses produce goods and services and in the process of doing so, incomes are generated for factors of production (land, labour, capital and enterprise) – for example wages and salaries going to people in work.

Leakages (withdrawals) from the circular flow

Not all income will flow from households to businesses directly. The circular flow shows that some part of household income will be:

• 1.Put aside for future spending, i.e. savings (S) in banks accounts and other types of deposit
• 2.Paid to the government in taxation (T) e.g. income tax and national insurance
• 3.Spent on foreign-made goods and services, i.e. imports (M) which flow into the economy

Withdrawals are increases in savings, taxes or imports so reducing the circular flow of income and leading to a multiplied contraction of production (output)

Injections into the circular flow are additions to investment, government spending or exports so boosting the circular flow of income leading to a multiplied expansion of output.

1. Capital spending by firms, i.e. investment expenditure (I) e.g. on new technology
2. The government, i.e. government expenditure (G) e.g. on the NHS or defence
3. Overseas consumers buying UK goods and service, i.e. UK export expenditure (X)

An economy is in equilibrium when the rate of injections = the rate of withdrawals from the circular flow.

Building up the model

In this next series of images we build up the circular flow model from just having a domestic sector and then adding in an external sector (exports and imports) before including the financial sector which channels savings and hopefully provides the finance available to fund investment.

The Domestic Circular Flow of Income and Spending

The external sector involves businesses exporting goods and services overseas (X) and consumers and business buying imported products from other countries (M)

The Circular Flow of Income and Spending with the External Sector added
 

Financial Sector Added to the Circular Flow Model