CHAPTER 1: MACROECONOMIC FUNDAMENTALS

MACROECONOMICS - The study of how we can best increase our country's

wealth given our available resources of land, labor, and capital, and how
these resources are transformed by entrepreneurs into final goods and
services that we ultimately consume to satisfy our needs and wants.

ROLE OF GOVERNMENT
 The Philippines is a mixed economy with a substantial amount of
government involvement in the form of direct government spending,
taxation, regulation, and monetary policies.
 After the Philippines gained its independence after World War II from the
United States in 1945, the country experienced a dramatic change in
economic beliefs about the role of the private sector and the government.
Afterwards, the role of the government in our country (as well as in
many other countries of the world) increased considerably at the end of
the war.
 Central banks, in particular, took control of the monetary system; labor
unions supported by government legislations gained more influence;
social programs, such as social security and health insurance were
considered necessary; new deal types of government spending (to
artificially create jobs when the economy is slowing down) became usual;
and taxes on income, goods, and services increase rapidly, to fund
growing government expenses and the exponentially growing number of
government employees.
 Public borrowing (both domestic and foreign became the 'in thing'
among developing and developed countries that could not meet target
revenues needed to support government spending.

PRODUCTION POSSIBILITIES FRONTIER

The production possibilities frontier represents the outcome, or the
production combination, that can be produced with a given number of
resources.
For instance, let us say that a very small island country currently availing
itself of 100 hectares of land, 20 types of machinery, and 50 workers, is able
to produce, maximally, 500 farm tractors and 350 tons of rice with these
resources. However, it could also, with the same number of resources,
produce 400 tractors and 500 tons of rice, or 300 tractors and 580 tons of
rice. Numerous other combinations, producing fractions of capital goods and
consumer goods, are possible.

FIVE GOALS OF MACROECONOMIC POLICY

1. Sustained economic growth

2. Price stability
3. Full employment
4. Trade balance
5. Redistribution of income

ECONOMIC GROWTH VS ECONOMIC

DEVELOPMENT
 The term economic growth is defined as the process whereby the
country's real national and per capita income increases over a
long period of time.
 Economic development is defined as a sustained improvement in the
material well-being of society.

POSITIVE VS NORMATIVE
 Positive economic statements are facts or relationships which can be
proven or disproven.
 Normative economic statement is someone's opinion or value judgment
about an economic issue and can never be proven.
 A normative statement is one which people commonly argue about. This
is not to say that a positive statement does not have to be a true
 statement; the statement could be disproven and be a false positive
statement.

EXAMPLES OF POSITIVE ECONOMIC

STATEMENTS
 The national deficit this past year breached the P280 billion mark
 When the value of the dollar falls, the Philippine products imported into
the United States become more expensive.
 Legalizing drugs will lower the prices of drugs and reduce the crime
rate among drug users.

THE CIRCULAR FLOW OF ECONOMIC

ACTIVITIES
CIRCULAR FLOW OF ECONOMIC ACTIVITY
1. Consumers

✓ Consumers play 3 roles in the economy

a. Consumer - user of goods and services. Free to choose. Can spend
now for immediate wants or save for future consumption.
b. Worker - producer of goods and services. Earner of income.
c. Citizen - join with others to make group decisions. Influence laws, pay
taxes, vote. Determine use of public goods and services.
2. Business and Industry

✔ Provides goods and services in return for profit.

4 Components: production, processing, distribution and services
3. Government

✔ Provides legal framework for economic activity. Also is a producer and

consumer as well as an economic force. Can use its economic power to
accomplish socially desirable goals.
4. International Trade
✔Provides better, different, or cheaper goods and services and sources we
need to produce.

THE CIRCULAR FLOW

 The circular flow follows two paths through the economy -- money and
goods and services.
 It shows the interaction between the 4 parts of the economy
consumers, businesses, government, and international trade.

FLOW OF GOODS AND SERVICES

 Individuals provide the factors of production (land, labor, capital,
management).
 Businesses use the factors to produce goods and services.

THE MONEY FLOW

Businesses pay for the factors of production. Individuals buy the goods and
services.
GROSS NATIONAL INCOME
• Gross National Income (GNI) is often used to measure the state of a country's economy.

The method of measuring national income by GNI (Gros National Income) is called
NATIONAL INCOME ACCOUNTING.

National Income Accounting

– is the system used to measure the aggregate income and expenditures for a nation. Despite
certain limitations, the national income accounting system provides a valuable indicator of an
economy's performance.

Importance of Measuring National Income

• According to Campbell R. McConnell and Stanley Brue in their Economics Principles,
Problems, and Policies (1999), the importance of measuring national income is as follows:

1. The system of measuring national income is able to provide an idea about the level of
production of the economy in a particular year and to explain why the country's production is
so high or low.
2. By comparing the national income over a number of years. we can monitor the direction
our economy is taking and know if there is any growth or decline in the country's total
production.
3. The information gathered from the national income will guide economic planners to
develop policies and policies that can improve the lives of the people and increase the
economic performance of the country.
4. If there is no systematic way of measuring national income only speculation will be the
basis without a solid bas the data is unreliable
5. Through National Income Accounting the health of the economy can be measured.

Gross National Product

• The Gross National Product (GNP) is the total market or money value of all final goods and
services produced in an economy by nation's residents (e.g. Filipinos), no matter where are
located.

• Only the value of final goods and services is included in the of GNP and the value of raw
materials is not counted to avoid double counting.

Gross Domestic Product

• The Gross Domestic Product (GDP) is the total market or money value of all final goods
and services produced in an economy over a period of one year. GDP excludes production
abroad by Philippine businesses.

All factors in the production of goods or services, whether foreign or local, located in the
Philippines

3 Important Points to Understand Gross Domestic Product

1. It is measured in market or money value.

2. It only counts new domestic production.
3. It only includes final goods and services.

2. GDP only counts new domestic production.

– National income excludes SECONDHAND TRANSACTIONS and NON-PRODUCTIVE
FINANCIAL TRANSACTIONS.
– Current GDP does not include the sale of a used car or appliance.
– GDP does not count private or public financial transactions. (Example: SSS and CSIS)

3. GDP counts only final goods.

– Finished goods and services produced for the final consumers.
– In order to count only final goods and avoid overstating GDP, national income accountants
must take care not to include intermediate goods.
– Intermediate goods are services used as inputs for the production of final goods

Methods of Measurement of Gross National Income

According to Villegas and Abola (1992), there are three ways to measure Gross
National Income:
(1) expenditure -based approach,
(2) income -based approach, and
(3) method based on industrial origin (industrial origin approach).

1. Expenditure Approach
The total value of goods and services (GDP) is calculated by adding the
expenditure on them across the four different economic sectors.
Four different economic sectors:
Consumption (C) Investment (I) Government (G) Net exports (NX)
• Consumption (C)- household by from domestic producers (not imported goods)
this includes groceries, furniture, and private spending generally
• Investment (I)- expenditure on a new capital for example. A factory used to
produce car.
• Government (G)- government spending, e.g., public roads, schools and hospitals.
• Net exports (NX)- imports exports (x) are goods and services sold to foreign
countries, imports (M) are goods and services bought from foreign countries

Formula in Expenditure Approach:

GDP=C+I+G+(X-M) =C+I+G+NX

2. Industrial Origin/ Value Added Approach

In a way based on industry origin, the Gross Domestic Product of the country
can be measured by combining the total production value of the major industries of
the country. It includes the agricultural, industrial, and service sectors. On the other
hand, if Net Factor Income from Abroad or Net Primary Income is included in the
computation, it can also measure the Gross National Income (GNI) of the country.

Formula in Industrial Origin/Value Added Approach

GDP = AS+IS+ SS
GNI = AS + IS + SS + NFIFA/NPI

3. Income Approach
• This approach measures GDP by adding all the incomes earned by households
in exchange for the factors of production during the period of time.
• The Income approach is also called the capitalization approach because it is the
process of converting an expected income into an indicator of market value.

HOW TO FIND GDP USING INCOME APPROACH

GDP = Compensation of Employees + Rents + Profit + Net Interest + Indirect Taxes
+ Depreciation
FORMULA: GDP=W+R+P+1+IBT+D
• Compensation of Employees (W) - Employee's compensation is the largest of the
national income accounts. Its term used in national accounts, balance of payments
statistics and sometimes in corporate accounts as well. It refers basically to the total
gross wages paid by employers to employees for work done in an accounting period.
• It is the largest slice of the GDP income
• Rental Income of Person (R) -Another source of income received by property
owners who permit other to use their assets during a period of time.
• Profit (P)-Profits include those earned by self-employed proprietorship and
partnership that fund business and the same time, pay themselves for labor services
rendered to their own firms.
• Corporates profit - income earned by stockholders.
• Net Interest (I) -households both receive and pay interest. This is the person who
take out loans to business earn interest income.
• Example of Net interest (PLDT, Housing loans, Credit cards, Car loans, Personal
loans)
• Indirect Business Taxes (IBT) -imposed on goods purchased by consumers.
Ultimately, the burden of paying indirect taxes falls on the consumer, not the business
selling the product. However, the business still has to collect the tax and transmit it to
the government.
• Vat, Excise tax, Indirect tax
• Depreciation (D) -In contrast, the income approach to calculating GDP includes
depreciation because it represents the income earned from the use of capital goods.
• This approach measures GDP by adding up the total income earned by households,
businesses, and the government from the production of goods and services.
GDP Shortcomings
• For the certain reasons, the GDP have certain measures of overall economic
like the basis of government economic policies, but there a concern that the GDP
may be giving us a false impression of the nation's material well-being. We should
remember that the GDP is a less-than-perfect measure of our nation's economic pulse,
because it excludes the Nonmarket Transactions, Neglect of Leisure Time, The
Underground Economy, and Economic Bands.
Nonmarket Transactions
• There are two reasons why nonmarket transactions are excluded from GDP.
1. First, it is extremely difficult for national income accountants to collect data
and assign a peso value to services people provide for themselves or others
without compensation.
2. Second, it is difficult to determine which nonmarket transactions to exclude
and which to include in GDP.
Neglect of Leisure Time
•Generally speaking, the more leisure time a country's citizens can afford, the
wealthier that country is. Therefore, instead of putting in more hours at the office,
workers frequently decide to take more time off for travel and leisure. Therefore,
GDP understates well-being because it doesn't take into account people who work
fewer hours than they once did.

The Underground Economy

• Illegal gambling, prostitution, illegal narcotics, illegal firearms, loan-
sharking and lending, and small-time trading are all goods and services that meet all
GDP requirements. These are final products with market values, but GDP does not
include unreported unlawful activity. As a result, even if the underground economy is
substantial, GDP will still understate an economy's performance. In the Philippines,
for example, it is believed that the underground sector accounts for 40 to 45 percent
of GDP.
Economic Bands
• Greater output means a higher GDP, regardless of the level of pollution
produced. Air, water, and noise pollution are economic bands that impose costs on
society and the environment, but these are not represented in private market pricing
or quantities bought and sold. As a result, when production causes pollution or
environmental damage, GDP might exaggerate a country's well- being.

Current/Nominal at Real/Constant Prices Gross National Product

• Gross National Income at current prices (current or nominal GNI) represents
the total value of finished goods and services produced over a period of time based
on current prices.
• On the other hand, GNI at real or constant prices (real or constant GNI) represent
the total value of finished goods and services produced over a given period based on
past prices or by using base-year.
• In measuring current and real GNI, it is first necessary to know the Price Index. The
Price Index measures the average change in the price of goods and services. We will
be able to find out if there is an increase or decrease in the price of products or
services through the Price Index.
Price Index = (8, 634, 132) / (7,883, 088) x 100 = 109.5
• Real/constant prices GNI is used to measure whether there is really a change or
growth in the country's total production without being affected by price increases.
This can be determined by the formula
Real GNP/GNI =100/109.5 x 8,634,132
= 0.91324201 x 8,634,132
= 7,885,052.05
We will be able to know if there has been economic growth through growth rate. Use
the formula below to measure the growth rate of Gross National Income.
Growth Rate = (current year GNI -previous year GNI) / (previous year
GNI) x 100
• The growth rate measures how much the economy has grown compared to the
previous year.
• When the growth rate is positive it can be said that there is a lift in the country's
economy.
• When the growth rate is negative, it can be said that there has been no lift in the
country's economy and it can be considered that it has become sluggish.