MACROECONOMICS: AN OVERVIEW

Economics is the study of how people choose to allocate their scarce resources to meet their
unlimited wants and involves the application of certain principles like scarcity, choice, and
rational self-interest, in a consistent manner. The study of economics is usually divided into two
separate branches, namely Micro Economics and Macro Economics.
Macroeconomics is the branch of economics which deals with economic aggregates. It makes a
study of the economic system in general. Macro Economics perceives the overall dimensions of
economic affairs of a country. It looks at the total size, shape and functioning of the economy as
a whole, rather than working of articulation or dimension of the individual parts. Macro
Economics is, in fact, a study of very large, economy- wide aggregate variables like national
income, total savings, total consumption, total investment, money supply, general price level,
unemployment, economic growth rate, economic development, etc.
Macroeconomics focuses on the economy as a whole (or on whole economies as they interact).
What causes recessions? What makes unemployment stay high when recessions are supposed
to be over? Why do some countries grow faster than others? Why do some countries have
higher standards of living than others? These are all questions that macroeconomics addresses.
Macroeconomics involves adding up the economic activity of all households and all businesses
in all markets to obtain the overall demand and supply in the economy.
Macroeconomics and Its Importance
 It explains the working of the economic system as a whole.
 It examines the aggregate behavior of macroeconomics entities like firms, households
and the government.
 Its knowledge is indispensable for the policy-makers for formulating macro-economic
policies such as monetary policy, fiscal policy, industrial policy, exchange rate policy,
income policy, etc.
 It is very useful to the planner for preparing economic plans for the country's
development.
 It is helpful in international comparison. Example: Macro Economic data like national
income, consumption, saving-income ratio, etc. are required for a comparative study of
different countries.
 It explains economic dynamism and intricate interrelationship among macroeconomic
variable, such as price level, income, output and employment. Its study facilities overall
purposes of control and prediction.

Macroeconomic Goals, Objectives, and Framework

Macroeconomics from three different perspectives:
1. What are the macroeconomic goals? (Macroeconomics as a discipline does not have goals,
but we do have goals for the macro economy.)
2. What are the frameworks economists can use to analyze the macroeconomy?
3. What are the policy tools governments can use to manage the macroeconomy
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Goals
In thinking about the macroeconomy's overall health, it is useful to consider three primary goals:
economic growth, low unemployment, and low inflation.
• Economic growth ultimately determines the prevailing standard of living in a country.
Economists measure growth by the percentage change in real (inflation-adjusted) gross
domestic product. A growth rate of more than 3% is considered good.
• Unemployment, as measured by the unemployment rate, is the percentage of people in the
labor force who do not have a job. When people lack jobs, the economy is wasting a precious
resource-labor, and the result lower goods and services produced.
• Inflation is a sustained increase in the overall level of prices, and is measured by the consumer
price index. If many people face a situation where the prices that they pay for food, shelter, and
healthcare are rising much faster than the wages they receive for their labor, there will be
widespread unhappiness as their standard of living declines. For that reason, low inflation—an
inflation rate of 1–2%—is a major goal.
Frameworks
The principal tools that economists use are theories and models. In microeconomics, the
theories of supply and demand are used. In macroeconomics, the theories of aggregate
demand (AD) and aggregate supply (AS) are being used.
Policy Tools
National governments have two tools for influencing the macroeconomy. The first is monetary
policy, which involves managing the money supply and interest rates. The second is fiscal
policy, which involves changes in government spending/purchases and taxes.
MEASURING THE ECONOMY
Gross Domestic Product (GDP)
GDP is the value of all final goods and services produced within a country in a specific time
period. It includes anything produced within its borders by the country's citizens and foreigners.
It is primarily used to assess the health of a country's economy.
GDP measures the value of output produced within the borders of a domestic economy,
whether or not this production takes place with foreign-owned factors of production
“Goods” are physical things that we consume while “services” are things that we consume but
which are not necessarily tangible. “Final” means that intermediate goods (goods produced and
utilized as inputs in the production of some other good or service) are excluded from the
calculation. For example, rubber is used to produce tires, which are used to produce new cars.
We do not count the rubber or the tires used to make a new car in GDP, as these are not final
goods – people do not use the tires independently of the new car. The value of the tires is
subsumed in the value of the newly produced car – counting both the value of the tires and the
value of the car would “double count” the tires, so we only look at “final” goods.
The components of GDP include consumer spending (C), investments (I), government
spending (G), exports (X), and imports (M).

GDP = Consumption + Investment + Government + Trade balance

GDP is equal to C + I + G + (X - M)

 Consumer spending, C, is the sum of expenditures by households on durable goods,

nondurable goods, and services. Examples include clothing, food, and health care.
 Investment, I, is the sum of expenditures on capital equipment, inventories, and
structures. Examples include machinery, unsold products, and housing.
 Government spending, G, is the sum of expenditures by all government bodies on goods
and services. Examples include naval ships and salaries to government employees.
 Net exports, NX, equals the difference between exports and imports.

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The sales of used goods are not included because they were produced in a previous year and
are part of that year’s GDP. The entire underground economy of services paid “under the table”
and illegal sales should be counted, but is not, because it is impossible to track these sales.
Transfer payments, such as payment by the government to individuals, are not included,
because they do not represent production. Also, production of some goods—such as home
production as when you make your breakfast—is not counted because these goods are not sold
in the marketplace
Nominal vs. Real GDP
GDP can be expressed in two different ways—nominal GDP and real GDP.

Nominal GDP – the total value of all goods and services produced at current market prices. This
includes all the changes in market prices during the current year due to inflation or deflation
(general decline in prices for goods and services).
Real GDP – the sum of all goods and services produced at constant prices. The prices used in
determining the Gross Domestic Product are based on a certain base year or the previous year.
This provides a more accurate account of economic growth, as it is already an inflation-adjusted
measurement, meaning the effects of inflation are taken out.

Economists generally prefer using real GDP as a way to compare a country's economic growth
rate. Real GDP is how economists can tell whether there is any real growth between one year
and the next. It is calculated using goods and services prices from a base year, rather than
current prices, in order to adjust for price changes. By comparing the resulting real GDP to
nominal GDP, economics can calculate a GDP price deflator, which can serve as a measure of
inflation in the economy.

Calculating GDP
A. The Expenditure Approach
The expenditure approach is the most commonly used GDP formula, which is based on the
money spent by various groups that participate in the economy. The expenditure approach, also
known as the spending approach, calculates spending by the different groups that participate in
the economy.
This include consumer spending (C), investments (I), government spending (G), exports (X),
and imports (M).

GDP = Consumption + Investment + Government + Trade balance

GDP is equal to C + I + G + NX

C = consumption or all private consumer spending within a country’s economy, including,

durable goods (items with a lifespan greater than three years), non-durable goods, and
services.
G = total government expenditures, including salaries of government employees, road
construction/repair, public schools, and military expenditure.
I = sum of a country’s investments spent on capital equipment, inventories, and housing.
NX = net exports or a country’s total exports less total imports.

B. The Income Approach

This GDP formula takes the total income generated by the goods and services produced . It
calculates the income earned by all the factors of production in an economy, including the
wages paid to labor, the rent earned by land, the return on capital in the form of interest, and
corporate profits.

GDP = Total National Income + Sales Taxes + Depreciation + Net Foreign Factor Income

Total National Income – the sum of all wages, rent, interest, and profits.
Sales Taxes – consumer taxes imposed by the government on the sales of goods and services.
Depreciation – cost allocated to a tangible asset over its useful life.
Net Foreign Factor Income – the difference between the total income that a country’s citizens
and companies generate in foreign countries, versus the total income foreign citizens and
companies generate in the domestic country.

Limitations of GDP as a Measure of Economic Welfare

1. GDP does not incorporate any measures of welfare

GDP only describes the value of all finished goods produced within an economy over a
set period of time but it does not include any indicator of welfare or well-being.

2. GDP only includes market transactions

It does not account for domestic or voluntary work, even though these activities have a
considerable positive impact on social welfare, as they complement the market economy and
thus improve the standard of living. On the other hand, GDP does not include black market
transactions or other illegal activities that may have a substantial negative impact on overall
social well-being.

3. GDP does not describe income distribution

If there is a high degree of inequality when it comes to income distribution, the majority
of people do not really benefit from an increased economic output because they cannot afford to
buy most of the goods and services. GDP does not describe what is being produced.

4. GDP does not describe what is being produced

Since GDP measures the value of all finished goods and services within an economy, it
also includes products that may have negative effects on social welfare.

5. GDP ignores externalities

Economic growth usually goes hand in hand with increased exploitation of both
renewable and non-renewable resources. Due to this overuse, more and more negative
externalities arise (e.g. pollution, overfishing) and social welfare will decrease as a result. This
effect is not included in GDP at all.

Gross National Product

Gross National Product (GNP) is a measure of the value of all goods and services produced by
a country’s residents and businesses. It estimates the value of the final products and services
manufactured by a country’s residents, regardless of the production location.
GNP is calculated by adding personal consumption expenditure, government expenditures,
private domestic investments, net exports, and all income earned by residents in foreign
countries, minus the income earned by foreign residents within the domestic economy. The net
exports are calculated by subtracting the value of imports from the value of the country’s
exports.

The formula for calculating GNP is as follows:

Y=C+I+G+X+Z

Where:

 C – Consumption Expenditure
 I – Investment
 G – Government Expenditure
 X – Net Exports (Value of imports minus value of exports)
 Z – Net Income (Net income inflow from abroad minus net income outflow to foreign
countries)

Gross National Income (GNI)

Instead of Gross National Product, Gross National Income (GNI) is used by large institutions
such as the European Union (EU), The World Bank, and the Human Development Index (HDI).
It is defined as GDP plus net income from abroad, plus net taxes and subsidies receivable from
abroad.

GNI measures the income received by a country’s residents from domestic and foreign trade.
Although both GNI and GNP are similar in purpose, GNI is considered a better measure of
income than production.
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David Andolfatto. Macroeconomic Theory and Policy, 2nd edition. Research Gate. 2014

Ang, A. P. & Manalapat, C. L. (2017) Macroeconomics: An Introduction. C&E Publishing, Inc.

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Inc.
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