MACROECONOMI

CS Compiled
topics
In partial fulfillment for Economics 2A
BE 311/8:00-9:00AM/7172
Carmela Mae C. Duron

UM Vision, Mission
and Goals
Vision
A leading institution of higher learning
recognized for its quality transformative
education serving the nation and the world.

Mission
To provide a dynamic and academic
environment through the highest
standards of instruction, research and
extension in a non sectarian institution
committed to democratizing access to
education.

Goals
To achieve its mission, the University
aims to:
Offer academic programs that meet the
changing national and international
community needs;

Produce graduates who are competent

leaders and productive members of society;

Harness a pool of ethical, qualified and

highly-trained human resources;

Goals
Provide an academic environment conducive to
optimum learning through adequate state-of-the-art
facilities;

Conduct researches and other scholarly activities

that generate new knowledge and contribute to the
improvement of the quality of life for all;

Engage in community services that foster selfreliance and empowerment among the marginalized
community; and

Lead in the promotion and perseveration of the

cultural heritage of Mindanao and of the country as a
whole.

Table of Contents
Topics:

UM Vision
Mission
Goals
Introduction to
Macroecomonics

Circular Flow Model

(Keynesian Process)

Slide Number:

..2
..3
..4-5
...8-22
...23-26

National Income Accounts

and Computation

GDP/GNP Components
Two Approaches of GDP

27
.28-31
.32-43

Table of Contents
Topics:
MPC and MPS
Multiplier effect
Aggregate Consumption

.44-60
.61-67
.68

Expenditure

Aggregate Investment
Expenditure

.69-76

Aggregate Government
Expenditure

Net Export
References

.77
.78-79
.80-81

Slide number:

Introduction to
Macroecomonics
Macroeconomics
The study of the performance of national
economies, and of the policies that
governments use to try to improve that
performance.
Examples: Quantitative easing (QE), Euro Zone
Crisis, Abenomics, China Economy Soft Landing,
Real Wage of Taiwan

Cont.
Economics is the study of choice under

conditions of scarcity (scarcity of

what?).
- intuitively, we are forced to make some
choice

As individuals and societies we are

faced with limited resources (dont you

believe?) and virtually unlimited wants
(hope you agree!).

MICRO AND MACRO

EFFECTS
Event: An increase in gasoline price
Micro effect: vehicle driver, bicycle market,
electricity
Macro effect: inflation, unemployment

Categories of
Economics
Positive economics deals with how the economy
works bare facts.
Normative economics deals with what should be
used to make judgments about the economy,
identify problems and prescribe solutions
Microeconomics study of the behavior of
individual households, firms and govts.; the choices
they make; and their interactions.

Macroeconomics study of the behavior of the

overall economy

TEN PRINCIPLES OF
ECONOMICS
Principle 1: People Face Tradeoffs.
To get one thing, we usually have to give up
another thing.
Guns v. butter
Food v. clothing
Leisure time v. work
Efficiency v. equity

Making decisions requires trading off

one goal against another.- Mark P.
Karscig

Principal 1: People Face

Tradeoffs.
Efficiency v. Equity
Efficiency means society gets the most that
it can from its scarce resources.
Equity means the benefits of those resources
are distributed fairly among the members of
society.

TEN PRINCIPLES OF
ECONOMICS
Principle 2: The Cost of Something Is
What You Give Up to Get It.
Decisions require comparing costs and
benefits of alternatives.
Whether to go to college or to work?
Whether to study or go out on a date?
Whether to go to class or sleep in?

The opportunity cost of an item is what you

give up to obtain that item.

TEN PRINCIPLES OF
ECONOMICS
Principle 3: Rational People Think
at the Margin.
Marginal changes are small,
incremental adjustments to an existing
plan of action.

TEN PRINCIPLES OF
ECONOMICS
Principle 4: People Respond to
Incentives.
Marginal changes in costs or benefits
motivate people to respond.
The decision to choose one alternative over
another occurs when that alternatives
marginal benefits exceed its marginal costs!

TEN PRINCIPLES OF
ECONOMICS
Principle 5: Trade Can Make
Everyone Better Off.
People gain from their ability to trade with
one another.
Competition results in gains from trading.
Trade allows people to specialize in what
they do best.

TEN PRINCIPLES OF
ECONOMICS
Principle 6: Markets Are Usually a
Good Way to Organize Economic
Activity.
A market economy is an economy that
allocates resources through the
decentralized decisions of many firms
and households as they interact in
markets for goods and services.
Households decide what to buy and who to
work for.
Firms decide who to hire and what to

TEN PRINCIPLES OF
ECONOMICS
Principle 7: Governments Can Sometimes
Improve Market Outcomes.
Market failure occurs when the market fails to allocate
resources efficiently.

When the market fails (breaks down) government can

intervene to promote efficiency and equity

Market failure may be caused by

an externality, which is the impact of one person or
firms actions on the well-being of a bystander.

market power, which is the ability of a single person or

firm to unduly influence market prices. .

TEN PRINCIPLES OF
ECONOMICS
Principle 8: The Standard of Living Depends
on a Countrys Production.
Almost all variations in living standards are explained
by differences in countries productivities.

Productivity is the amount of goods and services

produced from each hour of a workers time.

Standard of living may be measured in different

ways:
By comparing personal incomes.
By comparing the total market value of a nations
production.

TEN PRINCIPLES OF
ECONOMICS
Principle 9: Prices Rise When the
Government Prints Too Much Money.
Inflation is an increase in the overall level of
prices in the economy.

One cause of inflation is the growth in the

quantity of money.

When the government creates large

quantities of money, the value of the money
falls.

TEN PRINCIPLES OF
ECONOMICS
Principle 10: Society Faces a Shortrun Tradeoff Between Inflation and
Unemployment.
The Phillips Curve illustrates the tradeoff
between inflation and unemployment:

Inflation is lower Unemployment is

higher
Its a short-run tradeoff!

The Circular-Flow
Diagram
Trade takes the form of barter when
people directly exchange goods or
services that they have for goods or
services that they want.
The circular-flow diagram is a model
that represents the transactions in an
economy by flows around a circle.

The Circular-Flow
Diagram

Circular-Flow of
Economic Activities
A household is a person or a group of people that
share their income.

A firm is an organization that produces goods and

services for sale.

Firms sell goods and services that they produce to

households in markets for goods and services.

Firms buy the resources they need to produce

factors of productionin factor markets.

Wages, rents, interest,

profits

Factor services

Goods
Firms (production)

Household
Government
Financial markets

Other countries

2004 The McGraw-Hill Companies, Inc., All

Rights Reserved.

National Income
Accounting
Is a measurement of indicators of
national income/output
Example:
Transfer Payments- transactions wherein
one party is not obliged to deliver or return
goods or services in return.

Gross Domestic Product

(GDP)
Gross Domestic Product (GDP)
Total value of all final goods and services
produced for the marketplace during a given
period within the nations borders
It measures the current production,
transactions occurred prior to the current
one are deemed excluded.
Includes final goods and services only

GDP Cont
For the marketplace
GDP does not include all final goods and

services produced in the economy

Includes only the ones produced for the
marketplacethat is, with the intention
of being sold

GDP Cont
During a given period
GDP measures production during some
specific period of time
Only goods produced during that
period are counted
GDP is actually measured for each
quarter, and then reported as an
annual rate for the quarter
Once fourth quarter figures are in,
government also reports official GDP
figure for entire year

GDP Cont
Within the nations
borders
GDP measures output
produced within U.S. borders

Regardless of whether it was

produced by Americans

Approaches of GDP
The Expenditure Approach
- measures GDP as the sum of expenditures
on final goods/services
Formula:
GDP = C + I + G + NX

The Expenditure
Approach
Expenditure approach divides output into

four categories according to which group in

the economy purchases it as final users
Consumption goods and services (C)
purchased by households
Private investment goods and services (I)
purchased by businesses
Government goods and services (G)
purchased by government agencies
Net exports (NX)purchased by foreigners

The Expenditure
Approach
Consumer spending, C, is the sum of

expenditures by households on durable

goods, nondurable goods, and services.
Examples include clothing, food, and
health care.
Investment, I, is the sum of
expenditures on capital equipment,
inventories, and structures. Examples
include machinery, unsold products, and
housing.

The Expenditure
Approach
Government spending, G, is the sum

of expenditures by all government

bodies on goods and services. Examples
include naval ships and salaries to
government employees.
Net exports, NX, equals the difference
between spending on domestic goods by
foreigners and spending on foreign
goods by domestic residents. In other
words, net exports describes the
difference between exports and imports.

The Value-Added
Approach
- measures GDP as the sum of value-added

Value added
Firms contribution to a product as it is

produced or
Revenue it receives for its output minus cost
of all the intermediate goods that it buys
Example: Production of a ream of notebook
paper
Formula: GDP = Sum of value added by all
firms

The Factor Payments

Approach
In any year, value added by a firm is

equal to total factor payments made by

that firm
Factor payments: payments to the
owners of resources that are used in
production.
Formula:
GDP = Sum of factor payments made by
all firms
GDP = Wages and Salaries + interest +
rent + profit
GDP = Total household income

Real Versus Nominal

GDP
Since GDP is measured in dollars, a

serious problem exists when tracking

change in output over time
Value of the dollarits purchasing power
is changing

Most government statistics are

reported in both nominal and real

terms
Economists focus almost exclusively on
real variables

Real Versus Nominal

GDP
Usually need to adjust our

measurements to reflect changes in

the value of the dollar
Nominal variablewhen a variable is

measured over time with no adjustment

for the dollars changing value
Real variablewhen a variable is
adjusted for the dollars changing value

Real Versus Nominal

GDP
The distinction between nominal and

real values is crucial in macroeconomics

The public, the media, and sometimes
even government officials have been
confused by a failure to make this
distinction
Whenever we want to track significant
changes in key mac. Variables- such as
wealth, income, wage rate, GDP etc, we
always use real variables

How GDP Is Used

Governments reports on GDP are used
to steer the economy over both shortrun and long-run
In short-run, sudden changes in real GDP

can alert us to recessions/ too-rapid

expansion and give us a chance to stabilize
the economy by taking proper policies.
In long-run, to tell us whether our economy
is growing fast enough to raise output per
capita and our standard of living, and fast
enough to generate sufficient jobs for a
growing population

Problems With GDP

Quality changes
While BEA includes impact of quality changes
for many goods and services (such as
automobiles and computers)
Does not have the resources to estimate
quality changes for millions of different
goods and services

By ignoring these quality improvements,

GDP probably understates true growth in

output from year to year

The Underground
Economy
Some production is hidden from
government authorities
Either because it is illegal or

Drugs, prostitution, most gambling

Because those engaged in it are avoiding
taxes
Production in these hidden markets cannot be
measured accurately
BEA must estimate it

Many economists believe that BEAs estimates are

too low
As a result, GDP may understate total output

Consumption
Spending
Consumption is the part of GDP
purchased by households as final
users
Almost everything households buy
during the year is included as part of
consumption spending when we
calculate GDP

Consumption Function
Is the total expenditure in an economy
on goods and services by individual or a
nation in a given period of time.

Total consumption spending is sum

of spending by over a hundred
million U.S. households
What determines total amount of
consumption spending?

Disposable Income
Disposable Income = Income Tax
Payments + Transfers Received

Can be rewritten as

Disposable Income = Income (Taxes

Transfers) or
Disposable Income = Income Net Taxes

For almost any household, a rise in

disposable incomewith no other

changecauses a rise in consumption
spending

The Interest Rate

Interest rate is reward people get for
saving, or what they have to pay
when they borrow
All else equal, a rise in interest rate
causes a decrease in consumption
spending

Relationship between interest rate

and consumption spending applies

even for people who arent savers
in the common sense of term

Consumption and
Disposable Income
Of all the factors that influence

consumption spending, most

important and stable determinant is
disposable income
Relationship between consumption
and disposable income is almost
perfectly linearpoints lie
remarkably close to a straight line
This almost-linear relationship between

consumption and disposable income has

been observed in a wide variety of
historical periods and a wide variety of
nations

Real Consumption Spending

($ Billions)

The Consumption
Function
8,000
7,000

The consumption function shows the (linear)

relationship between real consumption
spending and real disposable income
Consumption
Function

6,000
5,000
600

4,000
3,000
2,000
1,000

1,000
The vertical intercept ($2,000
billion) is autonomous
consumption spending . . .

and the slope of the line

(0.6) is the marginal
propensity to consume.

1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000

Real Disposable Income ($ Billions)

Consumption Function
and Saving Function
Consumption and saving depend on the real
interest rate, disposable income, wealth, and
expected future income.
a) Disposable income is aggregate income minus taxes
plus transfer payments.

b) To explore the two-way link between real GDP and

planned consumption expenditure, we focus on the
relationship between consumption expenditure and
disposable income when the other factors are constant.

The relationship between consumption

expenditure and disposable income, other things
remaining the same, is the consumption
function. And the relationship between saving
and disposable income, other things remaining
the same, is the saving function.

Consumption Function
and Saving Function

Consumption Function
and Saving Function

Marginal Propensities
to Consume and Save
The marginal propensity to
consume(MPC) is the fraction of a
change in disposable income that is
consumed. It is calculated as the change
in consumption expenditure, C, divided
by the change in disposable income,
YD, that brought it about. That is:

MPC= C/YD.

Marginal Propensities
to Consume and Save
The marginal propensity to save(MPS) is
the fraction of a change in disposable
income that is saved. It is calculated as
the change in saving, S, divided by the
change in disposable income, YD, that
brought it about. That is:
MPS= S/YD.

Marginal Propensities
to Consume and Save
The MPC plus the MPS equals one. To
see why, note that, C+ S= YD. Then
divide this equation by YD to obtain,
C/YD+ S/YD= YD/YD, which
means that MPC+ MPS= 1.

Other Influences on Consumption

Expenditure and Saving

When an influence other than

disposable income changes the real
interest rate, wealth, or expected future
incomethe consumption function and
saving function shift.

Consumption as a
Function of Real GDP
Disposable income changes when either
real GDP changes or when net taxes
change.
If tax rates dont change, real GDP is the
only influence on disposable income, so
consumption expenditure is a function of
real GDP.
We use this relationship to determine
equilibrium expenditure.

The Spending
Multiplier Effect
An initial change in spending (C, IG,
G, XN) causes a larger change in
aggregate spending, or Aggregate
Demand (AD).

Multiplier = Change in AD
Change in Spending
Multiplier = AD/ C, I, G, or X

The Spending
Multiplier Effect
Why does this happen?
Expenditures and income flow
continuously which sets off a
spending increase in the economy.

The Spending
Multiplier Effect
Ex. If the government

increases defense spending

by $1 Billion, then defense
contractors will hire and
pay more workers, which
will increase aggregate
spending by more than the
original $1 Billion.

The Multiplier
After an
increase in
planned
investment,
equilibrium
output is four
times the
amount of the
increase in
planned
investment.

Calculating the
Spending Multiplier
The Spending Multiplier can be
calculated from the MPC or the
MPS.

Multiplier = 1/1-MPC or

/MPS

Multipliers are (+) when there is

an increase in spending and ()
when there is a decrease

Why Is the Multiplier

Greater than 1?
The multiplier is greater than 1 because
an increase in autonomous expenditure
induces further increases in
expenditure.
The Size of the Multiplier
The size of the multiplier is the change in
equilibrium expenditure divided by the
change in autonomous expenditure.

Imports and Income

Taxes
Income taxes and
imports both reduce
the size of the multiplier. Including
income taxes and imports, the multiplier
equals 1/(1 slope of the AE curve).

Aggregate Output and

Aggregate Income (Y)
Aggregate output (income) (Y) is a
combined term used to remind you of
the exact equality between aggregate
output and aggregate income.
When we talk about output (Y), we mean
real output, or the quantities of goods
and services produced, not the dollars in
circulation.

Investment Spending
In definition of GDP, word investment by itself

(represented by the letter I by itself) consists of three

components

Business spending on plant and equipment

Purchases of new homes
Accumulation of unsold inventories

In short-run macro model, we define (planned) investment

spending (IP) as

Plant and equipment purchases by business firms, and

new home construction

Inventory investment is treated as unintentional and

undesired

Excluded from definition of investment spending

For now, we regard investment spending (IP) as a given

value, determined by forces outside of our model

Planned Investment (I)

Investment refers to purchases by
firms of new buildings and equipment
and additions to inventories, all of which
add to firms capital stock.
One component of investment
inventory changeis partly determined
by how much households decide to buy,
which is not under the complete control
of firms.

Actual versus Planned

Investment
Desired or planned investment refers
to the additions to capital stock and
inventory that are planned by firms.
Actual investment is the actual
amount of investment that takes place;
it includes items such as unplanned
changes in inventories.

The Planned
Investment Function
For now, we will assume
that planned investment
is fixed. It does not
change when income
changes.
When a variable, such as
planned investment, is
assumed not to depend on
the state of the economy,
it is said to be an
autonomous variable.

Planned Aggregate
Expenditure (AE)
Planned
aggregate
expenditure is
the total amount
the economy plans
to spend in a
given period. It is
equal to
consumption plus
planned
investment.

Equilibrium Aggregate
Output (Income)
Equilibrium occurs when there is no
tendency for change. In the
macroeconomic goods market,
equilibrium occurs when planned
aggregate expenditure is equal to
aggregate output.

Equilibrium Aggregate
Output (Income)

The S = I Approach to
Equilibrium
Aggregate output will be equal to
planned aggregate expenditure only
when saving equals planned investment
(S = I).

Government Purchases
Include all goods and services that
government agenciesfederal, state,
and localbuy during year
In short-run macro model, government
purchases are treated as a given value
Determined by forces outside of model

Net Exports
If we want to measure total spending on U.S.

output, we must also consider international

sector
U.S. exports
But international trade in goods and services
also requires us to make an adjustment to
other components of spending
In sum, to incorporate international sector into
our measure of total spending, we must add
U.S. exports, and subtract U.S. imports

Net Exports = Total Exports Total

Imports

Net Exports
By including net exports, simultaneously

ensure that we have

Included U.S. output that is sold to foreigners, and
Excluded consumption, investment, and government
spending on output produced abroad

For now, we regard net exports as a given

value, determined by forces outside of our

analysis
Important to remember that net exports can be
negative
United States has had negative net exports since
1982
Imports are greater than exports

References (Websites)
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