PRINCIPELS OF

MacroEconomics

Dr. Hend El-

Mossalamy
Lecturer of economics
Faculty of Economic Studies and
Political Science (ESPS)
Alexandria University

Email:[email protected]
Lecture (2)
24 th of February 2024
 1. The Output Approach
• In calculating GDP, we can:
1. sum up the value added at each stage of production,
or
2. take the value of final sales (at the last stage).
The value added:
• Each firm’s value added is the net value of its output,
that is the value of its output minus the value of inputs
that it bought from other firms.

• The value-added concept is used to avoid double-counting.

• It measures each firm’s own contribution to total output or the market value of
what is produced by that firm.
The sum of all values added in an economy is a measure of the economy’s total output.
❖ Example: The Value Added in the production of a gallon of gasoline

Stage of Cost of Intermediate value of sales Value Added = value of

production Goods (Inputs from other sales –cost of inputs
firms)

Oil drilling 0 $ 3.00 $ 3.00

Refining $ 3.00 3.30 0.30
Shipping 3.30 3.60 0.30
Retail sale 3.60 4.00 0.40
Total Value Added 4.00

• GDP (using the value-added method) = (3.00+0.30+0.30+0.40) = $ 4.00

• GDP (using the value of final sales method) = $ 4.00
The four stages of the production of a gallon of gasoline are:
(1) Oil drilling. (2) Refining.
(3) Shipping. (4) Retail sale
• In the first stage, value added is the value of the crude oil.
• In the second stage, the refiner purchases the oil from the driller, refines it into gasoline,
and sells it to the shipper. The refiner pays the driller $3.00 per gallon and charges the
shipper $3.30. The value added by the refiner is thus $0.30 per gallon.
• The shipper then sells the gasoline to retailers for $3.60. The value added in the third stage
of production is $0.30.
• Finally, the retailer sells the gasoline to consumers for $4.00. The value added at the fourth
stage is $0.40;
• The total value added in the production process is $4.00, the same as the
value of sales at the retail level.
• Adding the total values of sales at each stage of production ($3.00 + $3.30 +
$3.60 + $4.00 = $13.90) would overestimate the value of the gallon of gasoline
due to double counting.
Problem (1):

The following table illustrate data about one economic sector which
consists of three factories: spinning, textile, and ready-made clothes
(Millions of dollars):
spinning textile ready-made
clothes
Purchases 0 5000 10000
Sales 5000 10000 30000
Calculate the contribution of this sector to the GDP using:
1- The value-added method.
2- The value of final sales method.
Solution:

1- The value added = total value of final sales - intermediate purchases

(last period - first period)
• Value added for spinning= 5,000 – 0 = $5,000
• Value added for textile= 10,000 – 5,000 = $5,000
• Value added for ready-made clothes = 30,000 – 10,000 = $20,000
• Total value added (contribution to GDP) = 5,000 + 5,000 + 20,000= $30,000.

2- The value of final sales = the value of ready-made clothes = $30,000

What about inventory not sold! Is it included in GDP?

Some of the firms’ current output might not be sold, and hence, will be kept
in stores or warehouses;
• Inventory or stock refers to produced goods that are not sold, but are held by
a business with a view of future sale.

• Therefore, inventory produced in a given period must be included in current

GDP; as it is not reflected in final sales. Otherwise, GDP will be under-
estimated.
Problem (2):
The following table contains data about one economic sector which consists of three
factories: spinning, textile and ready-made clothes ($Millions)

Calculate the contribution of this sector to the GDP using:

1- The value added method.
2- The value of final sales method.
Solution:
1- The value added = value of output - value of inputs from other firms + change in
inventory [(End- period) – (First - period)].
• Value added for spinning= 5000 – 0 + (3000-1000) = $7000
• Value added for textile= 10000 – 5000 + (2000-500) =$6500
• Value added for ready-made clothes = 30000 - 10000 + (5000-2000) = $23000

• Total value added (contribution to GDP) = 7000 + 6500 + 23000= $36500.

2- The value of final sales = the value of final goods + changes in inventory.
=30000+[(3000+2000+5000)-(1000+500+2000)] = 30000 + 6500 = $36500
 2. The Expenditure Approach
From the expenditure side of the national accounts
• GDP can be calculated by measuring the total amount
spent on all final goods and services in a given time
period.
GDP = C + I + G + [X - IM]
There are 4 categories of expenditure:
• C is private consumption expenditures.
• I is investment in fixed capital and inventories.
• G is government consumption.
• [X -IM] represents net exports, or exports minus
imports.
 1. Private Consumption Spending (C)
• Private consumption spending is spending by individual consumers on
goods and services produced and sold to their final users during the year.

• It consists of :
1- Durable Goods: Goods that last a relatively long time, such as cars,
television sets, and microwave ovens.

2- Non-durable Goods: Goods that are used up fairly quickly, such as food
and clothes.

3- Services: such as haircuts, telephone calls, legal and medical services and
education.
• Private consumption does not include purchases of existing houses or
cars as these are not part of current production. This involves only
ownership transfer of an existing asset.

• So, Used Goods and Services (old houses and cars) and Paper
Transactions (bonds & stocks) are not included in the GDP to avoid
double counting.
2. Gross Investment Spending (I)

• Investment spending is spending on the production of goods not for present

consumption but rather for future use, these goods are called investment or
(capital) goods. It can be divided in to:
1- Fixed Capital Formation: Creating new capital goods, such as machines,
computers, and factory buildings (i.e., non-residential investment).
2- Residential investment: Housing construction -by households or firms- is
counted as investment spending rather than consumption spending, since it
yields a utility (housing services) over a long period of time.
3- Changes in inventories:
• Inventories are new goods that firms produce now but intend to sell later.
• All firms hold stocks of their own outputs to allow firms to meet orders in
spite of temporary fluctuations in the rate of outputs or sales.
• An increase of stocks and unfinished goods in the production process counts
as current investment because it represents goods produced, but not used for
current consumption.

• The economy’s total quantity of capital goods is called the capital stock.
 Gross investment Vs. Net Investment
RULE
• Net Investment = Gross Investment –
Depreciation
Total investment spending
• Gross Investment = Net Investment +
Depreciation (Gross investment)

Net investment = –
net additions to the stock of
capital
Replacement investment
OR (depreciation)
• Net Investment = Capital (End of necessary to keep the level of existing
stock of capital (replaces worn out
period) - Capital (Beginning of period) capital)
❑ if Gross investment ˃ depreciation ⇒ net investment is positive.

❑ if Gross investment = depreciation ⇒ net investment is zero.

❑ if Gross investment ˂ depreciation ⇒ net investment is negative.

 3. Government Consumption Spending (G)
• Government consumption spending is all government purchases or
spending on final goods and services. e.g., expenditure on school buildings,
teachers’ salaries, health care, street lighting and military salaries.

• Transfer Payments from government to people for which no good

or service is received in exchange at the same period are excluded in
computing GDP. Transfer payments may include: social security, old age
pensions, disability pensions, unemployment benefit, income support,
student grants.
• Only government spending on currently produced goods and services is
included as part of GDP.
 Questions
State whether true or false, why?
1. Positive net investment increases the economy’s total stocks of capital, but
replacement investment only keeps the existing stock. ( )

2. Net investment only should be included in the GDP. ( )

3. Transfer payments is a government spending over a given period of time,

and it should be included in the GDP of the same period. ( )

4. Unemployment benefit is an important part of GDP. ( )

 4. Net Exports (X-IM)

1- Exports (X)
• It is the value of output produced in a country and purchased by foreigners, so
it should be included in its GDP.
2- Imports (IM)
• It is the value of output produced by a foreign country and purchased by
residents of a country, so it should not be included in its GDP.
• It contributes to the foreign country’s GDP.
❖ Net Exports (X–IM): Is the difference between foreign expenditure on
domestic goods (exports) & the domestic expenditure on imported goods
(imports).
Net exports = (X – IM)
 Total Expenditure (Spending)

GDP = C + I + G + (X- IM)

GDP expenditure-based is the sum of private consumption (C),

government consumption (G), gross investment (I), and net export
spending (X-IM); on currently produced goods and services.
 Example:
TABLE 21.2 Components of U.S. GDP, 2009: The Expenditure Approach
Billions of Dollars Percentage of GDP
Personal consumption expenditures (C) 10,089.1 70.8
Durable goods 1,035.0 7.3
Nondurable goods + 2,220.2 15.6
Services 6,833.9 47.9
Gross private domestic investment (l) 1,628.8 11.4
Nonresidential 1,388.8 9.7
Residential 361.0 2.5
Change in business inventories + −120.9 −0.8
Government consumption and gross investment 2,930.7 20.5
(G)
Federal 1,144.8 8.0
State and local + 1,786.9 12.5
Net exports (EX – IM) -392.4 - 2.8
Exports (EX) 1,564.2 11.0
Imports (IM) 1,956.6 13.7
Gross domestic product 14,256.3 100.0
Note: Numbers may not add exactly because of rounding.
• Personal consumption expenditures (C) = Durable goods + Non durable goods + Services
• Gross private domestic investment (I) = Nonresidential + Residential + Change in business
inventories
• Government consumption (G) = Federal + State and local
• Net exports (EX – IM) = Exports (EX) - Imports (IM)
• GDP = C+I+G+(X-M)

✓ Percentage of Personal consumption expenditures (C) of GDP = C/ GDP X 100

✓ Percentage of Gross domestic investment (I) of GDP = I/ GDP X 100
✓ Percentage of Government consumption (G) of GDP = G/ GDP X 100
✓ Percentage of Net exports (EX – IM) of GDP = (EX – IM) / GDP X 100
Problem (1):
Using the following data, compute the subtotals for each of the four major
spending categories; then compute the value of GDP.
Solution:
• Personal Consumption (C) = 659.3+1592+3234.5=$5485.8

• Gross Private Domestic Investment (I) =846.9+327.2+67.9=$1242.

• Government Spending (G) = 523.8+928.9=$1452.7

• Net Exports (X–IM) = 957.1-1058.1=$-101

➢ GDP = C+I+G+(EX–IM) = 5485+1242+1452.7–101=$8079.5

Q2. Using the spending-based definition, explain which of the
following is or is not included in the GDP :

• State pensions.
• Company pensions.
• Students grants.
• Theatre receipts.
• Judges’ salaries.
• Unsold cars in showroom.
• Receipts from purchases of new copies of this book.
• Receipts from purchases of second-hand copies of this book.
Problem (2):
Use the following information to answer the questions below. (number with
$million)
Personal consumption 1000
Imports 150 Calculate:
net investment 1100
Government consumption 600 1.GDP of this economy
exports 200 2.GNP of this economy
Receipts of income from abroad 200 3.NNP (national income NI)
Payments of income to abroad 50 of this economy
depreciation 200
Solution:

• GDP = C+I+G+(X-IM) = 1000+(1100+200)+ 600+ (200-150) =

$2950 million.

• GNP = GDP + receipts of income from abroad – payments of

income to foreigners abroad = 2950 + 200 - 50=$3100 million.

• NNP = GNP – depreciation = $2900 million