This document provides an overview of chapter 4 of a Grade 12 Economics textbook. It covers key macroeconomic concepts like national accounts, circular flow of income, and approaches to compiling national accounts using output, expenditure and income. It also defines macroeconomic objectives such as full employment, price stability, economic growth, balance of payments stability, equitable income distribution, and sustainable development. Specific policies and indicators are discussed for each objective.

1. GCE A/L Economics
Grade 12.
Chapter - 4
Lecturer – S. M. Irshad
BA in Social Sciences (OUSL)
MA in Economics (MKU) India. in progress.
Dip. in Governance, Democratization & Public Policy(CISS).
E-mail – irshad.sahabdeen@yahoo.com
1

2. 4. Demonstrates preparedness to compile
National Accounts within macroeconomic
framework.
 4.1 Investigates macroeconomic
objectives.
 4.2 Investigates key Macroeconomic
variables
 4.3 Analyses alternative approaches to
national accounting using the circular
flow of national income.
 4.4 . Demonstrates preparedness to
compile National Accounts using the
output approach.
 4.5 Investigates various concepts of2

3.  4.6 Demonstrates preparedness to
compile National Accounts using the
expenditure approach..
 4.7 Demonstrates preparedness to
compile National Accounts using the
income approach.
 4.8 Investigates the applications of
national accounts.
3

4. What is Macroeconomics?
 The study of the economy as a whole, and
the variables that control the
Macroeconomy.
 The study of government policy meant to
control and stabilize the economy over time,
that is, to reduce fluctuations in the economy.
 The study of monetary policy, fiscal policy, and supply-side
economics. the major variables describing the macro-
economy are the same. the three major policy approaches
are the same. but the quality to which these policies are
applied differ from one country to another; this because the
political process from which these policies emerge are
unique to each country. 4

5. Who introduced macroeconomics, and
what was its major objectives?
 John Maynard Keynes, an English
economist, hence macroeconomics is
also referred to as Keynesianism.
 Keynes argued that by itself the
market is unable to generate enough
savings (capital) to sustain
investment at full employment
levels; and that this could be
achieved only with the periodic
sharp increase in government
5

6. Macroeconomic Objectives
Full Employment.
 Price Stability.
 Economic Growth.
 Balance of Payments
stability.
 Equity in Income and
Wealth Distribution.
 Sustainable Development.
6

7. Full Employment
 Achieving the objective of full employment means
holding national product at its potential, or full
employment level. It does not mean achieving zero
unemployment. Indeed, zero unemployment is an
impossibility in any real economy because of the normal
turnover of labour.
 Turnover occurs because people leave one job to take,
or look for, another, and because there are always some
people leaving the labor force due to retirement, or
death, and others entering it.
 As a result, there is always a pool of people who are
unemployed because they are currently between jobs or
looking for their 1st job. Such unemployment, which is
due to the normal turnover of labour, is called frictional
unemployment. It is the amount of unemployment
that exists when output is at its potential level.
7

8.  Accordingly, a more realistic interpretation
of full employment suggests itself; full
employment is achieved when the number
of registered unemployed people is equal
to number of job vacancies.
 The labour market consists of 2 groups,
namely households who supply labour and
firms who demand labour.
 When the supply of labour is equal to the
demand for labour, the economy is in fully
employment. When labour supply exceeds
the demand, there is surplus labour. This
results in unemployment in the economy.
This is a major economic problem in Sri
Lanka since independence.
8

9. LABOUR
FORCE
ECONOMICALLY
ACTIVE POPULATION
– persons who are
employed and who
are willing to work,
but unemployed.
ECONOMICALLY
INACTIVE
POPULATION – who
are unable to engage
in productive
employment, they
include children,
elderly and disabled.
9

10. 10

11.  In Sri Lanka the overall employment levels
remained stagnant until the late 1970s. Slow
economic growth during that period did not
permit to absorb the growing labour force in
that period.
 With the economic liberalization of the
economy in 1977, the GDP growth
accelerated and more jobs were created in
the newly growing sectors like manufacturing
, banking and financial services, construction
and trade. As a result , the total employment
rose from 3.8 million in 1973 to 4.7 million by
1981/82. it reached 6.4 million by 2002.
 Today, Sri Lanka’s total labour force reached
to 8.864 million by 2013 compared to 8.254
million in 2012. 11

12. 12

13. Price Stability
 Economic and price stability is a situation
where there are no wide fluctuations in the
general price level in an economy which helps
to achieve sustainable economic growth. When
the prices fluctuate at a low rate, they would
not have any significant influence on economic
decisions of participants of an economy, viz.
households and firms.
 Therefore, stable prices would not distort the
economic decisions regarding what to produce
and how to produce, thus enabling efficient
allocation of resources in the economy leading
to economic stability.
13

14.  Price Stability is the economic term used to refer
to a situation where the general price level covering
Consumer goods remains unchanged or if it does
change, it happens at a low rate so that it is not
strong enough to make any significant influence on
economic decisions of participants in an economy,
viz. households and firms.
 We encounter prices in different forms in our daily
activities as buyers or sellers when we get engaged
in consumption, investment, production or trade.
 In a market economy, price changes are a
common phenomenon depending on the demand
for and supply of goods and services. Since prices
change in both directions and in different
magnitudes, it is difficult to figure out the general
movement in prices by examining each individual
price change in isolation 14

15.  The price level is usually examined through a
“basket of goods” approach, in which a
collection of consumer based goods and
services are examined in aggregate; changes
in the aggregate price over time will push the
index measuring the basket of goods higher.
 Price levels provide a snapshot of prices at a
given time, making it possible to review
changes in broad price level over time.
 As price rises (inflation), or fall (deflation),
consumer demand for goods is also
affected, which leads broad production
measures like gross domestic product
higher or lower.
15

16. Economic Growth
 Economic growth is a major concern of
Macroeconomics. Economic growth
means a rise in real income or real
output.
 Very often, economists use the rate of
change of national income to measure
economic growth.
 Most of the countries measure the GDP
growth in real terms. Economic growth in a
particular year is measured as the rate of
change in real GDP over the previous year. 16

17.  Sources of economic growth ; the total output
or GDP of an economy depends on the
quantity and quality of various resources that
are used as inputs in production. These
include land , labour, capital and raw materials.
Producers can raise their output by the
following 2 methods:
By increasing factors of production: land,
labor, capital and raw material.
By increasing the productivity of factors of
production: this means an increase in output
with the same quantities of inputs. This can be
achieved by several ways:
A. By improving human capital through skills
development.
B. By technological progress.
17

18. Balance of Payments
Stability
 Maintenance of equilibrium in the external
payments positions, known as the balance
of payments equilibrium and also is one of
the macroeconomic goals.
 Continuous external deficits reduce the
country's capacity to import and leads to an
accumulation of foreign debt. Hence it is
important to reduce the external deficits.
The main policy instruments that are used
to attain macroeconomic stability is the
fiscal policy.
18

19.  The use of government spending,
taxation and borrowings for the
achievement of macroeconomic stability.
The monetary policy also known as the
management of the money supply, cost of
money and credit conditions by the
central bank so as to achieve
macroeconomic goals.
 These two sets of policies are closely
interrelated, and they may be
contradictory at times. For example,
when the government runs a high budget
deficit, monetary authorities would find it
difficult to mange the money growth. 19

20. Income & Wealth
Distribution
 Justice or fairness in the manner in which the
economy’s output is distributed between individuals.
distributional equity is some times expressed in terms of
the distribution of income, of wealth.
 This is also a policy concerned with altering the pattern
of the personal distribution of income in an economy,
mainly with social rather than economic objectives in
mind.
 The general aim of such a policy is to achieve a more
equitable distribution of income as between the various
sections of the community so as to ensure that
everybody is provided with some minimum standard if
living. The transfer of income from one section to
another is achieved primarily by the use of a
progressive taxation system and a verity of welfare
provisions. Example. Housing schemes, old age20

21. Sustainable Development
 Sustainable development is the
development which meets the needs of the
present generation without compromising
the needs of future generations.
 The term 'sustainable development' was
used by the Brundtland Commission, which
coined what has become the most often-
quoted definition of sustainable
development: "development that meets the
needs of the present without compromising
the ability of future generations to meet
their own needs.
21

22.  In 1987, the United Nations released the
Brundtland Report, which included what
is now one of the most widely
recognized definition said above.
 The concept of sustainable development
divided in to three constituent parts:
environmental sustainability, economic
sustainability and socio-political
sustainability.
 In real terms all the macroeconomic
variables should be directed towards
economic development so as to mange
22

23.  According to the Brundtland report, the
above definition contains two main key
concepts:
 the concept of 'needs', in particular the
essential needs of the world's poor, to
which overriding priority should be given;
and
 the idea of limitations imposed by the
state of technology and social
organization on the environment's ability
to meet present and future needs.
23

24. Macroeconomic Variables
 The main variables which decide the
economic activities are known as
macroeconomic variables.
Macroeconomic variables can be shown
as follows;
National Output.
Employment.
The General Price Level.
Balance of Payment.
Foreign Exchange Rate.
24

25. National Output
 The nation's total output is loosely
described as its national product, national
output or national income. Precise
measures ad their definitions are
discussed in further in following topics.
 In the meantime, note that this total
product can be calculated by adding up
the money values of all the goods and
services that are produced in the
economy over some period of time,
usually taken as a year.
25

26. Employment
 This is an important variable which measure
the unemployment rate and the total labour
force. The unemployment rate is equal to the
number of unemployed people divided by the
total labour force.
26
General Price Level
• Price stability is a situation where there are no
wide fluctuations in the general price level in an
economy which helps to achieve sustainable
economic growth. When the prices fluctuate at a
low rate, they would not have any significant
influence on economic decisions of participants of
an economy, viz. households and firms.

27. Balance of Payments &
Foreign Exchange
RateAll international transactions are
recorded in what are known as
a country's balance of
payments. These transactions
are influenced by the exchange
rate, which is the rate at which a
country's own currency
exchanges for foreign 27

28. Business Cycle
( Trade Cycle)
Cyclical fluctuations in the level
of economic activity in an
economy can be observed by
examining annual changes in
real national income (or real
output ) over a long period of
years; these changes are
inversely related to variations
in the rate of unemployment. 28

29. “Business (Trade )
Cycle – a trade cycle
depicts fluctuations
in the level of
economic activity
over a period of
time.” 29

30.  The business cycle is characterized by four
phases;
1. Depression – a period of rapidly falling aggregate
demand accompanied by very low level of output and
heavy unemployment, which eventually reaches the
bottom of the trough;
2. Recovery – an upturn in aggregate demand
accompanied by rising output and a reduction in
unemployment;
3. Boom – aggregate demand reaches and then
exceeds sustainable output levels (potential GNP) as
the peak of the cycle is reached. Full employment is
reached and the emergence of excess demand
causes the general price level to increase (inflation);
4. Recession – the boom comes to an end and is
followed by recession. Aggregate demand falls,
bringing it it initially, modest falls in output and30

31. Business Cycle
31
Potential
GNP
Actual
GNP
Recession
Recovery
Depression
Boom
0
Level of
Economic
Activity
Time

32. National Accounting using the
Circular Flow of National Income.
 Economists illustrate the money
flow by using a diagram that is
known as the circular flow model.
 A model is usually a smaller,
simplified version of the real thing.
An economic model shows us how
our economy functions, tracing the
flow of money , resources, and
goods and services. 32

33. Two Sector Model
 Initially, let us assume that there are only two
sectors in the economy; the household and
business sectors, as shown in the figure 1.
households supply factors of production to firms in
the business sector.
 These factors are land , labour and capital. Firms
make payments to households in exchange for the
factors of production that they supply. Using their
factor incomes, households buy goods and
services from firms. In return, households pay the
value of these goods and services to firms.
 This is shown as consumption spending ( =C ) in
the diagram. You may have noticed that there are
only 2 markets in this economy; goods and
services market and factor market.
33

34. 34
( C )

35.  In the above economy; households spend their entire
income to buy goods from firms. Thus the total income
(=Y) received by households is equal to total expenditure
(=E) paid by them to firms in this economy. This may not
be true, because people usually save a part of their
income in their banks.
 Therefore, we need to expand our diagram to consider
savings. For this purpose, let us introduce financial
sector (banks) to our economy, as shown in figure 2. so,
households save a part of their income in banks. These
savings (=S) become deposits held with banks. The
savings go out of the circular flow, because households
do not spend that portion of income to buy goods and
services.
 Therefore, we consider savings a leakage. When firms
borrow from banks, the savings come back to the flow as35

36. 36

37. Three Sector Model
 So far, we have assumed that there is no
government, but this is not a realistic
assumption, as all countries have
governments. Therefore, let us introduce a
government into our economy, as shown in
figure 3.
 The government could influence the circular
flow in 2 ways; one is, it collects taxes (=T)
from households and firms, and second one
is, it makes various payments (=G) to
households and business sectors. Taxes are
37

38. 38

39. Four Sector Model
 Until now we considered a closed economy. But as you know,
all countries are engaged in foreign trade. Each country
exports goods and services to other countries, and imports
goods and services from others.
 Therefore, we should include exports ad imports in our
economy, as shown in figure 4. when a country exports goods
and services, it receives export earnings (=X) from other
countries.
 When a country imports goods and services, it has to incur
import payments (=Z). So, we should consider export as an
injection and import as a leakage. Now you can see that there
are a number of flows in our final circular flow diagram. The
level of income in the circular flow depends on leakages and
injections.
39

40. 40

41. Injections & Leakages
Injections Leakages
Investment (=I) Savings (=S)
Government Spending
(=G)
Tax (=T)
Export earnings (=X) Import Payments (=Z)
41

42. Measure of National
Income
We will discuss here how deferent
types of measures can be used to
estimate a country's national
income.
Gross domestic production (GDP);
is the market value of all final
goods and services produced
within a country in a given period of42

43.  It is important to understand the
following terms that are included in the
definition of GDP.
 GDP is a GROSS amount, because the
output is measured without deducting an
amount for depreciation of capital goods
like machinery and equipment.
 Market vales of the products are
counted
 GDP is domestic production because it
includes only goods and services
produced within the country.
43

44.  It is a measurement of final goods
produced because we count only the
goods and services that are produced for
final use. In other words, we do not use
intermediate goods produced by one firm
for use of another firm.
 We measure GDP in money terms.
 GDP is a flow concept. The reason is that
it measures the value of output or income
realized during a particular year or a
quarter. This is different from the concept
of stock which usually measures a variable
at a particular point of time. For example,
the total wealth of a country at the end of44

45. The following transactions
are excluded form GDP.
 The purchase and sale of used/ second
hand goods.
 The trading of shares, bonds, and
securities.
 Transfer payments.
 Domestic services, eg. Housewives
services.
 Illegal production and trading services.
 Environmental degradation arising from
45

46. Gross National Product
 GNP is the market value of all final goods and
services produced by citizens of a country in a
given period of time, usually a year.
 Thus GNP, is the total income earned by a
country's nationals regardless of the country in
which their factor services are supplied.
Accordingly, factor incomes earned by Sri
Lankan companies and individuals abroad and
remitted to Sri Lanka are included in GNP.
Similarly, outward remittances of factor
incomes from Sri Lanka by foreigners and
overseas companies working here are
deducted from GDP.
46

47.  Thus, GNP differs from GDP by
including factor income that our
citizens earn abroad and excluding
factor income that foreigners earn
here.
GNP = GDP + FACTOR
INCOME INFLOWS – FACTOR
INCOME OUTFOWS.
GNP = GDP + NET FACTOR
INCOME FROM ABROAD.
47

48. Net Domestic Product
Net domestic product is GDP
minus depreciation. Depreciation is
the wear and tear of the country's
stock of capital equipment.
NDP = GDP +
DEPRECIATION
48

49. Net National Product
Net national product
is GNP minus
depreciation.
NNP = GNP -
DEPRECIATION
49

50. Disposable Personnel Income
 This is the income earned by
individual households in a given
time period. Disposable income
equals personnel income minus
income taxes paid plus
government transfer to
households.
 Disposable Personnel Income =
personnel income + income tax
paid + government transfers to 50

51. Computation of National
Income.
 Economists use the following 3
approaches to compute national
income.
 Output approach
 Expenditure approach
 Income approach
 You may recall that the circular flow of
income showed us that the output
produced by using factors of production
is equal to the incomes received by the51

52. The Output Approach
 In this method of computation we assume, the value of
production of each economic activity. Then we add up all
these production values. But when we measure national
income using this method, we should not avoid double
counting of the same product. For instance, assume that
a country produces items such as rubber, tyres, milk,
butter, and ice cream. How can we value all these
products and total them up? Rubber is used in the
manufacture of tyres.
 Similarly, milk is used to produce butter and ice cream. If
we add the values of rubber sheets and tyres we would
be counting the value of rubber twice. Likewise, if we
value the total milk production and total ice cream
production, the value of milk that is used for ice cream52

53.  This type of counting should be avoid in
measuring the total output of the country. This
can be done by deducting the value of inputs
of goods and services used in the production
of each item. These inputs are also known as
intermediate goods.
 The value of output of an enterprise less than
the value of its inputs is known as the value
added. The total value added in all producing
units located within a country during a
particular period is Gross Domestic Product.
 The value added is also equal to the sum of
payments to factors of production (wages,
interest, rent and profit) at each stage of the
production process. 53

54. Value Added = Value of a
Firms Output – Value of
Inputs Purchased from
other Firms.
54

55. 55
Firm Producti
on stage
Product Sales
price
Cost of
intermediate
products
Value added
(wages,
interest, rent,
profit)
1 Tea estate Tea leaves 40 00 40
2 Tea factory Tea 60 40 20
3 Tea packing Tea
packets
70 60 10
4 retailer Retailing
sales
90 70 20
Final
sale
90=final sale
price=sum of value
added.

56.  The above table shows how value added is
calculated for the tea industry. Firm 1
produces tea leaves, and its value added is
Rs. 40. the tea factory uses the tea leaves to
produce tea. Although the total value of the
product is Rs. 60, the cost of intermediate
goods amounting to Rs. 40 should be
deducted. Thus , the value added of firm 2 is
only Rs. 20. likewise, try to calculate the value
added of the other firms and the sum of value
added.
 In computing national income using the
product approach, the economy is divided into
the following 11 sectors. The value added of
56

57. 1. Agriculture, forestry and fishing
2. Mining and quarrying
3. Manufacturing
4. Constructing
5. Electricity, water and gas
6. Transport, storage and communication
7. Wholesale and retail trade
8. Banking, insurance and real estate
9. Ownership of dwellings
10. Pubic administration and defense
11. Other services.
57

58. The Expenditure Approach
 In the expenditure approach we look at GDP
from the viewpoint of expenditure. This
identifies 4 types of spending as follows;
 Privet consumption spending (=C); this
includes consumption expenditure of
households and privet non-profit institutions
serving households.
 Investment (=I); this refers to investment in 3
areas; one is final purchases of machinery and
equipment by governments and business,
second construction and third changes in
inventories. Investment in this context does not
refer to financial investment. Which is merely58

59.  Government spending (=G); this refers to
government purchases of goods and services.
This does not include transfer payments and
expenditures for servicing the national debt, or
investment goods (which are already included
in I).
 Net export expenditure (exports – imports =
Xn); this refers to the net sales of goods
abroad (exports), less than the sales of goods
purchased from abroad (imports). If imports
are greater than exports, net exports would be
negative, and vice-versa.
 We obtain expenditure on GDP by adding
privet consumption, gross investment,
government expenditure and net exports.
59

60. GDE = C + I + G + (X – Z)
60
Gross Domestic Expenditure =
Consumption + Investment +
Government Spending + Net
Exports.

61. Income Approach
 In this method we measure the national
come as the sum of the incomes received
by households in a economy. As we saw in
the circular flow, households receive such
incomes by supplying FOP to firms, so they
receive rent for land, wages for labour,
interest for capital and profits for
entrepreneurship. We can derive gross
domestic income by adding up all these
factor incomes as follows;
Gross Domestic Income =
Rent + Wages + Interest +
61

62. Factor income can be
categorized as follows
 Employee income; this includes salaries, wages,
payments made to social security, insurance
and health facilities received by the employees.
 Rent income; this includes the income received
by renting fixed and natural resources, income
from housing rents, income from intellectual
property.
 Net interest; net interest from the business
sector
 Profit; includes cooperate income tax, dividends
and undivided profits.
 Income of self employees; this includes income
from sole proprietorships, partnerships,62

63. 63

64. 64

65. 65

66. 66

67. 67

68. 68

69. The Practical Usage of
National Income Accounting
National income accounting is
very useful for many purposes.
The min 2 aims of national
income accounting can be given
below.
To measure the level of
economic activity
To measure the level of69

70. Other Major Uses of National
Income Accounting.
 To measure a country’s economic growth
rate.
 Measure the standard of living, usually
high national income indicates high
standard of living.
 National planning for country’s
development.
 To investigate about income distribution
and its changes. Figures of wages, rent,
profits, interests etc.
 To measure the output of different
sectors in the economy. This enable us to
explore which sector contributes to the
economy most. 70

71.  To compare the economic productivity
and efficiency. If the national income
improved steadily over the years, this
shows a stable economy with improved
productivity.
 To compare with other countries, if
GNP per capita is greater than 18000$,
the country is considered as industrially
advanced, so when it is lower than
2000$ is considered as less developed
economy.
 To see the pattern of government
expenditure in the expenditure71

72. Limitations of National
Income Accounting.
 One of the main uses of national income data is in
measuring the economic well being of the
population through the concept of the standard of
living. The basic standard for this is to use real
GDP per person (per capita).
 Real GDP per capita does have some limitations
when assessing the standard of living.
 Regional Variations in income and spending
 National GDP figures hide significant regional
variations in output, employment and incomes per
head of population.
 Within each region there are also areas of relative
prosperity contrasting with unemployment black-
spots and deep-rooted social and economic
deprivation.
72

73.  GDP figures on their own do not show the
distribution of income and the uneven
spread of financial wealth. Incomes and
earnings may be very unequally
distributed among the population and
rising national prosperity can still be
accompanied by rising relative poverty.
 Economic growth and externalities
 Rising national output might have been
accompanied by an increase in pollution
and other negative externalities which
have a negative effect on economic
welfare. Output figures also tell us little
about the quality of goods and services 73

74.  The black economy and non monitored sectors
 GDP figures might understate the true living
standards because of the existence and growth of
the black economy.
 The black economy includes economic activity that
goes unrecorded by the Inland Revenue and
Customs & Excise.
 The non monitored sectors of the economy
include output that is not sold at market prices but
involves barter trade, and self-consumed products.
 The Economist's latest estimates for the total value
of the black economy throughout the world is $9
trillion. The scale of the underground economy is
estimated to average 15% of national output for
rich economies and 33% of national output for
emerging economies.
 According to their survey, Nigeria and Thailand
have the world’s largest black economies, both
accounting for more than 70% of official GDP.
74

75. What are the advantages and
disadvantages of Gross Domestic Product?
 Gross Domestic Product (GDP) is
an economic measure of a
nation's total income and output
for a given time period (usually a
year).
 Economists use GDP to measure
the relative wealth and prosperity
of different nations, as well as to
measure the overall growth or
decline of a nation's economy.
75

76.  The most common way to measure GDP is the
expenditure approach. With the expenditure
approach, GDP is the sum of the following elements:
 Total domestic consumption: This is the total
amount spent on domestically produced final goods
and services. Final goods are items that will not be
resold or used in production within the next year —
milk, cars, bow ties, and so on.
 Total domestic investment expenditures: This
measurement includes not only investments in stocks
and bonds, but also investments in equipment —
such as bulldozers, computer servers, and
commercial buildings — that will be useful over a
long period of time. It also includes inventory goods
— final goods waiting to be sold that a company still
has on hand.
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77.  Government expenditures: This
includes everything from paying military
salaries to building roads and maintaining
monuments, but does not include welfare
and social security payments.
 Net exports: Net exports is the total of
goods and services produced
domestically and sold to foreigners minus
goods and services produced by
foreigners but sold domestically (imports).
 Using GDP as a measure of a nation's
economy makes sense because it's
essentially a measure of how much
buying power a nation has over a given
time period. GDP is also used as an
indicator of a nation's overall standard of
living because, generally, a nation's 77

78.  But there are a number of shortcomings to using GDP. Here
are just a few:
 GDP doesn't count unpaid volunteer work: GDP doesn't
take into account work that people do for free, from an
afternoon spent picking up litter on the roadside to the
millions of man-hours spent on free and open source
software (such as Linux). In fact, volunteer work can
actually lower GDP when volunteers do work that might
otherwise have gone to a paid employee or contractor.
 Disasters can raise GDP: Wars require soldiers, oil spills
require cleanup, and natural disasters require health
workers, builders, and all manner of helping hands.
Rebuilding after a disaster or war can greatly increase
economic activity and boost GDP.
 GDP doesn't account for quality of goods: Consumers
may buy cheap, low-quality, short-lived products repeatedly
instead of buying more expensive, longer-lasting goods.
Over time, consumers could spend more replacing cheap
goods than they would have if they had bought higher-
quality goods in the first place, and GDP would grow as a
result of waste and inefficiency.
 Although economists are constantly working on other ways
to measure an economy, GDP is still the best indicator of a78

79.  Statistics collection and representation must be looked at carefully or
an incorrect thesis may be misconstrued from the data given. The
three main limitations to national income accounting are:
 Errors in Measurement: Black Market and underground activities are
not included when calculating GDP. This is because there is no way to
accurately measure black market activity. In the United States, this is a
relatively small percentage of the total GDP; however, in many other
less developed countries, it can go as high as 70% of the country's
total GDP. Another big measurement error is inflation. It is adjusted
according to base prices and various other things and the range of
possible inflation can be as much as 1% to 15% in some places.
 Subcategories that are Misrepresented: The various interpretations
of what should be included in consumption or government spending
plays a big part in the overall determination of GDP. Decisions are
made about what is to be included where, but minor discrepancies will
always arise.
 Welfare is NOT Measured: GDP only measures the market activity
and does not take welfare into account. The economic activity of a
country could rise, while welfare could possibly have fallen. Different
situations may occur that have a negative impact on the people which
cause them to increase spending, therefore increasing the GDP.
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80. Review Questions
1) What is macroeconomics?
2) What are the macroeconomic variables?
3) What are macroeconomic objectives?
4) What is national income?
5) What are the methods of national income
accounting?
6) What is income approach? Explain.
7) What is expenditure approach? Explain.
8) What is output approach? Explain.
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81. 1. Explain the 2 sector model.
2. Explain the 3 sector model
3. Explain the 4 sector model.
4. What are the advantages of
GDP?
5. What are the disadvantages
of GDP?
81

82. Reference
 Prof. S. S. Colombage.” Principles of Macroeconomics”
2006. The Open University Press, Nugegoda, Sri Lanka.
 Richard G. Lipsy,” An Introduction to Positive Economics”
7th Low Price Edition ,1989, Butler & Tanner Ltd,
London.
 Robert J. Gordon," Macroeconomics” 3rd Edition,1984,
Little Brown & Company Canada Ltd, USA.
 Robert H. frank, Ben S. Bernake, ”Principles of
Macroeconomics”, 2001. McGraw-Hill Companies Inc,
New York.
 David. W. Pearce," The Dictionary of Modern Economics”
2nd Low Price Edition, 1985, Anchor Brendon Ltd. UK.
 Prasadini Dharmawardena, GCE A/ L Economics – New
Complete Text Books for grade 12 & 13, ESL Publishers.
 Central Bank Reports 2009, 2010, 2011, 2012,Recent
Economic Development Reports from 2008, 2009, 2010,
2011, and 2012, Economics and Social Statistics form
2010, 2011, 2012.The Central Bank of Sri Lanka.
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