Introduction to Macroeconomics

LLB – 1B
Dated: 1st June 2021
Instructor: Dr. Asma Basit

©The McGraw-Hill Companies, 2002

 Macroeconomics is ...
• the study of the economy as a whole
• it deals with broad aggregates
• but uses the same style of thinking
about economic issues as in
microeconomics.

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 Microeconomics and
Macroeconomics
• Microeconomics is the study of how
individual households and firms make
decisions and how they interact with one
another in markets
• Macroeconomics is the study of the
economy as a whole
– Its goal is to explain the economic changes that
affect many households, firms, and markets at
once

©The McGraw-Hill Companies, 2002

 Macroeconomics
• Macroeconomics answers questions like
these:
– Why is average income high in some
countries and low in others?
– Why do prices rise rapidly in some time
periods while they are more stable in others?
– Why do production and employment expand
in some years and contract in others?

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Some key issues in macroeconomics

• Inflation
– the rate of change of the general price level
• Unemployment
– a measure of the number of people looking for work, but
who are without jobs
• Output
– real gross national product (GNP) measures total income
of an economy
• it is closely related to the economy's total output

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More key issues in macroeconomics

• Economic growth
– increases in real GNP, an indication of the
expansion of the economy’s total output
• Macroeconomic policy
– a variety of policy measures used by the
government to affect the overall
performance of the economy

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 The circular flow of income,
expenditure and output

C C+I
S

Households Firms

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Government in the circular flow
I
C+I+G C + I + G - Te
C
S G
Te

Households Government Firms

B - Td
Y + B - Td Y

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 Adding the foreign sector
• To incorporate the foreign sector into the
circular flow
• we must recognise that residents of a country
will buy imports from abroad
• and that domestic firms will sell (export)
goods and services abroad.

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 Total Income
• Recall that we need to measure the
health of an economy
• When judging whether an economy is
doing well or poorly, it is natural to look
at the total income that everyone in the
economy is earning

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 Total Income
• We can temporarily enjoy a high standard of living
even if total income is low
• How? By borrowing from others.
• But we can’t keep borrowing forever
• At some point we’ll have to repay—with interest—
what we’d borrowed
• At that point, we will have to repay out of our income
• This is why a nation’s standard of living depends
heavily on its own total income

CHAPTER 5 MEASURING A NATION’S INCOME

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 GDP and GNP
• Gross domestic product (GDP)
– measures the output produced by factors
of production located in the domestic
economy
• Gross national product (GNP)
– measures the total income earned by
domestic citizens
• GNP = GDP + net income from abroad
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 Gross Domestic Product
• GDP is the total market value of all final
goods and services produced within a
country in a given period of time.
• GDP is also the total expenditure on all
final goods and services produced within a
country in a given period of time.
• It is also the total income earned from all
productive activity in the domestic
Why “final goods and
services”?
economy

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 “Final” Goods and Services
• Final goods are those goods sold to
their final users
• Final goods are those goods that do not
disappear in the process of the
production of some other for-sale good
– Goods that disappear in the process of the
production of some other for-sale good are
called intermediate goods

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 “Final” Goods and Services
• A pencil is a final good because, once
produced, it is ready for use by its final
users
• The wood, the graphite, and the other
materials that disappeared in the pencil
are not final goods
– Their market value is counted when the
market value of the pencil is counted
– So, counting them separately in GDP would be
counting them twice

©The McGraw-Hill Companies, 2002

 What is Gross Domestic
Product (GDP)?
• Video: https://youtu.be/mjJmo5mN5yA

CHAPTER 5 MEASURING A NATION’S INCOME

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Nominal and Real GDP
How can we measure a nation’s productive activity so
that the numbers can be compared across time?

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 GDP: nominal and real
• GDP comes in two flavors:
– Nominal GDP (also called GDP at current
prices), and
– Real GDP (also called GDP at constant
prices)
• So, when you see or hear a discussion
of GDP, be sure to ask, “Nominal or
real?”
©The McGraw-Hill Companies, 2002
 Gross Domestic Product,
Nominal
• Nominal GDP is the total market value of all
final goods and services produced within a
country in a given period of time.
– The market value is calculated using current
prices, the prices that prevailed when the
production took place.
– For example, the nominal GDP of the United
States in 2018 was $20,580.2 billion, according
to the U.S. Department of Commerce
– Given a mid-year population of 327,436,000 (est.)
the per capita nominal GDP was $62,853.

©The McGraw-Hill Companies, 2002

Gross Domestic Product, Real
• Real GDP is the total market value of all
final goods and services produced
within a country in a given period of
time.
– The market value is calculated using
constant prices, which are the prices that
prevailed in a benchmark year called the
base year.

©The McGraw-Hill Companies, 2002

 Nominal and Real GDP
Apples Oranges
Quantit Quantit
Price ($) y Price ($) y
2015 50 10 20 50
2016 100 20 30 100
2017 150 20 50 200

Nominal GDP $
2015 ($50 ✕ 10) + ($20 ✕ 50) = 1500
Note that
2016 ($100 ✕ 20) + ($30 ✕ 100) = 5000
2017 ($150 ✕ 20) + ($50 ✕ 200) = 13000 the base
year’s
Real GDP (Base year 2015) 2015 $ nominal and
2015 ($50 ✕ 10) + ($20 ✕ 50) = 1500
real GDP
2016 ($50 ✕ 20) + ($20 ✕ 100) = 3000
must be the
2017 ($50 ✕ 20) + ($20 ✕ 200) = 5000
same.

©The McGraw-Hill Companies, 2002

 Nominal and Real GDP
Apples Oranges
Quantit
Price ($) y Price ($) Quantity
New value  Old value
2015 50 10 20 50 Growth Rate  100
Old value
2016 100 20 30 100
2017 150 20 50 200

Nominal GDP $ Growth Rate (%)

2015 ($50 ✕ 10) + ($20 ✕ 50) = 1500
100 ✕ [(5000 – 1500)/ 1500] =
2016 ($100 ✕ 20) + ($30 ✕ 100) = 5000 233
100 ✕ [(13000 – 5000)/ 5000] =
2017 ($150 ✕ 20) + ($50 ✕ 200) = 13000 160

Real GDP (Base year 2015) 2015 $

2015 ($50 ✕ 10) + ($20 ✕ 50) = 1500
100 ✕ [(3000 – 1500)/ 1500] =
2016 ($50 ✕ 20) + ($20 ✕ 100) = 3000 100
2017 ($50 ✕ 20) + ($20 ✕ 200) = 5000 100 ✕ [(5000 – 3000)/ 3000] = 67

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 Nominal vs. Real GDP
• Video: https://youtu.be/rGqhTQyY6g4

CHAPTER 5 MEASURING A NATION’S INCOME

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Three measures of national output
• Expenditure
– the sum of expenditures in the economy
–Y=C+I+G+X-Z
• Income
– the sum of incomes paid for factor services
– wages, profits, etc.
• Output
– the sum of output (value added) produced in
the economy

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 Components of GDP
• We need to pay attention not only to the total
expenditure on all final goods and services
made in a country (that is, GDP), we also need
to watch where the expenditure is coming from
• That way, when there’s a recession, we’ll know
which sector needs the most attention
• GDP = Consumption Spending +
Investment Spending +
Government Spending +
Exports – Imports

©The McGraw-Hill Companies, 2002

 Components of GDP
• Expenditure on “Made in USA” final goods and services can
come from only these four sources:
– Households (Consumption expenditure)
– Businesses (Investment expenditure)
– Government entities (Government purchases)
– Foreigners (Exports)
• So, one might think …
• GDP = Consumption Spending +
Investment Spending +
Government Spending + Exports
• But that would be incorrect!

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 Components of GDP
• GDP = Consumption Spending +
Investment Spending +
Government Spending +
Exports – Imports
• Q: Why do we subtract imports?
• A: GDP is the market value of all final “Made in
USA” goods. But consumption, investment, and
government purchases all include spending on
foreign goods. Therefore, to make the two sides of
the equation the same, we must take out all the
imports.
– Exports – Imports is called Net Exports

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 The Components Of GDP
• Consumption (C):
– The spending by households on goods and
services, with the exception of purchases
of new housing.
• Investment (I):
– The spending on capital equipment,
inventories, and structures, including new
housing.

CHAPTER 5 MEASURING A NATION’S INCOME

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National income accounting: a summary

NYA NYA Deprec'n

G Indirect
GNP taxes
(and I Profits,
GDP rents
GNI) NX at NNP
Self-
at market at basic National employment
market prices prices income
prices C Wages
and
salaries

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 What GNP does and does not
measure

• Some care is needed:

– to distinguish between real and nominal
measurements
– to take account of population changes
– to remember that GNP is not a
comprehensive measure of everything that
contributes to economic welfare

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