Economics — Macroeconomics

Chapter 1: Measurement of economic performance (I) — GDP and GNI

1. Gross domestic product (GDP)

(a) Definition
- GDP is the total value of production of all resident producing units of an economy during a specific period.

(b) Items not included in GDP

(i) Items not involving production (i.e. no production → not counted in GDP)
Items Explanations
Transfer payment - They are only money transfers, not payments for production.
Capital gain - It refers to an increase in the market value of an asset and not generated from
production.
Financial assets - They are intangible assets which allow owners to receive a payment from other units.
- Purchase prices are not payments for production
Second-hand goods - They already exist in the economy and their transactions do not involve production.

(ii) Items not produced by RPUs (e.g. imported goods and services)

(iii) Items not produced in the specific period (e.g. past inventories)

(iv) Items that are difficult to estimate the monetary value (e.g. unpaid services produced by household)

(c) Items that are counted in GDP

- Values of illegal (e.g. smuggling and piracy), unreported (e.g. private tutors and hawkers) or non-market
(e.g. agricultural products for self-consumption) production

2. Resident producing units (RPUs)

(a) Definition
- A producing unit is considered as a resident producing unit in an economy it maintains a centre of predominant
economic interest in the economic territory of that economy.

(b) Conditions for being a RPU

(i) An individual
- He has to remain in the economy for at least 12 months or intend to do so, regardless of his nationality.

(ii) An orgaisation
- It ordinarily operates in the economy.

3. Equivalence of the approaches to measuring GDP

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4. Approaches to measuring GDP — Production approach
(a) Value-added
- The value-added of a producing unit measures its contribution to production.
- Value-added = Value of output – Value of intermediate consumption

(b) How to calculate GDP by value-added

- GDP = Sum of value-added of all RPUs

(c) GDP at market prices and factor cost

- GDP at market prices = GDP at factor cost + Indirect taxes – Subsidies
- GDP at factor cost = GDP at market prices – Indirect taxes + Subsidies

5. Approaches to measuring GDP — Expenditure approach (C + I + G + X – M) / (C + I + G + NX)

(a) Private consumption expenditure (C)
- final expenditure of domestic households

(b) Gross investment expenditure (I)

- final expenditure of domestic firms

- Changes in inventories = Changes in stock

- Depreciation = Capital consumption = Capital consumption allowances
- ‘Gross’ = Depreciation included
- ‘Net’ = Depreciation excluded
- ‘Fixed’ = Changes in inventories excluded

(c) Government consumption expenditure (G)

- It is usually measured at cost since most of their products are not for sale in the market.

(d) Net exports (NX)

- Exports = Exports of goods + Exports of services
= Domestic exports of goods + Re-exports of goods + Exports of services
- Imports = Imports of goods + Imports of services
- Net exports = Total exports – Total imports
= Net exports of goods + Net exports of services
- Imports are not counted in GDP because they are not produced by RPUs of the economy but their values have
been included in the expenditure of (C, I, G and X).

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6. Gross national product / Gross national income (GNP) / (GNI)
(a) Definition
- GNP is the total income earned by residents of an economy from engaging in various economic activities during a
specified period.

(b) Conditions for being a resident

(i) An individual
- He has to remain in the economy for at least 12 months or intend to do so, regardless of his nationality.

(ii) An orgaisation
- It ordinarily operates in the economy.

(c) Calculating GNP from GDP

- GNP includes factor incomes earned by residents from outside the economy.
- These factor incomes are called ‘factor income from abroad’ or ‘inflow of factor income’.
- GNP excluded factor incomes earned by non-residents from within the economy.
- These factor incomes are called ‘factor income paid abroad ‘ or ‘outflow of factor income’.
- GNP = GDP + Factor income from abroad – Factor income paid abroad
- GNP = GDP + Net factor income from abroad

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Chapter 2: Measurement of economic performance (I) — national income statistics and the general price level

1. Nominal GDP and real GDP

𝑃𝑟𝑖𝑐𝑒 𝑙𝑒𝑣𝑒𝑙 𝑖𝑛 𝑡ℎ𝑒 𝑏𝑎𝑠𝑒 𝑦𝑒𝑎𝑟
- Real GDP = Nominal GDP × 𝑃𝑟𝑖𝑐𝑒 𝑙𝑒𝑣𝑒𝑙 𝑖𝑛 𝑡ℎ𝑒 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑦𝑒𝑎𝑟
- Nominal GDP is affected by changes in the price level.
- Real GDP is a better measure of aggregate output as it can eliminate the effects of changes in the price level.
- Real GDP can compare national power, living standard and economic growth in different economies.

2. Per capita GDP

𝐺𝐷𝑃
- Per capita GDP = 𝑃𝑜𝑝𝑢𝑙𝑎𝑡𝑖𝑜𝑛
- Per capita real GDP can measure the general standard of living of people of an economy.
- Per capita real GDP can compare national power, living standard and economic growth in different economies.

3. Growth rate of national income statistics

𝑆2 − 𝑆1
- Growth rate = 𝑆1
× 100%

- Growth rate of real GDP can assess the economic performance of an economy.
- Real GDP growth rates can compare national power, living standard and economic growth in different economies.

4. Limitations of national income statistics

- If the bad things did not count, GDP is overestimated.
- If the good things did not count, GDP is underestimated.

(a) Value of some unpaid services is not counted

- The value of unpaid services produced by households for self-consumption will not be counted in GDP.
- These productions can improve standard of living.
- GDP may underestimate the standard of living.

(b) Value of leisure is not counted

- The more the leisure time, the higher the living standard.

(c) Undesirable effects of production are not considered

- Production may lead to pollution which has negative effects on humans.
- GDP may overestimate the standard of living.

(d) Distribution of income is not consider

- If income distribution is highly uneven in an economy, most of its people may have a lower standard of living.
- GDP may overestimate the standard of living.

5. Price index
- It is a figure that shows the price level of a basket of goods and services in a specified period relative to its price
level in the base period.

6. Consumer price index (CPI)

- It shows the price level of consumer goods and services generally purchased by domestic households in a
specified period relative to the price level in the base period.

7. GDP deflator
- It shows the price level of goods and services related to GDP (including C, I, X and M) in a specified period
relative to the price level in the base period.
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8. Relationship between the CPI and the GDP deflator
(a) Similarity
- Show the price level in the specified period relative to that in the base period.

(b) Differences
(i) Converge of goods and services
- CPI better reflects households’ cost of living while GDP deflator reflects the general price level and the
purchasing power of money.

(ii) Weights
- CPI assigns a fixed weight to each product, which reflects the consumption pattern in the base period while
GDP deflator assigns a variable weight to each product, which reflects the output distribution in the current
period.

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Chapter 3: Macroeconomics problems

1. Inflation, Deflation and Disinflation

(a) Definition
- Inflation: phenomenon of a persistent increase in the general price level.
- Deflation: phenomenon of a persistent decrease in the general price level.
- Disinflation: phenomenon of a persistent increase in the general price level but at a declining rate (i.e. 越升越慢).

(b) Calculation of inflation and deflation

𝑃𝐼2 − 𝑃𝐼1
- Inflation rate in the specified period = 𝑃𝐼1
× 100%, where

PI2 = general price level of a specified period

PI1 = general price level of the preceding period
- If the inflation rates are persistently positive (≠ increase), there is inflation.
- If the inflation rates are persistently negative (≠ decrease), there is deflation.

(c) Identification of inflation, deflation, disinflation from diagrams

(i) Value of the CCPI
Inflation (AB, CE):
- CCPI increases continuously.
- The curve is upward sloping.

Deflation (BC):
- CCPI decreases continuously.
- The curve is downwards sloping.

Disinflation (AB, DE):

- CCPI increases continuously at a
decreasing rate.
- The curve is upward sloping with a
decreasing slope (i.e. 越來越平)

(ii) Percentage changes in the CCPI

Inflation (FH, IJ excluding points H and I):
- % change in the CCPI is positive.
- The curve lies above 0%.

Deflation (HI excluding points H and I):

- % change in the CCPI is negative.
- The curve lies below 0%.

Disinflation (GH excluding points G and H):

- % change in the CCPI is positive but
decreasing.
- The curve lies above 0% and is
downward sloping.

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2. Effects of inflation
(a) Nominal value and real value

Nominal value Real value

Definition Nominal value of an asset in a specified Real value of an asset is value measured at
period is value measured at current-period base-period prices.
prices.
Feature nominal value ↑ ≠ purchasing power ↑ real value ↑ = purchasing power ↑
Relation 𝑃𝑟𝑖𝑐𝑒 𝑖𝑛𝑑𝑒𝑥 𝑖𝑛 𝑡ℎ𝑒 𝑏𝑎𝑠𝑒 𝑝𝑒𝑟𝑖𝑜𝑑
Real value = Nominal value × 𝑃𝑟𝑖𝑐𝑒 𝑖𝑛𝑑𝑒𝑥 𝑖𝑛 𝑡ℎ𝑒 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑝𝑒𝑟𝑖𝑜𝑑

- Nominal value = Monetary value = Current value

- Purchasing power is measured by the amount of goods and services that the amount of money can purchase.
- Purchasing power ∝ General price level

(i) Unanticipated inflation

- Unanticipated inflation refers to a situation in which the general price level rises by more than people
expected.
- Price level increases more than expected.
- Actual real value / purchasing power of fixed future payment is smaller than expected.
- Future payment payers (debtors) gain but recipients (creditors) lose.

(ii) Unanticipated deflation

- Unanticipated deflation refers to a situation in which the general price level falls by more than people
expected.
- Price level decreases more than expected.
- Actual real value / purchasing power of fixed future payments is greater than expected.
- Future payments payers (debtors) lose but recipients (creditors) gain.

(b) Nominal interest rate and real interest rate

Nominal interest rate (Nominal rate of return) Real interest rate (Real rate of return)
Definition Nominal interest rate (n) is the percentage Real interest rate (r) is the percentage change in
change in the nominal value of an asset over a the real value of an asset over a specified period.
specified period.
Relation

(i) Unanticipated inflation

- Actual inflation rate > Expected inflation rate
- Actual real interest rate < Expected real interest rate
- Actual real interest rates that future payment payers (recipients) pay (receive) are smaller than expected.
- Future payment payers gain but recipients lose.

(ii) Unanticipated deflation

- Actual deflation rate > Expected deflation rate
- Actual real interest rate > Expected real interest rate
- Actual real interest rates that future payment payers (recipients) pay (receive) are greater than expected.
- Future payment payers lose but recipients gain.

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3. Anticipated inflation and deflation
(a) Definition
- Anticipated inflation: people correctly foresee the increase in the price level
- Anticipated deflation; people correctly foresee the decrease in the price level
∵ Actual price level = Expected price level
∴ No party gains or loses.
∴ No redistributive effects

(b) Indexation
- Indexation refers to the automatic adjustment of future payments according to a price index that reflects the cost
of living.
- It offsets the change in the price level so that the purchasing power of future payments can be maintained.
- Indexed future payments have no income redistribution effect on payers or recipients.

4. Wealth
(a) Definition
- Wealth is the total value of all possessions that an economic entity owns.
- Wealth = Total value of assets – Total value of liabilities

(b) Effects of inflation

- People prefer to hold less money as its real value decreases.
- They may prefer to invest more in assets with positive changes in their nominal values to avoid losses in real
value of wealth.

5. Other effects of inflation

- The standard of living may fall.
- Resources are reallocated.
- X ↓, M↑

6. Unemployment and underemployment

(a) Labour force
- People who are willing to and available for work, whether that are presently employed or unemployed.
- Only people aged 15 and over would be included.

(b) Components of population

Employed population - People who work for pay or profit or who have a formal job attachment.
Underemployed population - People who involuntarily work less than a specified number of hours (35
hours in HK).
- They have a job, but they are available for and seeking additional work.
Unemployed population - People who want a job but have failed to find one.
- They do not have a job but are available for and seeking work.

(c) Measurement of unemployment / underemployment rate

𝑈𝑛𝑒𝑚𝑝𝑙𝑜𝑦𝑒𝑑 𝑝𝑒𝑟𝑠𝑜𝑛𝑠
- Unemployment rate = 𝐿𝑎𝑏𝑜𝑢𝑟 𝑓𝑜𝑟𝑐𝑒
× 100%
𝑈𝑛𝑑𝑒𝑟𝑒𝑚𝑝𝑙𝑜𝑦𝑒𝑑 𝑝𝑒𝑟𝑠𝑜𝑛𝑠
- Underemployment rate = 𝐿𝑎𝑏𝑜𝑢𝑟 𝑓𝑜𝑟𝑐𝑒
× 100%

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7. Cost of unemployment
To the unemployed (a) Lower standard of living
- no income ⇒ cut consumption ⇒ living standard ↓

(b) Family problems

- ↓ self-esteem ⇒ family disputed
To society (a) Losss of output
- human resources which could have been used in production are idled ⇒ aggregate
output ↓

(b) Social problems

- unemployed people may turn to crimes ⇒ crime rate ↑
To the government (a) Financial burden
- government revenue from income taxed ↓
- more resources are needed to address the criminal

8. Phase of a business cycle

(a) Business cycle in terms of real GDP

Phase Expansion (AB) Peak (B) Contraction (BC) Trough (C)

Phenomena that can be commonly observed:
Real GDP is positively related
to:
C, I, M, sales receipts, profits, Increase Highest Decrease Lowest
tax revenue, business
confidence, employment level
Real GDP is negatively related
to:
Decrease Lowest Increase Highest
unemployment rate, transfer
payments, inventory levels
Inflation rate Increase High Decrease Low
Fiscal balance Improve — Worsen —
Trade balance Worsen — Improve —

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(b) Business cycle in terms of percentage change in real GDP

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Chapter 4: Aggregate demand and aggregate supply (I) – basic concepts

1. Aggregate demand
(a) Aggregate demand
- It shows the relation between the price level and the aggregate outputs demanded in an economy, ceteris paribus.
- It is represented by a table or a curve.

(b) Aggregate output demanded (C + I + G + NX)

- It is the real output demanded by an economy at a particular price level over a specified period. It can be
measured in terms of real GDP or real national income.
- It is represented by a point on the AD curve.

2. Reasons for a downward sloping AD curve

3. Movement along AD v.s. Shift in the AD curve

- Movement along the AD curve is caused by the change in price level.
- Shift in the AD curve is caused by the change in non-price-level factor of the aggregate output demanded.

4. Factor causing a shift in the AD curve

(a) Factors affecting private consumption expenditure:

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(b) Factors affecting gross investment expenditure:

(c) Factors affecting exports (X) and imports (M)

5. Aggregate supply
(a) Definition
(i) Aggregate supply
- It shows the relation between the price level and the aggregate output supplied in an economy, ceteris
paribus.
- It is represented by a table or a curve.

(ii) Aggregate output supplied

- It is the real output supplied by an economy at a particular price level over a specified period. It can be
measured in terms of real GDP or real national income.
- It is represented by a point on the AS curve.

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(b) Short run v.s. Long run in macroeconomics

Short run Long run

Definition It is a period within which an economy has not It is the period within an economy has fully
fully adjusted to the economic situation. adjusted to the economics situation.
Diagram

6. Reason for an upward sloping SRAS curve

7. Reasons for a vertical LRAS curve

- It is positioned at the full employment real GDP, which means the resources in a country are used efficiently.

(a) Flexible prices

- Since the input prices are fully flexible, when the price level increases, input suppliers renew long term contracts
at increased prices.
- It is not profitable for firms to produce at an output level that is higher than the original output level.
- Firms restore their original production plans.
- Changes in price level would have no effect on aggregate output supplied.
- The economy produces at the full employment output level.

(b) Capacity constraint

- The full employment output level of an economy is determined by its quantity, quality and the level of technology
available.
- These are independent of price level.

8. Movement along AS v.s. Shift in the AS curve

- Movement along the AS curve is caused by the change in price level.
- Shift in the AS curve is caused by the change in non-price-level factor of the aggregate output supplied.

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9. Factors affecting SRAS

10. Factors affecting LRAS

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Chapter 5: Aggregate demand and aggregate supply (II) – determination of output level and price level

1. Changes in SR equilibrium
(a) Changes in AD
In the short run: Price level Output level
AD rises ↑ ↑
AD falls ↓ ↓

(b) Changes in SRAS

In the short run: Price level Output level
SRAS rises ↓ ↑
SRAS falls ↑ ↓

2. Changes in LR equilibrium
(a) Change in AD
In the long run: Price level Output level
AD rises ↑ No change
AD falls ↓ No change

(b) Change in LRAS

In the long run: Price level Output level
LRAS rises ↓ ↑
LRAS falls ↑ ↓

3. Inflationary gap
① AD increases

- When the new output level > full employment output level (the original output level), the difference is called an
inflationary gap.
- The economy experiences overheating.

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② Automatic adjustment (SRAS falls)

- SRAS falls and it shifts leftwards until the inflationary gap is closed (i.e. the new equilibrium point is on the
LRAS curve).
- Output falls back to full employment output level and price level rises.

4. Deflationary gap
① SRAS decreases

- When the new output level < full employment output level (the original output level), the difference is called a
deflationary gap.
- The economy experiences unemployment.

② Automatic adjustment (SRAS rises)

- SRAS rises and it shifts downwards until the deflationary gap is closed.
- Output raises back to full employment output level and price level falls.
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5. Inflationary gap / Deflationary gap caused by the change in LRAS
① SRAS and LRAS increases

- Productivity rises so both SRAS and LRAS increase.

② Automatic adjustment (SRAS rises)

- SRAS increases until the deflationary gap is closed.

- Price level decreases while output level increases.

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