The Level of Overall

Economic Activity

What do you know?

In groups write down what you know
about macroeconomics
Think about these things (but dont
limit your thoughts to these)
What is the difference/link
between micro and macro
Who are the main players in the
macro economy?
What does a good economy look
like?
What is happening in the world
economy at the moment?
Even if you know words but dont
know their meaning write them down!

Learning Objectives
Understand the five main
macroeconomic objectives (goals)
Understand, describe and illustrate
the circular flow of income
Understand the different measures
of national income
Calculate national income
Explain the meaning and
significance of green GDP
Evaluate the uses of national
statistics
Explain and illustrate the business
cycle

What is Macro economics?

Before we looked at micro economics
We looked at what happened within the
firm and within the market
Now add all of those markets together
and we get the macro economy
We looked at allocation of resources in
a market
Macroeconomics is concerned with the
allocation of a nations resources
There are five main variables
Economic growth
Employment
Price stability
External stability
Income distribution

Macro objectives
There are five objectives that most
economies have
A steady increase of national
output (growth)
A low level of unemployment
A low and stable rate of inflation
A favourable balance of
payments (Trade - Exports minus
Imports)
An equitable (fair) distribution of
income

Macroeconomic policies
Government actions designed to affect the
performance of the economy as a whole
Types of macroeconomic policies
Monetary policy determination of the
nations money supply
Fiscal policy decisions determine the
governments budget, including the amount
and composition of government expenditures
and government revenues

Macroeconomic policies
Structural policy government policies
aimed at changing the underlying
structure, or institutions, of the nations
economy

The circular flow game

To understand how an economy works we
need to understand the flows
To do this we will use a really simple model
There are four households (families) who
have been shipwrecked on a desert island
Divide into 4 groups
The supply of money in the economy is 5
and we assume that all the money will be
used to buy good and services
Household A spends 5 and received from
household B goods and services in exchange.
Household B then spends 5 on goods sold
by household C and the process is repeated
until all households have participated.
Keep count of how much your household
spends
Keep count of how much you earn

The circular flow game

If these 4 families
are the entire
economy
What is the value of
national output = ?
20
What is national
income = ?
20
What is national
expenditure = ?
20

The circular flow game summary

In a simplified model
GDP = National Output =
National Income = National
Expenditure
Not only is this true in a
simplified model it is also
true (with a few statistical
adjustments) for any
economy
In a more sophisticated
economy households do
not trade with each other
and we need to add firms

GDP =
National
Output =
national
income =
national
expenditure

Check your understanding

National Income, National Output
and National Expenditure should
always be equal. Why is this?
If a newspaper headline says UK
National Income increased last
year by 2%, what does this mean
in terms of
output and expenditure?
Changes in flow?
Same amount of growth in
national output and national
expenditure
Flow has increased
More flowing in than out

What circular
flows do we
have in this 2
sector model?

Leakages and Injections

This model is very simplified
What is it not taking into
consideration?
Do people spend all of their
income?
No, they save some in the
bank or other financial
institutions
This is known as a leakage
from the circular flow
If households dont buy all the
output that is produced by the
firms will have unsold stock
They will reduce their output
They will use less factors of
production and pay less income
The amount of income in the
economy will fall

Saving: foregoing current

consumption to allow for
consumption in the future

Leakages and Injections

The good thing about savings
is that firms will have access to
them by borrowing money from
banks
They can use the money to
increase their stock of capital
and expand their output
This is known as investment
It is an injection into the
circular flow of income
Investment allows the amount
of income circulating in the
economy to rise

Leakages and Injections

Why is this model still too simple?
An economy is not closed
Households can buy goods and
services from other countries
Would this be an injection or a
leakage?
Imports are a leakage this is
income that is being spent and not
being returned to firms
People buy the countries exports
of goods and services
Are exports leakages or injections
Exports are an Injection because
they represent a source of income
not coming directly from the
households

Leakages and Injections

Why is this model still too simple?
There are more than two sectors
We now need to introduce the government sector
What injection and leakage can be added to this diagram due to the
introduction of the government sector?

Leakages and Injections

Some of the income earned by the households must be paid to the
government in the form of taxes
Taxes are a leakage
Governments spend money in the economy on schools, roads, campaigns,
hospitals etc
Government spending is an injection
Dont assume that government
spending = revenue from taxes

Leakages and Injections

You will see later that governments can spend more than they earn to
deliberately influence the level of leakages and injections to affect the level of
national income

How is national income

measured?
There are three ways (which we saw before
when we played the desert island game) of
measuring income
Can you remember?
Output the value of goods and services
produced (less the costs of inputs)
Income the value of all incomes earned in
the economy
Expenditure the value of all spending in the
economy
Spending by households known as
consumption (C)
Spending by firms known as investment (I)
Spending by government (G)
Spending by foreigners on exports minus
spending on imports or net exports (X-M)
There is an identity that you will need to
learn GDP = C + I + G + (X-M)

How is national
income
measured?
In practice, the
data collected to
calculate GDP
comes from many
different and varied
sources
There are often
inaccuracies
This can be due to
timing
Often figures have
to be revised at later
date when full
information is
collected

Different measures of
income
GDP the total of all
economic activity in a
country regardless of
who owns the
productive assets

GNI

Green GDP GDP

minus environmental
costs

GDP

Gross National
Product (GNP) or
Gross National
Income (GNI) the
total income that is
earned by a countrys
factors of production
regardless of where
the assets are
located

income
earned
from
assets
abroad

Over time capital

gets used up its
value depreciates
GDP does not take
this into
consideration. NNI
does. NNI = GNI
minus depreciation

income paid to
foreign assets
operating
domestically

Real GDP or nominal GDP

To make a comparison of GDP year on
year you need to take into consideration
the rise in prices
You are measuring by the total value of
goods and services
The goods and services may not have
changed
Inflation may mean that the prices of
the same goods and services have gone
up
We use a GDP deflator to do this
GDP x 100/(100 + inflation rate) = real
GDP
If the inflation rate was 4%
Real GDP = GDP x 100/104

Real GDP GDP

which has been
adjusted for inflation

Nominal GDP
GDP which has not
been adjusted for
inflation

GDP per capita

To make a judgement about the
progress of a country in comparison with
other countries in terms of raising living
standards the GDP per capita figure is
much more appropriate

GDP per capita

GDP divided by the
size of the population

Limitations of the data

Inaccuracies figures tend to become more accurate after
time as they are revised
Unrecorded or under-recorded economic activity (informal
markets)
DIY in developed countries
Care for elderly or children
Subsistence farming in developing countries
Illegal activities (alien workers, drug trafficking etc)
Work done for cash (and no tax is paid)
Countries with higher tax burdens tend to have a larger
hidden economy
External costs
GDP does not take into account resource depletion or
negative externalities
Quality of life concerns
GDP may grow because people are working longer hours
Composition of output
Output could be defence that does not benefit consumers

The
Business
Cycle
The business
cycle
fluctuations in
economic
activity
measured by
changes in real
GDP
Fluctuations
in practice are
highly irregular
Recovery: economic expansion largely driven by increase in aggregate
demand as households and consumers are encouraged to spend more.
Firms increase their output in response to the increase in demand. Newly
employed workers spend their income on goods and services

The
Business
Cycle

Trough: at some point the

contraction will come to an
end. Aggregate demand will
pick up and enter the
recovery phase

Recession: defined as
two consecutive
quarters of negative
GDP growth. Falling
aggregate demand will
lead firms to lay off
workers so
unemployment rises.
This means less
spending leading to
lower rates of inflation
or deflation

Boom: increased demand for goods and services pushes up average prices
(inflation). The rate of growth of GDP will fall as the economy nears its
potential output. Policy makers may try to slow growth (to reduce inflation)
causing a fall in total demand and recession could begin.

Long term trend

and output gaps
Economies fluctuate but
tend to have positive long
term growth trends

Negative output gap (A):

the economy is producing
below its trend and
unemployment is likely to be
a problem
Positive output gap (B):
the economy is producing
above its trend and inflation
is likely to be a problem