ECO 11-2

Basic Macroeconomics

GBS FOR WEEK NO. 02

Period Covered: ____________________________

SCHOOL YEAR _________________ | ________ Semester

OBJECTIVES:

After working in this material, the learner is expected to:

 Describe the path that a country’s actual economic growth takes over time (its business cycle).
 Sketch what happened to production, unemployment, and prices during the Great Depression.
 Explain what a hyperinflation is, and how people change behavior in order to cope with it.

CORE LESSON CONTENTS:

Introduction and Monitoring Macroeconomics Performance

Since the 1930s economists have split their domain into two parts, into Microeconomic and

Macroeconomics. The difference between microeconomics and macroeconomics is in the

problems with which is concerned. Microeconomics it examines how a society decides to produce
the bundle of goods and services it does (the “what” question), and who gets these goods and
services (the “for whom” question). It explores how various systems of incentives and ways of
making decisions (such as “dollar voting” or various forms of political voting) work to solve the
“what” and “for whom” questions. Central in much of this examination is the concept of economic
efficiency. Microeconomics asks whether the bundle that a society produces is the bundle that has
the highest value to that society, and if it does not, what changes would increase that value.
Macroeconomics deals with topics of inflation and unemployment. After the First World War, and
the massive unemployment in the United States during the 1930s.
Microeconomics vs. Macroeconomics

Microeconomics applies to small elements of an economy. This may be trade between two
people, or trade between two countries. It usually focuses on a small basket of goods being traded
between a small group of agents. On the other hand, Macroeconomics is the study of an entire
economy. It looks at aggregate inputs and outputs with the goal to understand the flows of total
consumption, employment rates, wages, prices and many aggregate parts of an economy. In
macroeconomics we look at both the long run and short run changes in the economy.
Microeconomics is the study of decisions that people and businesses make regarding the allocation
of resources and prices of goods and services. This means also taking into account taxes and
regulations created by governments. Microeconomics focuses on supply and demand and other that
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determine price levels for specific companies in specific industry sectors. For example,
Microeconomics would look at hoe specific company could maximize its production and capacity so
it could lower prices and better compete in its industry.
Macroeconomics, on the other hand, is the field of economics that studies the behavior of the
economy as a whole and not just on specific companies, but entire industries and economies. This
looks at economy-wide phenomena such as Gross National Product (GDP) and how it is affected by
changes in unemployment, national income, rate of growth, and price levels. For example,
macroeconomics would look at how an increase/decrease in net exports would affect a nation's
capital account or how GDP would be affected by unemployment rate.
While these two studies of economics appear to be different, they are actually interdependent and
complement one another since there are many overlapping issues between the two fields. For
example, increased inflation (macro effect) would cause the price of raw materials to increase for
companies and in turn affect the end product's price charged to the public.
The bottom line is that microeconomics takes a bottoms-up approach to analyzing the economy
while macroeconomics takes a top-down approach. Regardless, both micro- and macroeconomics
provide fundamental tools for any finance professional and should be studied together in order to
fully understand how companies operate and earn revenues and thus, how an entire economy is
managed and sustained.
Macroeconomic performance covers a wide range of indicators – summarized as:
• Real GDP Growth (short term and long term)
• Jobs (unemployment and employment rates)
• Prices e.g. as measured by the annual change in the consumer price index
• Trade balances and measures of competitiveness
• Productivity of labor and capita inputs
• Average standard of living e.g. measured by per capita GDP (PPP adjusted)
• Quality and accessibility of public services
The macroeconomic performance of any one nation is affected by events, policies and shocks in
other countries. No economy is immune to what is happening in the global financial and economic
system. The fallout from the credit crunch and a recession in global trade, production and jobs has
made it abundantly clear for people and businesses in Britain just how inter-connected the world is
in an economic sense.

Macroeconomic performance refers to an assessment of how well a country is doing in reaching key
objectives of government policy. The main aim of policy is usually an improvement in the real
standard of living for their population. The term ‘real’ means that we have taken into account the
effects of rising prices so that we get a better picture of how many goods and services we can afford
to buy and consume.
Macroeconomic policy is not solely concerned with living standards. The bigger picture would take
into account some of the following:
1.Jobs – are more people finding work in the jobs that they are suited to and which pay a living
wage? How high is unemployment? Is the economy creating enough new jobs for people
entering the labour market each year?
2. Prices –are price rises under control creating the conditions for price stability? Can the
economy avoid a period of price deflation? Price stability refers to low, stable, positive inflation
of between 1-3% per year.
3. Trade – is the economy performing well in trading goods and services with other countries?
4. Growth – how successful has the country been in achieving growth in the short term and in
laying the foundations for expansion in the future? Can grown be sustained especially in terms
of its environmental effects?

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 5. Efficiency - is the economy managing to increase the efficiency of factor resources e.g.
through higher productivity so that more goods and services can be supplied at lower cost?
6. Public services – have the benefits of growth flowed through into greater and improved
provision of key government services such as education, health and transport?
7. The environment – the effects of economic activity on our natural and built environment
have become ever more important over the years. Many economists now focus on whether an
expanding economy is sustainable in terms of its environmental impact.

Business Cycles
The term business cycle (or economic cycle) refers to economy-wide fluctuations in production or
economic activity over several months or years. These fluctuations occur around a long-term growth
trend, and typically involve shifts over time between periods of relatively rapid economic growth
(an expansion or boom), and periods of relative stagnation or decline (a contraction or recession).
Business cycles are usually measured by considering the growth rate of real gross domestic product.
Despite being termed cycles, these fluctuations in economic activity do not follow a mechanical or
predictable periodic pattern.

Economic Growth is an increase in the volume of goods and services produce by economy over
period of time.
Why Economic Growth Importance
 Economic growth is about increase in production within the economy.
 It is important because of living standards are influenced by the access of goods and
services.
 Without growth, individuals can only enjoy rising living standards at the expense of
other society.
 With economic growth we can all (potentially) be better off.

Benefits of economic growth for business

 Increased profits
 Rise in average living standards
 The creation of new jobs
 Lower unemployment
 Increased tax revenue to government –used to fund more spending in government
services.
 Improved business confidence
 Increased capital investment
 Technological innovation

Gross national product (GNP) is the market value of all products and services produced in one year
by labor and property supplied by the residents of a country. Unlike Gross Domestic Product (GDP),
which defines production based on the geographical location of production, GNP allocates
production based on ownership.
GNP does not distinguish between qualitative improvements in the state of the technical arts (e.g.,
increasing computer processing speeds), and quantitative increases in goods (e.g., number of
computers produced), and considers both to be forms of "economic grow An economic statistic that
includes GDP, plus any income earned by residents from overseas investments, minus income
earned within the domestic economy by overseas residents. ".
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Basically, GNP is the total value of all final goods and services produced within a nation in a
particular year, plus income earned by its citizens (including income of those located abroad), minus
income of non-residents located in that country. GNP measures the value of goods and services that
the country's citizens produced regardless of their location. GNP is one measure of the economic
condition of a country, under the assumption that a higher GNP leads to a higher quality of living,
all other things being equal.
Accounting Identities in Macroeconomics

In finance and economics, an accounting identity is an equality that must be true regardless of the
value of its variables, or a statement that by definition (or construction) must be true. The term is
also used in economics to refer to equalities that are by definition or construction true, such as
the balance of payments. Where an accounting identity applies, any deviation from the identity
signifies an error in formulation, calculation or measurement.
The term accounting identity may be used to distinguish between propositions that are theories
(which may or may not be true, or relationships that may or may not always hold) and statements
that are by definition true. Despite the fact that the statements are by definition true, the underlying
figures as measured or estimated may not add up due to measurement error, particularly for certain
identities in macroeconomics.

The Current Account

The balance of payments (BOP) is the place where countries record their monetary
transactions with the rest of the world. Transactions are either marked as a credit or a debit. Within
the BOP there are three separate categories under which different transactions are categorized: the
current account, the capital account and the financial account. In the current account, goods,
services, income and current transfers are recorded. In the capital account, physical assets such as a
building or a factory are recorded. And in the financial account, assets pertaining to international
monetary flows of, for example, business or portfolio investments, are noted. In this article, we will
focus on analyzing the current account and how it reflects an economy's overall position.

The Current Account

The balance of the current account tells us if a country has a deficit or a surplus. If there is a deficit,
does that mean the economy is weak? Does a surplus automatically mean that the economy is
strong? Not necessarily. But to understand the significance of this part of the BOP, we should start
by looking at the components of the current account: goods, services, and income and current
transfers.
 Goods - These are movable and physical in nature, and in order for a transaction to be
recorded under "goods", a change of ownership from/to a resident (of the local country)
to/from a non-resident (in a foreign country) has to take place. Movable goods include
general merchandise, goods used for processing other goods, and non-monetary gold. An
export is marked as a credit (money coming in) and an import is noted as a debit (money
going out).

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  Services - These transactions result from an intangible action such as transportation, business
services, tourism, royalties or licensing. If money is being paid for a service it is recorded like
an import (a debit), and if money is received it is recorded like an export (credit).
 Income - Income is money going in (credit) or out (debit) of a country from salaries, portfolio
investments (in the form of dividends, for example), direct investments or any other type of
investment. Together, goods, services and income provide an economy with fuel to function.
This means that items under these categories are actual resources that are transferred to and
from a country for economic production.
 Current Transfers - Current transfers are unilateral transfers with nothing received in return.
These include workers' remittances, donations, aids and grants, official assistance and
pensions. Due to their nature, current transfers are not considered real resources that affect
economic production.

Now that we have covered the four basic components, we need to look at the mathematical equation
that allows us to determine whether the current account is in deficit or surplus (whether it has more
credit or debit). This will help us understand where any discrepancies may stem from, and how
resources may be restructured in order to allow for a better functioning economy.
The following variables go into the calculation of the current account balance (CAB):
X = Exports of goods and services
M = Imports of goods and services
NY = Net income abroad
NCT = Net current transfers

The formula is:

CAB = X - M + NY + NCT

What Does It Tell Us?

Theoretically, the balance should be zero, but in the real world this is improbable, so if the current
account has a deficit or a surplus, this tells us something about the state of the economy in question,
both on its own and in comparison to other world markets.
A surplus is indicative of an economy that is a net creditor to the rest of the world. It shows how
much a country is saving as opposed to investing. What this means is that the country is providing
an abundance of resources to other economies, and is owed money in return. By providing these
resources abroad, a country with a CAB surplus gives other economies the chance to increase their
productivity while running a deficit. This is referred to as financing a deficit.

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A deficit reflects an economy that is a net debtor to the rest of the world. It is investing more than it
is saving and is using resources from other economies to meet its domestic consumption and
investment requirements. For example, let us say an economy decides that it needs to invest for the
future (to receive investment income in the long run), so instead of saving, it sends the money
abroad into an investment project. This would be marked as a debit in the financial account of the
balance of payments at that period of time, but when future returns are made, they would be
entered as investment income (a credit) in the current account under the income section. (For more
insight, read Current Account Deficits.)
A current account deficit is usually accompanied by depletion in foreign-exchange assets because
those reserves would be used for investment abroad. The deficit could also signify increased foreign
investment in the local market, in which case the local economy is liable to pay the foreign economy
investment income in the future.
It is important to understand from where a deficit or a surplus is stemming because sometimes
looking at the current account as a whole could be misleading.

Analyzing the Current Account

Exports imply demand for a local product while imports point to a need for supplies to meet local
production requirements. As export is a credit to a local economy while an import is a debit, an
import means that the local economy is liable to pay a foreign economy. Therefore a deficit between
exports and imports (goods and services combined) - otherwise known as a balance of trade deficit
(more imports than exports) - could mean that the country is importing more in order to increase its
productivity and eventually churn out more exports. This in turn could ultimately finance and
alleviate the deficit.
A deficit could also stem from a rise in investments from abroad and increased obligations by the
local economy to pay investment income (a debit under income in the current account). Investments
from abroad usually have a positive effect on the local economy because, if used wisely, they
provide for increased market value and production for that economy in the future. This can allow
the local economy eventually to increase exports and, again, reverse its deficit.
So, a deficit is not necessarily a bad thing for an economy, especially for an economy in the
developing stages or under reform: an economy sometimes has to spend money to make money. To
run a deficit intentionally, however, an economy must be prepared to finance this deficit through a
combination of means that will help reduce external liabilities and increase credits from abroad. For
example, a current account deficit that is financed by short-term portfolio investment or borrowing
is likely more risky. This is because a sudden failure in an emerging capital market or an unexpected
suspension of foreign government assistance, perhaps due to political tensions, will result in an
immediate cessation of credit in the current account.
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Conclusion
The volume of a country's current account is a good sign of economic activity. By scrutinizing the
four components of it, we can get a clear picture of the extent of activity of a country's industries,
capital market, services and the money entering the country from other governments or through
remittances. However, depending on the nation's stage of economic growth, its goals, and of course
the implementation of its economic program, the state of the current account is relative to the
characteristics of the country in question. But when analyzing a current account deficit or surplus, it
is vital to know what is fueling the extra credit or debit and what is being done to counter the effects
(a surplus financed by a donation may not be the most prudent way to run an economy). On a
separate note, the current account also highlights what is traded with other countries, and it is a
good reflection of each nation's comparative advantage in the global economy.
The deficits in trade and current account balances are quite large in comparison with aggregate
income. Financing of the deficits had recently included both large foreign private purchases of U.S.
securities and increased foreign official inflows. The sizable current account deficit could be viewed
as reflecting very low levels of national saving, in both its government and private components, in
relation to investment opportunities in the United States that were very attractive. The staff noted
that outsized external deficits could not be sustained indefinitely. However, the historical evidence
indicated that such deficits could be quite persistent, and the adjustment of imbalances was not
necessarily imminent. The adjustment, once under way, might well proceed in a relatively benign
fashion, particularly if fiscal, monetary, and trade policies were appropriate, but the possibility that
the adjustment could involve more wrenching changes could not be ruled out. In any case, a
movement toward balance in the trade and current accounts would likely have effects that differ
appreciably across sectors of the U.S. economy. Members of the Committee noted that monetary
policy was not well equipped to promote the adjustment of external imbalances but could best
contribute by maintaining an environment of price stability that would foster maximum sustainable
economic growth. Fiscal policy had a potentially larger role to play by
Measuring the current account

There are several points at issue—including what a current account deficit or surplus really
means and the many ways that a current account balances is measured.
The current account can be expressed as the difference between the value of exports of goods and
services and the value of imports of goods and services. A deficit then means that the country is
importing more goods and services than it is exporting—although the current account also
includes net income (such as interest and dividends) and transfers from abroad (such as foreign
aid), which are usually a small fraction of the total. Expressed this way, a current account deficit
often raises the hackles of protectionists, who—apparently forgetting that a main reason to
export is to be able to import—think that exports are “good” and imports are “bad.”

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The current account can also be expressed as the difference between national (both public and private)
savings and investment. A current account deficit may therefore reflect a low level of national
savings relative to investment or a high rate of investment—or both. For capital-poor developing
countries, which have more investment opportunities than they can afford to undertake because
of low levels of domestic savings, a current account deficit may be natural. A deficit potentially
spurs faster output growth and economic development—although recent research does not
indicate that developing countries that run current account deficits grow faster (perhaps because
their less developed domestic financial systems cannot allocate foreign capital efficiently).
Moreover, in practice, private capital often flows from developing to advanced economies. The
advanced economies, such as the United States (see chart), run current account deficits, whereas
developing countries and emerging market economies often run surpluses or near surpluses.
Very poor countries typically run large current account deficits, in proportion to their
grossdomestic produt(GDP), that are financed by official grants and loans.
Another way to look at the current account is in terms of the timing of trade. We are used
to intratemporal trade—exchanging cloth for wine today. But we can also think
of intertemporal trade—importing goods today (running a current account deficit) and, in return,
exporting goods in the future (running a current account surplus then). Just as a country may
import one good and export another under intratemporal trade, there is no reason why a country
should not import goods of today and export goods of tomorr Intertemporal theories of the
current account also stress the consumption-smoothing role that current account deficits and
surpluses can play. For instance, if a country is struck by a shock—perhaps a natural disaster—
that temporarily depresses its ability to access productive capacity, rather than take the full brunt
of the shock immediately, the country can spread out the pain over time by running a current
account deficit. Conversely, research also suggests that countries that are subject to large shocks
should, on average, run current account surpluses as a form of precautionary savin Smoothing
role that current account deficits and surpluses can play. For instance, if a country is struck by a
shock—perhaps a natural disaster—that temporarily depresses its ability to access productive
capacity, rather than take the full brunt of the shock immediately, the country can spread out the
pain over time by running a current account deficit. Conversely, research also suggests that
countries that are subject to large shocks should, on average, run current account surpluses as a
form of precautionary saving.

Judging whether deficits are bad

A common complaint about economics is that the answer to any question is, “It all depends.” It is
true that economic theory tells us that whether a deficit is good or bad depends on the factors
giving rise to that deficit, but economic theory also tells us what to look for in assessing the
desirability of a deficit.

If the deficit reflects an excess of imports over exports, it may be indicative of competitiveness
problems, but because the current account deficit also implies an excess of investment over
savings, it could equally be pointing to a highly productive, growing economy. If the deficit
reflects low savings rather than high investment, it could be caused by reckless fiscal policy or a
consumption binge. Or it could reflect perfectly sensible intertemporal trade, perhaps because of
a temporary shock or shifting demographics. Without knowing which of these is at play, it makes
little sense to talk of a deficit being “good” or “bad.” Deficits reflect underlying economic trends,
which may be desirable or undesirable for a country at a particular point in time.

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TOPIC INDEXES AND KEYWORDS (TIK):

 ________________________
 __________________________

TANGENT ADDITIONAL KEYWORDS (TAK):

 ___________________________________________

EVALUATION (OUTCOME):

ACTIVITIIES: RESEARCH

 Philippine Economy: A Macroeconomic Study

 Strengths of Philippine Macroeconomic : Fundamentals for Economic Superpower
 Fiscal Deficits and Fiscal Management in Philippines

PRIMARY REFERENCE MATERIAL(S):

 www. Tutor2u.net
 www.ifc.de/academy
 www.investopedia
 Macroeconomics by Noriel Roubini

SECONDARY REFERENCE MATERIAL(S):

 THE World Wide Web

SUBMISSION Instruction:

Deadline : Sunday of Week 03 (Extension: Sunday of Week 04).

e-mail : eco11-2@vem.edu.ph
[COPY FURNISH THE FOLLOWING e-mails: college@vem.edu.ph;
Filename : ECO 11-2 - WEEK 02 – Activity and Output - YOUR NAME.doc
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Compiled By:

 Instructional Support Network (ISN)

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INSTRUCTIONAL MATERIALS MADE EASY | GLOBAL NETWORK COLLABORATORS AND CONTRIBUTORS | COMPILED FOR EDUCATIONAL PURPOSES ONLY | UPDATED: 2014.05.15