Macro Economics Finals

College of Teacher Education- Undergraduate Program
Bachelor of Secondary Education major in Social Studies
Dr. Leonora M. Rodriguez

Faculty
CTE
This module is intended for the course SSEd 211-Macroeconomics, is designed to understand the cause and
effects of inflation, unemployment, fiscal and monetary policies, modes of taxation, international trade national
income. Gross National Policy, Gross Domestic Policy, and consumer development index. It elaborates on the
principles of the macroeconomics and international economics. Students learn the logic of economic analysis and
develops its core. This also includes the principles and theories pertinent to the understanding of national and
international economic issues.
In this module, you will demonstrate understanding of the economic issues and problems of a nation. It also
aims to present the basic fundamentals of the economics of a nation. It is believed that through this module, students
will develop the ability to evaluate the effectiveness and ineffectiveness of national leaders when it comes to
economic issues. Further, this module will also enable students understand certain government and business
decisions so each one of them will know how they could cooperate as economically literate citizens of the republic.
What are the intended learning outcomes of this module?
INTENDED LEARNING OUTCOMES

At the end of the course, the pre-service teachers should be able to:
1. Demonstrate factual knowledge on the nature and theories in macroeconomics.

2. Use knowledge learned from basic economics and microeconomics to make sound explanations about
macroeconomic concepts, principles and theories.
3. Apply course materials along with techniques and procedures covered in this course to analyze important
local and global economic issues.
4. Demonstrate specific skills, competencies and thought processes sufficient to support further study or work
in this course or related fields.
5. Demonstrate reasoned argument to the solution of familiar and unfamiliar problems relevant to the
course.
6. Express their knowledge through enhanced student participation, well-answered activities and well-
reasoned project.
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CHAPTER V: Consumption, Savings and Investment
Learning Objectives:
1. Discuss the concepts of consumption function and savings function.

2. Differentiate MPC from MPS
3. Use multiplier effect in determining government spending.
Learning Content
Demand Estimation. The science and art of converting qualitative understandings of a market
into quantitative data. Input demand estimates help dealer in preparation for business plans,
making financial arrangements, working out quantity to inputs to procure, arranging the storage
and transportation, formulation of business strategy and developing the sales promotion strategy.
Demand can be estimated with experimental data, time-series data, or cross-section data.
Consumption function or Keynesian consumption function, is an economic formula that

represents the functional relationship between total consumption and gross national income.
Introduced by British economist John Maynard Keynes, he argued that the function could be used
to track and predict total aggregate consumption expenditures.
Calculating the Consumption Function: C=A + MD
where:
C=consumer spending
A=autonomous consumption
M=marginal propensity to consume
D=real disposable income
Saving function is the starting point of the Keynesian economics analysis of equilibrium output
determination using the injections-leakages model. It captures relation between saving by the
household sector and income. Because income is used for either consumption or saving, the saving
function is a complement of the consumption function.
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According to Keynesian consumption function, savings are

positively related to the level of disposable income.
MPC and MPS. Keynes argued that as income grows, so does consumption, but by less than
income. Marginal Propensity to Consume represents the change in consumption spending that
arises from one peso change in income. Its value is between 0 and 1. Marginal Propensity to Save
is the change in saving as a result of an additional unit of disposable income.
Photo taken from:.wallstreetmojo.com/mpc-formula/ financial-dictionary.com
Factors Affecting Aggregate Consumption
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1. Real incomes
2. Direct and indirect taxation
3. Interest rates
4. Household wealth
5. Consumer confidence
6. The supply of credit
7. The distribution of income
8. Demographics
Government and Equilibrium Income
The government expenditure multiplier is, thus, the ratio of change in income (∆Y) to a
change in government spending (∆G). Thus,
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KG = ∆Y/∆G and ∆Y = KG. ∆G
In other words, an autonomous increase in government spending generates a multiple

expansion of income. How much income would expand depends on the value of MPC or its
reciprocal, MPS.
https://www.economicsdiscussion.net/
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https://marketbusinessnews.com
Economic equilibrium is a state in which economic forces, like market forces, are in perfect
balance. It is a state of balance in economic conditions when no outside forces are causing
disruption. The term ‘equilibrium ‘are often used by people with the same meaning.
In this context, ‘market forces’ refers to the forces of supply and demand. “In macro-
economics, national income is in equilibrium when aggregate demand (AD) equals aggregate
supply (AS).” Most simply, the formula for the equilibrium level of income is when aggregate
supply (AS) is equal to aggregate demand (AD), where AS = AD.
Adding a little complexity, the formula becomes
Y = C + I + G,
where Y is aggregate income, C is consumption, I is investment expenditure, and G is

government expenditure.
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The multiplier effect refers to the theory that government spending intended to stimulate
the economy causes increases in private spending that additionally stimulates the economy. In
essence, the theory is that government spending gives households additional income, which leads
to increased consumer spending. That, in turn, leads to increased business revenues, production,
capital expenditures, and employment, which further stimulates the economy
Investment
Investment is a basic economic activity in the economy. This activity is carried out by the firms or
producers in the economy. Investment is defined as addition to the existing capital stock. Capital
stock include fixed assets such as land, building, machinery and equipment etc and change in stock.
Investment by firms can be expressed in two ways:
Gross investment and Net investment.
Gross investment is defined as sum of net investment and depreciation. Gross investment = net
investment + Depreciation. It should be mentioned that in order to produce goods and services in
the economy for the purpose of consumption, producers or firms need to invest in machinery,
equipment, land, building etc and stock of raw material and finished goods. Also due to normal
wear and tear, these items loose their value over time period. Hence a producer must spend on
depreciation charges against wear and fear of machinery. The difference between gross and net
investment is called depreciation. We can write Gross investment – Net investment = Depreciation
Nature of investment
In macro economics investment can be categorized as autonomous and induced. Autonomous

investment is that part of investment which is fixed and most needed to carry out production
activity. It is independent of the level of income or value of output generated in the production
process. Expenditure on land, building or machineries needed for production can be treated as
constant or fixed as they are required to start production. It can be also treated in the same way as
fixed consumption told earlier. Symbolically autonomous investment can be written as I = I0 where
I = investment I0 = Autonomous investment which is constant. For example, let a firm wants to
produce garments. For this the minimum requirement is a room and sewing machine. Whatever
the level of output or income, expenditure on purchasing a room and sewing machine will be taken
as autonomous investment. Say this amount is Rs. 20,000. Then autonomous investment is Rs
20,000. The diagram for autonomous investment is given as a horizontal line as given below
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Take investment on vertical axis and income on horizontal axis. In the diagram the autonomous
investment line is horizontal at the value 20,000. This means that whatever be the level of income
i.e. be it 0, or 50,000 or 100,000, investment will always remain 20,000. On the otherhand induced
investment is that part of investment by firms which is influenced by the level of income and profit
motive. It may so happen that when income of firm increases, the firm gets encouragement to
increase its business activity and accordingly invest more in capital stock. Hence it is called
induced investment
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Test Your Knowledge
I. Define the following terms.
1. Demand Estimation =___________________________________________________
2. Multiplier Effect =___________________________________________________
3. Disposable Income =___________________________________________________
4. Equilibrium =___________________________________________________
II. Give the answers to the following:
1. Define consumption function and savings function.
______________________________________________________________________________
______________________________________________________________________________
______________________________________________________________________________
2. Give the factors affecting aggregate consumption. Explain each.
______________________________________________________________________________
______________________________________________________________________________
______________________________________________________________________________
______________________________________________________________________________
3. Differentiate MPC from MPS.
______________________________________________________________________________
______________________________________________________________________________
______________________________________________________________________________
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CHAPTER VI. Macroeconomics Instability: Unemployment and Inflation
1. Differentiate Keynesian theory from classical theory.

2. Discuss the subsistence theory of wages.
3. Discuss the quantity theory of money
4. Explain the meaning, causes and effects of inflation.
5. Differentiate demand pull and cost push inflation.
6. Use CPI in computing annual rate of inflation.
Learning Content.
I. Labor Problems. The labor problem encompasses the difficulties faced by wage-earners and
employers who began to cut wages for various reasons including increased technology, desire for
lower costs or to stay in business. The wage-earning classes responded with strikes, by unionizing
and by committing acts of outright violence.
Unemployment is a challenge generally found in every economy whether developed or

developing. It is a situation where some of those who are able and willing to work could not find
any work.
Unemployment rate. The percentage of people in the civilian labor force who are without
jobs and are currently seeking jobs.
Civilian labor force. The number of people 16 years of age and older who are employed
or who are actively seeking a job, excluding armed forces, homemakers, discouraged workers, and
other persons not in the labor force.
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II. Subsistence Theory of Wages

A theory explained by David Ricardo that is based on two assumptions: the law of
diminishing return applies to industry and rapid increase in population. This theory laid down that
the workers are paid to enable them to subsist and perpetuate the race without increase or
diminution. If the workers were paid more than subsistence wage, their numbers would increase
as they would procreate more and this would bring down the rate of wages.
If the wages fall below the subsistence level, the number of workers would decrease, as
many would die of hunger, malnutrition, disease, cold, etc. and may would not marry, when that
happened the rate would go up. This theory is criticized in the following grounds: it does not take
into consideration the demand for labor and is based on theory of population.
III. Classical Theory.
This theory of employment is a contribution of various classical and neo-classical

economists like Adam Smith, Ricardo J. etc. It is based on Say’s Law of market and on the
assumption of flexibility of wages, rates of interest and prices. According to Say’s Law, of markets,
“Supply creates its own demands.” According to classical economists, full employment is normal
feature of capitalist economy in the long run.
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If unemployment occurs in an economy that is for short time period because economic
forces will adjust in such way. Full employment is achieved due to flexible prices and wages.
Unemployment is due to high wage rate.
IV. The Keynesian Theory
Lord Keynes analyzed deeply the problem of unemployment and concluded that main
cause of unemployment was deficiency of effective demand. Effective demands refer to the level
of aggregate demand where it is equal to aggregate supply. He therefore suggested that
unemployment could be remove by increasing the effective demand.
Lord Keynes was of the opinion that to remove unemployment and to achieve full
employment, government interference in the economy is imperative.
V. Quantity Theory of Money.
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An economic theory which proposes a positive relationship between changes in the money
supply and the long-term price of goods. It states that increasing the amount of money in the
economy will eventually lead to an equal percentage rise in the prices of products and services.
The calculation behind the quantity theory of money is based upon the Fisher equation. This theory
assumes that all the transactions require money to change hand.
Goal of Full Employment.
Full employment does not mean “zero percentage unemployment”. Full employment is the
situation in which an economy operates at an employment rate equal to the sum of the frictional
and structural unemployment rates. Full employment therefore is the rate of employment that
exists without cyclical unemployment.
Test Your Knowledge.
1 Differentiate Keynesian theory from classical theory.
______________________________________________________________________________
______________________________________________________________________________
______________________________________________________________________________
2. Explain the subsistence theory of wages.
______________________________________________________________________________
______________________________________________________________________________
______________________________________________________________________________
3. Explain the quantity theory of money.
______________________________________________________________________________
______________________________________________________________________________
______________________________________________________________________________
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Inflation
Learning Content
Inflation is the increase in the general (average) price level of goods and services in the
economy. According to Coulborn, it is a state of too much money chasing too few goods. Price
inflation and money inflation are two broad categories of inflation. Inflation’s opposite is deflation.
Deflation is the decrease in the general (average) price level of good and services in the economy.
Note that inflation does not mean that all prices of all the products in the economy rise
during a given period of time.
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Undesirability of Inflation Gainers of Inflation
People who have fixed income People who have flexible income
Pensioners, insured or policyholder Speculators
Creditors Debtors
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Demand Pull Inflation
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Demand pull inflation which is a rise in general price level resulting from an excess of total
spending (demand). When sellers are unable to supply all the goods and services buyers demand,
sellers respond by raising the prices. In short, the general price in the economy is “pulled up” by
the pressure from buyers’ total expenditures.
It occurs at or close to full employment when the economy is operating at or near full
capacity.
Cost Push Inflation
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from:.tutor2u.net/economics
An excess of total spending is not the only possible explanation for rising prices. Cost-push
inflation is a rise in the general price level resulting from an increase in the cost of production.
Any sharp increase in costs to businesses can be a potential source of cost-push inflation.
This means that upward pressure on prices can be caused by increases for labor, raw
materials, construction, equipment, borrowing, and so on. Businesses can also contribute to cost-
push inflation by raising prices to increase profits.
Phillips Curve
A concept developed by William Phillips and prove in all major world economies. It states
that there is an inverse relationship between the inflation and the unemployment rate when
presented or charted graphically such as that the higher the inflation rate of the economy, lower
will be the unemployment rate, and vice-versa. However, it is found that the implications of the
Phillips curve are true only in the short term as it fails to justify in the situations when there is
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stagflation in the economy the situation when both unemployment and inflation are alarmingly
high.
Consumer Price Index
The most widely reported measure of inflation is the consumer price index, which measures
the changes in the average prices of consumer goods and services. It is sometimes called the cost-
of-living index. It includes only consumer goods and services in order to determine how rising
prices affect the income of consumers. It does not consider item purchased by businesses and
government.
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Base year is the year chosen as a reference point for comparison with some earlier or later year.
Photo taken from: cpiinflationcalculator.com
Whereas; CPI2 is the CPI in the given or current year, CPI1 is the CPI of the base or previous year.
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Consequences of Inflation
Inflation shrinks income.
Inflation tends to reduce your standard of living through declines in the purchasing power of
money. The greater the rate of inflation, the greater the decline in the quantity of goods we can
purchase with a given nominal income, or money income. Nominal income is the actual number
of pesos we received over a period of time. The source of income can be wages, salary, rent,
dividends, interest or pensions.
Inflation and Wealth.
Income is one measure of economic well-being, and wealth is another. Income is a flow of money
earned by selling factors of production. Wealth is the value of the stocks and assets owned at some
point in time. Inflation can benefit holders of wealth because the value of assets tends to increase
as prices rise. On the other hand, the impact of inflation on wealth penalizes people without it.
Inflation and real interest rate.
Borrowers or savers may be winners or losers, depending on the rate of inflation.
Test Your Knowledge:
1. Explain the meaning, causes and effects of inflation.
______________________________________________________________________________
______________________________________________________________________________
______________________________________________________________________________
______________________________________________________________________________
2. Differentiate demand pull and cost push inflation.
______________________________________________________________________________
______________________________________________________________________________
______________________________________________________________________________
______________________________________________________________________________
B. In 2019, the CPI was 188.9 while in 2020, it was 195.3. compute for the inflation rate.
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CHAPTER VII: Money, Banking and Monetary Policy

1. Explain the function of money in the economy.

2. Explain the role of Central Bank in money production.
3. Differentiate the approaches used by monetary policy and fiscal policy in addressing
economic problems.
Learning Content:
Functions of Money
Photo taken from:.economicsdiscussion.net
Money is anything that serves as a medium of exchange, unit of account and store of value.
Economists considered four main functions of money, which are a medium of exchange, a measure
of value, a standard of deferred payment, and a store of value.
Primary Functions: Refer to the basic or original functions of money.
1. Medium of Exchange:
Funtion of money in which money is considered as a mode of exchanging goods. The medium
of exchange function is considered as the main and unique function of money as it has removed
the problem of coincidence of wants because everyone is willing to accept money in payment,
rather than goods and services.
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Because money serves as generalized purchasing power, all society knows that no one will
refuse to trade their products for money. In short, money increases trade by providing a much more
convenient method of exchange than a cumbersome barter system.
2. Measure of Value:
Function of money that helps determine the value of goods and services. The value of all goods
and services are expressed in terms of money. Money is taken as the common denominator while
measuring the value of goods and services in monetary terms.
The measure of value function of money has the following advantages:
1. Helps in comparing and calculating the exchange rates between two goods
2. Provides more meaningful accounting systems
3. Helps in determining and comparing national income of different countries
4. Helps in comparing the cost incurred on production and distribution and the revenue generated
from the consumption of goods and services
Secondary Functions: Refer to important functions of money that are obtained from primary
functions.
1. Store of Value:
A secondary function that has been derived from the medium of exchange function of money.
Generally, individuals store their wealth in the form of money. Therefore, money acts as an asset
that sustains value over a period of time. Store of value is the ability of money to hold value over
time.
The key property of money is that it is liquid. This means that money is immediately available
to spend in exchange for goods and services without any additional expense. Money is more liquid
than real assets (real estate or gold) or paper assets (stocks or bonds). These assets also serve as
stores of value, but liquidating(selling) them often involves expenses, such as brokerage fees and
time delays.
2. Standard of Deferred Payments:

One of the most important functions of money. Deferred payments refer to payments made on
loans, salaries, pensions, insurance premium, interests, and rents. The necessary condition for
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deferred payment is that the amount of repaid money should be the same as it was at the time of
purchase.
Money Supply
The money supply is all the currency and other liquid instruments in a country's economy
on the date measured. The money supply roughly includes both cash and deposits that can be used
almost as easily as cash. Governments issue paper currency and coin through some combination
of their central banks and treasuries. Bank regulators influence money supply available to the
public through the requirements placed on banks to hold reserves, how to extend credit and other
regulation.
An increase in the supply of money typically lowers interest rates, which in turn, generates
more investment and puts more money in the hands of consumers, thereby stimulating spending.
Businesses respond by ordering more raw materials and increasing production. The increased
business activity raises the demand for labor. The opposite can occur if the money supply falls or
when its growth rate declines.
3 Money Supply definitions
M1: The most narrowly defined money supply
The narrowest definition of money supply. This money definition measures purchasing
power immediately available to the public without borrowing or having to give notice.
Specifically, M1 measures the currency, traveler’s checks, and checkable deposits held by the
public at a given time, such as a given day, month, or year. M1 does not include the money held
by the government, reserve banks, or depository institutions.
M2: Adding near monies to M1
A broader measure of the money supply because it equals M1 plus near money. M1 is
considered by many economists to be too narrow because it does not include near money accounts
that can be used to purchase goods and services. These includes passbook savings account, money
market mutual funds, and time deposits. Near monies are interest-bearing deposits easily converted
into spendable funds.
M3. Adding large time deposits to M2
This is the measure of the money supply that equals M2 plus large time deposits.
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Money Creation
Because banks are only required to keep a fraction of their deposits in reserve and may
loan out the rest, banks are able to create money. To understand this, imagine that you deposit
P100 at your bank. The bank is required to keep P10 as reserves but may lend out $90 to another
individual or business. This loan is new money; the bank created it when it issued the loan. In fact,
the vast majority of money in the economy today comes from these loans created by banks.
Likewise, when a loan is repaid, that money disappears from the economy until the bank issues
another loan.
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Thus, there are two ways that a central bank can use this process to increase or decrease
the money supply. First, it can adjust the reserve ratio. A lower reserve ratio means that banks can
issue more loans, increasing the money supply. Second, it can create or destroy reserves. Creating
reserves means that commercial banks have more reserves with which they can satisfy the reserve
ratio requirement, leading to more loans and an increase in the money supply.
Central Bank
Central banks are national institutions which control the commercial banking field, interest rates,
money in circulation and currencies. The idea of central banking was developed long ago, with the
first institutions of that type
opened in China about a millennium ago, together with the first-time issuance of paper money. In
the centuries of its existence, the central bank institution has evolved and improved, to reach the
present stage of contemporary banking systems.
Examples of central banks today include: the US Federal Reserve (Fed), the European
Central Bank (ECB), the Bank of England (BOE), the Bank of Canada, the Reserve Bank of
Australia (RBA) and others. The influence exerted by a central bank can spread over one country,
like the RBA, or it can represent the policy of a group or region of countries, an example being the
ECB.
Monetary Policy
Monetary policy, the demand side of economic policy, refers to the actions undertaken by
a nation's central bank to control money supply to achieve macroeconomic goals that promote
sustainable economic growth. Monetary policy consists of the process of drafting, announcing,
and implementing the plan of actions taken by the central bank, currency board, or other competent
monetary authority of a country that controls the quantity of money in an economy and the
channels by which new money is supplied.
Monetary policy consists of management of money supply and interest rates, aimed at
achieving macroeconomic objectives such as controlling inflation, consumption, growth, and
liquidity. These are achieved by actions such as modifying the interest rate, buying or selling
government bonds, regulating foreign exchange rates, and changing the amount of money banks
are required to maintain as reserves.
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Economists, analysts, investors, and financial experts across the globe eagerly await the
monetary policy reports and outcome of the meetings involving monetary policy decision-making.
Such developments have a long lasting impact on the overall economy, as well as on specific
industry sector or market. Monetary policy is formulated based on inputs gathered from a
variety of sources. For instance, the monetary authority may look at macroeconomic numbers like
GDP and inflation, industry/sector-specific growth rates and associated figures, geopolitical
developments in the international markets (like oil embargo or trade tariffs), concerns raised by
groups representing industries and businesses, survey results from organizations of repute, and
inputs from the government and other credible sources. Monetary authorities are typically given
policy mandates, to achieve stable rise in gross domestic product (GDP), maintain low rates of
unemployment, and maintain foreign exchange and inflation rates in a predictable range. Monetary
policy can be used in combination with or as an alternative to fiscal policy, which uses taxes,
government borrowing, and spending to manage the economy.
KEYNESIAN VIEW of the ROLE of MONEY
The demand for money
Why do people hold (demand) currency and checkable deposits (M1), rather than putting
their money to work in stocks, bonds, real estate, or other nonmoney forms of wealth? Because
money yields no direct return, people (including businesses) who hold cash or checking account
balances incur an opportunity cost of forgone interest or profits on the amount of money held. So,
what are the benefits of holding money? Why would people hold money and thereby forgo earning
interest payments? John Maynard Keynes gave three important motives for doing so: transactions
demand, precautionary demand and speculative demand.
Transactions Demand for Money.
The first motive to hold money Is the transactions demand. The transactions demand for
money is the stock of money people hold to pay everyday predictable expenses. The desire to have
“walking around money” to make quick and easy purchases is the principal reason for holding
money. Students, for example, have a good idea of how much money they will spend on the rent,
groceries, utilities, gasoline, and other routine purchases. A business can also predict its payroll,
utility bill, supply bills, and other routine expenses. Without enough cash, the public must suffer
forgone interest and possibly withdrawal penalties as a result of converting their stocks, bonds or
certificates of deposit into currency or checkable deposits in order to make transactions.
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Precautionary Demand for Money. In addition to holding money for ordinary expected
purchases, people have a second motive to hold money, called the precautionary demand. The
precautionary demand for money is the stock of money people hold to guard against those
proverbial rainy days. For example, your car might break down, or your income may drop
unexpectedly. Similarly, a business might experience unexpected repair expenses or lower-than-
anticipated cash receipts from sales. Because of unforeseen events that could prevent people from
paying their bills on time, people hold precautionary balances. This affords the peace of mind that
unexpected payments can be made without having to cash an interest-bearing financial assets or
to borrow.
Speculative Demand for Money
The third motive for holding money is the speculating demand. The speculative demand
for money is the stock of money people hold to take advantage of expected future changes in the
price of bonds, stocks or other nonmoney financial assets. In addition to the transactions and
precautionary motives, individuals and businesses demand “betting money” to speculate, or guess
whether the prices of alterative assets will rise or fall. This desire to take advantage of profit-
making opportunities when the prices of non-money assets fall is the driving force behind
speculative demand.
Fiscal and Monetary Policies
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from:
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I. Define the following terms:

1. Money =____________________________________________________
2. Money supply =____________________________________________________
3. Central Bank =____________________________________________________
4. Reserve deposit =____________________________________________________
5. Currency =____________________________________________________
II. Answer the following:

1. What is the function of money in the economy?
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
2. Explain the role of Central Bank in money production.
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
3. Differentiate the approaches used by monetary policy and fiscal policy in addressing
economic problems.
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
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CHAPTER VIII: Fiscal Policy
Learning Outcomes:
1. Describe the role of government in correcting the economy.

2. Explain the different principles of taxation.
3. Explain the concept of tax multiplier.
Learning Content:
Fiscal policy is the use of government spending and taxation to influence the economy.
Fiscal policy is the use of government spending and taxation to influence the economy.
Governments use fiscal policy to influence the level of aggregate demand in the economy in an
effort to achieve the economic objectives of price stability, full employment, and economic
growth.
The government has two levers when setting fiscal policy:
Change the level and composition of taxation, and/or
Change the level of spending in various sectors of the economy.
There are three main types of fiscal policy:
Neutral: This type of policy is usually undertaken when an economy is in equilibrium. In

this instance, government spending is fully funded by tax revenue, which has a neutral effect on
the level of economic activity.
Expansionary: This type of policy is usually undertaken during recessions to increase the
level of economic activity. In this instance, the government spends more money than it collects in
taxes.
Contractionary: This type of policy is undertaken to pay down government debt and to cap
inflation. In this case, government spending is lower than tax revenue.
In times of recession, Keynesian economics suggests that increasing government spending

and decreasing tax rates is the best way to stimulate aggregate demand. Keynesians argue that this
approach should be used in times of recession or low economic activity as an essential tool for
building the foundation for strong economic growth and working towards full employment. In
theory, the resulting deficit would be paid for by an expanded economy during the boom that
would follow. In times of economic boom, Keynesian theory posits that removing spending from
the economy will reduce levels of aggregate demand and contract the economy, thus stabilizing
prices when inflation is too high.
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Public sources of funding include those which are compulsory and pre-paid; meaning paid
before the need for care is identified or care is accessed. These are often taxes. A compulsory
source means the government requires some or all people to make the payment, whether they use
the service or not. Direct taxes are those paid by households and companies to the government or
other public agencies. This includes income tax, payroll tax (including mandatory social health
insurance contributions) and corporate or profit tax. Indirect taxes are paid to the government or
other public agency via a third party (retailer or supplier). The tax is based on what a household or
company spends and includes value-added tax, sales tax, excise tax on alcohol and tobacco and
import duties.
Non-tax revenues are from state-owned companies, including natural resource revenues
such as oil and gas. Financing from external (foreign) sources is considered ‘public’ when the
funds flow through recipient governments. Public sources of funding can be managed by private
entities, such as private insurers managing a public insurance scheme.
Public funding is money that comes from the government, often through taxes, that's used
to help the public through goods and services. The funds are gathered and distributed on different
levels such as the federal level, state level, and even local level. While taxes are a primary resource,
funding can also come from fines and fees.
Public funding helps provide health programs, community services, restoration programs,
public service programs, and even environmental programs. These programs benefit the members
of the community in which the funds are used. So, Chase learns that when taxpayers pay taxes, the
government uses that money to help maintain and improve communities through programs and
services.
Principles of Taxation
Jean Baptiste Colbert, finance minister to King Louis XIV of France once said, “The art of
taxation consists of so plucking the goose as to obtain the largest amount of feathers while
promoting the smallest amount of hissing”. The 18th-century economist and philosopher Adam
Smith attempted to systematize the rules that should govern a rational system of taxation. In The
Wealth of Nations (Book V, chapter 2) he set down four general canons:
I. The subjects of every state ought to contribute towards the support of the government,
as nearly as possible, in proportion to their respective abilities; that is, in proportion to the revenue
which they respectively enjoy under the protection of the state.…
II. The tax which each individual is bound to pay ought to be certain, and not arbitrary. The
time of payment, the manner of payment, the quantity to be paid, ought all to be clear and plain to
the contributor, and to every other person.…
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III. Every tax ought to be levied at the time, or in the manner, in which it is most likely to
be convenient for the contributor to pay it.…
IV. Every tax ought to be so contrived as both to take out and keep out of the pockets of
the people as little as possible over and above what it brings into the public treasury of the state.…
Distribution of tax burdens
Various principles, political pressures, and goals can direct a government’s tax policy. What
follows is a discussion of some of the leading principles that can shape decisions about taxation.
Horizontal equity
The principle of horizontal equity assumes that persons in the same or similar positions (so
far as tax purposes are concerned) will be subject to the same tax liability. In practice this equality
principle is often disregarded, both intentionally and unintentionally. Intentional violations are
usually motivated more by politics than by sound economic policy (e.g., the tax advantages granted
to farmers, home owners, or members of the middle class in general; the exclusion of interest on
government securities). Debate over tax reform has often centered on whether deviations from
“equal treatment of equals” are justified.
The ability-to-pay principle
A second popular principle of fairness sharply contrast with the benefits-received principle.
The ability-to-pay principle requires that the total tax burden will be distributed among individuals
according to their capacity to bear it, taking into account all of the relevant personal characteristics.
The most suitable taxes from this standpoint are personal levies. Those who have higher incomes
can afford to pay greater proportion of their income in taxes, regardless of benefits rcived.
Historically there was common agreement that income is the best indicator of ability to pay. There
have, however, been important dissenters from this view, including the 17th-century English
philosophers John Locke and Thomas Hobbes and a number of present-day tax specialists. The
early dissenters believed that equity should be measured by what is spent (i.e., consumption) rather
than by what is earned (i.e., income); modern advocates of consumption-based taxation emphasize
the neutrality of consumption-based taxes toward saving (income taxes discriminate against
saving), the simplicity of consumption-based taxes, and the superiority of consumption as a
measure of an individual’s ability to pay over a lifetime. Some theorists believe that wealth
provides a good measure of ability to pay because assets imply some degree of satisfaction (power)
and tax capacity, even if (as in the case of an art collection) they generate no tangible income.
The ability-to-pay principle also is commonly interpreted as requiring that direct personal
taxes have a progressive rate structure, although there is no way of demonstrating that any
particular degree of progressivity is the right one. Because a considerable part of the population
does not pay certain direct taxes—such as income or inheritance taxes—some tax theorists believe
32
that a satisfactory redistribution can only be achieved when such taxes are supplemented by direct
income transfers or negative income taxes (or refundable credits). Others argue that income
transfers and negative income tax create negative incentives; instead, they favour public
expenditures (for example, on health or education) targeted toward low-income families as a better
means of reaching distributional objectives.
Indirect taxes such as VAT, excise, sales, or turnover taxes can be adapted to the ability-
to-pay criterion, but only to a limited extent—for example, by exempting necessities such as food
or by differentiating tax rates according to “urgency of need.” Such policies are generally not very
effective; moreover, they distort consumer purchasing patterns, and their complexity often makes
them difficult to institute.
The benefit principle
Under the benefit principle, taxes are seen as serving a function similar to that of prices in
private transactions; that is, they help determine what activities the government will undertake and
who will pay for them. If this principle could be implemented, the allocation of resources through
the public sector would respond directly to consumer wishes.
Economic efficiency. The requirement that a tax system be efficient arises from the nature of a
market economy.
Progressive, Regressive and proportional taxes
Progressive Taxes.
A progressive tax charges a higher percentage of income as income rises. This tax rate
progressivity ns the principle behind the federal and state-income taxes.
Regressive Taxes.
A regressive tax charges a lower percentage of income as income rises. Such a tax runs afoul of
the ability-to-par principle of taxation.
Proportional Taxes.
Also called a flat tax. A proportional tax charges the same percentage of income, regardless of the
size of income.
Ease of administration and compliance

33
In discussing the general principles of taxation, one must not lose sight of the fact that taxes
must be administered by an accountable authority. There are four general requirements for the
efficient administration of tax laws: clarity, stability (or continuity), cost-effectiveness, and
convenience. Administrative considerations are especially important in developing countries,
where illiteracy, lack of commercial markets, absence of books of account, and inadequate
administrative resources may hinder both compliance and administration. Under such
circumstances the achievement of rough justice may be preferable to infeasible fine-tuning in the
name of equity.
Economic goals
The primary goal of a national tax system is to generate revenues to pay for the
expenditures of government at all levels. Because public expenditures tend to grow at least as fast
as the national product, taxes, as the main vehicle of government finance, should produce revenues
that grow correspondingly. Income, sales, and value-added taxes generally meet this criterion;
property taxes and taxes on nonessential articles of mass consumption such as tobacco products
and alcoholic beverages do not.
The multipliers are calculated as follows:
Where MPC is the marginal propensity to consume (the change in consumption divided by
the change in disposable income), and MPS is the marginal propensity to save (the change in
savings divided by the change in disposable income). The government spending multiplier is
always positive. In contrast, the tax multiplier is always negative. This is because there is an
inverse relationship between taxes and aggregate demand.
When taxes decrease, aggregate demand increases. The multiplier effect of a tax cut can
be affected by the size of the tax cut, the marginal propensity to consume, as well as the crowding
out effect. The crowding out effect occurs when higher income leads to an increased demand for
money, causing interest rates to rise. This leads to a reduction in investment spending, one of the
four components of aggregate demand, which mitigates the increase in aggregate demand
otherwise caused by lower taxes.
34
Income Distribution
Income distribution is the smoothness or equality with which income is dealt out among
members of a society. If everyone earns exactly the same amount of money, then the income
distribution is perfectly equal. If no one earns any money except for one person, who earns all of
the money, then the income distribution is perfectly unequal. Usually, however, a society's income
distribution falls somewhere in the middle between equal and unequal. Economists often measure
income equality by measuring how much income is earned by different segments of the population.
For instance, if we break down all workers into five segments in terms of how much money they
make: the top 20%, the second 20%, the third 20%, the fourth 20%, and the bottom 20%, and we
obtain data on how much money they make, we can then create a chart detailing how much income
each segment earns out of the total amount of income for all workers. The bigger the difference
between the different segments, the greater the income inequality.
Lorenz curve
Photo taken from:wallstreetmojo.com
35
Lorenz curve is a graphical representation of income inequality or wealth inequality

developed by American economist Max Lorenz in 1905. The graph plots percentiles of the
population on the horizontal axis according to income or wealth.
As we can see, there are two lines in the graph of the Lorenz curve, the curved red line,
and the straight black line. The black line represents the fictional line called the line of equality
i.e. the ideal graph when income or wealth is equally distributed amongst the population. The red
curve, the Lorenz curve, which we have been discussing, represents the actual distribution of
wealth among the population.
Hence, we can say that the Lorenz curve is the graphical method of studying dispersion.
Gini Coefficient, also known as the Gini Index, can be computed as follows. Let us assume in the
graph area between the Lorenz Curve and the line is represented by A1 and the line below the
curve is represented by A2. So,
Gini Coefficient = A1/ (A1+ A2)
Gini Coefficient lies between 0 and 1; 0 being the instance where there is perfect equality
and 1 being the instance where there is perfect inequality. The higher the area enclosed between
the two lines represents higher inequality in the economy.
By this, we can say that in measuring income inequality, there are two indicators:
1. The Lorenz curve is the Visual Indicator and

2. The Gini Coefficient is the Mathematical Indicator.
Income inequality is a pressing issue across the world. So, what are the reasons for inequality in
an economy?
1. Corruption
2. Education
3. Tax
4. Gender differences
5. Culture
6. Race and Cast discriminations
7. The difference in preferences of leisure and risks.
36

1. Fiscal Policy =____________________________________________________
2. Public Funds =____________________________________________________
3. Taxation =____________________________________________________
4. Government =____________________________________________________
5. Lorenz curve =____________________________________________________
II. Answer the following:
1. Describe the role of government in correcting the economy.
__________________________________________________________________
__________________________________________________________________
__________________________________________________________________
2. Explain the different principles of taxation.
__________________________________________________________________
__________________________________________________________________
__________________________________________________________________
3. Explain the concept of tax multiplier.
__________________________________________________________________
__________________________________________________________________
__________________________________________________________________
37
CHAPTER IX: International Trade Practices and Policies
Learning Outcomes:
1. Share insights on why countries engage in trade.

2. Narrate the history on how mercantilism started.
Learning Content.
Countries trade with each other when, on their own, they do not have the resources, or
capacity to satisfy their own needs and wants. By developing and exploiting their domestic scarce
resources, countries can produce a surplus, and trade this for the resources they need. Clear
evidence of trading over long distances dates back at least 9,000 years, though long distance trade
probably goes back much further to the domestication of pack animals and the invention of ships.
Today, international trade is at the heart of the global economy and is responsible for much
of the development and prosperity of the modern industrialized world. Goods and services are
likely to be imported from abroad for several reasons. Imports may be cheaper, or of better quality.
They may also be more easily available or simply more appealing than locally produced goods. In
many instances, no local alternatives exist, and importing is essential. This is highlighted today in
the case of Japan, which has no oil reserves of its own, yet it is the world’s fourth largest consumer
of oil, and must import all it requires.
The advantages of trade
International trade brings a number of valuable benefits to a country, including:
The exploitation of a country’s comparative advantage, which means that trade encourages
a country to specialize in producing only those goods and services which it can produce more
effectively and efficiently, and at the lowest opportunity cost. Producing a narrow range of goods
and services for the domestic and export market means that a country can produce in at higher
volumes, which provides further cost benefits in terms of economies of scale.
Trade increases competition and lowers world prices, which provides benefits to
consumers by raising the purchasing power of their own income, and leads a rise in consumer
surplus. Trade also breaks down domestic monopolies, which face competition from more efficient
foreign firms. The quality of goods and services is likely to increases as competition encourages
innovation, design and the application of new technologies. Trade will also encourage the transfer
of technology between countries. Trade is also likely to increase employment, given that
employment is closely related to production. Trade means that more will be employed in the export
sector and, through the multiplier process, more jobs will be created across the whole economy.
38
The disadvantages of trade
Despite the benefits, trade can also bring some disadvantages, including:
Trade can lead to over-specialization, with workers at risk of losing their jobs should world
demand fall or when goods for domestic consumption can be produced more cheaply abroad. Jobs
lost through such changes cause severe structural unemployment. The recent credit crunch has
exposed the inherent dangers in over-specialization for the UK, with its reliance on its financial
services sector.
Certain industries do not get a chance to grow because they face competition from more
established foreign firms, such as new infant industries which may find it difficult to establish
themselves. Local producers, who may supply a unique product tailored to meet the needs of the
domestic market, may suffer because cheaper imports may destroy their market. Over time, the
diversity of output in an economy may diminish as local producers leave the market.
Mercantilism
Mercantilism was an economic system of trade that spanned from the 16th century to the
18th century. Mercantilism is based on the principle that the world's wealth was static, and
consequently, many European nations attempted to accumulate the largest possible share of that
wealth by maximizing their exports and by limiting their imports via tariffs.
First popularized in Europe during the 1500s, mercantilism was based on the idea that a
nation's wealth and power were best served by increasing exports, in an effort to collect precious
metals like gold and silver. Mercantilism replaced the feudal economic system in Western Europe.
At the time, England was the epicenter of the British Empire but had relatively few natural
resources.
To grow its wealth, England introduced fiscal policies that discouraged colonists from
buying foreign products, while creating incentives to only buy British goods. For example, the
Sugar Act of 1764 raised duties on foreign refined sugar and molasses imported by the colonies,
in an effort to give British sugar growers in the West Indies a monopoly on the colonial market.
Similarly, the Navigation Act of 1651 forbade foreign vessels from trading along the
British coast and required colonial exports to first pass through British control before being
redistributed throughout Europe. Programs like these resulted in a favorable balance of trade that
increased Great Britain's national wealth.
Under mercantilism, nations frequently engaged their military might to ensure local
markets and supply sources were protected, to support the idea that a nation's economic health
heavily relied on its supply of capital. Mercantilists also believed that a nation's economic health
39
could be assessed by its levels of ownership of precious metals, like gold or silver, which tended
to rise with increased new home construction, increased agricultural output, and a strong merchant
fleet to provide additional markets with goods and raw materials.
Trade practices:
Unfair trade practices include false representation of a good or service, targeting vulnerable
populations, false advertising, tied selling, false free prize or gift offers, false or deceptive pricing,
and non-compliance with manufacturing standards. Alternative names for unfair trade practices
are “deceptive trade practices” or “unfair business practices.”
Trade Policy
Trade policy refers to the regulations and agreements that control imports and exports to
foreign countries. Trade policies determine the size of markets for the output of firms and hence
strongly influence both foreign and domestic investment. Over time, the influence of trade policies
on the investment climate is growing. Changes in technology, liberalization of host country
policies towards trade and investment and the growing organization of global production chains
within multinational enterprises (MNEs) have all served to make trade policies in home and host
countries alike a crucial ingredient in encouraging both foreign and domestic investment and in
maximizing the contribution of that investment to development.
A commercial policy is referred to as a trade policy or international trade policy) is a

government's policy governing international trade. Commercial policy is an all-encompassing term
that is used to cover topics which involve international trade. Trade policy is often described in
terms of a scale between the extremes of free trade (no restrictions on trade) on one side and
protectionism (high restrictions to protect local producers) on the other. A common commercial
policy can sometimes be agreed by treaty within a customs union, as with the European Union's
common commercial policy and in Mercosur. A nation's commercial policy will include and take
into account the policies adopted by that nation's government while negotiating international trade.
Types and aspects of Commercial policy
1. Regionalism or Regional Trade Agreements (RTA), are trade policies and agreements that
are crafted by the nations in a region for the purposes of increasing international trade in
the area.
2. Bilateral Free Trade Agreements. When two countries enter into a bilateral trade
agreement, they are essentially giving one another special deals and favorable treatment in
40
the arrangements. These privileges can include lowering tariffs on each other’s goods and
services.
3. Preferential Trade Agreements are trade deals that involve nations making deals with
specific countries that can aid the interests of one another as opposed to the
nondiscriminatory deals that are pushed by the WTO.

1. Trade =______________________________________________
2. Mercantilism =______________________________________________
3. Trade Policy =______________________________________________
4. Commercial Policy =______________________________________________
5. Commercial =______________________________________________
II. Share insights on why countries engage in trade.
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
III. Narrate the history on how mercantilism started.
______________________________________________________________________
______________________________________________________________________
______________________________________________________________________
41
RESOURCES AND LINKS:
Tucker, Irvin B. “Macroeconomics for Today’s World Fifth Edition”
Ali, H., Sharif Chaudhry, D., & Ali, H. (2015). The Relationship between Investment and
Output. Journal of Research in Business, Economics and Management, 3(3), 210-213. Retrieved
https://www.investopedia.com
https://saylordotorg.github.io/text_macroeconomics-theory-through-applications/s20-16-the-
circular-flow-of-income.html
https://en.ppt-online.org/266987
https://www.swlearning.com/
https://www.economicsonline.co.uk/
https://www.shareyouressays.com/
https://corporatefinanceinstitute.com/
https://www.referenceforbusiness.com/
https://www.economicsdiscussion.net/
https://www.wallstreetmojo.com/gdp-formula/
http://scitecresearch.com/
https://www.slideshare.net/
https://present5.com/
https://slideplayer.com/slide/5734566/
https://marketbusinessnews.com/
https://www.tutor2u.net/
https://www.coursehero.com/file/p55ha6k/Chapter-
https://courses.lumenlearning.com/
https://findependence.org/
42
https://www.who.int/health_financing/
https://maxpat.com/services/ip-law/advice/trade-practices/
http://www.oecd.org/
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Macro Economics Finals

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College of Teacher Education- Undergraduate Program

Bachelor of Secondary Education major in Social Studies

Dr. Leonora M. Rodriguez

What are the intended learning outcomes of this module?

INTENDED LEARNING OUTCOMES

1. Demonstrate factual knowledge on the nature and theories in macroeconomics.

CHAPTER V: Consumption, Savings and Investment

1. Discuss the concepts of consumption function and savings function.

Consumption function or Keynesian consumption function, is an economic formula that

Calculating the Consumption Function: C=A + MD

M=marginal propensity to consume

D=real disposable income

According to Keynesian consumption function, savings are

Photo taken from:.wallstreetmojo.com/mpc-formula/ financial-dictionary.com

Factors Affecting Aggregate Consumption

Photo taken from: https://www.tutor2u.net/economics

Government and Equilibrium Income

KG = ∆Y/∆G and ∆Y = KG. ∆G

In other words, an autonomous increase in government spending generates a multiple

Adding a little complexity, the formula becomes

where Y is aggregate income, C is consumption, I is investment expenditure, and G is

Gross investment and Net investment.

In macro economics investment can be categorized as autonomous and induced. Autonomous

Test Your Knowledge

I. Define the following terms.

1. Demand Estimation =___________________________________________________

2. Multiplier Effect =___________________________________________________

3. Disposable Income =___________________________________________________

II. Give the answers to the following:

1. Define consumption function and savings function.

2. Give the factors affecting aggregate consumption. Explain each.

3. Differentiate MPC from MPS.

CHAPTER VI. Macroeconomics Instability: Unemployment and Inflation

1. Differentiate Keynesian theory from classical theory.

Unemployment is a challenge generally found in every economy whether developed or

II. Subsistence Theory of Wages

III. Classical Theory.

This theory of employment is a contribution of various classical and neo-classical

IV. The Keynesian Theory

V. Quantity Theory of Money.

Goal of Full Employment.

Test Your Knowledge.

1 Differentiate Keynesian theory from classical theory.

2. Explain the subsistence theory of wages.

3. Explain the quantity theory of money.

Photo taken from: https:tutor2u.net

Undesirability of Inflation Gainers of Inflation

Pensioners, insured or policyholder Speculators

Demand Pull Inflation

Photo taken from:.tutor2u.net/economics

Cost Push Inflation

Consumer Price Index

Photo taken from: wallstreetmojo.com

Photo taken from: cpiinflationcalculator.com

Inflation shrinks income.

Inflation and Wealth.

Inflation and real interest rate.

Borrowers or savers may be winners or losers, depending on the rate of inflation.

Test Your Knowledge:

1. Explain the meaning, causes and effects of inflation.

2. Differentiate demand pull and cost push inflation.

CHAPTER VII: Money, Banking and Monetary Policy

1. Explain the function of money in the economy.

Photo taken from:.economicsdiscussion.net