MACROECONOMICS

LEVEL OF OVERALL ECONOMIC ACTIVITY

NATIONAL INCOME
The level of overall economic

The five main macroeconomic goals:

Economic Growth –a steady rate of increase of
national output
Employment- a low level of unemployment
Price Stability- a low and stable rate of inflation
External Stability- a favorable balance of payments
position
Income Distribution- an equitable distribution on
income
 The level of overall economic
◻ Economic growth
An increase in real GDP or an increase in the quantity of
resources
Gross Domestic Product (GDP) is often used to measure
economic growth
◻ Economic development
A qualitative measure of a country's standard of living which
takes into account numerous factors such as education and
health
The Human Development Index is normally used to measure a
country's economic development
◻ Sustainable development
The rate at which a country can develop without
compromising the needs of future generations
 1.Explain, using a diagram, the circular flow of income between
households and firms in a closed economy with no government.

The circular flow of income between households

and firms in a closed economy means that it has
no links with other countries (it is ‘closed’ to
international trade), and is also a model of an
economy with no government.
It is assumed that the only decision makers are
households and firms. Households and firms are
linked together through two markets: product
markets and resource markets.
 1.Explain, using a diagram, the circular flow of income between
households and firms in a closed economy with no government.

Households are owners of the four factors of production: land,

labor, capital and entrepreneurship.
Firms buy the factors of production in resource markets and use
them in the produce goods and services.
They then sell the goods and services to consumers in the product
markets.
When households sell their factors of production to firms, they
receive payments taking the form of rent for land, wages for
labor, interest for capital and profit for entrepreneurship.
These payments are the income of households.
The payments that households make to buy goods and services are
household expenditures and the payment that firms make to buy
the factors of production represent their cost of production.
The payment the firm receives is their revenue.
 1.Explain, using a diagram, the circular flow of income between
households and firms in a closed economy with no government.

This model demonstrates an important principle: the income

flow from firms to households is equal to the expenditure
flow from households to firms. In other words, the
household incomes comes from the sale of all the factors of
production equals the expenditures by households on goods
and services.
In addition, these two flows must equal to the value of goods
and services, or the value of total output produced by the
firms, known as the value of output flow.
The circular flow of income shows that in any given time
period, the value of output produced in an economy is equal
to the total income generated in producing that output, which
is equal to the expenditures made to purchase that output.
1.Explain, using a diagram, the circular flow of income between
households and firms in a closed economy with no government.
2. Identify the four factors of production and their respective
payments (rent, wages, interest and profit) and explain that these
constitute the income flow in the model.

Factors of production:
◻ Basic components or inputs which are required in the production of goods and services
Land: Rent
◻ Gifts of nature, this includes everything on the land, under the land, above the land, or in the
sea (e.g., oil, water)
Labor: Wages
◻ The human component hired to assist in producing a good or service. Simply the number of
hours of work put in by a person
Capital: Interest
◻ Any man-made aid to production. It is physical plant, machinery, equipment and buildings; it
is not the money that you invest in the stock market
Entrepreneurship: Profit
◻ Combines the other factors and takes risks recognizing the possibility of gain from employing
these factors in a specific way. An entrepreneur is the one who sees an economic
opportunity and mixes land, labor and capital together to produce a product with economic
value.
3. Outline that the income flow is numerically equivalent
to the expenditure flow and the value of output flow.

The circular flow model illustrates the essential idea

that all spending in the economy will roughly equal all
the income received.
Thus we can say that spending on output must, at the
same time, represent income to the factor of
production.
Economist have three main methods of counting
national income:
◻ The spending (expenditure) approach

◻ The income approach

◻ The output approach

3. Outline that the income flow is numerically equivalent
to the expenditure flow and the value of output flow.

Three equivalent measures of national income:

Income: takes into account wages and salaries, rent, interest,

self-employed income and adds up to make total domestic income. Wages
for labor, Interest for capital, Rent for land and Profits for entrepreneurship.
National Income = Wages + Interest + Rent + Profit
(W+I+R+P)

Expenditure: Takes into account all spending in an economy.

National Expenditures = Consumption spending + Investment spending
+ Government spending + [ Exports – Imports] C+I+G+[X-M]

Output: Takes into account everything which is produced in an economy.

National output = Outputs of the primary sector + the secondary
sector + the tertiary sector
4. Explain, using a diagram, the circular flow of income in an open economy with
government and financial markets, referring to leakages/ withdrawals (savings, taxes and
import expenditure) and injections (investment, government expenditure and export revenue).

Injections and Leakages Model:

One half of the injections-leakages model is injections, which are
non-consumption expenditures on aggregate production. The three
injections are investment expenditures, government purchases, and
exports. These are termed injections because they are "injected" into the
core circular flow of consumption, production, and income.
The other half of the injections-leakages model is leakages, which are
non-consumption uses of the income generated from production. The three
leakages are saving, taxes, and imports. These are termed leakages
because they are "leaked" out of the core circular flow of consumption,
production, and income.
Equilibrium in the injections-leakages model relies on a balance between
the injections into the core circular flow and leakages out of the flow.
If leakages match injections, then the volume of the core circular flow does
not change.
4. Explain, using a diagram, the circular flow of income in an open economy with
government and financial markets, referring to leakages/ withdrawals (savings, taxes and
import expenditure) and injections (investment, government expenditure and export revenue).

Savings is part of consumers

income that is not spent but saved.
Investment is spending by firms
for the production of capital goods.
Savings represents a leakage
because it is income that is not spent
to buy goods and services.
Households place their savings in
financial markets. Firms obtain
funds from financial markets to
finance investment, or the
production of capital goods. These
funds therefore flow back into the
expenditure flow as injections.
4. Explain, using a diagram, the circular flow of income in an open economy with
government and financial markets, referring to leakages/ withdrawals (savings, taxes and
import expenditure) and injections (investment, government expenditure and export revenue).

Taxes and government

spending are connected to
each other through the
government. Taxes are a
leakage because it is income
that is not spend to buy goods
and services. The government
uses the tax funds to finance
government expenditures
and this spending is injection
back into the expenditure
flow.
4. Explain, using a diagram, the circular flow of income in an open economy with
government and financial markets, referring to leakages/ withdrawals (savings, taxes and
import expenditure) and injections (investment, government expenditure and export revenue).

Imports and exports are linked

together through ‘other
countries’. Imports are a
leakage because they represent
households spending that leaks
out as payments to the other
countries that produced the
goods and services.
Exports are an injection
because they are spending by
foreigners who buy goods and
services produced by the
domestic firms.
4. Explain, using a diagram, the circular flow of income in an open economy with government and
financial markets, referring to leakages/ withdrawals (savings, taxes and import expenditure) and
injections (investment, government expenditure and export revenue).
5. Explain how the size of the circular flow will change
depending on the relative size of injections and leakages.

The critical implication from the circular flow is that a

balance between injections and leakages maintains a
constant flow of income, consumption, production, and
factor payments moving between the household and
business sectors.
This is the essence of macroeconomic equilibrium -- the
level of aggregate production remains unchanged.
However, if injections exceed leakages, then the volume of
the basic flow expands and aggregate production increases.
The size of the circular flow becomes bigger,
Alternatively, if leakages exceed injections, then the
volume of the basic flow contracts and aggregate production
decreases. The size of the circular flow becomes smaller.
6. Distinguish between GDP and GNP/GNI as
measures of economic activity.

Gross domestic product (GDP) is the market value of

all officially recognized final goods and services
produced within a country in a given period.
The term ‘domestic’ in ‘gross domestic product’ means
that output has been produced by factors of production
within the country, regardless of who owns them
(residents or foreigners).
GDP can be determined in three ways, all of which
should, in principle, give the same result. They are the
product (or output) approach, the income approach, and
the expenditure approach.
 6. Distinguish between GDP and GNP/GNI as
measures of economic activity.

Gross National Income (GNI) or Gross National Product

(GNP)
Is the total value of goods and services produced by a
country per year plus net income earned abroad by its
nationals; formerly called "gross national product.“
The term ‘national’ in GNI means that the income it
measures is the income of the country’s residents,
regardless where this income comes from.
The difference between GNI and GDP is the value of
any net property income from abroad.
6. Distinguish between GDP and GNP/GNI as
measures of economic activity.

GDP can be contrasted with gross national product (GNP) or gross

national income (GNI). The difference is that GDP defines its scope
according to location, while GNP/ GNI defines its scope according to
ownership.
GDP is product produced within a country's borders; GNP/ GNI is
product produced by enterprises owned by a country's citizens. The
two would be the same if all of the productive enterprises in a country
were owned by its own citizens, but foreign ownership makes GDP and
GNP/ GNI non-identical.
Production within a country's borders, but by an enterprise owned by
somebody outside the country, counts as part of its GDP but not its
GNP/GNI; on the other hand, production by an enterprise located
outside the country, but owned by one of its citizens, counts as part of its
GNP/GNI but not its GDP.
7. Distinguish between the nominal value of GDP and GNP/GNI
and the real value of GDP and GNP/GNI

Nominal gross domestic product is defined as the market

value of all final goods and services produced in a geographical
region, usually a country.
That market value depends on two things: the actual quantities
of goods and services produced and their respective prices .
Nominal GDP = Real GDP x Price Levels
Nominal GDP or GNI is measured in terms of current prices
(prices at the time of measurement), which does not account for
changes in prices.
Nominal GDP is nation’s output produced in a year along with
price level. (Base year)
 7. Distinguish between the nominal value of GDP and
GNP/GNI and the real value of GDP and GNP/GNI

Real gross domestic product (GDP) is a macroeconomic measure of

the value of output economy adjusted for price changes (that is,
inflation or deflation). The adjustment transforms the money-value
measure, called nominal GDP into an index for quantity of total
output.
Real GDP or GNI are measures of economic activity that have
eliminated the influence of changes in prices.
When a variable is being compared over time, it is important to use
real values.
Real GDP the value of a nation’s output in a particular year adjusted
for changes in the price level from a base year.
Real GDP Offers a more accurate measure of actual quantity of
goods and services a nation’s produces because it adjusts for price
changes.
Real GDP is nation’s output produced in a year minus inflation.
 8. Distinguish between total GDP and GNP/GNI and
per capita GDP and GNP/GNI.

Per capita means per person or per head. A per capita

measure takes the total value (of output, income, expenditure,
etc.) and divides this by the total population of a country.
GDP Per capita measures the total GDP of a nation divided
by the total population.
Gives a more realistic measure of a nations standard of living,
because it provides an indication of how much of total output
in the economy corresponds to each person in the population
on average.
Total GDP is intended to be a measure of total national
economic activity—a separate concept from standard of
living
 8. Distinguish between total GDP and GNP/GNI and
per capita GDP and GNP/GNI.

The distinction between total and per capita measures is very

important for two reasons:
Differing population sizes across countries.
Countries with similar total GDP’s but vastly different
populations will have far different per capita GDP’s which can
help give a better picture of a countries standard of living.
Population growth.
Changes in the size of GDP per capita over time depend very
much on the relationship between growth in total GDP and
growth in population.
In general, if total GDP increases faster than the population,
then GDP per capita increases. But if the country’s population
increases faster than total GDP, then GDP per capita falls.
8. Distinguish between total GDP and GNP/GNI and per
capita GDP and GNP/GNI.

Distinction between gross and net:

Investment, as we know, refers to spending by businesses on capital
goods. Total investment is known as gross investment, and is divided
into two parts:
❑ The part that goes toward replacing thrown-out capital goods
(depreciation)
❑ The part that consist of new additional of capital goods, known as
net investment.
GDP measures an economy’s total output, and therefore includes total
spending on capital goods, including replacement of depreciated capital
and new additions to capital goods.
Net Domestic Product (NDP), takes out spending on replacing capital
goods from GDP.
NDP = C + In + G + [X – M] Where In = net investment.
NDP = GDP – depreciation
9. Examine the output approach, the income approach and the
expenditure approach when measuring national income.

There are three ways of calculating GDP - all of which

should sum to the same amount:
National Output = National Expenditure (Aggregate
Demand) = National Income
The Expenditure Method = aggregate demand (AD)
The full equation for GDP using this approach is
GDP = C + I + G + (X-M) where
C: Household spending – Consumption
I: Capital Investment spending – Business Spending
G: Government spending
X: Exports of Goods and Services
M: Imports of Goods and Services
9. Examine the output approach, the income approach and the
expenditure approach when measuring national income.

The Income Method – adding together factor incomes

GDP is the sum of the incomes earned through the production of goods and services.
This is: GDP = Wage + Rent + Interest + Profit GDP=W + R + I + P
Income from people in jobs and in self-employment (+) Profits of private sector
businesses (+) Rent income from the ownership of land + Interest form the payment
of capital (=) Gross Domestic product (by factor incomes)
Only those incomes that are come from the production of goods and services are
included in the calculation of GDP by the income approach. We exclude:
◻ Transfer payments e.g. the state pension; income support for families on low
incomes; the Jobseekers’ Allowance for the unemployed and other welfare
assistance such housing benefit
◻ Private transfers of money from one individual to another
◻ Income not registered with the tax authorities Every year, billions of pounds
worth of activity is not declared to the tax authorities. This is known as the shadow
economy.
◻ Published figures for GDP by factor incomes will be inaccurate because much
activity is not officially recorded – including subsistence farming and barter
transactions
 Evaluate the use of national income statistics, including their use for making
comparisons over time, their use for making comparisons between countries and their
use for making conclusions about standards of living.

GNI is the gross national Income which means the value of output produced
domestically and the value of output from external resources owned by the economy.
It is calculated by the following equation:

GNI = GDP + Net Property Income from abroad.

Net property Income from abroad means the difference between inflows and outflows
of income in the form of profits or remittances.

NNI is the net national Income which is GNI out of which replacement investment has
been deducted. This is done because the capital formation which is being done to
replace depreciated capital should not be accounted in the output of the current year.
So equation for NNI is as follows:

NNI = GNI – Replacement Investment.

Evaluate the use of national income statistics, including their use for making
comparisons over time, their use for making comparisons between countries and
their use for making conclusions about standards of living.

Why measures of the value of output (GDP/GNI) cannot

accurately measure standard of living:
❑ GDP and GNI make no distinctions about the
composition of output.
❑ GDP and GNI cannot reflect achievements in levels of
education, health and life expectancy.
❑ GDP and GNI provide no information on the
distribution of income and output.
❑ GDP and GNI do not take into account increased leisure.

❑ GDP and GNI do not account for quality of life factors.

 Explain the meaning and significance of “green GDP”, a measure
of GDP that accounts for environmental destruction.

Green GDP is an attempt by economists to measure the growth of an economy

compared to the harm production does to the environment.
This is done by subtracting the costs of environmental and ecological damage done
in a specific period of time from the gross domestic product, or GDP, from that
some time.
As a result, the damage done to the environment as a whole is factored into the
equation to give a clearer picture of the consequences of growing an economy.
Unfortunately, green GDP can be difficult to measure because of the problems
inherent in trying to quantify the costs of ecological and environmental damage.
Environmental concerns have come to the forefront of nearly every aspect of life,
as people become increasingly concerned with depleted natural resources and
polluted environments.
These concerns are often not taken into consideration when measuring the strength
of an economy.
The gross domestic product, which is a measurement of both the consumption and
production within a country, isn't meant to encompass these environmental issues.
As a result, green GDP has been at the forefront of efforts to marry economic and
environmental concerns.
Explain, using a business cycle diagram, that economies typically
tend to go through a cyclical pattern characterized by the phases of
the business cycle.

Concept video: Economic Breakdown

Song
 15. Explain, using a business cycle diagram, that economies typically
tend to go through a cyclical pattern characterized by the phases of the
business cycle.

The Stages of the Business Cycle:

◻ There are four stages that describe the business cycle.

At any point in time you are in one of these stages:

◻ Contraction - When the economy starts slowing

down.
◻ Trough - When the economy hits bottom, usually in a

recession.
◻ Expansion - When the economy starts growing again.

◻ Peak - When the economy is in a state of "irrational

exuberance."
 15. Explain, using a business cycle diagram, that economies typically
tend to go through a cyclical pattern characterized by the phases of the
business cycle.

A business cycle is characterized by fluctuations in the overall

economic activity of an economy.
Real GDP does not go up in a straight line. Real GDP growth is
followed by a period of economic slowdown or decline.
So the business cycle is a period of growth followed by contraction –
the cycle then repeats.
Periods of declining (but not necessarily negative) real GDP and
rising unemployment are referred to as recessions.
A widely accepted definition of a recession is two or more
consecutive quarters of a decline in real GDP.
A depression is a very severe recession characterized by negative real
GDP (a very sharp decline in economic activity) and unusually high
unemployment.
Business cycles tend to be irregular in duration and magnitude.
 15. Explain, using a business cycle diagram, that economies typically
tend to go through a cyclical pattern characterized by the phases of the
business cycle.

To date, economists believe that there are five causes of the business cycle.

The first cause is changes in capital expenditures. When the

economy is strong, businesses have expectations of sales growth;
they invest heavily in capital goods.
After a while, businesses may decide that they have expanded to
their limit, so they begin to pull back on their capital investments
and cause an eventual recession.
The second cause of the business cycle is inventory adjustments.
At the first sign of an economy reaching its peak, there are some
businesses that cut back their inventories and then build them back
up again at the first sign of a trough. Either action causes the real
GDP to fluctuate.
 15. Explain, using a business cycle diagram, that economies typically
tend to go through a cyclical pattern characterized by the phases of the
business cycle.

Innovation and imitation are the third causes of the business

cycle. Innovations include new products, new inventions, or a new
way of performing a task.
When a business innovates, it often gains an edge on its
competitors because its costs decrease or its sales increase.
Whatever the case, profits increase and the business grows.
If other business in the same industry want to keep up, they then
copy what the innovator has done (imitation) or they come up with
something better.
Imitation companies usually invest heavily and an investment
boom follows. Once the innovation spreads to another industry, the
situation changes. Further investments are unnecessary and
economic activity may slow.
 15. Explain, using a business cycle diagram, that economies typically
tend to go through a cyclical pattern characterized by the phases of the
business cycle.

The fourth cause of the business cycle are the credit and loan
policies of commercial banking.

When "easy money" policies are in effect, interest rates are low
and loans are easy to get. They encourage the private sector to
borrow and invest, thus stimulating the economy.
Eventually the increased demand for loans causes the interest rates
to rise, which discourage new borrowers. As borrowing and
spending slow down, the level of economic activity declines.
The economy keeps declining until interest rates fall and the
business cycle begins over again.
 15. Explain, using a business cycle diagram, that economies typically
tend to go through a cyclical pattern characterized by the phases of the
business cycle.

The fifth and final cause of the business cycle if external

shocks.
Shocks such as increases in oil prices, wars, international
conflict, and natural disasters have the potential to either
drive the economy up, or drive it down.
The economy may benefit when a new supply of natural
resources is discovered. Such was the case with Great Britain
in the 1970's when an oil field was discovered off its coast in
the North Sea. The British economy of course profited
seeing that world oil prices were at an all time high, but the
high prices hurt the United States at the same time.