ECO2103

Macroeconomics

© 2022 Singapore Institute of Management Group Lim

 Lecture 1
Introduction to Macroeconomics,
GDP, and Economic Growth

Ref:
Tan Khay Boon, Macroeconomics,
SIM Global Education, 2016
Session 1
2
Learning Outcomes
1. Define Macroeconomics

2. Explain the main issues of Macroeconomics

3. Define and calculate GDP and economic growth

4. Explain the limitation of GDP

5. Distinguish between nominal GDP and real GDP

6. Explain the determinants of average labour productivity

 Microeconomics and
Macroeconomics
 Microeconomics studies
choice and its implications
for price and quantity in
individual markets
 Sugar
 Carpets
 House cleaning services
 Microeconomics considers
topics such as
 Costs of production
 Demand for a product
 Market structures
 Macroeconomics studies
the performance of national
economies and the policies
that governments use to try
to improve that performance
 Inflation
 Unemployment
 Growth
 Macroeconomics considers
 Monetary policy
 Fiscal policy
 International trade
Measuring Output

Gross Domestic Product (GDP) is

The market value of

Final goods and services

Produced in a country in a given

period of time
4-5
Market Value
• GDP only measures market value of output
• Good or service must be transacted through market
e.g. tomatoes, milk, beef purchased from the
supermarket
– Consumption of own produce is not included in GDP
i.e. tomatoes grown in backyard; milk from pet goat;
beef from family’s cattle house
• Goods and services sold directly to customers without
going through the market system not included
– Underground economy (private tuition, contraband
cigarettes) 4-6
Final Output
• Final goods and services are consumed by the ultimate
user
– End products of production
– Only final goods and services included in GDP
• Intermediate goods and services are used up in the
production of final goods and services
– Not included in GDP to avoid double counting
• A car producer buys 4 tyres at $200 to assemble a car that
is sold at $10,000.
– Car’s contribution to GDP is $10,000
– Value of the tyres included in car’s value; therefore not
included in GDP
4-7
 Goods Can Be Final and
Intermediate

• Milk can be sold as a final product or

used as an intermediate good

– Gallons of milk in the store

– Gallons of milk sold to restaurants

– Count only the final goods

4-8
Value Added

• Value added method used to calculate

GDP using all outputs without the problem
of double counting

• Value added is the market value of the

product minus the cost of inputs
purchased from other firms

9
Value Added
Cost of Purchased Value
Company Revenues
Inputs Added
Farmer $1.00 $0.00 $1.00
General Flour $2.20 $1.00 $1.20
Baker $4.00 $2.20 $1.80
Total $4.00

• Count value added in the year it is produced

• Baker buys flour and other inputs to make

bread that sells for $4.00

4-10
Produced in Domestic Economy

• "Domestic" in GDP means production is carried

out within geographical boundary of the country

• Ownership of the producing firms not relevant

– Output by foreign factories in Singapore is

included in Singapore GDP

– Output by Singapore factories in Thailand not

included in Singapore GDP

4-11
Gross National Product
• Gross National Product (GNP) measures
value of output by factor ownership
– Output by foreign firms in Singapore is NOT
included in Singapore GNP
– Output by Singapore firms in Thailand is
included in Singapore GNP
– GNP = GDP + Net factor income from abroad

• GDP more commonly used

12
Time Frame

• GDP is computed based on a 1 year timeframe

• Value must be produced in the year considered
– Sell a 20-year old house for $200,000
• Pay $12,000 commission
• Value added is $12,000
• House was not produced in the period of time studied
• Sale price of the house (used good) not counted

4-13
Calculation of GDP

• Output Approach

• Expenditure Approach

• Income Approach

• All methods give the same value of GDP

14
Output Method
• Measures market value of all final output produced:
∑ Price X Output
Firm Output Price ($) Qty Total Value ($)
A Food 1 1200 1200
B Clothing 2 800 1600
C Computer 300 30 9000
D Cars 10,000 10 100,000

• GDP = $(1200 + 1600 + 9000 + 100, 000) = $111, 800

• Tedious data collection

15
Expenditure Method

• Measures aggregate expenditure by four

users of final goods during the year
 Households (consumption)
 Firms (investment)
 Government (government spending)
 Foreigners (net exports)
• Amount spent = market value of output

4-16
Consumption Expenditure (C)

• Consumption expenditure is spending by

households on goods and services
– Consumer durables are long-lived consumer goods
• Cars • Furniture • Appliances
– Consumer non-durable goods are shorter-lived
goods
• Clothing • Food • Bedding
– Services are the largest component of consumer
spending
• Education • Taxi rides • Haircuts

4-17
Investment (I)
• Investment is spending by firms on final goods and
services
– Business fixed investment is purchases of new
• Plant
capital goods • Property • Equipment
– Residential investment is construction of new homes
and apartment buildings
– Inventory investment is the change in unsold goods
to the company's inventory
 These goods are produced but not yet sold
 This entry can be positive or negative
4-18
Investment (I)
• Financial investment not included in GDP
– Purchases of stocks, bonds, and other financial
assets

– Purchase generally transfers ownership of a

portion of the firm's existing capital stock

– Does not correspond to any increase in physical

capital or production capacity, in most cases
• New stock issues can be an exception

4-19
Government Spending (G)
• Government spending are final goods and
services bought by federal, state, and local
governments
• Fighter jets • Teaching • Office supplies
• Excludes transfer payments
– Transfer payments are made by government but the
government receives no current goods or services
• Social Security • Food Stamps
– No purchases of final goods and services involved in
transfer payments
– Spending by recipients is included in GDP
4-20
Net Exports (NX or X- M)
• Net exports equal exports minus imports
– Exports are goods and services produced
domestically and sold abroad
• Exports reduce the amount available to the domestic
economy
– Imports are purchases in the US of goods and
services produced abroad
• Imports can be consumption, investment, or government
spending
• Imports increase the amount available to the domestic
economy

4-21
GDP Expenditures Equation
Terminology
Y Gross Domestic Product or output
C Consumption Expenditure
I Investment
G Government Purchases
NX Net Exports
• Expenditure approach to measuring GDP

Y = C + I + G + NX
4-22
GDP Example
• Total production is 1 million cars, $15,000 each
• Production value is 1 million times $15,000 =
$15 billion
Sector # Cars Purchased GDP Contribution
Consumers 700,000 $10.500 billion
Businesses
Businesses 225,000
200,000 $3.375
$3.000 billion
billion
Government 50,000 $0.750 billion
Net exports 25,000 $0.375 billion
Total
Total 1,000,000
975,000 $15.000
$14.625 billion
billion

– 25,000 cars are unsold

• Investment in inventories increases by $0.375 billion

4-23
Income Method

Adding total factor earnings from 4 resource types

– Land: Rent obtained from the resource

– Labour: Wages obtained from the resource

– Capital: Interest obtained from the resource

– Entrepreneurship: Profits obtained from the

resource

24
Real GDP and Nominal GDP
• GDP changes over time because
– Prices change OR
– Quantity of output changes OR
– Prices and output changes
• Rise in GDP due to more output is known
as: Economic growth
• Rise in GDP due to mainly price increases is
known as: Inflation
4-25
Real GDP and Nominal GDP
• Real GDP values output in the current year
using the prices from the base year
– The base year is a reference year where price
changes infrequently
– Real GDP measures the physical volume of
production
• Nominal GDP values output in the current year
using prices from the current year
– Nominal GDP is the current dollar value of
production
4-26
Real GDP and Nominal GDP
2012
2013
(Base)
Output Price ($) Qty Price ($) Qty
Food 1 1200 1.20 1250
Clothing 2 800 2.20 830
Computer 300 30 330 35

• Nominal GDP in 2012 = ($1x1200) + ($2x800) + ($300x30) = $11,800

• Nominal GDP in 2013 = ($1.20x1250) + ($2.20x830) + ($330x35) =
$14 876
• Real GDP in 2012 = Nominal GDP in 2012 = $11,800
• Real GDP in 2013 = ($1x1250) + ($2x830) + ($300x35) = $13 410
• Both real and nominal GDP has increased as prices and output
increased
4-27
Real GDP and Nominal GDP
• Nominal GDP growth rate 2012 - 2013:

$14876 - $11800 X100% = 26.07%

$11800

• Real GDP growth rate 2012 – 2013:

$13410 - $11800 X100% = 13.64%

$11800

4-28
Observations on Real and Nominal
GDP
• Usually, nominal and real GDP increase each year
• Nominal GDP can go up and real GDP go down
– Fewer goods and services produced AND
– Prices increase faster than output decreased

• Nominal GDP will be smaller than real GDP if the

prices in the current year are less than in the base
year
– Usually true for years before the base year

4-29
Standard of Living

• Standard of living is a term used to refer

to the well being of people
• 2 aspects to standard of living
– Material well being
– Non-material standard of living

30
GDP and Standard of Living
• GDP measures economic performance of
economy
• Real GDP per capita is used as an
indicator of goods and services consumed
by an average person in the economy
– Real GDP per capita = GDP/Population

• Real GDP per capita is often used as an

indicator to measure standard of living
31
GDP and Standard of Living
• Real GDP per capita is positively associated
with several measures of well-being
– Material standard of living: more goods and
services
– Health and life expectancy
• Residents of industrialized countries fare better than
residents of developing countries in a range of
health measures
– Education
• Literacy and school enrollment rates are higher in
high-income countries
4-32
 GDP and Standard of Living

• Real GDP per capita is a flawed measure of

well-being
– Does not capture the true amount of goods and
services an average person might really get to
enjoy
– Does not take into consideration the non-
material aspect of standard of living

4-33
Nonmarket Economic Activities
• GDP omits services that are not traded in
markets
– Household production
– Volunteer services
• Valuing these services would be difficult
• Nonmarket activities are important in poor
countries
– Self-sufficient households and bartered goods
and services
4-34
Underground Economy
• Underground economy is all unreported transactions,
legal and illegal
• Casual labor is often paid in cash
– Failure to report transaction reduces taxes
– Includes baby sitters, lawn care, home repair, etc.

• Some underground activity is illegal

– A service of value is provided
– Drug dealers, bookies, fences, prostitution, etc

• Estimates suggest the underground economy is large

regardless of national income level
4-35
GDP Does Not Value Leisure

• Leisure produces no goods for market

– GDP places a value of zero on all leisure time

– Opportunity cost of an hour of leisure is your

hourly wage

– Omission of the value of leisure time makes

GDP seem larger
• Higher income may be the result of longer work
hours and therefore less leisure

4-36
Poverty and Economic Inequality

• GDP does not capture the effects of income inequality

• Real GDP per capita assumes everyone gets an equal
share
• Reality might be the case where majority of output is
concentrated with the minority
• Higher GDP does not imply higher welfare
• Real GDP per capita figures can be considered
together with the Gini-coefficient for better
representation
4-37
Production vs Consumption
• GDP records production output while
standard of living is concerned with share of
consumption
• High GDP figures may result from high
production of non-consumer goods that
does not benefit residents
– Approximately 25% of North Korea’s GDP
comes from military expenditure
38
Non-Material Well Being
• GDP does not account for intangibles
people value
– Crime rates
– Environmental Degradation
– Traffic congestion
– Civic organizations
– Open space
– Sense of community
4-39
Real GDP per Capita
• Notation
– Y = real GDP
– L = number of people employed
– POP = population
Y Y L
POP L POP
• Real GDP per capita is the product of output per
worker and the share of the total population that is
working
• Consumption per person depends on
– How much each worker produces and
– The share of people working
Economic Growth

• GDP per capita increases when

– Output per worker (Y / L) increases OR

– The share of the population employed

(L / POP) increases
Economic Growth

• In the long run continuous and sustainable

economic growth depends on raising Y/L
– Average Labour Productivity

• The scope to raise L/POP is limited

– Always a minimum group who are below
working age or do not want to work
(students/housewives)
 Determinants of
Average Labor Productivity
• Six factors determine average labor
productivity
1. Human capital
2. Physical capital
3. Land and other natural resources
4. Technology
5. Entrepreneurship and management
6. Political and legal environment
#1 Human Capital
• Human capital comprises the talents,
education, training, and skills of workers
• Human capital increases workers'
productivity
• No limit for human capital to enhance
output
#2 Physical Capital
• Physical capital comprises of tools,
machines, buildings etc
• More and better capital increases worker
productivity
• More capital increases output per hour
• Diminishing returns to capital
Diminishing Returns to Capital
• Diminishing returns to capital occurs if an addition of
capital with other inputs held constant increases output
by less than the previous increment of capital
– Assumption: all inputs except capital are held constant

– Result: output increases at a decreasing rate

• Implications of diminishing returns

– Increasing capital will increase output and labor productivity
• Positive contribution to growth

– There are limits to increasing productivity by adding capital

because of diminishing returns
#3 Land and Other Natural Resources
• Inputs other than capital increase worker
productivity
– Land for farming
– Manufacturing requires raw materials and energy

• Countries well endowed with natural

resources face less constraints
– Resources can be imported
– Japan, Hong Kong, Singapore and Switzerland
have high levels of GDP per capita with a limited
resource base
 #4 Technology
• New technologies are the single most important source
of productivity improvement
18th century transport
• Technical change can affect • Horse power
industries beyond the primary
19th century transport
application
• Steam engine
– Transportation expanded • Rail
markets for farm produce • River
– Medicine 20th century transport
– Communications • Road network
• Air
– Electronics and computers
• Technology requires substantial investment in R&D
#5 Entrepreneurship and Management
• Entrepreneurship need to combine resources into
productive uses
• Entrepreneurs create new economic enterprises
– Essential to a dynamic, healthy, growing economy
• Examples
– Henry Ford and mass production
– Bill Gates and standardized graphical user interface
operating system
– Larry Page and Sergey Brin and Google's search
• Policies should channel entrepreneurship in productive
ways
– Taxation policy and regulatory regime
– Value innovation
#6 Political and Legal Environment
• Encourage productivity

• Well-defined property rights are essential

– Patents & intellectual property rights

– Reliable legal recourse

• Political stability through consistent

government policy

• Promote free and open exchange of ideas

SUMMARY

• The basic measure of an economy’s output

is gross domestic product (GDP), the
market value of final goods and services
produced in a country during a given period
• 3 methods to compute GDP
– Output approach
– Expenditure approach
– Income approach
SUMMARY

• Output approach to compute GDP sums up

the market value of all goods and services
produced in the economy
• Only final goods and services are counted
in GDP, since they are the only goods and
services that directly benefit the ultimate
users
SUMMARY
• Intermediate goods and services, which
are used up in the production of final
goods and services, are not counted in
GDP, nor are sales of existing assets

• Summing the value added by each firm

in the production process is a useful
method of determining the final value of
goods and services
SUMMARY

• Expenditure approach calculates GDP

as the sum of 4 types of expenditure –
consumption, investment, government
purchases and net exports

• Income approach computes GDP by

summing up the earnings of resources:
wages, rental, interest and profit
SUMMARY

• GDP computed through the output

approach, expenditure approach and
the income approach is the same

• To compare levels of GDP over time

economists must eliminate the effect of
inflation

55
SUMMARY
• They do so by measuring the market value
of goods and services in terms of prices in
the base year, and this is called real GDP

• GDP measured in terms of current year

prices is called nominal GDP

• Real GDP should always be used in

making comparisons of economic activity
over time
SUMMARY
• Real GDP is a useful indicator of economic
well-being.
• Countries with high real GDP per person (per
capita GDP) enjoy high average standards of
living, have higher life expectancies, low rate
of infant mortality and high rate of school
enrollment and literacy
• However, real GDP per capita is an
imperfect measure of economic well-being
 SUMMARY

• Real GDP per capita is the product of

average labour productivity (Y/L) and the
share of the population that is employed
(L/POP)
Question 1
Suppose a jar of orange marmalade that is ultimately sold to
a customer at The Corner Store is produced by the following
production process:
Name of Company Revenues Cost of Purchased Inputs
Citrus Growers Inc. $0.75 0
Florida Jam Company $2.00 $ .75
The Corner Store $2.50 $2.00

What is the value added of Florida Jam Company?

(A) $0.00
(B) $0.50
(C) $0.75
(D) $1.25
(E) $2.00
59
Answer to Question 1

60
Question 2
Given the following data for the economy, compute
the value of GDP.

(A) 56
(B) 83
(C) 90
(D) 141 61
Answer to Question 2

62
Question 3
Which of the following is an example of an
intermediate product?
(A) A pair of skis sold by a sporting goods
retailer to a skier.
(B) A share of Facebook.Inc stock.
(C) The lumber produced by Boise Cascade
and sold to a builder of new houses.
(D) An antique car sold to the highest bidder.
63
Answer to Question 3

64
Question 4
In Econland total output is $6 billion, population
equals 250,000 people, and, of these, 200,000 are
employed workers. Output per person in Econland
equals _______ and average labor productivity
equals ______.
(A) $24; $30
(B) $30,000; $24,000
(C) $24,000; $30,000
(D) $30,000; $30,000
(E) $24,000; $24,000
65
Answer to Question 4

66
Question 5
If the share of population employed increases, real
GDP per person:
(A) increases.
(B) decreases.
(C) remains constant.
(D) fluctuates.
(E) may increase or decrease depending on
the change in average labor productivity.

67
Answer to Question 5

68
Question 6
A closed economy produces three products, bread, cloth and rice, in 2006
and 2007, as shown in the table below.

(i) Calculate the nominal GDP and the real GDP in both 2006 and 2007,
taking 2006 as the base year.

(ii) Compute and compare the nominal GDP growth rate and the real
GDP growth rate between 2006 and 2007. Which growth rate will
give a more accurate indicator on the performance of the economy?
Justify your answers.
2006 2007
Item Price Quantity Price Quantity
Bread $1.60 200 $2.00 250
Cloth $3.00 300 $5.50 450
Rice $1.50 180 $1.80 220
69
Answer to Question 6

70
Question 7

The real consumption figures of Country A is

higher than that of Country B. Yet the people in
Country A prefer to live in Country B. Explain
THREE reasons why they may think so.

71
Answer to Question 7
.

72
Thank you