EW LECTURE 1

MACRO 510*
Professor Abdul Bayes
([email protected])
01711564547

*Adapted from various sources

THE FOUNDATION OF
ECONOMICS
SOCIETY HAS VIRTUALLY
UNLIMITED WANTS...

THE FOUNDATION OF
ECONOMICS
SOCIETY HAS VIRTUALLY
UNLIMITED WANTS...

BUT LIMITED OR SCARCE

PRODUCTIVE RESOURCES!

What Is Economics?

Economics studies the choices

that can be made when there is
scarcity.
Scarcity is a situation in which
resources are limited in quantity
and can be used in different
ways.

What Is Economics?

Because our resources are

limited, we must sacrifice one
thing for another.
Economists are always
reminding us that there is
scarcitythat there are tradeoffs
in everything we do.

Positive versus Normative

Analysis

Positive economics predicts the

consequences of alternative
actions, answering the questions,
What is? or What will be?

Positive versus Normative

Analysis

Normative economics
answers the question, What
ought to be? Normative
questions lie at the heart of
policy debates.

Decisions in a Modern
Economy

Economic decisions are made at every level in

society.

The choices made by individuals, firms, and

governments answer three questions:
1.

What products do we produce?

2.

How do we produce the products?

3.

Who consumes the products?

Economic Analysis
and Modern Problems

Economic analysis provides

important insights into real-world
problems.
Economists attempt to diagnose
and provide solutions to
problems such as traffic
congestion, poverty in Africa, or
the problems of an entire
economy.

TEN PRINCIPLES OF ECONOMICS

HOW PEOPLE MAKE DECISIONS

1. People face trade-off
2. The cost of something is what you give up to get it opportunity cost
3. Rational people think at the margin additional benefit and cost
4. People respond to incentives tax on gasoline may reduce mileages,
encourage public transport
HOW PEOPLE INTERACT
5. Trade can make everyone better-off specialization
6.Markets are good ways of organizing economic activity invisible hand

Ten principles (contd)

7.Government can sometimes improve market outcomes farmers
need safe
crops, restaurants need payment by customers.
HOW THE ECONOMY AS A WHOLE WORKS
8.Countrys standard of living depends on ability to produce and
process goods
and services variations due to productivity
9. Prices rise when government prints too much money
10. Society faces a short-run trade-off between inflation and
unemployment

MICRO AND MACRO

ECONOMICS
Macroeconomics is the branch of economics that deals with a
nations economy as a whole
Microeconomics deals with firm, household and individual
Macroeconomics focuses on the economic issuesunemployment,
inflation, growth, trade, and the gross domestic productthat are
most often discussed in the media and in political debates.
As a biology teacher teaches anatomy with plastic replicas of human
body, economists use models stylized facts not details simple
economy interactions by circular flow diagram
The second model is Production possibility frontier (PPF) eg. cars
in horizontal axis (1000) and computers (0) or cars (0), computers
(3000) or cars 700, computers 2000.
Positive vs normative; doctor vs economist; broken window fallacy

CIRCULAR FLOW MODEL

$ COSTS

$ INCOMES
RESOURCE
MARKET

RESOURCES

INPUTS

BUSINESSES

HOUSEHOLDS

GOODS &
SERVICES

GOODS &
SERVICES
PRODUCT
MARKET

$ REVENUE

$ CONSUMPTION

The Circular Flow of

Production and Income

The circular flow shows how production of goods and services generates income for
households and how households purchased goods and services produced by firms.

COURSE CONTENT

Macro economic concepts GDP,GNP, Inflation, Growth rate etc.

Consumption, Investment functions

Inflation

Aggregate demand and supply

Inflation and unemployment

Monetary and fiscal policy

International trade, BOP, foreign exchange market and exchange rate

Financial market

Money and money market

Labor Market

REFERENCES

Mankwi: Macroeconomics
Paul R. Krugman and Maurice
Obstfeld: International economics

DISTRIBUTION OF MARKS

Class Attendance: 05
Quiz/Class Test: 10
Mid-term: 20
Mid-term:20
Assignment and prsentation:15
Final Examination: 30

MACRO ECONOMIC
PRINCIPLES
MICRO ECONOMICS AND MACRO
ECONOMICS

GOALS OF MACRO ECONOMICS

Growth: up
Inflation: down
Unemployment: down
Fluctuations: Small
Foreign sector: Expansion

 Macroeconomics focuses on two basic issues:

1.Long-run economic growth, or the factors
behind the rise in living standards in modern
economies.
2.Fluctuations in economic performance:
An economy is considered to be in a recession when
it fails to grow for at least six consecutive months.
At other times, unemployment may not be a
problem, but we become concerned about sustained
increases in prices, or inflation.

What is GDP ?
Gross domestic product (GDP) is a measure of the total
(aggregate) market value of _______________________
produced by all ________________________ of a
territory or an economy over a specified period of time,
usually a year or a quarter.
Example:
In 2002, Hong Kongs GDP was $1,259.8 billion.
In 2007-08, Bangladesh's GDP Tk.5,419 Million (Current
Prices) or roughly $79 billion

Key Points Parade

monetary value
Example:

Three packs of corn flakes and six

cans of corn soup cannot be added up
together

National Output and Value

Added
National Output: is the sum of all
output produced by all firms in the
economy .
But, one firms output could be
another firms input, which means
that some firms produce output that
are used as input by other firms .

Therefore, if we add the

output of all firms, we will
obtain a total output that
exceeds the value of the
economys actual output , so
we will overestimate the
value of the output produced
by the economy .

Example

Wheat

Flour

Baker

Total
Farmer
Purchase from
other firms

Mill
0

$ 100

$ 130

Factors of production 100

30
50
Total value of output 100
130
180
Here, we have a problem of Double Counting

$ 230
180
410

To avoid this problem, we measure the value of output by using

The Value Added Concept

The Value Added

It is the the market value of the output produced
by the firm minus the purchases from other firms
: Therefore
Value Added = Market Value purchases
by a firm
of output
from other
produced

firms

Example
Value added = market value of purchase from
by a firm
output
other firms
Value added by
Wheat Farmer =
$ 100
0 = $
100
Value added by
Flour Mill =
130
100 = $
30
Value added by
The Baker =
180
130 = $
50
Total value added = $ 410
$ 230 = $
180
by all firms in the economy

Measurement of National Income

and Product ( GDP )

If we add up the total flow of

expenditure on domestic output, this
is called the Expenditure
Approach .
If we add up the total flow of income
generated by the flow of domestic
production, this is called the Income
Approach .

I. GDP from the Expenditure

side
The GDP for a given year is calculated by,
adding up the expenditure needed to
purchase the final output produced in the
year . Therefore, the value of output or
GDP is the sum of four categories :
Consumption + Investment + Government expenditure + Net
Export

GDP = C +

+(XM)

 Consumption expenditure:
Includes expenditure on all goods and services
produces and sold to their final users during the year
such as: haircut, dental care, food, durable goods,
non-durables goods, and clothes.
Investment expenditure:
includes expenditure on goods not for present
consumption. This includes: inventories (stocks of
inputs), capital goods such as factories, machines,
warehouses, and residential houses.
Gross investment: is the total investment that
occurs in the economy which is divided into two
parts: replacement investment and net investment.

 Replacement investment: is the

amount of investment that just
maintain the level of existing capital
stock (it is called the capital
consumption allowance or
depreciation).
Net investment = gross investmentreplacement investment.

 Government purchases of goods

and services:
This includes government purchases of
currently produced goods and services .
Note that not all government expenditure
is counted as a part of GDP.
All transfer paymentsare excluded since
they are not made in return for currently
produced goods and services. For
example: social security payments for
retired people (pensions).

 Net exports:
Which means that we group actual exports
and actual imports together as net
exports. In other words, total exports total imports.
When total exports is greater than total
imports, then net exports will be positive
and vise versa.

Example
Given the following data, calculate the
GDP
C = $ 3261 ; I = $ 773 ; G = $ 955
X = $ 70
; M = $ 150

GDP = 3261 + 773 + 955 + ( 70

150 )
= $ 4909

GDP from the Income Side

Adding up factors income or factors payment and
other claims on the value of output.
Factor payments:
Wages and salaries: which includes all
compensation to employees (labor income).
Rent: which includes payments for the services of
land and other factors that are rented. The amount
of rent in the GDP includes payments for rented
housing plus imputed rent for the use of owneroccupied housing.

 Interest: includes interest earned

on bank deposits and on loans to
firms.
Profit: includes both dividends
(profits paid to the owners of firms)
and retained profits by firms.

 No factor payments:
These payments includes indirect taxes and
depreciation.
Note that taxes will be included when we calculate GDP
from the income side since they represent income
claimed by the government.
Note also that we have to subtract governmental
subsidies on goods and services since these payments
allow incomes to exceed the market value of output.
So, indirect taxes net of subsidies will be added to the
four components of factor payments in order to get the
Net Domestic Product.

 Depreciation: is the value of capital

that has been used up in the process
of producing final output. It is the
value that must be reinvested.
It is part of gross profits but because
it is needed to compensate for
capital used up in the production
process, it is not part of net profit.
Adding depreciation to net domestic
product gives Gross Domestic
Product (GDP).

GDP from the Income Side

Example:
Factor payments =
wages + rent + interest + profit
2933 + 20 + 396 + 652 = $ 4001
Net Domestic Product = factor payments + ( indirect
tax Govt. subsidies )
= 4001 + (424 - 10 ) = $4415

GDP = net domestic product + Depreciation

= 4415 + 508 - (statistical discrepancy) 14
= $ 4909

GDP VS GNP
GDP : Measures the value of total
output produced domestically by
summing the value added by each
industry.
GNP : Measures the income received
by residents of the country no
matter where that income was
generated.

Sources of differences between

GDP and GNP
1.

Some local production creates factor income for

foreigners which will be sent (at least partially)
abroad and thus, it is not a part of the countrys GNP
(and it will be counted as a part of the countrys
GDP).

2. Some of the local residents earn income as a

result of foreign investments which will be counted as
a part of the countrys GNP (but not in the countrys
GDP).

GDP VS. GNP

GDP
_ value of domestic based assets
owned by foreigners

+ value of foreign based assets

owned by local residents .

_________
= GNP
.

Example
Given that the value of GDP = $ 4909
and the value of domestic based assets
owned by foreigners equals to $ 2000 ,
and the value of foreign based assets
owned by the local residents equals to $
3000 . Find the value of the GNP ?
GNP = 4909 2000 + 3000 = $ 5909
If GNP > GDP the country is a net
creditor
If GNP < GDP the country is a net debtor

Which Measure Is Better?

GDP is superior to GNP as a measure
of domestic economic a activity.
GNP is superior to GDP as a measure
of the economic well-being of
domestic residents.

Disposable Personal Income

It is the part of national income that is
available to households to spend or to
save.
To calculate the disposable income we
have to subtract from GDP the parts
that are not available to households
such as: depreciation, taxes, retained
profits, interest paid to institutions, and
add transfer payments.

Total Value, Productivity and Per

Capita
GDP

per capita GDP or how much

there is on average for each

total population

person
GDP
worker

=average output per employed

# of people employed

GDP

=output per hour of labor input

Total # of working hours

Calculation of Nominal and

Real
National Income
Given the following data below, calculate both the
nominal and the real national income for 2 years
.Assuming that year 2 is the base year.
Quantity produced
Prices
Wheat Steel
Wheat Steel
year 1
100
20
$ 10
$ 50
year 2
110
16
12
55

Calculation of Nominal
Income
Nominal income = current X current
quantities
prices
Therefore :
Nominal income for year 1 equals to :
( 100 X 10 ) + ( 20 X 50 ) = $ 2000
Nominal income for year 2 equals to :
( 110 X 12 ) + ( 16 X 55 ) = $ 2200

Calculation of Real
income
Real income = current X prices of
the
quantities
base
year
Therefore :
Real income for year 1 equals to :
( 100 X 12 ) + ( 20 X 55 ) = $ 2300
Real income for year 2 equals to :
( 110 X 12 ) + ( 16 X 55 ) = $ 2200

REAL VS NOMINAL GDP

Prices and Quantities
GDP may rise because(a) the economy is producing larger
quantities of goods and services; (b) the goods and
services are sold at a higher price. Separate the two effects

Year Prices of HD
2005 $1
2006 $2
2007 $3

Quantity
100
150
200

Price of BB
$2
$3
$4

Quantity
50
100
150

Calculating nominal GDP:

2005: ($1 per HD) X 100 HD) + ($2 per BB X 50 BB)=$200
2006($2 per HD X 150 HD) +($3 per BB X100BB)=$600
2007:($3 per HD X200 HD) + ($4 per BB X150 BB)=$1,200
Calculating Real GDP (base year 2005)
2005: ($1 per HD X100 HD)+($2 per BBX50 BB)=$200
2006: ($1 per HD X150 HD)+ ($2 per BB X100 BB)=$350)
2007$1 per HD X 200 HD) + ($2 per BB X 150 BB)=$500
GDP Deflator:
2005: ($200/$200)X100=100
2006:($600/$350)X100=171 (How much price rose?)
2007$1200/$500)X100=240

Implicit GDP Deflator

Is an implicit price index that compares

the nominal and the real GDP over a
given period of time.
This index measures the change in prices
over that period . Therefore,
Implicit GDP = GDP at current prices_
X100
deflator
GDP at base year prices

Example
Given that :
Suppose, GDP at current prices for year 1 = $ 2000
( Nominal GDP of year 1), and
GDP at base year prices for year 1 = $ 2300
( Real GDP for year 1) , therefore
Implicit GDP Deflator =
for year 1

2000 X 100
2300
= 86.9
This means that the price level of year 1 is 86.9% of the price
level of year 2 (the base year).
Note that we can use year 1 as our base year.

What National Income Does Not

Measure ?
There are some economic activities
that are not included in the GDP or
GNP such as :
Illegal Activities.
Unreported Activities.
Nonmarket Activities.
Economic Bads.

GDP AND NATIONAL

INCOME
GDP = 5513.8
Plus: net factor payments (Income from capital
and employment abroad those sent abroad)
10.7
Equals GNP =5524.5
Less: depreciation =594.8
Equals NNP =4929.8
Less: sales and excise tax =439.2
Less business transfers = 27.7
Less statistical discrepancy=8.1
Equals National Income = 4459.6

NATIONAL INCOME AND

PERSONAL INCOME
National Income = 4459.6
Less: contribution to social insurance/security = 501.7
Less: corporate retained earning = 194.2
Plus: nonbuisness interest = 231.2
Plus: transfer payments from govt (social security) and business =
684.9
Equals personal income = 4679.8
Less: income tax = 621.0
Equals: Personal disposable income.

Illegal Activities
Example :
Drugs trade
Gambling
Liquor
All such activities are not
included in the value of the
GDP .

Unreported Activities
These are legal activities, but
are not reported for tax
purposes .

Non-market Activities
Any do it yourself activity
and any voluntary work

Economic Bads
Pollution, congestion, and other
disamenities associated with economic
growth are called economic bads
and are not reflected (measured) in
the calculation of GDP or GNP.
For example, the value of the damage
done by the acid rain is not deducted
from the GDP or GNP.

Do the Omission Matter ?

If we wish to measure the flow of goods and
services through the market sector of the
economy, then most of these omissions will
not matter.
But, If we wish to measure the overall flow of
goods and services available to satisfy the
peoples wants regardless of the sources of
goods and services , then the omissions

are undesirable.

Growth versus Development

Economic growth may be one aspect
of economic development but is not
the same
Economic growth:
A measure of the value of output of
goods and services within a time period

Economic Development:
A measure of the welfare of humans in a
society

Other considerations of human welfare:

Political freedoms?
Sustenance?
Sustainable development?
Self esteem?
Proportion of activity in different sectors of
the economy:
Primary
Secondary
Tertiary

Measuring Real Versus Nominal

GDP
GDP Data for a Simple Economy
Quantity Produced

Price
Nomina
Computers
l GDP

Year

Cars

Computer
s

2006

$10,000

$5,000

$45,000

2007

$12,000

$5,000

$75,000

Cars

To calculate real GDP we use constant

Price
prices. Quantity
Produced

Year

Cars Computers

Cars

Computers

Real GDP

2006

$10,000

$5,000

$45,000

2007

$10,00
0

$5,000

$65,000

Growth of real GDP:

PRODUCTIVITY
Production and productivity income differential
Daniel Defoes famous novel Robinson Crusoe a sailor
stranded on a desert island
Catches own fish, grows own vegetables, makes own cloth
a simple closed economy.
If Crusoe is good at all activities, he is well; if not lives
poorly.
Productivity is the key in Crusoes living standard.
Americans live better than than Bangladesh not because
America is bigger but because Americas labor is more
producutive.

DETERMINANTS OF
PRODUCTIVITY
Physical capital per worker saws, lathes and
drill for wood worker; sophisticated than basic
tools.
Human capital per worker knowledge, skills
Natural capital per worker land, rivers, mineral
deposits.
Renewable (forest) and non-renewable (oil)
Technological knowledge: understanding of how
world works; human capital transmits it to labor
force

SOURCES OF GROWTH
Capital accumulation new
investment in land, physical
equipment, human resources;
Growth in population and eventually
labor force
Technology

SOURCES OF GROWTH
Physical stock of capital e.g. new factories, machinery,
equipment supplemented by infrastructure. Harrod-Domar
Model:
g =s/c
where g = Y*/Y is the growth rate of national income, s =
S/Y, c = K*/Y* is marginal capital-output ratio (additional
capital investment required to produce one additional unit
of output) and assumed constant (Note: I = K*)
Population is an asset inventions, innovations, technology
from differentiated products, human capital as a factor of
growth: Y =f (K, L) vs. Y =f (K,L*)

SOURCES OF GROWTH
Y = ALK with alpha and beta affixed over L
and K to assume exponential function).
It measures percentage increase in output
corresponding to 1% increase in L and K
i.e., production elasticities of L and K.
If alpha and beta=1, constant returns to
scale (rts), if>1, increasing rts,<1,
decreasing rts.
A is technological progress higher value
better from new techniques, skills etc.

SOURCES OF GROWTH
Early growth on capital accumulation
Marx Pattern
Later growth on capital allocation
and technology Total Factor
Productivity (TFP) Kuznets Pattern.