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World Bank Institute

Macro-Economic Concepts and National
Income Identities

World Bank Institute

Prepared by the Poverty and Growth Program
Economic Policy Course for Civil Society
2004

Economics

Definition: Economics is the social science
concerned with the problem of using scarce
resources to attain the maximum
fulfillment of society’s unlimited wants.
Society wants to use limited resources
efficiently to maximize total satisfaction;
In order to do this, society must realize full
production and full employment.

Structure of the Presentation National Income Accounting Identities and Constraints Gross Domestic Product GDP Expenditures GDP Income Nominal vs. Real GDP Consumer Price Index Employment Economic Growth Conclusion .

Income. government services. Expenditure Methods.Macroeconomic Analysis Macroeconomic analysis is organized around 3 accounting concepts – production. income and expenditure (savings) Three methods of calculation Output. individuals. informal sector? Domestic services by household members vs others . Production of goods and services by resident economic agents – corporations.

operating surplus of enterprises. net income of financial institutions. gifts (unrequited transfer) Current: must use data from this accounting period Expenditures – durables.e. investment goods . self employed profits. net transfers from pension funds and social security. imputed value of production by households for own consumption (subsistence). nondurables. royalties & investment income. dividends. land (rent).Income The sum of all factor earnings from production of current goods and services Factor earnings: income from factors of production i. labor (salaries & wages) & capital (interest.

Expenditures Personal Consumption Expenditures (C) Household consumption of: Durable consumer goods (cars. . TVs) Non-durable consumer goods (bread. fridges. vitamins) Consumer expenditures for services (doctors. milk. mechanics) Always designated by the letter “C” in an income identity.

corporations or government or these entities may also receive income from abroad GDP – net factor payments = national income Income + transfers = expenditure + savings Savings + borrowing = physical or financial asset accumulation (not human) . some incomes may be transferred abroad by individuals.3 basic relationships For whole economy: value of domestic production by all agents = value of incomes (GDP) However.

. Avoids multiple counting-excludes value of intermediate goods. Is a monetary measure. Is sensitive to change in average price level. Excludes non-production transactions. Includes capital goods and inventories. Includes goods and services produced by citizen- supplied and foreign-supplied resources within a nation’s geographical boundaries.Gross Domestic Product Definition: The total market value of all final goods and services produced within a country in 1 year.

Multiple counting would exaggerate value of GDP.GDP (cont.) GDP as a Monetary measure: Facilitates comparison of heterogeneous collection of goods & services produced in different years Avoidance of Multiple counting Measuring total output correctly requires counting goods and services in a specific year once. . Therefore value of final goods included in GDP and value of intermediate goods excluded since value of final goods already includes value of intermediate goods.

GDP Expenditure and Income Expenditure or Income or Allocations Output Approach Approach Personal Consumption Wages Expenditures (C) Plus plus Rents Gross Private Domestic Plus Investment (Ig) Interest plus Plus Government purchases (G) Profits plus Plus Net Exports (X) which is Statistical Adjustments exports .imports .

monetary sector and external sector Government: Current + Capital Revenue = current + capital expenditures+ govt savings/deficit Total Revenues – Total Exp = . businesses).(domestic credit to govt + domestic borrowing + foreign borrowing) .Identities or Budget Constraints 4 actors – Government. private sector (individuals.

Private Sector Budget Constraint Wages + profits + net interest + net transfers from abroad = private spending + private savings Private income = private expenditures + investment = new money supply + new domestic and foreign borrowing .

Monetary and External Sectors Monetary System: new domestic credit to government and private sector + new foreign reserves/assets = new money supply External sector: Imports – Exports = new foreign borrowing – net interest payments .

.GDP Expenditures (cont.Imports = GDP Measures the market value of the year’s output.) GDP Equation Cons + Inv + Govt Spending + X .

Real GDP Nominal (money) values used to sum heterogeneous output into meaningful total for GDP calculations. . To accommodate inflation or deflation (changes in the value of money because of price increases/decreases) GDP is inflated for rising prices and deflated for falling prices. Nominal GDP is output valued at current prices. Real GDP is output valued at constant (base year) prices.Nominal vs.

CPI is a statistical measure of changes over time in prices of a basket of typical goods purchased by typical consumers.Inflation & Consumer Price Index Inflation occurs when average level of prices rises. CPI used to report rate of inflation each month CPI = price of 1997-1999 basket in a specific year X100 price of same basket in a base period (1997-1999) . while average price level falls during deflation. Price hikes for a single good not inflationary.

Macroeconomic Stability Macroeconomic stability is economic growth. economic growth is never steady. . full employment and price level stability. price level is often unstable and full employment is hard to achieve. However. Highly desired by society.

Price level may begin to rise before realization of full employment and full capacity production. . income. and output close to capacity (rise in price- level). employment and trade lasting six months or more Trough: the place where output and employment reach their lowest levels. Variations in duration. Recession: decline in total output. Four phases in business cycle: Peak: temporary maximum for a business cycle-full employment.Business Cycle Definition: the recurrent ups and downs in the level of economic activity extending over several years with variations in duration and intensity. Recovery: levels of output and employment expand toward full employment.

Sources of Unemployment Before looking at employment. either because of voluntary switching. desirable Cyclical Unemployment: caused by recession phase of business cycle. a deficiency of aggregate spending. and first-time job seekers. seasonal layoffs. Structural Unemployment: changes occurring in structure of consumer demand and technology alter structure of total demand for labour. workers in between jobs.e. let’s look at different types of Unemployment Frictional Unemployment: search unemployment and wait unemployment describes workers waiting to take jobs in the future i. dismissal. Inevitable and to some extent. Unemployment results since composition of labour force does not respond quickly or completely to new structure of job opportunities .

produce and maintain full employment. Also known as natural rate of unemployment. .e. total of frictional and structural unemployment. i. Economy’s potential output is the real output forthcoming when economy is fully employed. Full employment unemployment rate does not mean zero unemployment. but zero cyclical employment i.e. Natural rate of unemployment is subject to revision because of shifting labour force demographics or institutional changes.Employment One of economic policy’s goals is to be able to use all available resources. This does not mean economy always operates at natural rate. thereby realizing its potential output.

including those currently working. Three groups of people comprise total population for unemployment measurement purposes: .not in labour force . Adults potentially employable but choosing not to work— homemakers.Measuring Unemployment . retired. Labour force—all people able and willing to work. Under 16. Unemployment rate is therefore the percentage of labour force that is unemployed. or institutionalized and therefore unemployable . Controversial and complicated exercise. . and those currently unemployed but actively seeking work. Unemployment rate = unemployment X 100 Labour force .

the qualities of goods available or in how production is organized. .Economic Growth Economic growth is the single most important factor for influencing poverty and macroeconomic stability is essential for high and sustainable rates of growth. Economic growth enables more goods to be produced. Economic development entails improvements in the quality of life.

technological advances. Population growth with a proportional increase in the work force will actually result in a decline in GNP. Potential output rises through: . capital accumulation or through increases in the size or quality of labor force.Economic Growth . . Labour force as a percentage of the population is known as the labour force participation rate. . Growth and development focuses on enlarging potential real Gross National Product.