Macroeconomics: national economy (allocation of nation’s resources)
2.1 The level of overall economic activity
Circular flow of income model
● Two sector (closed economy)
○ 1. Households: consumers of goods/services + receive income by providing FOP
○ 2. Firms: hire FOP from households and use them to produce the nation’s output
● FOPs: labor, land, capital, entrepreneurship
○ Payment (by firms to households): rent, wages, interest, profit
● Four sector (open economy): takes into account leakages/injections
○ Households, firms, foreign sector (export/import), government sector
(government spending, taxes), financial sector (savings, investment)
Leakages and injections
● Leakages: causes amount of income circulating to FALL
○ Saving: do not buy all the output → unsold stocks of goods → firms reduce
output → firms use fewer FOP → less income
○ Taxes: income paid to government
○ Imports: money spent on imports doesn’t return to nation’s firms
● Injections: ways money can enter the economy outside consumer expenditure. allows
the amount of income circulating to RISE
○ Investment: firms borrow money from banks (people’s savings) to increase their
stock of capital → increase output
○ Government spending
○ Exports: foreigners spend money on nation’s goods → source of income from
outside households
● Injections > leakages = economic growth!
Measures of economic activity
GDP GNI/GNP
total value of all final goods/services Total value of all income earned by
produced in an economy a country’s FOP REGARDLESS OF
REGARDLESS OF WHO OWNS WHERE ASSETS ARE LOCATED
THE FOP
Nominal - At current prices
Real - Adjusted for inflation
- per capita GDP divided by population
, ● Shows output per person
● Better when comparing two
countries
● GDP: total value of all final goods/services produced in an economy (per year)
○ Measure of growth and living standards
● GNP/GNI: Total value of all income earned by a country’s FOP REGARDLESS OF
WHERE ASSETS ARE LOCATED
● Methods:
1) Output approach
2) Income approach
3) Expenditure approach: C + I + G + (X-M)
● Nominal GDP: at current prices
● Real GDP: adjusted for inflation
● GDP per capita: GDP divided by population
○ Shows output per person
○ Better when comparing two countries
● Green GDP: measure of GDP that takes into account environmental destruction
○ Accounts for costs caused by climate change
○ GDP - environmental costs of production = Green GDP
○ Significance: assess the impact of economic production on the environment and
the further implications it has on the economy
■ E.g. cost of clearing up environmental damage (ex. BP oil spills in US
2010)
■ E.g. health and industrial costs of air pollution/water pollution
● Evaluating the use of national income statistics:
Strengths Limitations
Make comparisons over time (economic Inaccuracies
growth = increase in a country’s national
income over time, thus statistics help
evaluate economic growth)
Make comparisons between countries Unrecorded data (informal markets)
Make conclusions about standard of living External costs
(rising national income = rising standard
of living)
Other quality of life concerns (GDP may
increase, but people working longer
hours)
, The business cycle
● Fluctuations in economic activity (rising, slowing, falling growth)
● Measured in by changes in real GDP
● IRL, fluctuations are irregular
● Phases:
1) Recovery: economic expansion (GDP increasing at rising rate)
○ Due to increase in Ag demand → households/firms encouraged to spend more
→ increase in AD = increase in output → firms hire more workers →
unemployment falls → newly employed workers spend income on goods/services
→ household spending increases
2) Boom: Increase in AD = increase in APL
○ Inflationary pressure will build up and rate of GDP will fall as economy nears its
potential output
3) Recession: when the economy contracts over a 6 month period (two consecutive
quarters of declining national output)
○ Falling AD → firms hire less → increase in unemployment → less spending (less
income)
○ Low AD = low rates of inflation… might become deflation
4) Trough
○ Contraction comes to an end eventually
○ Output cannot continue to fall forever, as there will always be some people with
jobs to keep the level of consumption (i.e. foreigners demand exports, gov
spending, consumers use savings)
○ Low demand for money for investment = lower interest rates = AD increase →
recovery phase (cycle repeats)
● Economies go through periodic fluctuations in real GDP around their long-term growth
○ Second recovery is higher real GDP than the first (each boom higher than the
last)
○ Periodic fluctuations: actual output line
○ Economy’s long term trend (trend line): shown as a steady increase in output
(= potential output of the economy)
■ Countries aim to keep it along the trend line to avoid drastic fluctuations
○ Point A: negative output gap. Producing below its trend = most likely
unemployment problem.
** Note **
● Decrease in GDP: economy actually gets smaller
● Decrease in GDP growth: economy continues to grow, but at a slower rate
2.1 The level of overall economic activity
Circular flow of income model
● Two sector (closed economy)
○ 1. Households: consumers of goods/services + receive income by providing FOP
○ 2. Firms: hire FOP from households and use them to produce the nation’s output
● FOPs: labor, land, capital, entrepreneurship
○ Payment (by firms to households): rent, wages, interest, profit
● Four sector (open economy): takes into account leakages/injections
○ Households, firms, foreign sector (export/import), government sector
(government spending, taxes), financial sector (savings, investment)
Leakages and injections
● Leakages: causes amount of income circulating to FALL
○ Saving: do not buy all the output → unsold stocks of goods → firms reduce
output → firms use fewer FOP → less income
○ Taxes: income paid to government
○ Imports: money spent on imports doesn’t return to nation’s firms
● Injections: ways money can enter the economy outside consumer expenditure. allows
the amount of income circulating to RISE
○ Investment: firms borrow money from banks (people’s savings) to increase their
stock of capital → increase output
○ Government spending
○ Exports: foreigners spend money on nation’s goods → source of income from
outside households
● Injections > leakages = economic growth!
Measures of economic activity
GDP GNI/GNP
total value of all final goods/services Total value of all income earned by
produced in an economy a country’s FOP REGARDLESS OF
REGARDLESS OF WHO OWNS WHERE ASSETS ARE LOCATED
THE FOP
Nominal - At current prices
Real - Adjusted for inflation
- per capita GDP divided by population
, ● Shows output per person
● Better when comparing two
countries
● GDP: total value of all final goods/services produced in an economy (per year)
○ Measure of growth and living standards
● GNP/GNI: Total value of all income earned by a country’s FOP REGARDLESS OF
WHERE ASSETS ARE LOCATED
● Methods:
1) Output approach
2) Income approach
3) Expenditure approach: C + I + G + (X-M)
● Nominal GDP: at current prices
● Real GDP: adjusted for inflation
● GDP per capita: GDP divided by population
○ Shows output per person
○ Better when comparing two countries
● Green GDP: measure of GDP that takes into account environmental destruction
○ Accounts for costs caused by climate change
○ GDP - environmental costs of production = Green GDP
○ Significance: assess the impact of economic production on the environment and
the further implications it has on the economy
■ E.g. cost of clearing up environmental damage (ex. BP oil spills in US
2010)
■ E.g. health and industrial costs of air pollution/water pollution
● Evaluating the use of national income statistics:
Strengths Limitations
Make comparisons over time (economic Inaccuracies
growth = increase in a country’s national
income over time, thus statistics help
evaluate economic growth)
Make comparisons between countries Unrecorded data (informal markets)
Make conclusions about standard of living External costs
(rising national income = rising standard
of living)
Other quality of life concerns (GDP may
increase, but people working longer
hours)
, The business cycle
● Fluctuations in economic activity (rising, slowing, falling growth)
● Measured in by changes in real GDP
● IRL, fluctuations are irregular
● Phases:
1) Recovery: economic expansion (GDP increasing at rising rate)
○ Due to increase in Ag demand → households/firms encouraged to spend more
→ increase in AD = increase in output → firms hire more workers →
unemployment falls → newly employed workers spend income on goods/services
→ household spending increases
2) Boom: Increase in AD = increase in APL
○ Inflationary pressure will build up and rate of GDP will fall as economy nears its
potential output
3) Recession: when the economy contracts over a 6 month period (two consecutive
quarters of declining national output)
○ Falling AD → firms hire less → increase in unemployment → less spending (less
income)
○ Low AD = low rates of inflation… might become deflation
4) Trough
○ Contraction comes to an end eventually
○ Output cannot continue to fall forever, as there will always be some people with
jobs to keep the level of consumption (i.e. foreigners demand exports, gov
spending, consumers use savings)
○ Low demand for money for investment = lower interest rates = AD increase →
recovery phase (cycle repeats)
● Economies go through periodic fluctuations in real GDP around their long-term growth
○ Second recovery is higher real GDP than the first (each boom higher than the
last)
○ Periodic fluctuations: actual output line
○ Economy’s long term trend (trend line): shown as a steady increase in output
(= potential output of the economy)
■ Countries aim to keep it along the trend line to avoid drastic fluctuations
○ Point A: negative output gap. Producing below its trend = most likely
unemployment problem.
** Note **
● Decrease in GDP: economy actually gets smaller
● Decrease in GDP growth: economy continues to grow, but at a slower rate
