Econotes 7 – Aggregate Supply and Aggregate Demand

For TE2, TI3, and TJ3

National Body of statistics which helps policy makers to determine whether the economy
income and is contracting or expanding and whether severe recession or inflation threatens.
product
accounts OR
national
accounts
GDP is a  Total market value of the final goods and services produced within a nation
measure of the during a given year.
overall  GDP equals the total production of consumption and investment goods,
performance of government purchases, and net exports to other lands.
an economy  Most comprehensive measure of a nation’s total output of goods and services.

GDP=C+ I +G+( X−M ), notice that

AD=C+ I +G+( X−M ), thus
GDP=AD

Measuring the Flow-of-Product Approach

National  Suppose the economy is simplified which means there are no government,
Product foreign trade, and investment. The economy produces only consumption
goods which are purchased by the households to satisfy their wants.
 In this approach, only the final goods—goods ultimately bought and used by
the consumers—are included. Adding all the consumption dollars (peso)
spent on these final goods and you will get the simplified economy’s GDP.
 In a simplified economy, national income or product can be calculated by
getting the sum of the annual flow of final goods and services.
 National accountants use market prices as weights in valuing the different
commodities because the market price reflects the relative economic value of
diverse goods and services i.e., how much the consumers value their last (or
marginal) units of consumption of these goods.

Earnings or Income Approach

 The total earnings that households receive from firms or the total of factor
earnings (wages, interest, rents, and profits) that are the cost of producing
society’s final products.

 GDP obtained from flow-of-product approach and income approach should

be EQUAL.
 The resulting GDPs from two approaches are equal because “profits” in the
income approach is included in the earnings approach.
 Concluding, GDP can be measured by getting the sum of the (1) flow of
spending on final products or (2) total costs or incomes of inputs.
National Account for a firm is a numerical record of all flows (outputs, costs, etc.) during a
accounts given period.
derived from The national accounts is simply the aggregate the outputs and costs of all the
business businesses in the society.
The Econotes are heavily drawn from Economics (19 th Ed.) by Paul Samuelson and William Nordhaus. This serves only as
a supplementary reviewer for the Economics 11 students under TE2, TI3, TJ3 (1 st Sem AY 2014-2015) and must not be
considered as a complete alternate to Samuelson’s Book. Note that this document is still a work in progress and may
contain unnoticed errors. Students are expected to exercise due diligence in reviewing the notes and encouraged to do
necessary corrections.
 accounts
The problem of  Final product is one that is produced and sold for consumption or
“double investment.
counting”  GDP excludes intermediate goods—goods that are used to produce other
goods. For example, in making pizza, the value of the pizza is included in the
calculation of GDP but not the flour, tomato sauce, etc.
 This is not a problem for the flow-of-product approach as we can easily
distinguish the intermediate goods from the final goods.
 How do we avoid the problem of double counting in the earnings or income
approach?
 Measuring GDP via earnings or income approach consider ONLY the
firm’s
 VALUE ADDED—the difference between a firm’s sales and its
purchases of materials and services from other firms.
 Value Added=sales receipts−cost of intermediate products
In summary

Product Approach Earnings Approach

Consumption Consumption of labor (wages,
salaries, and supplements)
Gross private domestic Corporate profits
investment
Government purchases Other property income (rent,
interest, proprietor’s income)
Net exports Depreciation
Net production taxes

Components of Consumption
GDP  Personal consumption expenditures. This can be divided into three
categories: (1) durable goods such as automobiles, (2) nondurable goods
such as food, and (3) services such as medical care.
Investment and capital formation
 Investing – devoting part of the output to production of capital—durable
items that increase future production.
 In the accounts, investment consists of the additions to the nation’s capital
stock of buildings, equipment, software, and inventories that represent
additions to the stock of durable capital that increase production
possibilities.
 Investment takes place when durable capital good is produced.
 Net vs Gross Investment
o Gross investment is not adjusted for depreciation
o Net investment = Gross investment – depreciation
o Depreciation is the amount of capital that has been used up in a year.

Government Purchases
 Also known as government consumption expenditures and gross
investments
The Econotes are heavily drawn from Economics (19 th Ed.) by Paul Samuelson and William Nordhaus. This serves only as
a supplementary reviewer for the Economics 11 students under TE2, TI3, TJ3 (1 st Sem AY 2014-2015) and must not be
considered as a complete alternate to Samuelson’s Book. Note that this document is still a work in progress and may
contain unnoticed errors. Students are expected to exercise due diligence in reviewing the notes and encouraged to do
necessary corrections.
  National output purchased by the state and local governments. It may be in
the form of consumption type goods (food or military) or investment type
goods (schools or roads). It also includes payroll expenditures on its
employees plus the costs of goods it buys from private industries.
 Transfer payments are payments to individuals that are NOT made in
exchange for goods or services supplied. TP includes social security
insurance, etc.
 Under the income or earnings approach, indirect and direct taxes, being
part of the costs of production, are part of GDP

Net Exports
 Difference between export and import
GDP, NDP, and  NDP = GDP – Depreciation
GNP  GNP = total output produced with labor or capital owned by the citizens (e.g.
PH)
National  Total incomes received by labor, capital, and land (wages, rental income, net
income interest, income of proprietors, and corporate profits)
 GDP – depreciation = national income
 Disposable income = (incomes received + transfer payments) – taxes
 DI – income that goes to the consumers, less taxes, for their disposal
Savings and  Output can be either consumed or invested.
investment  Investment is part of the NATIONAL OUTPUT which is not consumed.
 Savings is part of NATIONAL INCOME which is not consumed
 Mathematically,

I = product approachGDP−consumption
S=earnings approachGDP−consumption

AD=GDP=C + I
Y =C + S
AD=Y ∨GDP=Y ,
C+ I =C+ S, transferring the RHS C to the LHS, then
I =S

Assuming, there is a government

AD=GDP=C + I + G
DI =Y −T =C +S
AD=Y ∨GDP=Y ,
C+ I +G=C+ S+T , transposing C
I =S+T −G ,
where taxes minus government expenditure is equal to government savings,
where national savings is equal to private savings and government savings

Coolio!

National investment = private investment + net exports

National savings = private savings + government savings
Private savings + government savings = private investment + net exports
The Econotes are heavily drawn from Economics (19 th Ed.) by Paul Samuelson and William Nordhaus. This serves only as
a supplementary reviewer for the Economics 11 students under TE2, TI3, TJ3 (1 st Sem AY 2014-2015) and must not be
considered as a complete alternate to Samuelson’s Book. Note that this document is still a work in progress and may
contain unnoticed errors. Students are expected to exercise due diligence in reviewing the notes and encouraged to do
necessary corrections.
Beyond the Omitted nonmarket activities
national  Household activities (e.g., meals, laundering, and child-care services
accounts  Value of leisure time
 Illegal activities (gambling, prostitution, drug dealings)
Omitted environmental damage
 Harmful effects of the economic activity
Augmented national accounts
 Value of R&D
 Human capital investment
 Unpaid production at home
 Value of forests
 Value of leisure time

The Econotes are heavily drawn from Economics (19 th Ed.) by Paul Samuelson and William Nordhaus. This serves only as
a supplementary reviewer for the Economics 11 students under TE2, TI3, TJ3 (1 st Sem AY 2014-2015) and must not be
considered as a complete alternate to Samuelson’s Book. Note that this document is still a work in progress and may
contain unnoticed errors. Students are expected to exercise due diligence in reviewing the notes and encouraged to do
necessary corrections.