Macro-Economic Principles and Macro-Economic Objectives of A Country

Macro-economic principles and macro-economic objectives of a country
Economics - B
Introduction
When wants exceed the resources available to satisfy them, there is scarcity. Faced with scarcity, people must make choices. Economics is the study of the choices people make to cope with scarcity. Choosing more of one thing means having less of something else. The opportunity cost of any action is the best alternative forgone. Microeconomics - The study of the decisions of people and businesses and the interaction of those decisions in markets. The goal of microeconomics is to explain the prices and quantities of individual goods and services. Macroeconomics - The study of the national economy and the global economy and the way that economic aggregates grow and fluctuate. The goal of macroeconomics is to explain average prices and the total employment, income, and production
SCOPE:-
MICROECONOMICS I. II. III. IV. V. scarcity supply & demand markets consumer producer changes/impacts efficiency technology resources III. IV. I. II.
MACROECONOMICS
business cycles unemployment/ employment inflation trade, international markets (global economy)
Economics - B
(01) Explain the importance of calculating national income. You should refer to sources of national income & their significance?
(1) National income estimates help us to know this performance of an economy during one year and over a period of years.
(2) National income estimates also tell us about the economic welfare enjoyed by the people. We can know the per capital income by dividing national income by population.
(3) On the basis of national income estimate comparison between various economics of the world may be made. National income figures for various countries provides us the rates of growth in different economies.
(4) In an economy, inter-sector comparison can be made with the help of national income statistics
(5) National income figures are inevitable for an economy, which wants to develop with the help of economic planning.
(6) National income accounts reflect the structural change in a growing economy.
(7) National income estimated over period of years enable us evaluate the planning.
(8)National income estimated are also important in the formation of the budget by the finance Minister of the country.
(9) National income estimates are also important because they indicate how the income or wealth is distributed among the various classes. Thus we can know whether the national income is equally distributed or not
Economics - B
GDP: Production and Income There are three ways of defining GDP: 1. GDP is the value of the final goods and services produced in the economy during a given period. A final good is a good that is destined for final consumption. An intermediate good is a good used in the production of another good. 2. GDP is the sum of the incomes in the economy during a given period. 3. GDP is the sum of value added in the economy during a given period. Value added equals the value of a firms production minus the value of the intermediate goods it uses in production.
Gross Domestic Product: Expenditure and Income For first two definitions: Total expenditure on domestically-produced final goods and services. Total income earned by domestically-located factors of production.
Economics - B
Economics - B
(02) Explain the methods of calculating national income and their limitations?
What is National Income ? National income measures the total value of goods and services produced within the economy over a period of time National Income can be calculated in three main ways 1. The sum of factor incomes earned in production 2. Aggregate demand for goods and services 3. The sum of value added from each productive sector of the economy
Why is National Income important? Measuring the level and rate of growth of national income why is important to economists when they are considering: Economic growth and where a country is in the business cycle Changes to average living standards of the population Looking at the distribution of national income (i.e. measuring income and wealth inequalities)
Economics - B
Gross Domestic Product (GDP) Gross domestic product (GDP) is the total market value of all final goods and services
produced within a given period by factors of production located within a country. GDP measures the value of output produced within the domestic boundaries. GDP includes the output of the foreign owned firms with production plants. There are three ways of calculating GDP - all of which should sum to the same amount since by identity: National Output = National Expenditure = National Income GDP is now known as Gross Valued Added
Three Approaches in calculating GDP

1. Expenditure approach 2. Output approach 3. Income approach (01) Expenditure approach GDP = C + I + G + (X- M) C = Private consumption expenditure I = Investment Expenditure G= Government Consumption Expenditure X = Value of Exports M = Value of Imports Note: - Expenditure on final goods and services Expenditure on imports needed to be deducted from the calculation
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Private Consumption Expenditure (C) 1. Second Hand Goods Ans: Exclude. There is no current production 2. Commission spent on buying a second-hand bag Ans: Include. Current production 3. Expenditure on illegal goods/services Ans: Exclude. No official record
Investment Expenditure (I) I = Gross Domestic Fixed Capital Formation + Change in Stock (Inventories) Gross Domestic Fixed Capital Formation: Expenditure on purchasing land, factories, flats, office, machinery, commission, legal charges Investors spend on intermediate goods and services E.g. raw materials, electricity charges, water charges Ans: Excluded because the value of the final goods already include the value of the intermediate goods and services. I = Gross domestic fixed capital formation + Change in stock Gross domestic fixed capital formation = Net domestic fixed capital formation + depreciation I = Net domestic fixed capital formation + depreciation + Change in stock
Economics - B
Government Expenditure (G) Items Included:e.g. Housing allowance of civil servants e.g. Medical allowance of civil servants e.g. Expenditure on building new airport Items Excluded:Transfer Payment/Public Assistance
Net Exports (X-M) Net Exports = Domestic Exports of goods + Re-exports of goods + Exports of Services - Imports of Goods - Imports of Services Count the VALUES of import and export
Economics - B
(02) Income approach

A method of computing GDP that measures the income - wages, rents, interest, and profits received by all factors of production in producing final goods.
Calculating GDP the Income Approach
National income is the total income earned by the factors of production owned by a countrys citizens. The income approach to GDP breaks down GDP into four components:GDP = national income + depreciation + (indirect taxes subsidies) + net factor payments to the rest of the world + other
GDP at factor cost
In theory, no government intervention local production of cigarettes Rs 360/- (LKR), Market value = factor income = total cost = total value added = Rs 360/- (LKR) But if there is indirect tax or subsidies, Market value total value added
Economics - B
(03) Describe the underlying causes for inflation and unemployment. Select and analyze Sri Lankan data to support your answer Un employment Unemployment occurs when a person is available and willing to work but currently without work. The prevalence of unemployment is usually measured using the unemployment rate, which is defined as the percentage of those in the labor force who are unemployed. Unemployment rate in Sri Lanka: 5.9% (2009 est.) 5.5% (2008 est.)
Year Unemployment rate Rank Percent Change Date of Information 2003 2004 2005 2006 2007 2008 2009 2010 8.00 % 8.40 % 7.80 % 7.70 % 7.60 % 6.00 % 5.20 % 5.90 % 115 116 68 76 86 75 62 53 5.00 % -7.14 % -1.28 % -1.30 % -21.05 % 13.46 % 2002 2003 2004 est. 2005 est. 2006 est. 2007 est. 2009 est.
-13.33 % 30 September 2008 est.
This entry contains the percent of the labor force that is without jobs.
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Note: Minimum Age Limit needs to be fixed for coverage in order to limit the data collection to working age population. In Sri Lanka 10 years of age is fixed as the minimum though there are only a very small percentage in the Labour Force below age 15 years.
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Few general suggestion on creation of employment opportunities:
(i) The share of the employment in Agriculture is gradually decreasing, which is inevitable when the country is developing. However, this trend should not affect the agriculture sector. As such it is necessary to encourage the use of modern technology and more scientific methods in improving productivity. This may attract educated youth to Agriculture. In addition to this, agro-based industries should also be encouraged in the agricultural areas so that the youth who do not want to get engaged in traditional agriculture, could find employment in such industries or start self-employment in their own local areas.
(ii) Extension services for Agriculture should be improved to advice farmers on how they could improve their productivity, use of modern technology available, and how they could market their produce. Private sector organizations should also be encouraged to provide extension services to farmers while they provide other services to them.
(iii) Improve infra-structure facilities like Electricity, Transport and Communication, to disadvantaged areas, so that more job opportunities could be created in those areas. Proper roads, electricity and communication facilities are essential to improve industries and service activities in these areas. Indepth analysis on poverty shows that there is a very high coorelation between incidence of poverty and non-availability of proper road network.
(iv) Credit facilities, which could be easily obtained, should be made available to youth who intend starting self-employment in Agriculture as well as nonagricultural sector.
(v) Marketing facilities should be improved to assist those who are engaged in self-employment, so that they could find suitable markets for their produce, without having to sell their produce at very low prices, to traders, who try to exploit from their helplessness.
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Economics - B
Inflation rate in Sri-Lanka
Inflation In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time. When the price level rises, each unit of currency buys fewer goods and services; consequently, annual inflation is also erosion in the purchasing power of money a loss of real value in the internal medium of exchange and unit of account in the economy. A chief measure of price inflation is the inflation rate, the annualized percentage change in a general price index over time. Unemployment Unemployment occurs when a person is available and willing to work but currently without work. The prevalence of unemployment is usually measured using the unemployment rate, which is defined as the percentage of those in the labor force who are unemployed. The unemployment rate is also used in economic studies and economic indices such as the United States' Conference Board's Index of Leading Indicators as a measure of the state of macroeconomics
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Types of Unemployment: There are basically four types of unemployment which we discuss mainly in macroeconomics subject. 1. Frictional Unemployment 2. Seasonal Unemployment 3. Structural Unemployment 4. Cyclical Unemployment
Frictional Unemployment: This unemployment occupies people in the middle of transiting between jobs, searching for new ones; it is compatible with full employment. In other words, we can say it like when the job looses or job leaving situation is occurred, we can say it frictional unemployment. There are many people in this world who are not totally satisfied with their jobs. We can explain it more efficiently by taking the examples. Example No 1: One of my friends did the MBA in Marketing. He was offered a job from a company in the field of Finance. He worked there for few days and realized that Im losing my potential. He searched for a new job and left the previous job. Example No 2: My uncle is so religious. He was offered with the job in a bank. He studied about the system of banks and concluded that all the non muslim banks are surviving on interest. He decided to left his job and join the Islamic bank where he could feel satisfaction. Example No 3: My cousin was working in a reputed import firm. His work get him to the commission of rupees more than twenty hundred thousand. The firm refused to give them his right. He decided to left that job and started their own business.
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Economics - B
Seasonal Unemployment: The unemployment occur due to the change in a seasons or season factors, is called seasonal unemployment. We can also say it like layoff. In this unemployment, people get unemployed due to seasonal changes. We can easily define it more clearly by taking three good examples. Example No 1: In the business of garments, the business during summer is not much good. Some of the owners of the business decided to layoff some employees so that they couldnt be a burden on them. Example No 2: During the season of winter, most of the ice factories limit their business because of no demand during winter. They sometimes but I would say mostly layoff some of the employees to save the expenses and cost during the season of winter. Example: No 3: During the month of Ramazan, many restaurants limit their services. So that they dont need to apply double shifts in the restaurants. Employees are needed just after the aftari. In this situation, employees have to be layoff.
Structural Unemployment: The unemployment due to structural changes in the organization, economy or environment is called structural unemployment. To clear this point, we would take some examples. Example No 1: There was an operating system called DOS. Few years later, it got vanished from the market due to the fabulous entry of Windows Operating System. People are not required who only knows DOS. Though Windows was user friendly, but even then those people required some time to understand the operating system. The time lag between these two events was the structural unemployment.
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Economics - B
Example No 2: We all know that now a day, firms are going for computerization. They eventually converted their accounts to computerized accounts software. People, who dont know the computerized accounting system, had to left their jobs. Because computerized accounting system is so beneficial and time saving. Now, there are many institutes whore encouraging manual accountants to learn the computerized accounting system. Example No 3: In the developed countries, the use of letter for communication is gradually decreasing. They started to use email system that is very efficient and time saving. People dont have to wait for their letters. Industry of post office is not decreasing. People are getting unemployed due to the structural changes in the system.
Cyclical Unemployment: This refers to unemployment that rises during economic downturns and falls when the economy improves. It is a bit typical statement to understand but we will try to clear this point from the examples. Example No 1: You must have heard about the stock market. Now a day, the stock market is decreasing day by day due to economical changes. Due to the downfall of economy, people are getting unemployed due to low work activities in stock market. Example No 2: The representative of World Bank recently had a press conference about continues decline in the economy of world and considered the year 2009 as the heavy loss and declining year for the economies of world. Investments are losing in the countries and companies are trying to close their business especially under developed and non developed countries to save themselves from heavy losses. In this situation, thousands of the people got unemployed due to economic changes in the whole world.
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Example No 3: Recently, the well know Fashion Company, Marks and Spencer decided to decrease the number of employees. The company said bye to their 2000 employees because of economic stability in the world and also decided to close its more than 50 stores all over the world. Purchasing power of the people is decreasing.
Effect of Inflation on Unemployment Inflation is another big problem of macroeconomics. It is said like too much money chasing few goods. p. It is all because of economics changes in the world. it also has the great impact on all the sectors of the economy like unemployment, consumers etc It is understood when the manufacturer is facing the high cost on producing the goods, he has to do something to cut down the cost. The major effect on cost is human resource. Then manufacturer has to downsize human resource to meet the cost for good profits. As I said earlier that inflation limits the purchasing power of a consumer and nobody would be easy to spend lot of money in few goods. To retain the cost according to the customer is so hard during the inflation. That affects the unemployment too. Todays condition of world economy is showing gloomy picture. Even the worlds second largest motor manufacturing company Toyota decided to downsize and just think what would do the smaller companies? Inflation is the problem of almost every country even the America and Australia where unemployment reaches to 12%. It is very bad for the countries like above. It becomes very hard to maintain the prices of the goods and services in such a severe situation. Inflation in Pakistan has been increased from 20% and unemployment rate is also increasing rapidly.
Inflation Inflation is divided into two types: Price Inflation and Monetary Inflation, the first type is when there is a rise in the general level of prices of goods and services over a period of time,
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the second type (monetary) is when there is a rise in the quantity of money in an economy. Both types are in many times interrelated, and both have negative effects on the economy and individuals.
Effects of Inflation Most effects of inflation are negative, and can hurt individuals and companies alike, below is a list of negative and positive effects of inflation: Negative effects are: 1. Hoarding (people will try to get rid of cash before it is devalued, by hoarding food and other commodities creating shortages of the hoarded objects). 2. Distortion of relative prices (usually the prices of goods go higher, especially the prices of commodities). 3. Increased risk - Higher uncertainties (uncertainties in business always exist, but with inflation risks are very high, because of the instability of prices). 4. Income diffusion effect (which is basically an operation of income redistribution). 5. Existing creditors will be hurt (because the value of the money they will receive from their borrowers later will be lower than the money they gave before). 6. Fixed income recipients will be hurt (because while inflation increases, their income doesnt increase, and therefore their income will have less value over time). 7. Increased consumption ratio at the early stages of inflation (people will be consuming more because money is more abundant and its value is not lowered yet). 8. Lowers national saving (when there is a high inflation, saving money would mean watching your cash decrease in value day after day, so people tend to spend the cash on something else). 9. Illusions of making profits (companies will think they were making profits while in reality theyre losing money if they dont take into consideration the inflation rate when calculating profits). 10. Causes an increase in tax bracket (people will be taxed a higher percentage if their income increases following an inflation increase). 11. Causes mal-investment (in inflation times, the data given about an investment is often deceptive and unreliable, therefore causing losses in investments). 12. Causes business cycles (many companies will have to go out of business because of the losses they incurred from inflation and its effects).
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13. Currency debasement (which lowers the value of a currency, and sometimes cause a new currency to be born) 14. Rising prices of imports (if the currency is debased, then its purchasing power in the international market is lower).
"Positive" effects of inflation are: 1. It can benefit the inflators (those responsible for the inflation) 2. It be benefit early and first recipients of the inflated money (because the negative effects of inflation are not there yet). 3. It can benefit the cartels (it benefits big cartels, destroys small sellers, and can cause price control set by the cartels for their own benefits). 4. It might relatively benefit borrowers who will have to pay the same amount of money they borrowed (+ fixed interests), but the inflation could be higher than the interests, therefore they will be paying less money back. (example, you borrowed $1000 in 2005 with a 5% fixed interest rate and you paid it back in full in 2007, lets suppose the inflation rate for 2005, 2006 and 2007 has been 15%, you were charged %5 of interests, but in reality, you were earning %10 of interests, because 15% (inflation rate) 5% (interests) = %10 profit, which means you have paid only 70% of the real value in the 3 years. Note: Banks are aware of this problem, and when inflation rises, their interest rates might rise as well. So don't take out loans based on this information. 5. Many economists favor a low steady rate of inflation, low (as opposed to zero or negative) inflation may reduce the severity of economic recessions by enabling the labor market to adjust more quickly in a downturn, and reducing the risk that a liquidity trap prevents monetary policy from stabilizing the economy. The task of keeping the rate of inflation low and stable is usually given to monetary authorities. Generally, these monetary authorities are the central banks that control the size of the money supply through the setting of interest rates, through open market operations, and through the setting of banking reserve requirements. 6. Tobin effect argues that: a moderate level of inflation can increase investment in an economy leading to faster growth or at least higher steady state level of income. This is due to the fact that inflation lowers the return on monetary assets relative to real assets, such as physical capital. To avoid inflation, investors would switch from
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holding their assets as money (or a similar, susceptible to inflation, form) to investing in real capital projects. The first three effects are only positive to a few elite, and therefore might not be considered positive by the general public. How to Survive Inflation?
1. Be careful when buying bonds, high inflation rates completely destroy the value of long-term bonds. 2. If you have a variable-rate mortgage, fix it if you can find a good deal, have a low fixed interest rate or 0% interest if you can find one. 3. Invest in durable goods or commodities rather than in money. Check out our commodities list. 4. Invest in things that you're going to use anyway and will serve you for a long time. 5. Invest for long-term capital gains, because short term investments tend to give deceptive results or sense of making profits while in reality youre not making profits. 6. Learn about bartering which is trading goods or services without the exchange of money (it was very popular in hyperinflation times). 7. Manage wisely your recurring monthly bills such as (phone bills, cable TV...), it would help to reduce them or eliminate some of them. 8. Same goes with ephemeral items (movies, restaurants, hotel rooms...) theyre not bad if you spend money on them in moderation. 9. Ask yourself, do I really need these things Im spending my money on? Think how much and how often you will need something before buying it. 10. Use the money saving tips such as: you need to reduce your consumption of things that are rising rapidly in price (eg, gas) without having to reduce your consumption of goods that are rising less rapidly or even falling in price (eg, clothes). 11. Buy only what you need, especially objects that have multi-tasks, and are considered durable goods.
(04) Explain the implications of inflation and unemployment for an economy
Inflation and the economy of a country are closely related. The effect on the economy of any country is not immediate or it does not affect the economy overnight. There is a cumulative
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effect. Several such changes build up to bring about a big change. The economy of a country is affected by inflation in a number of ways.
Inflation and the economy both influence all the major macroeconomic indicators of a country. The various macroeconomic indicators include the following:

Gross domestic product or GDP Producer price index (industrial) Consumer price indices Industrial production Capital Investment Agricultural production Export Import Demography Debt Inflation not only affects the macroeconomic indicators, it affects the living standards of the people. As the percentage of inflation increases, the cost of all commodities also increases. However, the same is not true for the salaries or the wages. It results in a mismatch of income and expenses. As a result, the people are immensely impacted by these changes. The exchange rates of all currencies also change. This in turn influences trade. When exchange rates are affected, the interest rates cannot be far behind.
Inflation and its effect on economy is enormous. In other words, all events are interlinked and the entire economic cycle gets upset. Inflation and its effect on economy may be of two types:

Expected inflation Unexpected inflation Inflation and unemployment go hand in hand. For every country, maintaining a low unemployment rate is the main objective. It is usually believed that inflation and unemployment are inversely proportional. There are many economists, who hold the opinion that low rate of unemployment together with low inflation rate may be a
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source of concern. Both low inflation rate and low unemployment rate, may be hypothetical. In real practice, this rarely happens. If a particular country, has full employment, it can be said to have minimum rate of unemployment. If a nation maintains a minimum rate of unemployment in a condition when inflation rate is stable, it is said to follow the natural rate of unemployment. In other words, the natural rate of unemployment is the minimum rate of unemployment, which can be sustained.
Inflation and unemployment If rate of inflation increases suddenly, it temporarily reduces, the rate of increase in the wages. Consequently, unemployment rate decreases. If the workers are able to cope with the increase in inflation, unemployment rate is also less. However, when they do realize that in order to compensate for the increase in price of commodities, the wages ought to be increased, unemployment may rise to a considerable extent. This increase in the demand of wages, has a tendency to reverse the unemployment curve to some extent (unemployment rises). If the rate of inflation is very high, it does not mean that, there will be a permanent decrease in the rate of unemployment. As a rule, rate of inflation and unemployment adjust themselves to attain the equilibrium state, which is known as the natural rate of unemployment state, effortlessly. It just happens. The Philips Curve: The Philips Curve, as the name suggests is named after the William Philips, who was a famous economist. He suggested the relationship between inflation and unemployment. The Philips curve shows how inflation and unemployment are related. He suggested that if rate of inflation is high, rate of unemployment is low. On the other hand, if the rate of inflation is low, unemployment rate is high.
(05) Identify and explain the main macroeconomic objectives of a country taking Sri
Lanka as an example. You must refer to economic performance, economic growth, and international trade
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Impact on Sri Lankas Economic Performance and Outlook Current Growth Performance Recession averted but economy decelerated sharply in 1Q 2009, with gradual improvement expected from 2Q 2009 onwards
GDP 1Q2008 2Q2008 3Q2008 4Q2008 1Q2009 2Q2009 3Q2009f 4Q2009f 6.2 7.0 6.3 4.3 1.5 2.1 4.5 4.7
Quarterly change (% yoy) Agriculture Industry Services 5.9 6.0 6.4 7.4 6.9 6.9 12.4 5.6 5.5 4.0 5.2 3.8 3.0 1.9 1.0 4.4 3.0 1.1 6.9 3.3 4.6 7.2 4.5 4.4
% of GDP Agriculture Industry Services 13.3 28.4 58.3 12.0 27.7 60.4 12.8 28.2 59.0 10.2 29.5 60.3 13.5 28.5 58.0 12.2 27.9 59.8 13.1 27.9 59.0 10.5 29.4 60.1
Export-oriented industries will lead rebound but growth not expected to be robust given the fragile global economic recovery.
Agriculture rebounding more strongly than other sectors

14.0%
Quarterly change (% year-on-year)
12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0%
GDP
Agriculture
Industry
Services
Recovering food and non-fuel commodity prices
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50% 40% 30%
% yoy change
20% 10% 0% -10% -20% -30% -40%
Index of Non-Fuel Primary Commodities (2005=100) Food Index: Cereals, veg oils, protein meals, meats, seafood, sugar, bananas & oranges Index of Beverages: Coffee, Cocoa & Tea
Industrial Production The major impact from the global recession on Sri Lankas economy has been a sharp slowdown in industrial output.
10.0 8.0
% year-on-year change
6.4 5.1
6.4
IPI
6.0
6.0
3.4 0.2 Textile, Wearing Apparel & Leather -3.7 Chemicals, Rubber, Plastic & Petroleum Food, Beverages & Tobacco
4.0
2.0 0.0 -2.0 -4.0 -6.0 3.7
Industrial production dragged down by contraction in export-based industries
Export Performance
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60.0
40.0
Monthly change (% year-on-year)
20.0
0.0
All exports Industrial exports Agric exports
-20.0
-40.0
-60.0
Industrial and agricultural exports recorded pronounced monthly declines Improvement in trade balance Trade deficit narrows as imports contracted more sharply than exports.
200
150
Imports
100
LKR billion
50
Exports
-50 Trade deficit -100

Apr-2007 Apr-2008 Apr-2009
Jan-2007
Jan-2008
Jan-2009
Jul-2007
Jul-2008
Oct-2007
Exports hit by global recession

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Oct-2008
Jul-2009
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Exports to Emerging Asia have been picking up gradually since the beginning of 2009; exports to the US and EU trend have been trending downwards.
350
300
+
USD million
250 200
EU
150 100 50 0
US Emerging Asia
Price disinflation rather than deflation Disinflation as price level stabilises due to sharp fall in commodity prices and weak demand amidst economic slowdown.
215
210
30.0
25.0 20.0 15.0 10.0
205
2002=100
200
195
190 185 180 175 170
5.0
0.0
CCPI (2002=100) (LHS)
% annual change (RHS)
Short-term Outlook for 2010 and 2011

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% yoy change
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Sri Lankas economy is forecast to expand 5.6% in 2010 and pick up more strongly to 6.3% in 2011.
Real GDP
Private Government consumption consumption
Gross domestic capital formation 13.3 8.2 4.7 4.3 5.5 5.9 5.8 6.7 26.7 27.1 28.0
Exports
Imports
2006 2007 2008 2009f 2010f 2011f Period average 2011-15f 2016-20f Share to GDP 2010f 2015f 2020f
7.7 6.8 6.0 3.5 5.6 6.3 5.5 6.0 100.0 100.0 100.0
6.5 3.9 7.6 3.0 5.8 6.0 5.8 6.0 66.6 67.6 67.5
9.6 7.4 9.8 8.2 7.1 5.9 2.8 1.0 15.5 13.6 10.6
3.8 7.3 0.4 1.7 4.9 6.2 5.8 5.0 31.3 31.8 30.3
6.9 3.7 4.5 2.4 3.5 3.8 4.0 3.2 40.1 37.4 32.6
Stronger domestic and external demand is anticipated to underpin growth in all sectors.
GDP A. Annual change % 2007 6.8 2008 6.0 2009f 3.5 2010f 5.6 2011f 6.3 Agriculture 3.4 7.5 5.6 7.9 4.1 Industry 7.6 5.9 3.3 5.5 6.4 2.1 1.7 0.9 1.6 1.8 28.5 28.4 28.4 28.4 28.4 Services 7.1 5.6 3.1 5.2 6.7 4.2 3.4 1.9 3.1 4.0 59.6 59.5 59.3 59.0 59.3
B. Contribution to GDP growth (% points) 2007 6.8 0.4 2008 6.0 0.9 2009f 3.5 0.7 2010f 5.6 1.0 2011f 6.3 0.5 C. Share of GDP (%) 2007 100.0 2008 100.0 2009f 100.0 2010f 100.0 2011f 100.0 11.9 12.1 12.3 12.6 12.3
Medium-to-long term growth prospects

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Over the medium-term horizon (from 2010 to 2015), the economy is expected to expand 5.5% per annum. This is slightly above the current underlying potential output, estimated at 5.3% with another statistical technique. Medium-to-long-term growth prospects are likely to be enhanced by more efficient resource allocation, reduced macroeconomic imbalances and the expected re-direction of resources to economic development and reconstruction
8.0 7.0 6.0 6.0 5.5 7.0
7.2
Annual growth (%)
5.0 5.0 4.0
5.0
5.0 3.7 3.0
2000-09a
2010-15f
3.0 2.0 1.0 0.0
2016-20f
Baseline
High case
Low case
High case scenario of 2 percentage points above baseline forecast achievable with: Raising productivity growth by 10% per annum. Closing the human-capital development gap (as proxied by the average number of years of schooling). Raise employment level to 46% from the current 36% of the countrys population. Increase investments share of GDP increases to 35% from 27% in 2008. For growth to be sustainable, there is a need to promote a shift in resources and production capacity to higher-value and productivity-driven industries within the manufacturing and services sectors.
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Addressing macroeconomic imbalances Projected narrowing of Sri Lankas current-account deficit and improvement in the savings-investment balance.
Government spending cuts needed to reduce deficit
0% -2% -4%
1600 1400 1200
14% 12% 10% 8% 6% 4%
% of GDP
LKR billions
1000 800 600 400 200
-6% -8% -10% -12% 2000 2001 2002 2003 2004 2005 2006 2007 2008
2%
0% 2000 2001 2002 2003 2004 2005 2006 2007 2008
Government Expenditure (LHS)
Fiscal deficit (% of GDP)
Military spending as a % of total government expenditure (RHS)
Gradual pace of fiscal consolidation projected
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Persistently large fiscal deficits must be reined in to restore the countrys macroeconomic stability. Sri Lankas fiscal deficit is projected to gradually narrow to a more sustainable level.
Disinflation across Asia, but Sri Lankas CPI inflation likely to remain higher than regional averages
25.0 20.0
22.6
CPI inflation (%)
15.8 15.0
10.0 5.0 0.0
14.2
9.6 11.0 South Asian Average 10.0 6.8 7.4 3.3
9.0 9.0
Sri Lanka
Developing Asia
ASEAN-5
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With inflation normalising, the directions of interest rates and exchange rates are expected to reflect the improving macroeconomic fundamentals.
500,000 450,000
400,000
120.0
100.0
350,000
80.0
LKR millions
300,000 250,000 200,000 150,000

100,000
60.0
40.0
20.0
50,000 0 0.0
Foreign Reserve (LHS)
USD/LKR (2006=100) (RHS)
NEER (2006=100) (RHS)
Improving macroeconomic fundamentals expected to underscore rise in foreign reserves and currency strengthening.
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Index
Economics - B
Sustaining international competitiveness International ranking of Sri Lankas exports
Sector exports in USD mn (Total no. of countries in ranking)
Clothing (USD2,813 mn) (181) Fresh food (USD1,159 mn) (159) Chemicals (USD311 mn) (140) Minerals (USD303 mn) (156)
IT & Consumer electronics (USD256 mn) (144) Basic manufactures (USD256 mn) (124)
5
34 26 29 76
37 19
107 71 72
94 105
Processed food (USD189 mn) (145) Textiles (USD164 mn) (144) Misc manufacturing (USD162 mn) (115) Transport equipment (USD114 mn) (107) Electronic components (USD108 mn) (147)
Wood products (USD45 mn) (126)
26 37 22 25 59 60 58 54 30
94
56 60 85
107
Leather products (USD39 mn) (126) Non-electronic machinery (USD12 mn) (119) 0 20
92
40
60
80
100
120
Rank in Current Index
Rank in Change Index
High ranking in resource-based (fresh food) and low-technology products (clothing) Change index suggests improved ranking in Chemicals, IT & Consumer Electronics, Transport equipment, Non-electronic machinery and Miscellaneous Manufacturing
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Economics - B
Promoting private sectors dynamism and entrepreneurship

8.0 7.0 6.0
Ireland Singapore
Sri Lanka India
New density
5.0 4.0 3.0 2.0
Malaysia
Pakistan Malaysia Singapore
1.0
0.0 2000 2001 2002
Sri Lanka
2003 2004 2005 2006 2007
Ireland
"New density" is the number of newly registered corporations divided by total working age population.
Enhancing private sector financing Given the sizeable gap in financial intermediation, expanding Sri Lankas domestic credit to the private sector will help to unleash this private sector-led growth and dynamism.
33
Economics - B
Vast scope for expanding financial intermediation and deepening of Sri Lankas financial system.
Comparison of financial structures and performance .
34
Economics - B
(06) Identify the multiple effects of these objectives. You must refer to budget deficit and balance of trade
Budget Deficit Definition The amount by which a government company or individual's spending exceeds its income over a particular period of time. also called deficit or deficit spending. .
Balance of trade
Definition
A country's exports minus its imports; the largest component of a country's balance of payments.
A budget deficit occurs when an entity spends more money than it takes in. The opposite of a budget deficit is a budget surplus. Debt is essentially an accumulated flow of deficits. In other words, a deficit is a flow and debt is a stock. An accumulated deficit over several years is referred to as the government debt. Government debt is usually financed by borrowing, although if a government's debt is denominated in its own currency it can print new currency to pay debts. Monetizing debts, however, can cause rapid inflation if done on a large scale. Governments can also sell assets to pay off debt. Most governments finance their debts by issuing long-term government bonds or shorter term notes and bills. Many governments use auctions to sell government bonds. Governments usually must pay interest on what they have borrowed. Governments reduce debt when their revenues exceed their current expenditures and interest costs. Otherwise, government debt increases, requiring the issue of new government bonds or other means of financing debt, such as asset sales
35
Economics - B
Primary deficit, total deficit & debit The government's deficit can be measured with or without including the interest it pays on its debt. The primary deficit is defined as the difference between current government spending and total current revenue from all types of taxes. The total deficit is spending, plus interest payments on the debt, minus tax revenues. Therefore, if Gt is government spending and Tt is tax revenue, then Primary deficit = Gt Tt If Dt 1 is last year's debt, and r is the interest rate, then Total deficit = Gt + rDt 1 Tt Finally, this year's debt can be calculated from last year's debt and this year's total deficit: Dt = (1 + r)Dt 1 + Gt Tt Economic trends can influence the growth or shrinkage of fiscal deficits in several ways. Increased levels of economic activity generally lead to higher tax revenues, while government expenditures often increase during economic downturns because of higher outlays for social insurance programs such as unemployment benefits. Changes in tax rates, tax enforcement policies, levels of social benefits, and other government policy decisions can also have major effects on public debt. For some countries, such as Norway, Russia, and members of the Organization of Petroleum Exporting Countries (OPEC), oil and gas receipts play a major role in public finances. Inflation reduces the real value of accumulated debt. If investors anticipate future inflation, however, they will demand higher interest rates on government debt, making public borrowing more expensive.
36
Economics - B
Structural deficits, cyclical deficits, and fiscal gap A government deficit can be thought of as consisting of two elements, structural and cyclical. At the lowest point in the business cycle, there is a high level of unemployment. This means that tax revenues are low and expenditure (e.g. on social security) high. Conversely, at the peak of the cycle, unemployment is low, increasing tax revenue and decreasing social security spending. The additional borrowing required at the low point of the cycle is the cyclical deficit. By definition, the cyclical deficit will be entirely repaid by a cyclical surplus at the peak of the cycle. The structural deficit is the deficit that remains across the business cycle, because the general level of government spending is too high for prevailing tax levels. The observed total budget deficit is equal to the sum of the structural deficit with the cyclical deficit or surplus. The idea of cyclical vs. structural deficits has come under criticism by those economists who believe that the business cycle is too difficult to measure to make cyclical analysis worthwhile. A concept related to the structural deficit is the fiscal gap, defined by economists Alan Auerbach and Lawrence Kotlikoff. It refers to the shortfall in government revenues over the very long term. It includes not only the structural deficit at a given point in time, but also the difference between promised future government commitments, such as health and retirement spending, and planned future tax revenues. Since the elderly population is growing much faster than the young population in many countries, many economists argue that these countries have important fiscal gaps, beyond what can be seen from their deficits alone.
37
Economics - B
38
Economics - B
Sri-Lankas External sector performance
In April 2010, we have a trade deficit : the total external sector performance balance is negative in numbers at -($115.4 million) after adding the workers remittances($308.2 million) to the balance of imports($967.1 million) and exports($543.5 Million). During the month of April in 2009, we had a balance of trade ($83.5 million), a trade surplus. The numbers for the first quarter of 2010 also shows a trade deficit, it is again negative in numbers at -($-686.1 million) after adding the workers remittances($1198.8 million) to the balance of imports($4191.9 million) and exports ($2307.0 Million). During the first quarter of 2009, it was a positive figure of balance ($198.8 million). The workers remittances are trending upwards and according to the CBSL : During the first quarter of 2010, workers remittances increased by 14.5 per cent over that of the corresponding quarter of 2009 to US dollars 1,199 million. The gross official reserves, with and without Asian Clearing Union (ACU) funds, increased to US dollars 5,440 million and US dollars 5,215 million, respectively, by end April 2010.
39
Economics - B
Sri Lankas Earnings from exports grew by 24.2 per cent in April 2010 to US dollars 543 million led by higher earnings from the industrial and agricultural sectors. There were significant increases in exports of machinery and equipment, comprising mainly of transport equipment such as boats and bicycles and electrical equipment such as transformers, static converters, inductors and insulated cables. Earnings from exports of rubber products, petroleum products and diamond and jewellery have also performed well. Export earnings from textiles and garments have increased marginally to US dollars 227 million in April 2010 after seven consecutive months of year-on-year declines.
Expenditure on imports of intermediate goods increased, mainly led by higher petroleum and fertilizer imports. Import price of crude oil averaged at $85.02 per barrel in April 2010 vs $54.45 per barrel in April 2009. Expenditure on imports of consumer goods increased by 63.6 per cent, imports of sugar, milk products and other food items were responsible for higher expenditure. Import of milk products expenditure alone increased by 258.6 per cent in April 2010. Expenditure on investment goods also increased in April 2010, led by higher imports of transport equipment, particularly motor cycles, followed by machinery and equipment such as electrical equipment and printing machinery.
40
Economics - B
41
Economics - B
(07) Explain the use of macroeconomic data to interpret the economic condition of
Sri Lanka. You must refer to key indexes & their usefulness.
The economic structure of Sri Lanka can be divided into the following sectors: Primary Sector: Sri Lankan primary agriculture sector can be divided into three major categories .i.e. farming, fishing and aquaculture. As of 2008, 32.7% of the labor force was employed in the sector. Some major crops are rice and the staple cereal. Coconut, tea and rubber plantation is done extensively. Tea is one of the countrys biggest foreign exchange earners. Secondary Sector: The industrial sector provides employment to 26.3% of the workforce (as of 2008). Around 18% of the GDP comes from manufacturing which is also the countrys largest industrial subsector. The construction sector contributes 7% to the GDP followed by mining and quarrying that account for 1.5%. Measured by value addition food, beverage, and tobacco contribute 44% followed by textiles, garment, and leather that contribute 20%. Some other major manufacturing industries include petroleum, chemical, plastic rubber and non-metallic mineral-based products. Tertiary Sector: Sri Lankan services sector is the major employer as 41% of the countrys labor force is engaged in it (as of 2008). The growth rate in 2006-07 was 7% and dropped to 5.6% in 2008 due to recession. The major contributory sectors to growth were the financial services, telecom, trading and transport. The information technology sector is growing steadily in Sri Lanka. Tourism, which has been one of the major foreign exchange earners for decades, is also taking off post civil war. The target of the countrys tourism development board is to attract 2.5 million tourists and earn $2 billion by 2016.
42
Economics - B
(08) Explain the macroeconomic tools available for the government to regulate the state of the economy in relation to construction industry
Planned economy is an economic system in which the state directs the economy. It is an economic system in which the central government controls industry such that it makes all decisions regarding the production and distribution of goods and services. Its most extensive form is referred to as a command economy, centrally planned economy, or command and control economy. In such economies, central economic planning by the state or government controls all major sectors of the economy and formulates all decisions about the use of resources and the distribution of output. Planners decide what should be produced and direct lower-level enterprises to produce those goods in accordance with national and social objectives. Planned economies are in contrast to unplanned economies, i.e. the market economy, where production, distribution, pricing, and investment decisions are made by the private owners of the factors of production based upon their individual interests rather than upon a macroeconomic plan. Less extensive forms of planned economies include those that use indicative planning, in which the state employs "influence, subsidies, grants, and taxes, but does not compel." This latter is sometimes referred to as a "planned market economy". A planned economy may consist of state-owned enterprises, private enterprises directed by the state, or a combination of both. Though "planned economy" and "command economy" are often used as synonyms, some make the distinction that under a command economy, the means of production are publicly owned. That is, a planned economy is "an economic system in which the government controls and regulates production, distribution, prices, etc." but a command economy, while also having this type of regulation, necessarily has substantial public ownership of industry. Therefore, command economies are planned economies, but not necessarily the reverse.
43
Economics - B
There are two major tools of macroeconomics policy. Begin with fiscal policy, which denotes the use of taxes and government expenditures. Government expenditures come in two distinct forms. First there are government purchases. These compromise spending on goods and services purchases of tanks, construction of road, salaries for judges, and so forth. In addition, there are government transfer payments, which boost the incomes of targeted groups such as the elderly or the unemployed.
Government spending determines the relative size of the public and private sectors, that is, how much of our gross domestic product is consumed collectively rather than privately. From a macroeconomic perspective, government expenditures also affect the overall level of spending in the economy and thereby influence the level of gross domestic product.
44
Economics - B
Conclusion Gross Domestic Product (GDP) measures both total income and total expenditure on the economys output of goods & services. Nominal GDP values output at current prices, real GDP values output at constant prices Changes in output affect both measures. but changes in prices only affect nominal GDP GDP is the sum of consumption, investment, government purchases, and net exports The overall level of prices can be measured by either the Consumer Price Index (CPI), the price of a fixed basket of goods purchased by the typical consumer, or the GDP deflator, the ratio of nominal to real GDP The unemployment rate is the fraction of the labor force that is not employed.
45
Economics - B
References: Michael Burda and Charles Wyplosz (1995), European Macroeconomics, 2nd ed., Ch. 3.5.1, p. 56. Oxford University Press, ISBN 0198774680
ASHWORTH, A. 1999. Cost studies of Buildings SEELY, I. 1997. Quantity Surveying Practice
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