TOPIC 1
There are many examples
Stock vs. Flow
Stock – quantity measured at any specific point in time;
it could be an initial quantity or the initial
quantity plus the net of additions to and subtractions
from a stock
Flow – addition to (an inflow) or subtractions from (an
outflow) an existing stock, measured per unit of
Time
GDP and GNI
a. Gross domestic product- total value of goods
and services produced WITHIN the country
during a specific period of time.
- total value of goods and services (total value of the
final sales OR total value of raw and intermediate
inputs used in production; care is taken to avoid
duplication; production is counted only once in the
GDP.)
- produced within the country (no matter who
produces them or where the products are used)
- during a specific period of time (a year, regardless of
whether the product is sold in the year it was
produced). If not sold in the year the product is
produced, it becomes part of that year’s inventory for
the purposes of GDP estimation.
- In an economy where the only economic activities are
pancake production and consumption, or rice
production and consumption, the final cost of output
including producer profits OR the final sales of the
product (the two are equal) will be that economy’s
GDP.
What activities or transactions are included or
excluded in the GDP?
Where and when the transactions took place matter
in the determination
Illegal transactions are excluded, e.g. smuggling
Transactions, even if legal, not reported nor
monitored by government agencies cannot not be
measured and, in principle, are excluded. But note the
next item -
The informal sector is the biggest non-reporting
category. Efforts to monitor the sector have yielded
information that allows for corrections to the GDP to
account for the sector’s contribution.
The true costs to natural resource and the
environment degradation as a result of GDP generation
are not taken into account, e.g. the economic and
social costs of mining.
Beyond price differences, the real value of quality-of-
life improvements resulting from new and improved
products are not included.
among communication gadgets.
Further notes
It is not unusual for localities adversely affected by
natural calamities to experience a burst in economic
activities because of rebuilding and rehabilitation
activities even if the stock of physical capital stock is
reduced.
Natural resource, environmental and climate change
adverse impacts take decades to manifest and become
measurable, costs do not get internalized because
culprits are often not the victims of environmental
damages and many governments are reluctant to
curtail environmental practices to reverse damages
that, in the short-term, will lower national incomes and
increase unemployment.
Advances in information and communication, R&D in
the medical sciences, improvements in technological
knowhow, among others have introduced successive
improvements in the quality of life of individuals not
measured and considered in GDP estimation.
Circular flow of goods and incomes: 2-sector, 3-sector
economies, with or without government, closed or
open economy
a. 2-sector closed economy model
sectors: households, firms
markets: product markets, factor markets
value of produced goods and services = value of
consumption = total incomes received by factor
owners = GDP of the 2-sector economy
firms’ production is the source of incomes of
household (wages, rents, interest earnings, profits);
firms are ultimately owned by households
households provide factor inputs to the economy’s
production; they are also the consumers of the
produced goods and services
b. 3-sector closed economy model
sectors: households, firms, government
taxes paid to government reduce the resources in the
circular flows, reducing amount available for
production and consumption and thus, the GDP
government expenditures return some or all of
resources to the circular flows
c. 3-sector open economy model
exports are goods and services produced within the
country, employing factor inputs thus providing
employment and incomes to households and
increasing the GDP.
imports are payments for goods and services
produced outside the country, paid for by resources
withdrawn from the circular flows, reducing the
nation’s GDP.
 Gross national income (GNI) GNI = NNI +D
Approaches to the GDP / GNI measurement (D) Depreciation

1. Value added approach (industrial origin of incomes Gross domestic product GDP = GNI - NROW
or outputs) Net factor incomes from abroad (NROW)
2. Final expenditure approach
3. Factor incomes approach Personal Income – total income received by all
individuals and households.
1. Value added approach (industrial origin of incomes
or outputs) PI = Wages + Rents + Interests + Profits + Dividend
incomes paid out by corporations + Net transfers
GDP = Σ gross value added (GVA) from all sectors
The sectors: PDI = PI – Personal direct taxes
a. Agriculture, hunting, forestry and fishing
b. Industrial (mining, manufacturing, Personal Disposable Income (PDI) – income that
construction, utilities) individuals and households can spend at their
c. Services (transport, trade, financial, public ad, discretion
defense, etc)
GVA includes: SUMMARY: Approaches to GDP estimation
a. Indirect business taxes (IBT) Value added approach: GDP = Σ GVA from all sectors
b. Depreciation (D) Expenditure approach: GDP = C + I + G + (X-M)
NDP = GDP – depreciation Income approach: GDP = WRIP + CI + IBT +D - NROW
*gross value added – w/ depreciation GDP = GNI – NROW
*net value added – w/o depreciation
Current vs Constant GDP
2. Final expenditure approach Implicit GDP deflator = (GDP in current price/GDP in
constant price) x 100
Nominal GDP = GDP measured in prices of the curren year
(C) Private consumption expenditures Real GDP = GDP measured in prices of the base year
(I) Gross domestic investment Issues in the measurement of GDP
(Ip) Private gross domestic investment 1. GDP as a measure of economic welfare
(Ig) Public gross domestic investment 2. comparison of GDP values over time when prices
(G) Government expenditures are changing - use of Constant Prices. This improves
(X-M) Net exports the comparability of GDP with other years as constant
terms factors out the effects of inflation.
Gross national expenditure, also known as Gross 3. comparison of GDP expenditures when the nation’s
national product: consumption habits change over time (illustrate how
GNE = C + I + G + (X-M) = GDP GDP deflation to a common base is done and how
GDP implicit deflators or price deflators are derived) -
3. Factor incomes approach GDP in constant prices = GDP in current Prices/ Price
Deflator and to get the formula for price deflator, we
Wages, rents, interests and profits (WRIP) WRIP = W + just have to derive the formula into Price Deflator =
R+I+P GDP current/GDP constant.
(W) Wages 4. comparison of GDP expenditures when the quality
(R) Property income or Rents of items in the basket of goods and services change
(I) Interest incomes over time – use Quality Adjustment Index or
(P) Profits comparing real GNPs over time would suffice
5. GDP comparisons when countries have different
Corporate Income (CI) CI = CR + CD + CT values of currency - applying the rate of exchange to
(CR) Retained earnings arrive at a similar measurement or monetary value
(CD) Dividends (dollar, peso, yen).
(CT) Taxes 6. GDP comparisons when countries have different
rates of growth of their population - GDP per capita is
Net income at factor costs (NI) NI = WRIP + CI used as a measurement, wherein the GDP is divided
by the population in order to know the economic
Net national income (NNI) NNI = NI + IBT output per head.
(IBT) Indirect business taxes 7. GDP comparison by countries when respective
currencies do not buy the same quantity of the same
goods and services - PPP (purchasing power parities)
multiplier is used. At PPP rate, one international unit I + (X-M) = S + (T-G)
of currency has the same purchasing power over injections – leakages
domestic income that the US dollar has over the US
domestic income. Trade balance
8. comparability of national statistics when estimation X-M > 0 trade surplus
methods are different X-M < 0 trade deficit
9. Comparability of GDP estimates when there is Fiscal balance
under-coverage and underestimation - Imputation or T-G > 0 fiscal surplus
the estimation of value of goods and services through T-G < 0 fiscal deficit
surveys and/or other less direct methods, can help ____________________________________________
lessen the under-coverage and underestimations
within the GDP. TOPIC 2 : BALANCE OF PAYMENTS (BoP)

PPP of the Philippine peso: peso to dollar exchange
rate in physical quantity terms
PPP of the Philippine peso = Cost of basket in the
Philippines in peso/Cost of same basket in US in dollars
PPP multiplier = Actual exchange rate of peso to 1
dollar/PPP of the Philippine peso
Example: if reference basket costs 10,000 pesos in the
Philippines and 500 dollars in the US, and the exchange
rate is 50 pesos to 1 dollar, the simple PPP multiplier is
calculated as:
= (50/1) / (10,000 / 500)
= 50/1 X 500/10,000
= 2.5
Balance of payments (BOP)
• is an accounting record of all monetary
transactions between a country and the rest
of the world within a specified period of time.
• The financial flows correspond to use of
foreign currency in transactions. What are the
flows?
Inflows of foreign exchange
• Receipts, also called credits. They increase the
Philippine holding of foreign exchange.
Outflows of foreign exchange
• Payments, also called debits. They decrease
the Philippine holding of foreign exchange.

Injection and Leakages

• Recall from our circular flows of exchange
among agents in the economy that domestic
output domestic income received by
individuals and households.
• The individual and household income is spent
(consumed) or saved or collected by
government as taxes. That is, Y = C + S + T
• Since in the economy, total expenditure is
equal to total income:

E=Y
C + I + G + (X-M) = C + S + T
or
C+I+G+X=C+S+T+M
injections = leakages

• Injections increase the amounts of resources

in the circular flows.
• Leakages produce the opposite effect.

Another re-arrangement Debits and credits in the BoP items

G-T = S - I - (X-M)
Budget deficit reduces the capacity of domestic
savings to finance domestic investment and exports,
thus weakening domestic productive capacity and
increasing the economy’s reliance on imports.
• The inflows and outflows of foreign exchange
as receipts and payments respectively for
transactions on the items of the balance of
payments are resolved as surplus or deficits.
* surplus: when credits > debits or liabilities
* deficits: when credits < debits or liabilities
Net status of the balance of payments account and its
components
• Trade surplus or trade deficits
• The trade account is in surplus if Exports >
imports, i.e, net exports is positive. Otherwise,
the economy has a trade deficit. Trade items
are part of the Current Account.
• Current Account (CA) surplus or deficits
• The current account has a surplus if net exports
and receipts from remittances and donations
and transfers intended for consumption are
greater than payments. Otherwise the current
account is in deficits.
• Capital Account
• If credits to capital transfers (i.e. remittances
intended for investment) and non-financial
transfers (e.g. patents and copyrights) also for
investment are greater than the debits, the
Capital Account is in surplus. Otherwise it is in
deficit.
• We will lump the Capital Account with the
Current Account. At present, it has a very small
role in the BoP.
• Financial Account
• If overall receipts in the Financial Account
items are greater than payments, the account
is in surplus. Otherwise, the account is in
deficit.
• Official adjustment when CA and CF do not balance
a. Monetization of gold
b. Revaluation of assets
c. Change in the reserve position
d. Borrowing from IFIs, use of Special
Drawing Rights
Additional Notes:
1. For the course, our main interests are the
contributions of specific items to the international
reserves (and whether the net transactions
increase or decrease the reserves), and specific net
status or balances. The specific BoP items of
interest are exports and imports, factor incomes,
transfers and donations in the Current Account.
And direct investments, portfolio investments, and
international loans and repayments in the Financial
Account. Macroeconomic developments in
relation to the items are often subject of current
news, for example the contraction in the exports of
electronic components or the level of OFW
remittances, entry into and exit of “hot money”
from the country, offshore borrowing. The specific
net status of interest to the course and the
economy are trade balance, current account
balance, the financial account balance and BoP
balance.
2. We will use the technical term gross international
reserves (GIR) instead of international reserves for
convenience.
3. Factor income receipts (or primary income) are
earnings during the year of the factors (labor
services, financial / real estate / other assets) of
Filipino nationals and residents remitted into the
country. Financial transfers include other
remittances and donations (secondary income).
4. Receipts of borrowed funds like financial
instruments such as offshores bonds are inflows
(also called receipts or credits) to the Financial
Accounts. Repayments are outflows (also called
payments, debits or liabilities). The principal and
repayments of Philippine loans are recorded under
the Financial account, while interest earnings and
interest payments are classified as factor incomes.
5. Investment in business is classified as direct
investment if an entity or group of related firms is
able to exercise control or a significant degree of
influence over the enterprise or where ownership
constitutes 10% or more. The assumption is that of
stable long-term interest in the business evidenced
by the “sinking in” of significant amount of
financial capital. This is in contrast with the
“volatile” nature of portfolio investment (stocks
and bonds that do not reach more than 10%
ownership). Purchases and sales of stocks and
bonds are easily undertaken (“at the touch of a
button”), facilitated by the efficient operations of
investment houses and internet access.
6. The CA on one hand, and the Financial accounts
offset each other’s foreign exchange surpluses and
deficits. Net overall surplus or deficit (“BoP surplus
or deficits”) affect principally the foreign exchange
reserve position (or level of GIR), the usual
adjustment for overall surplus or deficits. In the
current pandemic, the government expanded
borrowing – raising funds through offshore
issuance of government (“sovereign bonds”) and
through loans from multilateral lending
institutions. Surplus in the net CA and Financial
accounts increase the foreign exchange reserves
while deficits reduce them. International reserves
are readily available to and controlled by the BSP
for direct financing of imbalances and managing
the magnitude of such imbalances.
TOPIC 3: CONSUMPTION
Basic consumption theory
GDP by expenditures share: Y = C + I + G + NX
 Introduction • YD (disposable income) is either spent on
consumption (C) or is saved (S). In equation
• Consumption expenditures are the realized form:
(actual) demand for final goods by all
household consuming units. You will recall in YD = C + S C > 0, S ≥ 0
the GDP data that consumption accounts for
the biggest share of expenditures. Although • Further, any change in the disposable income
this is expected, we refer to economic growth will show up as a change in consumption, a
as “consumption-driven” - if its share change in savings or both.
inordinately dominates the other items.
• Other things remaining equal, high ΔYD = ΔC + ΔS ΔC ≥ 0, ΔS ≥ 0
consumption expenditures are conducive to or ΔYD = ΔC + S
higher economic growth. However, most or ΔYD = C + ΔS
investment is financed by saving, so there is a
cost to too much consumption. Magnitudes of the C-Y relationship
• In pursuit of growth objectives, governments • Level of consumption the amount C/E
do take measures to stimulate or dampen • Marginal propensity to consume *dC / dYD ≡ mpc
consumption demand, utilizing knowledge of • Average propensity to consume C / YD ≡ apc
factors that influence household consumption. (**d = derivative)
• When households receive their incomes, how MPC = ratio of change in consumption to change in income
APC = ratio of total consumption to total income
much they will spend on consumption and
consequently, how much will go to saving
depends on many factors.
• The foundation of the consumption theory is in
the realm of microeconomics. In fitting
consumption theory in macroeconomics, we
generalize individual or household behavior to
the consumption behavior of the entire
economy. Factors that affect individuals or
individual households also affect the same
individuals or households that make up the
macroeconomy.
• However, there are differences in the Graph Notes:
aggregate behavior and that of individuals and • dY = ΔY and dC = ΔC
firms: (1) some characteristics affecting • any point in the 45 line > C=Y or APC=1
consumption levels of households tend to • Y=YD if taxes=0
cancel out on the average because population
distribution across age groups tend to be To derive the marginal relationship between C, S
stable, e.g. life cycle effects; (2) some macro and Y, divide both sides of the equation by YD:
variables have no equivalent at micro level;
e.g. income distribution; (3) aggregate
behavior in response to government policy
decisions might be very different compared to
the behavior of individual or firm, e.g. effects
of aggregate consumption demand on incomes
and prices are not equal to those of the sum of Another description of C and S as incomes
the demand of individuals and households change: the proportion of total income allocations to C
acting independently. and S.

**For the graphs and tables that you will encounter in

the pdf, make sure you take note of the graph structure
(what go into the axes) and table structure (row and
column labels).

Income, consumption and saving

• Basic proposition: the level of C depends on
the level of (current) disposable income.
Worksheet from Sicat for the calculation of mpc, mps **Note: “expenditures” used interchangeably with
using cross-section data “consumption”

**Observe that the mpc is a decreasing function of

income; mps is increasing with respect to income

To think about:
The previous observations hold in this actual C
schedule.

• How can families exhibit the C >Y behavior? (Get

resources from savings/debt/subsidies from
government)

• At incomes rise, what does the behavior ΔC = 0 and

ΔS = ΔY imply regarding mpc and mps?
• Where in the schedule can they be observed?
(MPC=ΔC/ΔY=0 while MPS=ΔS/ΔY=1)

• Compare the apc at the lower vs higher levels of

incomes. (APC will only be equal to all income groups if
they’re in the 45o line)

The C schedule is slightly concave with respect to

horizontal axis. Observations:
• The higher the incomes, the higher the level of family
consumption expenditures and savings.
• C > YD at lower levels of income, thus savings are
negative.
• Families with low incomes have higher relative
consumption compared with families at higher income
levels:” To think about:
• Savings invariably increase as incomes increase; i.e. For the Philippine population in 1994,
dS/dY > 0 • Food command the highest proportion of incomes of
the typical household. How do the relative shares of
Inference: Assuming a high income inequality exists, food consumption change as incomes increase?
what will a redistribution of income do to the • Think of a plausible story why the share of clothing,
economy’s C level? To the GDP? (Answer: negative footwear, etc in the expenditures exhibit the observed
damage in MPC = MPC, at higher income, is lower ; changes as incomes rise.
Increase GDP) • Comment on household priority on education.

Another way of describing the relationship:
Income elasticity of expenditure
ε = % change in expenditure / % change in income
ε = mpc/apc is computationally convenient but
is not helpful in interpretation.
When explaining elasticity, bear the definition
in mind: percent change in expenditure given a one
percent change in income.
The previous equation measures elasticities
evaluated over a specific initial income level.
When elasticities are measured over a large
income interval, evaluating elasticities using initial
values of C and Y are subject to large measurement
errors. To reduce such, the mid-point of the interval
are used as evaluation reference.
Finally,
YD = C + S
• The empirical behavior of consumption as
incomes change has over the years
strengthened the foundations of consumption
theory.
• The behavioral relationship between C and YD
can be written as:
C = c(YD) and S = s(YD)
• Because YD = f(Y), C and S are also functions
of Y:
C = c(Y) basic consumption function
S = s(Y) basic savings function
Other theories of the consumption – income
relationship
• The basic consumption theory relates
consumption to current income. There are
limitations, and a serious one is that a faithful
behavior is not observed in not so uncommon
circumstances.
• If household income suddenly declines or rises,
as when the breadwinner loses his job, then
finds a better income- earning one – does the
family go through periods of starvation and
plenty?
• That is not what we observe. Instead, families
attempt to “smooth out” consumption over
periods of time.
• Adherents to other theories - life cycle
consumption theory, permanent income
hypotheses, among others - think the basic
relationship is inadequate and argue that
individual perception of “incomes” and needs
would explain consumption behavior better.
a. Life cycle theory - suggests that one’s income
follows a pattern over its lifetime.
b. Permanent income hypothesis - permanent-
income hypothesis recognizes that people
experience fluctuations in their incomes from
each period.
c. LC-PIH
Other factors that affect consumption levels
Price - when price increases, consumption
expenditure on an item decreases
Interest Rate - a higher level of interest results to
lower consumption
Size of family - a large family tends to have higher
consumption levels, all other things equal
“Life Cycle” - consumption patterns differ each age
group or generation
Income Distribution - wage-earners tend to consume
more than non-wage earners
TOPIC 4-1: INTRODUCTION TO THE KEYNESIAN
MODEL
Short-run tools - Graphing basics
• AD-AS
• Keynesian cross
a. Aggregate Demand
P = price level, an average
for all goods and services; a
price index (the best price
index would be the GDP
deflator)
Y = total expenditure/
income/ output
• AD curve: shows total amount of expenditures of
economy at specific levels of prices, given the
spending resources economy has at its disposal
• Downward (or negative) slope: the higher the
price level, the less quantity of goods and services
the economy’s spending resources can buy
not changing. More often, we will be using the
earlier AD-AS tool more so we can graphically
introduce price changes.
*Underlying assumption: Price can be ignored
*Since expenditures equal output (= incomes), AD=Y is
on the 45o line.

Movements and shifts in the AD

c. Aggregate Supply
• Movements along the AD curve – relationship
between Y and P
• Shifts in the AD curve – any change in autonomous
C, I, G, X, M will shift the aggregate demand curve
Y = total output of the
not coming from price. Autonomous/Exogenous - doesn't depend on level of price
economy’s productive
sector

• AS curve: shows the quantity of g & s that

producing units together will be willing to supply at
specific levels of prices.
• In the graph, we assume an upward or positive
sloped AS – the higher the price, the greater the
sector will produce and sell.

Movements and shifts in the AS

• Movements along the AS curve – relationship between

Y and P
• Shifts in the AS curve – any change in technical inputs
and input efficiency, technology, other factors like
weather.

b. The Keynesian Cross

• The Keynesian cross is the graph that
corresponds to the Keynesian model of
aggregate demand - the C+I+G+NX equation, a
“short-run” model that assumes that prices are
 AD Shock

Another example of economic “shocks” or “stimulus AS Shock

affecting AS. Assume an initial state.
• While the pandemic is going on, the swine flu
is back in some provinces in the country.

Upward/shift to the left

of AS (lower Y, higher P)

d. When AD meets AS graphically:

• The economy is in an initial

state of equilibrium.
• A negative stimulus shocks it
out of the equilibrium.
• Always of interest to us:
How does the final compare
to the initial equilibrium?
• We’ll use comparative statics – a comparison
of two equilibrium states pre- and post
adjustment to a shock. Comparative statics
does not look at the process of adjustment.
However, the application of the model to real
world changes of macroeconomic variables
will require that we understand what is
happening behind our graphs and equations.
• It will also be partial equilibrium analysis –
we’ll take one shock at a time and assume
other variables remain equal, unchanging,
ceteris paribus
Additional:
Stock Variables
a. The value of gold in the BSP vault
b. The national debt as of 2020
**Not stock variables:
a. Tuition payments for this semester
b. Total household income
c. The Philippine national budget
1-4. When the current plus capital accounts on one hand
and the financial account
on the other are in deficits, the following can be used
as adjustment for the BoP shortfall.
a. Sell bonds in the internation market – False
b. Raise tariffs on imports – False
c. Use the gross international reserves – True
d. Tap the country’s IMF special drawing rights allocation – True

CAUTION: DO NOT MIX AD AND AS SHOCKS