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Macroeconomics
Week 7-10 October 19 – November 13, 2020

Name: JUN MARK B. YABO Year Level__________

Search the following topics.

National Income Accounting

1. Approaches to National Income Accounting
a. Income approach
: The income approach, sometimes referred to as the income capitalization approach, is
a type of real estate appraisal method that allows investors to estimate the value of a
property based on the income the property generates.
b. Expenditure approach
: The expenditure method is a system for calculating gross domestic product (GDP) that
combines consumption, investment, government spending, and net exports. It is the
most common way to estimate GDP. The expenditure method may be contrasted with
the income approach for calculated GDP.
c. Industrial Origin Approach
: Industrial Origin Approach also called as the "Value Added Approach" measures GNP
by adding the total gross value added of the three sectors of the economy – agriculture
(primary), manufacturing (secondary), and services (tertiary)

2. GNP Accounting: Meaning, Purpose and Limitations

Meaning: (GNP)Gross National Product- Market value of all final products
produced by the resources of the economy during a specified period of time.
Purpose and Limitation: Three important limitation to zero in on the identification
of final product
First, excludes products not produced by the resources of the economy as imports.
Second, definition only includes those products that can no longer be use for higher
stage of production and therefore, have reached the highest level of transformation
using the economy’s resources. Product can be considered final once they flow
directly from the producing units to consumption, the government and the rest of the
world.
Third, limitation is time and the definition eliminates from the aforementioned those
not produced by the economy within the period of time accounted.
 GNP reflects the value of the economy’s production since it also includes the value of
products from the lower stage of production. GNP camera is a formal tool which
cannot picture the informal and hence, undeclared activities in the economy.
Economic activities of a cigarette vendor is undeclared and unrecorded. “underground
economy”.
3. GNP vs. GDP

 Gross domestic product (GDP) and gross national product (GNP) are both widely
used measures of a country's aggregate economic output.
 GDP measures the value of goods and services produced within a country's borders,
by citizens and non-citizens alike.
 GNP measures the value of goods and services produced by only a country's citizens
but both domestically and abroad.
 GDP is the most commonly used by global economies. The United States abandoned
the use of GNP in 1991, adopting GDP as its measure to compare itself with other
economies.

4. Money GNP vs. Real GNP

: Money GNP – is GNP at current prices obtained by multiplying the number of final goods
or products (Q) and services by prevailing market prices (P).
real GNP - a version of the GNP that has been adjusted for the effects of inflation. real gross
national product. GNP, gross national product - former measure of the United States
economy; the total market value of goods and services produced by all citizens and capital
during a given period (usually 1 yr).

Consumption, Savings and Investment

1. Factors of consumption
1. The Rate of Interest:
Saving directly depends on interest. When the rate of interest rises saving will
increase and consumption will fall. In other words, at high rates of interest people
often curtail their consumption voluntarily to save more. Thus the rate of interest
affects the consumption spending indirectly.
2. Sales Efforts:
Through various sales promotion measures, such as advertising, it is possible to
increase the demand for consumer goods. In practice, advertising has the effect of
shifting consumer demand from one product to another.
An increase in total demand from one good may be at the expense of another good,
but an increase or decrease in the amount of selling effort may effect the total volume
of consumer expenditure, given a fixed level of income.
3. Relative Price:
Changes in relative price can only shift demand from one product to another. But, in
some cases, relative price changes might affect aggregate consumption.
4. Capital Gains:
Keynes pointed out that, consumption spending might be influenced by capital gains.
This implies that real consumption is influenced by the stock of wealth. The rise in
American consumption spending in the late 1920s reflected the realised and
unrealised capital gains which were being made in the stock market. In fact, an
 increase in the perceived wealth of the community might stimulate consumption
spending.
5. The Volume of Wealth:
The total wealth of consumer is a possible influence on consumer expenditure. This
point has been made by A. C. Pigou. He argued that, current utility depends on
consumer wealth, current and future (the larger the current wealth the larger, cet. par.
will be future wealth, too). The larger the stock of wealth the lower is the marginal
utility, and, therefore, the less the strength of desire to add to future wealth through
reducing current consumption.

2. Consumption function
The consumption function, or Keynesian consumption function, is an economic formula that
represents the functional relationship between total consumption and gross national
income. It was introduced by British economist John Maynard Keynes, who argued the
function could be used to track and predict total aggregate consumption expenditures.

Understanding the Consumption Function

The classic consumption function suggests consumer spending is wholly determined by

income and the changes in income. If true, aggregate savings should increase proportionally
as gross domestic product (GDP) grows over time. The idea is to create a mathematical
relationship between disposable income and consumer spending, but only on aggregate
levels.

The stability of the consumption function, based in part on Keynes' Psychological Law of
Consumption, especially when contrasted with the volatility of investment, is a cornerstone of
Keynesian macroeconomic theory. Most post-Keynesians admit the consumption function is
not stable in the long run since consumption patterns change as income rises.

Calculating the Consumption Function

The consumption function is represented as:

C = A + MD
where:
C=consumer spending
A=autonomous consumption
M=marginal propensity to consume
D=real disposable income
3. Other concepts of consumption ( Equi-Marginal Principle , Income
and Substitution Effects )
Equimarginal principle
The equimarginal principle states that consumers will choose a combination of goods to
maximise their total utility. This will occur where
  The consumer will consider both the marginal utility MU of goods and the price.
 In effect, the consumer is evaluating the MU/price.
 This is known as the marginal utility of expenditure on each item of good.

4. Investment, Its determinants

The determinants of investment
The level of investment in an economy tends to vary by a greater extent than other
components of aggregate demand. This is because the underlying determinants also have a
tendency to change.
The main determinants of investment are:
The expected return on the investment
Investment is a sacrifice, which involves taking  risks. This means that businesses,
entrepreneurs, and capital owners will require a return on their investment in order to cover
this risk, and earn a reward. In terms of the whole economy, the amount of business profits is
a good indication of the potential reward for investment.
Business confidence
Similarly, changes in business confidence can have a considerable influence on investment
decisions. Uncertainty about the future can reduce confidence, and means that firms may
postpone their investment decisions until confidence returns.
Changes in national income
Changes in national income create an accelerator effect. Economic theory suggests that, at the
macro-economic level, small changes in national income can trigger much larger changes in
investment levels.
Interest rates
Investment is inversely related to interest rates, which are the cost of borrowing and the
reward to lending. Investment is inversely related to interest rates for two main reasons.
1. Firstly, if interest rates rise, the opportunity cost of investment rises. This means that a rise
in interest rates increases the return on funds deposited in an interest-bearing account, or
from making a loan, which reduces the attractiveness of investment relative to lending.
Hence, investment decisions may be postponed until interest rates return to lower levels.
2. Secondly, if interest rates rise, firms may anticipate that consumers will reduce their
spending, and the benefit of investing will be lost. Investing to expand requires that
consumers at least maintain their current spending. Therefore, a predicted fall is likely to
discourage firms from investing and force them to postpone their investment decisions.
General expectations
Because investment is a high-risk activity, general expectations about the future will
influence a firm’s investment appraisal and eventual decision-making. Any indication of a
downturn in the economy, a possible change of government, war or a rise in oil or other
commodity prices may reduce the expected benefit or increase the expected cost of
investment.
Corporation tax
Firms pay corporation tax on their profits, so a reduction in tax increases the profits they
retain after tax is paid, and this acts as an incentive to invest. There current rate of 20% will
fall to 19% in 2017, and then to 18% in 2020.
The level of savings
Household and corporate savings provides a flow of funds into the financial sector, which
means that funds are available for investment. Increased saving may reduce interest rates and
stimulate corporate borrowing and investment.
The accelerator effect
Small changes in household income and spending can trigger much larger changes in
investment. This is because firms often expect new sales and orders  to be sustained into the
long run, and purchase larger quantities of capital goods than they need in the short run.
In addition, machinery is generally indivisible which means it cannot be broken into small
amounts and bought separately. Even small increases in demand can trigger the need to buy
complete new machines or build entirely new factories and premises, even though the
increase in demand may be relatively small.
The combined effect of these two principles creates what is called the accelerator effect. For
example, if in a given year national income rises by £20b, and investment rises by £40b, the
value of the accelerator is 2.

5. Savings and Investment

Saving
Saving involves income that is not consumed. Typically surplus income is saved in a bank
account. But, it could be saved as cash (cash under the bed e.t.c)
The Savings Ratio is the % of income that is saved. In recent years the UK and US have had
low savings ratios as people have been encouraged to borrow and spend more. The credit
crunch and impending recession are encouraging more to save.
Levels of savings are influenced by
 Interest rates – higher interest rates make it more attractive to save
 Confidence – low confidence can encourage households to save more
Investment
Investment in economics is defined as an addition to the capital stock. (Gross fixed capital
formation) For example, investment can involve spending on factories or new capital.
Investment can also involve spending on human capital such as investment in training and
education.
Levels of investment are affected by
 Interest rates – higher interest rates make investment more expensive (cost of borrowing
goes up)
 Confidence – if firms are confident, they are more willing to invest.
 Economic growth – An increase in the rate of economic growth will encourage firms to
invest to meet future demand.
Note: In everyday terminology, people refer to investing money in a bank, however, this does
is not investment in an economic sense. It is saving.
Saving = investment
In neo-classical economics, it is assumed that the level of saving will equal the level of
investment. This is because investment is determined by available savings in the economy.
If there is an increase in savings, then banks can lend more to firms to finance investment
projects. In a simple economic model, we can say the level of saving will equal the level of
investment.
6. Multiplier and Accelerator

For a clear grasp of the concept of accelerator, it is useful to distinguish between

multiplier and accelerator. Multiplier shows the effect of a change in investment on
income and employment whereas accelerator shows the effects of a change in
consumption on investment. In other words, in the case of multiplier, consumption is
dependent upon investment, whereas in the case of accelerator investment is
dependent upon consumption.

Further, multiplier depends upon the propensity to consume and accelerator depends
upon durability of the machines. In other words, the former is dependent upon
psychological factors, while the latter is dependent upon technological factors.
However, even accelerator is psychological in its origin because it is linked to induced
investment but it becomes highly technical on the operational plane. The accelerator
shows the reaction (effect) of changes in consumption on investment and the
multiplier shows the reaction of consumption to increased investment.

Further, another very important point of difference between the multiplier and
accelerator is in their working backwards. Multiplier works as rigorously in the
reduction of income as it does in its increase. But the working of the accelerator is
restricted in the downward direction to the rate of replacement of capital because
businessmen can at the most disinvest to the extent of not replacing the wearing-out
capital.

Working of the Accelerator:

It is interesting to analyse the working of the Principle of Acceleration.
Accelerator depends primarily upon two factors:
(i) The capital-output ratio, and
(ii) The durability of the capital equipment.
A numerical example will clarify the dependence of acceleration value on the
durability of the machine, capital-output ratio being given.
 7. The Paradox of Thrift
Paradox of Thrift

 The paradox of thrift is a concept that if many individuals decide to increase their private
saving rates, it can lead to a fall in general consumption and lower output.
 Therefore, although it might make sense for an individual to save more, a rapid rise in
national private savings can harm economic activity and be damaging to the overall
economy.
 In a recession, we often see this 'paradox of thrift'. Faced with the prospect of recession and
unemployment, people take the reasonable step to increase their personal saving and cut
back on spending. However, this fall in consumer spending leads to a decrease in aggregate
demand and therefore lower economic growth.

Paradox of thrift during 2020 corona recession

 In 2020, the economic shutdown will lead to an unprecedented rise in savings. Partly
because people are very nervous about the future economy but also because opportunities
to spend are severely limited.
 On the other hand, people who see a large fall in income will have to dip into their savings
and borrow to stay afloat.