9. The macroeconomy

In an open economy with government, MPS = 0.20, MRT = 0.30 and MPM = 0.30. Total marginal leakage is 0.80, so k = 1/0.80 = 1.25. A $100 million autonomous export rise therefore increases equilibrium income by$125 million. Of the $125 million income rise, imports rise by$37.5 million and tax by $37.5 million.

If C = 40 + 0.5Y, I = 80, X = 100 and M = 100, equilibrium requires Y = 40 + 0.5Y + 80 + 100 - 100. Hence 0.5Y = 120 and Y = 240. The same answer follows from autonomous spending of 120 and k = 1/(1 - 0.5) = 2.

To find the initial AD change needed for a target income change, reverse the multiplier: required autonomous change = desired ΔY ÷ k. If income must rise from 1000 to full-employment income 1200 and MPC = 0.8, k = 5, so the required initial injection is 200 ÷ 5 = 40.

A rise in disposable income moves upward along an unchanged consumption function and increases induced consumption. Greater confidence or wealth raises autonomous consumption and shifts the whole function upward. An increase in autonomous consumption can coincide with a lower MPC if the intercept rises while the slope falls; inspect both intercept and gradient.

The accelerator says induced net investment depends on the change in demand or output, because firms need extra capital to produce a persistently higher flow of output. If v = 3 and desired output rises by 20, induced investment is 60. If output still rises but by less than before, induced investment can fall. Temporary demand growth or large spare capacity weakens the response.

Lower interest rates can raise C and I; higher government education spending raises G; stronger foreign growth raises X; higher domestic income raises induced M. The final change in AD depends on all components, so a fall in net exports and private investment may be offset by government spending.

If planned spending exceeds current output, unplanned inventories fall and firms raise output, income and employment. If planned spending is below output, inventories accumulate and firms cut production. This adjustment can stop at an equilibrium below full employment because weak spending can persist.

If equilibrium income is 1000, full-employment income is 1200 and k = 5, the horizontal output gap is 200, but the deflationary expenditure gap is only 200 ÷ 5 = 40. A 40 autonomous-spending rise is multiplied into a 200 income rise in the model.

If equilibrium income is 1000, full-employment income is 800 and k = 5, the economy has an inflationary position. The excess autonomous spending at full employment is (1000 − 800) ÷ 5 = 40, so a 40 reduction would return planned spending to the full-employment equilibrium in the stylised model.

Actual growth may occur without potential growth when idle machines and labour return to work. Potential growth may occur without immediate actual growth when capacity expands but AD is too weak to use it. At or near full employment, sustained real growth needs potential capacity to expand; extra AD alone is more likely to raise prices.

Reopening an idle production line moves output toward an unchanged PPC: actual growth. Building a more productive line or improving workforce skills shifts the PPC/LRAS outward: potential growth. One investment project can do both if construction raises AD now and the completed asset raises capacity later.

Potential output is not directly observed, so the gap is an estimate and can be revised. A negative gap often accompanies unemployment and weak inflation pressure; a positive gap may accompany bottlenecks and demand-pull inflation.

If actual GDP is 980 and potential GDP is 1,000, the output gap is −2% of potential. The number is not a precise count of unemployed people.

Automatic stabilisers reduce the multiplier and the size of output fluctuations; they do not prevent every recession or boom. Their strength depends on tax progressivity, benefit coverage/take-up, marginal propensities, informality, fiscal credibility and the size/cause of the shock. Discretionary policy may still be needed.

First diagnose actual versus potential growth. In a recession, demand support can move output toward existing capacity quickly. At full employment, extra AD mainly creates inflation unless labour, capital or productivity expand. Public infrastructure or human-capital spending can affect both AD now and LRAS later.

Judge effectiveness by the size and cause of the gap, multiplier/leakages, response elasticities, finance and debt, implementation quality, time horizon, policy interaction, political constraints, external balance, distribution and environmental/resource effects. Compare the policy with a feasible alternative or package, not with doing nothing in an unspecified economy.

An ageing economy with an immediate worker shortage may gain capacity faster from skilled immigration or higher participation than from birth-rate policy; automation can raise output per worker but may need skills and finance. A low-income economy with weak transport and skills may need infrastructure plus training rather than demand stimulus alone.

Equality asks how evenly outcomes such as income are distributed. Equity asks whether the distribution and opportunities are fair according to a stated criterion. Growth can reduce absolute poverty while relative inequality rises, so average real GDP per person is not enough to establish inclusion.

Assess changes in employment and participation, real disposable income by group, poverty, income/wealth distribution, access to health/education/infrastructure, regional and gender gaps, social mobility and who bears taxes, prices and environmental costs. Use both level and distribution evidence over time.

Conserve renewable resources by keeping use within regeneration where possible, and manage non-renewables by reducing waste, recycling, substituting renewable inputs and investing resource rents in reproducible/human capital. Sustainability is about the total stock of productive, human and natural assets, not never using a resource.

Judge net effects across the full life cycle, current versus future generations, actual versus potential growth, distribution, transition jobs/energy reliability, policy credibility, innovation response, leakage, enforcement and whether damage is reduced absolutely or only per unit of GDP. A policy package can combine a credible pollution price with targeted transition support and clean infrastructure.

Subsidising recycled inputs can raise output while reducing virgin-resource demand, but it is sustainable only if collection, processing energy and total material use also improve. A fish farm may relieve pressure on wild stocks, but feed, water pollution and ecosystem effects still need assessment.

The term is a benchmark, not a claim that every person has a job immediately. It depends on definitions, labour-market matching, participation and the time horizon.

A worker changing jobs may be temporarily unemployed while the economy is at full employment; a recession that leaves many workers idle creates a negative output gap below the benchmark.

In a recession, lower AD reduces firms' output and labour demand. If money wages are inflexible downward, unemployment can persist rather than wages rapidly clearing the market. Keynesian analysis therefore permits long-lasting involuntary unemployment and a below-full-employment equilibrium.

With hysteresis, a later interest-rate cut may have little effect because firms cannot immediately match vacancies to workers. Early demand support can prevent scarring, while retraining, job matching, mobility and employer incentives may be needed to reverse it.

Employment rate and unemployment rate use different denominators. If 76.6% of a working-age group is employed and 4.0% of the group is unemployed and seeking work, 80.6% is economically active only when both percentages use that same age-group denominator; do not add rates defined on different bases.

The classification depends on the relevant wage, location, hours, skills and working conditions. A person refusing one unsuitable job is not automatically voluntary unemployed if no reasonable job is available.

A worker who rejects a vacancy far below their reservation wage may be described as voluntary under a simple model; a qualified worker seeking jobs at the prevailing wage but finding none is involuntarily unemployed.

Expansionary fiscal or monetary policy can reduce cyclical unemployment toward the natural rate. It does not directly solve a skill or location mismatch; trying to hold unemployment persistently below the natural rate with AD alone risks accelerating inflation. Supply-side matching, skills and mobility measures can lower the rate itself, but take time and may fail if demand is also weak.

A lower natural rate means full-employment output can be sustained with fewer people unemployed, usually lowering unemployment-benefit payments and expanding the effective labour supply. The estimate can change after shocks and may rise through hysteresis.

Patterns may differ by age, sex, region, occupation and sector. Business-cycle demand, demographics, migration/participation, technology/productivity, trade and sector composition, policy/institutions and seasonal conditions can shift employment and unemployment differently. Sector job losses can coexist with total job growth.

If real output rises 4% while employment rises 1%, output per worker increases approximately 3%; if output falls less than employment, measured productivity may also rise during a downturn. A graph rising from 2020 to 2022 and falling to October 2022 should be reported as two different sub-period trends, while its overall 2020-to-October change depends on the endpoints.

High mobility helps labour markets match vacancies and can reduce structural unemployment, but moving has costs and may harm communities losing workers. Training raises occupational mobility only when it matches real opportunities.

A worker may be qualified for a vacancy but unable to relocate because housing is unaffordable; a short course may help occupational movement if employers recognise the skill.

Policies can affect more than one type. Lower direct taxes may raise AD and reduce cyclical unemployment, while higher unemployment benefits support AD and search quality but can lengthen frictional/voluntary unemployment if withdrawal rules make work pay little. Infrastructure spending can raise AD now and mobility/capacity later; capital-intensive investment may raise output without many jobs.

In a high-income recession dominated by weak AD, timely fiscal/monetary expansion may reduce unemployment faster than training alone. For long-term unemployment after industrial change, retraining, mobility and employer/job-creation measures are more direct, but temporary demand support may still prevent hysteresis. A credible package targets both missing demand and employability when both constraints exist.

Hyperinflation first damages store of value and deferred payment, then unit of account and finally medium of exchange if sellers reject the currency. A local currency can still be money within its acceptance network if it performs all functions; a cheque is normally a payment instruction transferring bank-deposit money, not money itself because acceptance is limited.

Demonetising widely used notes immediately reduces narrow money if invalid notes cease to count. M1 can later recover when replacement cash is issued or people deposit valid money into qualifying bank accounts. Always report units and the aggregate definition before interpreting the change.

Modern money includes bank deposits, not only currency. Cheques, cards and payment apps are instruments that instruct transfers of deposit money; the instrument is not an extra stock of money. Central-bank reserve balances are different from household deposits and enter aggregates only under their stated definition.

If M rises 3%, V is unchanged and T rises 3%, P is unchanged. If M rises 5% while V and full-employment T are fixed, P rises about 5%. If V falls 5% while M rises 5% and T is unchanged, the price effects approximately offset.

Velocity can change with payment frequency, technology, interest rates and desired balances. Monthly rather than weekly pay tends to make people hold larger average balances, reducing V; easier card/ATM access can reduce balances and raise V. A fall in V can therefore absorb an increase in M without a price rise.

Liquidity means an asset can be converted into cash quickly with little loss; security means limiting default/market/operational risk; profitability comes from interest spread, fees and asset returns. More liquid/secure assets usually yield less, while high-return lending can be illiquid/risky, so banks diversify, screen borrowers, require security/collateral and hold reserves/capital.

If customers withdraw extra cash, bank reserves fall and lending ability tightens. Requiring a higher liquidity ratio similarly reduces potential lending. Weak collateral checks and excessive risk can raise profit temporarily but increase defaults and threaten capital and confidence.

With a 10% required cash ratio and a new $50 million reserve base, the simple maximum deposit stock is$50m ÷ 0.10 = $500m. If deposits were$600m backed by $50m cash, raising the ratio to 10$500m unless cash rises.

A higher public cash-to-deposit or idle-balance preference restricts repeated bank lending and spending; easier bank/ATM access can lower the cash ratio. Higher liquidity/reserve requirements restrict lending. A reserve/QE injection may be absorbed as excess reserves or idle balances, especially in recession, so the full multiplier is not guaranteed.

QE is least destabilising in a deep recession with unemployment and weak inflation. Near full employment it is more likely to raise asset prices, exchange-rate pressure and inflation. It differs from ordinary bank lending and from a government spending decision, even if transactions interact.

Demand-pull inflation from excess AD is directly reduced by contractionary demand policy. Cost-push inflation shifts AS left: aggressive demand restraint may lower second-round pressure but deepens the output/unemployment loss without removing the original cost. Mixed inflation often needs credible demand control plus source-specific supply action.

High rates are stronger against an interest-sensitive credit boom than against a one-off imported energy shock. If consumers expect faster future inflation, they may bring spending forward and weaken rate rises. Inaccurate inflation measurement can cause under- or over-tightening. Monetarist rules target stable money growth, but broad money is difficult to define/control and V/output can move.

Bond prices and yields move inversely. At a very low current interest rate, investors may expect rates to rise and bond prices to fall, so they hold money to avoid a capital loss. At high rates/low bond prices, they are more willing to buy bonds, reducing speculative money balances.

In a liquidity trap at a very low interest rate, speculative money demand becomes highly/perfectly interest-elastic: people absorb extra money into idle balances because they expect bond losses. Increasing MS then barely lowers the interest rate, so investment, AD and output may not rise. Fiscal policy or measures changing expectations/bank balance sheets may be more effective.

In the Keynesian liquidity trap, LP is nearly horizontal at a very low rate. A larger MS is absorbed into idle balances and may leave the rate, investment and output unchanged. To hold a rate down after LP shifts right, the central bank can buy bonds/increase MS; outside the trap this shifts MS right and offsets the rise.

Even when the policy/market rate changes, investment and output respond only if bank lending and investment demand are interest-sensitive. Different maturities, risk and bank margins mean policy rates, government-bond yields and household/business loan rates need not move equally.