MACROECONOMICS

(ECO 101)
NATIONAL ECONOMY AND NATIONAL
INCOME ANALYSIS
 COURSE CONTENT
 Introduction
 National Equilibrium and the Circular Flow of Income
 National Income Identity: Variables and Definitions
 Approaches in the measurement of National Income
 National Income Determination: Aggregate Demand
Approach
 The concept of multiplier and policy implications.
 INTRODUCTION
 Microeconomics is the study of economic behaviour
of individual decision makers (consumers, producers
and owners of factors of production) and price
determination of individual products and factor inputs.
 In contrast, macroeconomics is the study of the
economy as a whole.
 It deals with the study of the structure and performance
of national economies and of the policies that
government uses to try to affect economic performance
 INTRODUCTION CONT……
 Precisely, macroeconomics studies the relationship
and interaction between factors that determine:
 The level of economic growth
 General price level
 National output and employment and
 Balance of payment
 The major theoretical issues that arise out of
macroeconomic literature are:
1. How is the level of employment determined in a country?
2. What causes fluctuations in the national output and
employment?
3. What determine the general price level in a country?
 INTRODUCTION CONT……
4. What causes disequilibrium in the balance of payment of
a country?
5. What roles can the government play in correcting
economic imbalances
Therefore macroeconomics provides analytical
framework and guidelines for finding reasonable
solutions to these problems.
NATIONAL EQUILIBRIUM AND THE
CIRCULAR FLOW OF INCOME
 In the market directed economies, goods and
services are produced only when there is a market
demand for them.
 If firms produce more than customers can buy;
excess aggregate supply will develop, leading to
decline in prices. As a result, firms will cut down
production, laying off workers.
 Conversely if customers demand more than it is
being produced i.e. excess aggregate demand
develops, leading to price rise and hence firms will
tend to increase output and employment
NATIONAL EQUILIBRIUM AND THE
CIRCULAR FLOW OF INCOME cont…
 For any economy to be in equilibrium national
output must equal to total income of the country.
 This can be explained by what is known as a
Circular Flow of Income.
 The circular flow of income is a simple model of
the economy showing flows of goods and services,
factors of production and income between firms
(producers) and households (consumers).
 NATIONAL EQUILIBRIUM AND THE
CIRCULAR FLOW OF INCOME cont…
 Assumptions of the simple economy model:
1) There are only two sectors namely; household
and firms.
2) There is no government and no foreign trade
hence, payments made to firms are equal to
payments made to households.
3) Households own all factors of the production and
consume all goods and services
 NATIONAL EQUILIBRIUM AND THE
CIRCULAR FLOW OF INCOME cont…
4) Households income consist of wages, rent,
interest and profits.
5) Business firms, hire factors of production from
households,
6) They produce and sell goods and services to
households
7) No Saving to households and firms
8) Production in a given year is sold in that year
NATIONAL EQUILIBRIUM AND THE
CIRCULAR FLOW OF INCOME cont….
Figure 1: Circular Flow of Income
Flow of expenditure on
final goods and services

PRODUCT MARKET
DEMAND VALUE: Final goods & SUPPLY
Services

HOUSEHOLD
BUSINESS

SUPPLY Factor Input (land,

labor, capital and DEMAND
entrepreneurship)

PRODUCT MARKET
VALUE: Flow of Income
(wages, rent, interest & profit)
NATIONAL EQUILIBRIUM AND THE
CIRCULAR FLOW OF INCOME cont….
 For the business sector to produce goods and
services should hire the services of the household
sector, in the form of labour, land and capital etc.
 In exchange for the services the business sector
pays wages, salaries, rents, interests and profits
to the household sector (labours, firms and land
owners).
 Thus, there is a flow of earnings or income to the
household sector which matches the flow of
services to the business sector.
NATIONAL EQUILIBRIUM AND THE
CIRCULAR FLOW OF INCOME cont….
 The upper Side:
 The goods and services produced by the business
sector are then sold to the household sector.
 In exchange for receipts of produced
goods/services, households pay firms prices.
 There is therefore a matched flow of
expenditures on final goods and services from
the household to the business sector.
NATIONAL EQUILIBRIUM AND THE
CIRCULAR FLOW OF INCOME cont….
 NB:
 An important feature of the product and money flow
is that the value of real flows equal to the money
flows.
 This is due to the fact that factor payments (wages,
rent, interest, and profits) are equal to households
income.
 Since households spend all their income on goods
and services, households expenditure equals the total
receipts of the firms which equals to the value of
output.
NATIONAL EQUILIBRIUM AND THE
CIRCULAR FLOW OF INCOME cont….
 This means that the value of output produced in this
economy can be measured in three ways
1. National output = value of goods and services
flowing from the firms to households
2. National income = value of rent, wages, interest
and profit paid to households
3. National expenditure = value of spending by
households on goods and services
 Therefore:
Households income (factor payments) Ξ Expenditure
ΞThe money Value of Output
 To make the model more realistic and useful, it is necessary
to introduce injections and leakages, which are accompanied
by an increase in the number of active groups in the
economy.
 Injection = money joins the circular flow as a result of
spending on goods and services from a group other than the
households.
 Leakage = money leaves the circular flow passing from the
households to a group other than the firms.
 There are three pairs of injections and leakages, each
connected by an additional active group in the economy.
NATIONAL EQUILIBRIUM AND THE
CIRCULAR FLOW OF INCOME cont….
 Criticisms
1. In reality the households do not spend all their
current income, some is saved. This represents a
leakage from the circular flow.
2. Firms also carry out investment spending. This is
an injection to the circular flow of income, as it
does not originate from consumers' current
income.
3. In the real world the government and
international trade sectors must also be included.
NATIONAL EQUILIBRIUM AND THE
CIRCULAR FLOW OF INCOME cont….
 Government spending will be injected into the circular
flow
 The injection provided by the government sector is
government spending (G) that provides collective
services and welfare payments to the community
 Taxation will leak income from the flow
 The leakage that the Government sector
provides is through the collection of revenue
through Taxes (T) from households and firms. it
is a leakage out of the current income thus
reducing the expenditure on current goods and
services
NATIONAL EQUILIBRIUM AND THE
CIRCULAR FLOW OF INCOME cont….
 International trade flows will be injected
 Exports (X) of goods and services which generate
income for the exporters from overseas resident
 Imports flows leaked. Imports (M) represent
spending by residents into the rest of the world.
 Injection = money joins the circular flow as a result
of spending on goods and services from a group
other than the households.
 Leakage = money leaves the circular flow passing
from the households to a group other than the firms.
 NATIONAL INCOME V IDENTITY:
VARIABLES AND DEFINITIONS
 Some Basic Concepts
 National Income- National Income is the money
value of all final goods and services produced in
a country during a period of one year.
 National Income is the most important
macroeconomic variable and determinant of the
business level and economic status of the
country.
 NATIONAL INCOME V IDENTITY:
VARIABLES AND DEFINITIONS cont….
 Other macroeconomics variables are: Inflation,
Employment, Price Level, Interest etc.
 In the following discussion will look on some
basic concepts of national income used in
business analysis and different methods of
measuring national income.
 NATIONAL INCOME V IDENTITY:
VARIABLES AND DEFINITIONS cont….
 GNP- the total market value of all final goods and
services that the country's citizens have produced in a
year, regardless of their location.
 It includes income earned abroad by nationals and
excludes income earned locally by the foreigners.
 Gross Domestic Product (GDP) – the total market
value of all final goods and services produced within
a country’s national borders in a year, regardless of
who owns the factors of production.
 It includes income earned locally by foreigners and
excludes incomes earned abroad by nationals.
 NATIONAL INCOME V IDENTITY:
VARIABLES AND DEFINITIONS cont….
National Income (NI):-
 This is the total of all incomes earned by the
factors of production in the country (land,
capital, labour, entrepreneur) at a specified
period of time usually one year.
 It is the total money value of all incomes
received by persons and enterprises in the
country during the year.
 Such income may be in the form of wages,
salaries, interest, rents and profit.
 NATIONAL INCOME V IDENTITY:
VARIABLES AND DEFINITIONS cont….
 Net National Product (NNP)-This is the (Net) market
value of final goods/services produced in the economy
over a specified period of time, usually one year.
 Personal Income (PI)-Is the total income received by
all individuals in the economy i.e. what individuals
have to spend, save or pay tax.
 Disposable Personal Income (DPI)-This is what
people are left with after they pay taxes.
 Nominal national income -national income measured
at the current level of prices
 Real national income - national income measured at
constant prices to remove the effect of inflation