The National Economy

The Scope of Macroeconomics

 Fathers of modern macroeconomists
• The foundation of macroeconomics was laid down by a
British economist, John Maynard Keynes (1883 – 1946) in
his revolutionary book “The General Theory of
Employment, Interest and Money (1936)”.
• Milton Friedman
• James Tobin
• Paul Samuelson
• Robert E. Lucas Jr
• Robert Solow
• N. Gregory Mankiw etc.
 Macroeconomics
• Macroeconomics is the economics of the
economy as a whole and microeconomics
is the economics of the single market.
• Macroeconomics simplifies by ignoring
differences among individual households.
• Macroeconomics is important — and
even interesting — because it affects all of
us.
Important issues in macroeconomics
• Why does the cost of living keep rising?
• Why are millions of people unemployed,
even when the economy is booming?
• Why are there recessions?
• Can the government do anything to combat
recessions? Should it?
Important issues in macroeconomics
• What is the government budget deficit?
How does it affect the economy?
• Why does Ghana have such a huge trade
deficit?
• Why are so many countries poor?
What policies might help them grow out
of poverty?
THE SCOPE OF MACROECONOMICS
• Definitions
• Rate of economic growth: The
percentage increase in national output over
a 12-month period.
• Inflation: A persistent increase in the
general price level over a given period of
time.
• Rate of inflation is the percentage
increase in prices over a 12-month period.
• Unemployment: those of working age
who are without work, but who are
available for work at current wage rates.
THE SCOPE OF MACROECONOMICS
• Definitions
• Exchange rate: The rate at which one
national currency exchanges for another. The
rate is expressed as the amount of one
currency that is necessary to purchase one
unit of another currency (e.g. a Gh¢8 = $1)

• Balance of payments account: A record

of the country’s transactions with the rest
of the world.
It shows the country’s payments to or
deposits in other countries (debits) and its
receipts or deposits from other countries
(credits)
THE SCOPE OF MACROECONOMICS
• The major macroeconomic issues/Goals of
Macroeconomics
• (Rapid) economic growth: If output – real
Gross Domestic Product (GDP)– grows faster
than population, the average person can enjoy an
improved standard of living
• High Employment (Unemployment): The
main source of households’ incomes is labour
earnings. When unemployment is high, many
people are without jobs and must cut back their
purchases of goods and services
THE SCOPE OF MACROECONOMICS
• The major macroeconomic issues/Goals of
Macroeconomics
• Inflation (Stable Prices): This goal is
important because inflation imposes costs
on society.
Therefore keeping inflation rate low helps to
reduce these costs.
• Balance of payments and stable
exchange rates: A stable exchange rate
will help reduce inflation, promote
international trade and help the country
achieve a favourable trade balance.
Economic growth (average % per annum),
Unemployment (average %), Inflation (average % per annum)
Economic growth (average % per annum),
Unemployment (average %), Inflation (average % per annum)
Economic growth (average % per annum),
Unemployment (average %), Inflation (average % per annum)
THE SCOPE OF MACROECONOMICS

• Microeconomics and macroeconomics

• The major macroeconomic issues
• economic growth
• unemployment
• inflation
• balance of payments and exchange rates
• Government macroeconomic policy
THE SCOPE OF MACROECONOMICS

• Microeconomics and macroeconomics

• The major macroeconomic issues
• economic growth
• unemployment
• inflation
• balance of payments and exchange rates
• Government macroeconomic policy
• choosing between macroeconomic theories
THE SCOPE OF MACROECONOMICS

• Microeconomics and macroeconomics

• The major macroeconomic issues
• economic growth
• unemployment
• inflation
• balance of payments and exchange rates
• Government macroeconomic policy
• choosing between macroeconomic theories
• choosing the order of priorities
• Societies face trade-offs between
economic objectives.
• The goal of faster rate of economic
growth may conflict with favourable
balance of payment.
• The goal of lower unemployment may
conflict with that of lower inflation.
• This is an opportunity cost.
• The existence of trade-offs means that
policy-makers must make choices
THE CIRCULAR FLOW OF INCOME
• Aggregate demand (AD). This is the total
spending on goods and services made within
the country.
• This spending consists of four elements.
AD = C + I + G + X − M
where,
C= Household Consumption
I =Investment
G=Government expenditure
X=Exports
M=Imports
The National Economy
The Circular Flow of
Income
 National Income Accounting and The
Circular Flow of Income

•National Income Accounting is the

measurement of the annual output and
income flows of an economy.

•It provides basis for assessing the economic

performance, for designing public policy and
for understanding how all the sectors of an
economy interact.
 National Income Accounting and The
Circular Flow of Income

•It is an accounting framework used in

measuring current economic activity in an
economy over a period of time.

•The various approaches for measuring

national income and their links can be
explained by the Circular Flow of Income
Model.
The Circular Flow of
Income
 The Circular Flow of Income
Figure: Circular Flow – Two – Sector Closed Economy
Incomes to factors of Production

Costs
Factor services

Factor market

Goods market

Receipts

Goods and Services

Household expenditure
 The circular flow of income

Firms

Consumption of
Factor domestically
payments produced goods
and services (Cd)

Households
 THE CIRCULAR FLOW OF INCOME
• Withdrawals (W):

• Only part of the incomes received by households will

be spent on the goods and services of domestic firms.
The remainder will be withdrawn from the inner flow.
• Likewise only part of the incomes generated by firms
will be paid to the households. The remainder of this
will also be withdrawn.
• There are three forms of withdraws (or ‘leakages’).
• Net savings (S): Saving is income that households
choose not to spend but to put aside for the future.
Savings are normally deposited in financial
institutions such as banks
 THE CIRCULAR FLOW OF INCOME
• Withdrawals (W):

• Net taxes (T): When people pay taxes (to either

central or local government), this represents a
withdrawal of money from the inner flow

• Import expenditure (M): Income spent on

imported goods and services, or on goods and
services using imported components.
 THE CIRCULAR FLOW OF INCOME
• Injections (J)

• Only part of the demand for firms’ output arises from

consumers’ expenditure.
• The remainder comes from other sources outside the
inner flow. These additional components of
aggregate demand are known as injections
• There are three types of injections.
• Investment (I): This is the money that firms
spend after obtaining it from various financial
institutions – either past savings or loans, or
through a new issue of shares
 THE CIRCULAR FLOW OF INCOME
• Injections (J)

• Government expenditure (G): When the

government spends money on goods and
services produced by firms, this counts as an
injection

• Export expenditure (E): Money flows into the

circular flow from abroad when residents
abroad buy our exports of goods and services
 The circular flow of income

INJECTIONS

Export
expenditure (X)
Investment (I)
Government
Consumption of expenditure (G)

Factor domestically
BANKS, etc GOV. ABROAD
payments produced goods
and services (Cd)
Import
Net expenditure (M)
Net taxes (T)
saving (S)

WITHDRAWALS
THE CIRCULAR FLOW OF INCOME
• The links between injections and
withdrawals

• There are indirect links between saving and

investment, taxation and government
expenditure, and imports and exports, via
financial institutions, the government (central
and local) and foreign countries respectively.

• Example: If more money is saved (S), there

will be more available for banks and other
financial institutions to lend out (I).
THE CIRCULAR FLOW OF INCOME
• The links between them (Example)

• If tax receipts are higher (T), the

government may be more keen to increase
its expenditure (G).

• If imports increase (M), incomes of

people abroad will increase, which will
enable them to purchase more of our
exports (X).
The circular flow and the four macroeconomic
objectives
• However, Planned injections (J) may not equal
planned withdrawals (W).
• If injections exceed withdrawals, the level of
expenditure will rise and AD will rise
• Consequence on macroeconomic objectives
• Unemployment will fall
• Inflation will tend to rise
• The exports and imports part of the balance of
payments will tend to deteriorate
• There will be economic growth
 Equilibrium in the circular flow
• When injections do not equal withdrawals, a state
of disequilibrium will exist
• This will set in train a process to bring the
economy back to a state of equilibrium where
injections are equal to withdrawals.
• Assume injections exceeds withdrawals :
• National income will increase
• People will save more (S), pay more taxes (T)
and buy more imports (M). In other words,
withdrawals will rise.
• This will continue until they have risen to equal
injections
The National Economy
Measuring National Income
 MEASURING NATIONAL INCOME
• National Income is measured by GDP
• Gross domestic product (GDP): The value
of output produced within the country over
a 12-month period.
• The three ways of measuring GDP
1. the product method
2. the income method
3. the expenditure method
The circular flow of national income and expenditure
The circular flow of national income and expenditure
(1) Production

(2) Incomes (3) Expenditure

 MEASURING NATIONAL INCOME
• The product (Output) method: This is the market
value of final goods and services produced by
countries’ own factors of production within a given
period.

• That is adding up the monetary value of the

physical goods and services in an economy within a
given period, usually within a year.

• The final total output is called National Product of

Output/GDP.
 MEASURING NATIONAL INCOME

• The output approach involves adding up the market

value of the total output (goods and services) of all
firms in the various sectors of the economy
(agriculture, mining, manufacturing, services, etc)
in a year.

• This yields the GDP at market price

 MEASURING NATIONAL INCOME
• The product (Output) method:
Stages of Value of output Cost of Gross Value
production (Cedis) intermediate Added (GVA)
goods (Cedis) (Cedis)
Farmer sells
cassava 8,000 0 8,000
Miller turning
cassava to 11,000 8,000 3,000
cassava dough
Woman turning
dough to gari 20,000 11,000 9,000

Gari delivered
to retailer 30,000 20,000 10,000
Total 69,000 39,000 30,000
 MEASURING NATIONAL INCOME
• The product (Output) method
• Net Factor Income from abroad: The difference
between income earned by foreigners in the domestic
country and income earned by the citizens residing
abroad)
• GDP at market prices + Net Factor Income from
abroad = Gross National Product (GNP) at market
prices.
• GNP at market prices – Indirect taxes + subsidies =
GNP at factor cost.
• GNP at factor cost – Depreciation = Net National
Product (NNP) at factor cost.
 MEASURING NATIONAL INCOME
• Problems of the product (Output) method
• The problem of double or multiple counting
• Non-marketed activities
• Underground activities
• Poor Statistics
• The valuation of public services
 MEASURING NATIONAL INCOME
• The Income method/approach
• The National Income is arrived at by adding
up all the money values of incomes earned
(wages, rent, dividend, interest etc) by the
factors of production employed in producing
the output in an economy within a specified
period of time like one year

• There are four factors of production. These

are labour, land, capital and
entrepreneurship.
 MEASURING NATIONAL INCOME
• The Income method/approach
• Wages and salaries are paid to labour;

• Rent and interest are paid to land and capital

respectively and profit to entrepreneurship.

• If all remunerations to factors of production are

added up, the value should be equal to the total
expenditure on total output.
 MEASURING NATIONAL INCOME
• The Expenditure method/approach
• This approach measures the total
expenditure needed to purchase output
produced in the economy within a year.
• It is the expenditure of households, firms
and government within a year.
• Total or Aggregate expenditure (AE)
therefore is the sum of consumption
expenditure on final goods and services and
net exports (Exports minus Imports).
MEASURING NATIONAL INCOME
• The Expenditure method/approach
• That is:
AE = C + I + G + (X − M)
where,
C= Household Consumption
I =Investment
G=Government expenditure
X=Exports
M=Imports
 MEASURING NATIONAL INCOME
• The Expenditure method/approach
• Problems with the expenditure approach
• The high illiteracy rate in developing countries
including Ghana makes record keeping on
expenditures very difficult to permit a reasonable
assessment of expenditures.
• A large proportion of the national expenditure
consists of private expenditures from the small-
scale earners who are unwilling to give correct
information on their expenditures for fear of high
taxes.
• Subsistence production makes it difficult to
compute subsistence consumption
 Nominal versus real GDP
• Nominal GDP, measures GDP in the prices ruling
at the time and thus takes no account of inflation.

• Real GDP measures GDP in the prices that ruled in

the base year. Thus we could measure each year’s
GDP in, say, 1990 prices.

• This would enable us to see how much real GDP

had changed from one year to another. In other
words, it would eliminate increases in money GDP
that were merely due to an increase in prices.
• Taking account of population:
• the use of per-capita measures

• Taking account of exchange rates:

• the use of PPP measures:
For example, $1 may exchange for, say, Gh¢8.
But will $1 in the US buy the same amount of
goods as
Gh¢8 in Ghana? The answer is almost certainly
no
• To compensate for this, GDP can be converted
into a common currency at a purchasing power
parity (PPP) rate.

• PPP rate is the rate of exchange rate that

would allow a given amount of money in one
country to buy the same amount of goods in
another country after exchanging it into a
currency of the other country.
 MEASURING NATIONAL
• National income INCOME
statistics: Suitable measures of
living standards?
• Items that are excluded
• non-marketed items
• the underground economy
• Production: poor indicator of welfare?
• production does not equal consumption
• human costs of production
• Externalities (external costs)
• the production of 'regrettables'
• distribution of income
• The use of GDP per capita (GDP/Total
population)
Short-term Growth and the Business
Cycle
SHORT-TERM GROWTH & THE BUSINESS CYCLE
• Actual and potential national income
• Actual growth is the percentage annual increase
in national output: the rate of growth in actual
output
• Potential economic growth: It is the percentage
annual increase in the economy’s capacity to
produce: the rate of growth in potential output.
• Contributors to potential economic growth are:
Discovery of natural resources
Technological advances leading to efficiency
Growth and the production possibility curve

Growth in
actual output
Good X

b
a

O
Good Y
 Growth and the production possibility curve

Growth in
potential output
Good X

I II
O
Good Y
SHORT-TERM GROWTH & THE BUSINESS CYCLE

• Actual and potential national income

• actual and potential economic growth
• Economic growth & the business cycle
SHORT-TERM GROWTH & THE BUSINESS
CYCLE
• Actual and potential national income
• actual and potential economic growth

• Economic growth & the business cycle

• Business cycle is the periodic fluctuation
of national output around its long-term
trend.
• fluctuations in actual growth
• A business cycle may thus be defined as
alternating periods of economic growth
and contraction in an economy
SHORT-TERM GROWTH & THE BUSINESS
CYCLE
• Actual and potential national income
• actual and potential economic growth
• Economic growth & the business cycle
• When the actual GDP is above trend for a
number of years in a row the economy is
regarded as experiencing a boom or an
expansion

• When the actual GDP is below trend for a

number of years in a row we say that the
economy is in contraction or recession.
SHORT-TERM GROWTH & THE BUSINESS CYCLE
• Actual and potential national income
• actual and potential economic growth
• Economic growth & the business cycle
• Phases of Business Cycle
• Upturn: contracting or stagnant economy begins
to recover
• Expansion: there is rapid growth: the economy
is booming
• Peak: growth slows down or even ceases
• Slow down or recession: there is little or no
growth or even a decline in output
 The business cycle

Potential output
National output

3
4
2 Actual
3
output
4
2 1

O
Time
SHORT-TERM GROWTH & THE BUSINESS
CYCLE
• Actual and potential national income
• actual and potential economic growth
• Economic growth & the business cycle
• fluctuations in actual growth
• the phases of the business cycle
• upturn
• expansion
• peaking out
• slowdown or recession
• Long-term output trend
• sustainable national income
SHORT-TERM GROWTH & THE BUSINESS CYCLE

• Actual and potential national income

• actual and potential economic growth
• Economic growth & the business cycle
• fluctuations in actual growth
• the phases of the business cycle
• upturn
• expansion
• peaking out
• slowdown or recession

• Long-term output trend

• sustainable national income
SHORT-TERM GROWTH & THE BUSINESS CYCLE
• Long-term Output Trend
• A line can be drawn showing the trend of national
output over time (i.e. ignoring the cyclical
fluctuations around the trend)
• If the average level of potential output that is
unutilised stays constant from one cycle to another,
the trend line will have the same slope as the
potential output line.
• In other words, the trend rate of growth will be the
same as the potential rate of growth.
 The business cycle

Potential output

Trend
National output

output

Actual
output

O
Time
SHORT-TERM GROWTH & THE BUSINESS CYCLE

• Causes of fluctuations in growth

• Changes in aggregate demand
• A rapid rise in aggregate demand will create
shortages. This will tend to stimulate firms to
increase output. The reverse holds

• Changes in aggregate demand relative to

potential output
• Expansion of potential output in relation to
increased aggregate demand
The National Economy
Long-term Economic Growth
LONG-TERM ECONOMIC GROWTH
 LONG-TERM ECONOMIC GROWTH

• Example: if GH¢100 million of extra capital yielded

an annual income of ¢25 million, the marginal
efficiency of capital would be ¢25 million/¢100
million=(1/4).

• Effects of actual growth on potential growth

• Actual growth stimulates investment and the

development of new technology

• the importance of investment: Investment plays a

twin role in economic growth (Think about it!!).
LONG-TERM ECONOMIC GROWTH
• Policies to achieve growth

• Demand-side policies

• Fiscal and monetary policies are intended to

increase aggregate demand

• The principal policy instruments are

government expenditure, taxation (fiscal
policy); and the stock of money in circulation
and interest rate (monetary policy)
LONG-TERM ECONOMIC GROWTH
• Policies to achieve growth

• Supply-side policies

• These policies are intended to increase the

economy’s potential rate of output by
increasing the supply of factor inputs and by
increasing productivity

Example: providing subsidies to firms

• Measures to encourage research and

development, innovation and training
 LONG-TERM ECONOMIC GROWTH
• The desirability of economic
growth
• The benefits of economic growth
• increased consumption
• reduces other macro problems
• easier to redistribute incomes to
the poor
LONG-TERM ECONOMIC GROWTH
• The desirability of economic growth
• The costs of economic growth
• current opportunity costs
• Higher savings for investment would
mean a cut in consumption
• may generate extra wants
• adverse social effects
• an excessive pursuit of material
growth by a country can lead to a
more greedy, more selfish and less
caring society: suicides, divorce and
other
LONG-TERM ECONOMIC GROWTH
• The desirability of economic growth
• The costs of economic growth

• environmental costs
• pollution and waste
• depletion of resources
Thank You