Summary of key concepts in

each module (modules 8 to

10)
Summary of Module 8 – can you explain
these concepts?
• Macroeconomic problem
• How do you evaluate performance of a country’s economy? How do you know
if the economy is growing?
• Indicators?

• After WWII, the concept of national income was created

• National income – total value of new production (income) generated

in a particular time period; commonly measured using GDP
• 3 ways to calculate GDP
• Income approach: Add up all incomes earned by all factor inputs
(wages/salaries, profits, rent, etc)
• Expenditure approach: Add up expenditures made by all parties in a country
• Output/product approach: Add up value-added (approx. profits) of all firms
• 2 commonly reporting format for GDP
• Real GDP or GDP at constant prices – value of new production/income
generated in a time period, measured based on a ‘base year’ (or constant)
price. Comparing real GDP over 2 periods – the comparison captures changes
in production volume but not prices, since the prices in both periods are the
same
• Nominal GDP, or GDP at current prices - value of new production/income
generated in a time period, measured based on current/existing price level. If
one compares nominal GDP over 2 periods – the comparison captures both
changes in production volume AND prices

• To see if economy is growing in production, use real GDP.

• Parties responsible for production and spending in economy
(production side, or real sector)
• Households – consume, save, pays taxes, receives subsidies from government,
supplies labour to firms, demand/hold money
• Firms (non-banks) – produce, invest, hires labour, pays taxes, receives
subsidies
• Government – spend, impose tax, regulates
• External sector – provides market for exports and imports
• Financial sector – financial intermediaries and markets
• Intermediaries – banks, insurance companies (regulated by a Central Bank)
• Markets – equity, bond, derivatives etc. (regulated by Securities Commission,
and operated by Stock Market agency; for Malaysia the agency is Bursa
Malaysia)
• Purpose – to pool funds from parties with surplus funds (savers,
lenders) and direct the funds to parties who are in need (borrowers,
investors)
• Banks have special role – they are the channel through which money
and credit get created for the economy
• Understanding behaviour of economy – AD-AS model
• Demand side
• Aggregate demand (AD) = C + I + G + (X – M)
• AD affected by price level (-), will shift when components of AD changes

• Supply side
• Actual (Real) GDP – actual production by all firms. Contributes to AS (short run)
• AS affected by price level (+), will shift when technology/productivity (+) or production
cost changes (-)
• AS also shifts when expected inflation (-) changes
• Potential (Real) GDP – actual production by all firms at 100% (full)
capacity. Contributes to AS (long run). Also known as full
employment GDP
• AS not affected by price level will shift when technology/productivity
(+) changes
• Technology/productivity changes can come from supply side policies
• Interaction of AD and AS produces changes in GDP and prices

• Price level – usually measured by consumer price index (CPI)

• % change in CPI = inflation rate

• Shifts in AD, and AS affects price level, actual GDP and unemployment
rate
• AD-AS framework
• AD is straightforward
• Problem usually comes from AS
o Very short-run, AS is horizontal line (realistic assumption when economy in deep recession with high
unemployment). Increase in demand will not put pressure on wage rate and production cost since
unemployment is high (plenty of unused resources)
o Keynesian AS – upward sloping line. This is when the economy recovers to a point where demand for
goods and resources start to push up wage rates and cost. Producers expect higher prices to compensate
o Classical AS – vertical line extending from full employment GDP. Economy reaches full capacity, all
resources fully utilised. Any demand cannot be translated to supply since factories already running at
full capacity – so demand pressure translates directly to price increase
• AD-AS usually used with a Keynesian AS for short-run analysis. For MBA level, this should be
sufficient.
• Note: AD-AS is more intuitive and useful than the Phillips curve model, but both convey similar information.
• Another framework is the Phillips curve model – shows relationship between
unemployment rate and inflation rate, conveys similar info as AD-AS, although
with a different perspective

• 2 primary causes of high inflation – cost push vs demand pull inflation

• Inflation cost – high inflation produces some effects e.g. income distribution
effects, menu cost, shoe-leather cost, increased uncertainty

• But a bit of inflation is necessary – it is the oil/lubricant that keeps the

economy running
• More on unemployment – actual unemployment rate is the % of labour
force who are unemployed

• Actual unemployment vs ‘full employment’ unemployment – the latter

refers to the unemployment rate when the economy is operating at full
capacity.
• Technically, at full capacity the unemployment rate should be zero. But in
reality this is hard to achieve.
• When actual unemployment rate is close to zero, that unemployment rate can
be the ‘full employment’ unemployment rate
• Types of unemployment (common textbook examples)
• Seasonal
• Frictional
• Structural
• Demand-deficient
• Real wage

• Only demand-deficient unemployment is caused by lack of AD. The other

unemployment types are due to structural issues in the economy
• Structural is due to mismatch in skills caused by changes in the economy e.g. rise in
IT sector and decline in heavy industries. Workers from the latter sector do not have
right skills to fit into IT sector
• Existence of unemployment problems can be worsened by institutional
arrangements in a country. In some countries, governments hand out
generous unemployment benefits

• Such benefits can discourage workers from finding jobs

• Long-term unemployment issues can lead to deterioration in a

country’s human capital, affecting long-run growth and potential
output; also affects mental health and increases crime rates
• Balance of payments (BOP)
• A summary of transactions between a country and rest of the world

• For ease of explanation, consider Malaysia as the home country

• Transactions can be trade related i.e.

• Firms in Malaysia selling exported goods and services/people in Malaysia
purchasing imported goods and services
• Transfer of incomes: people in Malaysia sending income to other countries, or
Malaysians in other countries sending income back to Malaysia
• These transactions are recorded under current account
• Transactions can be related to assets
• Selling and purchase of land, real estate, equities, bonds
• Such transactions recorded under financial account
• Includes transactions by private firms, or transactions by the central bank

• There is also capital account for recording movement of capital into

and out of Malaysia

• All accounts record inflow (credit item) and outflow (debit item) of
income
• Double entry principle – a debit entry has to be matched with a credit entry,
either in the same account or a different account

• Due to this principle, inflows and outflows must always match – the net balance
in the BOP must always be zero

• In reality, there may be errors in the recording and computation of BOP entries
– so net balance may be slightly different from zero. The accounting process has
an item called ‘net errors and omissions’
• If the net balance is initially $0.2 million, the net errors and omissions term is an
equivalent figure of -$0.2 million, which, after adding to the net balance, ensures that the
total figure is zero
• Refer to slide #16, if there is difficulty to get a zero net balance, there is
the official transactions by the central bank or buying or selling securities
in foreign currencies – these transactions help a country to balance its BOP

• Example: if there is persistent current account deficit but insufficient

surplus in the financial account (some private investors pulled out funds
from country) – here the central bank can sell foreign securities to generate
the additional inflow to balance up the BOP
• The reserves of foreign currency will fall in this case
• There is side effect on money supply – selling foreign currencies will lead to a fall
in money supply (reverse is true)
• Intervention by central bank also prevents exchange rate from changing
• If there is no central bank intervention, the local currency would depreciate
– this creates more export demand due to cheaper local currency, and
increase the surplus in current account, to a point that helps to balance the
BOP (recall in the 1st place, the initial situation was where current account
surplus could not balance out the deficit in financial account)

• Central bank intervention helps protect the value of the domestic currency

• In practice, central banks can engage in similar interventions to ensure that

the value of domestic currency fluctuates within an acceptable range
• Exchange rate – value of domestic currency vs a foreign currency; this
is example of a bilateral exchange rate

• Can be defined in many ways. To see how a domestic currency is

valued vs a bunch of foreign currencies, concept of ‘effective
exchange rate’ is used – this is where a domestic currency is compared
with a basket of foreign currencies

• Key terminologies – domestic currency weakens (strengthens) against

foreign currency or domestic currency depreciates (appreciates)
Summary of Module 9 – can you explain
these concepts?
• Economic policy

• Demand management
• Fiscal
• Monetary

• Supply-side policies
• Interventionist approach
• Non-interventionist approach
• Government’s objective
• Manage business cycles – these are short-term fluctuations in actual GDP
• Debate is on how much government intervention is ideal

• Sustainable BOP

• Price stability (low, stable inflation)

• Job-creation and low unemployment

• Long-term growth in potential GDP, and increase in per capita GDP

• Fiscal policy

• Directly affects government budget in the immediate and short-run

• Taxation affects consumption  which will then affect AD,

government spending affects AD directly
 Changes in tax/spending will shift AD  GDP changes – Can demonstrate this using AD-
AS; AD shifts causing changes to GDP and price level. The multiplier effect is already
incorporated into the diagram, so there is no need to demonstrate this effect.
 Note:
o Change in GDP has feedback on interest rates. More government spending  increases
demand for loans, and pushes up interest rates, so there is some dampening effect on the
initial expansion of GDP. Usually, this dampening effect will not offset the GDP
expansion entirely. YOU DO NOT NEED TO DEMONSTRATE THIS EFFECT BY
SHIFTING THE LINES IN AD-AS AGAIN, SINCE THE EFFECTS ALREADY
INCORPORATED IN THE DIAGRAM
o Effect on GDP, and interest rates, in turn feeds back upon government budget. However,
AD-AS framework does not capture changes in budget.
• Note on government budget

• Revenue – tax (direct and indirect), excise duties, stamp duties, fines,
etc

• Expenditure – operating and developmental purposes

• Revenue does not always cover expenditure, so borrow to finance the

difference/deficit; incurring debts is part of governance
• Debts differ in many ways, e.g. in terms of maturity (short vs long
term), ownership (foreign vs local lenders) and currency denomination
(local/domestic vs foreign currency)

• In theory, a government with 100% domestic currency debt cannot

default on this debt. The central bank has a monopoly over the supply of
such a currency, so technically the governing authority cannot default

• Debt repayment capability depends on inflation (-), interest rates (+),

economic growth (-) and in the case of foreign debts, the exchange rate
• Monetary policy

• Conventional policy – affects short-term interest rates (cost of borrowing

in a market where loans are repaid quickly). This interest rate, also know
as policy rate, directly affects cost of funds in banks. So banks need to
adjust interest rates in all their products – you have a chain reaction

• Interest rates affect investment, which affects AD – AD shifts etc. (again,

multiplier is already captured in the AD-AS diagram so no need to
demonstrate this effect explicitly).
 Unconventional policy – this is where short-term rates are already so low (close
to zero %), no more room to cut rates. This is where central banks then attempt
to cut rates on borrowings that are repaid much later (longer term interest rates).
o In history of central banking, this policy is rarely attempted until around 2010, during the
global financial crisis
o That is why such policies are unconventional
o This is a big area of study, will not be explored further

 Monetary policy has impact on government budget also – by changing GDP and
interest rates
• Purpose of either policies? – to stabilise short-run movements of the
economy (business cycles), to prevent actual GDP from fluctuating too
much
• Why do economies fluctuate in short-run? Answer lies in business
cycle theories
• Supply side policies – meant to help develop the potential of the
economy  increasing potential GDP

• Interventionist approach – popular in most parts of Asia, where

government directly and thoroughly involved in making plans to
increase productivity and improve technological capability

• Non-interventionist approach – developing entrepreneurship and risk-

taking by cutting taxes and reducing bureaucratic red-tape
• Successful policies will lead to gradual increase in per capita GDP/income –
indication that the people in the country are becoming more well-off with
higher living standards

• Growth theories
• Long-run growth depends on productivity/technological improvements
• Supply side policies aim at unleashing this change

• Main motivation – improvement in world rankings based on per capita income

• World Bank for example, maintains a ranking of countries according to income level
(see link here)
• But is income a good indicator of well-being? Is a high-income individual necessarily
happy?
Summary of Module 10 – can you explain
these concepts?
• Trade – why do countries trade? Trading in goods is one aspect of
globalisation (affects current account of BOP); this is the main
globalisation aspect that the course is focusing on

• Absolute advantage – a country that can produce more of a good than

other countries, has absolute advantage in the production of that good

• Comparative advantage – a country that can produce a good with

lower opportunity cost than other countries, has comparative
advantage in the production of that good
• If a country has comparative advantage in making a good, the country should specialise in
making that good. So, if 2 countries have comparative advantage in making different goods,
the countries can specialise in their respective areas, and then exchange the goods with each
other

• Due to specialisation, each country can make more specialised goods – production increases.
Moreover, by trading with each other, consumers can continue to enjoy variety in
consumption; trade increases production of the specialised goods and total consumption –
benefits of trade

• However, the non-specialised goods in each country experience a decline in production, due
to competition from imported varieties – downside of trade

• Overall, benefits from increased production and consumption exceed the costs of trade – trade
speeds up economic growth (see East Asian Miracle)
• Protectionism – the parties that lose out from trade (producers
producing goods similar to import varieties) do not remain silent; they
lobby politicians to impose trade barriers to minimise their losses

• To stem tide of protectionism, the global community set up

GATT/WTO – members of this group required to lower trade barriers
to enable better market access for traders; countries keen to joint the
group due to potential access to new markets for exports

• However, WTO hampered by global politics

• To break the impasse of stalled trade negotiations, countries pursuing regional
trade agreements instead. If trade openness cannot be done globally, then pursue
partnerships that encourage trade between neighbouring countries

• Trading is one way to integrate the global economy – other methods include
corporations (MNCs particularly) setting up a physical presence (e.g. factories,
offices, distribution units etc) in a foreign country
• For instance, EV makers in China can access the market in Mexico by either selling their
products directly to Mexico via exports, or set up factories in Mexico to produce Evs
• Whether to export or set up factories depends on a cost-benefit assessment
• Lots of debates about the pros and cons of MNCs, esp. how effective they are in
promoting growth in the host country – not expected to know details of the debates; if
interested you can access this article here