Macroeconomics
- looks at the economy as a whole.
-Specialises in aggregate phenomena: Total output, living standards, business cycles, economic growth,
inflation and BOP.
Objectives are stable and low inflation rate, low unemployment rate, Bop & Exchange rate stability and
+ve change in GDP.
Instruments: fiscal, monetary and exchange rate policy.
National Income Accounts
Attempts to quantify and express the total income, output and expenditure of the whole country for a
particular period.
NB:
National income: total income earned by all factors of production in a country at a given period of time
National Output: total output produced in a country at a given period of time.
National expenditure: total expenditure of a country at a given period of time.
Importance
Trends of production and consumption are established for purposes of studying.
Measure of economic performance.
Nature income and production composition
Can be used access loans from financial institutions
Formulate, implement and evaluate policies.
METHODS FOR MEASURING NATIONAL INCOME
METHODS INCLUDE: THE OUTPUT METHOD, INCOME AND EXPENDITURE METHOD
OUTPUT APPROACH
-Sums total value of output at market prices produced by all economic agents in an economy during a
specific period of time, usually a year.
-This gives GDP.
EXPENDITURE APPROACH
-Sums expenditure on final goods at market prices for a country within a particular period of time.
-This gives GDP
GDP= C+I+G+(x-m)
INCOME APPROACH
-Sums the total value of income earned by factors of production over a period of time.
FOP
LAND-RENT
LABOUR-WAGES AND SALARIES
CAPITAL-IINTEREST
ENTERPRISE-PROFIT (DIVIDENDS)
Relationship between GDP, GNP AND NNP
-GDP refers to the measure of total market value of goods and services produced within the boundaries
of a country in a particular period of time.
GDP= C + I + G + (x-m)
-GNP is the total measure of the flow of goods and services at market value resulting from current
production during a year in a country, including net income from abroad.
GNP=GDP + Net property income.
Net National Product
GNP includes the value of total output of consumption and investment goods.
NNP=GNP-Depreciiation.
CIRCULAR FLOW OF INCOME
-shows connections between different sectors of an economy.
TWO MODEL (CLOSED)
-Is a way of representing the flows of money between the two main groups in society - producers
(firms) and consumers (households).
-Facilitated by production and consumption only.
- People in households work for firms (selling their factor services) and receive wages in
exchange.
-On the scale of the whole economy, this is known as national income - the total amount of
income earned over a given time period.
-This money is spent on food, clothing, transport, entertainment etc, and so it returns to the
firms. On the scale of the whole economy, this is known as national expenditure.
Y=C
TWO SECTOR MODEL (OPEN ECONOMY)
EQUILIBRIUM POSITION
Y=C+I+(X-M) or I+X=S+M
Leakages
-Not all income earned households is spent on goods and services with the circular flow of income.
Some is saved (Savings) and some is spent on imports. These are called leakages from the circular flow
of income.
Injections
Not all products produced are sold on the circular flow of income because firms export them.
Not all income received is attributable to goods sold but can come from Investments.
With regards to imports and exports, this economy is regarded as an open economy because there’s
international trade.
THREE SECTOR MODEL (OPEN)
Government levies taxes (leakage) on income earned by households and finances its expenditure
(injection) on goods and services. Government expenditure consists of: recurrent and investment
expenditure.
3 Sector model includes the government.
TAX
EXPENDITURE
GOVERNMENT
TAX EXPENDITURE
EQUILIBRIUM POSITION
EXPENDITURE APPROACH
Y=C+I+G+(X-M)
INJECTION = WITHDRAWAL
I+G+X = S+T+M
NOMINAL VS REAL GDP
Nominal GDP is value of all the goods taking price changes into account.
Adjustment to remove the effects of inflation (in contrast to real) are not accounted for.
Nominal value changes due to shifts in quantity and price.
Real GDP accounts for inflation and deflation.
It transforms the money-value measure, nominal GDP, into an index for quantity of total output.
Calculations
Nominal GDP-sum of all market prices of final goods and services that are current in that year in
which the output is produced.
NOMINAL GDP=C+I+G+(X-M) or Nominal GDP= Current year production x current year
prices
Real GDP-It is calculated using the prices of a selected base year.
𝐍𝐨𝐦𝐢𝐧𝐚𝐥 𝐆𝐃𝐏
Real GDP= 𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝒚𝒆𝒂𝒓 𝒑𝒓𝒊𝒄𝒆 x base year prices or REAL GDP= Current Quantities X base
year price
The GDP Deflator
The GDP deflator is a price index that measures inflation or deflation in an economy by
calculating a ratio of nominal GDP to real GDP.
𝑵𝑶𝑴𝑰𝑵𝑨𝑳 𝑮𝑫𝑷
GDP DEFLATOR= X 100
𝑹𝑬𝑨𝑳 𝑮𝑫𝑷
STANDARD OF LIVING
-Way of life of an average entity.
- Average quantity (and quality) of goods and services that people in a country can afford to
consume.
-Commonly measured using GDP per capita that is real GDP divided by population.
𝑅𝐸𝐴𝐿 𝐺𝐷𝑃
GDP PER CAPITA =
𝑃𝑂𝑃𝑈𝐿𝐴𝑇𝐼𝑂𝑁
LIMITATIONS
Ignores qualitative factors- standard of living includes all elements that affect people’s well-
being, whether they are market transactions or not.
GDP does not account for leisure time.
GDP does not account for income inequalities.
GDP ignores the actual levels of environmental cleanliness, health and learning but includes
only money spent on these.
GDP does not include anything about technology available.
National Income Determination
-It is concerned with finding out the equilibrium level of national income.
-Equilibrium level of income refers to state of balance between national income and national
expenditure.
-Several main schools of thought are available to try and explain how national income is
determined that is: Keynesian, Classical and Monetarist.
Keynesian School of thought
-It focuses on the relationship between aggregate income and expenditure on output.
-Aggregate income- total income
-Aggregate expenditure- total expenditure
-Equilibrium is achieved at a point where:
1. Equilibrium at full employment level- Aggregate demand is equal to Aggregate supply.
2. Equilibrium at less than full employment level-Aggregate demand is no sufficient to absorb all
those who seek employment (deflationary gap).
3. Equilibrium at more than full employment level- Aggregate demand is greater aggregate
supply
-If aggregate expenditure falls short of national output, national output is reduced to match the
level of expenditure.
-If aggregate expenditure is greater than national output, national output is increased to match
the level of expenditure.
-Keynes's income‐expenditure model.
-It considers the relationship between expenditure and income.
AE=C+I+G+(X-M)
-Expenditure is partly autonomous and partly varies with national income.
-Aggregate Autonomous expenditure includes investment (I), government (G) and net exports
which are autonomous (independent) of current income.
-Aggregate consumption is partly autonomous and partly varies with national income.
Aggregate consumption= C+mpc(Y)
-Autonomous Consumption: expenditure independent regardless of changes in national income.
-MPC (Marginal Propensity to Consume): fraction of income spent consumption.
-Therefore, equilibrium level of national income is:
Y=C + mpc(Y) + I + G + (X-M)
NATIONAL INCOME EQUILIBRIUM (INCOME & EXPENDITURE APPROACH)
In the figure above, national income equilibrium is at point E
INFLATIONARY AND DEFLATIONARY GAP
Causes
Of Excess Demand Of Deficient Demand
Government expenditure > Government expenditure <
Government revenue Government revenue
Increase in autonomous investment Cut in autonomous investment
Surplus on balance of payments Deficits in balance of payments
Increase in capital formation Cut in capital formation
*SOLUTION TO DEFLATIONARY GAPS*
Fiscal policy-reduce taxes and increase government expenditure.
Monetary policy- Increase money supply and reduce interest rates.
Trade policy- stimulate exports and reduce spending on imports.
Exchange rate policy-downward revision of local currency value, making local goods and foreign
goods relatively cheaper and expensive respectively.
*SOLUTION TO INFLATIONARY GAPS*
Fiscal policy-increase taxes and reduce government expenditure.
Monetary policy- decrease money supply and increase interest rates
Trade policy- stimulate imports and reduce exports.
Exchange rate policy-upward revision of local currency value, making local goods and foreign
goods relatively expensive and cheap respectively.
*MULTIPLIER EFFECT*
-It states that national income is a multiple of automous aggregate expenditure.
-Multiplier is the inverse of marginal propensity to save (portion of national income saved) given
2 sector model closed.
-It is the inverse of the sum of MPS, MPM & MPT on a 4 sector model.
*Derivation of Multiplier*
-AAE=AC + AI + AG+ A(X-M)
-Y=AAE + mpc(Y)
-[Y-mpc(Y)] = AAE
-Y [1-MPC] = AAE
𝑨𝑨𝑬 𝑨𝑨𝑬
-Y = 𝟏−𝑴𝑷𝑪 OR Y= 𝑴𝑷𝑺
NB: MPS+MPC=1, assuming it’s a 2 sector economy.
EQUILIBRIUM (INJECTIONS & WITHDRAWAL)
CLASSICAL THEORY
-This theory states that full employment is a normal feature of a capitalist economy.
-The economy would always be in a full employment equilibrium.
- It implies that there will never be a possibility of over- production or under- production in the
economy.
-It is based on the following assumptions:
Say’s law of market- supply creates its own demand
Flexibility of interest rates
Flexibility of wage rates
-There’s no government intervention.
EQUILIBRIUM
MONETARISTS