Fundamental Concepts of Macroeconomics

By:

Lecturer, Department of Economics

Wolkite University

Wolkite , Ethiopia
 INTRODUCTION

 macroeconomics, studies about overall or aggregate behavior of the

economy, such as;

 Economic growth

 Employment

 Inflation

 distribution of income

 macroeconomic policies and

 International trade.
 Goals of Macroeconomics
 Macroeconomics studies the working of an economy in aggregation
or as a whole. And it aimed at how;
 To achieve high economic growth
 To reduce unemployment
 To attain stable prices
 To reduce budget deficit and balance of payment deficit
 To ensure fair distribution of income
 Full employment and
 Fair distribution of income among citizens of a country
 National Income Accounting (NIA)
 National income accounting refers to a set of rules and

techniques that are used to measure the national income of a

country.

 It is a set of guidelines that provide a way of measuring the

value of economic activity over period of time.

 National income is a measure of the value of goods and goods

produced by the residents of an economy in a given period of
time, usually a quarter or a year.
 Cont’d

 NIA is an accounting record of the level of economic activities

of an economy.
 It is a measure of an aggregate output, income and
expenditure in an economy.
 Why do we need to study NIA?
 It enables us to measure the level of total output in a given
period of time, and explain level of performance.
 It enables us to observe the long run trend of the economy.
 It provides information to formulate policies and design
plans.
 Approaches to measure national income (GDP/GNP)

 Gross Domestic Product (GDP): It is the total value of

currently produced final goods and services that are produced

within a country‘s boundary during a given period of time,
usually one year.
 It measures the current production only.
 It takes in to account final goods and services only.
 Intermediate goods are goods that are completely used up in

the production of other products in the same period that they

themselves are produced.
 Cont’d

 Gross National Product (GNP): is the total value of final goods

and services currently produced by domestically owned

factors of production in a given period of time, usually one
year, irrespective of their geographical locations.
 GDP and GNP are related as follows:
GNP=GDP + NFI
 Net Factor Income received from abroad which is equal to

factor income received from abroad by a country‘s citizens less

factor income paid for foreigners to abroad.
 Cont’d

 Thus, NFI could be negative, positive or zero depending on

the amount of factor income received by the two parties.

 If NFI >0, then GNP > GDP

 If NFI<0, then GNP < GDP

 If NFI =0, then GNP =GDP

 Approaches to Measure GDP/GNP
 Product Approach: In this approach, GDP is calculated by adding

the market value of goods and services currently produced by each

sector of the economy.
 In this case, GDP includes only the values of final goods and services

in order to avoid double counting.

 Double counting will arise when the output of some firms are used as
intermediate inputs of other firms.
 There are two possible ways of avoiding double counting.
1. Taking only the value of final goods and services
2. Taking the sum of the valued added by all firms
Example: Taking only the value of final goods and services
 Cont’d

 Expenditure Approach: Measured by adding all expenditures

on final goods and services produced in the country by all

sectors of the economy.

 GDP can be estimated by summing up,

 Personal consumption of households (C)

 Gross private domestic investment (I)

 Government purchases of goods and services (G)

 Net exports (NE)

 Cont’d

 Personal consumption expenditure

 Durable consumer goods, Non-durable consumer goods and

services.
 Gross private domestic investment

 Residential investment
 Business fixed investment
 Inventory investment
 Government purchases of goods and services
 Both federal and state
 Net exports: Exports less total value of imports.
 Cont’d
 3. Income approach: GDP is calculated by adding all the incomes
accruing to all factors of production used in producing the national
output.
 Transfer payments: payments which are made to the recipients who

have not contributed to the production of current goods and services

in exchange for these payments are excluded from national income.
 As these are mere redistribution of income from taxpayers to the
recipients of transfer payments.
 Transfer payments may take the form of old age pension,
unemployment benefit, subsidies, etc.
Cont’d
 Cont’d


 Other Income Accounts
 Net National product (NNP) : GNP as a measure of the economy‘s
annual output

 Depreciation (capital consumption allowance) which is necessary to

replace the capital goods used up in that year‘s production.

 National income (NI): National income is the income earned by

economic resource.

 Personal Income (PI): refers to income earned by persons or

households.
 Cont’d
 Personal Disposable Income: it is personal income less personal

tax payments.

 DI = PI – Personal taxes DI = C + S where, C = personal

consumption expenditure, S = Personal savings.

Nominal versus Real GDP

 Nominal GDP is the value of all final goods and services
produced in a given year when valued at the prices of that year.

 Real GDP is the value of final goods and services produced in

a given year when valued at the prices of a reference base year.
 GDP Deflator and Consumer Price Index(CPI)

 The GDP Deflator: The ratio of nominal GDP in a given year to

real GDP of that year.

 Cont’d
 The Consumer Price Index: is an indicator that measures the

average change in prices paid by consumers for a representative

basket of goods and services.

 It compares the current and base year cost of a basket of goods of

fixed composition

 The CPI is the ratio of today's cost to the base year cost.
Macroeconomic Problems
 1. Business Cycle
 Business cycle refers to the recurrent ups and downs in the level of
economic activity.
 Ups and downs in the level of total output and employment over
time.
 Phase of Business Cycle
 Boom/peak: It is a phase in which the economy is producing

the highest level of output in the business cycle.

 Recession/contraction: During a recession phase, the level of

economic performance generally declines.

 Trough/Depression: This phase is the lowest point in a

business cycle.

 Recovery/Expansion: During this phase, the economy starts to

grow or recover
 2. Unemployment

 Unemployment refers to group of people who are in a

specified age who are without a job but are actively searching
for a job.

 The specified age is between 14 and 60 which are normally

named as productive population.

 To better understand what unemployment is, it is important to

begin with classifying the whole population of a country into
labor force and outside the labor force.
 Types of Unemployment
 Frictional unemployment: refers to a brief period of unemployment

experienced due to.

 Seasonality of work E.g. Construction workers

 Voluntary switching of jobs in search of better jobs

 Entrance to the labor force and re-entering to the labor force

 Structural unemployment: Mismatch between the skills or locations

of job seekers and the requirements or locations of the vacancies

 Cyclical unemployment: results due to absence of vacancies.

 Cont’d

 Frictional and structural unemployment are more or less

unavoidable; hence, they are known as natural level of
unemployment.
 Measurement of rates of unemployment
 Cont’d

 When the unemployment rate is equal to the natural rate of

unemployment, we say the economy is at full employment.

 Thus, full employment does not mean zero unemployment.

 3. Inflation

 It is the sustainable increase in the general or average price

levels commodities.

 Two points about this definition need emphasis.

 First, the increase price must be a sustained one

 Second, it must be the general level of prices

 Where, Pt is price index at time t and Pt-1 is price index at time t-1.
 Causes of Inflation

 Demand pull inflation: A rapid increase in demand for goods and

services than supply of goods and services.

 This is a situation where too much money chases too few goods.

 Cost push or supply side inflation: It arises due to continuous decline

in aggregate supply.

 This may be due to bad weather, increase in wage, or the prices of

other inputs.
 4. Trade Deficit and Budget Deficit

 Budget Deficit: Any excess of tax revenue over government spending

is called public saving, which can be;

 Either positive (a budget surplus) or negative (a budget deficit).

 When a government spends more than it collects in taxes, it faces a

budget deficit.

 It finances by borrowing from internal and external borrowing.

 Trade deficit: The national income accounts identity shows that net

capital outflow always equals the trade balance.

S − I = NX.
 Cont’d

 Net Capital Outflow = Trade Balance

 Net cash out flow is Saving(S) – Investment (I)

 Balance of Trade = Merchandize Exports – Merchandize

Imports

 If this balance between S − I and NX is positive, we have a

trade surplus. In this case, we are net lenders in world financial
markets, and we are exporting more goods than we are
importing.
 Cont’d

 If the balance between S − I and NX is negative, we have a

trade deficit. In this case, we are net borrowers in world

financial markets, and we are importing more goods than we
are exporting.

 If S − I and NX are exactly zero, we are said to have balanced

trade because the value of imports equals the value of exports.
 Macroeconomic Policy Instruments

 The ultimate policy objective of any country in general is to

have sustainable economic growth and development.

 Policy measures are geared at achieving moderate

 Reduce inflation rate,

 keeping unemployment rate low,

 balancing foreign trade,

 stabilizing exchange and interest rates,

 attaining stable and well-functioning macroeconomic

environment.
 Types of Policy

 Monetary policy: refers to the adoption of suitable policy

regarding the control of money supply and the management

of credit which is important measure for adjusting aggregate
demand to control inflation. It is concerned with the money
supply, lending rates and interest rates and is often
administered by a central bank.

 Fiscal policy: involves the use of government spending,

taxation and borrowing to influence both the pattern of

economic activity and also the level and growth of aggregate
demand, output and employment
 Major Functions of Fiscal Policy

 Allocation: The first major function of fiscal policy is to determine

exactly how funds will be allocated.

 Distribution: The distribution functions of the fiscal policy are

implemented mainly through progressive taxation and targeted
budget subsidy.

 Stabilization: Stabilization is another important function of fiscal

policy in that the purpose of budgeting is to provide stable
economic growth.

 Development: The fourth and most important function of fiscal

policy is that of promoting development
 Tax Policies in Ethiopia
 The underlying principles of the tax policies in Ethiopia are as
follows:
 To introduce taxes that enhance economic growth, broaden the
tax base and increase government revenue;
 To introduce taxes that are helpful to implement social policies
that discourage consumption of substances that are hazardous
to health and social problems;
 To introduce tax system that accelerate industrial growth and
achieve transformation of the country and to improve foreign
exchange earnings, as well as create conducive environment for
domestic products to become competitive in the international
commodity markets;
 Cont’d
 To ensure modern and efficient tax system that supports the
economic development;

 To make the tax system fair and equitable;

 To minimize the damage that may be caused by avoidance

and evasion of tax; and

 To promote a tax system that enhances saving and

investment.
 THANKS!!!

The End of Lecture Six!!!

THANKS!!!