ECON 1211Lecturer: Dr B. Nowbutsing

Topic 1: Introduction to Macroeconomics and National Income Accounting

20.2

1. Macroeconomics

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.

20.3

2. 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

20.4

3. 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

20.5

4. Inflation in the UK, 1950-99

0

5

10

15

20

25

30

% p

.a.

Source: Economic Trends Annual Supplement, Labour Market Trends

20.6

5. Inflation in selected European countries

0 1 2 3 4 5

% change 1998 compared with 1997

Greece

Portugal

Italy

Spain

UK

Finland

EU

Belgium

France

Germany

20.7

6. Inflation in UK, USA and Germany

0

2

4

6

8

10

12

14

16

% p

.a.

1960-73 1973-81 1981-90 1990-98

UK USA Germany

20.8

7. Unemployment in the UK, 1950-99

0

2

4

6

8

10

12

14

% p

.a.

Source: Economic Trends Annual Supplement, Labour Market Trends

20.9

8. Unemploymentin selected European countries

0 5 10 15 20

% unemployment (ILO measure) 1998

Greece

Portugal

Italy

Spain

UK

Finland

EU

Belgium

France

Germany

20.10

9. Unemploymentin UK, USA and Germany

0

2

4

6

8

10

% p

.a.

1960-73 1973-81 1981-90 1990-98

UK USA Germany

20.11

10. Economic growthin UK, USA and Germany

0

1

2

3

4

5

% p

.a.

1960-73 1973-81 1981-90 1990-98

UK USA Germany

20.12

11. Inflation Rate in Mauritius

20.13

12. Employment Rate in Mauritius

20.14

13. Economic Growth Rate in Mauritius

20.15

14. An Overview of Circular Flow

The circular flow shows how real resources and financial payments flow between firms and households

Households: supply factor services to firms, receive factor incomes from firms, buy output from firms

Firms: use factors to make output, rent factor services from households, sell output to households

20.16

15. The circular flow of income, expenditure and output (closed economy)

Households Firms

Y

C

20.17

16. National Income Accounting

Gross Domestic Product (GDP) – measures the output made in the domestic economy, regardless of who owns the production inputs.

Transactions do not take place between a single firm and a single household

Firms hire labour from households but buy raw materials from other firms

To avoid double counting, we have to use value added

20.18

16. National Income Accounting

Value added: firm’s output – firm’s input goods used to make that output

Intermediate vs. final goods Final goods are purchased by the ultimate

user. Intermediate goods are partly-finished goods

that form inputs to a subsequent production process that then uses them up

20.19

17. Investment and Saving

In the initial flow, there was no saving and investment

A leakage from the circular flow is money no longer recycled from households to firm (saving)

An injection is money that flows to firms without being cycled through households (investment)

20.20

17. Investment and Saving

Three measures of GDP (income, expenditure, output)

Y = C + S

Y: GDP; C: Consumption; S: Saving Y = C + I

I: Investment

Thus, S = I

20.21

18. The circular flow of income, expenditure and output

Y

Households Firms

C + I

I

CS

20.22

19. Government in the Circular flow

Government raises revenue both through direct taxes (Td) and indirect taxes (Te)

Government finance two kinds of expenditures:

(1) spending on goods and services, G, is purchase by the government of

physical ` goods and services including wages

(2) Transfer payment, B, pensions and other benefits

20.23

19. Government in the Circular flow

Given B and Te, we must make a distinction

between Y and Yd such that Yd = Y+ B – Td,

Y = C + I + G The above measures GDP at market prices It we exclude indirect taxes, we get GDP at basic

prices, i.e.

Y = [C + I + G] – Te

S = (Y + B- Td) – C or Y = S + C + Td - B

20.24

19. Government in the Circular flow

Given Y = [C + I + G] – Te and Y = S + C + Td - B

We get [C + I + G] – Te = Y = S + C + Td – B

This implies S + Td – Te = I + G + B

Left hand side is leakages from the circular flow

Right hand side is injections to the circular flow The equation can be written as

S – I = G + B - Td – Te

Financial surplus in private sector can be offset by a government deficit

20.25

19. Government in the circular flow

Y

C + I + G

I

CS

Households FirmsGovernment

C + I + G - Te

Te

G

B - Td

Y + B - Td

20.26

20. Adding the foreign sector

To incorporate the foreign sector into the circular flow

we must recognize that residents of a country will buy imports from abroad

and that domestic firms will sell (export) goods and services abroad.

Y = C + I + G + (X – Z) - Te

20.27

21. 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

20.28

22. 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

20.29

23. National income accounting: a summary

GNP(andGNI)

atmarketprices

GDPat

marketprices

NYA

C

X - Z

I

NYA

G

NNPat market

prices

Deprec'n

Nationalincome

Indirect taxes

Wagesand

salaries

Self-employment

Profits,rents

20.30

24. What GNP does and does not measure

GNP is an aggregate measure (does not consider distribution of income- Lorenz Curve)

GNP is a combination of price and quantity (inflation inflate GDP - distinguish between real and nominal measurements)

GNP is not a comprehensive measure of everything that contributes to economic welfare

Population change should be considered