Class Lecture-3
Macroeconomics in Business (Econ-1202)
Rational Expectations Theory
Economic-behavior observation according to which: (1) On average, people can quite correctly predict future conditions and take actions accordingly, even if they do not fully understand the cause-and-effect (causal) relationships underlying the events and their own thinking. Thus, while they do not have perfect foresights, they construct their expectations in a rational manner that, more often than not, turn out to be correct. Any error that creeps in is usually due to random (non-systemic) and unforeseeable causes. (2) In efficient markets with perfect or near perfect information (such as in modern open-market economies) people will anticipate government's actions to stimulate or restrain the economy, and will adjust their response accordingly. For example, if the government attempts to increase the money supply, people will raise their prices and wage demands to compensate for the inflationary impact of the increase. Similarly, during periods of accelerating inflation, they will anticipate stricter credit controls accompanied by high interest rates. Therefore they will attempt to borrow up to their credit capability, thus largely nullifying the controls. This theory was proposed not as a plausible explanation of human behavior, but to serve as a model against which extreme forms of behavior could be compared. It was developed by the US economist Robert Lucas (born 1937) who won the 1955 Nobel Prize for this insight. Not to be confused with rational choice theory. Also called rational expectations hypothesis.
An economic idea that the people in the economy make choices based on their rational outlook, available information and past experiences. The theory suggests that the current expectations in the economy are equivalent to what the future state of the economy will be. This contrasts the idea that government policy influences the decisions of people in the economy.
The idea is that rational expectations of the players in an economy will partially affect what happens to the economy in the future. If a company believes that the price for its product will be higher in the future, it will stop or slow production until the price rises. Because the company weakens supply while demand stays the same, price will increase. In sum, the producer believes that the price will rise in the future, makes a rational decision to slow production and this decision partially affects what happens in the future.
If we think of a stock price. It is common to assume that the price reflects all of the available information about the stock. If there was other information, someone would make money on the poop stock. This is a similar idea to the expectation that the Rational Expectations economist has when looking at economic agents. While acknowledging that the market for stocks has few of the distortions that other markets have, this paradigm allows for pretty good predictions of behavior, largely as a result of the observation that with large numbers the deviations start to cancel out.
Business cycle
- A predictable long-term pattern of alternating periods of economic growth (recovery) and decline (recession), characterized by changing employment, industrial productivity, and interest rates. also called economic cycle.
- The recurring and fluctuating levels of economic activity that an economy experiences over a long period of time. The five stages of the business cycle are growth (expansion), peak, recession (contraction), trough and recovery. At one time, business cycles were thought to be extremely regular, with predictable durations, but today they are widely believed to be irregular, varying in frequency, magnitude and duration
- The business cycle describes the phases of growth and decline in an economy. The goal of economic policy is to keep the economy in a healthy growth rate -- fast enough to create jobs for everyone who wants one, but slow enough to avoid inflation. Unfortunately, life is not so simple. Many factors can cause an economy to spin out of control, or settle into depression. The most important, over-riding factor is confidence -- of investors, consumers, businesses and politicians. The economy grows when there is confidence in the future and in policymakers, and does the opposite when confidence drops.
The Stages of the Business Cycle
There are four stages that describe the business cycle. At any point in time you are in one of these stages:
- Contraction - When the economy starts slowing down.
- Trough - When the economy hits bottom, usually in a recession.
- Expansion - When the economy starts growing again.
- Peak - When the economy is in a state of "irrational exuberance."
Chapter-2: Circular Flow of Income and National Income Accounting :
Income
Y=C+S
Y= Income Or
C=Consumption
S=Saving
Disposable Income
Y=C+S+R-T
Y= Income
C=Consumption
S=Saving
R=Transfer Payments or Subsidy
T=Tax
GDP=Gross Domestic Product
Definition: GDP is the market value of all the final goods and services produced within a country in a given time period.
Market Value: the prices at which each item is traded in market.
Example: if the price of an apple is 10tk, the market value of 20 apple is 10×20=200tk
Final goods and services: A final good or service is an item that is bought by its final user during a specified time period.
Intermediate goods and services: An Intermediate good or service is an item that is produced by one firm, bought by another firm and used as a component of a final good or services.
Example: Computer-Final goods
Motherboard- Intermediate goods
Within a country: only goods and services that are produced within a country count as part of that country’s GDP.
In a given time period: GDP measures the value production in a given time period.
Such as: Yearly-Annual GDP, Quarterly GDP.
GDP: Production of goods and services by Bangladeshi Residents in Bangladesh + Production of goods and services by Foreigner who lives in Bangladesh.
GNP=Gross National Product
Definition: GNP is the market value of all the final goods and services produced by the residents of a country both at home and abroad in a given time period.
GNP: Production of goods and services by Bangladeshi Residents in Bangladesh + Production of goods and services by Bangladeshi Residents in Abroad -Production of goods and services by Foreigner who lives in Bangladesh.
NDP (Net Domestic Product) at market prices: GDP-Depreciation
NNP (Net National Product) at market prices: GNP-Depreciation=National Income
Depreciation: is the decrease in the stock of capital that results from wear &tear and obsolescence, also called capital consumption.
NDP (Net Domestic Product) at factor cost: NDP-Net Indirect Taxes
Net Indirect Taxes=Subsidy-Indirect Taxes.
NNP (Net National Product) at factor cost: NNP- Net Indirect Taxes
=National Income at factor cost
Personal Income: Income+Transper payments
Personal Disposable Income: personal Income+Transper payments-personal taxes
Personal Income: National Income-social security contribution-corporate income taxes-undistributed profits Transfer payments
National Disposable Income: National Income-social security contribution-corporate income taxes-undistributed profits Transfer payments-personal taxes
Disposable Income: C+S
Measurement of National Income:
- Expenditure Approach
- Income approach
- Value added approach
- Expenditure Approach
GDP at market price
GDP=Y=C+I+G+X-M
Y= Income/GDP
C=Personal Consumption Expenditure
I=Gross Private Investment
G=Government purchases of goods and services.
X=Export
M=Import
NDP (Net Domestic Product) at market prices: GDP-Depreciation
NDP mp =C+I+G+X-M-Depreciation
NDP (Net Domestic Product) at factor cost: NDP-Net Indirect Taxes
Net Indirect Taxes=Subsidy-Indirect Taxes.
NDP FC= C+I+G+X-M-Depreciation-Net Indirect Taxes
NNP (Net National Product) at market prices: GNP-Depreciation=National Income
NNP (Net National Product) at factor cost: NNP- Net Indirect Taxes
=National Income at factor cost
- Income approach
GDP at market price
GDP mp: Compensation of employees or wage +Net interest+ Rent +corporate profit+ proprietor’s income-indirect taxes+subsidy+depreciation
GDP FC: Compensation of employees or wage +Net interest+ Rent +corporate income tax+ undistributed profits+dividends-indirect taxes+subsidy+depreciation
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