MACROECONOMICS:
It is the study of the economy as a whole. It deals with a lot of issues such as National economic goals ( inflation, unemployment, short and long term economic growth, business cycle, balance of payments, exchange rates budget deficits, and others). It is also very important for the business sector and government sector of any nation to have some knowledge about Macroeconomics. For example, it is very necessary for the business sector, to know the effect of the economic down turn, lower per capita income inflation, higher unemployment on their sales revenue. For the government sector, it is very necessary for any government, a president who wants for the second term, has to deal with the above national economic goals. Macroeconomics is also a center for international policy decisions. For example, take look at the events that took place for last two or even more decades in Europe, Asia, Latin America, and Africa.
Therefore economic models are used to understand, explain, and predict economic events.
These models do have exogenous and endogenous variables. The endogenous variables are those variables that are explained and determined within the model, while exogenous variables are given outside the model.
The question is now how to measure economic activity of a Nation?
National Income Accounting is a measurement system used to estimate national income, output, and its components.
Gross domestic product( GDP) is the market value of all final goods and services produced within the nation’s borders during a period of time.
Final goods, means that intermediate products are not counted.
Gross National product(GNP) is the market value of all final goods and services produced by using resources owned by U.S. residents over period of time.
GNP = GDP + (income earned by U.S. residents from abroad) – ( income paid by U.S. residents to foreigners).
There are two basic approaches to measure GDP: the expenditure and income approach.
GDP = GDI |
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1- The expenditure approach 2- The income approach |
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A- Consumption Expenditures by households(C) Compensation of employees |
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- Durable goods (furniture’s, cars, PCs) -(wages, salaries, and benefits) |
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- Non durable goods (food, clothing,) - plus |
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- Services
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Plus + |
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B- Investment expenditures by businesses Rental Income (renting lands, farms, warehouses) |
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-Fixed investment |
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· non residential (plants, equipments, machines) |
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· Residential |
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· Changes in inventories |
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PLUS C- Government purchases of goods and services Interest income
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PLUS PLUS |
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D- expenditures by foreigners (exports- imports) Profits (corporate profits and no corporate profits) |
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Plus |
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Depreciation |
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Plus |
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Indirect business |
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We can explain the above table by using Circular Flow of product and income diagram.
Total income equals total output.
Total output is the value of all the final goods and services produced in the economy. That is the total receipts from the sale of final goods and services.
Total income is the total amount earned by the nation’s resources from the sale of final goods and services.
In the circular flow diagram, there two markets, the product markets and factor markets.
Product markets are markets where households buy goods and services from businesses. The transaction takes place in the upper part of the circular flow diagram.
Why total income equals total output?
Since total output is the value of all final goods and services produced and sold in the economy and total income is all the income received from producing that output, then they must be equal.
Value added is another way of measuring GDP and it is the value of firms’ sales minus the value of intermediate goods.
Exclusions from GDP.
- Financial transactions ( buying and selling securities and bonds) because there is only exchange of ownership rights but no productive activity occurs. Note the fee for the broker’s services is included GDP.
- Private and Public transfer payments: payments for which no productive services are provided in exchange.
- Transfer of second hand goods
- other excluded transactions are household production at home( repairing your house, and so on ), and Underground activities.
GDP – Depreciation = Net domestic product(NDP) or
GNP – Depreciation = net national product(NNP)
GDP can be computed as a flow of expenditures:
GDP= consumption expenditure by household( C) + Business expenditures by businesses or gross domestic Investment( I) + Government purchases of goods and services( G) + Foreign purchasers( i.e. net exports) which is exports – imports
Net Domestic Investment = Gross private domestic investment (I ) – Depreciation
If net investment is positive, then I is greater than depreciation and therefore, the economy’s production capacity is expanding. Its stock of capital is growing.
If net investment is negative, that is Gross Investment is less than depreciation, then the economy’s production capacity is declining. That is the economy is using up more capital than it produces. For example net investment is negative during depression( 1930s)
If net investment is equal to zero then a nation’s production capacity is static, for example in 1942 both depreciation and net investment were equal, $10 billion.
Because we are interested in variation in real output of the economy, we use Real GDP.
Real GDP = Nominal GDP¤ GDP deflator, Real GDP is the nominal GDP adjusted for inflation(price changes)
Real GDP ¤ Population = per capita real GDP, so per capita real GDP or income provides a measure of a nation’s living standards.
Three types of price index:
Consumer price index(CPI) , Implicit GDP price deflator, and producer price index(PPI).
Consumer price Index: is a weighted average of prices of a specified set of goods and services purchased by urban consumers( the cost of living index).
That is the price of a marked basket today expressed as a percentage of the price of that market basket in the base year. ( CPI = Cost of market basket in 2000/ the cost of same market basket in the base year).
Inflation is measured by computing consumer price index.
Inflation = this year’s( CPI – last year’s CPI) / last year’s CPI.
GDP deflator measures is the weighted average prices of all new goods and services produced by the economy. It is a broader measure than CPI.
Producer price Index: is the weighted average of prices of goods purchased by business firms.
The problem with CPI : It over estimates inflation because it doses not take in to consideration the substitution bias, the introduction of new product in the economy, the quality changes of the products.
GDP is measured in chain-weighted averages while CPI is measured in fixed weighted averages.
Redistributed effects of inflation
Real money income =(W/ p), W = wages , P = prices
- Fixed income groups
- Savers or (lenders, creditors)
- Borrowers( debtors)
What is business cycle( economic fluctuations)?, leading indicators?
What is unemployment? Unemployment rate?, labor force?, and labor force participation rate?