Chapter Six : Overview of Macroeconomics

Macroeconomics is the branch of economics which

study the behaviour of the economy taken as a whole.

The Concept of National Income Accounting

• How income of the a nation (country) is measured? Or

• What is income of Ethiopia?
• All goods and services produced in the country in a given year
makes income of that country.
• Meaning measuring income of a country requires adding all goods
and services produced in the country in a given year.
• The problem here is that, goods produced in the country are very
much diversified.
 The Concept of National Income
Accounting (Cont. …)

➢How can milk and orange be added?

➢To add them we have to convert them
into common unit.
➢This unit is monetary value
➢ I.e., goods/services produced in the country
will be multiplied by their respective price
to get their value and this will be added to
get income of the nation.
➢ To do so we need a systematic record of all
goods produced in a given year
 National Income (Cont. …)
➢National income accounting: Is a
systematic record of all goods and
services produced in country.
➢It is accounting system used to measure
aggregate economic activities.
➢It is an official measurement of the
flow of income and product in a given
economy.
 What are the Measurements?
There are two measurements
– Gross National Product (GNP)
– Gross Domestic Product (GDP)
Gross National Product (GNP): is the total money
value of goods and services produced by the
citizens (nationality) of a country at a given
period of time.
– GNP is citizen oriented
– It includes all income / amount produced by
the citizen regardless of where the citizen
lives.
• Gross Domestic Product (GDP): The monetary value of all
goods and services produced within the country at a given
period of time.
– GDP is boundary oriented
• It include total income or expenditure made in country
by different agents including foreigners.
• Unlike GDP, GNP would include some output produced by
a citizen of a country living abroad and excludes the
output produced in the country by the nationality of
other country
• Therefore, GNP can be obtained from GDP by adding net
factor payment on GDP.
GNP = GDP+ Net factor payment.
• Net factor payment: is receipts of factor income
(wage, profit and rent) from the rest of the world
less payment of factor income to the rest of the
world.
Use of GDP
GDP is an important indicator of economic growth.
– It is used to measure economic growth rate.
Growth Rate at time period (t)
= [(GDPt-GDPt-1)/GDPt-1] *100
– GDP (2014) = 50 Bn. USD and GDP (2015) = 53Bn. USD
– What is the economic growth rate in year 2015 ?
GDP can also be used to compare countries’
income level.
 Ethiopia Kenya
GDP (2020) 80 Bill USD 40 Billion USD
Population 100 Million 20 million
PCI 800 USD 2000 USD

Per Capita Income (PCI) = GDP/ Population

PCI is GDP per capita : It measure

amount produced per citizen
It is also used to categorize countries in different income level

Low income country (If PCI is ess than 995 USD)

Middle country (PCI 996-12,345 USD)

• Low middle income country ( PCI-996-3945 USD)
• Upper middle income country (PCI-3946- 12345 USD)
High Income country
• Above 12,346 USD
• Which country has the highest income?
• PCI of the world.xlsx
 Real Vs. Nominal GDP
• A measurement to be useful it has to be valid
• GDP to be a valid measurement it has to be free
from the influence of price change.
• Example
– If a price of 1 kg orange is birr 50/kg then the values
of 100kg orange is birr 5000
– If the price of orange increased to birr 80 per kg.,
the value of 100kg orange increase to 8,000 birr
• The increase in the value of orange is due to
increase in price of orange not due to increase
in mount of orange produced
 Nominal GDP

• Nominal GDP: Is GDP measured at the current

market price.
• It will not eliminate the influence of market
price
• Hence, it is not reliable measurement of GDP
• The problem with such measurement is
that it will not reflect the cause of
change in GDP.
– Is it resulted from change in price ? or
– change in quantity of output overtime ?
 Consider the economy producing two goods,
nominal GDP calculated for three years

Price
Price of
Quantity Value of of Quantity Value of
Year banana/ GDP
of banana Banana coffee/ of coffee Coffee
kg
kg

2011 20 10,000 200,000 50 20,000 1,000,000 1,200,000

2012 30 10,000 300,000 100 20,000 2,000,000 2,300,000

2013 60 10,600 636,000 120 20,500 2,460,000 3,096,000

 Real GDP
• Real GDP is GDP measured at constant price.
• It eliminates the influence of price on the GDP
measurement
• To calculate Real GDP, we need to determine
base year
• Goods/services will be valuated by the base year
price.
– By doing so we eliminate the influence of
market price
• Real GDP is measured (valued) by base year
price
 Real GDP calculated for three years
Base year =2011

Price
Price of
Quantity Value of of Quantity Value of
Year banana/ GDP
of banana Banana coffee/ of coffee Coffee
kg
kg

2011 5 10,000 200,000 50 20,000 1,000,000 1,200,000

2012 10 10,000 200,000 100 20,000 1,000,000 1,200,000

2013 20 10,600 212,000 110 20,500 1,025,000 1,237,000

 7.3. Approach to Measure GDP
Is GDP a stock or a flow concept?
• Stock : Is a quantity measured at a given point
– Water in a bath tube is stock
– Wealth is a stock concept
• Flow : Is a quantity measured per unit of time
– Quantity of water added in and leaked out of
the bath tube per unit of time (say per
second) is a flow
– Income is a flow concept as it is earned per
month
 Approach to measure GDP(Cont. …)
• GDP of a given economy is measured in the
same manner
– as the amount of water moving in or out of the
bath tube
• Thus, GDP is a flow concept
– It shows the amount of money flowing
among different economic agent (firms,
households and other) per year or months
• Such flow of money among economic agents is
in the form of expenditure or income can be
represented by circular flow of income
Tax The Circular Flow Diagram
Income
Import Cost of production
Payment
Saving
Labor, land & Capital MARKETS FOR FACTORS Factors of Government
OF PRODUCTION
productionSpending
Investment

Export
HUOSEHOLDS
FIRMS

Goods &Services Goods & Services

MARKETS FOR GOODS
AND SERRVICES
Expenditure Revenue
 Leakage Vs. Injection

Leakage Injection

•Tax •Government
•Import Spending
•Saving •Investment
•Export
 Last week

Equilibrium in perfectly competitive market

Overview of Macroeconomics

The Concept of GDP and GNP

Flow and Stock Concept

What are Approaches to Measure GDP
• Depending upon the route we follow (Top loop
or lower loop)
– We have three different approaches to measure
GDP
• These are:
➢ Income approach
➢Expenditure approach and
➢Value added approach (product
approach)
• All of these methods result in the same value of
GDP
– since the expenditure of one agent is income to
other agent.
 1. Income Approach
• In this approach we add all income to factors in the
economy in a given year.
– This is measuring the top (upper) loop in the circular
flow diagram
• In this approach, depending up on the owner of
factors/input, the GDP includes the following
components:
➢Wage/Salary (W): Compensations payment made for
labor. It includes all benefits paid to the workers.
➢Wages/salaries
➢Pension payment
➢Unemployment benefit
➢ Health insurance, etc.
➢Rents(R): It is payments received by households for
the use of land, building and other capital input
➢Interest income (r): Payment received by
households on their savings and deposit.
➢Profit (𝝅): Payments made to the owner of firms
❖ It includes the following components:
✓Proprietor’s Income is the net income of
proprietorship and partnership
✓Corporate profit : This includes:
❑ corporate income tax
❑ dividends and
❑ retained earnings
❑ Aggregating together the above income to factor input
we get national income of an economy.
❑ So to arrive at GDP two component must be added
these are:
❑Indirect Business Tax (T): It is a revenue to the
Government
❑ These are
–sales taxes
–Excise tax
–VAT etc.
❑ Depreciation (D): Loss in the value of fixed asset due to
wear and tear and being obsolete
Finally, GDP = W + R+ r+ 𝝅+T+D
 GDP of hypothetical economy in billions of Birr
Component of GDP Values in dollars
Wages and salaries 6,657.4
Rents 153.8
Interest rate 546.7

Depreciation 1,479.9

Indirect business tax 885.9

Profit including proprietors 7,248
income
Plus statistical discrepancy 90.4

GDP
17,062.10
 2. Expenditure Approach
• Expenditure Approach: In this approach
GDP is calculated by adding all
expenditure made by economic agents
• This represents demand (expenditure)
for domestically produced goods
– it includes the following components
• Consumer Expenditure (C),
• Business Investment expenditure (I)
• Government Expenditure (G), and
• Net foreign expenditure/ net export (NX)
• Consumption Expenditure (C): It is the expenditure
made by households on domestically produced
final goods and services
– It includes expenditure made on durable and non
durable goods and services.
• Business Investment Expenditure (I): Expenditure made
by the firm on investment goods and services which
are used for production of other goods.
❖Business Expenditure Includes:
❖ Expenditure on fixed capital item like
❖New plants and equipment
❖ Residential investment and
❖inventory investment (investment made to
change firm’s inventories of goods)
• Government Purchase or Spending (G): is government
spending made on domestic goods and services by
federal, state and local government.
• It includes government spending on
– infrastructures,
– military equipment and
– spending made for services of government
employees
• Net export (NX): represents the value of goods and
services exported minus value of other countries
produced and supplied to us.
GDP = C + I + G + NX
Where,
Net Export (NX) = Export (X) – Import (M)
 GDP and it components, in $ billions in 1987 for USA

Component of GDP Amount of spending

 Personal consumption expand (C) …………………………………….4432.00
o Durable goods…………………………………… … 3012.00
o Non durable goods…………………………………… 422.00
o Services goods……………………………………… …998.00
 Business investment (I) .…………………………………………………1607.00
o Business fixed investment ……………………….… …713.00
o Structures………………………………………..………447.00
o Producers durables……………………………………. 140.00
o Residential Structure………………… ………………. 307.00
 Net export (NX)…………………………......…(69.00)
o Exports……………………………….……………….…482.00
o Import………………………………………………..…..551.00
 Government spending (G)……………………………………………....1307.00
Federal Gov’t spending………………………………..382.00
National defence……………….......……………… ……295.00
Others…………………………………………....…. 87.00
State and local………………….... …………543.00
GDP = C + I + NX +G = 4432.00+1607.00 - 69.00+1307.00 = 7277.00
 3. Product or Value Added Approach

• Production of a particular good passes through

different stages.
– Each stage may involve a separate market
transaction and flow of income
– In each stage certain value may be added to the
product.
• Thus, in this approach GDP is a summation of
value added at each stages of production of all
products
 E.g. Consider the production of bread
• A production of bread may pass through
number of stages and market transaction before
the final product – bread is reached to the
ultimate consumer. These include,
– Farmer planting and growing wheat
– The miller will buy and process it into flour
– The beaker buy flour and convert it into bread
– The whole seller buy the bread from beaker to
distribute
– Consumer will buy bread for consumption
Stage of production Value of transaction Value added

1.Farmer grows wheat

and sells to miller ……....................….3.50…….....…… 3.50
2. Miller converts wheat to
Flour and sells it to baker………………..8.20……....……. 4.70
3. The baker bake bread
and Sell it to store owner…….......... 9.60….......…….. 1.40
4. The store sells bread to the
Consumers …….............................… 10.00….......……… 0.40
Total 31.30 10:00
• In this approach the value added at each stage of
production will be added to get GDP
– Or the value of final product will be considered
• But
• If we add up separate value of each market
transaction we would come to conclusion that
the value of the product will be birr 31.30
• This show that there is a problem of double
counting
• Such problem arises because of difficulties of
distinguishing intermediate good and final good
Intermediate goods: are goods
purchased to be used as input in
further stage of production
• Such goods should be excluded from the
process of calculating GDP.

Final Goods : are goods ready for final

consumption

• It is only the value of final goods that will be

added at each stage of production
 6.4. Other measures of output/income

➢There are other measures that

are used to represent the total
output produced in an economy.
These are:
I. Net Domestic Product (NDP) or
II.Net National Product (NNP)
III.National Income (NI)
IV.Personal Income (PI)
V. Disposable Income (DI)
I. Net Domestic Product (NDP) – It
represent the value of total output of
an economy after net out depreciation.
▪ NDP=GDP - Depreciation.
II. Net National Product (NNP)-measures
the value of total output produced by a
citizen of a given country within a
specified time period after subtracting
the consumption of fixed capital
(depreciation).
▪ NNP= GNP – Depreciation
III. National Income (NI) – It is the
total income earned by resource
owner from current production.
❑It Can be determined in two ways
NI= NNP-Indirect business tax
▪ NI= GNP - Depreciation – Indirect
business tax
▪ NI=Wage + Profit + Rent+ Interest
▪ NI= NDP-Indirect business tax +Net foreign
factor income
➢ IV. Personal income: is the amount of income that households
and non corporate businesses receive.
▪ Personal income (PI) =National Income
-Corporate profit
–Social Insurance contributions
- Net interest (public)
+ Dividend
+ Government transfer
+ Personal interest income
V. Disposable Personal Income- Households non
corporate business income that is ready to spend after
tax and non tax payments.
➢ Disposable income (DI) = Personal income - Personal
tax and non-tax payments
▪ DI = Consumption + Saving
 Inflation and Unemployment

Inflation
• What is Inflation?
• How it is Measured?
Inflation: a sustained increase in the overall level
of price
– It is a decrease in the purchasing power of
domestic currency
• Note
– The increase in price must be a sustained one
– It must be the general level of price which is
increasing
 Measuring Inflation
Rate of Inflation shows the level of price change since
some standard date
Rate of inflation at time period “t” is measured as
follows

𝝅𝒕 =

Where,
• Pt is price index at time period “t”
• Pt-1 is price index at time t-1
 Price Index
• Price Index: Is a measurement of price change at
some standard date
– It shows the change in general level of price
since the base year
– Thus, price index measures the rate of
inflation
• How price index is calculated?
• Price index at time period (t ) (Pt) = (Current
year output valued at current year
price)/(Current year output valued at base year
price ) X 100
 Types of Price Index
• Depending on the type of products used to calculate
the price index we have different types of price
index
i. Consumers’ Price Index (CPI): It is commonly used
price index
• It measures the cost of living
– It is commonly used measurement of inflation
– CPI is measured based on the baskets of goods
and services consumed by an average family
– Goods and services used to calculate CPI differs
from country to country
 Price Index (Cont. …)
ii. Producers’ Price Index (PPI): It is also called Input
Price Index (whole sale price index)
– It is measured based on materials goods and services
purchased by firms
– It measures change in cost of production
iii. GDP Deflator
• It is weighted average price of all final goods and
services produced in the country
• It is defined as the ratio of nominal GDP to real GDP
GDP Deflator = Nominal GDP
Real GDP
 Price Index (Cont. …)

• As the name indicates it also used to

deflate nominal GDP to get real GDP.

𝑵𝒐𝒎𝒊𝒏𝒂𝒍 𝑮𝑫𝑷
• Real GDP = *100
𝑮𝑫𝑷 𝒅𝒆𝒇𝒍𝒂𝒕𝒐𝒓
 Difference b/n GDP deflator and CPI

• GDP deflator measures the price of all product

bought by consumers, producers and
government produced in the economy,
– CPI use prices of goods/services consumed
only by consumers

• GDP deflator does not include imported

goods.
–CPI includes imported goods
 Exercise
• Suppose a private university student’s yearly
consumption basket is composed of five items. The
price of these goods/services for the past three
years is given in the table below.
• Using the information provided, your are required to
measure his cost of leaving such as:
– Price index in each year
– Rate of inflation in the year 2013 and 2914
– If his monthly pocket money since 2012 was
Birr200, determine the real value of his monthly
income in year 2013 and year 2014!
• Base year = 2012
Item 2012 2013 2014
Price Q Value at Value Price Q Value Value Price Q Value Value
current @ base at at at @ base
Price year current base current year
price price year year Price
price price

Hose rent 500 12 6000 6000 800 12 9600 6000 1000 12 12000 6000

Soft drink 10 300 3000 3000 12 250 3000 2500 15 20 3000 2000
0
Tuition 250 12 3000 3000 300 12 3600 3000 400 12 4800 3000
fee
Transport 75 12 900 900 80 12 960 900 100 12 1200 900

Cloth 1200 2 2400 2400 1500 2 3000 2400 2500 2 5000 2400

15300 15300 20160 14800 26000 14300

Total value
15300/15300 = 1 20160/14800 = 26000/14300
1.36 =1.82
 Solutions
1. Price index for each year
A. Price index at the base year (2012) = 100
• 1*100= 100
B. Price index in the year 2013 = 136
• 1.36*100 = 136
C. Price index in 2014 = 182
• 1.82*100=182
2. Rate of inflation in year 2013 and 2014
A. Rate if inflation in 2011
• (136-100)/100 = 36%
• Price has increased by 36% since year 2010
• The purchasing power of money decreased by 36%
 Measuring Inflation rate
B. Inflation Rate in year 2014
• [(182-136)/136 ]*100 = 34%
• Price has increased by 34 % since 2011
Note that
• We can also determine price change since
the base year
– [(182-100)/100 ]*100 = 82%
– Price in year 2014 has increased by 82% since
the base year
 Determination of real value
3. Real value of Income (200 Birr)
In year 2013
– Real value = (Nominal value/Price index)*100
Real Value in 2013 = (200/136)*100 = Birr 147.1
– The real value of birr 200 is 147.1
In year 2014
Real value 2014 = (200/182)*100= 110
– The real value of Birr 200 in 2012 is only Birr 110
Inflation.pptx
 Cause of inflation
➢ The Major causes of inflation are:
I. Demand pulls factors.
• It is caused by rapid increase in demand for
goods and services than supply.
– Demand increase when the authority print
money
II. Cost push (supply side) factors
• Inflation caused by a decrease in supply of
goods/service
• This occurs when prices of input increases
which increase cost of production
(increases price of input)
• Or any other structural bottle neck may
force firms to reduce the supply of goods
 Effects of Inflation (Economic cost of inflation)
1.Inflation reduces purchasing power of
money.
2.Inflation increases nominal interest rate
3.Inflation increases uncertainties (decrease
investment)
4.Inflation hurts individuals with fixed income
(pension).
5.People buy more durable goods during inflation
6.Menu cost of inflation
 Unemployment
• Other Problem of Macroeconomics is
unemployment
• Unemployment is also called “Social Evil”
• Unemployment: Is involuntary idleness of a person
willing to work at the prevailing rate of payment
but unable to get a job.
▪ Unemployment is measured by rate of
unemployment
Unemployment Rate = No of Unemployed X 100
Labour Force
 Unemployment (Cont. …)
• Labour Force: All persons over 16 years old who
are either working for paid job or actively seeking
a job
• Labor Force (LF) = Employed +Unemployed
• Labor Force Participation Rate = Labor force X 100
Population
• Out of Labor Force:
– Subset of population who are not looking for
work either because they don’t want a job or
they have given up looking for a job
Exercise (unemployement).pptx
 3.2.1. Types of Unemployment
1. Frictional unemployment.
• This arises because of the continuous
movement of people
• Here belongs people who are unemployed for
short period of time due to
– Changing their job
– Graduates until they get job
• The reason behind frictional unemployment is
that it takes time to match workers with jobs.
• In dynamic economy frictional unemployment
will always be their
 2. Structural Unemployment
• It is unemployment caused by
structural change in economy
–It is unemployment created due to
mismatch between the skill of
unemployed people and available job
– Structural change may create skills gap
• Structural Change
–Change in sectoral composition
–Technology change
 3. Cyclic Unemployment
• Cyclical unemployment is unemployment
associated with fluctuation of the
economy.
– During recession many people may loss their
job
– During expansion such unemployment will not
be their
Natural rate of Unemployment:
– The minimum acceptable rate of
unemployment.
• It is less than 5%
 Costs of unemployment
• An increase in the unemployment rate
decreases the real GDP of an economy.
• It reduces living standard
• Causes psychological distress.
• It causes inequality among employed
and unemployment workers
 Business Cycle
• The economy may pass through ups and downs
– The ups and downs of the economic activity is
called Business Cycle
• Business cycle: Is a regular pattern of expansion
and contraction of economic activity
• Business Cycle has four phases namely:
– Expansion (boom/recovery)
– Recession (contraction/depression)
– The pick
– The trough
•
Actual
output
Peak

Gap

Trough

Peak Recovery,
Expansion

Trough
Contraction

Growth trend

1/25/2024 58
• The deviation of output from the trend level is called
Output gap
• Expansion: Is a phase where the economic
activity increases
– GDP increases
– Unemployment decreases
– Over all price (indeterminate) ..Why?
• Recession : A decrease in the overall level of
output for two successive quarters
– GDP decreases
– Unemployment increases
– Over all price level (indeterminate) … why?
• Peak : The highest point of business cycle
• The trough : The lowest point of business cycle
 Policy Instrument
• The following policy measures are used in combination
to control economic fluctuation.
– Monetary measures - decreasing money
supply (to control demand pull inflation )
– Fiscal measures – decreasing government
expenditure and increasing tax that decreases
aggregate demand (to control demand pull
inflation )
– Wage and price control – setting price and
wage (to control cost push inflation)
 The End
&
Thank You