Introduction to Macroeconomics and National Income Accounting

Macroeconomics

• the study of the economy as a whole

• it deals with broad aggregates
• but uses the same style of thinking about economic issues as in
microeconomics.

Some key issues in Macroeconomics

• Inflation
o the rate of change of the general price level
• Unemployment
o a measure of the number of people looking for work, but who are
without jobs
• Output
o real gross national product (GNP) measures total income of an
economy
ƒ it is closely related to the economy's total output
• Economic growth
o increases in real GNP, an indication of the expansion of the
economy’s total output
• Macroeconomic policy
o a variety of policy measures used by the government to affect the
overall performance of the economy
ƒ taxes
ƒ government spending
ƒ money supply
ƒ interest rates
ƒ exchange rates
The Circular flow Model

Assumptions

• Factor income = household spending

o all income is spent
• The value of output = spending
o all goods are sold
• value of output = households income
o profits, wage or rent to households
o

Spendings on
Goods & services

Goods & Services

Households Firms

Services of
productive factors
Factor Incomes
Investment and Saving

• Investment
o is the purchase of new capital goods by firms
• Saving
o is that part of income which is not spent buying goods and
services
Investment
Saving Spendings on spending
Goods & services

Goods & Services

Households Firms

Services of
productive factors

Factor Incomes

National Income Accounting

National Income Accounting is a branch of macroeconomics that captures the

total flows of income as well as of goods and services within a certain period.

GDP and GNP

• Gross domestic product (GDP)

ƒ Gross Domestic Product is the market
ƒ value of all final goods and services
ƒ produced within a country within a
ƒ year.

• Gross national product (GNP)

o measures the total income earned by domestic citizens
• GNP = GDP + net income from abroad
• Y : GDP
• C: households spending on consumption
• S: saving
• S ≡ Y - C or Y ≡ C + S
• Y or GDP by expenditure
 • Y ≡ C +I or
• Y≡C+I=C+S
• thus S ≡ I

Over any given period of time, the National Income Accounting Definitions are
such that the amount of Investment Spending must be exactly equal to the
amount of Household Saving (in the simple economy so far considered).

The circular flow of income, expenditure and output

C C+I
S

Households Firms

Government in the circular flow

• Government
o collects direct taxes on factor income
ƒ wages, profit, rent Td
o collects indirect taxes (sales taxes) on sales Te
ƒ in Turkey KDV (katma deger vergisi)
o Spends on goods and services G
ƒ wages of civil servants, military expenses, health,
education, all equipment
 I
C+I+G C+I+G
C - Te
S G
T
Households Government Firms

B - Td
Y+B Y
T

Three Measures of National Output

A. Expenditure Approach
– the sum of expenditures in the economy
– Y=C+I+G+X–Z

Components of GDP

• Consumption expenditures are for

– Durable goods, products that last more than one year (cars,
appliances)
– Nondurable goods, products that last less than one year (food,
clothing)
– Services (medical care, insurance)

• Investment includes:
– Business Fixed Investment
• Nonresidential - business purchases of plant and
equipment
• Residential - construction of new houses
– Change in Business Inventories
• The difference between what a firm produces and what it
sells within the year
– Economic investment does not include purchases of stocks,
bonds, and other financial assets

• Government Spending
 – Government expenditures may also be classified as consumption
and investment spending.
– Government transfer payments are not included in GDP.

• Net Exports
– + Spending by foreigners on local production
– - Spending by local consumers, businesses, government on foreign
production.

B. Income Approach
– the sum of incomes paid for factor services

Components of National Income

• Compensation of Employees
– Wages and salaries paid to individuals and employer contributions
for social security and other pension and health funds
• Proprietors’ Income
– Earnings of sole proprietorships and partnerships
• Rental Income
– Income from property, received by households
• Net Interest
– Income private businesses pay to households that have lent them
money
• Corporate Profits
– Revenue left after compensation to employees, rents, and interest
have been paid

C. Output Approach
– the sum of output (value added) produced in the economy
– Measures economic activity from the product side. It focuses on
the value added within a country. Gross value added is the sum of
all output values corrected for intermediate inputs

D. Personal Disposable Income

– Personal Disposable Income (PDI) is the amount of income
individuals have left after paying all personal taxes.
– PDI is the amount of income individuals have to spend on goods
and services.

E. Welfare Considerations
– Legal nonmarket activities are excluded from GDP.
– Illegal nonmarket activities are excluded from GDP.
– Resource depleting activities are included in GDP.
In terms of formulae

We know from the expenditure approach that everything produced in a country

in a period is „consumed“, in the wider sense, as private consumption,
government consumption, investment, and net exports. This can be expressed
in a basic formula:

GDP= Y= C+ I+ G + (X-M)

Approaching from the income side, we see that all income is spent on
consumption, savings, or taxes. Accordingly, we receive:

GDP= Y= C + S + T

Both are identities that have to hold all the time. We can therefore always
combine them to get

C + S + T= C+ I+ G + (X-M)

which can obviously be rewritten as

(S-I)+ (T-G)= (X-M)

NOTE:
• In a closed economy: X-M=0 →Private savings are invested or pay a
government budget deficit

• Without a government: T-G=0 →Private savings are invested at home or

abroad

• Closed economy without government: S=I!

References

Dornbusch, R., Fischer, S. and Startz, R., Macroeconomics, 7th edition,

1998.

Colander, David C. Macroeconomics, 6th edition, Wall Street Journal

Edition, Irwin/McGraw Hill.