Macroeconomic issues and measurement

1. Macroeconomics Issues and
Measurement
Chapter 15

2. Learning Outcomes
 Macroeconomics looks at the economy as a whole,
dealing with such aggregate phenomena as growth
in total output and living standards, commonly
called ‘economic growth’, business cycles, inflation,
unemployment, and the balance of payments.
 Macroeconomics focuses on the cycle in activity,
whereas growth theory focuses on determinants of
the long-run trend in output.

3. Learning Outcomes
 The GDP gap is the difference between actual real
GDP and its potential or trend value.
 The total output of the economy as a whole is the
sum of the value added by each firm or enterprise.

4. Learning Outcomes
 GDP can be measured as the
 sum of value added by all producers,
 as the sum of income claims generated in producing goods
and services,
 or as the spending on all final goods and services produced.
 GDP measures the value of what is produced in this
country, while GNI (or GNP) measures the income
accruing to UK residents, including net income from
overseas.
 GDP is a specific measure of output in the market
economy, and is not a measure of welfare or happiness.

5. INTRODUCTION - MACROECONOMIC ISSUES AND
MEASUREMENT
What is Macroeconomics
 Macroeconomics is about the economy as a whole. It
studies aggregate phenomena, such as business
cycles, living standards, inflation, unemployment, and
the balance of payments. It also asks how
governments can use their monetary and fiscal policy
instruments to help stabilize the economy.

6. INTRODUCTION - MACROECONOMIC ISSUES AND
MEASUREMENT
Why do We Need Macroeconomics
 Macroeconomics is useful because it enables us
to study events that affect the economy as a
whole without getting into too much detail about
specific products and sectors.

7. The GDP gap
 Potential GDP is the level of national output that
would be produced if the economy were operating
at its normal capacity, of full-employment level.
 The GDP gap is the difference between actual GDP
and its potential level.
INTRODUCTION - MACROECONOMIC ISSUES AND
MEASUREMENT

8. Measurement of National Output
 Each firm’s contribution to total output is equal to
its value added, which is the gross value of the
firm’s output minus the value of all intermediate
goods and services - that is, the outputs of other
firms - that it uses.
 Goods that count as part of the economy’s output
are called final goods; all others are called
intermediate goods. The sum of all the values
added produced in an economy is called gross
value added at basic prices.
INTRODUCTION - MACROECONOMIC ISSUES AND
MEASUREMENT

9. Measurement of National Output
 Goods that count as part of the economy’s output
are called final goods; all others are called
intermediate goods.
 The sum of all the values added produced in an
economy is called gross value added at basic
prices. Basic prices are the prices received by
producers net of taxes on products [plus
subsidies].
INTRODUCTION - MACROECONOMIC ISSUES AND
MEASUREMENT

10. The circular flow of income, output and
spending
 The determination of GDP and national
income can be represented as a circular
flow of income and spending.
INTRODUCTION - MACROECONOMIC ISSUES AND
MEASUREMENT

11. The circular flow of income, output, and
spending
 Withdrawals of spending arise when
income received is not spent on the
domestic economy.
 Injections of spending are those that are
not the result of domestic income receipts,
but rather come from sources other than
domestic income recipients.
INTRODUCTION - MACROECONOMIC ISSUES AND
MEASUREMENT

12. Domestic
households
Financial
System
Government
Domestic
producers
Abroad
The Circular Flow of Income, Output, and Expenditure

13. The circular flow of expenditures and income
13

14.  Individuals provide labour to firms and they
buy the firms’ output.
 National output or income can be measured
from the expenditure side in terms of
expenditure on the final output, or on the
income side in terms of value added and
factor incomes generated.
 Saving, taxes and imports represent a leakage
from the circular flow.
The Circular Flow of Income, Output, and Expenditure

15.  Investment, government consumption and
exports represent injections into the circular
flow.
 For any equilibrium level of national activity
(GDP) injections must equal leakages.
 So saving plus taxes plus imports must equal
investment plus government consumption plus
exports.
The Circular Flow of Income, Output, and Expenditure

16. GDP, GNI, and GNP
 Gross domestic product, [GDP] can be calculated
in three different ways:
◦ [1] as the sum of all values added by all producers of both
intermediate and final goods
◦ [2] as the income claims generated by the total production
of goods and services; and
◦ [3] as the expenditure needed to purchase all final goods
and services produced during the period.
INTRODUCTION - MACROECONOMIC ISSUES AND
MEASUREMENT

17.  From the expenditure side of the national
accounts GDP = Ca + Ia + Ga + [Xa - Ima].
 Ca comprises private consumption expenditures.
 Ia is investment in fixed capital [including
residential construction], inventories, and
valuables (jewellery, art etc).
 Gross investment can be split into replacement
investment [necessary to keep the stock of capital
intact] and net investment [net additions to the
stock of capital].
 Ga is government consumption. [Xa -IMa]
represents net exports, or exports minus imports;
it will be negative if imports exceed exports.
INTRODUCTION - MACROECONOMIC ISSUES AND
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18.  GDP income-based adds up all factor rewards in
production.
 The main income categories making up GDP are
operating surplus, mixed incomes and
compensation of employees.
 Operating surplus is net business income after
deduction of payment made to employees and for
material input but before direct taxes ie corporate
tax etc. Operating surplus is largely the firm’s
profit ie both distributed (dividends) and retained
earnings.
 Mixed income is income earned by self employed
individuals and consists both of wage and salary
of the self employed and profit or surplus of the
business operated by them.
INTRODUCTION - MACROECONOMIC ISSUES AND
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19.  Compensation of employees is the payment for
the services of labor inclusive of net salary, taxes
withheld and other deductions made for pension
etc ie wages are measured gross.
 UK GDP measures production that is located in
the United kingdom, and UK gross national
income [GNI] measures income accruing to UK
residents.
 The difference is due to net income from abroad.
 GNI is the same thing as what used to be called
gross national product [GNP].
INTRODUCTION - MACROECONOMIC ISSUES AND
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20. Income-based GDP and Its Components, UK, 2008

21. GDP
Plus: Receipts of factor income from the rest of the
world
Less: Payments of factor income to the rest of the
world
Equals: GNP
Less: Depreciation
Equals: Net national product (NNP)
Less: Statistical discrepancy
Equals: National income

22. GDP at Factor Cost vs GVA at Basic Prices
 In place of GDP at factor cost, gross value added (GVA) at
basic prices will be used now.
 For a producer, GDP at factor cost represents what he gets
from the industrial activity. This can be broken down into
various components — wages, profits, rents and capital —
also commonly known factors of production.
 Aside from these costs, producers may also incur other
expenses such as property tax, stamp duties and
registration fees, among others. Similarly, producers may
also receive subsidies (production related) such as input
subsidies to farmers and to small industries. It is only taxes
and subsidies on intermediate inputs are adjusted.
 For arriving at the new gross value added (GVA) at basic
prices, production taxes, such as property tax, are added
and subsidies are subtracted from GDP at factor cost.

23. GDP at Factor Cost vs GVA at Basic
Prices
 Put simply, GVA at basic price represents what accrues
to the producer, before the product is sold.
 The price paid by the consumer is not the same as the
revenue received by the producer. This is because of
the taxes that are paid to the government in the form of
indirect taxes.
 GVA at basic prices will include production taxes and
exclude production subsidies available on the
commodity.
 GVA at factor cost includes no taxes and excludes no
subsidies.
 GDP at market prices include both production and
product taxes and excludes both production and product
subsidies.

24. Production taxes vs Product taxes
 Production taxes/subsidies are independent of
the quantity (volume) of production. It is often imposed
even if the products are not produced (Eg: tax —land
revenues, stamps fees, registration fees tax on the
profession; subsidies —subsidies to Railways, input
subsidies to farmers, subsidies to the village and small
industries, administrative subsidies to corporations or
cooperatives, etc.).
 Product taxes/subsidies depend on quantity produced.
Product taxes or subsidies are paid or received on per
unit of product (Eg: tax —excise tax, sales tax, service
tax and import and export duties; subsidies — food,
petroleum and fertiliser subsidies, interest subsidies
given to farmers, households, etc)

25.  Real GDP is calculated to reflect changes in real
volumes of output and real income.
 Nominal GDP reflects changes in both prices and
quantities.
 Any change in nominal GDP [or GNI] can be split
into a change in real GDP and a change due to
prices.
INTRODUCTION - MACROECONOMIC ISSUES AND
MEASUREMENT

26. GDP deflator / Implicit deflator
 GDP deflator is the price index used to
deflate nominal GDP.
 It is a broad measure of economy-wide
inflation as it includes prices of all goods &
services in economy
Real Gross Domestic Product (GDP) is an
economic measure of the value of output produced
by the economy adjusted for price changes (that
is, inflation or deflation)
26
100
GDP
Real
GDP
price
current
or
Nominal
deflator
GDP 


27.  Personal income is income received by individuals
before any allowance for personal taxes.
 Personal disposable income is the amount
actually available for individuals to spend or to
save, that is, income minus taxes.
INTRODUCTION - MACROECONOMIC ISSUES AND
MEASUREMENT

28. Interpreting National Income and Output
 GDP and related measures of national income
and output must be interpreted with their
limitations in mind.
 GDP excludes production that takes place in the
underground economy or that does not pass
through markets.
 It excludes services of housewives, work done by
self etc
 It also excludes economic bads such as damage
done to environment etc.
INTRODUCTION - MACROECONOMIC ISSUES AND
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29. Interpreting National Income and Output
 Moreover, GDP does not measure everything that
contributes to human welfare.
 GDP is one of the best measures available of the
total economic activity within a country.
 It is particularly valuable when changes in GDP
are used to indicate how economic activity has
changed over time.
INTRODUCTION - MACROECONOMIC ISSUES AND
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30. UK potential GDP and the output gap, 1970-
2014

31. UK potential GDP and the output gap, 1970-
2014

32. Value added through stages of production

33. Gross Value Added at Current Basic Prices, by Sector, UK 2008

34. Expenditure-based GDP and Its Components, UK, 2008

35. UK national income and output measures, 2008

36. Nominal and real GDP at market prices (1900-
2008)

37. International comparisons of living standards

38. Revision to UK current balance of payment deficit
(1997 to 2005)