Macroeconomics 1B

Mthokozisi Mlilo
Office: NCB Room 202
Tel: 011.717.8099
Consultation: Fri (TBA)
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Lecture 1*
Measuring A Nations
Income

*Mankiw, N. Gregory and Mark P. Taylor. 2014. Macroeconomics. UK:

Cengage Learning EMEA, Ch5

Purpose of Lecture

Understand
Why an economys total income equals its total
expenditure
How GDP is defined and measured
The components of GDP
The distinction between real GDP and nominal
GDP
Whether GDP is a good measure of economic wellbeing

Economics

The study of how society manages its

scarce resources

The Economys Income and

Expenditure

For an economy as a whole income equals

expenditure because:
Every transaction has a buyer and a seller.
Every rand of spending by some buyer is a dollar of
income for some seller

The Economys Income and

Expenditure
The Circular-Flow Diagram

The Measurement of Gross Domestic

Product

Gross Domestic Product (GDP)

Is the market value of all final goods and services
produced within a country in a given period of time

The Measurement of Gross Domestic

Product

GDP is the Market Value

A monetary measure

The Measurement of Gross Domestic

Product

Three Types of GDP

Gross value added at factor cost
+ other taxes on production*
- other subsidies on production**
Gross value added at basic prices
+ taxes on production#
- subsidies on production##
GDP at market prices

*Taxes on factors of production: property, capital and payroll taxes, etc.

**Subsidies on factors of production: job creation and training subsidies, etc.
#Taxes on products: general sales taxes, VAT, fuel levy, duties and taxes on imports, etc.
##Subsidies paid on agricultural commodities, transportation services and energy, etc.

The Measurement of Gross Domestic

Product

Of All Final
Avoid double counting
Intermediate goods versus Final goods
Value added

The Measurement of Gross Domestic

Product

Goods and Services

It includes both
tangible goods: food, clothing, cars and
intangible goods: haircuts, house cleaning, doctor visits

The Measurement of Gross Domestic

Product

Produced
It includes goods and services produced in the
period were considering, not transactions
involving goods produced in the past.
E.g. do not include second hand goods, i.e, used
cars, used houses, second hand cellphone etc.
No unilateral transfers between individual or form
government.

The Measurement of Gross Domestic

Product

Within a Country
It measures the value of production within the
geographic confines of a country. Ownership is
not important.

In a Given Period of Time.

It measures the value of production that takes
place within a specific interval of time, usually a
year or a quarter. GDP is a flow & not a stock.

Three Approaches to GDP

Expenditure Approach
Money spent on final goods and services

Income Approach
Incomes of the factors of production

Production Approach
Sum of the value added during each phase of the
production process

The Components of GDP: The Expenditure

Approach

GDP (Y) is the sum of the following:

Consumption (C)
Investment (I)
Government Purchases (G)
Net exports (NX)

Y = C + I + G + NX

The Components of GDP: The Expenditure

Approach

Consumption:
The spending by households on goods and services,
with the exception of purchases of new housing
Spending includes:
Durable goods (with over 3 years of life span)
Cars, washing machines, fridges, ovens

Non-durable goods (with no more than 3 years life

span
Food and clothing

Services (intangible items)

Haircuts and medical care

The Components of GDP: The Expenditure

Approach

Investment
The spending on capital equipment, inventories,
and structures, including new housing

The Components of GDP: The Expenditure

Approach

Government Purchases
The spending on goods and services and gross
investment in highways, bridges, and so on.
Does not include transfer payments because they
are not made in exchange for currently produced
goods and services

The Components of GDP: The Expenditure

Approach

Net exports
Exports minus imports
Exports
The purchase of domestically-produced goods and
services by foreign residents, firms and governments

Imports
The purchase of foreign-produced goods and services
by domestic residents, firms and governments

From GDP to GNP

GNP (gross national product) is the total income earned by a countrys
nationals. It is equal to GDP + Factor income of domestic residents from
abroad less the Factor income accruing to foreigners employed domestically.
From GNP to NNP
Total income of a nations residents minus losses from depreciation (i.e.
consumption of fixed capital or the replacement cost of fixed capital)
From NNP to NI
National Income (NI) differs from NNP in that it is calculated by subtracting
indirect business taxes & adding business subsidies.
From NI to PI
personal income (PI) is the measure of income received by households, i.e.
NI plus transfer payments (social security benefits, unemployment benefits,
welfare benefits, disability benefits) less payroll taxes (social security
contributions), corporate profit taxes & undistributed corporate profits)
From PI to DI
disposable income (DI) is PI less personal taxes (personal income, personal
property & inheritance taxes)

The Income Approach: National

Income*

Compensation of Employees
Wages and salaries paid to employees
Employers contributions to social security and employee benefit plans
Monetary value of fringe benefits, tips, and paid vacations

Proprietors Income
All forms of income earned by self-employed individuals

Corporate profits
All the income earned by stockholders of corporations

Rental Income (of persons)

Income received by individuals for the use of their nonmonetary assets (land, houses,
offices).

Net Interest
The interest income received by households and government minus the interest they
paid out

*Reading 1: Principles of Macroeconomics

The Income Approach: Making Some

Adjustments*

GDP = National Income

- Income earned from the rest of the world

+Income earned by the rest of the world
+Indirect business taxes
+Capital consumption allowance (depreciation)
+Statistical discrepancy

*Reading 1: Principles of Macroeconomics

The Production Approach

Stages of
Production
Firm A: Sheep
Farm

Sales Value
R0 R120

Firm B: Wool
processor

R120 R180

Firm C: Suit
Manufacturer

R180 R220

Firm D: Clothing
wholesaler

R220 -R270

Firm E: Retail
Clothier

R270- R350

Total Sales Value

R1140

van Rensburg, J. J., C. R. McConnell and S. L. Brue. 2011. Macroeconomis. New York: McGraw Hill, Table
15.4.

The Production Approach

Stages of
Production
Firm A: Sheep
Farm

Sales Value

Value Added

R0 R120

R120

Firm B: Wool
processor

R120 R180

R60

Firm C: Suit
Manufacturer

R180 R220

40

Firm D: Clothing
wholesaler

R220 -R270

R50

Firm E: Retail
Clothier

R270- R350

R80

Total Sales Value

Value Added

R1140
R350

van Rensburg, J. J., C. R. McConnell and S. L. Brue. 2011. Macroeconomis. New York: McGraw Hill, Table
15.4.

Other National Income Accounting

Measurements

Net Domestic Product (NDP)

NDP = GDP Capital Consumption Allowance (Deprcn)

Personal Income
Personal income = National Income

- Undistributed corporate profits

- Social insurance taxes
- Corporate profit taxes
+Transfer payments

Disposable Income
Disposable Income = Personal Income Personal Taxes

Real GDP, Nominal GDP and GDP

Deflator

Nominal GDP
Values the production of goods and services at
current prices

Real GDP
Values the production of goods and services at
constant prices

An accurate view of the economy requires

adjusting nominal to real GDP by using the
GDP deflator

Real GDP, Nominal GDP and GDP

Deflator

The GDP Deflator

N o m in a l G D P
G D P d e fla to r =
100
R eal G D P

It tells us the rise in nominal GDP that is

attributable to a rise in prices rather than a rise in
the quantities produced

Converting Nominal GDP to Real GDP

R e a l G D P20X

N o m in a l G D P 20X X

100
G D P d e f la to r2 0 X X

Real GDP, Nominal GDP and GDP

Deflator
Year

(1)
Units of
Output

(2)
Price of
Pizza per
Unit

(3)
Unadjuste
d or
Nominal
GDP,

(4)
GDP
Deflator
(Year 1 =
100)

(5)
Adjusted
or Real
GDP

10

50

100

50

20

140

200

70

25

200

250

80

10

30

van Rensburg, J. J., C. R. McConnell and S. L. Brue. 2011. Macroeconomis. New York: McGraw Hill, Table
15.5.

Real GDP, Nominal GDP and GDP

Deflator
Year

(1)
Units of
Output

(2)
Price of
Pizza per
Unit

(3)
Unadjuste
d or
Nominal
GDP,
(1)x(2)

(4)
GDP
deflator,
(Year 1 =
100)

(5)
Adjusted
or Real
GDP

10

50

100

50

20

140

200

70

25

200

250

80

10

30

300

van Rensburg, J. J., C. R. McConnell and S. L. Brue. 2011. Macroeconomis. New York: McGraw Hill, Table
15.5.

Real GDP, Nominal GDP and GDP

Deflator
Year

(1)
Units of
Output

(2)
Price of
Pizza per
Unit

(3)
Unadjust
ed or
Nominal
GDP,
(1)x(2)

(4)
GDP
deflator,
(Year 1 =
100)

(5)
Adjusted
or Real
GDP,
(1)x base
year
price

10

50

100

50

20

140

200

70

25

200

250

80

10

30

300

100

Note: Also (5) = ((3)/(4))x100

van Rensburg, J. J., C. R. McConnell and S. L. Brue. 2011. Macroeconomis. New York: McGraw Hill, Table
15.5.

Real GDP, Nominal GDP and GDP

Deflator
Year

(1)
Units of
Output

(2)
Price of
Pizza per
Unit

(3)
Unadjuste
d or
Nominal
GDP,
(1)x(2)

(4)
GDP
deflator,
((3)/
(5))x100
(Year 1 =
100)

(5)
Adjusted
or Real
GDP,
(1)x base
year price

10

50

100

50

20

140

200

70

25

200

250

80

10

30

300

300

100

Note: Also (5) = ((3)/(4))x100

van Rensburg, J. J., C. R. McConnell and S. L. Brue. 2011. Macroeconomis. New York: McGraw Hill, Table
15.5.

GDP and Economic WellBeing

Higher GDP per person indicates a higher

standard of living

GDP is not a perfect measure of the

happiness or quality of life, however.

GDP Excludes:

The value of leisure

GDP Excludes:

The value of a clean environment

GDP Excludes:

The value of non-market activities

GDP Excludes:

Underground activities
Legal
Illegal

GDP Excludes:

Second Hand Sales

GDP Excludes:

Financial Transactions
Stock market transactions

GDP Excludes:

Transfer Payments
Public transfer payments

GDP Excludes:

Transfer Payments
Private transfer payments

Next Lecture

Measuring the cost of living

Reading: Mankiw, Ch6