Welcome to BECN 225

Macroeconomics
 Introducing myself

 Dr. Genanew B.Worku (PhD)

 Assistant Professor
◦Dubai Business School
◦University of Dubai, Dubai, UAE
◦Tel. +971 045566921
◦E-mail: gbekele@ud.ac.ae

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 Course Description

This course will:

• provide you with an overview of determination of output; unemployment;
interest rates, and inflation.
• discuss Monetary and Fiscal policies besides public debt and international
economic issues.
• Introduces basic models of macroeconomics and illustrates principles with
the experience of the UAE and other economies.
• It also exposes students to the Islamic economics whenever applicable.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Course Objectives

Upon successful completion of this course, the students will be able to:

 Describe the nation’s macroeconomic performance.

 Compare the major economic and social costs of unemployment and

inflation.

 Explain how the nation’s total output is determined.

 Recognize the macroeconomic impact of fiscal and monetary policy.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Course Learning Objectives (CLO)

 Describe the basic concepts of macroeconomics and how to measure

nation’s economic performance.
 Explain the different phases of business cycle and the causes and cures of
inflation/unemployment and how they affect the economy.
 Identify the basic macroeconomic relationships such as the income –
consumption relationships.
 Explain the determinants of the A.D/A.S and how they are used to explain
demand-pull and cost-push inflation as well as recessions.
 Apply fiscal and monetary policy impacts on the UAE/GCC economy.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 FYI: How to Read Your Textbook

1. Read before class: You’ll get more out of class.

2. Summarize, don’t highlight: Highlighting is a passive activity that won’t improve your
comprehension or retention. Summarize in your own words.
3. Test yourself: Try the “Quick Quiz” for each section. Compare you answer with that in
the back of the book.
4. Practice, practice, practice: Work through the end-of-chapter review questions and
problems.
5. Go online: The book comes with excellent web resources. Visit:
http://academic.cengage.com/economics/mankiw
6. Study in groups: Get together with a few classmates to review each chapter, quiz
each other, and help each other understand the material.
7. Teach someone: The best way to learn something is to teach it to someone else
8. Don’t skip the real world examples: Read the Case Studies and “In The News” boxes
in each chapter. They will help you see how the new terms, concepts, models, and
graphs apply to the real world. As you read the newspaper or watch news, see if you
can find the connections with what you’re learning in the textbook.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Chapter 23
Measuring A Nation’s Income

In this chapter, look for the answers to these

questions:
• What is Gross Domestic Product (GDP)?
• How is GDP related to a nation’s total income and spending?
• What are the components of GDP?
• How is GDP corrected for inflation?
• Does GDP measure society’s well-being?
 National Income Accounting
(National Income and Product Accounts, NIPA)

 Measures the economy’s overall performance, as a whole

(as private accounting does for individual firm/household)

 Compiled by Bureau of Economic Analysis, which helps

◦ Assess health of economy: comparing output levels at regular intervals
◦ Track long-run course: see whether or not the economy has grown

◦ Formulate policies: that improve the health of the economy

 Gross Domestic Product (GDP)
 The primary measure of the economy’s performance is its aggregate
output – often measured by GDP.

 GDP is the aggregate output as moetary value of all final goods

and services produced within the boarders of a given country
during a given period of time, typically a year
 See the following video:
http://www.youtube.com/watch?v=yUiU_xRPwMc&p=F2A3693D8481F442&index=22

 Example: GDP Data for the Six GCC Countries – See Table 23.1, Page 394
https://www.dsc.gov.ae/en-us/Pages/Search.aspx?k=GDP

◦ Aggregate output within the boarders of a given country

E.g.: TOYOTA produced in UAE account as part of UAE GDP
rather than Japanese GDP.
◦ Monetary measure
 Helps to compare the relative value of different goods/services
(see 389 - 390)
 Gross Domestic Product (GDP)
◦ Avoid multiple counting: all goods/services must be counted once only

 Market value final goods

 Final goods are consumption goods, capital goods, services that are
purchased by final users.
 Example: Wheat Flour Bread

 Ignore intermediate goods

 Intermediate goods are goods/services that are purchased for resale or
for further processing or manufacturing .
 See above: Wheat and Flour

 Count value added

 Value added is the market value of a firm’s output less the value
of the inputs the firm brought from others.
 This value is paid out as wages, rent, interest, and profit.
 Gross Domestic Product (GDP)
Example: Value of final product = Value added

Value of Sum of Value

final product added
Note:
Final product & value-added approaches are two ways of looking at the same thing.
 Gross Domestic Product (GDP)

 Exclude Nonproduction transactions: These transactions have nothing to

do with the generation of current final goods. They include:

◦ Financial transactions
 Public transfer payments: include social security payments, welfare
payments, and veterans’ payment.

 Private transfer payments: include parents’ cash-gift to children

 Stock (& bond) market transactions: buying/selling of stocks is just

swapping bits of paper.

Note: Payments for the stockbroker’s services are included in the GDP

◦ Second hand sales

 Example: Selling used car to a friend generates no current production.
 The Components of GDP: Two Approaches

 Expenditure approach (also called Output approach)

◦ Count sum of money spent on buying the final goods
◦ Who buys the goods?
 Domestic sector (Households, Businesses, and Government), and
 Foreign buyers

 Income approach (also called Earning or Allocations approach)

◦ Count income derived or created from production
◦ Wages, rental income, interest income, profit
 Two Approaches to GDP
Expenditure approach Income approach

Consumption by Wages
Households +
+ Rents
Investment by +
Businesses
G
=D= Interest
+ +
Government P
Profits
Purchases
+ +
Statistical
Expenditures
Adjustments
By Foreigners
 Expenditure Approach
 Personal consumption expenditures (C): it covers expenditures by
households on domestic plus foreign products:

 Durable consumer goods (e.g. Autos, Refrigerators,…)

 Nondurable consumer goods (e.g. Milk, Pencils, …)
 Consumer expenditures for services (e.g. Doctor, Lawyer,…)

 Gross private domestic investment (Ig):

 All final purchases of Machinery, equipment, and tools by business
enterprises
 All construction (Are own-occupied houses investment goods?)
 Changes in inventories –unsold goods (adding to the stock of capital
goods)
Note:
 Gross Investment include investment in replacement capital and in
added capital: Gross Investment (Ig) = Net Investment (In) + Depreciation
 Investment does not include the transfer of paper assets
(stocks/bonds), resale of assets (e.g. jewelry)
 Expenditure Approach
 Government purchases (G): this is officially labeled “government
expenditures on consumption and gross investment” . Has two components:
 Expenditures for goods and services that government
consumes in providing public services
 Expenditures for publicly owned capital or social capital
(e.g. school) which have long lifetime.
 Note:
 Government purchases include all government expenditures on final
goods and all direct purchases of resources
 It excludes transfer payments

 Net exports (Xn):

◦ Add exported goods
◦ Subtract imported goods
◦ Net export (Xn)= exports (X) – imports (M)

Thus, GDP = C + Ig + G + Xn
 Income Approach
 First let us look at the items that make up national income, i.e.
Components of National Income:
 Compensation of employees: wages, and wage supplements- social
insurance, private pension, health, and welfare funds)
 Rents: income received for the supply of property resources– tenants
payment to landlords, lease payments for office space.
 Interest: money paid to the suppliers of loans used to purchase
capital – also interest received on savings, certificate of deposits (CDs),
& corporate bonds
 Profits:
 Proprietor’s income: flows to the Proprietors, and includes net
income of proprietorships, partnerships, and other unincorporated
business
 Corporate profits: earning of corporations
◦ Corporate income taxes: levied on profits, & flows to the government
◦ Dividends: after-tax profits distributed to stockholders (households)
◦ Undistributed corporate profits: retained earnings to be invested later
• Taxes on production and imports: excise tax, business property
tax, license fee, custom duty.
 Other national accounts
◦ Provide additional information about the economy’s performance:

◦ Net domestic product (NDP): GDP adjusted for depreciation

◦ NDP = GDP – Depreciation (or consumption of fixed capital)
◦ National income (NI): income earned by U.A.E.-owned resources
here or abroad.
◦ Can be negative if foreigners earned more in U.A.E than U.A.E
resources earned abroad
◦ Personal income (PI): income received by households
◦ NI – Taxes on production and imports
– Payroll taxes or social security contributions
– Corporate income taxes
– Undistributed corporate profits,
+ Transfer payments
◦ Disposable income (DI): personal income - personal taxes (personal
income taxes, personal property taxes and inheritance taxes)
◦ DI = households left over after paying their personal tax
=C+S
Example: Relationship on GDP, NDP, NI, PI, and DI
Gross Domestic Product (GDP) AED 13,841

Less: Consumption of Fixed Capital 1687

Equals: Net Domestic Product (NDP) 12,154
Net Domestic Product (NDP) 12,154
Less: Statistical Discrepancy 29
Plus: Net foreign factor income 96
Equals: National income (NI) 12,221
National income (NI) 12,221
Less: Taxes on Production and Imports 1009
Less: Social Security Contributions 979
Less: Corporate Income Taxes 467
Less: Undistributed Corporate Profits 344
Plus: Transfer Payments 2237
Equals: Personal Income (PI) 11,659
Personal Income (PI) 11,659
Less: Personal Taxes 1482
Equals: Disposable Income (DI) 10,177
 Real vs. Nominal GDP
 Recall that GDP is a dollar measure of production
 Using dollar values creates problems:
◦ GDP is determind by multiplying total output by prices

◦ How do we know if GDP change is due to change in output and/or price?

 Nominal or unadjusted GDP (Calculated at Current price):

◦ GDP based on the prices prevailing when the output was produced

 Real or adjusted GDP

◦ GDP that has been deflated or inflated to reflect changes in price

The following videos illustrate the concept of Nominal vs Real GDP:

http://www.youtube.com/watch?v=29S7FzI7s7g&NR=1
http://www.youtube.com/watch?v=HfCEHYukiPw&p=F2A3693D8481F442&index=24&playnext=1
 GDP Price Index
 Use price index to determine real GDP
Price of Market Basket
In Specific Year
Price Index x 100
In Given =
Year Price of Same Basket
In Base Year

Nominal GDP
Real GDP =
Price Index (in hundredths)

Nominal GDP
GDP = x 100
Deflator Real GDP

Example: On Calculating GDP Deflator.

 Example: Calculating Real GDP (Base year = Year I)

• Inflation: Is a rise in the general level of prices

• Reduces the “purchasing power” of money.
• Does not mean that all prices are rising

GDP deflator - GDP deflator

in year 2 - in year 1
Inf. Rate in year 2 = x 100
GDP deflator
in year 1
Example: On Calculating Inflation rate.
IS GDP a good measure of Economic well being:
Shortcomings of GDP

 GDP is a reasonably accurate and highly useful measure

 It has also shortcomings as a measure of total output and well-being:
◦ Nonmarket activities
 Some producative activities do not take place in any market
 Example: the service of unpaid work, such as homemakers
◦ Leisure
 GDP understates well-being by egnoring leisure‘s value
 Does not include satisfaction (`psychic-income`) of people from their work
◦ Improved product quality
 GDP is a quantitative (not a qualitative) measure
 It fails to capture the full value of improvements in product quality
◦ The underground economy
 Unreported portion of the economy‘s income
 Example: Gambler‘s income, Barista‘s tips, ...
 Value of the underground economy vary world wide: see next slide
 Underground Economy
As a percentage of GDP, Selected Nations, 2007

Percentage of GDP
0 5 10 15 20 25 30
Mexico
South Korea
India
Italy
Spain
China
Sweden
Germany
France
United Kingdom
Japan
Switzerland
United States

• Three factors explaining the variations:

- extent of regulations - type/degree of taxation - law enforcement
 Shortcomings of GDP
◦ GDP and the environment
 GDP growth is accompanied by `gross domestic by-product` - polluted air,
water, congestion, noise,...

 These reduce economic well-being, and yet not reduced from GDP
 Ironically, expenses to clean up pollution are added to GDP

◦ Composition and distribution of the output

 GDP does not tell whether product mix is enriching (e.g. books) or
not (e.g. rifle) to society
 Also GDP tells nothing about the way output is distributed: more evenly
or not!

◦ Noneconomic sources of well-being

 Many things could make a society better off without raising GDP
 Example: Crime reduction, People‘s civility toward one another,...
 Key Terms
 national income accounting  government purchases
 gross domestic product  net exports
 intermediate goods  taxes on production
 final goods and imports
 multiple counting  national income
 value added  net domestic product
 expenditures approach  personal income
 income approach  disposable income
 personal consumption  nominal GDP
expenditures  real GDP
 gross and net private  GDP deflator/price
domestic investment index