INTRODUCTION TO MACROECONOMICS

UNIT 1: NATIONAL INCOME AND SOCIAL ACCOUNTS

Lecturer: Elias Muwau

 National Income and Social Accounts
 Meaning, definition and importance of
macro economics
 Circular Flow of Income
 Concepts and measurement of national
income
 Limitations of national income as an
indicator of economic welfare
 Social Accounting
 Macroeconomics is concerned with the analysis of the
behaviour of the economic system in totality
 It studies how the large aggregates such as total
employment, national product or national income of
an economy and the general price level are
determined
 It is a study of aggregates
 It explains how the productive capacity and national
income of the country increase over time in the long
run
 Macroeconomics is the study of the economy as a
whole
 It covers issues such as:
 Employment and unemployment
 Determination of Gross Domestic Product (GDP)
 Inflation
 Business cycle
 Economic growth
 BoP and exchange rate determination
 Fiscal and Monetary Policy
 Here, one need to understand aggregate demand and its
components
 Aggregate demand is the total spending on goods and
services made in the economy
 It consists of four elements:
 consumer spending (C),
 investment (I),
 government spending (G) and
 Net exports - expenditure on exports (X), less any
expenditure on foreign goods and services (M)
 Or simply put AD = C + I + G + X - M
 Factors of Production

Payment for factors of production

HH F

Payment for Goods and Services

Goods and Services

Y=C Y=C
 Factors of Production

Payment for factors of production

Saving (S) Investment (I)

HH F
FM
Payment for Goods and Services

Goods and Services

𝒀=𝑪+𝑺 𝒀=𝑪+𝑰
 Factors of Production

Payment for factors of production

Saving (S) Investment (I)

HH F

Payment for Goods and Services

Goods and Services

𝒀 =𝑪+𝑺+𝑻 𝒀 =𝑪+𝑰+𝑮
Gov
 Factors of Production

Payment for factors of production Exports

Imports

Saving (S) Investment (I)

HH F

Payment for Goods and Services

Goods and Services

𝒀=𝑪+𝑺+𝑻+𝑴 𝒀=𝑪+𝑰+𝑮+𝑿
 Since Y = C + S + T + M and Y = C + I + G +X
 Then in equilibrium
𝐶+𝑆+𝑇+𝑀 = 𝐶+𝐼+𝐺+𝑋
𝑆+𝑇+𝑀 =𝐼+𝐺+𝑋
Leakages/ Injections
Withdraws
𝑆 − 𝐼 = 𝐺 − 𝑇 + (𝑋 − 𝑀)
Private Government Trade
savings/ budget deficit
investment deficit (surplus)
(surplus)
 Thus, W = S + T + M
 and J = I + G + X
 If injections exceed withdrawals, the level of expenditure
will rise (i.e. J > W)
 The increase in spending from injections is greater than
the reduction in spending from withdrawals
 GDP will rise and there will be economic growth
 Unemployment will reduce
 May lead to increased inflation
 The opposite is true if injections are less than withdraws
(i.e. J < W)
 GDP is the total market value of all final goods and services
produced in a year in the domestic territory of a country
 Note the following about GDP:
 GDP is the monetary measure
 Not double counting is allowed
 GDP only considers final goods and not intermediate
goods
 It is a flow measure of output of goods and services per
time period
 GDP only considers output by normal residents of a
country working within its domestic territory
 Final goods are those goods which are purchased for final
use and not for resale or further processing
 Intermediate goods, on the other hand, are those goods
which are purchased for further processing or for resale
 GDP excludes;
 Second hand transactions
 Products produced in a different year
 Resale of used car for example is excluded but costs of
the repair works are included
 Non-productive financial transactions
 Intermediate goods
 The components of GDP include:
1. Value of final consumer goods and services produced in a year
and consumed by the households which is denoted by
consumption (C) by households.
2. Value of new capital goods produced and addition to the
inventories of goods such as raw materials, unfinished goods
and consumer goods produced but not sold during a year. This
is called Gross Private Investment (I)
3. Value of output of General Government which is taken to be
equal to the value of purchases of goods and services by the
Government which we denote by G.
4. Net Exports (NX) which is equal to value of goods exported
minus the value of goods imported (M)
 Other concepts include
 Transfer payments
 A payment which does not involve an exchange of a
good or service
 Examples include students allowances, unemployment
allowances, cash transfers
 Taxes: Revenue for the government levied on individuals
and businesses
 The measurement of National incomes starts with the basic
concept of GDP
 There are three methods of measuring national income
1. The value added/output/production method
2. The income method
3. The expenditure method
 Regardless of the method you use to compute GDP, the
value will be the same
 Meaning, all three methods give the same value
 The value added method
 Value added is the increase in the value of goods as a result
of the production process
 This measure the contribution of each involved player in
the production process
 This method makes use of the value of output (quantity of
goods and services produced by a particular enterprise
multiplied by their market prices)
 Value added can be gross or net; and can be measured at
market price or factor cost (Basic price)
 The value added method
 In this method, it is worth noting the following:
1. Imputed rent values should be included
2. Sale and purchase of second-hand goods should not be
included but commission or brokerage earned in their
sale and purchase has to be included
3. Value of production for self-consumption are included
4. Value of services of housewives are not included
5. Value of intermediate goods are not included
 CLASS ACTIVITY
 A farmer grows a bushel of wheat and sells it to a miller for
ZMW100. The miller turns the wheat into flour and then
sells the flour to a baker for ZMW300. The baker uses the
flour to make bread and sells the bread to an engineer for
ZMW600.The engineer eats the bread.
 What is the value added by each person?
 What is GDP?
CLASS ACTIVITY
PLAYER SELLS VALUE VALUE-ADDED

Farmer ZMW100 ZMW100

Miller ZMW300 ZMW200
Baker ZMW600 ZMW300
Engineer ZMW0 ZMW0
GDP ZMW600
Income Approach
 Here, GDP is obtained by summing up incomes of all
individuals of a country
 Items include rent of land, wages and salaries of
employees, interest on capital, profits of
entrepreneurs (including undistributed profits,
dividends, corporate income tax) and incomes of self
employed people
 It also includes indirect taxes, and the ware and tear
of equipment (Depreciation)
 Consider the data below and compute the GDP using
Income approach
Income Approach
Transfer Payment ZMW54
Interest Income ZMW150
Depreciation ZMW36
Wages ZMW67
Gross Private Investment ZMW124
Business Profits ZMW200
Indirect taxes ZMW74
Rental Income ZMW75
Net exports ZMW18
Net factor income from abroad ZMW12
Government Purchases ZMW156
Consumption ZMW304
Income Approach
 GDP =
 Interest Income, plus
 Wages, plus
 Business Profit, plus
 Rental Income
 Depreciation
 Indirect taxes
𝐺𝐷𝑃 = K150 + K67 + K200 + K75 + K36 + K74
𝐺𝐷𝑃 = ZMW602
CLASS ACTIVITY
 Suppose a woman marries her butler. After they are
married, her husband continues to wait on her as
before, and she continues to support him as before
(but as a husband rather than as an employee).
 How does the marriage affect GDP?
 How should it affect GDP?
CLASS ACTIVITY
 When a woman marries her butler, GDP falls by the
amount of the butler’s salary. This happens because
GDP measures the total income and since income has
reduced by the amount of the butler’s salary, GDP
falls by that amount.
 If GDP truly measure the total amount of goods and
services produced, then the marriage should not
affect GDP since total amount of economic activities
has not changed
Expenditure Approach
 Here, GDP is obtained by summing up all
expenditures made on goods and services during a
year
 Depending on the model under consideration

𝐺𝐷𝑃 = 𝐶 + 𝐼 + 𝐺 + 𝑁𝑋
 Consumption is the total expenditure made by the
household
 It is split into three parts: nondurable goods,
durable goods, and services
Expenditure Approach
 Investment is the total expenditure made by the
household
 It is split into three parts: business fixed
investment, residential fixed investment, and
inventory investment
 Government expenditure are the goods and
services bought by central and local governments
 It includes expenditure on roads, bridges,
education, etc
Expenditure Approach
 Net exports Net exports are the value of goods and
services exported to other countries minus the value
of goods and services that foreigners import from us
 It is the difference between exports and imports of
a given country
 Exports are the total volumes of good and services
sold to other countries
 Imports are the total volumes of goods and
services bought from other countries
Expenditure Approach
Transfer Payment ZMW54
Interest Income ZMW150
Depreciation ZMW36
Wages ZMW67
Gross Private Investment ZMW124
Business Profits ZMW200
Indirect taxes ZMW74
Rental Income ZMW75
Net exports ZMW18
Net factor income from abroad ZMW12
Government Purchases ZMW156
Consumption ZMW304
 GDP can be presented at market price or at basic
price
 GDP at market price includes the indirect taxes
 GDP at basic price excludes the indirect taxes
 See other measures below
𝑁𝐷𝑃 = 𝐺𝐷𝑃 − 𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛
GNP= 𝐺𝐷𝑃 + 𝑁𝑒𝑡 𝑓𝑎𝑐𝑡𝑜𝑟 𝑖𝑛𝑐𝑜𝑚𝑒 𝑓𝑟𝑜𝑚 𝑎𝑏𝑟𝑜𝑎𝑑 (𝑁𝐹𝐼)
𝑁𝐹𝐼 = 𝑟𝑒𝑐𝑒𝑖𝑡𝑠 𝑓𝑟𝑜𝑚 𝑎𝑏𝑟𝑜𝑎𝑑 − 𝑃𝑎𝑦𝑚𝑒𝑛𝑡 𝑡𝑜 𝑎𝑏𝑟𝑜𝑎𝑑
𝑁𝑁𝑃 = 𝐺𝑁𝑃 − 𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛
𝑁𝐼 = 𝑁𝑁𝑃 − 𝐼𝑛𝑑𝑖𝑟𝑒𝑐𝑡 𝑡𝑎𝑥𝑒𝑠
 𝑃𝑒𝑟𝑠𝑜𝑛𝑎𝑙 𝐼𝑛𝑐𝑜𝑚𝑒 = 𝑁𝐼
- Corporate Profits
- Social Insurance Contributions
- Net Interest
+ Dividends
+ Government Transfers to Individuals
+ Personal Interest Income.
 𝐷𝑖𝑠𝑝𝑜𝑠𝑎𝑏𝑙𝑒 𝐼𝑛𝑐𝑜𝑚𝑒 = 𝑃𝐼 − 𝑝𝑒𝑟𝑠𝑜𝑛𝑎𝑙 𝑇𝑎𝑥𝑒𝑠 −
𝑛𝑜𝑛 𝑡𝑎𝑥 𝑝𝑎𝑦𝑚𝑒𝑛𝑡
Savings – Investment Identity
 In a two sector model;

𝑌 = 𝐶 + 𝐼: Expenditure

𝑌 = 𝐶 + 𝑆: Income

This implies that 𝑆 = 𝐼

Balanced Government Budget Identity
 In a three sector model;

𝑌 = 𝐶 + 𝐼 + 𝐺: Expenditure

𝑌 = 𝐶 + 𝑆 + 𝑇: Income

Since 𝑆 = 𝐼
Then a balanced budget is met when G = 𝑇
If 𝐺 > 𝑇 then government will run a budget deficit
If 𝐺 < 𝑇 then government will run a surplus deficit
Balanced Government Budget Identity
𝑌 = 𝐶+𝐼+𝐺 and 𝑌 = 𝐶 + 𝑆 + 𝑇

⇒𝐼+𝐺 =𝑆+𝑇

⇒𝐺−𝑇 =𝑆−𝐼
If 𝐺 > 𝑇 (deficit)
To finance the deficit the government will borrow from
the financial markets
Balanced Government Budget Identity
Hence private investment (I) by firms must be less than
the savings (S) by the households
Thus government borrowing reduces private investment
( it crowds out private investment)
National, Public and Private Savings Identity
 Using the Expenditure model,
Y≡C+I+G
Rearranging the equation gives
Y – C –G ≡ I
The LHS represents national savings (S)
To fully understand national saving we break it into two
parts: public saving (T – G) and private saving (Y – C –
T). Thus
S = (Y – C – T) + (T – G)
Open Economy Identity
 C+ I+ G+ (X – M) ≡ C+ S+ T , from this , we can
write:
 I+ G+ (X-M) ≡ S+ T or
 (S – I) + (T – G) ≡ (X – M)
 (X – M) measure trade balance
 (S – I) represents the net savings of the private
sector
 (S – I) > 0, the private sector is said to have a
financial surplus
 (S – I) < 0, the private sector is said to have a
financial deficit
Calculate NI and PI
Transfer Payment ZMW54
Interest Income ZMW150
Depreciation ZMW36
Wages ZMW67
Gross Private Investment ZMW124
Business Profits ZMW200
Indirect taxes ZMW74
Rental Income ZMW75
Net exports ZMW18
Net factor income from abroad ZMW12
Government Purchases ZMW156
Consumption ZMW304
 GDP per capita or per capita GDP, measure the
amount of GDP per person in a population.
𝐺𝐷𝑃
 𝑃𝑒𝑟 𝐶𝑎𝑝𝑖𝑡𝑎 𝐺𝐷𝑃 =
𝑃𝑜𝑝𝑢𝑙𝑎𝑡𝑖𝑜𝑛

Example
If GDP is ZMW2,000,000 and the population is
15,000,000. What is the per capita GDP?
 Nominal GDP measures the value of output in a
given period in the prices of that period
 It is the GDP at current prices
 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑦𝑒𝑎𝑟 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 × 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑦𝑒𝑎𝑟 𝑃𝑟𝑖𝑐𝑒
 Real GDP measures changes in physical output in
the economy between different time periods by
valuing all goods produced in the two periods at the
same prices
 It is the GDP adjusted for inflation
 It used the base year prices
 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑦𝑒𝑎𝑟 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 × 𝑏𝑎𝑠𝑒 𝑦𝑒𝑎𝑟 𝑃𝑟𝑖𝑐𝑒
Example
 Calculate the nominal and real GDP for each year,
taking 2000 to be the base year
Year Quantity Price of Quantity Price of a
of Bread Bread of Tomato
(ZMW) Tomatoes (ZMW)
2000 500 4 1000 1
2005 450 7 1400 3
2010 501 11 1300 3.5
2015 620 12 4000 5
2020 600 15 2100 6
 One of the useful measures of inflation is the GDP
deflator
 The GDP deflator is the ratio of nominal GDP of a
given year to real GDP of that year
 The deflator measures the change in prices that has
occurred between the base year and current year
 The answer is usually multiplies by 100 to be read as
percent
𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝐺𝐷𝑃
𝐺𝐷𝑃 𝐷𝑒𝑓𝑙𝑎𝑡𝑜𝑟 = × 100
𝑅𝑒𝑎𝑙 𝐺𝐷𝑃
 Another useful measures of inflation is the GDP
deflator
 The CPI is used to measure cost of living of the
people and is based on retail prices of the selected
goods constituting the consumption basket of a
particular group of consumers
 Steps in computing CPI
1. Choose the basket of consumer goods and services
2. Select the base year
3. Collect the retail prices for the current year of
various goods included in the consumption basket
4. Choose weights to be given to the prices of different
items in the consumption basket of the specific
group of consumers
5. We use the Laspeyre’s index
𝑃𝑡 𝑄0
𝐶𝑃𝐼 = × 100
𝑃0 𝑄0
 Another useful measures of inflation is the GDP
deflator
 The CPI is used to measure cost of living of the
people and is based on retail prices of the selected
goods constituting the consumption basket of a
particular group of consumers
 The first step is to choose the basket of consumer
goods and services that is generally purchased by a
specific group of consumers, for example, industrial
workers.
𝑃𝑡 𝑄0
𝐶𝑃𝐼 = × 100
𝑃0 𝑄0