ECODEV130
Lesson 5: Measuring a Nation’s Income
By: Gregory Mankiw
Micro vs. Macro
 Microeconomics - The study of how individual
households and firms make decisions, interact with
one another in markets.
 Macroeconomics - The study of the economy as a
whole.
"We begin our study of macroeconomics with the country's
total income and expenditure.”
Income and Expenditure
 Gross Domestic Product (GDP) measures total income
of everyone in the economy.
 GDP also measures total expenditure on the
economy's output of goods & services.
For the economy as a whole, Income equals expenditure
because every dollar a buyer spends is a dollar of income for
the seller.
The Circular-Flow Diagram
 a simple depiction of the macroeconomy
 illustrates GDP as spending, revenue, factor payments,
and income
 Preliminaries:
Factors of production are inputs like
labor,land, capital, and natural resources.
Factor payments are payments to the factors
of production (e.g., wages, rent).
What This Diagram Omits
 The government
collects taxes, buys g&s
 The financial system
Matches savers’ supply of funds with borrowers’
demand for loans
 The foreign sector
Trades g&s, financial assets, and currencies with
the country’s residents
Gross Domestic Product (GDP) Is…
…the market value of all final goods & services
produced within a country in a given period of
time.
Goods are valued at their market prices, so:
 All goods measured in the same units (e.g., dollars
in the US)
 Things that don’t have a market value are
excluded, (e.g., housework you do for yourself)
Gross Domestic Product (GDP) Is…
…the market value of all final goods & services
produced within a country in a given period of
time.
Final goods - intended for the end user
Intermediate goods - used as components or ingredients in
the production of other goods
GDP only includes final goods – they already embody the
value of the intermediate goods used in their production
Gross Domestic Product (GDP) Is…
…the market value of all final goods & services
produced within a country in a given period of
time.
GDP includes:
tangible goods e.g. DVDs, mountain bikes, beer
intangible services e.g. dry cleaning, concerts, cell phone service
Gross Domestic Product (GDP) Is…
…the market value of all final goods & services
produced within a country in a given period of
time.
GDP includes currently produced goods,
not goods produced in the past.
Gross Domestic Product (GDP) Is…
…the market value of all final goods & services
produced within a country in a given period of
time.
GDP measures the value of production that occurs within a
country's borders, whether done by its own citizens or by
foreigners located there.
Gross Domestic Product (GDP) Is…
…the market value of all final goods & services
produced within a country in a given period of
time.
Usually a year or a quarter (3 months)

The Components of GDP

Recall: GDP is total spending.
Four components:
 Consumption (C)
 Investment (I)
 Government Purchases (G)
 Net Exports (NX)
These components add up to GDP (denoted Y):
Y = C+I+G+NX
Consumption (C)
 is total spending by households on g&s
 Note on housing costs:
For renters,
consumption includes rent payments.
For homeowners,
consumption includes the imputed rental
value of the house, but not the purchase price or
mortgage payments.
Investment (I)
 is total spending on goods that will be used in the
future to produce more goods.
 includes spending on
capital equipment (e.g., machines, tools)
structures (factories, office buildings, houses)
inventories (goods produced but not yet sold)
Note: "Investment" does not mean the purchase of
financialassets like stocks and bonds.
Government Purchases (G)
 is all spending on the g&s purchased by govt at the
federal, state, and local levels.
 G excludes transfer payments, such as Social
Security or unemployment insurance benefits.
They are not purchases of g&s.
ACTIVE LEARNING 1
GDP and its components
In each of the following cases, determine how much GDP
and each of its components is affected (if at all).
A. Debbie spends $200 to buy her husband dinner at the
finest restaurant in Boston. new laptop to use in her
 Consumption and GDP rise by $200.
B. Sarah spends $1800 on a publishing business. The laptop
was built in China.
 Investment rises by $1800, net exports fallby
$1800, GDP is unchanged.
C. Jane spends $1200 on a computer to use in her editing
business. She got last year's model on sale for a great price
from a local manufacturer.
 Current GDP and investment do not change,
because the computer was built last year.
D. General Motors builds $500 million worth of cars,but
consumers only buy $470 million worth ofthem.
 Consumption rises by $470 million, Inventory
investment rises by $30 million, and GDP rises by
$500 million.
Real versus Nominal GDP
 Inflation can distort economic variables like GDP,
so we have two versions of GDP:
One is corrected for inflation, the other is not.
 Nominal GDP values output using current prices
 Real GDP values output using the prices of a base
year. Real GDP is corrected for inflation.

Net Exports (NX)

 NX = exports - imports
 Exports represent foreign spending on the
economy's g&s.
 Imports are the portions of C, I, and G that are
spent on g&s produced abroad.
 Adding up all the components of GDP gives:
 Y = C+I+G+NX

The GDP Deflator
 The GDP deflator is a measure of the overall level
of prices.
 Definition:
 One way to measure the economy’s inflation rate is
to compute the percentage increase in the GDP
deflator form one year to the next.
GDP Does Not Value:
Then Why Do We Care About GDP?
GDP and Economic Well-Being
 Real GDP per capita is the main indicator of the
average person’s standard of living.
 But GDP is not a perfect measure of well-being.
 Robert Kennedy issued a very eloquent yet harsh
criticism of GDP:
Gross Domestic Product…
“…does not allow for the health of our children, the
quality of their education, or the joy of their play. It
does not include the beauty of our poetry or the
strength of our marriages, the intelligence of our
public debate or the integrity of our public officials.
It measures neither our courage, nor our wisdom,
nor our devotion to our country. It measures
everything, in short, except that which makes life
worthwhile, and it can tell us everything about
America except why we are proud that we are
Americans.”
- Senator Robert Kennedy, 1968
 The quality of the environment
 Leisure time
 Non-market activity, such as the child care
a parent provides his or her child at home
 An equitable distribution of income
 Having a large GDP enables a country to afford
better schools, a cleaner environment, health
care, etc.
 Many indicators of the quality of life are
positively correlated with GDP. For example…

CHAPTER SUMMARY
 Gross Domestic Product (GDP) measures a country’s
total income and expenditure
 The four spending components of GDP include:
Consumption, Investment, Government Purchases, and
Net Exports.
 Nominal GDP is measured using current prices.
Real GDP is measured using the prices of a constant base
year and is corrected for inflation.
 GDP is the main indicator of a country’s economic well-
being, even though it is not perfect.
Lesson 6: Savings, Investments, Financial System and
Unemployment
Saving, Investment and Financial System
 The financial system consist of the group of
institutions in the economy that help to match
one’s person saving with another person’s
investment
 It moves the economy’s scarce resources from
savers to borrowers
Financial Institutions in the US Economy
 Financial markets are the institutions through
which savers can directly provide funds to
borrowers
 Financial intermediaries are financial institutions
through which savers can indirectly provide funds
to borrowers
Financial Intermediaries: Banks
 Banks take deposits from the people who want to
save and use the deposits to make loans to people
who want to borrow
 Banks pay depositors interest on their deposits and
charge borrowers slightly higher interest on their
loans
Financial Markets
The Stock Market
 Stock represents a claim to partial ownership in a
firm and is therefore, a claim to the profits that the
firm makes.
 The sale of stock to raise money is called equity
financing.
 Compared to bonds, stocks offer both
higher risk and potentially higher returns.
 The most important stock exchanges in the United
States are the New York Stock Exchange, the
American Stock Exchange, and NASDAQ.
 Bond Prices react to interest rates
 If a bond is paying 10% and interest rates go to 5%
is the bonds price going to go up or down?
 What if interest rates go to 15% what is that bond
going to be worth? See 2010 Question 2 AP Test.
 So if interest rates go up bond prices go down and
vice versa.
Banks
 Banks help create a medium of exchange by
allowing people to write checks against their
deposits.
 A medium of exchanges is an item that people can
easily use to engage in transactions.
 This facilitates the purchases of goods and services.
National Income Accounts
 National saving - the total income in the economy
that remains after paying for the consumption and
government purchases.
Y = C + I + G + NX
 Remember that GDP can be divided up to four
components: Consumption, Investment,
Government Purchases and Net Exports
National Savings
 So Y=C+G+I
 To isolate investment, we can subtract C and G
from both sides:
 Y-C-G=I
 Or GDP-Consumption-Government Purchases
=Investment
 What is left is called national savings.
 Savings=Y-C-G=I
 Savings =Investing
 You will have to keep reminding students what the term
"investment” means to macroeconomists. Outside of the
economics profession, most people use the terms
"saving" and "investing" interchangeably.
 In macroeconomics, investment refers to the purchase of
new capital, such as equipment or buildings. (factories)
  If an individual spends less than he earns and uses the  Then, after many rejections, he becomes a
rest to buy stocks or mutual funds, economists call this reluctant discouraged worker.
saving.  With pressure from bill collectors (and his wife), he
holds up an ATM called Kenny and shoots it.
Definition of National Saving (Saving): the total income in
the economy that remains after paying for consumption and Then What?
government purchases  Eventually he is caught and incarcerated.
 And his kids will cry because they can no longer go
Savings = GDP-Consumption-Govt Spending
to college.
 If T= Taxes and Transfer payments back to SS and
 And – the Texas Justice System will tell him to,
Welfare
“Take that.”
It can be broken down also like this
S=(Y-T-C) + (T-G)
Social Cost of Unemployment
This breaks down into private savings and public
Crime rates move with the business cycle...rising during
savings
periods of high unemployment and falling during periods
Private Saving: of low unemployment. The crime statistics released in the
 the income that households have left after paying fall of 1997 bear this out. With unemployment at a 25-year
for taxes and consumption. low at 4.9% the rate of violent crime was down for a fifth
Public Saving: consecutive year, and the murder rate fell to its lowest level
 the tax revenue that the government has left after since 1969. FBI crime statistics show that both property
paying for its spending. crime and violent crime increased sharply between 1985
Budget Surplus: and 1991 and fell dramatically from 1991 to 1997 in step
 an excess of tax revenue over government with unemployment.
spending.
Budget Deficit:
 a shortfall of tax revenue from government
spending.

How Is Unemployment Measured?

 The labor-force participation rate is the percentage
of the adult population that is in the labor force.

Labor force participation rate:

Types of Unemployment
 Frictional Unemployment:
Types of Savings unemployment due to the natural "frictions" of the
 Budget Deficit economy, which is caused by changing market
conditions and is represented by "qualified
The important point to make here is that with a government
individuals” with “transferable skills” who change
budget deficit, public saving is negative and the public
jobs
sector is thus “dissaving.” To make up for this shortfall, it
 Structural Unemployment:
must go to the loanable funds market and borrow the
unemployment due to structural changes in the
money. This will reduce the supply of loanable funds
economy that eliminate some jobs and create
available for investment.
others for which the unemployed are “not
qualified”. So they have “nontransferable skills".
Is There A Social Cost to Extended Unemployment?
 Natural Unemployment Rate:
Here is What Happens.
The sum of the Frictional Unemployment Rate and
 At first the job seeker optimistically looks for his
the Structural Unemployment Rate
next job.
 Full Employment:
 when the unemployment rate is equal to the
natural unemployment rate
 Cyclical Unemployment Rate:
the difference between the unemployment rate
and the natural unemployment rate. This is due to
deficient demand & implies a “recession".
Frictional Unemployment
 Refers to the unemployment that results from the
time that it takes to match workers with jobs.
- In other words, it takes time for workers to search
for the jobs that are best suit their tastes and skills.
Structural Unemployment
 Is the unemployment that results because the
number of jobs available in some labor markets is
insufficient to provide a job for everyone who
wants one.
Cyclical Unemployment
 Refers to the year-to-year fluctuations in
unemployment around its natural rate.
 It is associated with short-term ups and downs of
the business cycle.
Full Employment
 Because Frictional and Structural unemployment
are unavoidable does not count against
unemployment.
 Cyclical unemployment does.
 Thus 100 percent employment is not truly 100
percent.
 If there were no cyclical unemployed in the
economy we would have 100 percent employed.
Natural Rate of Unemployment
 The natural rate of unemployment is
unemployment that does not go away on its own
even in the long run.
 It is the amount of unemployment that the
economy normally experiences.
Definition of "Full Employment"
1. Full employment does not mean zero
unemployment.
2. The full-employment unemployment rate is equal
to the total frictional and structural
unemployment.
3. The full-employment rate of unemployment is also
referred to as the natural rate of unemployment.
4. The natural rate is achieved when labor markets
are in balance; the number of job seekers equals
the number of job vacancies. At this point the
economy's potential output is being achieved. The
natural rate of unemployment is not fixed, but
depends on the demographic makeup of the labor
force and the laws and customs of the nations. The
recent drop in the natural rate from 6% to 5.5% has
occurred mainly because of the aging of the work
force and increased competition in product and
labor markets.
Why Are There Always Some People Unemployed?
In an ideal labor market, wages
would adjust to balance the
supply and demand for labor,
ensuring that all workers would
be fully employed.
Public Policy and Job Search
 Unemployment insurance
 increases the amount of search
unemployment.
 reduces the search efforts of the
unemployed.
 may improve the chances of workers
being matched with the right jobs.
Lesson 7: International Trade
International Trade
 The branch of economics concerned with the
exchange of goods and services with foreign
countries
 Purchase, sale, or exchange of goods and services
across national borders
 Almost every kind of product can be found on the
international market such as:
 Food
 Clothes
 Spare Parts
 Oil Jewelry
 Wine
 Stock
  Currencies TRADE POLICY DEVELOPMENTS
Philippines:
 continues to hold with importance its membership
in the WTO and recognizes the value of the WTO's
achievements in fostering a competitive
environment.
 with its membership in 1995, the Philippines made
substantial commitments on market access and
plans to seek technical assistance programs from
its donor agencies and bilateral partners to assist
in the compliance of Trade Facilitation
commitments.

Did you know that?

It was last Nov. 10, 2012, when Management Board  of the
Advisory Center  on WTO Law (ACWL) under Pres. Aquino 
appointed Ambassador  Esteban B. Conejos Jr. as Philippine
permanent  representative to the  World Trade
Organization  (WTO)

Absolute Advantage and Comparative Advantage

The Growth in World Trade

 about 15 percent of the world's output is traded in
international markets in a typical year.
 while the importance of the international sector
varies enormously from country .to country, the
volume of international trade has increased
substantially.
 Year 1947: saw the creation of the GATT (General
Agreement on Tariffs and Trade) as an attempt to
reduce such barriers to trade as quotas, subsidies,
tariffs and taxes.
 In 1997 GATT was replaced by the WTO
(World Trade Organization), its mandate
expanded to include intellectual property
rights and foreign investment.
Absolute
World Trade Organizations
 only global international organization dealing with
the rules of trade between nations.
 Main Goal: to help producers of goods and
services, exporters, and importers conduct their
business.

WTO: What They do?

 Implementation and monitoring trade Advantage
 Dispute settlement Occurs when one producer can do a task using fewer inputs
 Building trade capacity than the other producer
 Investment and Trade
 Trade Policy Reviews Comparative Advantage
Occurs when a person or country can produce a good or
service at a lower opportunity cost than others. Reasons for Trade Barriers
 Domestic Employment
Why Specialize?  Low foreign wages
Because of specialization, both nations can be better off,  Infant Industry
even if one nation has an absolute advantage in both goods  Unfair Trade
over th other.  National Security

Demand and Supply in International Trade

Why Trade?
Reasons countries benefit from foreign trade:
 They can import resources they lack at home.
 They can import goods for which they are a
relatively inefficient producer.
 Specialization sometimes permits economies of
large-scale production.
Trade Barriers (tariffs, quotas, and subsidies)
A. Tariff
B. Non-tariff
A. Tariff Trade Barrier
 a tax on goods shipped internationally
 A price-based barrier
Types of tariffs
 Import and export tariffs: a tax levied on imports
or exports of a country.
 Transit tariff: a tax levied on goods passing through
the country.
 Specific duty: a tariff based on the number of items
being imported.
 Ad valorem duty: a tariff based on a percentage of
the value of imported goods.
 Compound duty: a tariff consisting of both a
specific and ad valorem duty.
Consumer Surplus
Excess of what a consumer is willing to pay to what he
actually has to pay.
Producer Surplus
Excess of what a supplier is willing to receive at a minimum
amount and what he actually receives.
Demand Curve
Represents a collection of maximum prices a consumer is
willing and able to pay for different quantities of
commodities.
Supply Curve
Represents a collection of maximum prices that suppliers
require to be willing to supply different quantities of
commodities.
Consumer & Producer Surplus Maximize
Once the equilibrium output is reached at the equilibrium
price, all of the mutually beneficial opportunities from trade
between suppliers and demanders will have taken place.
Total gains to the economy from trade is the sum of
consumer and producer surplus

B. Non- Tariff Trade Barrier

 Quota
 Subsidies
Free Trade and Export:
Import Quotas
Domestic producers gain more than domestic consumers
A legal limit on the imported quantity of a good that is
lose.
produced abroad and can be sold in domestic markets
Export Subsidies
Government payments made to domestic firms to
encourage exports.
Closely related to subsidies is dumping.
– A firm or industry sells products on the world market at
prices below the cost of production.
Free Trade and Import:
Domestic consumers gain more than domestic producers
lose.

Law of Supply and Demand

International Trade version
 If the price of a good or service of Country X
increases, the quantity of goods or services offered
by suppliers, foreign and domestic, increases and
vice versa.
 If the prices of the goods of Country X increases,
the demand for those goods will decrease and the
demand of the goods of Country Y which costs less
will increase.

ADVANTAGES AND DISADVANTAGES OF INTERNATIONAL

TRADE
Advantages of International Trade
 Leads to more efficient resource allocation and lower
cost per unit of output as the market becomes bigger
and broader to exercise economies of scale, etc.
 Non-economic advantages like political, social and
cultural advantages to be gained by fostering trade in
international organizations like WTO, etc.
 It helps to widen the range of choice of goods or
products
 It allows the transfer of knowledge, technologies and
information between trading partners
 It enables the countries to specialization which increases
the world output and standard of living
 It increases the need to become efficient and effective in
the production process because of competition
 It stimulates research and development policies and
more rapid adoption of new technology to reduce cost
of production

Disadvantages of International Trade

 One may need to wait for long term gains
 Hiring professional staffs to launch international trade is
timely and costly to do
 Modifying product or packaging
 Develop new promotional material
 Incur added administrative costs
 Dealing with special licenses and regulations
 Apply for additional financing