2. What is macroeconomics
• Macroeconomics is concerned with
– The behaviour of economic aggregates
• Total national product, total investment, exports for
the entire economy
– The average price of all goods and services
• In macroeconomics, we study
– The aggregate national product – value of all
goods and services
– The general (average) price level (CPI)
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4. • The macroeconomic policy problem is to choose appropriate
values of the policy instruments in order to achieve the best
possible combination of the outcomes of the targets.
• This is a continually hanging problem, because the targets are
perpetually being affected by shocks from various parts of
the economy (world economy included)
Targets Instruments
Growing living standards, high
employment, low
unemployment, avoiding
inflation and recession
Taxes, government spending,
interest rates and money supply
(fiscal and monetary policy)
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5. The GDP Gap
• Potential gross domestic product (GDP) and the GDP
gap
– Actual GDP – what the economy actually produces
– Potential GDP – measures what the economy would
produce if all resources were fully employed at their
normal levels of utilization
• GDP (output) gap
• Measures the difference between what would have
been produced if potential or full employment GDP
had been produced and what is actually produced, as
measured by the current GDP
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6. Measurement of National Output
• Summing up all the value added for each
industry or sector gives us a standard measure of
national product
• We can arrive at the same measure of national
product from the spending side of the economy
and from adding up factor incomes
• The national output of the national product is
related to the sum of all the outputs produced in
the economy by individuals, firms, and
governmental organizations
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7. Measurement of National Output
Value added as output
• One firm’s output is another firm’s input
• Value added measures each firm’s own
contribution to total output, the amount of
market value that is produced by that firm minus
the cost of inputs purchased from other firms. Its
use avoids the statistical problem of double
counting
– Intermediate goods and services – outputs of some
firms that are in turn used as inputs for other firms
– Final goods and services – goods that are not used as
inputs by other firms
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8. The circular flow of income,
output, and spending
• The circular flow diagram shows how incomes
give rise to spending which gives rise to output
which gives rise to income
• Withdrawals, or leakages, arise from income
that is not passed on in the circular flow through
spending
– Taxes, saving, and imports
• Injections are spending that does not arise out of
incomes but is exogeneous
– Investments, government consumption, and exports
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9. GDP Calculations
• There are two ways of measuring national
income
– By determining the value of what is produced and
– The value of the income claims generated by
production
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10. GDP Calculations
• By adding up the total spending for each of
the main components of final output we get
GDP spending-based
• By adding up all the incomes generated by the
act of production, we get GDP income-based
Lecture 1, 2013-11-22 10
11. GDP Calculations
GDP spending-based
• For a given year, it is calculated by adding up the
spending (consumption, investment, and net exports)
going to purchase the final output produced in that
year
– The GDP spending-based is the sum of private
consumption, government consumption, investment, and
net export spending on currently produced goods and
services
GDP = C + I + G +(X – IM)
• It is GDP at market prices
– Market prices – prices paid by consumers
– Basic prices – part of prices (sales revenue) received by
producers
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12. Private Consumption Spending (C)
• Spending by individuals on goods and services
produced and sold to their final users during
the year
• Spending by charities (non-profit making
institutions serving households)
• Excludes newly built houses (investment)
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13. Government Consumption Spending (G)
• Goods and services provided by the government
(health care, policing, street lighting, pollution
control, refuse collection, maintaining parks,
services of judges, MPs, etc)
• Include only spending on currently produced
goods and services
• Thus, transfer payments are excluded (e.g.
pensions, unemployment benefits, income
support, student grant, interest on national debt)
• Government output is valued at cost rather than
at the market value
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14. Investment Spending (I)
• Spending on the production of goods not for
present consumption, but rather for future use.
(investment/capital goods)
• Changes in inventory
– firm’s stock held
• Fixed capital formation
– creating capital stock in the form of equipments and
buildings used by firms or government agencies in the
production of goods and services
• Net acquisition of valuables
– Valuables such as jewellery and works of art
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15. Investment Spending (I) contd
• Changes in inventories
– Inventories – stocks of inputs and outputs
– Accumulation of stocks and unfinished goods in
the production process counts as current
investment because it is not used for current
consumption even though produced
– De-stocking is negative investment because it
represents reduction in stocks of finished goods
available for future use
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16. Investment Spending (I) contd
• Fixed capital formation
– Fixed capital formation is the creation of new
capital goods
– Much of the capital stock is in the form of
buildings and equipment used by firms or
government agencies in the production of goods
and services
– Includes – hospitals, schools, and offices, houses
(but transfer of house ownership is not part of
current GDP)
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17. Investment Spending (I) contd
• Gross and Net investment?
– Gross investment (total investment) minus
replacement investment is net investment
– Replacement investment – the amount of
investment that just maintains the level of existing
capital stock. It replaces the bits that have worn
out (classified as depreciation or capital
consumption allowance)
• All gross investment is included in the
calculation of GDP
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18. Net Exports (X-M = NX)
• Total exports of goods and services minus
total imports of goods and services
– Private consumption, government consumption,
and investment all have an import content
– All goods and services that are produced
domestically and sold to foreigners (exports) must
be part of GDP
• When the value of exports exceeds the value
of imports, the net export is positive and vice
versa
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20. GDP Income-based
• Involves adding up the income claims of
owners of resource inputs
• All value must be owned by someone, so the
value of production must equal the value of
income claims generated by that production
• There are three main categories of income
– Operating surplus
– Mixed incomes
– Compensation of employees
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21. Operating Surplus
• Net business incomes after payment has been
made to hired labour and for material inputs
but before direct taxes (corporation tax) have
been paid
• They are profits of firms and also the financial
surplus of organizations other than
companies, such as universities
– Profits are paid out (dividends) or retained
(retained earnings). Both included in the GDP
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22. Mixed Incomes
• Covers people who sell their services but are
not employed by any organization
– Consultants, Short contract workers, self-
employed, some partnerships
• Mixed incomes because not easy to
differentiate between the proportion of their
earnings as salary or profit
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23. Compensation of Employees
• Payment for the services of labour
– Wages and salaries (take-home pay, taxes
withheld, national insurance contributions,
pension fund contributions, and any other fringe
benefits)
• Wages are measured gross
• Wages represent that part of the value of
production that is attributable to hired labour
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24. Lecture 1, 2013-11-22 24
Market
value of
final goods
and
services
Consumption
Investment
Government
Purchases
Net Exports
Operating
Surplus
Mixed Income
Compensation
of Employees
Production Expenditure Income
= =
The Three Faces of GDP
25. GDP, GNI or GNP
• GDP measures the output (income) that is produced in the
country
• GNI measures the income that is received by the country
• To convert GDP to GNI add
– Employees compensation receipts from the rest of the world
minus payments to the rest of the world
– (Minus) net taxes on production paid to the rest of the world plus
subsidies received from the rest of the world
– Property and entrepreneurial income receipts from the rest of the
world minus payment to the rest of the world
• Total output produced in the economy (GDP), differs from
total income received (GNI), because of net income abroad.
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26. Real and Nominal Measures
• When you add up money values of outputs,
spending, or incomes, we end up with what
are called nominal values
• Suppose for a period of 10 years, nominal GDP
rise by 70 percent, this may be due to two
things
– Due to increases in the general price level or
– Due to increases in quantities of goods and
services produced
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27. Real and Nominal Measures
• GDP valued at current prices is a nominal
measure. GDP valued at base-period prices is a
real measure of the volume of national output
and national income
• Any change in nominal GDP reflects the
combined effects of changes in quantities and
changes in prices
• However, when real income is measured over
different periods by using a common set of base-
period prices, changes in real income reflect only
changes in real output
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28. Real and Nominal Measures(Price
Index)
• Comparing what has happened to nominal
and real GDP over the same period implies
the existence of a price index measuring the
change in prices over that period
• This is because an index can be inferred by
comparing these two values
• Such an index is called implicit price index or
implicit deflator (GDP Deflator)
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29. International Comparisons of GDP
• One purpose to which GDP measures are
often put is international comparison of living
standards of real income
• Normally we are interested in how well off the
average individual is in each country
• For this purpose we want to look at GDP per
head or per capita (GDP divided by the total
population of the country)
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30. International Comparisons of GDP
• GDP is measured in local currency so
comparisons can only be made if currencies
are converted using an exchange rate
• To solve the comparison problem using
unreliable exchange rates, we use the
purchasing power parity (PPP) rate (exchange
rate that equates the prices of a
representative bundle of goods in two
countries)
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31. What does GDP not Measure
• Unreported activities
– Underground or black economy
• Non-marketed activities
– Do-it-yourself activities
– Leisure
• Economic bads
– Pollution, congestion, and other disamenities of
modern living
• But do the omissions matter?
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32. Summary
• What is macroeconomics
• Why do we need macroeconomics
– Major macroeconomic issues
• The GDP gap
• Measurement of national output
– Value added as output
• Circular flow of income, out, and spending
• GDP, GNI, GNP
– GDP spending-based, income-based
– Real and nominal GDP
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33. Next time…
• Build a model that explains the causes and
consequences of deviations of GDP from its potential
level (GDP gap)
• We will learn that
– The determination of GDP in the short run depends on the
behaviour of key categories of aggregate spending
– Consumption spending depends on disposable income and
wealth
– Investment spending depends on real interest rates and
business confidence
– A necessary condition for GDP to be in equilibrium is that
desired domestic spending is equal to actual output
Lecture 1, 2013-11-22 33
34. ?• Assignment
– Explain why an economy’s income must equal its
expenditure.
– A farmer sells wheat to a baker for GHC20. The baker
uses the wheat to make bread, which is sold for
GHC30. What is the total contribution of these
transactions to GDP?
– Why do economists use real GDP rather than nominal
GDP to gauge economic well-being?
– Why is it desirable for a country to have a large GDP?
Give an example of something that would raise GDP
and yet be undesirable.
Lecture 1, 2013-11-22 34
