Basics of Macroeconomics

Key Concepts of Macroeconomics

• Macroeconomics : Macroeconomics is the study of the

behavior of the economy as a whole.
• It examines the forces that affect firms, consumers, and
workers in the aggregate.
• It contrasts with microeconomics , which studies individual
prices, quantities, and markets.
 Central Questions of Macroeconomics

• The three central questions of macroeconomics:

1. Why do output and employment sometimes fall, and how can
unemployment be reduced?
2. What are the sources of price inflation, and how can it be kept
under control?
3. How can a nation increase its rate of economic growth?
 Objectives
1. Output:
– High level and rapid growth of output
2. Employment:
– High level of employment with low involuntary unemployment
3. Price Level:
– Stable prices
 Goals
The goals of macroeconomic policy are:

1. A high and growing level of national output

2. High employment with low unemployment
3. A stable or gently rising price level
 Instruments
The Tools of Macroeconomic Policy:
1. Monetary policy:
• The government conducts monetary policy through managing the nation’s
money, credit, and banking system.
• Monetary policy, conducted by the central bank, determines short-run
interest rates.
2. Fiscal policy: Fiscal policy denotes the use of taxes and government
expenditures.
i) Government expenditures:
• Government expenditures come in two distinct forms.
• a) Government purchases: These comprise spending on goods and
services—purchases of tanks, construction of roads, salaries for judges, and
so forth.
• b) Government transfer payments: which increase the incomes of targeted
groups such as the elderly or the unemployed.
2. Taxation
 Gross Domestic Product (GDP)

• GDP is the market value of all final goods and services produced
within a given period of time by factors of production located within
a country.
• GDP can be solved using the formula:

GDP = Consumer Spending (C) + Investment (I) + Government Spending

(G) + (Exports (X) - Imports (M))
 Types of GDP

1. Nominal GDP: Nominal GDP is the market value of all final goods
and services produced within a given period of time by factors of
production located within a country at current prices.

2. Real GDP : Real GDP is the market value of all final goods and
services produced within a given period of time by factors of
production located within a country at constant prices.
 GDP Calculation

• The General Equation used to compute Nominal GDP is:

• Nominal GDP  (Current-year prices  Current-year quantities)

• The general equation used to compute Real GDP is:

Calculating Nominal and Real GDP
 GDP GNP

Definition: An estimated value of the total GDP (+) total capital gains from
worth of a country’s production and overseas investment (-) income
services, calculated over the course earned by foreign nationals
on one year domestically

Stands for: Gross Domestic Product Gross National Product

Formula for Calculation: GDP = consumption + investment GNP = GDP + NR (Net income
+ (government spending) + from assets abroad (Net Income
(exports − imports) Receipts))

Layman Usage: Total value of products & Services Total value of Goods and Services
produced within the territorial produced by all nationals of a
boundary of a country country (whether within or outside
the country)

Application (Context in which To see the strength of a country’s To see how the nationals of a
these terms are used): local economy country are doing economically
 Concepts of National Income (Cont......)
• Gross National Product ( GNP ) : Gross National product is defined as the total market
value of all final goods and services produced during a year by the factors owned by a
nation.

• Gross Domestic Product ( GDP ) : Gross domestic product is the money value of all final
goods and services produced by normal residents as well as non-residents in the
domestic territory of a country.

GDP = C + I + G + NX

• Net National Product ( NNP ) : When charges for depreciation are deducted from the
gross National Product we get net national product.
NNP = GNP – Depreciation Cost.

• Net Domestic Product ( NDP ) : When charges for depreciation are deducted from the
Gross Domestic Product we get net domestic product.

NDP = GDP - Depreciation Cost.

 Concepts of National Income (Cont......)
• Personal Income ( PI ): Personal income is the sum of all incomes actually received
by all individuals or households during a given year.
• Personal Disposable Income ( PDI ) :

• PDI = Personal Income – Personal Taxes

• Disposable income on either be consumed or saved

Hence,
DI = Consumption + Saving,
Yd = C + S,
 Concepts of National Income

• National Income: National Income of a country can be defined as the

total market value of all final goods and services produced in the
economy in a year. Two things must be noted in regard to this
meaning of National Income. First, it measures the market value of
annual output. Secondly, National Income is a monetary measure.
•
• National Income = National Product = National Expenditure
•
• There are three measures of NI in a country:
•
• The sum of values of all final goods and services produced.
• The sum of all incomes and
• The sum of all expenditures,
•
• above “a”, “b”, and “c” will be the same.
 National Income Accounting

• Three alternative methods of measuring national income are

possible.
1. Income Method:
• This methods approaches national income from distribution side. This
method measures NI at distribution of income paid and received by
individuals of the country. Thus under this method, NI is obtained by
summing up of the incomes of all individuals of a country. Therefore,
NI is calculated by adding up the rent land, wages of employees,
interest on capital, profits of entrepreneurs and income of self
employed people.

• NI = Rent (r) + Wage (w) + Interest ( i ) + Profit (p)

 National Income Accounting (Cont……)

• Expenditure Method:
• Expenditure method arrives at NI by adding up all expenditures made
on goods and services during a year. Income can be spent either on
consumer goods or capital goods, Again expenditure can be made by
private individuals and households or by government and business
enterprises.

NI = C + I + G + (X-M)
• NI = Consumption + Investment + Government expenditure + Net
exports
 National Income Accounting (Cont……)

• Product Method:
• This is called output method or value added method. In this method
the contribution of each enterprise to the generation of flow of
goods and services is measured. Value of output of an enterprise is
found out by multiplying the physical output with market price of the
goods produced.

NI = X1P1 + X2P2 + ....................+ XnPn

Here,
X1, X2-------------Xn = Goods 1, 2, ..........n
P1, P2---------------Pn = Price 1, 2, ............n

• Multiplied of all goods by its price we can get National Income.

 Problems of Measuring National Income in Developing Countries

• Measuring of economy on GDP standards consist some drawbacks.

1. Double Counting Problem : Including the price of intermediate goods
individually and with final product.
2. Self doing activities: Unrecorded economy in personal activities like the
duties performed by oneself, housewives etc are not included in the GDP.
3. Illegal Economy: The economy which can be shown incorrectly due to
corruption, bribery and drugs business.
4. Statistical Errors: People measuring the economy not performing their
duties with honesty or the standard they are using are not current to
measure the accurate value of GDP.
5. Pollution Factor: Pollution factor can’t be included in GDP.
6. Facilities and living standards: facilities and living standards improvement
can’t be indicated by GDP, to show whether the people of the country are
worst off or well off.
7. Quality Improvement: As the time passes quality improve with speed as
compared to the price, GDP can only measure the price as value but not
quality.