Macroeconomic Fundamentals: Demand, Supply, and Economic Policies
Aggregate Demand (AD)
The total amount all sectors of the economy are willing to spend during a given period for a given average price level.
AD = Consumption + Investment + Government Spending + (Exports – Imports).
Aggregate Supply (AS)
The relationship between the average price level and the quantity of goods and services supplied in an economy.
Factors Affecting Aggregate Supply
Average Price Level: If prices and costs remain constant while profits decrease, production lowers.
Production Costs: Rising raw material prices increase production costs, lower company profits, and reduce production.
Business Expectations: Favorable expectations increase production.
Business Expectations
The total amount of goods and services businesses are willing to produce and sell at various price levels in a given period.
Macroeconomic Stability
When buyers’ intentions match sellers’ intentions.
If the desired price level is below equilibrium, inflation occurs.
AD Curve Displacement: If production costs rise, supply shifts to the left.
If AD is low, production is low.
Consumption
Household spending on consumer goods and services.
Types of Goods
- Durable goods
- Perishable goods
- Services
Factors Influencing Consumption
- Disposable income each year
- Consumer freelance (independent) income
- Permanent income: Income level after removing temporary influences
- Life cycle hypothesis: People save to maintain consistent consumption throughout life
- Wealth effect
Business Investment
Production of capital goods that contribute to future production; foregoing immediate satisfaction for future benefits.
Functions
Attracts demand, increasing the country’s installed production capacity.
Types of Investment
- Plant and equipment: Durable goods used for economic activities over several years
- Construction: Investment in goods and equipment used in construction
- Variation of stocks: Stored production
Factors Influencing Investment
- Revenue: Price (P) x Quantity (Q)
- Cost: Lowering income and production costs increases investment
- Installed production capacity: If facilities are not at maximum capacity, investment increases
- Future expectations: Improved expectations boost consumption (Stability policy)
Savings
The portion of income not consumed.
Key Aspects
- Disposable income: Consumption + Savings / Income – State Expenses
- Investment/Savings Value: Money for investment comes from family savings
- Reasons to Save: Improve future life, family heritage, retirement, unforeseen events
Economic Cycles
Alternating phases of economic activity growth and decline.
Phases
- Depression or Trough: High unemployment, rising stocks, low demand and investment
- Expansion: Replacement of old capital with new, increased investment, employment, income, and consumption
- Peak or Summit: Full employment of productive capacity, increasing production difficulty
- Recession: Descending phase (smooth or abrupt), low consumption, sales, production, investment, rising unemployment, low incomes
Economic Policies
State interventions in the economy to achieve objectives related to production, employment, and prices, using tools like taxes, public spending, and the cost of money.
Objectives
- Sustainable economic growth: Increase goods and services while respecting the environment
- Full employment: Avoid social problems
- Price stability
Means
- Direct: Public sector institutions, regional entities, trade advice
- Indirect: Banking, unions, large corporations
Types of Economic Policy
Fiscal Policy
State intervention through taxes and public spending.
Fiscal Policy Instruments
Discretionary Policies
Government actions to intentionally influence income or expenses:
- Public works programs: Boost production, employment, and infrastructure
- Employment and training plans: Recruit and train the unemployed
- Transfer programs: Pensions and unemployment benefits to maintain disposable income
- Changing tax rates: Lowering taxes increases disposable income
Automatic Stabilizers
Income or expenses that automatically increase or decrease with the production level, smoothing economic cycles.
Types of Fiscal Policy
- Expansionary: Increased government spending and lower taxes raise disposable income, consumption, and aggregate demand
- Contractionary: Lower direct taxes, consumption, aggregate demand, lower prices, and production
Overall State Budgets
Instruments of fiscal policy expressing income and expenditure plans based on economic objectives.
Public Revenue
- Social contributions: Payments by employers and employees to social security
- Taxes: Half of total revenue
- Direct taxes: Levied on individuals and legal entities
- Indirect taxes: Applied to the procurement of goods or services
- Fees: Payments for public service use
- Other income
- Transfers: Income from other entities
- Asset income: Income from state-owned assets
- Disposal of investments: Sale of state-owned assets
- Capital transfers: Funds from EU structural programs for investment projects
Public Expenditure
Costs incurred by the public sector.
- Current expenditure: Providing public services
- Investment costs: Maintaining and expanding productive capacity
- Transfers and subsidies: Pensions, aid to companies
- Real spending: Goods and services offered by the public sector
- Transfers and subsidies: Income distribution
Budgetary Balance
- Balanced budget: Revenue = Spending
- Budget deficit
- Budget surplus: Revenue exceeds spending
Keynesian model: Budget deficits in the long term, surpluses during expansion.
Neoliberal policies: Minimizing state intervention, seeking a balanced budget.
Types of Deficit
- Cyclical: Occurs during recessions
- Structural: Permanent, persists even during economic growth
Financing Public Debt
- Issuing public debt: The state borrows from businesses and individuals, promising to repay with interest
- Raising taxes: Higher taxes lower consumption, investment, and aggregate demand
- Increasing money in circulation: Causes inflation