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Economics Lesson
Note for Grade 11
Units 4 & 5
 Unit-3
Notes

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 The Ethiopian economy produces thousands
of goods and services each day and we want
to measure these economic activities and
analyze the performance of the economy over
time.
 One of the principal ways is to compute gross
domestic product (GDP).
 GDP is one of the most important economic
measurements which is used by economists
in the national income accounts.

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 It is an official measurement of the flow of
income and product in each economy
represented by Gross domestic product (GDP)
or gross national product (GNP).
 National income accounting practice is good
for an economy for the following reasons.
◦ It enables us to know the level of output of an
economy.
◦ To observe the long-run trend of the economy.
◦ It helps in policy formulation since it can be used as
evidence in policy making.
◦ It makes cross-country comparison easier.

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 Gross domestic product (GDP) is the market
value of all final goods and services which are
produced in a country each year.
 What matters is that the goods are produced
within the territory.
 GDP can be represented by the total income
of everyone in the economy or total
expenditure made on the economy’s goods
and services by different agents.
 GDP measurement is time specific.

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 Gross national product (GNP) is the total
market value of goods and services which are
produced by the nationality of a given
country for a given period.
 It does not include production by non-
nationals even though they operate in the
country in question.

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 The concept of net foreign factor income (NFFI)
captures the deviation between GDP and GNP.
 NFFI is the difference between the aggregate
amount that a country’s citizens and companies
earn abroad and the aggregate amount that
foreign citizens and overseas companies earn in
that country.
 NFFI is sometimes written simply as net factor
income (NFI).
 GNP can be obtained from GDP by adding net
factor payment to GDP.
 GNP = GDP + net foreign factor income .

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 A stock is a quantity which is measured at a
given point in time, whereas a flow is a
quantity measured per unit of time.
 A flow shows the amount of new addition to
the existing value while a stock shows the
total accumulated value of something.
 Note that a flow represents the change in the
stock.

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 What do you mean by national income
accounting? Explain the various reasons for
which national income accounts are
important.

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 There are three ways to compute GDP. These
are:
◦ The Expenditure Approaches
◦ The Income Approaches
◦ The Value Added Approaches

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 Expenditure approach of measuring GDP involves
adding the market value of all final products in
the economy over a given period of time. To
compute GDP using the expenditure approach,
add the amount of money that is spent by buyers
on final goods and services.
 A final good (or service) is a good in the hands of
the final user, or ultimate consumer.
◦ Examples include orange juice or mobile phones.
 The words “final goods and services” are
important in computing GDP for not all goods are
final goods. This is because some goods are
intermediate goods. (that are used as inputs in
the production of other goods)

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 The demand (expenditure) for domestically
produced goods is comprised of four main
components depending on what makes the
expenditure. These are
◦ consumer expenditure (C)
◦ business investment (I)
◦ government expenditure (G)
◦ Foreign expenditure or net export (NX)

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 In the income approach, we add the returns
(income) to factors of production such as labor,
land, capital and profits in the economy. In this
approach, depending up on the owner of factor
input, the components of GDP include the
following:
◦ Employment compensation payment made for labor in
the form of wages and salaries.
◦ Rent payments for use of land, building and other capital
inputs.
◦ Interest income which is received by households on their
saving deposit.
◦ Profit payments made to the owner of firms in return for
the output produced after deduction of the cost of
production.

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 Aggregating the above returns to factor input gives
the national income of an economy.
 So, to arrive at GDP, we add back indirect business
taxes (IBT) and depreciations to the national income.
 Indirect business taxes like sales taxes are payments
that represent the difference between what buyers
pay for final product and what sellers receive. They
are income to the government.
 Similarly, depreciation is capital consumption
allowance (CCA) which represents consumption of
fixed capital which can be considered as a cost of
production.
 Depreciation is estimated saving from profits for
future maintenance of the equipment. Depreciation
and IBT are added as non-factor incomes in the
income approach of measuring GDP.

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 Production of goods and services typically
involves distinct stages.
 Each stage involves separate market transaction
and flow of income.
 For example, there are four different stages
having their own market transaction in
production of bread.
◦ The farmers first grow the wheat and then sell it to the
miller.
◦ Next, the miller converts to flour and sells to a baker.
◦ Finally, the baker sells the bread to the consumer.
 Value addition at a given stage is the difference
between the price of the final good and the price
of the intermediate input bought.

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 The expenditure of one agent becomes an
income for the other and vice versa.
 There is a circular flow of income and
expenditure in the economy.
 Adding up all the spending on the current
final goods is the same as adding all the
relevant incomes.
 Every transaction that affects expenditure
must affect income and every transaction that
affects income must affect expenditure.

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 Double counting is one among them.
 Sales of used items does not represent current production,
 The existence of a large informal sector
 Unpaid workers in family businesses
 Non-productive Transactions
◦ Public transfer payments
◦ unemployment compensations
◦ monetary payments to the poor
◦ social security
◦ subsidy
 Not traded
◦ voluntary works
◦ government services
◦ do-it-yourself activities
 improvement in quality

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 to take care while registering the sale of used
items.
 Non-productive transactions should not be
registered.
 The values of informal sector activities and
goods and services for own consumption or
self-service should be estimated and
included in the GDP.

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 There are two types of GDP values:
◦ Nominal GDP
◦ Real GDP
 Nominal GDP values goods and services at
current prices whereas real GDP values goods
and services at constant prices.
 Nominal GDP is the value of goods and services
measured at current prices.
 Real GDP rises only when the amount of goods
and services has increased, whereas nominal GDP
can rise either because output has increased or
because prices have increased.

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 GDP is the sum of market values ( P* Q) of all
current final goods for all consumers.
 Assume an economy with only two products
(apples and oranges), the GDP can be estimated
as:
 GDP = (Price of Apples × Quantity of Apples) +
(Price of Oranges × Quantity of Oranges) = Σ for
n number of consumers and i-commodities.
 The difference between nominal and real GDP is
which price to use to evaluate the quantities.
 Real GDP is GDP adjusted for price changes. It is
GDP computed using a base year price.

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 Nominal GDP rises much more rapidly than real GDP
since prices tend to move upwards over time.
 The difference between the growth rate of nominal
and real GDP occurs because the price of goods is
rising over time or there has been inflation.
 That is, real GDP shows what would have happened to
expenditure on output if quantities had changed but
prices had not.
 For the base year, for instance, real GDP equals
nominal GDP since they both use the same price and
quantity.
 The deviation of the nominal GDP from the real GDP
would be larger during inflation.

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 Policy makers use change in the general level
of price to measure the performance of an
economy in combination with the level of
GDP. To measure the general price of an
economy, they use the
◦ GDP deflator
◦ Consumer’s price index (CPI)
◦ producer price index (PPI)
 The GDP deflator is a broad measure of
changes in general prices in the economy.

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 GDP deflator sometimes called the “implicit
price deflator”. It is defined as the ratio of
nominal GDP to real GDP.
 Mathematically: GDP deflator=Nominal
GDP/Real GDP *100
 The GDP deflator measures the price of
output (goods) which are relative to its price
in the base year. It shows whether the price
of goods increases or decreases in reference
to the base year price.

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 For the hypothetical economy, assume that
◦ NGDP = 950m USD
◦ RGDP = 750m USD
 GDP deflator =950,000,000/750000000
*100= 127
 This means that 27% of the change (increase)
in GDP is due to a rise in general price
compared to the base year price of 100.
 Note that if there was no increase (no change)
in general price, GDP=RGDP and GDP deflator
equals to 1.

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1. The income approach of measuring GDP
leads to a higher value for the GDP.
2. The GDP deflator is sometimes called an
“implicit measure of general price”.

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 This is the most used price index to measure
the general price level of an economy.
 It represents the price of a fixed basket of
goods and services that are purchased by a
typical consumer which is relative to price of
the same basket of goods and services in
some base year.
 CPI can be calculated as follows:

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 As an alternative to the CPI sometimes the
cost of producer goods is measured by the
PPI.
 PPI measures the price of typical basket of
goods which are bought by firms.
 The CPI is used to measure a change in
general price (inflation) level in the economy.
 Inflation is the rate of growth in the CPI
between two periods.
 Mathematically,

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 Firstly, the GDP deflator measures the price of both
consumer and producer goods which are produced in the
economy, whereas CPI measures the prices of goods and
services that are bought by consumers only. Thus, an
increase in the price of goods bought by firms or the
government will show up in the GDP deflator but not in the
CPI.
 Secondly, the GDP deflator includes only those goods
which are produced domestically; imported goods are not
part of GDP and do not show up in the GDP deflator.
Hence, an increase in prices of imported goods affects CPI,
but not the GDP deflator.
 Lastly, CPI is computed using a fixed basket of goods
whereas the GDP deflator allows the basket of goods to
change overtime as the composition of GDP changes.

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 We have also common measurements other
than the GDP in economics.
 Two of them are worth mentioning
 Net domestic product (NDP)
 National income (NI)

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 Net domestic product equals gross domestic
product (GDP) minus the capital consumption
allowance (depreciation).
 Mathematically, it is written as follows.
◦ NDP = GDP – Capital consumption allowance
(depreciation).

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 It is the sum of the payments for resources (land,
labor, capital, and entrepreneurship).
 it is total income earned by Ethiopian citizens
and businesses, no matter where they reside or
are located.
 It equals income that is received by workers
(wage), rent payment, profit and net interest rate.
 National income=
Compensation of employees +
Proprietors’ income +
Corporate profits +
Rental income of persons +
Net interest

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 Personal income is a measure of the income that people
actually receive. In economics, there is distinction between
income earned and income received.
 Personal income is equal to national income minus such
major earned-but-not received items as undistributed
corporate profits, social insurance taxes (social security
contributions), and corporate profits taxes, plus transfer
payments (which are received but not earned).
 Income received is that part of income to be received by
people. People may not be able to receive some part of
their earned income. A simple example is
◦ social security (transfer payment) contributions and tax
deductions from income.
◦ Undistributed profits are another example of income earned but
not received.

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 The portion of personal income that can be
used for consumption or saving is referred to
as disposable personal income or simply
disposable income.
 It is equal to personal income minus personal
taxes (especially income taxes). Sometimes,
disposable income is referred to as spendable
income, take-home pay, or after-tax income.
 Disposable income =Personal income –
Personal taxes

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 Per capita GDP shows the amount of GDP per
person.
 It shows what an average individual earns in
the economy for a given year.
 It is computed by taking the ratio of the GDP
to the total population.
◦ Per capita GDP=GDP/Population
◦ Per capita Real GDP=RGDP/Population
◦ Per capita Nominal GDP=NGDP/Population

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 GDP is usually measured by using market price,
but sometimes people use factor cost to measure
it.
 Factor cost refers to the total cost of factors of
production. i.e. land, labor, capital and
entrepreneurship.
 The market price of the goods and services will
include indirect taxes such as product taxes.
 Market Price =
◦ Factor Cost + Net Indirect Taxes
◦ Factor Cost + Indirect Taxes – Subsidies
 since Net Indirect Tax is Indirect Taxes –
Subsidies.

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 Although GDP is a good measure of economic
performance over years, it does not show income
distribution. The best we can do is to study
average earnings like per capita GDP.
 Income distribution has been one of the key
challenges in many economies and economists
have made a move to go beyond the study of
GDP to capture income distributions.
 Inequality measures, poverty analysis, and other
development indicators are now common in
government economic policy analysis.

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 Page-297-302 Questions
 1,3,4,6,7,9,11,12,13,14,15,16,17,18,19,21
 Page-312-319 Questions
 51,52,53,56,57,59,60,65,69,70,75,76,77,78,
80
 Page-327-342 Questions
 1,2,4,6,8,10,11,13,14,15,16,17,21,22,24,25,
26,27,29,32,33,34,35,50,51,

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 Page-297-302 Questions
 1,3,4,6,7,9,11,12,13,14,15,16,17,18,19,21
 Page-312-319 Questions
 51,52,53,56,57,59,60,65,69,70,75,76,77,78,
80
 Page-327-342 Questions
 1,2,4,6,8,10,11,13,14,15,16,17,21,22,24,25,
26,27,29,32,33,34,35,50,51,

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 Unit-4
Note for students

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 INTRODUCTION
 “Consumption is the sole end and purpose of all
production.” — Adam Smith
 In the previous unit, we saw that consumption is
an important element of the GDP of an economy.
 In this unit, we will study the nature and
relationships among the three important
macroeconomic variables:
◦ Consumption
◦ Saving
◦ investment

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 The consumption decision is crucial for
short-run analysis because of its role in
determining the total or aggregate demand.
 In general, consumption accounts for two-
thirds of GDP (2/3), so fluctuations in
consumption is a key element of
◦ Booms (Good development)
◦ Recessions (depression- decline)

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 Income that is left in the hand of consumers after
tax is deducted is called disposable income.
 It is calculated as gross income (Y) minus
personal taxes (T).
 This is the amount of income that determines
household consumption.
 The consumption spending of individuals
depends on their real personal disposable
income (Y −T) .
 Yd= Y − T. where
◦ Y is gross income,
◦ T is personal income tax
◦ Yd is the disposable income

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 The R/ship b/n consumption and disposable
income is summarized in John Maynard Keynes’s
General Theory of Employment, Interest and
Money, which was published in 1936.
 Keynes made the consumption function central to
his theory of economic fluctuations, and it has
played a key role in macroeconomic analysis ever
since.
 For Keynes, there is a
◦ Non-linear positive relationship between consumption
spending and disposable income.
◦ Households save a greater proportion of their income if
their real income increases more than the increase in
consumption.
 But for simplicity let us assume a linear R/Ship
between consumption and disposable income.
 Linear relationship means that the rate of change
in consumption as income changes remains the
same or is constant.
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 Hence, Consumption is given as
 C = C0 + CYd ……………………………….. 0 < c
<1
 where ;Yd is the disposable income and C0 is the
minimum consumption that a household needs
to survive at zero income.
 Autonomous consumption is the minimum
consumption that a household needs to survive
at zero income and is independent of income.
 It is the y-intercept of the consumption function.
 An autonomous consumption changes due to
changes in factors other than the disposable
income.

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 In the equation above, c(Yd) depends on
disposable income and is called “induced
consumption” since this part of the
consumption depends on or is induced by
income.
 Hence, total consumption is the sum of
autonomous consumption and induced
consumption.

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 Keynes posited that the ratio of consumption to
income, called the APC , falls as Yd rises.
 APC is the ratio of the total consumption
expenditure (C) to the total income (Yd) at a
given level of income in an economy.
 APC is a measure of tendency to consume
income on average.
 The value of APC may be greater than 1, because
when income is at a very low level, consumption
exceeds income to meet the very basic
necessities.
 This implies that saving becomes negative for
such consumption levels.

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 4.1.2 Marginal Propensity to Consume (MPC)
 The small (c) in the consumption function, which
is the coefficient of the disposable income (Yd),
is the slope of the consumption function and it is
called marginal propensity to consume (MPC).
 The MPC shows the rate of change in a H/H’s
tendency to consume due to a change in income.
 It is the unit increase in consumption for any unit
increase in disposable income of the consumer.
 MPC=Change in consumption/Change in
disposable income
 MPC=∆C/∆Yd
 Since it is expected that any rise in disposable
income (Yd) will be partly spent and partly saved,
‘’c ‘’ is strictly less than one and greater than
zero (0<c<1).

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1. Marginal propensity to consume “c” is
between zero and one.
2. Average propensity to consume falls as
income rises. APC↓=C/Yd↑
3. Consumption is determined by current
income.

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 Assume your family consumption function is of the
type indicated in the above table and is given by
◦ C=80 + 0.7 Yd
 The autonomous consumption is 80 and
 The slope equals to 0.7.
 If the disposable income (Yd) of the consumer is
estimated to be 800 ETB, we can calculate the
induced consumption and the total consumption of
the consumer.
 The induced consumption will be 0.7*800 = 560 .
 The total consumption will be the induced
consumption (80) plus the induced consumption
(560) and this equals to 640. (80+560=640)

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 MPC values lie between zero and 1.
◦ Zero means no change in consumption and 1 shows
maximum (total) consumption of the new income.
 MPC decreases with an increase in income.
◦ In other words, MPC of the poor is higher than MPC
of the rich.The poor people tend to consume a
higher proportion of their income relative the rich
people.

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 when disposable income changes, MPC also
changes causing a change in APC.
 The initial source of change in the model is
the change in disposable income.
 Consumption can be affected through.
1. change in MPC.
2. change in disposable income
3. Change in the autonomous component

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 The major determinants of consumption
expenditure at individual and national levels
are:
1. Money income
2. Distribution of income
3. Level of direct taxes
4. Expectation about future income and prices
5. Rate of interest
6. Level of wealth

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 Savings is the difference between disposable
income and consumption.
 The part of income which is not spent on
consumption is called “savings”.
 Disposable income can be used only for
consumption or saving; that is, Yd= C + S
 Hence, saving is the difference b/n income
and consumption. People save what is left
after spending for consumption. S=Yd-C

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Economics For Grade 11
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 Note that saving and savings are not the
same.
 Saving refers to the act of depositing money
while savings refer to the already
accumulated money.
 Saving is a flow concept (Continuous)while
savings is a stock (a point in time) concept.

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 4.2.1 Average Propensity to Save (APS)
 APS is the ratio of total savings (S) to total
income (Y). It is part of total income which is
saved.
 It captures the tendency of the consumer to
save on average.
4.2.2 Marginal Propensity to Save (MPS)
 The MPS is the ratio of the change in saving
to the change in disposable income.
 It is the slope of the saving function and is
given by 1− c .
 MPS values lie between zero and 1.
 MPS increases with an increase in income.

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 The major determinants of saving at the
individual and national levels are:
1. Level of income
2. Distribution of income
3. Expectation about future prices and income
4. Rate of interest
5. Level of wealth
6. Level of direct taxes
7. Individual nature

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 If the consumption function of a given
individual is given as C = 44 + 0.86Yd, and
the individual’s disposable income for a
specific period was Birr 3600, then calculate
the:
a) autonomous consumption
b) induced consumption
c) total consumption
d) saving

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 4.3 The Relationship B/n Saving and
Consumption
The Relationship b/n MPC And MPS
 If MPS is given to be 0.6, MPC will be 1− 0.6 which
equals to 0.4. Symbolically,
◦ MPC (c)+ MPS (1-c) = 1
◦ Mathematically, this is adding c and 1-c .
◦ Hence, c +1− c =1
The Relationship Between APC And APS
 In general, APS + APC = 1
 A 450 reference line shows equality between the value
of the variable on the x-axis and the y-axis.
 Hence, if we measure income on the x-axis and the
total expenditure (C+S) on the y-axis, the 450
reference line shows locus of points where Y = C + S
.
 Y = C + S is called the “expenditure equals income”
line. Its significance is that each
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Economics For Grade 11
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 4.4 Investment
 Investment: the amount of goods that are
purchased or accumulated per unit of time
and which are not consumed at the present
time.
4.4.1 Investment Types
 There are different ways of categorizing
investment.
 It can be divided into two
◦ As Gross and Net Investment
◦ As induced and autonomous
◦ As private and public investment depending on who
makes the investment

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 Distinguish between the following terms
1. Private investment and public investment
2. Induced investment and autonomous
investment

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 Interest rates
 There are two types of interest rates that
affect profitability of investment and hence
income.
 These are nominal interest rate and real
interest rate
4.4.2 Determinants of Investment
As outlined below, investment depends on
◦ Interest Rate
◦ Expectations About Future Sales
◦ Business Taxes
◦ Income

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 The Ethiopian Central Statistical Agency (CSA)
and the World Bank (WB) collect information
on the main challenges that firms face. The
main factors include:
◦ lack of infrastructure (access to electricity, road,
land, water and communication)
◦ Access to finance
◦ Rules and regulations( tax rules, customs duties)
◦ lack of raw materials
◦ Practices of the informal sector
◦ Lack of market for output

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 The World Bank encourages countries to solve
these and other related challenges to improve
the business environment for firms.
 Currently 11 but aiming for 12 indicators
 Ethiopia’s rank was 159th out of the 190
countries in the index in 2019.

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1. Process of starting a business
2. Dealing with construction permits
3. Obtaining an electricity connection
4. Getting access to credit
5. Protecting minority investors
6. Paying taxes
7. Engaging in international trade
8. Enforcing contracts
9. Resolving insolvency.
10. Employing workers
11. Contracting with the government

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 Economic growth refers to an increase in the
total output of a nation over time.
 Investment boosts economic activities.
 Investment adds to the stock of capital
 Investment changes the capital stock.

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1. What are the main factors that determine or
affect the level of investment?
2. What does the accelerator theory shows?

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 Accelerator theory states that capital
investment outlay is a function of output.
 If a firm operates in an industry where dd is
rising and there is excess dd for the goods in
the market, the firm is expected to respond
to this situation.
 Firms respond by
◦ include expansion of production
◦ full utilization of the existing capacity to produce
◦ Selling their existing inventory
◦ investing more in capital goods

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Economics For Grade 11
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