LESSON 8

PART III: AN OVERVIEW OF MACROECONOMICS

LEARNING OUTCOMES
At the end of the lesson the students, were able to
 valued the roles of each sector to the economy in achieving the potential goals of the country; and
 valued the measurement of income and output to the development and growth of the country.
 relate the economic theories and concepts in outstanding economic issues; and
 analyze the policies and its implication to the issues.
 Identify and differentiate the different policy a government uses in managing the market
system and economic system

CHAPTER 6: MEASURING THE ECONOMY

An entrepreneur or a business firm who wants success in their business performance also shows
eagerness to understand how the performance of the economy is measured.

MEASURES OF INCOME AND OUTPUT

¬ It is used in assessing the Economy’s performance

¬ National Income Accounting measures the economy’s overall performance. It operates in much the
same way for the economy as whole.

Common Economic Goals and Major Issues of Countries

1. Economic growth – increase in the number goods and services produced in the country
2. Economic development – improvement of the quality of life of the people or a higher standard of living
3. Full employment –provide suitable jobs for all citizens who are willing and able to work
4. Economic efficiency – achieve the maximum fulfillment of wants using the available productive resources.
5. Price stability – avoid upswings and downswings in the general price level, that is, avoid inflation and
deflation
6. Economic freedom – guarantee that business, workers, and consumers have a high degree of freedom
in their economic activities
7. Economic security – to assure the fulfillment of economic needs of every member of society, including
the handicapped.
8. Equitable distribution of income
9. Balance of trade – seek a reasonable overall balance with the rest of the world in international trade and
financial transactions.

The Circular Flow of Income

 It is an interrelated web that shows how an income and output is generated from and among the different
sectors and their different activities. Thus, it shows how the goods and services are distributed among
the different sectors of the economy
 It shows the development of the two basic flows, one of which is the real flow or flow of goods, services
and resources and the other is the money flow, which came about when money became a medium of
exchange.

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The Four Sectors of the Economy

Household Sectors
¬ are the largest private sectors of the economy whose role is to provide the economic resources for the
economy. They are the ultimate consumers of final goods and services, which is their function.
¬ They represent the consumers

Business sectors
¬ are also one of the private sectors whose role is to convert the resources into final goods and services,
provide jobs for the economy especially investments. They are the producers and suppliers of the final
goods and services, which is their function.

Government sectors
¬ they are the public sectors that provide public services and goods to its constituents. They regulate the
economy to balance the private and the public sectors, which is their ultimate function.

Foreign sectors/Rest of the world

¬ they are other economies which have also a household, business and government sectors that performs
also their own duties. They are responsible for every external activity performed outside the country.

Figure 15: the circular flow of income

Import payment
Taxes

Savings

PM

HS BS
FM GS FS

RM

Investment
Government spending

Export payment

Gross Domestic Product

 The primary measure of economy’s performance is its annual total output of goods and services as it is
called aggregate output. Aggregate output is labeled gross domestic product: the total market value of
all final goods and services produced in a given year.
 It includes all goods and services produced by either a citizen – supplied or foreign – supplied resources
employed within the country.

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Gross National Income

 Another way to measure the economy’s performance which is a sum of all the final market value of goods
and services in a given economy during a given period. It is the sum of all final goods and services produced
by the citizens in a given period of time.

 Included in the GDP or GNI are only final goods and services or the final market value. WHY?

¬ To avoid multiple counting (avoid double counting). Intermediate goods are goods and services that
are purchased for resale or for further processing or manufacturing. Final goods are goods and services
that are purchased for final use by the consumer.
¬ GDP and GNI must be a monetary measure because without such a measure we could not compare the
relative values of different goods and services produced in different years.
¬ GDP/GNI excludes nonproduction transactions because they have nothing to do with the generations of
final goods. Non production transactions are of two types: purely financial transactions and second hand
sales.

Three ways of looking at GDP/GNI

 Expenditure Approach/Product Approach

 Using this approach, we add up all the spending in final goods and services that has occurred throughout
the year.
 It has 4 major components:
• Personal consumption expenditure of goods and services. This constitutes the largest share of the
nation’s output which includes all the household final purchases of:
o durable consumer goods
o non – durable consumer goods
o services

• Investment (gross private domestic investments). This is the sum of the expenditure on equipment,
structure and inventories. It is also called capital formation or business spending which includes the
following:
o Inventories = unconsumed outputs
o All final purchases of machineries, tools and equipment
o All constructions including residential construction

• Government spending. It is the sum of expenditures incurred by the government. This includes the
following
o salaries and wages of public servants and daily operations (government payroll)
o national government and local spending
o payments of debts

• Net exports. (Export – Import). This is the difference between export and imports. It is either positive
or negative.
o private consumption of goods and services
o investment goods
o government consumption of goods and services
o exports less imports

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 Table 7: GNI (Expenditure Approach)

Household or personal consumption expenditure

+ Gross Domestic capital formation (I)
+ Government Purchases of Goods and Services (G)
± Net Export
+ Statistical Discrepancy
= Gross Domestic Product
+ Net Factor Income Abroad
= Gross National Income

 Income Approach

 An approach measuring the GDP/GNI using the earnings of the household sectors that they receive from
the business sectors as payment for the economic resources.
 A component for this approach includes all income received as the owners of the economic resources
known as the factor payments. But not only the households that receives income but also the
government sector and the business sectors.
 It includes: salaries or wages to labor, rent paid for allowing the use of one’s property, profits and
dividends paid to capital., interest income for the payment that flows from the business enterprises to
owners of monetary capital
 It also includes indirect business taxes which are levied on businesses in the government. These includes
the following:
o general sales tax
o excise tax
o customs duties
o license fees
o business property tax

 Depreciation allowances of all businesses. Depreciation is the allowances for the wear and tear of
machinery tools and equipment.

Table 8: GNI (Income Approach)

Compensation of employees
Private compensation of employees
Public compensation of employees
+ Entrepreneurial and property income of
persons
+ Government income from entrepreneurial
and property
+ Corporate Income
Corporate tax
Corporate savings (dividends)
= Net operating surplus
+ Indirect taxes
+ Depreciation
- subsidies
+ Import duties and taxes
= Gross domestic Product
+ Net factor income abroad
= Gross National Income

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 Value-added Approach/Industrial Origin Approach

 It is an approach that determines the GDP/GNI by determining the sum of the market value of the total
production of all the major industries comprising the economy.

Table 9: GNI (value added-approach)

Agriculture, Fisher and Forestry sector

+ Industry Sector
Mining
Manufacturing
Construction
Electricity, Gas and Water
+ Service Sector
Transportation, Communication and Storage
Trade
Finance
Owners Dwelling and Real Estate
Service (Private & Government)
= Gross Domestic Product
- Factor Income from the Rest of the World
= Gross National Income

REAL GDP vs. NOMINAL GDP

¬ In determining the GDP, we usually use prices to determine the market value of goods and services.
Thus, it uses either a constant price or a current price.

Nominal GDP
 It is the sum of all goods and services at current price. It is a GDP based on the prices that prevailed
when the output was produced.
 This kind of price measurement shows a GDP increase but not an increase in the number or goods and
services. An increase that is due to the price increase not on the output being produced.

Real GDP
 It is the sum value of all final goods and services at a constant price. With this method, the price that is
used in computing the real GDP uses a specified base year
 In this measure of GDP, the effects of price changes are eliminated so as to arrive at GDP values which
reflect only changes in quantity

METHODS USE

Nominal GDP = PN x QN
Real GDP = PO x QN
Where Po = price of the base year
QN = quantity of the current year
PN = price of the current year
QO = quantity of the base year

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 𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁 𝐺𝐺𝐺𝐺𝐺𝐺
Price Index = or
𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 𝐺𝐺𝐺𝐺𝐺𝐺

𝑝𝑝𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟 𝑖𝑖𝑖𝑖 𝑎𝑎𝑎𝑎𝑎𝑎 𝑔𝑔𝑔𝑔𝑔𝑔𝑔𝑔𝑔𝑔 𝑦𝑦𝑦𝑦𝑦𝑦𝑦𝑦

= x 100
𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝 𝑖𝑖𝑖𝑖 𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏 𝑦𝑦𝑦𝑦𝑦𝑦𝑦𝑦

Example
Table 10: hypothetical data for nominal GDP

year quantity price GDP

2010 2,000 15 30,000
2011 2,500 30 75,000
2012 3,000 45 135,000
2013 3,600 60 216,000
2014 4,000 75 300,000
2015 4,800 80 384,000
2016 5,000 95 475,000

What if the base year is the year 2014 what is the real GDP?

Table 11: deriving real GDP

year quantity price GDP

2010 2000 15 160,000
2011 2500 30 200,000
2012 3000 45 240,000
2013 3600 60 288,000
2014 4000 75 320,000
2015 4800 80 384,000
2016 5000 95 400,000

• To determine if the effect of price deflated or inflated

We use the Price Index which if GDP deflator

Price Index
 Must reflect well the average increase in prices of all the goods and services using the prices of the given
year

GDP Deflator
 This means that deflating the price refers to the process of removing the price effect of current figures
so as to arrive at real values or measures stated constant price.
 When the value of GDP deflator is higher than one or more than 100%, then inflation has occurred in
the current year. That is why, it is known to reflect the real purchasing power of money and the real
increase in the production.

𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛 𝐺𝐺𝐺𝐺𝐺𝐺
𝐺𝐺𝐺𝐺𝐺𝐺 𝐷𝐷𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒 =
𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟 𝐺𝐺𝐺𝐺𝐺𝐺

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 Table 12: deriving price index

current year/base year

year price index
price
2010 (15/80) x 100 18.75
2011 (30/80) x 100 37.5
2012 (45/80) x 100 56.25
2013 (60/80) x 100 75
2014 (75/80) x 100 93.75
2015 (80/80) X 100 100

For specification
Example:
Table 12: deriving price index

product year 1 year 2

price quantity price quantity
food 125 1000 120 1200
clothing 180 800 160 900
real
110 M 450 80M 540
estates

Nominal GDP YR 1 = PN x Q N

= (125 x10000) + (180 x 8000) + (110M x 4500)

= 125,000 + 144, 000 + 49,500M
= 318500

Nominal GDP YR 2 = PN x Q N

= (120 x 1200) + (180 x 900) + (110M x 540)

= 144, 00 + 147, 200 + 43, 200
= 334. 400

Base year is year 1

Real GDP YR 2 = PO x Q N

= (125 x 1200) + (180 x 900) + (110M x 540)

= 150,000 + 165, 600 + 59, 400
= 375, 000

Price Index YR 2 = nominal / real GDP

334,400
= x 100
375,000
= 0.891733 or 89.17333%

The result means that the price of the year one was deflated in year 2. Thus, what you can buy at year one can
now be bought at .89¢

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 THE MAJOR MACROECONOMIC ISSUES

GN figure 16: phases of the business

cycle
30 peak
recession
25
20
15
10 expansion
5 trough
0
TIM
0 20 40 60

A. INFLATION
 It is sustained, relatively large and general increase in prices in all or nearly all of the market in the
economy. It is expresses in a single average percentage rise in overall prices in the economy from one
period to another (usually, a year).

Causes of Inflation

1. Demand – pull inflation

 “too much spending chasing too few goods” is the description of demand-pull inflation
 It occurs when the level of spending in the economy exceeds the amount firms are capable of
producing.
 When this issue occurs, each peso value of income will buy fewer goods and services than before. It
also reduces the purchasing power of the money.

2. Cost – push inflation

 This is an inflation that occurs more due to the supply side of the economy that push up the cost of
production and force firms to raise prices
 It occurs when vital resource become scarce, causing its price to rise which explains the rising prices
in terms of factors that raise per-unit production costs at each level of spending.
 If increase in wage is the reason for the commodity prices to increase, then it is called wage-push
inflation. If the raw materials needed in the production are the reason for the general price to increase
then it is called commodity-push inflation, but if it is due to the desire of the firm to have higher
sales revenue to acquire more profit then it is called profit-push inflation.

B. DEFLATION
 This occurs when the general prices are declining over time.
 Deflation is not good to the economy because producers will lose and eventually shut-down their
business, because a substantial decrease in price will eventually affect individuals’ incomes.
 The long term effect of deflation is depressions.

C. UNEMPLOYMENT
 It is a condition of people who are able and willing to work but cannot find jobs.
 Unemployment rate is measured from the labor force

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 Figure 16: the total population bracket

Under 15 and/or
institutionalized; these are
Labor
mentally ill and children
force
Not in the labor force;
Total involuntarily unemployed, full-
popula time students, retirees and
tion homemakers

Employed; 15 – 65 yrs. of age

who are willing and able to work
Unemployed: willing and able
to work and seeking for jobs

TYPES OF UNEM PLOYM ENT

1. Unavoidable unemployment
a. Frictional unemployment
¬ This occurs due to the maladjustments in the economic and productive activities. It is a temporary
unemployment which happens for a number of reasons like workers are “between jobs”, moving from
one job to another, those who are fired and will be seeking for jobs, etc.
b. Structural unemployment
¬ This type of unemployment occurs when the location and qualifications of the labor force does not
match the available jobs. Usually this happens when the economy undergoes structural changes that
affects the labor force
¬ It is due to composition of the economy like geographical reason, occupational reason (mismatch of
jobs and skills) and technological change.

c. Cyclical unemployment
¬ Unemployment caused by the recession phase of the business cycle.
¬ It is caused by inadequate total spending. As the demand of goods and services decline, employment
falls and unemployment rises. For this reason, it is sometimes called as demand-deficient
unemployment

2. Avoidable unemployment
a. Disguised unemployment
¬ It is a situation where the productivity of the working force is very low because the number of workers
is more than what is optimally desired
b. Seasonal unemployment
¬ This condition is likely to exist in such productive activities, which can be undertaken only during a
specific season.
c. Classical unemployment
¬ This results from the legislative decisions of the government and /or economic choices made by the
labor unions and/or political parties.
¬ This is either a voluntary unemployment and involuntary unemployment

D. Economic productivity and development

 This issue occurs when the economy does not produce the optimum output needed by the people. It is
also the imbalances to the different expenditures and incomes of the economy
 And if the later three issues were not resolved then it may also cause an inefficient production to the
economy creating an underdeveloped economy and lower economic growth.
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