Chapter 8: Measures of Economic Activity

An Introduction to
Macroeconomics
Date: Fall 2009
Course: CIA 4U1
Mr. Raposo

The Business Cycle
• Refers to the general “ups and downs” in
economic activity over a period of time
• Typically characterized by 4 phases

Recovery
The Business Cycle
The Business Cycle
Trough
Peak
Peak
Recession Recession
Recession Recession
Recovery
Trough
Time
Business Level of Activity

4 Phases of the Business
Cycle
1. Peak
2. Recession
3. Trough
4. Recovery

Economic Prosperity:
The Demand Side
• The total output of the economy (GDP)
will depend on the level of total spending
on goods and services in the economy
(the demand side).
• Aggregate Demand (AD): : Total
spending on goods and services

Aggregate Demand
• consists of consumption (C), investment
spending (I), government spending (G) and
net exports (X – M).
• AD = C + I + G + ( X – M )
• C = Consumption
• I= Investment
• G=Government Spending
• Net Exports = exports (X) minus imports
(M)

A: What Determines
Consumption (C)?
1. Personal Disposable Income
2. Consumer Confidence
3. Interest Rates
4. Consumer Indebtedness
5. Personal Savings

Personal Disposable
Income
• = personal income minus personal taxes
• The amount of money households have
available to spend
• As personal disposable income rises,
consumption rises

Consumer Confidence
• The degree to which consumers feel optimistic
(or pessimistic) about future economic
conditions.
• Higher consumer confidence is likely to
increase consumption through more spending
and borrowing of money
• Lower consumer confidence is likely to
decrease consumption through less spending
and borrowing of money

Interest Rates
• The cost of money
• Low interest rates encourage spending
(housing, cars, appliances) and therefore
will increase consumption
• High interest rates discourage consumer
borrowing and depresses spending (less
consumption)

Consumer Indebtness
• A strong factor affecting consumers
willingness to spend
• Heavy debt loads prevent further
borrowing

Personal Savings
• That part of disposable income that isn’t
spent on consumption
• Example: If personal disposable income
is $500 B and consumption is $450 B
then personal savings equals $50 B
($500 - $450)
• Savings accounts, GIC’s, , Bonds, stocks,
etc.

How much do Canadians
save?
• Personal Savings Rate: Percentage of
personal disposable income that is not
spent
• In the above example, the personal
savings rate is 10% ($50 B divided by
$500 B

What determines the level
of personal savings?
• Key determinant is PERSONAL DISPOSABLE
INCOME
• As disposable income rises, so does the volume of
savings
• High interest rates encourage savings
• Government taxation policies can encourage savings
(tax deductions for RRSP’s)
• Demographic Factors (baby boomers growing older,
therefore increase in savings)

Investment Spending By
Businesses (I)
• Investment: Spending by businesses on capital
goods (producer goods)
• Examples: factories, machinery, equipment,
tools, computers, office equipment, etc.
• Investment also includes factories,
warehouses, retail stores, residential
construction, government roads, public
buildings, schools, etc.

Investment Spending By
Businesses
• NOTE: Business spending is important to
economic progress because the addition
of capital goods to the economy
increases output per worker
(productivity). This affects aggregate
supply and can shift the AS curve
(chapter 22).

What Determines the Level
of Business Spending?
1. Expectations Regarding The
Profitability Of Investment Projects
2. Interest Rates

Expectations Regarding The
Profitability Of Investment
Projects
• How high sales & production are relative to
production capacity & whether sales are
expected to increase in the future
• If production is at capacity and sales are
expected to rise then investment will increase
• If sales are expected to fall investment will be
low
• If economic forecasts predict the economy will
do well then investment will increase
• Poor economic outlook will result in low
investment

Interest Rates
• When interest rates are lower,
investment by businesses is higher
• When interest rates are higher,
investment by businesses is lower
• Why? Interest rates are the cost of
borrowing money!

The Saving-Investment
Process
• Investment is not possible without
savings
• Savings can come from 3 sources:
1. Personal Savings (households)
2. Business Savings (retained earnings)
3. Foreign Savings

GOVERNMENT SPENDING
ON GOODS & SERVICES
(G)
• Includes federal, provincial and municipal
government
• Large percentage of government
spending is on wages and salaries of
government employees (healthcare
workers, teachers, law enforcement, etc.)

Net Exports (X-M)
• If exports (X) are greater than imports (I), net
exports is positive (sell more goods to
foreigners than we purchase from foreigners)
• If exports (X) are less than imports (I), net
exports is negative (buy more goods from
foreigners than we sell to foreigners)

Questions & Homework