The Economics Environment of Business

4008AFE The Economics Environment of Business
Week 7: Introduction to Macroeconomics, Macroeconomic
Dr Alban Asllani
Lecture Outline
1 Introduction
2 Measuring the Standard of Living
3 Cost of living
4 Unemployment
5 Conclusion
Economics have a long history of ideas and theories.
Before the first economist, there were philosophers that talked
about economic issues
Probably the first was Hesiod (around 750 BC).
He was the first to discuss the topic of scarcity in his work
“Εργα καL ‘Ηµέραι, Erga kai Hemerai (transl. ”Works and

Plato and Aristotle discussed various economic issues (they
even described the concept of marginal utility!)
Ibn Khaldun (1332–1406), for some is considered the father of
modern economics
In his work Muqaddimah (Prolegomena), he discussed the
forces of Supply and Demand and how to promote economic
growth and development.
During the Enlightment many scholars discussed and
introduced various economic ideas (e.g. property rights)

Modern Economics
Adam Smith: The invisible hand (Classical Economics)
Alfred Marshall : Mathemantical foundation of economics.
Supply and Demand, marginal utility, costs of production
Neoclassical Economics)
John Maynard Keynes: Government intervention to promote
economic activity (
Keynesian Economics) Milton Friedman:
Role for monetary policy (
Robert E. Lucas: Rational Expectations (New classical
Various: Elements from all the above (New neoclassical
Today’s lecture
Study the economy as a whole.
Measures of well-being
Interest Rate
One measure to rule them all
Gross domestic product (GDP)
To be able to discuss and compare whole economies weneed
a way to calculate their production.
Revenue Approach
Expenditure Approach
Income and Expenditure Approach
In any economic system the expenditure should be equal to
the revenue.
This means that wecan either use the different forms of
income or expenditure in the economy to calculate GDP
The diagram demonstrates the circular-flow of income within
the economy

Circular-Flow Diagram
Gross Domestic Product
Gross Domestic Product
GDP is the market value of all the final goods and services produced
in the country in agiven period of time.
Other measures used in some cases:
Gross National Product (GNP): Total income earned by
Net National Product (NNP): GNP minus depreciation
Other: National income, personal income, disposable income.
Income Identity
GDP(Y) = C + I + G + NX
Consumption: Spending on goods and services by consumers
Investment: Spending on Capital (new equipment,
structures, inventories, new housing)
Government Spending: Spending on goods and services by
the government
Net Exports: Export minusimports
Nominal vs Real
Consider the following prices in £:

Good/Service 1500s Today
Beer 0.12 3.50
Rent (excl. London) 3.00 700
Bread 0.10 1.00
Oxford Uni (per year) 8.50 22000

Can you say when was bread cheaper? Was it in 1500s ortoday?
Nominal vs Real
Consider the following per year wagesin $:

Job 1900s Today
Janitor 720 30000
Unskilled worker 600 18000
Lawyer 2000 150000
Mayor 10000 160000

Can you say who is earning more? A mayor in 1900s or today?
Nominal vs Real
To be able to compare weneed to take into consideration the price
level in the economy.
It is important to distinguish between real and nominal terms.
The wages in the table are nominalvalues
We cannot compare nominal variables.
Nominal vs Real
Nominal GDP
Nominal GDP is the market value of all the final goods and services
produced in the country at current prices
Formula Nominal GDP
Nominal GDP2018= Price1
Quantity2018 1 +Price22018 Quantity 2 2018
Nominal vs Real
Real GDP
Real GDP is the market value of all the final goods and services
produced in the country taking into account changesin prices
To calculate real GDP weneed to choose a base year
Then weuse the prices of that year to calculate real GDP.
To calculate real GDP2018 with base year 2010:
Formula Real GDP
Real GDP2018= Price1 2010 Quantity 1 2018 + Price22010 Quantity 2 2018
GDP Deflator
GDP Deflator
A measureof the price level using the ratio of nominal to real GDP
GDP Deflator
Real GDP
GDP Deflator
= Nominal GDP 100
GDP Growth
Real GDP Growth
The rate at which GDP changedin aspecific time period
Growth rate of real GDPt = GDPt GDPt1
Comparing the Standards of Living
We have established that GDP is the best measure wehave for the
economic prosperity of a country
We have established that GDP is the best measure wehave
for the economic prosperity of a country
However, can weuse GDP figures to compare the standard of
living between different countries?
Who has a higher standard of living, the average US citizen or
a Chinese citizen, a German or a citizen of Luxembourg?

Comparing the Standards of Living

Country GDP
million $
1.China 23,159,107
2.US 19,390,600
3.India 9,459,002
4.Japan 4,170,790
5.Germany 4,170,790
9.UK 2,914,042
38.Singapore 527,021
51.Qatar 347,887
105.Luxembourg 63,549

Comparing the Standards of Living

Country GDP
million $
1.China 23,159,107
2.US 19,390,600
3.India 9,459,002
4.Japan 4,170,790
5.Germany 4,170,790
9.UK 2,914,042
38.Singapore 527,021
51.Qatar 347,887
105.Luxembourg 63,549


Country GDP
per capita
1.Qatar 124,927
2.Luxembourg 109,192
3.Singapore 90,531
11.US 59,495
17.Germany 50,206
79.China 16,624
26.UK 43,620
28.Japan 42,659
122.India 7,174

GDP per Capita
To be able to compare the standard of livings between
different countries weneed to consider the population of the
GDP per capita is simply the GDP of the economy divided by
the population.
In this way, wemeasure the income of the ”average” citizen of
that country
There are some obvious issues with this measure as well, but
it is the best we have.

Cost of Living
Following the numbers in the tables presented above,
a janitor used to earn $720 a century ago and they earn
around $30000 today.
If the price of bread was 7 cents and now is 65 cents.
When is/was the janitor earning more?
If the price of a house was $3000 in 1910 and now the same
house costs around $250000.
When is/was the janitor earning more?
Cost of Living
The janitor in our simple example
could buy around 10000 loafs of bread in 1900s vs 45000
today per year (4.5 times more!)
needed to save for about 5 years to be able to buy a house,
while now they need to save for morethan 8 years.
Wages increased, but so did prices!

Cost of Living
What changed in the previous example?
It is the
purchasing powerof the janitor that has significantly
Purchasing power
The value of goods and services you can buy with oneunit of a
Measuring the Cost of Living
In economics the cost of living refers to:
Cost of living
The amount of money people needto maintain the standards of
living in terms of the goods and servicesthey can afford to buy
Measuring the Cost of Living
In reality weneed to take a snapshot of the prices in the economy
to understand how prices change over time.
Price level
A snapshot of the prices in an economy at aparticular period of time
Measuring the Cost of Living
Prices change over time, usually upwards.
The rate at which prices increase over aperiod of time
If prices decrease, then wecall this phenomenon deflation.
Consumer Price Index
Statistical offices around the world use different statistics to keep
track of how prices change.
Consumer Price Index
The CPI is ameasureof the overall prices of the foods and services
bought by atypical consumer.
In the UK the Office of National Statistics, every month, measures
the prices of goods consumed by the typical consumer and
calculates and reports the CPI.
Consumer Price Index
To calculate CPI:
CPIt =
Cost of basket of goods
Cost of basket of goodsbaseyear
and for the inflation rate:
Inflationt= Price IndextPrice Indext1
Price Indext1
CPI Issues
The CPI is not a perfect measure (as most measuresin
Substitution Bias: Prices change from year to year but not
all goods’ prices change at the rate. Consumers tend to
substitute goods that had a significant increase in price. CPI
involves a fixed basket of goods that in some cases tends to
overstate inflation.
Introduction of new goods: A new good may provide an
easier and cheaper method to consume the same good or
service. CPI and the fixed basket of goods ignores this.

CPI Issues
Unmeasured quality change: If the quality of a good falls
from one year to the other the value of your money has
changed and this cannot be reflected in the CPI.
Relevance of the CPI: Lastly, CPI involves a typical
consumer and in general many individuals are a lot different
than the typical consumer. The spending patterns of all of us
are not the same and CPI may be irrelevant forsome.

One of the most important issues in economic policy making
is decreasing unemployment.
Losing a job or not being able to find a job has a negative
impact on an individual’s life.
In simple terms, unemployment affects the standard of living.
What is Unemployment?
Intuitively, anyone who does not have a job.
There are a few issues with this definition.
What about all of you, do you consider yourselves
One of the most important aspects is being ”available” to

Measuring Unemployment
Governments have two main ways to measureunemployment:
Claimant count: All those who claim unemployment benefits.
Labour forcesurveys:
Some key terms to define unemployment correctly.
Employed :All people who worked for payment during last
Unemployed : All people at the working age who are not
employed AND looking for a job (willing to work).
Working age: All people 16 or older and below the retirement
Economically active: people who are not in employment due
to reasons such as being in full-time education, raising a
family etc.

More key terms to define unemployment correctly.
Labour force: Total number of workers (employed and
Participation rate: The percentage of the adult population in
the labour force.
Unemployment rate: The percentage of of the labour force
that is unemployed.

Causes of Unemployment
Natural unemployment: The normal rate around which the
unemployment fluctuates.
Frictional unemployment: unemployment that is caused
because it takes time for workers to search for jobs that best
suit their tastes and skills.
Structural unemployment: unemployment that results because
the number of jobs in some labour markets are not sufficient to
provide a job to everyone.

Structural Unemployment
Occupational Immobility :e.g. A mine closes and people lose
their job their skills are not easily transferable.
GeographicalImmobility :e.g. An opportunity might be
available for these miners that is 200 miles away.
Technological Change: Jobs become obsolete due to changes
in technology
Structural changesin the economy: Economies evolve through
time, all started with the main focus being agriculture because
growing food was important for our survival, then we shift to
manufacturing and now developed economies focus on

GDP: measures the value of production of a country.
Y = C+ I + G+ NX
Nominal vsReal :Difference is the pricelevel.
Real GDP per capita: Allows us to compare the standard of
living in different regions
Purchasing power: The total value of goods you can buy with
a unit of a currency.

Inflation: is the rate of change of prices.
GDPDeflator : Formula, one measure of inflation. Limitations.
CPI: Changes in prices of a basket of goods. Limitations.
Unemployment: Definitions and different types of

Review today’s lesson.
Read the relevant chapters in the book (Ch. 20-23. Including
all boxes and case studies)
Search online for more sources.
Ask questions in seminar if anything is unclear.
Do self-test questions at the end of the chapter and online.
Thank youfor your attention.