ECO0006

Economics for Managers

© 2022 Singapore Institute of Management Group Limited

 Lecture 6
The National Economy

Ref:
Tan Khay Boon, Economics for Managers Module Book,
SIM Global Education, 2014
Session 6
Learning Objectives
At the end of the lesson, students will be able to:
1. Distinguish between microeconomic and
macroeconomic issues and problems.
2. Explain the circular flow of income.
3. Describe the various phases of the business cycle.
4. Explain the three ways of estimating GDP, namely
the product, income and expenditure methods.
5. Understand the limitations of GDP as a measure
of the standard of living and the ways to correct it.
3
The Scope Of Macroeconomics
• Microeconomics and macroeconomics
– Microeconomics concentrates on individual units –
the household, the firm, markets and the industry.
– Macroeconomics studies the economy as a whole.
Specifically it examines the economic behaviour of
aggregates:
• economic growth
• unemployment
• inflation
• balance of payments and exchange rates
4
The National Economy
The Circular Flow of Income

5
 The circular flow of income

Firms

Payment for INNER FLOW

Payment for
goods and
resources
services

Households 6
THE CIRCULAR FLOW OF INCOME
• Withdrawals (W)
– net saving from households (S)
– net taxes to government from households & firms (T)
– import expenditure of households & firms (M)
– W=S+T +M
• Injections (J)
– investment expenditure through intermediaries such as
banks (I)
– government expenditure on infrastructure (G)
– export expenditure by foreigners on domestic goods (X)
– J=I+G+X

7
 The circular flow of income

INJECTIONS

Export
expenditure (X)
Investment (I)
Government
Payment for expenditure (G)
Payment for goods and Financial
Govt Foreign
resources services) Intermediaries
Sector

Import
Net expenditure (M)
Net taxes (T)
saving (S)

WITHDRAWALS

8
The National Economy
Short-term Growth and the Business Cycle

9
 Business Cycle
• GDP increases in the long term due to
– Improvement in technology
– Improvement in the quality of resources and
productivity
– Discovery of new resources (e.g. population
growth, foreign labour or new mineral deposits)
• In between the upward trend, GDP fluctuates
in a cyclical manner – known as a business
cycle
10
 The Business Cycle

C
Trend line
National output

Business cycle
B

O
Time 11
 Analysis Of The Business Cycle
• Peak: Highest point of the business cycle
– A & C are considered as the peaks in the business cycle
• Trough: Lowest point of the business cycle
– B & D are considered as the troughs in the business cycle
• The phases of the business cycle
• Expansion: Period between a trough and the next peak
e.g. B to C
• Recession: Period between a peak and the next trough e.g.
A to B
– Recession is a mild contraction for 6 months
– Depression is a prolonged recession with a sharp
reduction in output and high unemployment 12
The National Economy
Measuring National Income

13
 Definition of GDP
Market value of all final goods and services produced
within the geographical boundary of the country, during
a particular time period.

1. Market Value: The GDP figure can only capture goods

and services that are marketed
2. Final Good and Services: These are the goods and
services sold to the final user
3. Geographical Boundary: Within the country borders.
4. During a particular time period: Usually one calendar
year but quarterly data also compiled
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 Market Value
• Market Value
– Only include goods and services transacted
through the market
– Production of food or services as gifts or for
family are not recorded as output in GDP
– Transactions in the underground economy is not
recorded
–Private tuition by university students
–Hawkers under declare output for tax evasion
–Illegal sale of cigarettes or alcohol
15
 Final Output
• Intermediate goods are not included in GDP as
the final price of the product already reflects
the value of all its components (including
intermediate goods).

• Intermediate good is a good used in the

production of a final good/services that is for
consumption
– E.g. car tyres, leather, car battery are all intermediate goods
used to produce a car – which is the final good
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 Final Output
• To avoid double-counting, count only the
value added to a product as it moves through
each stage of its production process.

• The gross value added during each stage of

production is the difference between the
value of the product (its selling price) and the
cost of materials needed to make it.

17
 Computation of Value Added
Stage of Sale Cost of Intermediate Gross Value
Production Value Goods Added
(1) (2) (3)

Farmer $1 -
$1

Flour Producer $2.20 $1

$1.20

Baker $4 $2.20 $1.80

GDP $4
 Produced in Domestic Economy
• GDP measures goods and services produced within
the geographical boundary of Singapore
• Does not differentiate between factor ownership
• Exports from Singapore are included in GDP
• Imports to Singapore are not included in GDP
• GNP exclude value of output by foreign firm and
include value of output by local firms located
abroad

19
 Time Frame
• GDP measures value of output based on one year
timeframe

• To avoid double counting, GDP does not include

value of second hand goods

20
 Standard of Living
• GDP measures performance of the economy
overtime and with other economies
• Real GDP per capita = Real GDP/Population
– An indicator of the well being of a person in the
country
– High Real GDP per capita is associated with a
high standard of living
– However there are limitations to Real GDP per
capita as a measure of standard of living
– Primarily it does not take into account the
qualitative aspect of standard of living 21
 Standard of Living
GDP is a limited measure of standard of living as it
ignores:
• Household production and underground economy
– Goods and services produced by family members
contribute to welfare but is not included
– A large underground economy significantly
understates the well being of the residents

22
 Standard of Living
• Leisure
– Higher output in the economy invariably leads to
longer working hours and a sacrifice of leisure
– This is not reflected in GDP figures
• Environment
– Increase in GDP tends to result in pollution and
damage to the environment
– Therefore a higher GDP may not mean that the
resident is better off as the trade off is a more
unpleasant living environment

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 Standard of Living
• Crime and congestion
– High crime rate and congestion reduces well
being of residents, even if they enjoy higher
output levels
• Income distribution
– GDP per capita assumes that everyone gets an
equal share
– In reality, majority of output may be
concentrated amongst minority
– General population may then still not be well off
despite high GDP figures 24
 Standard of Living
• Consumption
– GDP focuses on value of production
– However if output is primarily made up of
investment goods and not consumption goods,
residents are not better off

25
 Measuring National Income

The three ways of measuring GDP

– the product method
– the income method
– the expenditure method

26
 Output Method
• Measure market value of all final output
• Market value of final output = Price x Output
Firm Output Price Quantity 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

• Easy to use but tedious in data collection and
computation

27
MEASURING NATIONAL INCOME
• The expenditure method

– C+G+I+X–M

• Gross national income (GNY)

• Net national income (NNY)

28
 Expenditure Approach
Consumption
• Personal consumption expenditure
• Consists of purchases of final goods and services by
households during the year.
• Three main types of consumer expenditures
– durable goods (e.g. cars, furniture)
– non-durable goods (e.g. food, clothing)
– services (e.g. education, transportation)
29
 Expenditure Approach
Investment
• Gross private domestic investment
• Consists of spending on new capital goods
• Investment consists of spending on current
production that is not used for current
consumption
– Physical capital investment
– Inventory investment
– Residential investment

30
 Expenditure Approach
• Physical capital investment
– Expenditure to produce more goods and services
– Purchase of machinery, computers, vehicles,
shops and buildings
• Inventory investment
– Stock of completed or semi-completed goods
– Firms may hold on to inventory to sell at later
time for better profit
– Helps firm to smoothen demand for its goods
– Measured by the value of inventory at year end
minus that at the beginning of the year 31
 Expenditure Approach
• Residential investment
– Purchase of newly constructed houses by
households
– Purchase of existing houses are not included to
avoid double counting
*** Purchase of financial assets such as stocks and
bonds are not included in the Investment
component as no new goods or services are
produced

32
 Expenditure Approach
Government Expenditure
• Government consumption and investment
• Spending by all levels of government for final goods and
services
• Do not include transfer payments

33
 Expenditure Approach
Net Exports
• Difference between export earnings and import
payments (X – M) resulting from the interaction
between that country and the rest of the world
• Includes merchandise trade and services

34
 Expenditure Approach
Aggregate Expenditure (AE)

= Consumption + Investment + Government

Purchases + Net Exports
= C + I + G + (X - M)
= GDP

35
 Income Approach

• The income method

– adding factor earnings from 4 resource types
– Rent obtained from the resource :Land
– Wages obtained from the resource: Labour
– Interest obtained from the resource: Capital
– Profits obtained from the resource: Entrepreueurship

36
 Income Approach
Some qualifications
• Transfer payments: social security benefits,
pensions & gifts are excluded because no
goods and services are exchanged.
• Direct taxes are excluded as gross income are
counted.
• Indirect taxes and subsidies on products: add
taxes and subtract subsidies to get market
price valuation.

37
 Accounting for Inflation
Nominal GDP
• measures the value of output in current dollars i.e. GDP
valued at current year output multiply by current year
price
• since the economy’s average price level changes over
time, current dollar comparisons across years can be
misleading
Real GDP
• eliminates price changes
• measures the value of output in constant dollars i.e.
GDP valued at current year output multiply by the
prices prevailing in a selected year (base year)
38
 Accounting for Inflation
2012 2013
Output Price Quantity Price Quantity
Food $1 1200 $1.20 1250
Clothing $2 800 $2.20 830
Computer $300 30 $330 35

• 2012 nominal GDP = ($1 x 1200) + ($2 x 800) + ($300 x 30) = $11800.

• 2012 real GDP = $11800 (2012 is base year)

• 2012 nominal GDP = ($1.20 x 1250) + ($2.20 x 830) + ($330 x 35) =

$14876.

• 2013 real GDP = ($1 x 1250) + ($2 x 830) + ($300 x 35) = $13410.

• Nominal GDP > Real GDP as both P & Q increase 39

 Accounting for Inflation
• Growth rate of economy
– Measured by percentage change in real GDP
• Between 2012 and 2013, the nominal GDP growth
rate is: $14876-$11800 X 100% = 26.07%
$11800
• The real GDP growth rate is:
$13410-$11800 X 100% = 13.64%
$11800
• Nominal growth > Real growth as prices has
increased.
40
 Tracking Economic Performance
• A simple and quick gauge to determine whether an
economy is doing well or is growing is to check
whether it has managed to produce a larger output
of goods and services when compared to the
previous year.
• An economy is declared to be growing if the real GDP
for that year is larger than the real GDP for the
previous year.
• An economy is declared to be in recession if the real
GDP for that year is less than that for the previous
year.
41
 Discussion Question 1
One shortcoming of GDP as an indicator of society’s
social well-being is that it fails to take into account the
__________.

A. growth in productivity.
B. increase in the quantity of goods.
C. non-market production.
D. change in the price level.

42
 Discussion Question 2
If Nike, an American firm produces T-shirts in Vietnam,
this would

A. add to neither U.S. GDP nor Vietnam GDP.

B. add to Vietnam GDP but not to U.S. GDP.
C. count towards U.S. GDP as it is a U.S. firm.
D. count towards both Vietnam and U.S. GDP.

43
 Discussion Question 3
Intermediate goods and services are __________
production and __________ counted in GDP.

A. the end products of; are

B. end products of; are not
C. used up in the process of; are
D. used up in the process of; are not

44
 Discussion Question 4
Suppose that the total production of an economy
consists of 10 oranges and 5 candy bars; each orange
sells for $0.20 and each candy bar sells for $1.00. What
is the market value of production of this economy?

A. $1.20
B. $2.00
C. $5.00
D. $7.00

45
 Discussion Question 5
In symbolic terms where Y equals real GDP, POP equals
total population, real GDP per capita is measured by:

A. Y + POP
B. Y × POP
C. Y ÷ POP
D. Y - POP

46
 Discussion Question 6
A1’s Shoeshine Stand shined 1,000 pairs of shoes in
2011 and 1,200 pairs of shoes in 2012. He charged $4
for a shine in 2011 and $5 for a shine in 2012.

a) If 2011 is the base year, find A1’s contribution to

both nominal GDP and real GDP for both years.

b) Which measure would be better to use if you were

trying to measure the change in A1’s productivity
over the 2 years? Why?
47
 Discussion Question 7
GDP Data
Consumption expenditures $600
Exports $75
Government purchases of goods and services $200
Construction of new homes and apartments $100
Sales of existing homes and apartments $200
Imports $50
Beginning-of-year inventory stocks $100
End-of-year inventory stocks $125
Business fixed investment $100
Government payments to retirees $100

Refer to the following table:

(a) Calculate nominal GDP for the economy using
data from the table above.
(b) What items are excluded and why? 48
Thank you