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MN10574: Business Economics Lecture Notes
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- University Of Bath (UoB)
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Introduction to macroeconomicsMajor macroeconomic issues and objectives
Macroeconomic issue Macroeconomic objective
Economic growth A steady rate of increase in national output
Inflation A low and stable rate of inflation
Unemployment A low level of unemployment
Gross domestic product (GDP)
GDP — the market value of the final goods and services produced within a country over a given time
period
GDP = C + I + G + (X - M)
GDP — the total economic activity in a country regardless of who owns the productive assets
Economic growth — an increase in real GDP over time
Why GDP is useful
● Allows for a comparison of economic welfare over time in a country
● Allows for a comparison of economic welfare across countries
● A high GDP for countries is desirable because it indicates that an economy is strong and powerful
Methods of calculating GDP
There are three methods of calculating this…
1
, 1. The output method
a. Measures the value of the final goods and services produced by all sectors in the economy, e.g.
agriculture sector or the energy sector
b. Relates to arrow (3)
2. The income method
a. Measures the value of all the incomes earned in an economy (payments to the factors of
production)
b. Relates to arrow (2)
3. The expenditure method
a. Measures the value of all spending on goods and services in an economy on domestic output
b. Spending by households (consumption) → C (the largest component of AE)
c. Spending by firms i.e. the addition of capital stock to the economy (investment) → I
d. Spending by the government (government spending) → G
e. Spending on exports minus spending on imports (net exports) → (X - M)
f. Relates to arrow (4)
g. GDP = AE = C + I + G + (X - M)
h. There is a two-way link, an increase in real GDP increases AE, and an increase in AE increases
GDP
Adjustments to GDP
1. Adjusting for inflation
2. Per capita adjustment
3. Purchasing power parity (PPP)
Adjusting for inflation
● Because all countries experience economic growth in the long term, they experience steady inflation
● This causes an increase in average price levels in the economy, resulting in an increase in nominal
GDP, which is the GDP at current price levels
● However, an increase in nominal GDP does not necessarily mean that there has been a real increase
in economic activity
● Hence it is necessary to adjust nominal GDP for inflation to get the real GDP and see if there has been
an actual increase in consumption, investment, government spending, and net exports
𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝐺𝐷𝑃
GDP deflator = × 100
𝑅𝑒𝑎𝑙 𝐺𝐷𝑃
Per capita adjustment
● Absolute GDP is able to give an indication of the total economic activity in a country, however cannot
given an indication of living standards
2
, ● One of the ways high living standards can be measured is through looking at how much each person in
a country is consuming
● Thus it is necessary to divide the absolute GDP by the population size
● Just because a country has a high GDP, does not mean each person is consuming a lot, it may just
mean that the population is very large, and just because a country has a very small GDP, does not
mean that each person is consuming very little, it just may have a very small population
● Although China has a significantly higher GDP than Sweden, Swedes enjoy a much higher standard of
living
𝐴𝑏𝑠𝑜𝑙𝑢𝑡𝑒 𝐺𝐷𝑃
GDP per capita =
𝑃𝑜𝑝𝑢𝑙𝑎𝑡𝑖𝑜𝑛 𝑠𝑖𝑧𝑒
Purchasing power parity (PPP)
● Eliminates the exchange rate differentiential
● One of the uses of GDP is to compare the standard of living between different countries
● Real GDP must be converted into the same currency as the real GDP of the other country
● Prices of particular products in one country may be much lower or much higher than prices in another
country, and thus the exchange rate may be a poor indicator of the purchasing power of the currency at
home
Disadvantages of GDP AS A MEASURE OF ECONOMIC WELFARE
It is not a perfect measure of economic welfare for several reasons..
1. Underground economy
a. It doesn’t take into account the underground economy, which includes illegal activity that goes
unreported, often for tax avoidance reasons
b. This is a particular issue is less developed countries
2. Other indicators of economic welfare
a. It doesn’t take into account that GDP may be growing because people are working longer hours,
or taking fewer holidays for instance.
b. Does not take into account a multitude of factors that could reduce economic welfare such as
gender discrimination or ethnic marginalization
3. External costs
3
, a. GDP figures don’t take into account externalities, including the costs of resource depletion
such as deforestation, which are almost certain to compromise the quality of life
b. However, a solution to this would be to calculate Green GDP which are GDP figures
minus the environmental costs of production
Disadvantages of economic growth / NEGATIVES OF HIGH GDP
● The more economies grow, inequality tends to get worse
○ This is because the price of capital grows at a faster rate than the increase in workers’
wages
● Greater environmental degradation
● Greater corruption
Leakages and injections
Leakage — money which leaves the circular flow of income in an economy
Injection — money which enters the circular flow of income in an economy
● Leakages explain how increases / decreases in GDP / national income take place
Leakages Injections
Saving Investment
Taxes Government spending
Imports Exports
An increase in GDP / national income
● Occurs when injections > leakages
A decrease in GDP / national income
● Occurs when leakages > injections
The Easterlin paradox
4
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