Micro and Macro Economics

• Microeconomics studies individual household and firm decisions and their market interactions.
• Macroeconomics studies inflation, unemployment, and economic growth.

Circular Flow Diagram

• Illustrates Gross Domestic Product (GDP) as spending, revenue, factor payments, and income.
• It omits the government, financial system, and foreign sector.
• The government collects taxes and buys goods and services.
• The financial system connects savers and borrowers.
• The foreign sector involves exchanges between a country and the rest of the world via importing and exporting, buying and selling stocks, investments, and exchanging currencies.

Gross Domestic Product (GDP)

• GDP measures the total monetary value of all goods and services a country produces in a year.
• It includes all items produced and sold legally in markets.
• GDP excludes illicitly produced and sold items, as well as most items produced and consumed at home.
• It only includes final goods, not intermediate goods.
• GDP includes tangible goods and intangible services like healthcare and education.
• It measures the value of production within a country’s borders, whether by citizens or foreigners.
• GDP includes currently produced goods, not goods produced in the past, usually measured yearly or quarterly.

Components of GDP: Y = C + I + G + NX

• Consumption (C) is the total spending by households on goods and services. It includes rent payments and the imputed rental value of owner-occupied housing. It does not include the purchase of a new house.

• Investment (I) is the total spending on goods that will be used in the future to produce more goods.

• Investment includes business capital (office buildings, equipment, intellectual property), residential capital (apartment buildings, houses), and inventory accumulations.

• Government purchases (G) include all government spending on goods and services at the federal, state, and local levels, but excludes transfer payments like social security or unemployment benefits.

• Net exports (NX) is the difference between the value of a country’s exports and imports. It is calculated as NX = Exports - Imports.

• Exports are spending on domestically produced goods by foreigners, which increases GDP.

• Imports are spending on foreign goods by domestic residents, which decreases GDP.

Real vs. Nominal GDP

• Nominal GDP uses current prices to value the economy’s production.
• Real GDP uses constant base-year prices to value the economy’s production.
• Real GDP is a more reliable indicator of economic progress than nominal GDP.
• GDP deflator measures the price level, and is calculated as (Nominal GDP / Real GDP) x 100.
• Inflation is when an economy’s overall price level is rising.
• The inflation rate is the percentage increase in the overall price level of production over a period of time, calculated as: (GDP deflator in year 2 - GDP deflator in year 1) / GDP deflator in year 1 x 100.

GDP and Economic Well-Being

• GDP measures total income and total expenditure in an economy.
• GDP per person indicates the average income and spending of individuals.
• A higher GDP per person usually means a higher standard of living.

Limitations of GDP

• It does not measure aspects of well-being like health, education, happiness, or environmental quality.
• GDP does not account for leisure time or income distribution.

Importance of GDP

• A larger GDP allows nations to afford better healthcare, education, and living conditions.
• Despite its limitations, GDP indicates a country’s ability to provide a good life for its citizens.