Lecture 2

• Recap of Lecture 1
• National Income Accounting (Part 1)

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 Lect 1: Recap
• What Macroeconomics Tries to Explain
– Goal of Macroeconomic Policy
• Economic Growth
• Full employment
• Stable prices

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 Macroeconomic Goals
• Different ways of viewing the economy
– Macroeconomic view
– Microeconomic view

3
 Macroeconomic Goals
• Which view is better?
– Depends on aim
• Why are computers getting better and cheaper
every year?
• Why are earnings of skilled workers rising every
year while earning of unskilled workers fall?
– But..
• Overall level of economic activity in economy
• What percentage of the workforce is
unemployed
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 Macroeconomic Goals
• Although disagreement about how to
make macroeconomy perform well;
• General agreement on macroeconomic
goals to achieve
– Economic growth
– Full employment
– Stable prices
• Why?
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 Economic Growth
• Real GDP
– Total quantity of goods and services
produced in a country over a year
– Increasing faster than the population in
some countries
• When real GDP rises faster than population
growth, output per person and average
standard of living rises

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 Economic Growth
• Figure 1 U.S. Real Gross Domestic Product, 1929–2006

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8
 Economic Growth
• What do you notice about the two graphs
wrt to:
– GDP over time
– Rate of growth over time

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 Economic Growth
• Growth increases size of economic pie
– Everyone gets a larger slice... In principle
– Does growth really benefit everyone in
practice?

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 Economic Growth
• Going forward:
– What makes real GDP grow in the first
place?
– Why does it grow faster in some periods
than in others?
– Why do some countries experience very
rapid growth (e.g. US) while other countries
hardly grow at all?
– Can government policy do anything to alter
the rate of growth?
• Are there any downsides to such policies?
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 High Employment/Low Unemployment

• Economic growth not only important goal

in macroeconomics
– Would economy be doing well if real
GDP was growing at x% and
unemployment was y%?
• (where x, y >0)

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 High Employment/Low Unemployment
• Unemployment affects distribution of
economic well-being among unemployed
citizens
– People who cannot find jobs suffer loss of
income and lower living standards
• Unemployment also affects those who have
jobs
– Many people who could be working to
increase the amount of goods and services
in economy are not doing so
– Lower average standard of living
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 High Employment/Low Unemployment

• Unemployment rate
– Percentage of the workforce that is
searching for a job but hasn’t found one
– High unemployment rate implies
economy is not achieving its full
economic potential
– What is current unemployment rate in
Ghana?

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 U.S. Unemployment Rate, 1920–2006
• Figure 2 U.S. Unemployment Rate, 1920–2006

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 Employment and the Business Cycle

• Real GDP and employment are closely

related
– How?

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 Employment and the Business Cycle
• Real GDP and employment are closely
related
• Firms produce more
– Hire more workers
• Firms produce less
– Lay off workers
• Business cycles
– Fluctuations in real GDP around its long-
term growth trend
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 The Business Cycle
• Figure 3 The Business Cycle

Real Long-run upward

GDP trend of real GDP

The business cycle

fluctuation of actual
output around its
long-run trend.

Expansion Recession Expansion

Time
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Employment and the Business Cycle
• Expansion
– A period of increasing real GDP
• Increasing employment
• Contraction
– A period of declining real GDP
• Decreasing employment
• Recession
– A contraction of significant depth and
duration
• Decreasing employment
• Depression
– An unusually severe recession
• Decreasing employment
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 Unemployment
• Going forward....
– Why is unemployment often higher than
the intended target?
– What causes average unemployment
rate to fluctuate from year to year?
– Why are there business cycles?
– Is there anything we can do to prevent
recessions from occurring, or at least
make them milder and shorter?
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 Stable Prices- Inflation
• Inflation
– Percentage increase in the average level of
prices
• Extreme case- Zimbabwe
– For a period, inflation had been above 100%
since 2001
– In Nov 2008, annual rate of inflation was
89,700,000,000,000,000,000,000
(89.7 sextillion)
– Prices were doubling every day
– If an item cost you a dollar at the beginning of
the month, would cost $1bn at the end of the
month
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 Stable Prices
• A low inflation rate - important
macroeconomic goal
– Inflation is costly to society
• Why?

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 Stable Prices
• No-one willing to hold domestic
currency, or accept it as payment
• Extreme case- people waste time and
resources bartering with each other
– Little time left for producing goods and
services
– Average standard of living falls

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 Stable Prices
• ...However, some level of inflation good
– Why?
• What is Ghana’s current inflation rate?

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 Stable Prices
• Going forward....
– What causes inflation/deflation?
– How would a moderately high inflation
rate of say 7 or 8% harm society?
– How does a recession bring down the
inflation rate, and how does the
government actually create a recession?
– Why might a period of decreasing prices
be a threat to the economy?
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 Next Class
• National Income accounting
– The circular flow of income and
expenditure
– Definition of national income

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 Lecture 2

National Income Accounting

 National Income Accounting

• The circular flow of income and

expenditure
• Definition of national income

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 Economy’s Income & Expenditure
• Gross Domestic Product (GDP)
– Measures the total income of everyone in the
economy
– Measures the total expenditure on the
economy’s output of goods and services
• For an economy as a whole
– Income must equal expenditure
– Every transaction has a buyer and a seller
• If someone pays someone else Ghc100 to mow a
lawn, the expenditure on the lawn service (Ghc100)
is exactly equal to the income earned from the
production of the lawn service (Ghc100).
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 Economy’s Income & Expenditure

• Circular-flow diagram:
– Describes all transactions between all
households and firms in a simple
economy

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 Circular Flow diagram
• Assumptions
– Markets
• Goods and services
• Factors of production
– Households
• Spend all of their income
– Firms
• Pay rewards (wages, rent, profit) to resource
owners

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The Circular-Flow Diagram

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 The Circular Flow Diagram

• GDP can be calculated by:

– Adding up total purchases of households
(expenditure)
• Or,
– Adding up total income of earned by
households

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 The Circular Flow Diagram
• Model unrealistic, however
• Limitations?

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 The Circular Flow Diagram
• Model unrealistic, however
• Limitations
– Omits
• Savings
• Taxes
• Government purchases

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 The Measurement of GDP

• Gross domestic product (GDP)

– Market value of all final goods and
services produced within a country in a
given period of time

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 The Measurement of GDP

• “GDP is the market value…”

– “Cannot compare apples and oranges”.
– Market prices - reflect the value of the
goods

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 The Measurement of GDP

• “… of all…”
– All items produced in the economy
• And sold legally in markets
• Would goods like land, stocks or bonds be
included in GDP? Why?
– Excludes some items
• Produced and sold illicitly
– Examples?
• Produced and consumed at home
– Examples?
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 The Measurement of GDP

• “… final…”
– Value of intermediate goods is already
included in the prices of the final goods
– Why is this important?

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 The Measurement of GDP

• “… goods and services…”

– Tangible goods & intangible services
• Books, shoes, etc
• Haircut, music concert, etc

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 The Measurement of GDP

• “… produced…”
– Goods and services currently produced
– Sale of new vs. used car

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 The Measurement of GDP

• “… within a country…”
– Goods and services produced
domestically
• Include output produced by foreigners
• Exclude output produced by nationals in a
foreign country

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 The Measurement of GDP

• “… in a given period of time”

– A year or a quarter

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 Discussion questions
1. What contributes more to GDP- production of an
economy car or a luxury car? Why?
2. Explain why an economy’s income must equal its
expenditure
3. GDP does not include the value of used goods that are
resold. Why would including such transactions make
GDP a less informative measure of economic well-
being?
4. A few years ago, Ama paid Ghc500 to put together a
record collection. Today, she sold her albums at a
garage sale for Ghc100. How does this sale affect GDP?

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 Next Class
• Components of GDP
• Measurements of National Income
– Product (value added) approach
– Expenditure approach
– Income approach

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