Macroeconomic Indicators

Instructor : Dr. Mallika Sinha

Assistant Professor (Economics)
School of Social Sciences and Languages
VIT Chennai
Simplified Circular Flow

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Circular flow of National Income
• We divide output in two ways – production side and demand side
• Production side
• Output paid out to labor in form of wages and to capital : interest and dividends.
• Division of output into factor payments (wages, etc.) provides a framework for
our study of growth and aggregate supply
• Demand side
• Output is consumed or invested for the future.
• Division of income into consumption, investment, and so on, provides the
framework for studying aggregate demand.
• Input and output, or demand and production, accountings are necessarily
equal in equilibrium.

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Circular flow of dollars through the economy

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National Income Accounting
• National income accounting dictates that total output produced must equal
total income generated, and must also equal total spending (demand)

• Gross Domestic Product (GDP):

• Value of all final goods and services produced in a country in a period.

❑The Income Approach (Production Side):

• Transforms inputs, such as labor and capital, into output, GDP
• GDP = Sum of all Factor Payments (Wages, Interest, Rent, Profit).
(Roughly 75% goes to labor)
• Output produced = labor payments + capital payments + profit
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 National Income Accounting
• Final Goods and Value Added
➢Emphasis on final goods & services avoid double-counting interm goods.
• Summing the value added at each stage of production.

• You buy bread for $5. The wheat farmer sold wheat to the miller for
$1.50, and the miller sold flour to the baker for $3. What is the value
added by the baker?

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GDP, NDP, GNP
• GNP : GDP + factor payments from abroad
• Domestically owned, foreign-located factors of production, and
• Exclude factor pay made to foreign owners of India-based production.
• Part of India’s GDP corresponds to the profits earned by Honda from its
Indian manufacturing operations.
• These profits are part of Japan’s GNP, because they are the income of
Japanese-owned capital.
• NDP = GDP – depreciation
• Net amount of goods and services produced in the country in a given period
• Businesses pay indirect taxes (?) that must be subtracted from NDP
before making factor payments.
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The Expenditure Approach (Demand Side)

❖Total demand for domestic output is made up of four components:

• Consumption spending by households (C )
• Investment spending by businesses and households (I )
• Additions to the physical stock of capital
• Government purchases of goods and services (G)
• Foreign demand for our net exports (NX)

• Y ≡ C + I + G + NX

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A Simple Economy – No G and Foreign trade
• Output produced equals output sold

Y≡C+I (1)

Y≡S+C (2)

C+I≡Y≡C+S (3)

• Value of output produced is equal to income received, and income received, in

turn, is spent on goods or saved

• Subtract C in all parts of (3)

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A simple economy – with G and foreign trade
I ≡ Y − C ≡ S (4)
• Investment is identically equal to saving.

Y ≡ C + I + G + NX (5)
• Total spending on domestic goods, Y, can be split into spending by domestic
residents, C + I + G, and net demand for domestic goods from foreigners, NX

YD≡Y+TR−TA (6)
YD ≡ C + S (7)
• Using 5 and 6

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A simple economy – with G and foreign trade
YD = C+I+G+NX +TR-TA
YD-TR+TA≡ C + I + G + NX (8)

• Putting identity (7) into identity (8) yields

C + S − TR + TA ≡ C + I + G + NX (9)

• With some rearrangement, we obtain

S − I ≡ (G + TR − TA) + NX (10)
❑Excess of private sector saving (S) over investment (I) is equal to the
sum of the government budget deficit (BD) and the trade surplus (NX):
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Investment, Saving, Budget deficit and Trade
• G+TR : Govt exp | TA : Govt receipt
• G+TR-TA : Budget deficit

• S − I ≡ (G + TR − TA) + NX (10)
❑If private saving equals investment (S=I), then the government’s budget
deficit must be reflected in an equal external (trade) deficit
❑Private sector is not providing any net saving to finance the deficit (since ).
❑Govt must borrow from abroad.
❑Borrowing from abroad shows up as imports > exports, i.e., a trade deficit.

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Real vs Nominal GDP
• GDP changes from year to year due to
• changes in physical output
• changes in market prices.
• Nominal GDP
• Measures the values goods and services at current prices
• When can it increase ? Is it a good indicator?
• Real GDP
• Measures changes in physical output by valuing all goods produced in different
periods at the same prices (in "constant dollars").
• When can it increase ? Is it a good indicator?
❖Which one is a better measure?
❖GDP Deflator
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Difficulties in Measurement of National Income
• GDP is an imperfect measure of output and welfare ?

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Difficulties in Measurement of National Income
• Non-Market Activities

• Environmental Degradation
• failure to account for environmental costs can overestimate true growth.

• Quality Changes:
• Adjusting price indexes for improvements in the quality of goods and the
introduction of new products (like computers) is challenging.
• improvements in electric light efficiency are often not captured in official
statistics

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 GDP deflator
• GDP deflator is a price index that measures the average level of prices of
all final goods and services produced domestically in a country in a given
year, relative to a base year.

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Key Macroeconomics Formulas
• Nominal GDPₜ = Σ Pₜ × Qₜ
• Real GDPₜ = Σ P₀ × Qₜ (base year 0)
• GDP Deflatorₜ = (Nominal GDPₜ / Real GDPₜ) × 100
• Growth of X: gₜ = [(Xₜ – Xₜ₋₁) / Xₜ₋₁] × 100%

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Source : World Bank
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Gross National Savings
• Part of national income that is not consumed by HH, firms, or govt
• Shows how much resources an economy sets aside for investment and
future growth.
• GNS = GNDI − Total Consumption
• GNDI = Gross National Disposable Income.
• Components:
• Household savings
• Corporate (business) savings
• Government savings (surplus or deficit)

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Gross Capital Formation
• Total addition to the capital stock of an economy in a given period.
• Includes new machinery, buildings, infrastructure, inventories,
• Higher GCF → more investment → higher productive capacity →
higher future output.
• Components:
• Gross fixed capital formation (machines, buildings, infrastructure)
• Change in inventories (stocks of goods)
• Valuables (like precious metals, artwork etc., sometimes counted)

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Relationship between GNS and GCF
• In a closed economy, GNS must equal GCF

Open economy
• GNS – GCF = Current Account Balance
• If GNS > GCF → net lender to the world.
• If GNS < GCF → net borrower.

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CPI
• Measures cost of fixed basket of consumer goods relative to base year.
• Aggregates prices of thousands of goods and services into a single index.
• Cost-of-living and purchasing power.
• Wage indexation, poverty lines, etc.

• Methodology:
• Collects prices for a wide range of goods and services.
• Weights different items by computing the price of a basket of goods and
services purchased by a typical consumer.
• CPI : price of this basket relative to the price of the same basket in a base
year.

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CPI
• If typical consumer buys five apples and two oranges, the CPI would be:
(5 × Current Price of Apples) + (2 × Current Price of Oranges)
(5 × 2017 Price of Apples) + (2 × 2017 Price of Oranges)
(assume 2017 as the base year).
how much it costs now to buy five apples and two oranges relative to how much it cost to buy the
same basket of fruit in 2017

PCE Deflator or Private Final Consumption Expenditure

• Similar to GDP deflator but only for consumption goods, and allows the
basket to change over time

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Other Price Indices
❖Producer Price Index
• Measures the cost of a given basket of goods, but focuses on raw
materials and semifinished goods and measures prices at an early stage of
the distribution system
• measures the price of a typical basket of goods bought by firms rather
than consumers

❖Core Inflation:
• Measures the increase in price of a consumer basket that excludes food
and energy products.
• Often seen as a better gauge of ongoing inflation trends due to the substantial
short-run volatility of food and energy prices
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 CPI vs. GDP Deflator
• Scope of Goods and Services
• GDP deflator: Measures prices of all goods and services produced.
• CPI: Measures prices of only goods and services bought by consumers.

• Inclusion of Imported Goods

• Weighting of Prices (Fixed vs. Changing Baskets)

• CPI: Assigns fixed weights to prices of different goods (a Laspeyres index).
• GDP deflator: Assigns changing weights as the composition of GDP changes over
time (a Paasche index).

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 Does the CPI Overstate Inflation?
• Substitution Bias
• Introduction of New Goods
• Unmeasured Changes in Quality

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Index of Industrial Production (IIP)
• Measures the changes in the level of industrial output in an economy over
time, relative to a chosen base year.
• How fast (or slow) the industrial sector is growing by tracking production
in mining, manufacturing (highest weight), and electricity
• Helps policymakers, analysts, and researchers understand:
• Industrial health : which ones are growing shrinking
• Business cycles

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Trends and Business Cycle
• GDP grows over time primarily because
• Available amt of resources changes
• Efficiency of those factors improves.
• Productivity increases from new knowledge/technology

• Trend path of real GDP is

• Hypothesized path GDP would take if factors of prod were fully employed.

• Business cycle
• Fluctuations in econ activity (expansion and contraction) around the trend path.
• Past (past conditions feeding into current outcomes), present, future (where it is
heading),
• Key Phases: Peak → Recession → Trough → Recovery
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Coincident, leading Indicators
• Coincident Indicators
➢Move simultaneously with the economy or business cycle.
➢What is happening to the economy right now?
➢Examples: IIP, GDP, Employment levels, retail sales

• Leading Indicators :
➢Tend to change before the broader economy or business cycle turns
➢Predict future economic activity. (just like weather forecast)
➢Examples: Stock market returns, Consumer sentiment, Building permits

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Lagging indicators
• Lagging Indicators
➢Change after the overall economy or business cycle has already begun to
turn
➢Confirm trends after they occur.
➢Examples: Unemployment rate, CPI/WPI inflation, Corporate profits
(annual reporting), Bank loan defaults / (NPAs)

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Unemployment
• Unemployment rate
• measures the fraction of the labor force that is out of work and looking for a job.
• Why would the costs of unemployment be large?
• Okun’s Law: Unemployment and output are tightly linked.
• 1 extra point of unemployment costs roughly 2 percent of GDP.

• Unemployment : frictional, structural and cyclical

• Natural rate of unemployment
• Baseline level of unemployment even when the economy is at full employment
• Includes frictional and structural

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Unemployment
• Frictional unemployment
• Because it takes time for an individual to find the right new job
• New jobs, switching jobs, firms expanding/reducing – hiring/firing
• Structural unemployment
• Mismatch between the skills or location of the job seekers and the requirements
or location of the available job vacancies
• Cyclical unemployment
• contraction in the business cycle
• Due to lack of agg DD

• Discouraged Workers

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