MACRO ECONOMICS

I. Measures of National Income

A variety of measures of national income and output are used in economics to
estimate total economic activity in a country or region, including gross domestic product
(GDP), gross national product (GNP), net national income (NNI), and adjusted national
income (NNI* adjusted for natural resource depletion). All of the measures are especially
concerned with counting the total amount of goods and services produced within some
boundary. The boundary is usually defined by geography or citizenship, and may also restrict
the goods and services that are counted. For instance, some measures count only goods and
services that are exchanged for money, excluding bartered goods, while other measures
may attempt to include bartered goods by imputing monetary values to them.

Gross Domestic Product

The Gross domestic Product (GDP) is the market value of all final goods and services
produced within a country in a given period of time. The GDP is the officially recognized
totals. The following equation is used to calculate the GDP:
GDP=C+I+G+(X−M)
Written out, the equation for calculating GDP is:
GDP = private consumption + gross investment + government investment + government
spending + (exports – imports).
For the gross domestic product, “gross” means that the GDP measures production
regardless of the various uses to which the product can be put. Production can be used for
immediate consumption, for investment into fixed assets or inventories, or for replacing
fixed assets that have depreciated. “Domestic” means that the measurement of GDP
contains only products from within its borders.
Nominal GDP
The nominal GDP is the value of all the final goods and services that an economy produced
during a given year. It is calculated by using the prices that are current in the year in which
the output is produced. In economics, a nominal value is expressed in monetary terms. For
example, a nominal value can change due to shifts in quantity and price. The nominal GDP
takes into account all of the changes that occurred for all goods and services produced
during a given year. If prices change from one period to the next and the output does not
change, the nominal GDP would change even though the output remained constant.
Real GDP
The real GDP is the total value of all of the final goods and services that an economy
produces during a given year, accounting for inflation. It is calculated using the prices of a
selected base year. To calculate Real GDP, you must determine how much GDP has been
changed by inflation since the base year, and divide out the inflation each year. Real GDP,
therefore, accounts for the fact that if prices change but output doesn’t, nominal GDP
would change.
In economics, real value is not influenced by changes in price, it is only impacted by changes
in quantity. Real values measure the purchasing power net of any price changes over time.
The real GDP determines the purchasing power net of price changes for a given year. Real
GDP accounts for inflation and deflation. It transforms the money-value measure, nominal
GDP, into an index for quantity of total output.
Nominal GDP versus Real GDP
Nominal GDP, or unadjusted GDP, is the market value of all final goods produced in a
geographical region, usually a country. That market value depends on the quantities of
goods and services produced and their respective prices. Therefore, if prices change from
one period to the next but actual output does not, nominal GDP would also change even
though output remained constant.
In contrast, real gross domestic product accounts for price changes that may have occurred
due to inflation. In other words, real GDP is nominal GDP adjusted for inflation. If prices
change from one period to the next but actual output does not, real GDP would be remain
the same. Real GDP reflects changes in real production. If there is no inflation or deflation,
nominal GDP will be the same as real GDP.

Gross National Product

Gross National Product (GNP), is summation of GDP plus receipts of factor income
(wages, profit, and rent) from the rest of the world and subtract payments of factor income
to the rest of the world.
• GNP measures the total income earned by nationals (residents of a nation)
III. Net National Product
To obtain net national product (NNP), we subtract from GNP the depreciation of
capital—the amount of the economy’s stock of plants, equipment, and residential structures
that wears out during the year:

II. Inflation and Deflation

Inflation
Inflation measures how much more expensive a set of goods and services has become
over a certain period, usually a year.
Inflation is the rate of increase in prices over a given period of time. Inflation is
typically a broad measure, such as the overall increase in prices or the increase in the cost
of living in a country.
But it can also be more narrowly calculated—for certain goods, such as food, or for
services, such as a haircut, for example. Whatever the context, inflation represents how
much more expensive the relevant set of goods and/or services has become over a certain
period, most commonly a year.
Deflation
When the overall price level decreases so that inflation rate becomes negative, it is
called deflation. It is the opposite of the often-encountered inflation.
A reduction in money supply or credit availability is the reason for deflation in most
cases. Reduced investment spending by government or individuals may also lead to this
situation. Deflation leads to a problem of increased unemployment due to slack in demand.
Central banks aim to keep the overall price level stable by avoiding situations of
severe deflation/inflation. They may infuse a higher money supply into the economy to
counter- balance the deflationary impact. In most cases, a depression occurs when the
supply of goods is more than that of money.
 III. The Business/Trade Cycle
The term “business cycle” (or economic cycle or boom-bust cycle) refers to
economy-wide fluctuations in production, trade, and general economic activity. From a
conceptual perspective, the business cycle is the upward and downward movements of
levels of GDP (gross domestic product) and refers to the period of expansions and
contractions in the level of economic activities (business fluctuations) around a long-term
growth trend.

Business Cycle Phases

Business cycles are identified as having four distinct phases: expansion, peak,
contraction, and trough.
An expansion is characterized by increasing employment, economic growth, and
upward pressure on prices.
A peak is the highest point of the business cycle, when the economy is producing at
maximum allowable output, employment is at or above full employment, and inflationary
pressures on prices are evident.
Following a peak, the economy typically enters into a correction which is
characterized by a contraction where growth slows, employment declines (unemployment
increases), and pricing pressures subside.
The slowing ceases at the trough and at this point the economy has hit a bottom
from which the next phase of expansion and contraction will emerge.
Business Cycle Fluctuations
Business cycle fluctuations occur around a long-term growth trend and are usually
measured in terms of the growth rate of real gross domestic product.
An expansion is the period from a trough to a peak, and a recession as the period
from a peak to a trough. A recession as “a significant decline in economic activity spread
across the economy, lasting more than a few months, normally visible in real GDP, real
income, employment, industrial production. ” This is significantly different from the
commonly cited definition of a recession being signaled by two consecutive quarters of
decline in real GDP. If the economy does not begin to expand again then the economy may
be considered to be in a state of depression.
Three factors cause each phase of the business cycle: the forces of supply and
demand, the availability of capital, and consumer and investor confidence. 3 The most critical
is confidence in the future—when consumers and investors have faith in the future and
policymakers, the economy tends to expand. It does the opposite when confidence levels
drop.4
Impact on Business Operations
How the business cycle affects business operations may be best explained by looking
at how one business responds to these cycles. Normal Maintenance is a small business that
provides a variety of construction services to homeowners. They specialize in roofing, deck
installations, siding, and general home maintenance. They employ three full-time workers,
who typically work forty hours per week for an average of twelve dollars per hour. The
company has been in business in the same town for than twenty years and has a solid
reputation for quality work and reliability.
Expansion
Normal Maintenance is busy and has recently had to turn down jobs because it lacks
the capacity to do all the work offered. Homeowners now want to make home repairs and
improvements which they had had to put off during the sour economy. With the economy
improving, others are fixing up their homes to sell. Faced with so much demand, the owner
of Normal Maintenance must decide whether to pay his existing workers overtime (which
will increase the costs for each job and reduce profits) or hire additional workers. The
competition for qualified construction labor is steep, and he is concerned that he will have
to pay more than his usual rate of twelve dollars per hour or possibly get workers who are
not as qualified as his current crew. He is, however, able to charge higher prices for his work
because homeowners are experiencing long waits and delays getting bids and jobs
completed. The owner purchases a new truck and invests in additional tools in order to
keep up with the demand for services. Customers are willing to pay more than usual so they
can get the work done. Business is expanding to such an extent that Normal Maintenance
and its suppliers are starting to have trouble obtaining materials such as shingles and siding
because the manufacturers have not kept pace with the economic expansion. In general,
business is great for Normal Maintenance, but the expansion brings challenges.
Peak
At the peak of the business cycle, the economy can be said to be “overheated.” Despite
hiring additional workers, the owner and crews of Normal Maintenance are working seven
days a week and are still unable to keep up with demand. They can’t work any harder or
faster. As a result, the crews are exhausted and the quality of their work is beginning to
decline. Customers leave messages requesting work and services, but the owner is so busy
he doesn’t return phone calls. Jobs are getting started and completed late as the crews
struggle to cover multiple job sites. As a result, customer complaints are on the rise, and the
owner is worried about the long-term reputation of the business. Neither the business nor
the economy can sustain this level of activity, and despite the fact that Normal
Maintenance is making great money, everyone is ready for things to let up a little.
Contraction
As the economy begins to contract, business begins to slow down for Normal Maintenance.
They find that they are caught up on work and they aren’t getting so many phone calls. The
owner is able to reduce his labor costs by cutting back on overtime and eliminate working
on the weekends. When the phone does ring, homeowners are asking for bids on work—not
just placing work orders. Normal Maintenance loses out on several jobs because their bids
are too high. The company begins to look for new suppliers who can provide them with
materials at a cheaper price so they can be more competitive. The building material
companies start offering “deals” and specials to contractors in order to generate sales. In
general, competition for work has increased and some of the businesses that popped up
during the expansion are no longer in the market. In the short term the owner is confident
that he has enough work to keep his crew busy, but he’s concerned that if things don’t pick
up, he might have to lay off some of the less experienced workers.
Trough
On Monday morning, the crew of Normal Maintenance show up to work and the owner has
to send them home: there’s no work for them. During the week before, they worked only
three days, and the owner is down to his original crew of three employees. Several months
ago he laid off the workers hired during the expansion. Although that was a difficult
decision, the owner knows from hard experience that sometimes businesses fail not
because their owners make bad decisions, but because they run out of money during
recessions when there isn’t enough customer demand to sustain them. Without enough
working capital to keep the doors open, some are forced to close down.
Representatives from supply companies are stopping by the office hoping to get an
order for even the smallest quantity of materials. The new truck and tools that the owner
purchased during the boom now sit idle and represent additional debt and costs. The
company’s remaining work comes from people who have decided to fix up their
existing homes because the economy isn’t good enough for them to buy new ones. The
owner increases his advertising budget, hoping to capture any business that might be had.
He is optimistic that Normal Maintenance will weather this economic storm—they’ve done
it before—but he’s worried about his employees paying their bills over the winter.
The owner of Normal Maintenance has been in business for a long time, so he’s had some
experience with the economic cycle. Though each stage has its stressors, he has learned to
plan for them. One thing he knows is that the economy will eventually begin to expand
again and run through the cycle all over again.