Macroeconomic Fundamentals PDF

MACROECONOMIC FOUNDATIONS FOR FDNECON T1 AY 2024-2025 BASIC ECONOMIC QUESTIONS SCARCITY Imposes CHOICE Answered by the type of 1. Traditional 1....

MACROECONOMIC FOUNDATIONS FOR FDNECON T1 AY 2024-2025 BASIC ECONOMIC QUESTIONS SCARCITY Imposes CHOICE Answered by the type of 1. Traditional 1. What to produce? ECONOMIC 2. Command/Planned = communism 2. How to produce? SYSTEM 3. Market System 3. For whom to produce 4. Mixed System (e.g., socialism, HOW A MARKET ECONOMY OPERATES Assumptions: 1. Households are the owners of factors of production 2. No government 3. Closed economy 4. Incomes = used to consume 5. Revenues = used to buy of economic resources MACROECONOMIC GOALS ECONOMIC GROWTH FULL EMPLOYMENT PRICE STABILITY BALANCE OF PAYMENTS EQUALITY FAIR INCOME DISTRIBUTION INFLATION ECONOMIC FREEDOM EFFICIENCY EQUITY NATIONAL INCOME ACCOUNTING NIA The set of rules and techniques used for measuring the total flow of output (goods and services) produced and the total flow of incomes generated by this production. Basic Premise TOTAL PRODUCTION = TOTAL INCOME = TOTAL EXPENDITURE NATIONAL INCOME ACCOUNTING Gross National Product (GNP) The sum of ALL market values of ALL the final goods and services produced by the nation in a given period (e.g., month, quarter, or year). Important notes to the definition: (1) Value – refers to a measurement in money terms ($, ₱, ￡,…); market value – implies that prices are used to measure the value (GNP = ⨊P x Q) (2) Final goods and services – need no further transformation; end point of a particular production-to-consumption cycle; this is so to avoid double counting the value of intermediate goods (e.g., raw materials, semi- manufactured goods) NATIONAL INCOME ACCOUNTING Gross Domestic Product (GDP): An Alternative Measure  GNP takes into account the market price of a final good or service that has been produced by a country’s factors of production within the country and the returns to investments and other income from abroad derived by its nationals.  GDP considers only the first part.  GNP = GDP + NFIA NFIA = Net Factor Income From Abroad  The difference between the factor (of production) income received from the rest of the world and the payments to factors of production abroad for their investment in the Philippines NATIONAL INCOME ACCOUNTING Gross Domestic Product (GDP): An Alternative Measure  GDP is used as a standard measure for international comparison of economic performance because it reflects how well the economy is doing given or using only its available resources and it does not depend on foreign investment.  GNP has special relevance for analytical purposes as it provides significant additional income to domestic households. APPROACHES TO MEASURING GNP Three Approaches to GNP (1) EXPENDITURE APPROACH (2) PRODUCTION APPROACH (3) INCOME APPROACH Statistical Discrepancy Under the 3 approaches, GNP will not always exactly equal so that a balancing figure called statistical discrepancy is introduced in the expenditure approach. APPROACHES TO MEASURING GNP EXPENDITURE APPROACH (The demand side of GNP)  Focus: spending on final goods and services or final demand  Whatever final g/s produced by the economy is either used up (consumed) or not. (consumption goods + investment goods)  Classification of spending: (1) Private consumption of goods and services (C)-private (households) (2) Investment goods (I) (business firms) (3) Government consumption of goods and services (G) (4) Net exports (or exports, X, minus imports, M) (X – M) (M is to reflects goods not produced in the country) >> with the absence of NFIA: Y = C + I + G + (X – M) APPROACHES TO MEASURING GNP EXPENDITURE APPROACH (The demand side of GNP) (1) Private consumption of goods and services (C)  Spending by households (durable and non-durable goods; services)  Purchases of those items which directly and immediately satisfy people’s wants.  Exception: residential housing units are considered investment (I)  APPROACHES TO MEASURING GNP EXPENDITURE APPROACH (The demand side of GNP) (2) Investment goods (I)  Investment – spending on goods that are use to produce other g/s  Called capital goods and are additions to the nation’s capital goods or stock (which represents the productive capacity of the economy). K = capital stock; ∆K = I  Two Types: a. Fixed Capital Equipment – spending on: (1) construction (of houses or buildings, roads and bridges, etc), (b) durable equipment (e.g., machinery & equipment), (c) breeding stock and orchards Construction: Breeding stock and orchard development: 1. Public (roads, bridges, airports, school buildings, etc.) 1. live animals for breeding (+ breeding facilities, 2. Private: a. residential (houses, townhouses, condominiums) pens, etc.) b. non-residential (commercial & industrial structures) 2. Fruit-bearing trees (+ green houses, fencing, etc.) APPROACHES TO MEASURING GNP EXPENDITURE APPROACH (The demand side of GNP) (2) Investment goods (I)  Two Types: b. Change (∆) in inventories (or stock of goods)  Inventories - They do not form part of current period’s GNP, but they are generated income for the workers, interest to banks, etc. - They constitute an addition to the economy’s stock of wealth and will be consumed later. - Goods produced but not used up during the current income period. APPROACHES TO MEASURING GNP EXPENDITURE APPROACH (The demand side of GNP) (2) Investment goods (I)  Two Types: b. Change (∆) in inventories (or stock of goods)  Why consider only the change? - Example: Year Inventories Accounted in GNP as Investment 0 0 1 P20M P20M (20 – 0) 2 30M (inventories 10M (30 – 20) in total) APPROACHES TO MEASURING GNP EXPENDITURE APPROACH (The demand side of GNP) (3) Government Consumption Expenditures (G)  Simply the spending of government on goods and services (e.g., s/w of those employed by the government, repair and maintenance, day-to-day operational expenses)  Unique feature of NIA: include government spending on infrastructure as part of investment APPROACHES TO MEASURING GNP EXPENDITURE APPROACH (The demand side of GNP) (4) Net Exports (X – M)  Net Exports = Value of Exports – Value of Imports Value of exports is the amount of money generated by a given country for goods and services from a foreign market. Value of Imports is the amount of money that the nation has spent on services and goods from other countries.  Vs Balance of Trade (BOT) Value of Exports is the value of goods and services that are sold to buyers in other countries. Value of Imports is the value of goods and services that are bought from sellers in other countries. APPROACHES TO MEASURING GNP PRODUCTION OR VALUE-ADDED APPROACH This approach is simply a breakdown of the contribution of one sector to the value of final g/s.  The transformation is done in stages.  Each stage in the production cycle contributes value to the final product.  Try to estimate what is the value added by each stage of the production APPROACHES TO MEASURING GNP PRODUCTION OR VALUE-ADDED APPROACH Value Added by raw material producing firm Value of output of Value added by the the raw material intermediate good producing firm producing firm Value added by Value of output of intermediate good- final-good producing firm producing firm VALUE OF FINAL OUTPUT  APPROACHES TO MEASURING GNP PRODUCTION OR VALUE-ADDED APPROACH A simple illustration: Producing Production Value of Purchases Valued- Firm Output from other Added Firms Farmer Harvest $100 $0 $100 wheat Miller Makes into $200 $100 $100 flour Baker Makes into $300 $200 $100 bread $600 $300 $300 APPROACHES TO MEASURING GNP INCOME APPROACH This approach is the sum of the rewards to the owners of the factors of production in National Income. 1) Income of Natural Persons – compensations as employees for their labor (from private and government corporations, general government, and households) 2) Reward to entrepreneurship – profits or net operating surplus of corporations (private and government, unincorporated family businesses) 3) Rewards to capital in the form of interest payments and depreciation APPROACHES TO MEASURING GNP INCOME APPROACH This approach is somehow “complicated” by two “non-income accounts” 1) Depreciation – current usage of long-lasting assets 2) Indirect taxes – goes to government, also form part of the price of a product. NOMINAL GNP AND REAL GNP NOMINAL GNP GNP at current prices = sum of final g/s produced using the current prices (or the year you want to measure GNP) REAL GNP GNP at constant prices = GNP that is removed from the effect of inflation 𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝐺𝑁𝑃 𝑅𝑒𝑎𝑙 𝐺𝑁𝑃 = 𝐷𝑒𝑓𝑙𝑎𝑡𝑜𝑟 NOMINAL GNP AND REAL GNP REAL GNP 𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝐺𝑁𝑃 𝑅𝑒𝑎𝑙 𝐺𝑁𝑃 = 𝐷𝑒𝑓𝑙𝑎𝑡𝑜𝑟 Deflator – a price index Price Index - a measure of the price of a specified collection of goods and services, called a “market basket,” in a given year as compared to the price of an identical (or highly similar) collection of goods and services in a reference year. That point of reference, or bench-mark, is known as the base period or base year. 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑚𝑎𝑟𝑘𝑒𝑡 𝑏𝑎𝑠𝑘𝑒𝑡 𝑖𝑛 𝑠𝑝𝑒𝑐𝑖𝑓𝑖𝑐 𝑦𝑒𝑎𝑟 𝑃𝐼𝑡 = × 100 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑠𝑎𝑚𝑒 𝑚𝑎𝑟𝑘𝑒𝑡 𝑏𝑎𝑠𝑘𝑒𝑡 𝑖𝑛 𝑏𝑎𝑠𝑒 𝑦𝑒𝑎𝑟 NOMINAL GNP AND REAL GNP REAL GNP Illustration: Year 1 Product Price Quantity Value (PxQ) X 1.00 100 100 Y 1.50 105 157.5 GNP P257.5 This is GDP at current prices Y1 Year 2 Product Price Quantity Value (PxQ) X 1.05 100 105 Y 1.52 106 161.12 GNP P266.12 This is GDP at current prices Y2 NOMINAL GNP AND REAL GNP REAL GNP Illustration: Base year: Year 1 σ 𝑃𝑛 𝑄𝑛 1 100 + (1.50)(105) 257.5 𝑃𝐼1 = = = = 1 × 100 = 100 σ 𝑃𝑜 𝑄𝑜 1 100 + (1.50)(105) 257.5 σ 𝑃𝑛 𝑄𝑛 1.05 100 + (1.52)(106) 266.12 𝑃𝐼2 = = = = 1.03347 × 100 σ 𝑃𝑜 𝑄𝑜 1 100 + (1.50)(105) 257.5 = 103.345 Compare prices in year 2 and year 1: Prices increase by (approximately) 3.345% = inflation rate NOMINAL GNP AND REAL GNP REAL GNP Illustration: Base year: Year 1 257.5 𝑅𝑒𝑎𝑙 𝐺𝐷𝑃1 = = 𝑃ℎ𝑝257.5𝑀 1 266.12 𝑅𝑒𝑎𝑙 𝐺𝐷𝑃2 = = 𝑃ℎ𝑝257.51𝑀 1.03345 The value of the real output in year 2 is P257.51M (removed from the effect of inflation) if prices in year 2 could have been the prices in year 1. (257.51 − 257.5) 0.01 𝐺𝑅 = × 100 = × 100 = 0.003883% 257.5 257.5 The output grew by only 0.0039% EXCLUDED FROM GDP/GNP GNP Excludes Nonproduction Transactions 1. Financial Transactions a. Public transfer payments b. Private transfer payments c. Stock market transactions 2. Secondhand Sales LIMITATIONS 1. Nonmarket activities 2. Leisure 3. Improved product quality 4. Underground economy