From this point forward, we will be discussing the Macroeconomics section of this book. Hence, here are 5 key concepts which must be understood very well while studying Macroeconomics.

1. Aggregate supply and demand model

• Be able to draw diagrams, and label all axes and curves.

2. Use technical words, related to the chapters

   • Understand each and every term, and how to use them, as they will be very helpful when trying to analyse graphs.

3. Monetary and Fiscal Policy concepts

   • Understand how these aid in the reduction of unemployment and inflation. Also, be able to demonstrate how to illustrate a diagram and work on an aggregate supply/demand diagram.

   • Be able to explain the reasons why monetary and fiscal policy may not work

   • These policies will not be as effective in economies which depend on international trade, be able to explain why.

4. Understand diagrams as well as formulas, maybe even more

   • Diagrams are required to draw and explain, which is why it is important to understand what the implication behind the diagram is.

5. Have definite responses and conclusions to the free-response questions

   • State your position clearly, and use the right approach to avoid any mistakes

   • Drawing diagrams properly and labeling them accordingly will also lead to you gaining points. To gain the full mark, explain and analyse what is going on in the graph, and how it relates to the real world.

Keep these key points in mind, and you will be able to solve any question splendidly.

Ch 12

Gross Domestic Product

• GDP is the primary statistic for measuring the overall performance of the economy. It measures the dollar value of production within the nation’s borders.

  • The more produced, the healthier the economy

• Analysts are people who are responsible for collecting information about the production & price of certain goods, which is how GDP is calculated.

  • By multiplying the level of production and the price of each product, we get the value of it and therefore are able to estimate GDP. This is just the theory of GDP calculation, real life is more complicated than these practices, as the government needs to include expenditure and income approaches as well.

  • National Economic Accounts: group of statistics which measure various aspects of economy’s performance

• Gross National Product (GNP): dollar value of production within a country’s citizens

The Expenditure Approach

• Consumption Expenditures

  • Consumption expenditure: is the total amount of money spent on goods and services which are used to satisfy needs and wants

  • In order to make GDP calculation easier on the government, the BEA categorises all goods and services which were sold to households and refers to them as consumption expenditure.

• Government Expenditures

  • Is the total of government spending which includes all government consumption, transfer payments, and investments.

  • These are also goods and services which are produced and sold to the government. Since the government purchases a variety of goods which may not be from the same category, it is safe to create an entirely new government expenditure just for them.

• Investment Expenditures

  • This is referred to as the spending on purchases such as land, machinery, production inputs, or infrastructure. The BEA gathers the change in inventories in with business spending on plant and equipment and residential construction to get what it calls investment.

• Exports and Imports

  • This is the cost of goods and services which are produced in a country and sold abroad (exports). However, some expenditure made by households or governments and such could be on goods and services from abroad (imports).

  • Imports should not be included in the GDP calculation as they are goods from outside the country’s borders. Imports are subtracted from exports to get “net exports”. This is because imports were not a product of this country, and do not count as production.

Formula

GDP = C + I + G + X

• Where C is consumption expenditures by households

• I is investment by firms

• G is government purchases

• X is net exports = exports - imports

The Income Approach

• Is the method of converting income stream into an indicator of market value. The alternative method to measure GDP would be to add up all income earned in the economy, since GDP measures production.

• Disposable Personal Income (DPI): the income of households after taxes have been paid

The Value Added Approach

• It is similar to the income approach, however, instead of calculating who earned income during the production process, the value added approach considers how much the final retail price was added by each producer or industry

• This method is not only used to measure GDP, it is also used to tax producers at each stage of the production process.

Real GDP

• The rise in prices lead to a decline in production volume, which increases the value of GDP. If the prices of goods and services changes, so will GDP. As the amount calculated will be higher than the previous GDP, regardless of production.

• Real GDP is given in constant prices and refers to the volume value of GDP. The year where prices to calculate GDP are taken from is called a base year.

  • Any “real” economic term refers to a figure which has been adjusted for inflation, interest rates, and real consumer spending.

The Underground Economy

• The Underground economy are economic transactions which are illegal as the goods and services are unlawful. However, it could also be considered as the evasion of measuring this sort of production.

• Any figure which has not been measured by the BEA as a sort of production, is categorised into the underground economy.

• There are many goods and services which are not counted in the GDP, such as:

  • Sale of Second hand goods. The goods which are being resold were not produced in that year, and it would be inaccurate to categorize them as such

  • Purely financial transactions. Such as the purchase of stocks, bonds, and so on. These do not affect the GDP (except if brokerage services were provided)

  • Intermediate sales. These are raw materials which will be incorporated and sold in the final product by a firm. For example, when making popsicle sticks, firms must purchase sticks in order to include them in the final product, however, this is not included in the GDP. The final product with the popsicle is included in the GDP.

• GDP is also calculated per capita, meaning that it is divided by the country’s capital to get the final answer.

• Formula: GDP per Capita = GDP/Population

Limitations of GDP

• GDP does not account for factors such as the differences between countries and traffic and congestion, even though these two countries could have the exact same GDP.

• The Quality of life is not accounted for as well, since GDP only measures the amount of production.

  • More production does not equal better quality of life.