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Notes on reading Essentials of Economics
By J. Sloman and D. Garratt
FT/ Prentice Hall
ISBN: 0273722514
2009, 500 pp., £44.99
The book delivers on its title; it provides an understandable way into the field of economics. It is clearly written and easy to read.
Ch. 8: Aggregate demand
Macroeconomics: 4 major objectives relating to: economic growth, unemployment, inflation and the balance of payments. 'The pursuit of any of these objectives will make any of the others worse.'
Aggregare Demand (AD): total spending on goods and services made in the economy, made up by consumer spending, investment, government spending and expenditure on exports.
The circular flow of income - withdrawals and injections. Disequilibrium that eventually brings equilibrium.
AD=C(d)+J. Household spending accounts for at least half of it.
Multiplier effect: an x increase in AD will lead to an increase in national income exceeding x, until withdrawals rise and equilibrium is reached.
Equilibrium shown with the withdrawals and injections approach, where W=J and Y=E, or the income and expenditure approach (p. 253-5).
GDP measured in 3 ways:
-the product method: adding up the value of goods and services produced in the country.
-the income method: adding up the income generated from the production of goods and services produced in the country.
-the expenditure method: adding up all the expenditure on final output.
Ch. 9: Aggregate Supply and Growth
The AD-AS model: devised to take account of prices impact on demand and supply decisions, sth that the circular flow model and the Keynensian multiplier model don't.
Growth: the % annual increase in national output.
2 major growth issues: keeping actual output as close as possible to potential output; and the long-term issue of what determines the rate of potential growth.
Business cycle: four phases.
Fluctuations in BC attributed to fluctuations in AD by Keynensians.
Instability of investment and the Accelerator theory: the level of investment depends on the rate of change of national income/ output/ demand and not so much on its level, and therefore is unstable (p282-3).
Fluctuations in BC attributed to fluctuations in AS by new classical economists.
Long-term economic growth depends on the supply side.
Long-term economic growth depends on the growth of the quantity and/ or productivity of a country's resources.
Capital accumulation. An increase in capital requires investment, which requires more saving.
The neoclassical growth model has two qualifications: diminishing returns to capital and increased proportion of investment going for replacement purposes. Solow growth model (p. 291).
A higher long-term rate of growth will require a faster rate of technological progress.
Endogenous growth theory stressing the need for innovation.
Ch. 10: Banking and Interest rates
Retail banking/ wholesale banking
Assets/ liabilities
Balance between profitability and liquidity. Liquid assets tend to be relatively unprofitable and illiquid assets tend to be relatively profitable.
Banks central in the process of credit creation (p322-4).
Ch. 11: Inflation and unemployment
Inflation refers rising price levels. Not confuse a rise or fall in the rate of inflation with a rise or fall in prices; a fall in the rate of inflation means a slower increase in prices, but still an increase as long as the the rate of inflation is positive.
Causes of inflation:
-demand-pull inflation
-cost-push inflation
These causes can occur together.
Expectations of inflation result in the realization of these expectations.
70's-80's monetarists/ contemporary new classical economists: inflation can be attributed entirely to increases in money supply (quantity theory of money - the equation of exchange)
Keynensians see a much looser connection between money and inflation.
Controversy focuses on what is the impact of an increase in money supply (1) to AD (2) and what is the impact of an increase in AD to output (3).
Summary: The effect of a change in 1 on 2 can be quite strong or quite small in the short run, depending on variables (p. 346).
In the long-run, there is no connection between the two (theory of portfolio balance).
Point of controversy: What would the impact be of an increase of 2 on inflation (4) and 3?
In the short-run, there is a positive impact of a rise in 2 on 3.
In the long-run, monetarists claim that there will be higher inflation but no higher output. Keynensians claim that there would be higher output too.
How will changes in AD affect inflation and unemployment?
Recessionary gap/ inflationary gap.
Keynensians advocate an active demand mgt policy.
The Philips curve, showing the relationship between inflation and unemployment.
From 1966 onwards it seemed to break down though.
Monetarists' 'expectations augmented Philips curve'. There is a vertical long-run Philips curve, i.e. there is no connection between inflation and unemployment, i.e. government policy to reduce unemployment by rising AD is futile.
Accelerationist theory: the theory that unemployment can only be reduced below the natural rate at the cost of accelerating inflation.
If equilibrium national income is below the full-employment level of national income, there will be a recessionary gap. The gap can be closed by increasing injections or reducing withdrawals.
The opposite will cause demand-pull inflation.
Ch. 12: Macroeconomic policy
Fiscal policy (FP): policy to affect AD by altering government expenditure and/ or taxation.
Discretionary FP vs target-oriented FP.
Monetary policy: it involves the Central Bank intervening in the money market to ensure that the interest rate that has been announced is also the equilibrium interest rate.
What is the goal of the policy? to control inflation? to affect output and employment? to control the exchange rate?
To control money growth, governments need to control money supply. Two sources of money supply: banks holding lower liquidity ratios (increasing minimum reserve ratio) and governments borrowing from the banking sector ( but danger of financial crowding out).
Short-term monetary measures: governments: altering the money supply; altering interest rates; and rationing credit.
Techniques to control the money supply: open-market operations (the sale or purchase by the government of government securities), the central bank lending to the banks, altering banks' reserve ratio and changing the funding mix of government debt.
Demand-side policy
Debate focusing on whether governments should pursue an active demand mgt policy (Keynensians) or set firm rules (monetarists).
Supply-side policy: policies aiming to influence the quantities of the factors empoyed (labour and capital) and their effectiveness in production. They can be either market-orientated or interventionist.
Ch. 13: Int'l Trade
Two major components of globalization: trade and financial markets.
Specialisation as the basis for trade.
Law of comparative advantage
Arguments for restricting trade
Trade strategies in development:
-primary outward-looking stage,
-secondary inward-looking stage (import-substituting industrialization)
-secondary outward-looking stage
Ch. 14: Balance of payments and Exchange rates
Balance of payments account: a record of all flows of money between residents of a country and the rest of the world; made up of: the current account, the capital account and the financial account.
Balance of payments and the circular flow model (ch. 8): injections must equal withdrawals. A net withdrawal on the balance of trade must be offset by a net injection elsewhere: either investment exceeding saving and/ or government expenditure exceeding tax revenue.
Floating ER: when the government doesn't intervene in the foreign ER markets, but allows the ER to be freely determined by D & S.
Banks make money by exchanging currency, and they don't want to be left holding large amounts of it unsold. They would therefore adjust ER accordingly, depending on D&S.
What causes currency demand and supply to shift?
-a fall in domestic interest rates
-higher domestic rates of inflation
-rise in domestic incomes
-investment prospects improving abroad
-speculation that the ER will fall.
Ways for a government to intervene:
-using reserves
-borrowing from abroad
-raising interest rates
-contractionary policies (p. 478)
-Supply-side policies
-controls on imports and/or foreign exchange dealing.
Pros and cons of free-floating/ fixed ER.
Notes on reading Essentials of Economics By J. Sloman and D. Garratt
FT/ Prentice Hall
ISBN: 0273722514
2009, 500 pp., £44.99
The book delivers on its title; it provides an understandable way into the field of economics. It is clearly written and easy to read.
Ch. 8: Aggregate demand
Macroeconomics: 4 major objectives relating to: economic growth, unemployment, inflation and the balance of payments. 'The pursuit of any of these objectives will make any of the others worse.'
Aggregare Demand (AD): total spending on goods and services made in the economy, made up by consumer spending, investment, government spending and expenditure on exports.
The circular flow of income - withdrawals and injections. Disequilibrium that eventually brings equilibrium.
AD=C(d)+J. Household spending accounts for at least half of it.
Multiplier effect: an x increase in AD will lead to an increase in national income exceeding x, until withdrawals rise and equilibrium is reached.
Equilibrium shown with the withdrawals and injections approach, where W=J and Y=E, or the income and expenditure approach (p. 253-5).
GDP measured in 3 ways:
-the product method: adding up the value of goods and services produced in the country.
-the income method: adding up the income generated from the production of goods and services produced in the country.
-the expenditure method: adding up all the expenditure on final output.
Ch. 9: Aggregate Supply and Growth
The AD-AS model: devised to take account of prices impact on demand and supply decisions, sth that the circular flow model and the Keynensian multiplier model don't.
Growth: the % annual increase in national output.
2 major growth issues: keeping actual output as close as possible to potential output; and the long-term issue of what determines the rate of potential growth.
Business cycle: four phases.
Fluctuations in BC attributed to fluctuations in AD by Keynensians.
Instability of investment and the Accelerator theory: the level of investment depends on the rate of change of national income/ output/ demand and not so much on its level, and therefore is unstable (p282-3).
Fluctuations in BC attributed to fluctuations in AS by new classical economists.
Long-term economic growth depends on the supply side.
Long-term economic growth depends on the growth of the quantity and/ or productivity of a country's resources.
Capital accumulation. An increase in capital requires investment, which requires more saving.
The neoclassical growth model has two qualifications: diminishing returns to capital and increased proportion of investment going for replacement purposes. Solow growth model (p. 291).
A higher long-term rate of growth will require a faster rate of technological progress.
Endogenous growth theory stressing the need for innovation.
Ch. 10: Banking and Interest rates
Retail banking/ wholesale banking
Assets/ liabilities
Balance between profitability and liquidity. Liquid assets tend to be relatively unprofitable and illiquid assets tend to be relatively profitable.
Banks central in the process of credit creation (p322-4).
Ch. 11: Inflation and unemployment
Inflation refers rising price levels. Not confuse a rise or fall in the rate of inflation with a rise or fall in prices; a fall in the rate of inflation means a slower increase in prices, but still an increase as long as the the rate of inflation is positive.
Causes of inflation:
-demand-pull inflation
-cost-push inflation
These causes can occur together.
Expectations of inflation result in the realization of these expectations.
70's-80's monetarists/ contemporary new classical economists: inflation can be attributed entirely to increases in money supply (quantity theory of money - the equation of exchange)
Keynensians see a much looser connection between money and inflation.
Controversy focuses on what is the impact of an increase in money supply (1) to AD (2) and what is the impact of an increase in AD to output (3).
Summary: The effect of a change in 1 on 2 can be quite strong or quite small in the short run, depending on variables (p. 346).
In the long-run, there is no connection between the two (theory of portfolio balance).
Point of controversy: What would the impact be of an increase of 2 on inflation (4) and 3?
In the short-run, there is a positive impact of a rise in 2 on 3.
In the long-run, monetarists claim that there will be higher inflation but no higher output. Keynensians claim that there would be higher output too.
How will changes in AD affect inflation and unemployment?
Recessionary gap/ inflationary gap.
Keynensians advocate an active demand mgt policy.
The Philips curve, showing the relationship between inflation and unemployment.
From 1966 onwards it seemed to break down though.
Monetarists' 'expectations augmented Philips curve'. There is a vertical long-run Philips curve, i.e. there is no connection between inflation and unemployment, i.e. government policy to reduce unemployment by rising AD is futile.
Accelerationist theory: the theory that unemployment can only be reduced below the natural rate at the cost of accelerating inflation.
If equilibrium national income is below the full-employment level of national income, there will be a recessionary gap. The gap can be closed by increasing injections or reducing withdrawals.
The opposite will cause demand-pull inflation.
Ch. 12: Macroeconomic policy
Fiscal policy (FP): policy to affect AD by altering government expenditure and/ or taxation.
Discretionary FP vs target-oriented FP.
Monetary policy: it involves the Central Bank intervening in the money market to ensure that the interest rate that has been announced is also the equilibrium interest rate.
What is the goal of the policy? to control inflation? to affect output and employment? to control the exchange rate?
To control money growth, governments need to control money supply. Two sources of money supply: banks holding lower liquidity ratios (increasing minimum reserve ratio) and governments borrowing from the banking sector ( but danger of financial crowding out).
Short-term monetary measures: governments: altering the money supply; altering interest rates; and rationing credit.
Techniques to control the money supply: open-market operations (the sale or purchase by the government of government securities), the central bank lending to the banks, altering banks' reserve ratio and changing the funding mix of government debt.
Demand-side policy
Debate focusing on whether governments should pursue an active demand mgt policy (Keynensians) or set firm rules (monetarists).
Supply-side policy: policies aiming to influence the quantities of the factors empoyed (labour and capital) and their effectiveness in production. They can be either market-orientated or interventionist.
Ch. 13: Int'l Trade
Two major components of globalization: trade and financial markets.
Specialisation as the basis for trade.
Law of comparative advantage
Arguments for restricting trade
Trade strategies in development:
-primary outward-looking stage,
-secondary inward-looking stage (import-substituting industrialization)
-secondary outward-looking stage
Ch. 14: Balance of payments and Exchange rates
Balance of payments account: a record of all flows of money between residents of a country and the rest of the world; made up of: the current account, the capital account and the financial account.
Balance of payments and the circular flow model (ch. 8): injections must equal withdrawals. A net withdrawal on the balance of trade must be offset by a net injection elsewhere: either investment exceeding saving and/ or government expenditure exceeding tax revenue.
Floating ER: when the government doesn't intervene in the foreign ER markets, but allows the ER to be freely determined by D & S.
Banks make money by exchanging currency, and they don't want to be left holding large amounts of it unsold. They would therefore adjust ER accordingly, depending on D&S.
What causes currency demand and supply to shift?
-a fall in domestic interest rates
-higher domestic rates of inflation
-rise in domestic incomes
-investment prospects improving abroad
-speculation that the ER will fall.
Ways for a government to intervene:
-using reserves
-borrowing from abroad
-raising interest rates
-contractionary policies (p. 478)
-Supply-side policies
-controls on imports and/or foreign exchange dealing.
Pros and cons of free-floating/ fixed ER.
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