MONITORING MACROECONOMIC PERFORMANCE Economic growth-

Economic growth is the expansion of the economy’s production possibilities

Difference between Micro and Macro- which is an outward shifting PPF/PPC. We measure economic growth by the
Microeconomics deals with the behaviour of individuals: firms and consumers. increase in real GDP.
Macroeconomics deals with the economy as a whole. Real GDP (Gross Domestic Product) is the value of the total production of all
the nation’s farms, factories and offices, measured in the prices of a single year.
Macroeconomic problems- Growth, Inflation, Unemployment
The Figure highlights the (smooth) growth of GDP
Origins and Issues of Macroeconomics and fluctuations of real GDP around potential
Economists began to study economic growth, inflation and international GDP.
payments during the 1750s. Modern macroeconomics dates back towards The
Great Depression, a decade (1929-1939) of high unemployment and stagnant Real GDP fluctuates around potential GDP in a
production throughout the world economy. business cycle- a periodic but irregular
John Meynard Keynes’ book, The General Theory of Employment, Interest and up-and-down movement in production.
Money, began the subject. In the book he discussed Short-Term vs Long-Term
goals. Keynes focused on the short-term issues of unemployment and lost
production. “In the long run, we are all dead”, said Keynes. During the 1970’s and Every business cycle has two phases
1980’s, macroeconomists became increasingly concerned with the long-term 1) A recession
issues of inflation and economic growth. 2) An expansion
and two turning points-
1) A peak
2) A trough

Recession- It is a period during which real

GDP decreases for at least two consecutive
quarters.

Expansion- It is a period during which real

GDP increases

According to ONS, UK’s GDP fell by 20.4% in April 2020, following a fall of 5.8%
in March 2020.

This drop-off of GDP suggests unemployment.

Unemployment is a state in which a person does not have a job but is available
for work, willing to work and has made some effort to find work within the
previous four weeks.
The workforce/labour is the total amount of people who are employed and
unemployed.
The unemployment rate is the percentage of people in the workforce who are
unemployed.
A discouraged worker is a person who is available for work, willing to work but
Benefits and Costs of Economic Growth
has given up the effort to find work.
The main benefit of long-term economic growth is expanded consumption
Labor-force participation rate is the percentage of adult population that is in
possibilities, including more health care for the poor and elderly, more research
the labour force.
on cancer and AIDS, better roads, more and better housing and a cleaner
environment.
The costs of economic growth are foregone consumption in the present, more
rapid depletion of non-renewable natural resources and more frequent job
changes.
Why is unemployment a problem? Inflation around the world is shown, as it compares
Unemployment is a serious economic, social and personal problem for two main inflation rates in a number of countries. Industrial
reasons- countries tend to have similar inflation rates and has
1) Lost production and income- serious but temporary lower inflation rates than developing countries.
2) Lost human capital- devastating and permanent
Is inflation a problem?
Inflation - Unpredictable changes in the inflation rate are a
Inflation is the process of rising price. We measure inflation rate as the problem because they redistribute income in arbitrary
percentage change in the average level of prices or price level. ways between employers and workers and between
borrowers and lenders.
Here, the inflation rate since 1962 in the United A high inflation rate is a problem because it diverts
Kingdom is shown. resources from productive activities to inflation
Inflation was low in the 1960’s, increased in the forecasting. Eradicating inflation is costly because it
1970’s and decreased during the 1980’s and brings a period of greater than average unemployment.
1990’s.
The impact of COVID-19
The inflation rate fluctuates, but it has been Surveys of business activity show the world economy continued to shrink at a
consistently positive- the price level has not fallen during the years shown in the record pace in April 2020 when most major countries’ lockdown measures were
figure. toughest. After imposing tight control on business and social life later than other
European countries, Britain’s economy appears to be underperforming many
A falling price level depicts a negative inflation rate, otherwise known as other wealthy nations.
deflation. Official figures show just nine days of lockdown caused gross domestic product
(GDP), the broadest measure of the economy, to fall by 5.8% in March, and by
2% in the first three months of the year.

Surplus and deficits Two broad groups of macroeconomic policy tools are:
Government budget- ● Fiscal policy- making changes in tax rates and government spending
If a government collect more taxes than it spends, then it has a government ● Monetary policy- changing interest rates and changing the amount of
budget surplus. money in the economy
If a government spends more than it collects in taxes, it has a government
budget deficit.
GDP , Measuring GDP, and Economic growth
Internationally-
If a nation imports more than it exports, it has an international deficit. Gross Domestic Product (GDP)
If a nation exports more than it imports, it has an international surplus. GDP is the market value of all final goods and services produced in a country in
The current account deficit or surplus is the balance of exports minus imports a given time period. The definition has four parts:
plus net interest paid to and received from the rest of the world. ● Market value
GDP is a market value- goods and services are valued at their market
● Do surplus and deficits matter? price. To add apples and oranges, we add the market values so we have a
● What happens if the government can’t cover its expenditures using taxes? total value of the output.
- The government would need to borrow. This would increase the governments ● Final goods and services
debt. Interest on the debt must be paid until it is eventually paid off. So, future GDP is the value of the final goods and services produced. A final good (or
taxes may have to go up or future public spending may have to go down. service) is an item bought by its final user. A final good contrasts with an
International (current account) deficits have similar implications. Countries can’t intermediate good used as a component of a final good and service e.g.
borrow to consume indefinitely. potatoes are an intermediate good for making potato chips as a final good.
● Produced within a country
Macroeconomic policy GDP measures production within a county- domestic production.
Challenges and tools- ● In a given period of time
There are five widely agreed policy challenges for macroeconomics are to: GDP measures production during a specific time period- normally a year.
● Boost economic growth
● Stabilize the business cycle
● Lower unemployment
● Keep inflation low
● Reduce government and international deficit
GDP and the Circular Flow of Expenditure and Income All of this can be written in a formula-
GDP measures the value of production, which also equals total expenditure on Y= AD= C+I+G+(X-M)
final goods and total income.
GDP equals expenditure which equals income.
Firms pay out all their receipts from the sale of final goods and services, so
aggregate income equals total expenditure.

It is vital that we measure the value of production with reasonable accuracy. For
such a measure is the basis of measurement of the standard of living, economic
welfare and making international comparisons.

Calculation- Assume a small nation has the following statistics

● Its consumption expenditure is $15 million
● Investment is $2 million
The circular flow shows the transactions among households, firms, governments
● Govt. expenditure on goods and services is $1 million
and the rest of the world.
● Export of goods and services to foreigners is $1 million
Firms hire factors of production from households. The blue flow, Y, shows total
● Import of goods and services from foreigners is $1.5 million
income paid by firms to households.
Households buy consumer goods and services.The red flow, C, shows
Calculate the nation’s GDP
consumption expenditures.
GDP= C+I+G+(X-M)
Households save, S, and pay taxes, T. Firms borrow some of what households
= $15m+$2m+$1m+($1m-$1.5m)
save to finance their investment.
= $17.5 million
Firms buy capital goods from other firms. The red flow, I, represents this
investment expenditure by firms.
Financial Flows
Governments buy goods and services, G, and borrow or repay debt if spending
Financial markets finance deficits and investment. Household savings, S, is
exceeds or is less than taxes.
household income minus net taxes and consumption expenditure
The rest of the world buys goods and services from us, X, and sells us goods
Y= C+S+T
and services, M. Net exports are (X-M). The rest of the world borrows from us or
S= Y-T-C
lends to us depending on whether net exports are positive or negative.
Household’s savings flows from households to financial markets.

Now, if government expenditure exceeds net taxes, the deficit (G-T) is borrowed Depreciation- It is the decrease in the stock of capital that results from wear and
from the financial markets (if T exceeds G, the government surplus flows to the tear and obsolescence.
financial markets).
Gross investment- It is the amount spent on purchases of new capital and on
If imports exceed exports, the deficit with the rest of the world (M-X) is borrowing replacing depreciated capital.
from the rest of the world.
Net investment- It is the change in the stock of capital.
Finally, we have firms borrowing from financial markets. We can use the circular Net investment= Gross investment- Depreciation
flow diagram above to help us understand how such investment is financed.
There are three sources of firms borrowing- Calculating GDP
● Private (household) saving, S To calculate the GDP or the total market value of all the goods and services
● Government budget surplus (T-G) produced within a year, we need to know the price and quantities of the particular
● Borrowing from the rest of the world (M-X) goods and services for the current year as well as the base year.
A base year is used for comparison in the measure of a business activity or
Gross and Net Domestic Product economic index. For example- to find the inflation rate between 2013 and 2018,
“Gross” means before accounting the depreciation of capital. The opposite of 2013 is the base year or the first year in the time set. The base year can also
gross is net. To understand the distinction, we need to distinguish between flows describe the starting point from a point of growth. Thus, two different types of
and stocks. GDP is introduced, nominal and real.

Flows and Stocks in Macroeconomics Nominal and Real GDP

A flow is a quantity per unit of time; a stock is the quantity that exists at a point Nominal GDP is the value of all the final goods and services that an economy
of time. produced within a given year. Nominal GDP measures the value of the goods
On the other hand, wealth is the value of all the things that people own, is a and services produced in a country at current prices, providing a snapshot at a
stock. Saving is the flow that changes the stock of wealth. country’s current output in the current moment. It is calculated by using the prices
that are in the current year in which the output is produced. In economics, a
Capital and Investment nominal value is expressed in monetary terms.
Capital is the plant, equipment and inventories of raw and semi-finished
materials that are used to produce other goods and services. It is a stock.
Investment is the flow that changes the stock of capital.
To calculate the real GDP, given the prices and quantities of goods and services Ans- In 2017, nominal GDP calculated using 2017 prices
we can use the formula below- = (18 X 20)+(5 X 15)
= 360+75
=435

Base year / Reference year prices will be mentioned for your calculation.
Because 2017 is the base year, real GDP equals nominal GDP, so real

Nominal GDP measures output using current prices, but real GDP measures GDP in 2017 was 435.

output using constant prices, keep in mind the quantity is in the current year.
In 2018, nominal GDP calculated using 2018 prices

Real GDP, is the inflation-adjusted total economic output of a nation's goods and = (20 X 30)+(7 X 20)

services in a given period of time. Also known as "constant price GDP," = 600 + 140

"inflation-corrected GDP," or real GDP is derived by isolating and removing = 740

inflation thus making GDP a more accurate reflection of a nation's economic

output. To calculate real GDP in 2018, we need to value the production in 2018
using 2017 prices. Real GDP in 2018 using 2017 prices is

Measuring Real GDP = (18*30)+(5*20)

Let us assume Country X only produces Books and Magazines. The table below = 640

gives data on the production and prices. Using 2017 as the base year, we can If price index is given

calculate the real GDP in 2017 and 2018- Real GDP of Current year = Nominal GDP of Current Year x (100/Price index of
current year)
Uses and limitations of GDP
Uses-
We use estimates of real GDP for two main purposes. They are:
● To compare the standard of living over time
● To compare the standard of living across countries

The growth of potential GDP- Potential GDP is the value of production when all
The table gives data on the production and prices in a Country X. Use 2017 as
the economy's labor, capital, land, and entrepreneurial ability are fully employed.
the base year. What is the Nominal GDP and real GDP in 2017 and 2018?

Comparing standard of living across countries

Two problems arise in using real GDP to compare living standards across
countries-
1) The real GDP of one country must be converted into the same currency
units as the real GDP of the other country.
2) The goods and services in both countries must be valued at the same
prices.
GDP growth rate is measured as:
Comparing the US and China provides a striking example of these two problems-

The prices of some goods are higher in the US than in China, so these items get
Economic growth or real GDP growth is the rate at which a nation's GDP
a smaller weight in China's real GDP than they get in the US real GDP. Some
changes/grows from one year to another.
prices in China are higher than in the US but more prices are lower, so Chinese
prices put a lower value on China's production than do US prices.
Above, GDP growth rate from 2017 to 2018 is =

Limitations
Real GDP measures the value of goods and services that are bought in markets.
Some of the factors that influence the standard of living and which are not part of
GDP are:
● Household production
● Underground economic activity
● Leisure time
● Environmental quality

GDP and Economic Growth

Economic growth is a sustained expansion of production possibilities measured
as the increase in real GDP over a given period.