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Macro Economics

Macro Economics

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National Income Accounting A variety of measures of national income and output are used in economics to estimate total economic

activity in a country or region, including gross domestic product (GDP), gross national product (GNP), and net national income (NNI). All are concerned with counting the total amount of goods and services produced within some "boundary". The boundary may be defined geographically, or by citizenship; and limits on the type of activity also form part of the conceptual boundary; for instance, these measures are for the most part limited to counting goods and services that are exchanged for money: production not for sale but for barter, for one's own personal use, or for one's family, is largely left out of these measures, although some attempts are made to include some of those kinds of production by imputing monetary values to them. As can be imagined, arriving at a figure for the total production of goods and services in a large region like a country entails an enormous amount of data-collection and calculation. Although some attempts were made to estimate national incomes as long ago as the 17th century, the systemmatic keeping of national accounts, of which these figures are a part, only began in the 1930s, in the United States and some European countries. The impetus for that major statistical effort was the Great Depression and the rise of Keynsian economics, which prescribed a greater role for the government in managing an economy, and made it necessary for governments to obtain accurate information so that their interventions into the economy could proceed as much as possible from a basis of fact. In order to count a good or service it is necessary to assign some value to it. The value that all of the measures discussed here assign to a good or service is its market value – the price it fetches when bought or sold. No attempt is made to estimate the actual usefulness of a product – its use-value – assuming that to be any different from its market value. Three strategies have been used to obtain the market values of all the goods and services produced: the product (or output) method, the expenditure method, and the income method. The product method looks at the economy on an industry-by-industry basis. The total output of the economy is the sum of the outputs of every industry. However, since an output of one industry may be used by another industry and become part of the output

Therefore we sum up the total amount of money people and organisations spend in buying things. wear-and-tear or obsolescence of the nation's fixed capital assets. regardless of the use to which it is subsequently put. Wages. regardless of by whom.. their total income must be the total value of the product. or "Expenditure". the difference between the value of what it puts out and what it takes in. proprieter's incomes. This amount must equal the value of everything produced. "Net" gives an indication of how much product is actually available for consumption or new investment. Since what they are paid is just the market value of their product. to avoid counting the item twice we use. Usually expenditures by private individuals. "Gross" means total product. . followed by one of the words "National" or "Domestic". "Domestic" means the boundary is geographical: we are counting all goods and services produced within the country's borders. "Income". The names of all of the measures discussed here consist of one of the words "Gross" or "Net". and corporate profits are the major subdivisions of income. and expenditures by government are calculated separately and then summed to give the total expenditure. followed by one of the words "Product". The income method works by summing the incomes of all producers within the boundary. that is. All of these terms can be explained separately. expenditures by businesses. The expenditure method is based on the idea that all products are bought by somebody or some organisation.of that second industry. but the value-added. Also. not the value output by each industry. a correction term must be introduced to account for imports and exports outside the boundary. "Net" means "Gross" minus the amont that must be used to offset depreciation – ie. The total value produced by the economy is the sum of the values-added by every industry.

We count all goods and services produced by the nationals of the country (or businsses owned by them) regardless of where that production physically takes place. However. and also because wages are collected often after a period of production. One problem for instance is that goods in inventory have been produced (therefore included in Product). "Income"."National" means the boundary is defined by citizenship (nationality). for instance. Countries with higher GDP may be more likely to also score highly on other measures of welfare. particularly if inputs are purchased on credit. "Expenditure" specifically means that the expenditure approach was used. Sometimes the word "Product" is used and then some additional symbol or phrase to indicate the methodology. so. including changes in inventory levels and errors in the statistics. often used when any of the three appraoches was actually used. "GDP(I)". but not yet sold (therefore not yet included in Expenditure). such as life expectancy. "Product" is the general term. there are serious limitations to the usefulness of GDP as a measure of welfare: . Note that all three counting methods should in theory give the same final figure. income. National income and welfare GDP per capita (per person) is often used as a measure of a person's welfare. The output of a French-owned cotton factory in Senegal counts as part of the Domestic figures for Senegal. "Income" specifically means that the income approach was used. in practice minor differences are obtained from the three methods for several reasons. we get "Gross Domestic Product by income". but the National figures of France. However the terms are used loosely. "GDP (income)". However. "Product". and "Expenditure" refer to the three counting methodologies explained earlier: the product. and similar constructions. Similar timing issues can also cause a slight discrepancy between the value of goods produced (Product) and the payments to the factors that produced the goods (Income). and expenditure approaches.

This leads to distortions. if everyone worked for twice the number of hours. • Comparison of GDP from one country to another may be distorted by movements in exchange rates. other measures of welfare such as the Human Development Index (HDI). Similarly. Genuine Progress Indicator (GPI). For example. but the negative impact of the spill on well-being (e. for example.g. due to concentration of wealth in the hands of a small fraction of the population. and sustainable national income (SNI) are used. the impact of economic activity on the environment is not measured in calculating GDP. such as the quality of the environment (as distinct from the input value) and security from crime. then GDP might roughly double. . This leads to distortions . even though they are both carrying out the same economic activity. but this does not necessarily mean that workers are better off as they would have less leisure time. loss of clean beaches) is not measured. a paid nanny's income contributes to GDP. gross national happiness (GNH). • GDP takes no account of the inputs used to produce the output. Because of this. Countries with a skewed income distribution may have a relatively high percapita GDP while the majority of its citizens have a relatively low level of income. spending on cleaning up an oil spill is included in GDP. • GDP is the mean (average) wealth rather than median (middle-point) wealth. Measuring national income at purchasing power parity may overcome this problem at the risk of overvaluing basic goods and services.• Measures of GDP typically exclude unpaid economic activity. • GDP does not measure factors that affect quality of life. for example subsistence farming. but an unpaid parent's time spent caring for children will not. most importantly domestic work such as childcare.for example. Index of Sustainable Economic Welfare (ISEW).

and then $60 from the supermarket.Gross National Product (GNP) is defined as the market value of all goods and services produced in one year by labour and property supplied by the residents of a country. This avoids an issue often called 'double counting'. by counting it repeatedly in several stages of production. As an example.depreciation + NFIA (net factor income from abroad) . Because of the complication of the multiple stages in the production of a good or service. only the final value of a good or service is included in total output. The value that should be included in final national output should be $60. and $30. The values added at each stage of production over the previous stage are respectively $10. In the example of meat production. the table below shows some GDP and GNP.net indirect taxes . Formulae: GDP(gross domestic product) at market price = value of output in an economy in a particular year . and NNI data for the United States: The output approach The output approach focuses on finding the total output of a nation by directly finding the total value of all goods and services a nation produces. the value of the good from the farm may be $10.Gross Domestic Product Gross domestic product (GDP) is defined as the "value of all final goods and services produced in a country in 1 year". $100.intermediate consumption NNP at factor cost = GDP at market price . then $30 from the butchers. $20. not the sum of all those numbers. wherein the total value of a good is included several times in national output. Their sum gives an alternative way of calculating the value of final output.

which stands for "net exports" .M) Where: C = household consumption expenditures / personal consumption expenditures I = gross private domestic investment G = government consumption and gross investment expenditures X = gross exports of goods and services M = gross imports of goods and services Note: (X .the businessman who combines these resources to produce a good or service).M) is often written as XN. and then combining them to find the total output. The main types of income that are included in this approach are rent (the money paid to owners of land). It focuses on finding the total output of a nation by finding the total amount of money spent.The income approach The income approach focuses on finding the total output of a nation by finding the total income received by the factors of production. such as machines used in production). salaries and wages (the money paid to workers who are involved in the production process. and those who provide the natural resources). Formulae:NDP at factor cost = compensation of employee + operating surplus + mixed income of self employee National income = NDP at factor cost + NFIA (net factor income from abroad) The expenditure approach The expenditure approach is basically a socialist output accounting method. GDP = C + I + G + (X . the total value of all goods is equal to the total amount of money spent on goods. This is acceptable. The basic formula for domestic output combines all the different areas in which money is spent within the region. because like income. and profit (the money gained by the entrepreneur . interest (the money paid for the use of man-made resources.

Business Cycles Fluctuations in economic activity are a feature of every economy and pose a persistent problem. will deteriorate into depression. which are reflected in output and employment levels. These short run fluctuations in economic activity. the economy begins to look up with the economic activity gradually peaking. The onset of a business cycle and the phase that it is in at a point in time is charted by looking at the movements in the real GDP growth rates. Business cycles typically go through a phase of low levels of economic activity called recession which. what cannot be predicted at all is the period for which each phase would last. Policy makers intervene with a set of policies called stablization polices to reduce the severity of the short run fluctuations in output and employement. While these upturns and downturns exist in every business cycle. spurred by some panic factor. Recessions could las for a few weeks or a few years. especially in the short run. This is followed by a down turn in economic activity. if not remedied. the economy is looking for quicker results. This phase is called boom. These stablisations polices are largely demand management policies in the short run. are called business cycles. . Recession then sets in and the cycle continues. After this phase. because supply management policies take a longer time to work and in the short run.

uncertainty about future inflation may discourage investment and saving. and through the setting of banking reserve requirements. each unit of currency buys fewer goods and services. Generally. Economists generally agree that high rates of inflation and hyperinflation are caused by an excessive growth of the money supply. Inflation can have positive and negative effects on an economy. The task of keeping the rate of inflation low and stable is usually given to monetary authorities. as well as to growth in the money supply. A chief measure of price inflation is the inflation rate. inflation is a rise in the general level of prices of goods and services in an economy over a period of time. and debt relief by reducing the real level of debt. most mainstream economists favor a low steady rate of inflation. consequently. Low (as opposed to zero or negative) inflation may reduce the severity of economic recessions by enabling the labor market to adjust more quickly in a downturn. Negative effects of inflation include loss in stability in the real value of money and other monetary items over time. inflation is also an erosion in the purchasing power of money – a loss of real value in the internal medium of exchange and unit of account in the economy. Views on which factors determine low to moderate rates of inflation are more varied. Positive effects include a mitigation of economic recessions.Inflation In economics. However. Today. the consensus view is that a long sustained period of inflation is caused by money supply growing faster than the rate of economic growth. or changes in available supplies such as during scarcities. and reduce the risk that a liquidity trap prevents monetary policy from stabilizing the economy. through open market operations. Low or moderate inflation may be attributed to fluctuations in real demand for goods and services. these monetary authorities are the central banks that control the size of the money supply through the setting of interest rates. the annualized percentage change in a general price index (normally the Consumer Price Index) over time. and high inflation may lead to shortages of goods if consumers begin hoarding out of concern that prices will increase in the future. When the price level rises. .

the sampling variance is normally ignored. along with the population census and the National Income and Product Accounts. salaries. since a single estimate is required in most of the purposes for which the index is used. region.. The CPI can be used to index (i. . or nation). housing. and RPIX. Although some of the sampling is done using a sampling frame and probabilistic sampling methods. A consumer price index measures a price change for a constant market basket of goods and services from one period to the next within the same area (city. clothing. Therefore. These weights are usually based upon expenditure data obtained for sampled decades from a sample of households. but different. or quarterly in some countries. and regulated or contracted prices. Related. much is done in a commonsense way (purposive sampling) that does not permit estimation of confidence intervals. Two basic types of data are needed to construct the CPI: price data and weighting data. It is a price index determined by measuring the price of a standard group of goods meant to represent the typical market basket of a typical urban consumer. The price data are collected for a sample of goods and services from a sample of sales outlets in a sample of locations for a sample of times. Stocks greatly affect this cause. each of which is in turn a weighted average of sub-sub-indices. as a weighted average of sub-indices for different components of consumer expenditure. such as food. The index is usually computed yearly. one of the most closely watched national economic statistics. adjust for the effect of inflation on the real value of money: the medium of exchange) wages. RPI.e. The weighting data are estimates of the shares of the different types of expenditure as fractions of the total expenditure covered by the index. It is one of several price indices calculated by most national statistical agencies. pensions. The CPI is.Consumer Price Index A consumer price index (CPI) is a measure estimating the average price of consumer goods and services purchased by households. The percent change in the CPI is a measure estimating inflation. terms are the United Kingdom's CPI.

However. manufacturing and construction. Some countries (like India and The Philippines) use WPI changes as a central measure of inflation. rather than goods bought by consumers. Utilizing the data retrieved by this procedure and with the assumption that other non-surveyed "sample prices" remain unchanged. in particular India – The Indian WPI figure is released weekly on every thursday and influences stock and fixed price markets. The Wholesale Price Index or WPI is the price of a representative basket of wholesale goods. Calculation of Wholesale Price Index The wholesale price index consists of over 2.Wholesale Price Index (WPI) Wholesale Price Index (WPI) is the price of a representative basket of wholesale goods. The following methods are used to compute the WPI: Laspeyres Formula (relative method):It is the weighted arithmetic mean based on the fixed value-based weights for the base period. the WPI is determined through the averaging principle. The indicator tracks the price movement of each commodity individually. Ten-Day Price Index: Under this method. This helps in analyzing both macroeconomic and microeconomic conditions. which is measured by the Consumer Price Index. Some countries use the changes in this index to measure inflation in their economies. . Based on this individual movement. The Wholesale Price Index focuses on the price of goods traded between corporations. “sample prices” with high intra-month fluctuations are selected and surveyed every ten days through phone.400 commodities. India and the United States now report a producer price index instead. a "ten-day price index" is compiled and released. The purpose of the WPI is to monitor price movements that reflect supply and demand in industry. Calculation Method: Monthly price indexes are compiled by calculating the simple arithmetic mean of three ten-day “sample prices” in the month.

Fiscal policy can be contrasted with the other main type of economic policy. • An expansionary stance of fiscal policy involves a net increase in government spending (G > T) through rises in government spending. The distribution of income. . The three possible stances of fiscal policy are neutral. monetary policy. or a surplus if the government previously had a balanced budget. Contractionary fiscal policy is usually associated with a surplus. • A contractionary fiscal policy (G < T) occurs when net government spending is reduced either through higher taxation revenue. The pattern of resource allocation. or a combination of the two. which attempts to stabilize the economy by controlling interest rates and the supply of money. This would lead to a lower budget deficit or a larger surplus than the government previously had. or a combination of the two. Expansionary fiscal policy is usually associated with a budget deficit. Government spending is fully funded by tax revenue and overall the budget outcome has a neutral effect on the level of economic activity. The two main instruments of fiscal policy are government spending and taxation. fiscal policy is the use of government spending and revenue collection to influence the economy. and contractionary: • A neutral stance of fiscal policy implies a balanced budget where G = T (Government spending = Tax revenue). Fiscal policy refers to the overall effect of the budget outcome on economic activity. expansionary.Fiscal Policy In economics. Changes in the level and composition of taxation and government spending can impact on the following variables in the economy: • • • Aggregate demand and the level of economic activity. or a deficit if the government previously had a balanced budget. a fall in taxation revenue. reduced government spending. This will lead to a larger budget deficit or a smaller budget surplus than the government previously had.

If the interest and capital repayments are too large. and may be invested in local (same currency) financial instruments. When income from taxation or other sources falls.Methods of funding Governments spend money on a wide variety of things. a nation may default on its debts.. This can be used in times of recession or low economic activity as an essential tool for building the framework for strong economic growth and working toward full employment. the benefit from printing money Borrowing money from the population. without incurring additional debt. resulting in a fiscal deficit Consumption of fiscal reserves.g. in an effort to achieve economic objectives of price stability. from the military and police to services like education and healthcare. reserves allow spending to continue at the same rate. Funding the deficit . as during an economic slump. Consuming the surplus -A fiscal surplus is often saved for future use. either for a fixed period or indefinitely. usually to foreign creditors. until needed. Sale of assets (e. The government can implement these deficit-spending policies to stimulate trade due to its size and prestige. these deficits would be paid for by an expanded economy . land). like treasury bills or consols. Economic effects of fiscal policy Governments use fiscal policy to influence the level of aggregate demand in the economy. full employment. as well as transfer payments such as welfare benefits. In theory.A fiscal deficit is often funded by issuing bonds. These pay interest. and economic growth. Keynesian economics suggests that adjusting government spending and tax rates are the best ways to stimulate aggregate demand. This expenditure can be funded in a number of different ways: • • • • • Taxation Seignorage.

funds will need to come from public borrowing (the issue of government bonds). Keynesian theory posits that removing funds from the economy will reduce levels of aggregate demand and contract the economy.during the boom that would follow. when government runs a budget deficit. this is known as the Treasury View[citation needed]. thus stabilizing prices. This is because government borrowing creates higher demand for credit in the financial markets. interest rates can increase across the market. the stimulus is increasing demand while labor supply remains fixed. it is a "sister" of monetary policy. Governments can use budget surplus to do two things: to slow the pace of strong economic growth. there is no inflationary effect. The same general argument has been repeated by neoclassical economists up to the present. and inflationary effects driven by increased demand. Monetary Policy Monetary policy is the process by which the government. which Keynesian economics rejects. and to stabilize prices when inflation is too high. This concept is called crowding out. however. this was the reasoning behind the New Deal. contrary to the objective of a budget deficit. or the printing of new money. fiscal stimulus does not cause inflation when it uses resources that would have otherwise been idle. if a fiscal stimulus employs a worker who otherwise would have been unemployed. overseas borrowing. who opposed Keynes' call in the 1930s for fiscal stimulus. in order to attain a set of objectives oriented . From their point of view. causing a lower aggregate demand (AD). if the stimulus employs a worker who otherwise would have had a job. or monetary authority of a country controls (i) the supply of money. (ii) availability of money. For instance. In theory. When governments fund a deficit with the release of government bonds. Other possible problems with fiscal stimulus include the time lag between the implementation of the policy and detectable effects in the economy. leading to inflation. The Treasury View refers to the theoretical positions of classical economists in the British Treasury. and (iii) cost of money or rate of interest. central bank. Some classical and neoclassical economists argue that fiscal policy can have no stimulus effect.

which refers to government borrowing. in order to attain a set of objectives oriented towards the growth and stability of the economy. or monetary authority of a country controls (i) the supply of money. or decreases the interest rate. Monetary policy is contrasted with fiscal policy. Monetary policy is the process by which the government. and (iii) cost of money or rate of interest. Monetary theory provides insight into how to craft optimal monetary policy. or where there is a regulated system of issuing currency through banks which are tied to a central bank. A policy is referred to as contractionary if it reduces the size of the money supply or raises the interest rate.Monetary policy is referred to as either being an expansionary policy. (ii) availability of money. while contractionary policy involves raising interest rates in order to combat inflation. neutral. An expansionary policy increases the size of the money supply. if it is intended neither to create growth nor combat inflation. central bank. Expansionary policy is traditionally used to combat unemployment in a recession by lowering interest rates. . Monetary theory provides insight into how to craft optimal monetary policy. Monetary policy rests on the relationship between the rates of interest in an economy. or a contractionary policy. and the total supply of money. inflation. to influence outcomes like economic growth. if the interest rate set by the central monetary authority is intended to create economic growth. where it was used to maintain the gold standard. The beginning of monetary policy as such comes from the late 19th century. spending and taxation. or tight if intended to reduce inflation. that is the price at which money can be borrowed. and a contractionary policy decreases the total money supply. exchange rates with other currencies and unemployment. the monetary authority has the ability to alter the money supply and thus influence the interest rate (in order to achieve policy goals). Furthermore. Monetary policy uses a variety of tools to control one or both of these. monetary policies are described as follows: accommodative. Where currency is under a monopoly of issuance. where an expansionary policy increases the total supply of money in the economy.towards the growth and stability of the economy.

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