Macro Econ My

Macroeconomics
Dr. Algassim Mohamed Ebrahim

University of Khartoum
School of Management Studies
Undergraduate program
2022
1
Macroeconomic Equilibrium
Lecture (4 and 5)
18/6/2022 – 25/6/2022
Contents:
1) Circular Flow of Income and Expenditure
2) Aggregate Demand and Aggregate Supply
2
The circular flow of income forms the basis for all the macroeconomic
models of the economy and it is essential to understanding concepts
like national income, aggregate demand and aggregate supply.
The circular flow of income describes the movement of goods or
services and income among the different sectors and markets of the
economy.
The Four Macroeconomic Sectors:

a) The Households Sector:
This sector includes all the individuals in the economy. The primary
function of this sector is to provide the factors of production. The
factors of production include land, labour and capital. The household
sectors are the consumers who consume the goods and services
produced by the firms and in return make payments for the same.
3
b) The Firms Sector
This sector includes all the business entities, corporations and
partnerships. The primary function of this sector is to produce goods
and services for sale in the market and make factor payments to the
household sector.
c) The Government Sector
The government sector incurs both revenue as well as expenditure.
The government earns revenue from tax and non-tax sources and
incurs expenditure to provide essential public services to the people.
d) The Foreign Sector
This sector includes transactions with the rest of the world. Foreign
trade implies net exports (exports minus imports). Exports include
goods and services produced domestically and sold to the rest of the
world and imports include goods and services produced abroad and
sold domestically.
4
The Three Markets:
a) The Goods Market
In this market the goods and services are exchanged among the four
macroeconomic sectors. The consumers are the household,
government and the foreign sector while the producers are the firms.
b) The Factor Market
The factors of production are traded through this market. For the
production of final goods and services, the firms obtain the factor
services and make payments in the form of rent, wages and profits for
the services to the household sector.
c) The Financial Market
This market consists of financial institutions such as banks and non-
bank intermediaries who engage in borrowing (savings from
households) and lending of money.
5
We have three models to study the Circular Flow of Income:
A. Two - Sector Model (closed economy)
B. Three - Sector Model (closed economy)
C. Four - Sector Model (open economy)
A. The Circular Flow of Income in a Two-Sector Model

• In this model, the economy is assumed to be a closed economy and
consists of only two sectors, i.e., the households and the firms. A
closed economy is an economy that does not participate in
international trade.
• In this model, the households sector is the only buyer of the goods
and services produced by the firms and it is also the only supplier of
the factors of production. The households sector spends the entire
income on the purchase of goods and services produced by the firms
implying that there is no saving or investment in the economy.
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• The firms are the only producer of the good and services. The firms
generate income to the household sector by selling the goods and
services and the latter earns income by selling the factors of
production to the former.
• Thus, the income of the producers which is the value of goods and
services (National Product) is equal to the income of the households
(National Income) is equal to the consumption expenditure of the
household. And the demand of the economy is equal to the supply.
• In this model, Y = C
where, Y is Income and C is Consumption.
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A.1 The Circular Flow of Income in a Two- Sector Model with Saving
and Investment:
• In the above model, we assumed that the household sector spends
its entire income and that there is no saving in the economy however,
in practice, the household sector does not spend all its income; it
saves a part of it.
• The saving by the household sector would imply monetary
withdrawal (equal to saving) from the circular flow of income. This
would affect the sale of the firms since the entire income of the
household would not reach the firm implying that the production of
goods and services would be more than the sale. Consequently, the
firms would decrease their production which would lead to a fall in
the income of the household and so on.
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• There is one way of equating the sales of the firms with the income
generated; if the saving of the household is credited to the firms for
investment then the income gap could be filled. If the total
investment (I) of the firms is equal to the total saving (S) of the
household sector then the equilibrium level of the economy would
be maintained at the original level.
• The equilibrium condition for a two-sector model with saving and
investment is as follows:
Y=C+S
Or
Y=C+I
Or
C + S = C + I Or S = I
Where, Y = Income, C = Consumption, S = Saving and I = Investment
10
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B. The Circular Flow of Income in a Three – Sector Model
• The three-sector model of circular flow of income highlights the role

played by the government sector. This is a more realistic model which
includes the economic activities of the government however, we
continue to assume the economy to be closed. There are no
transactions with the rest of the world. The government charges
taxes on the households and the firms and it also gives subsidies to
the firms and transfer payments to the household sector. Thus, there
is income flow from the household and firms to the government via
taxes in one direction and there is income outflow from the
government to the household and firms in the other direction.
• If the government revenue falls short of its expenditure, it is also
known to borrow through financial markets.
• This sector adds three key elements to the circular flow model, i.e.,
taxes, government purchases and government borrowings.
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• In this model, the equilibrium condition is as follows:

Y=C+I+G
Where, Y = Income; C = Consumption; I = Investment and G =
Government Expenditure.
• In a closed economy, aggregate demand is measured by adding
consumption, investment and government expenditure. Thus,
aggregate demand is defined as the total demand for final goods and
services in an economy at a given time and price level and aggregate
supply is defined as the total supply of goods and services that the
firms are willing to sell in an economy at a given price level.
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C. The Circular Flow Of Income in a Four - Sector Model (open
economy):
• This is the complete model of the circular flow of income that
incorporates all the four macroeconomic sectors. Along with the
above three sectors it considers the effect of foreign trade on the
circular flow. With the inclusion of this sector the economy now
becomes an ‘open economy’. Foreign trade includes two
transactions, i.e., exports and imports.
• Goods and services are exported from one country to the other
countries and imports come to a country from different countries in
the goods market.
• There is inflow of income to the firms and government in the form of
payments for the exports and there is outflow of income when the
firms and governments make payments abroad for the imports.
• The import payments and export receipts transactions are done in
the financial market.
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• In this model, the equilibrium condition is as follows:
Y = C + I + G + NX
NX = Net Exports = Exports (X) – Imports (M)
Where, Y = Income; C = Consumption; I = Investment; G = Government
Expenditure; X = Exports and M = Imports
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A. Aggregate Demand:
• Aggregate demand is a schedule or curve that shows the amounts of

real output (real GDP) that buyers collectively desire to purchase at
each possible price level.
• The relationship between the price level (as measured by the GDP
price index) and the amount of real GDP demanded is inverse or
negative: When the price level rises, the quantity of real GDP
demanded decreases and vice versa. that means the aggregate
demand curve AD slopes downward, as does the demand curve for
an individual product. This relationship is shown in below figure.
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❑The downward slope of AD (i.e. the inverse relationship), Why?
• Other things equal, a change in the price level will change the
amount of aggregate spending and therefore change the amount of
real GDP demanded by the economy. Movements along a fixed
aggregate demand curve represent
• these changes in real GDP.
• The explanation of this relationship rests on the following three
effects of a price-level change.
1. Real-Balances Effect:
• A change in the price level produces a real-balances effect. A higher
price level reduces the real value or purchasing power of the public’s
accumulated savings balances (such as savings accounts or bonds), as
a result the public will reduce its spending. So a higher price level
means less consumption spending. This reduces the real GDP
demanded.
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2. Interest-Rate Effect
• We assume that the supply of money in the economy is fixed. But
when the price level rises, consumers need more money for
purchases and businesses need more money to meet their payrolls
and to buy other resources. So a higher price level increases the
demand for money. Given a fixed supply of money, an increase in
money demand will drive up the price paid for its use (that price is
the interest rate). Higher interest rates shorten investment spending
and interest-sensitive consumption spending.
• So, by increasing the demand for money and consequently the
interest rate, a higher price level reduces the amount of real output
demanded.
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3. Foreign Purchases Effect
• When the price level of a country rises relative to foreign price levels
(and exchange rates do not respond quickly or completely),
foreigners buy fewer goods of this country and its citizens buy more
foreign goods. Therefore, the country exports fall and imports rise.
• In short, the rise in the price level reduces the quantity of goods
demanded as net exports.
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❑Changes in Aggregate Demand:
• If one or more of those “other things” change, the entire aggregate

demand curve will shift. We call these other things determinants of
aggregate demand.
• Determinants of Aggregate Demand: (Factors That Shift the

Aggregate Demand Curve):
1. Change in consumer spending
a. Consumer wealth
b. Consumer expectations
c. Household borrowing
d. Taxes
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2. Change in investment spending
a. Interest rates
b. Expected returns
3. Change in government spending
4. Change in net export spending
a. National income abroad
b. Exchange rates
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• A change in one or more of above determinants of aggregate
demand will shift the aggregate demand curve. The rightward shift
from AD1 to AD2 represents an increase in aggregate demand; the
leftward shift from AD1 to AD3 shows a decrease in aggregate
demand. Let’s examine each of the determinants of aggregate
demand listed above.
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1. Change in Consumer Spending:
• When price level is constant, domestic consumers may change their
purchases produced real output. If those consumers decide to buy
more output at each price level, the aggregate demand curve will
shift to the right, as from AD1 to AD2, If they decide to buy less
output, the aggregate demand curve will shift to the left, as from AD1
to AD3.
• Several factors other than a change in the price level may change
consumer spending and therefore shift the aggregate demand curve,
theses factors are:
a. Consumer Wealth:
Consumer wealth is the total dollar value of all assets owned by
consumers in the economy less their liabilities. Assets include stocks,
bonds, and real estate. Liabilities include mortgages, car loans, ..etc.
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• The increase in wealth stimulates consumers to save less and buy
more. The resulting increase in consumer spending shifts the
aggregate demand curve to the right. In contrast, as result of a
reduction in consumer wealth consumers increase savings and
reduce consumption, thereby shifting the aggregate demand curve to
the left.
b. Household Borrowing
• Consumers can increase their consumption spending by borrowing.
Doing so shifts the aggregate demand curve to the right. By contrast,
a decrease in borrowing for consumption purposes shifts
• the aggregate demand curve to the left.
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c. Consumer Expectations:
• Changes in expectations about the future may change consumer
spending. When people expect their future real incomes to rise, they
tend to spend more of their current incomes. Thus, the aggregate
demand curve shifts to the right. Conversely, expectations of lower
future income or prices reduce current consumption and shift the
aggregate demand curve to the left.
d. Personal Taxes:
• Reduction in personal income tax raises income and increases
consumption spending. Thus, shift the aggregate demand curve to
the right. Tax increases reduce consumption and shift the curve to
the left.
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2. Change in Investment Spending
• A decline in investment spending at each price level will shift the
aggregate demand curve to the left. An increase in investment
spending will shift it to the right. This is shown through the following
factors.
a. Real Interest Rates
• We are identifying a change in the real interest rate resulting from a
change in a nation’s money supply. An increase in the money supply
lowers the interest rate, thereby increasing investment and aggregate
demand. A decrease in the money supply raises the interest rate,
reducing investment and decreasing aggregate demand.
b. Expected Returns
• Higher expected returns on investment projects will increase the
demand for capital goods and shift the aggregate demand curve to
the right. Alternatively, declines in expected returns will decrease
investment and shift the curve to the left.
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3. Change in Government Spending
• An increase in government purchases will shift the aggregate
• demand curve to the right. In contrast, a reduction in government
spending will shift the curve to the left.
4. Change in Net Export Spending

• Higher exports mean an increased foreign demand for a country
goods. So a rise in net exports, shifts the aggregate demand curve to
the right. In contrast, a decrease in net exports shifts the aggregate
demand curve leftward.
• What might cause net exports to change, other than
• the price level? There are two possibilities those are: 1) changes in
national income abroad, 2) changes in exchange rates.
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B. Aggregate Supply:
• Aggregate supply is a schedule or curve showing the relationship
between the price level and the amount of real domestic output that
firms in the economy produce.
• This relationship varies depending on the time horizon and how
quickly output prices and input prices can change. We will define the
aggregate supply curve (AS) in three time horizons, the relationship
between the price level and total output is different in each of the
three time horizons because input prices are stickier than output
prices. While both become more flexible as time passes, output prices
usually adjust more rapidly.
1) Aggregate supply in Immediate short run.

2) Aggregate supply in Short run.
3) Aggregate supply in the long run.
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1) In the immediate short run, both input prices as well as output
prices are fixed. The aggregate supply curve in the immediate
short run (ASISR) is horizontal at the economy’s current price level,
P1. With output prices fixed, firms collectively supply the level of
output that is demanded at those prices.
32
• The horizontal shape implies that the total amount of output
supplied in the economy depends directly on the volume of spending
that results at price level (P1). If total spending is low at price level
P1, firms will supply a small amount to match the low level of
spending. If total spending is high at price level P1, they will supply a
high level of output to match the high level of spending.
• The amount of output that results may be higher than or lower than
the economy’s full-employment output level (Qf).
33
2) In the short run, input prices are fixed, but output prices can vary
(flexible). The aggregate supply curve (AS) is upward sloping
indicates a direct (or positive) relationship between the price level
and the amount of real output that firms will offer for sale. (AS)
slopes upward because, with input prices fixed, changes in the
price level will raise or lower real firm profits.
34
3) In the long run, input prices as well as output prices can vary
(flexible). The aggregate supply curve in the long run (ASLR) is
vertical at the full-employment level of real GDP (Qf) because in
the long run wages and other input prices rise and fall to match
changes in the price level. So price-level changes do not affect
firms’ profits and thus they create no incentive for firms to alter
their output.
35
• The vertical curve means that in the long run the economy will
produce the full-employment output level no matter what the price
level is. The explanation lies in the fact that in the long run when
both input prices as well as output prices are flexible, profit levels
will always adjust so as to give firms exactly the right profit incentive
to produce exactly the full-employment output level, Qf.
• Note: The focus will be on short-run aggregate supply curves.
36
❑ Changes in Aggregate Supply:
• The aggregate supply curve identifies the relationship between the
price level and real output, other things equal. But when one or more
of these other things change, the curve itself shifts.
37
• The rightward shift of the curve from AS1 to AS2 represents an

increase in aggregate supply, indicating that firms are willing to
produce and sell more real output at each price level. The leftward
shift of the curve from AS1 to AS3 represents a decrease in aggregate
supply. At each price level, firms produce less output than before.
• The other things that cause a shift of the aggregate supply curve are
called the determinants of aggregate supply. Changes in these
determinants raise or lower per-unit production costs at each price
level (or each level of output). These changes in per-unit production
cost affect profits, thereby leading firms to alter the amount of
output they are willing to produce at each price level.
38
• Determinants of Aggregate Supply:

1. Change in input prices
a. Domestic resource prices
b. Prices of imported resources
2. Change in productivity
3. Change in legal-institutional environment
a. Business taxes and subsidies
b. Government regulations
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1. Change in input prices:
• Input or resource prices (different from output prices are a major
ingredient of per-unit production costs and therefore a key
determinant of aggregate supply. These resources can either be
domestic or imported.
a. Domestic Resource Prices:
• Other things equal, decreases in domestic inputs prices such as
(labour, land capital) reduces per-unit production costs. So the
aggregate supply curve shifts to the right. Increases in domestic
inputs prices shift the curve to the left.
a. Prices of Imported Resources:
• A decrease in the price of imported resources reduce per-unit
production costs and increases the aggregate supply, while an
increase in their price reduces the aggregate supply.
40
2. Change in Productivity
• It is the measure of relationship between a nation’s level of real
output and the amount of resources used to produce that output.
• An increase in productivity enables the economy to obtain more real
output from its limited resources therefore shifts the aggregate
supply curve to the right. It does this by reducing the per-unit
production cost. And decreases in productivity increase per-unit
production costs and therefore reduce aggregate supply (shift the
curve to the left).
41
3. Change in legal-institutional environment:

• Two changes of this type are (1) changes in taxes and subsidies and
(2) changes in the extent of regulation.
a. Business Taxes and Subsidies
• Higher business taxes, increase per unit costs and reduce short-run
aggregate supply, the curve shift to the left. Decrease in tax shift the
aggregate supply curve to the right.
a. Government Regulation
• It is usually costly for businesses to comply with government
regulations. More regulation therefore tends to increase per-unit
production costs and shift the aggregate supply curve to the left.
deregulation will reduce per-unit costs and shift the aggregate supply
curve to the right.
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C. Equilibrium of Aggregate Demand and Aggregate Supply:
• Equilibrium of AD and AS occurs at the price level that equalizes the

amounts of real output demanded and supplied.
• The intersection of the aggregate demand curve AD and the
aggregate supply curve AS establishes the economy’s equilibrium
price level and equilibrium real output. So aggregate demand and
aggregate supply jointly establish the price level and level of real GDP.
• Of all the possible combinations of price levels and levels of real GDP,
which combination will the economy gravitate toward, at least in the
short run? The following key graph and its table provides the answer.
43
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D. Changes in Equilibrium:
• In the following we will apply the AD-AS model to various situations:
1. Increases in AD: Demand-Pull Inflation

2. Decreases in AD: Recession and Cyclical Unemployment
3. Decreases in AS: Cost-Push Inflation
4. Increases in AS: Full Employment with Price-Level Stability
45
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• If the price level had remained at P1, the increase in aggregate
demand from AD1 to AD2 would increase output from Qf to Q2 and
the multiplier would have been at full strength. But because of the
increase in the price level, real output increases only from Qf to Q1
and the multiplier effect is reduced.
47
2. Decreases in AD: Recession and Cyclical Unemployment

• Decreases in aggregate demand describe the opposite end of the
business cycle: recession and cyclical unemployment (rather than
above-full employment and demand-pull inflation)
• As shown in the below figure, if the price level is downwardly
inflexible at P1, a decline of aggregate demand from AD1 to AD2 will
move the economy leftward from a to b along the horizontal broken-
line segment (similar to an immediate-short-run aggregate supply
curve) and reduce real GDP from Qf to Q1. Idle production capacity,
cyclical unemployment, and a recessionary GDP gap (of Q1 minus Qf)
will result.
• If the price level were flexible downward, the decline in aggregate
demand would move the economy depicted from a to c instead of
from a to b.
48
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3. Decreases in AS: Cost-Push Inflation

• Suppose that a major terrorist attack on oil facilities severely disrupts
world oil supplies and drives up oil prices by, say, 300 percent. The
aggregate supply curve would shift to the left, say, from AS 1 to AS 2
in below figure. A leftward shift of aggregate supply from AS1 to AS2
raises the price level from P1 to P2 and produces cost-push inflation,
and real output declines from Q f to Q1. Along with the cost-push
inflation, a recession (and negative GDP gap) occurs.
50
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4. Increases in AS: Full Employment with Price-Level Stability

• This is a situation when the economy experiences a combination of
full employment, strong economic growth, and very low inflation, as
what happen in United States between 1996 and 2000.
• As shown the below figure, normally, an increase in aggregate
demand from AD1 to AD2 would move the economy from a to b
along AS1. Real output would expand to Q2, and inflation would
result (P1 to P3). But in the late 1990s, significant increases in
productivity shifted the aggregate supply curve, as from AS1 to AS2.
The economy moved from a to c rather than from a to b. It
experienced strong economic growth (Q1 to Q3), full employment,
and only very mild inflation (P1 to P2.
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First Assignment of Macroeconomic
1- Write a brief about the characteristics of Sudan macroeconomy and sectors.

2- Sudan economy witnessed different phenomena, write in brief about the
impact of the following phenomena on Sudan macroeconomic performance, and
what types of macroeconomic policies used by the government and central bank
of Sudan to improve the performance.
1) Impact of South Sudan secession on Sudan Economy
2) Impact of US Economic Sanction on Sudan Economy.
Notes:
Assignment should be in typing of not less than two A4 papers and not to exceed
3 papers.
Assignment handover date: Max by Saturday 16th of Jul 2022
54

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Macroeconomics

Dr. Algassim Mohamed Ebrahim

The Four Macroeconomic Sectors:

A. The Circular Flow of Income in a Two-Sector Model

• The three-sector model of circular flow of income highlights the role

• In this model, the equilibrium condition is as follows:

• Aggregate demand is a schedule or curve that shows the amounts of

• If one or more of those “other things” change, the entire aggregate

• Determinants of Aggregate Demand: (Factors That Shift the

4. Change in Net Export Spending

1) Aggregate supply in Immediate short run.

• Note: The focus will be on short-run aggregate supply curves.

• The rightward shift of the curve from AS1 to AS2 represents an

• Determinants of Aggregate Supply:

3. Change in legal-institutional environment:

C. Equilibrium of Aggregate Demand and Aggregate Supply:

• Equilibrium of AD and AS occurs at the price level that equalizes the

• In the following we will apply the AD-AS model to various situations:

1. Increases in AD: Demand-Pull Inflation

2. Decreases in AD: Recession and Cyclical Unemployment

3. Decreases in AS: Cost-Push Inflation

4. Increases in AS: Full Employment with Price-Level Stability

1- Write a brief about the characteristics of Sudan macroeconomy and sectors.

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