This document discusses key macroeconomic measures used by governments, including GDP, GNP, NNP, NDP, and factors that influence comparing economic growth between countries. It also covers the circular flow of income, aggregate expenditure, consumption and investment functions, and differences between the Keynesian and monetarist approaches to macroeconomics.

1. Theory and Measurement in
the macroeconomy
Key measures used by governments and consider differences between the Keynesian and
Monetarist approach
CAMBRIDGE A’LEVELS ECONOMICS
Kalaiarasi Danabalan
http://www.youtube.com/watch?v=yUiU_xRPwMc

2.  A government uses a variety of measures of the country’s output. These collectively
known as NATIONAL INCOME. It cover the total country output is equal to total income.
 Gross Domestic Product (GDP) = National Income
 Gross  Total, domestic refers to the home economy.
 Product Output
 GDP = C+I+G+ (X-M)
C- consumption
I- investment
Expenditure
X- Export
M- Import
• GDP + net property income from abroad = GNP (Gross National Product)
• Net Property Income = Income which the country’s residents earn on their physical
assets (factories & leisure parks) owned abroad and foreign financial assets – the returns
on assets held in the country owned by foreigners.

3.  NNP ( Net National Product)= GNP- capital consumption / depreciation
 NDP (Net Domestic Product) = GDP – Capital Consumption
 Market Price = The prices charged for goods and services in shops and other types
of retail business.
 Factor Cost = Market price – Indirect Tax + Subsidies
Ways of Measuring GDP
 Output measure
 Income measure
 Expenditure measure

4. Expenditure Measure
 What is produced in a year will either
be sold or added to stocks.
 This method necessary to
(+)expenditure on exports and (- )
expenditure on imports.
Find GDPFC , GDPMC, and GNP.

5. Output Measure
(Value of output produced by industries)
 economic activity by adding the market values of goods and services produced,
excluding any goods and services used up in intermediate stages of production.
 This approach makes use of the value‐added concept.
 The value added of any producer is the value of its output (-
the value of the inputs it purchases from other producers.
 The product approach computes economic activity by summing the values added by
all producers.

6. Income measure/ Approach
If someone bought it, then someone is
being paid to make it. The income
components include
- Wages and salaries
- Corporate profits
- Proprietors income (the profits of
partnerships and solely owned businesses,
like a family restaurant)
- Farm income
- Rent
- Interest
- Sales taxes
- Depreciation (the amount of capital that
has worn out during the year)

7.  Find GDP
1st step : find Nominal Income
NI = W + R + i + PR
2nd Step : GDP = NI + Indirect Business Taxes + Depreciation
Your answer : GDP = $602
Did you get this answer?

8. Three formula:
GDP at market price=C+I+G+(X-M)
GDP at factor cost=sum of value added
GDP at factor cost
= wage+rent+interest+gross profits+depreciation
GDP at factor cost + indirect business taxes –
subsidies = GDP at market price

9. GDP vs GNP
 Under what situation when GDP is greater than GNP?
 Income earned by non-residents locally is greater than income earned by residents
abroad
 Net Income from abroad is negative

10. Money and real GDP
 Money (nominal) GDP = GDP measured in the prices operating terms in the year
in which the output is produced.
 GDP at current prices & measure which has not been adjusted for inflation.
 Money GDP may give a misleading impression of how well a country is performing.
 The money GDP value may rise because prices have risen.
 Convert money into real GDP show what happening to output.
 By measuring GDP at constant price, it remove the distorting effect of inflation.
Real GDP = money GDP x
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푝푟푖푐푒 푖푛푑푒푥 푖푛 푐푢푟푟푒푛푡 푦푒푎푟

11. Real GDP
To remove the effects of price change,
We have Real GDP,
= GDP at constant market price
= Price in base year x Output in current year
 GDP deflator = Price index used to convert money into real GDP
Let we try
In 2008 a country’s GDP is $1000 billion. In 2009 nominal GDP rises to $1092 billion
and the price index increases by 4%. Calculate
a.) real GDP
b.) the percentage increase in real GDP.

12. Comparison of economic growth over time
and between countries
 Changes in real GDP- economic growth
 Official real GDP- the true change in output  hidden, informal/ underground
economic activity
 Reasons of people didn’t declare their earned income to the authorities
1.) seeking to evade paying tax
2.) not declaring economic activity is itself illegal (smuggling goods).

13. Effects of the Size of the Hidden Economy
 Measuring gap between GDP as measured by the expenditure and income
methods.
 Make international comparisons of economic growth rates difficult. It’s happen
because of the hidden economy size varies between economies.

14. Factors influence comparing economic
growth
 The nature of economic growth
 Living standard over time
 Living standard between countries
 Money supply
- total amount of money . It consists of currency in circulation plus relevant deposits.
- 2 types of money supply
 Narrow money – medium of exchange and consists of notes and coins in
circulation and notes and coins consists and cash held in banks and balances held
by banks at the central bank.
 Broad money – Consists of the above plus a items range that are commensurate
with money’s function as a value store.

15. The circular flow of income
 Refers to a simple economic model which describes the
reciprocal income circulation between producers and
consumers.
 The interdependent producers and consumer entities are
referred to as “firms” and “households” respectively and
provide each other with factors in order to facilitate
income flow.
 A continuous production flow, income and expenditure
is known as income circular flow. It is circular because it
has neither any beginning nor an end. The income
circular flow involve 2 basic assumptions:
1.) In any exchange process, the seller/ producer receives
the same amount what buyer or consumer spends.
2.) Goods and services flow in one direction.

16. Aggregate Expenditure
 Total amount which will be spent at different levels of income in a given time
period.
 Consumption ( C ), Investment (I), Government Spending (G) and net exports (X-M).
CONSUMPTION (consumer spending)
 It’s spending by households on goods and services to satisfy current wants.
 Main influence- the level of disposable income
 Income Total spending
 Total spending rises with income, the disposable income proportion which is spent
tends to fall.

17.  MPC (Marginal Propensity to Consume)
- The change in consumption that occurs with a change in income.
- The MPC is less than one because individuals consume only a portion of an
increase in income.
MPC = C/YD
 MPS (Marginal Propensity to Save)
- the fraction of a change in disposable income that is saved.
- calculated as the change in saving, S, divided by the change in disposable income,
YD, that brought it about.
- That is:
MPS = S/YD

18. Fixed Prices and Expenditure Plans
 The MPC plus the MPS equals one. This is because the way we define disposable income, the
only things that can be done with it is consume it or save it. So the fraction of a change
consumed plus the fraction saved must equal one – all of it.
 In symbols,
 C + S = YD.
 Divide this equation by YD to obtain,
 C/YD + S/YD = YD/YD,
 or
 MPC + MPS = 1
 Consumption Function
C= a+bY
 Saving Function
S= -a +sY
a = Autonomous consumption / dissaving

19.  Investment
Spending by firms on capital goods such as factories, offices, machinery and delivery
vehicles.
The investment amount undertaken is influenced by changes in consumer demand, interest
rate, technology change, capital cost goods, expectations and government policy.
Ir fall---I rise = investment cost fall & lower interest rate raise consumer demand.
Technology rise
 Government spending
Spending on items such as the teachers wages in state schools, medicine used in state
hospitals and government investment in new roads and new hospitals.
The government spending amount undertaken in any period is influenced by government
policy, tax revenue, demographic changes etc.
 Net export
Influenced by the country’s GDP, other countries GDP, the relative price and quality
competitiveness of the country’s product and it’s exchange rate.
Exchange rate fall- export become cheaper- import become expensive.

20. Income Determination
 The level of income in an economy is determined where aggregate expenditure =
output.
 If aggregate expenditure is below current output, firms will reduce production.
 Output will change until it matches aggregate expenditure.
 Money GDP- horizontal and aggregate expenditure- vertical
 450line shows the points at which aggregate expenditure = national income (GDP).
 Output determined where the C+I+G+(X-M) cuts this 450 line.
AE- PLANNED SPENDING
GDP – ACTUAL SPENDING

21. The Keynesian 450 diagram Y= C+I+G

22. What if AE and Y are not Equal?
 If AE< Y
People want to buy less than what has been produced so firms will accumulate
inventories.
Firms will reduce production.
 If AE > Y
What people want to buy is greater than actual production so inventories will decline
Firms will increase production

23. Impact of rise in aggregate
Expenditure
Withdrawals and injections
 Withdrawal- S, T, M (Leakages)
 Injection - I,G,X (Extra Spending)

24. Inflationary and Deflationary Gaps
 Economy may not achieve full employment in short run and long run.
 Short run - period of time in which the quantity of at least one input is fixed and
the quantities of the other inputs can be varied. Some inputs variable, some fixed.
New firms do not enter the industry, and existing firms do not exit.
 Long run - period of time in which the quantities of all inputs can be varied. All
inputs variable, firms can enter and exit the market place.
 Inflationary gap- AE exceeds the potential output of inflationary. Limited resources
 Deflationary gap – The E level of GDP may below the full employment level.

25. Inflationary and Deflationary Gaps
How to escape from Inflationary and Deflationary gaps?

26. The Multiplier
 Measures the change in E income as a result of a one-peso change in the sum of
the autonomous components of AE.
 훼 =
1
1−푀푃퐶
 The multiplier is used determine the amount by which Y* changes in response to a
change in investment.
 3 Sector =
1
푀푃푆+푀푅푇
MRT - Marginal Rate of Taxation
 4 Sector =
1
푀푃푆+푀푅푇+푀푃푀
MPM- Marginal Propensity to import

27. Lets Try
 In an economy, MPS is 0.4, MRT is 0.2 and MPM is 0.2. GDP is $300 billion. The
government raises its spending by $6 billion in a bid to close gap of $20 billion.
Calculate
a.) The Value of the multiplier for 2 sector, 3 sector and 4 sector
b.) The increase in GDP
C.) Whether the injection of extra government spending is sufficient, too high or too
low to close the deflationary gap.

28.  Autonomous investment- Investment which is undertaken independently of
changes in income
 Induced investment- Contrast to autonomous investment.
 Accelerator – Focus on induced investment and emphasizes the volatility of
investment.
Ex: If GDP is rising but at a constant rate, induced investment will not change. Firms
can continue to buy the same number of machines each year to expand the capacity.

29. Increase in the Money supply and the
creation of credit
 The cause of an increase in aggregate demand is an increase in the money supply.
 The main cause of an increase in the money supply:
1.) An increase in commercial money spending
2.) An Increase in government spending financed by borrowing from the banking
sector.
3.) More money entering than leaving the country.

30. Credit Creation
 Commercial bank make their profits by lending to customers and when they
lend they create money.
 Every loan created as deposit.
 Payments involve a money transfer using entries in the records that banks keep
of their customers’ deposits rather than by paying out cash.
The Credit Multiplier
 used in the analysis of money supply.
 the ratio of additional credit creation (Δ CC) to the total cash reserves (Δ R).
Or
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100
퐿푖푞푢푖푑푖푡푦 푟푎푡푖표

31.  The change in liquid assets is deducted from the change in liabilities. This is
because the change in liabilities will include deposits given to those putting in the
liquid assets.
 In practice, a bank may not lend as much as the credit implies it can. There may be
a lack of households and firms wanting to borrow / a lack of credit-worthy
borrowers.
 A bank may also change its liquidity ratio if people alter the proportion of their
deposits they require as cash, if other banks alter their lending policies / if the
country central bank requires banks to keep a set liquidity ratio.
 A central bank may seek to influence commercial banks ability to lend.

32. Deficit Financing
 Planned expenditure by a government to put more money into the economy than
it takes out by taxation, with the expectation that increased business activity will
bring enough additional revenue to cover the shortfall.
Total Currency Flow
 The TCF of the balance of payments refers to the total outflow / inflow of money
resulting from international transactions as recorded in the current account,
financial account, capital account and balancing item.

33. Relationship between money supply, price
level and output
 Change in money supply will effect on the price level and output in an economy.
 Although the change in the money supply has some relevance, there are other
factors that must be taken into account when explaining a change in the price level.

34. Interest rate determination and the
demand for money
 Monetarist support the loanable
funds theory.
 The DD for loanable funds comes
from firms wanting to invest,
households wanting to buy a car on
credit & from the G seeking to fund a
budget deficit.
 The SS comes from S. A higher ir will
increase the return from savings & so
the supply curve is upward sloping.

35. Keynes
 Liquidity preference- Explain the demand for money.
 There are 3 motives to show why households 7 firms may decide to hold part of
their wealth in a money form
- Transaction motive
The desire to hold money to make everyday purchases & meet everyday payments.
The more income received & the more infrequently the payments are received, the
higher the amount which will be held
- Precautionary motive
Firms & households hold money rather more of their wealth than they anticipate they
will spend. They can meet unexpected expenses, take advantage of unforeseen
bargains.
- Speculative motive
Holding money balances is interest elastic. Households & firms will hold what are
sometimes called idle balances when they believe tht the returns from holding
financial asset which firms & households may decide to hold is government bonds.

36.  Figure shows the combined transactions,
precautionary & speculative motives for
holding money in the form of liquidity
preference/ DD for money.
 An Increase in Money supply- ir fall some
households & firms having higher money
balances than they want to hold.

37. Liquidity Trap
 Speculators would expect the price of
bonds to fall in the future, so if the
money supply was to be increased
they would hold all the extra money;
they would not buy bonds for fear of
making a capital loss & the return
from holding such securities would
be low.
 The interest rate , the DD for money
become perfectly elastic & rise in
money supply has no effect on the
interest rate.