FUNDAMENTALS OF

MACROECONOMICS
 LEARNING OUTCOMES

• EXPLAIN THE MAIN MACROECONOMIC TARGETS AND ISSUES

• EXPLAIN THE RELATIONSHIP BETWEEN OUTPUT AND INCOME USING THE
CIRCULAR FLOW MODEL
• MEASURING NATIONAL INCOME AND OUTPUT
• DISCUSS THE BUSINESS CYCLE
 MACROECONOMICS

• MACROECONOMICS IS THE BRANCH OF ECONOMICS THAT STUDIES THE

BEHAVIOR AND PERFORMANCE OF AN ECONOMY AS A WHOLE. IT FOCUSES ON
THE AGGREGATE CHANGES IN THE ECONOMY SUCH AS UNEMPLOYMENT,
GROWTH RATE, GROSS DOMESTIC PRODUCT AND INFLATION.
THE FOUR MAIN MACROECONOMICS TARGETS

• ECONOMIC GROWTH
• FULL EMPLOYMENT
• PRICE STABILITY
• A FAVOURABLE EXTERNAL POSITION
 ECONOMIC GROWTH

• ECONOMIC GROWTH IS DEFINED AS AN INCREASE IN THE AMOUNT OF GOODS

AND SERVICES PRODUCED WITHIN THE ECONOMY AS A WHOLE. IT IS NORMALLY
CALCULATED AS GROWTH IN REAL GROSS DOMESTIC PRODUCT.
 ECONOMIC GROWTH CALCULATION

• ECONOMIC GROWTH = PERCENTAGE CHANGE IN REAL GDP

 ECONOMIC GROWTH CALCULATION

YEAR REAL GDP ECONOMIC GROWTH = PERCENTAGE CHANGE

IN REAL GDP
2000 $60
2001 $66 = (66-60)/60 * 100
= 6/60 * 100%
= 10.0%
2002 $70 = (70-66)/66 * 100
= 4/66 * 100%
= 6.1%
2003 $65 =
 ECONOMIC GROWTH CALCULATION

YEAR REAL GDP ECONOMIC GROWTH = PERCENTAGE CHANGE

IN REAL GDP
2000 $60
2001 $66 = (66-60)/60 * 100
= 6/60 * 100%
= 10.0%
2002 $70 = (70-66)/66 * 100
= 4/66 * 100%
= 6.1%
2003 $65 = (65-70)/70 * 100
= -5/70 * 100%
= -7.1%
FULL EMPLOYMENT OR THE ELIMINATION OF
UNEMPLOYMENT
• FULL EMPLOYMENT IS AN ECONOMIC SITUATION IN WHICH ALL AVAILABLE LABOR RESOURCES
ARE BEING USED IN THE MOST EFFICIENT WAY POSSIBLE. FULL EMPLOYMENT EMBODIES THE
HIGHEST AMOUNT OF SKILLED AND UNSKILLED LABOR THAT CAN BE EMPLOYED WITHIN AN
ECONOMY AT ANY GIVEN TIME.
• UNEMPLOYMENT OCCURS WHEN A PERSON WHO IS ACTIVELY SEARCHING FOR EMPLOYMENT
IS UNABLE TO FIND WORK.
• UNEMPLOYMENT IS OFTEN USED AS A MEASURE OF THE HEALTH OF THE ECONOMY. THE MOST
FREQUENT MEASURE OF UNEMPLOYMENT IS THE UNEMPLOYMENT RATE, WHICH IS THE
NUMBER OF UNEMPLOYED PEOPLE DIVIDED BY THE NUMBER OF PEOPLE IN THE LABOR FORCE.
FULL EMPLOYMENT OR THE ELIMINATION OF
UNEMPLOYMENT
 PRICE STABILITY – NO INFLATION

• INFLATION IS DEFINED AS A SUSTAINED RISE IN THE GENERAL OR AVERAGE

PRICE LEVEL. INFLATION CAUSES A DECLINE IN THE PURCHASING POWER OF
CONSUMER INCOMES WHICH AUTOMATICALLY DECREASES THE STANDARD OF
LIVING OF HOUSEHOLDS.
MEASUREMENT OF INFLATION: CONSUMER
PRICE INDEX
 A FAVOURABLE EXTERNAL POSITION IN THE
BALANCE OF PAYMENTS
• THE BALANCE OF PAYMENTS (BOP) IS A STATEMENT OF ALL TRANSACTIONS
MADE BETWEEN ONE COUNTRY AND THE REST OF THE WORLD OVER A DEFINED
PERIOD OF TIME, SUCH AS A QUARTER OR A YEAR. THESE TRANSACTIONS
INVOLVE THE INFLOW AND OUTFLOW OF MONEY.
 MEASURING THE VALUE OF OUTPUT
PRODUCED BY AN ECONOMY
• THE MOST USED MEASURE OF THE SIZE OF AN ECONOMY IS GROSS DOMESTIC PRODUCT.
• GROSS DOMESTIC PRODUCT (GDP) IS THE MARKET VALUE OF ALL FINAL GOODS AND SERVICES
PRODUCED IN A NATION DURING A PERIOD OF TIME, USUALLY A YEAR.
• IF GDP IS INCREASING OVERTIME, IT MEANS THAT MORE GOODS AND SERVICES ARE BEING
PRODUCED AND THE SIZE OF THE ECONOMY IS EXPANDING. THIS USUALLY MEANS AN INCREASE IN
THE NUMBER OF WORKERS EMPLOYED AND AN INCREASE IN INCOME RECEIVED BY INCOME
EARNERS.
• IF GDP IS DECREASING IT IMPLIES THAT LESS GOODS AND SERVICES ARE PRODUCED, AND THE
ECONOMY IS THEREFORE SHRINKING OR CONTRACTING. AS SUCH UNEMPLOYMENT INCREASES
AND THE INCOME EARNED BY OWNERS OF THE FACTORS OF PRODUCTION FALLS.
 CIRCULAR FLOW OF INCOME MODEL

• THE CIRCULAR FLOW OF INCOME OR CIRCULAR FLOW IS A MODEL OF

THE ECONOMY IN WHICH THE MAJOR EXCHANGES ARE REPRESENTED AS FLOWS
OF MONEY,  AND GOODS AND SERVICES BETWEEN ECONOMIC AGENTS.
• THE ECONOMIC AGENTS ARE FIRMS WHICH EMPLOY THE FACTORS OF
PRODUCTION TO PRODUCE GOODS AND SERVICES AND CONSUMERS WHO OWN
THE FACTORS OF PRODUCTION AND CONSUME GOODS AND SERVICES PRODUCED
BY FIRMS
CIRCULAR FLOW OF INCOME
CIRCULAR FLOW OF INCOME
 THREE METHODS FOR CALCULATING GDP

1. THE EXPENDITURE APPROACH MEASURES GDP BY ADDING

ALL THE SPENDING FOR FINAL GOODS DURING A PERIOD OF
TIME.

• EXPENDITURE APPROACH EQUATION = C + I + G + (X - M)

GDP = C + I + G + (X-M)
 EXPENDITURE APPROACH COMPONENTS
GDP = C + I + G + NX
• CONSUMPTION (C): SPENDING BY DOMESTIC HOUSEHOLDS ON FINAL GOODS
AND SERVICES PRODUCED BY DOMESTIC FIRMS AS WELL AS GOODS AND
SERVICES PRODUCED BY FOREIGN FIRMS:
• 1. CONSUMER DURABLES: LONG LASTING CONSUMER ITEMS
E.G. (CARS, FURNITURE, TELEVISION AND MAJOR APPLIANCES)
• 2. NON-DURABLE GOODS: SHORTER LIVED ITEMS
E.G. (FOOD, CLOTHING, FUEL)
• 3. SERVICES (INTANGIBLES)

• E.G. (EDUCATION, HEALTH CARE, TRANSPORTATION)

 EXPENDITURE APPROACH COMPONENTS
GDP = C + I + G + NX
• INVESTMENT: INVESTMENT INCLUDES SPENDING FOR NEW
CAPITAL GOODS, CALLED FIXED INVESTMENTS AND CHANGES IN
FIRMS INVENTORY HOLDINGS CALLED INVENTORY INVESTMENTS.
• FIXED INVESTMENTS OR GROSS FIXED CAPITAL FORMATION: EXPENDITURE ON
MANUFACTURED RESOURCES.
E.G. BUILDING AND EQUIPMENT
• INVENTORIES ARE THE STOCK OF FINISHED GOODS, UNFINISHED GOODS OR WORK IN
PROCESS WHICH FIRMS POSSESS.
 EXPENDITURE APPROACH COMPONENTS
GDP = C + I + G + NX
• GOVERNMENT SPENDING (G) INCLUDES THE PURCHASE OF GOODS AND SERVICES
MEASURED BY THEIR COST AT THE GOVERNMENTAL LEVEL.
• THESE GOODS AND SERVICES ARE ON NEWLY PRODUCED GOODS AND SERVICES:
E.G. (HOSPITAL, EDUCATION, INFRASTRUCTURE)
NOT ALL GOVERNMENT EXPENDITURE IS INCLUDED:
E.G. TRANSFER PAYMENTS (WELFARE PAYMENTS, UNEMPLOYMENT INSURANCE,
SOCIAL SECURITY AND MEDICAL BENEFITS) ARE NOT INCLUDED IN THE
GOVERNMENT SPENDING COMPONENT OF GDP.
 EXPENDITURE APPROACH COMPONENTS
GDP = C + I + G + NX
• NET EXPORTS (NX) ARE EXPORTS MINUS IMPORTS (X – M).
• EXPORTS ARE THE GOODS AND SERVICES PRODUCED IN A COUNTRY THAT ARE PURCHASED BY
FOREIGNERS
• IMPORTS ARE GOODS AND SERVICES PRODUCED ABROAD THAT ARE PURCHASED BY A COUNTRY’S
RESIDENTS.
• TRADE DEFICIT?
• IMPORTS > EXPORTS, I.E. WHEN NET EXPORT IS NEGATIVE
• TRADE SURPLUS?
• EXPORTS > IMPORTS, I.E WHEN NET EXPORT IS POSITIVE
 THREE METHODS FOR CALCULATING GDP

2. THE OUTPUT METHOD: THE VALUE-ADDED APPROACH

THE OUTPUT METHOD MEASURES THE VALUE OF OUTPUT PRODUCED BY ALL
INDUSTRIES IN AN ECONOMY. FOR EXAMPLE IT INCLUDES THE OUTPUT OF THE
MANUFACTURING, CONSTRUCTING, ENERGY, AGRICULTURE AND SERVICES
SECTOR.
NOTE: THE MEASUREMENT OF GDP IS BASED ON THE VALUE OF FINAL GOODS
AND SERVICES ONLY. THIS MEANS THAT THE VALUE OF INTERMEDIATE GOODS
AND SERVICES ARE NOT INCLUDED IN THE CALCULATION OF GDP.
 VALUE ADDED
• VALUE ADDED IS THE DIFFERENCE BETWEEN THE SALES REVENUE RECEIVED AND
THE COST OF RAW MATERIALS USED.
• IN OTHER WORDS, VALUE ADDED IS THE VALUE OF WHAT IS PRODUCED MINUS THE
VALUE OF THE INTERMEDIATE INPUTS.
 THREE METHODS FOR CALCULATING
NATIONAL INCOME
3. INCOME METHOD
THE INCOME APPROACH CALCULATES THE GDP BY ADDING ALL INCOMES EARNED
BY HOUSEHOLDS IN EXCHANGE FOR THE FACTORS OF PRODUCTION DURING A
PERIOD OF TIME
THIS INCLUDES COMPENSATION OF EMPLOYEES (WAGE), RENTS, INTEREST, PROFITS

GDP = WAGES + RENTS + PROFITS + INTEREST

 THREE METHODS FOR CALCULATING GDP

• BECAUSE OF THE WAY OF HOW THE CALCULATIONS ARE DETERMINED, THE

THREE METHODS OF CALCULATIONS OF GDP MUST GIVE THE SAME RESULT.

• EXPENDITURE METHOD = OUTPUT METHOD = INCOME METHOD

 BUSINESS CYCLE

• THE BUSINESS CYCLE, ALSO KNOWN AS THE ECONOMIC CYCLE OR TRADE

CYCLE, ARE THE FLUCTUATIONS OF GROSS DOMESTIC PRODUCT AROUND ITS
LONG-TERM GROWTH TREND. THE LENGTH OF A BUSINESS CYCLE IS THE PERIOD
OF TIME CONTAINING A SINGLE BOOM AND CONTRACTION IN SEQUENCE.
BUSINES
S CYCLE
DIAGRA
M

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 FOUR PHASES OF THE BUSINESS CYCLE
1. PEAK: THE PHASE OF THE BUSINESS CYCLE IN WHICH REAL GDP
REACHES ITS MAXIMUM AFTER RISING DURING A RECOVERY PERIOD

2. RECESSION: THE PHASE OF THE BUSINESS CYCLE DURING WHICH

REAL GDP DECLINES AND THE UNEMPLOYMENT RISES. THIS IS ALSO
CALLED A CONTRACTION
 DURING A RECESSION, BUSINESS PROFITS FALL, THE PERCENTAGE OF THE WORKER
WITHOUT JOBS INCREASES AND THE PRODUCTION CAPACITY IS UNDERUTILIZED
 A GENERAL RULE IS THAT A RECESSION CONSISTS OF AT LEAST TWO CONSECUTIVE
QUARTERS (SIX MONTHS) IN WHICH THERE IS A DECLINE IN REAL GDP
29
 FOUR PHASES OF THE BUSINESS CYCLE
3. TROUGH: THE PHASE OF THE BUSINESS CYCLE IN WHICH REAL
GDP REACHES ITS MINIMUM AFTER FALLING DURING A RECESSION
 UNEMPLOYMENT AND IDLE PRODUCTIVE CAPACITY ARE AT ITS HIGHEST LEVELS
 THE LENGTH OF TIME BETWEEN THE PEAK AND TROUGH IS THE DURATION OF THE
RECESSION

4. RECOVERY: AN UPTURN IN THE BUSINESS CYCLE DURING WHICH

REAL GDP RISES. IT IS ALSO CALLED AN EXPANSION
 DURING THIS PERIOD, PROFITS GENERALLY IMPROVE, REAL GDP INCREASES, AND
EMPLOYMENT MOVES TOWARDS FULL EMPLOYMENT
30
 QUESTION

• WHICH BUSINESS CYCLE PHASE, WOULD YOU USE TO DESCRIBE TRINIDAD AND
TOBAGO CURRENTLY:
• A TROUGH
• B RECESSION
• C EXPANSION
• D PEAK