Review Guide: ECONTWO

Macroeconomics- focuses on an aggregate scale, studies the whole economy/ other economies/
governments
3 Goals of Macroeconomic Policy
Sustainable Economic Growth - increasing Gross Domestic Product / increasing Gross National Product
Full Employment- measured from the employment rate does not necessarily mean that everyone is
employed but at least 95% of the countrys population must have a job.
Underemployment - can be defined as having training or skills which do not fit the current job being
undertaken. Alternatively, it can also refer to individuals working less than 8
hours a day.
Causes of Unemployment:
1. Demand Side- lack of aggregate demand/ low demand for workers
2. Supply Side- results from imperfections in the labor market (e.g. minimum wage)
3. Price Stability prices are considered stable when there is single digit inflation
APPROACHES TO MEASURING NATIONAL INCOME:
Gross Domestic Product (GDP) = value of all goods and services in the country
Net Factor Income Abroad (NFIA) = earnings of OFWs - earnings of expats in RP
Gross National Product (GNP) = value of goods produced in foreign countries plus foreign
investments.
So

GDP + NFIA = (GNP)

Net domestic Product = GDP - depreciation (or capital consumption allowance [CCA])
Net National Product = GNP - depreciation [CCA]
3 ways to get GDP:
Expenditure Approach =
GDP = C +I+G+NX
C = personal Consumption or spending of the household sector
I = spending of business sectors (Investment)
G = Government spending
NX = (X-M) = Net Export = Balance of Trade
X = Export ; M = Import if [X>M] - Balance of trade SURPLUS
If [X<M] - Balance of trade DEFICIT
**To get Investment
I = construction + durable capital equipment + change in inventory
Net Investment (In) = I - CCA

EconOrg Review Guide: ECONTWO

Page 1

Factor Income Approach = GDP = NY + CCA + IBTn

NY = National Income
IBTn = indirect business taxes net of subsidies
To get NY = wages (w) + interest income (i) + rental income (r) + corporate income (CY) +
unincorporated income (UCY)
To get CY = Dividends + Retained Earnings + Corporate Income Tax
Industrial Origin Approach = GDP = Agricultural sector + Industry sector + Service sector
Agricultural Sector
Farming
Fishing
Forestry
Animal husbandry

Industrial Sector
Mining
Utilities
Manufacturing
Construction

Service Sector
Transportation
Banking
Commerce
Communication

To compute for NOMINAL GNP

** use current prices
NGNP = GNP(year2) - GNP(year1) x 100
GNP(year1)
To compute for REAL GNP Growth Rate
** use constant prices and same base year
RGNPGR = RGNPGR(year3) - RGNPGR(year2)
RGNPGR(year2)

x 100

CIRCULAR FLOW MODEL

Image taken from: http://www.harpercollege.edu/mhealy/ecogif/ppc/cirflowppt.gif

EconOrg Review Guide: ECONTWO

Page 2

Goods Market - business

Money market - banks
Labor market - household

2 SECTOR ECONOMY
** for a 2 sector economy (2 sector - no Government expenditures and no imports and exports)
Yd = C+I
Consumption and Savings function
C = C0 + C1Yd
and
S= (-C0) + (1-C1)Yd
C0 = autonomous consumption
C1Yd= induced consumption
C1 =C = marginal propensity to consume (mpc)
Yd
(-C0) = autonomous saving
(1-C1) = induced saving
I = I0 = autonomous investment
NOTE: S=I only happens in a 2 sector economy
Multiplier Effect for a 2 sector economy: Ye = C0+I0
1-C1
3 SECTOR ECONOMY
**with autonomous tax only
T = T0
Then: Ye = C0+I0+G0-C1T0
1-C1
**with T0 +t1Y
Ye = C0+I0+G0-C1T0
(1-C1) (1-t1)
IS-LM INTERACTION AND THE ROLE OF FISCAL AND MONETARY POLICIES

EconOrg Review Guide: ECONTWO

Page 3

GOODS MARKET AND THE IS CURVE

Income is affected by the goods and assets market
Goods market is represented by aggregate demand for goods and services and it is directly impacted
by Fiscal policy.
Interest rates affect the investment function, hence b2i in the investment function.
There is a negative relationship between interest rate (i) and the level of total investment.
**INVESTMENT FUNCTION
I= I0 +b2i
**for a 2 sector economy:

i= (C0 +I0) - (1-C1)Y

b2
b2

Goods Market Equilibrium

Aggregate Supply= Aggregate Demand
AS=AD
THE MONEY MARKET AND THE LM CURVE
- A graphical description of equilibrium in the money market
4 Major Problems of Barter
No standard value of goods
Double-coincidence of wants
Storing value/wealth is a problem
No standard means of settling debts

Money
Unit of account
Medium of exchange
Can be stored/ has a corresponding store value
Standard deferred payment

MONEY - is a medium of exchange and a standard of value for purchasing goods and services and settling
debts.
M1 - [narrow money]
- currency in circulation (cc) = cash - most liquid type of money
- demand deposits (dd) - can be converted to cash when demanded
- transfer checks
M2 - [broad money]
- M1 + savings deposits (less liquid than cash) + time deposit (type of savings investment)
M3 - [near money]
- M2 + deposit substitutes (treasury bills, bonds)
_____________________________________________________________________________________
L=M
L=represents total money demanded
M= represents total money supply
Motives why people hold onto money:
transactions motive- medium of exchange for goods and services
*if you are a high income person, you will engage in more transactions
precautionary motive- for unforeseen emergencies/expenditures
speculative motive- hold onto money due to speculation
iREAL =iNOMINAL RATE - iINFLATION RATE
**if there is high interest = then low LS ; if there is low interest = then high LS

EconOrg Review Guide: ECONTWO

LT = f(Y)

LS =f(i)

Page 4

Total demand for money = L=LT + LS

LT = m1Y ; LS = L0 - m2i
so L= m1Y + L0 - m2i
Where: m1 = LT/Y
L0 = autonomous demand for money
m2= slope for speculative demand for money transaction

LS
i

Total money supply = M=M0 --autonomous money supply

Money Market Equilibrium
Money Supply= Money Demand
MS=MD
Tools of Monetary policy
Reserve Requirements (RR) amount required from banks that is kept in BSP vaults
Monetary expansion - lower RR- increase money supply
Monetary contraction increase RR- decrease MS
Rediscount Rate bankers bank
Rates at which banks can borrow from the central bank
Monetary expansion lower rediscount rates- increase MS
Monetary contraction increase rediscount rate decreases MS
Open Market Operations (OMO) buying and selling of government securities
EXPANSIONARY MONETARY POLICY TOOLS
Lower reserve requirement ratio
Lower rediscount rate
Buy government securities
CONTRACTIONARY MONETARY POLICY
Higher reserve requirement ratio
Higher rediscount rate
Selling government securities

MS

- i - LS

- LT

- Y

MS - i - LS - LT - Y

Inflation - the increase in price levels of goods and commodities.

2 sources of inflation:
demand pull inflation occurs when there is an increase in aggregate demand outrunning aggregate
supply
AD > AS
cost push inflation - occurs when there is a decrease in the aggregate supply of goods and services
emanating from an increase in the cost of production
Objective of BSP: Price stability
inflation targeting- used to achieve price stability (predict inflation for future periods and then use
different policies to not go over the inflation target)

EconOrg Review Guide: ECONTWO

Page 5

Prepared By:
Academics Committee
Economics Organization

EconOrg Review Guide: ECONTWO

Page 6