Macroeconomics

What’s an economist?

“Mathematician, historian, statesman, philosopher, in some

degree . . . as aloof and incorruptible as an artist, yet
sometimes as near the earth as a politician.”
-John Maynard Keynes-
 What’s Macroeconomics?
• Study of the economy as a whole, including
growth in incomes, changes in prices, and the
rate of unemployment.

• Macroeconomists attempt both to explain

economic events and to devise policies to
improve economic performance.
 How bout Microeconomics?
• Study of how firms and individuals make
decisions and how these decisionmakers
interact.
• Because macroeconomic events arise from
many microeconomic interactions, all
macroeconomic models must be consistent
with microeconomic foundations, even if
those foundations are only implicit.
 3 Main Macroeconomic Variables
1. Output (level & growth)

2. Unemployment Rate

3. Inflation Rate
 Philippine Economy at a Glance
1. Output (level & growth)
 Philippine Economy at a Glance
1. Output (level & growth)
 Philippine Economy at a Glance
2. Unemployment Rate
 Philippine Economy at a Glance
3. Inflation Rate
Philippine Economy at a Glance
Philippine Economy at a Glance
 Philippine Economy at a Glance
3. Inflation Rate
 How ‘s this related to Finance?
• Macroeconomics & Finance are intertwined.
The Great Recession was a good example.

• Ways in which Macroeconomics can be used

in investing:

1.Top-down investing
2.General valuation of the stock market
 How ‘s this related to Finance?
1. Top-down investing
-Investment approach that consists of analyzing
the “big picture” (world or domestic economy),
then moving down to the industry –level then
down to company-specific level.

-no hard & fast rule so long as analysis goes

from big to small picture
How ‘s this related to Finance?
 How ‘s this related to Finance?
Example:
Big picture: Low interest rates

Small picture: Bank stocks

 How ‘s this related to Finance?
2. Valuation

a. Total Market Cap to GDP Ratio (Buffett

indicator)
b. Cyclically Adjusted Price to Earnings Ratio
(CAPE, Shiller P/E, and P/E10 ratio)
 How ‘s this related to Finance?
2. Valuation

a. Total Market Cap to GDP Ratio (Buffett

indicator)

-A ratio used to determine whether an overall

market is undervalued or overvalued.
 How ‘s this related to Finance?

“The market value of all publicly traded securities as a

percentage of the country's business -- that is, as a
percentage of GNP. The ratio has certain limitations in telling
you what you need to know. Still, it is probably the best
single measure of where valuations stand at any given
moment.”
-Warren Buffett, Fortune Magazine 1999 & 2001-
 How ‘s this related to Finance?

“If the percentage relationship falls to the 70% or 80% area,

buying stocks is likely to work very well for you. If the ratio
approaches 200% -- as it did in 1999 and a part of 2000 --
you are playing with fire.”
-Warren Buffett, Fortune Magazine 1999 & 2001-
How ‘s this related to Finance?
How ‘s this related to Finance?
How ‘s this related to Finance?
How ‘s this related to Finance?
How ‘s this related to Finance?
 How ‘s this related to Finance?
2. Valuation

b. Cyclically Adjusted Price to Earnings Ratio

(CAPE, Shiller P/E, and P/E10 ratio)

-A valuation measure, generally applied to

broad equity indices, that uses real per-share
earnings over a 10-year period
 How ‘s this related to Finance?
2. Valuation

b. Cyclically Adjusted Price to Earnings Ratio

(CAPE, Shiller P/E, and P/E10 ratio)

-a better market valuation indicator than the

P/E ratio as it eliminates fluctuation of the
ratio caused by variation of profit margins
during business cycles
 How ‘s this related to Finance?
Computation steps:

1. Take the annual Earnings Per Share (EPS) of an

index for the past 10 years
2. Express these earnings in today’s money
(dollars)
3. Get the average of these real EPS for the 10 year
period
4. Divide the current level of the index by the 10
year average
5. Compare the figure to its historical mean
 How ‘s this related to Finance?
2018 index level: 1,131

2017 CPI: 227.20

2016 CPI: 218.70

Average real EPS:69.4

CAPE ratio: 16.3x
Historical average of CAPE: 19x
Where does the US Market stand?

Historical Mean: 85%

Current: 133.7%
Where does the US Market stand?

Historical Mean: 16.9x

 John Maynard Keynes
• Widely regarded as the father of
Macroeconomics

• Was a successful stock market investor in the

later part of his investing career and held a
concentrated portfolio instead of a diversified
one.

• Had Friedrich Hayek as his rival

John Maynard Keynes
• The core of
Macroeconomics
evolved from the
principles laid out in
his 1936 book General
Theory of Employment,
Interest, and Money
 John Maynard Keynes
• His economic theories were the staple of the
economic policies of developed nations in the
later part of the Great Depression, World War
II, and post War economic expansion.

• Went out of fashion during the stagflation of

the 70’s

• Saw a resurgence during the Great Recession

 Friedrich Hayek
-Austrian economist whose anti-big-
government book, Road to Serfdom (1944),
inspired Milton Friedman and many other
libertarians

-his 1945 article, “The Use of Knowledge in

Society,” helped inspire the efficient market
hypothesis
 Aggregate Output
Different Measures of Output:

1. Gross National Product (GNP)

2. Gross National Income (GNI)
3. Gross Domestic Product (GDP)
 Aggregate Output
Gross National Product (GNP)

-the market value of the goods and services

produced by labor and property supplied
by the residents of a particular economy
(usually a state)
 Aggregate Output
Gross National Income (GNI)

-based on a similar principle to GNP

- sum of value added by all resident producers
plus any product taxes (less subsidies) not
included in the valuation of output plus net
receipts of primary income (compensation of
employees and property income) from abroad
(World Bank)
 Aggregate Output
Gross National Income (GNI)

-sum of value added by all producers who are

residents in an economy, plus any product
taxes (minus subsidies) not included in output,
plus income received from abroad such as
employee compensation and property income
(Investopedia)
 Aggregate Output
Gross National Income (GNI)

-the World Bank now uses GNI instead of GNP

-The Philippine Statistics Authority (PSA)

emphasizes GNI rather than GNP
 Aggregate Output
Gross Domestic Product (GDP)

-the market value of the goods and services

produced by labor and property located in
a particular economy (usually a state)
 Aggregate Output
Gross Domestic Product (GDP)

1. Value of the final goods & services produced in

the economy during a given period (Production
side)

2. Sum of value added in the economy during a

given period (Production side)

3. Sum of Incomes in the economy during a given

period (Income side)
Circular Flow-2 Sector Model
 Circular Flow-2 Sector Model
The inner loop represents the flows of labor and
bread: households sell their labor to firms, and the
firms sell the bread they produce to households

The outer loop represents the corresponding flows

of dollars: households pay the firms for the bread,
and the firms pay wages and profit to the
households
Circular Flow-4 Sector Model
 Circular Flow-4 Sector Model
Households receive income from firms & the
government; purchase goods and services from
firms; and pay taxes to the government

They also purchase foreign-made goods and

services (imports)
 Circular Flow-4 Sector Model
Firms receive payments from households and the
government for goods and services; pay wages,
dividends, interest, and rents to households; and
pay taxes to the government

For exporters, they also receive payments for

domestically-made good (exports)

Sometimes, the firms also purchase imports

 Circular Flow-4 Sector Model
The government receives taxes from firms and
households; pays firms and households for goods
and services (including wages to government
workers); and pays interest and transfers to
households

Sometimes, the government also purchases

imports
 Circular Flow-4 Sector Model
Finally, people in other countries purchase goods
and services produced domestically (exports).
 Aggregate Output
In this economy, GDP is both the total
expenditure on bread and the total income
from the production of bread

Because every transaction has a buyer and a

seller, every dollar of expenditure by a buyer
must become a dollar of income to a seller
 Aggregate Output

When Joe paints Jane’s house for $1,000, that

$1,000 is income to Joe and expenditure by Jane

The transaction contributes $1,000 to GDP,

regardless of whether we are adding up all
income or all expenditure
 Aggregate Output
Gross Domestic Product (GDP)
Consider an economy composed of just 2
firms:
Firm 1 produces steel, employing workers
& using machines to produce the steel. It
sells the steel for $100 to Firm 2, which
produces cars. Firm 1 then pays its workers
$80, leaving $20 in profit to the firm.
 Aggregate Output
Gross Domestic Product (GDP)
Firm 2 buys the steel & uses it, together
with the workers & machines, to produce
cars. Revenues from car sales are $210. Of
the $210, $100 goes to pay for the steel &
$70 goes to workers in the firm, leaving
$40 in profit to the firm.
Compute the GDP.
Aggregate Output
 Aggregate Output
Value of the final goods & services produced
in the economy during a given period
(Production side)

GDP = $210

-Keyword here is final goods & services

-Steel is an intermediate good, NOT FINAL!
 Aggregate Output
Sum of value added in the economy during a
given period (Production side)

GDP = $210
Value added = Production – value of
intermediate goods
Aggregate Output
 Aggregate Output
Sum of Incomes in the economy during a
given period (Income side)

GDP = $210
Income= indirect taxes + labor income + capital
income
Aggregate Output
 Aggregate Output
GDP = $210

Production side = Income side

The figure should be the same whichever way

one looks at it
 Aggregate Output
Computation caveats

1. Sale of used goods is excluded (only

production in the current period is counted)
2. Increase in inventory is included (called
inventory investment & counted as
expenditure by owners)
3. Sale out of inventory has no effect on GDP
4. Underground economy is excluded
 Aggregate Output
Given the exclusion of the underground
economy, GDP is an imperfect measure of
economic activity

These imperfections are most problematic

when comparing standards of living across
countries
 Aggregate Output
The size of the underground economy varies
widely from country to country

Yet as long as the magnitude of these

imperfections remains fairly constant over
time, GDP is useful for comparing economic
activity from year to year
 Aggregate Output
Types:

1. Nominal GDP/ GDP at current prices/ PHP

GDP/ EUR GDP

2. Real GDP/ GDP at constant prices/GDP

adjusted for inflation
 Aggregate Output
1. Nominal GDP
-sum of the quantities of final goods
produced times their current price

-definition makes clear that nominal GDP

increases over time for 2 reasons:
1. Production of most goods increases over time
2. Prices of most goods also increase over time
 Aggregate Output
1. Nominal GDP

-GDP computed this way is not a good

gauge of economic well-being because this
does not accurately reflect how well the
economy can satisfy the demands of
households, firms, and the government.
 Aggregate Output
1. Nominal GDP

-If all prices doubled without any change in

quantities, nominal GDP would double. Yet
it would be misleading to say that the
economy’s ability to satisfy demands has
doubled, because the quantity of every
good produced remains the same