Running head: Fundamentals of Macroeconomics 1

ECO 372

Fundamentals of Macroeconomics

Week 2 Assignment

Fundamentals of Macroeconomics 2

Macro Economics is a study which is concerned with the economy as a whole and the level of

total output which is also referred to as national income is a very important variable in any

economy. National income measures the value of an output produced in an economy over a

period of time and the policy makers should be aware of the level of economic activity taking

place within the country on behalf of the nationals.

One of the most important objectives of the government is to increase the level of the rate of

economic growth which is possible only be measuring the national income. The main uses of the

national income statistics are:

1. It shows the current allocation of resources,

2. It helps the government in economic planning,

3. It helps measures the country’s standard of living, and

4. It helps in the comparison of the living standard between different countries.

There are some important concepts of National Income such as Gross Domestic Product, Gross

National product, net National product and The GDP per capita.

Gross domestic product: “GDP is the total value of all output produced using resources located

within the economy over a given period of time”. It refers to the market value of all final goods

and services produced within a country in a given period (O'Sullivan, Arthur).

GDP measures the annual value of all economic activity taking place within the economy and the

GDP measures are on a value added basis in order to avoid the problem of double counting.

There are three ways of calculating the GDP but the results of all the three methods should be the

same. They are:

Fundamentals of Macroeconomics 3

The Output Method.

The Income Method.

The Expenditure Method.

Nominal GDP: Also known as the money GDP is measured in terms of the prices operating in

the year in which the output is produced. it is sometimes referred to as GDP at market prices. It

can give a wrong impression about the performance of the economy, because of the changes in

the value of money which depends on the price level, which is subject to changes. Normally the

Nominal GDP converted into Real GDp which is a measure of adjustment for inflation is used to

calculate the National performance. Real GDP therefore is: money GDP/ the price index of the

current year X Price index of the base year or money GDP/ GDP deflator of the current year X

Price index of the base year (HM Treasury, Background information on GDP and GDP

deflator).

Unemployment rate: Employment is the total number of people with a job which includes the

employees, businessmen and self employed people. The number employed may change over

time due to many factors. While unemployment refers to those people who have registered, able,

available and willing to work at the going wage rate at any suitable job but cannot find

employment. Unemployment is measured at a point of time and the level of unemployment

changes over time.

The number unemployed refers to the number of people of working age, who are without job but

are available for work at the current wage rates. While the rate of unemployment refers to those

working age, who are without job, but are available for work at current wage rates is expressed

as percentage of the total labor force.

Fundamentals of Macroeconomics 4

Unemployment Rate = Unemployed X 100

Labor Force

Inflation Rate: Inflation is defined as the persistent or sustained rise in general price level. It is

the change in the average prices in an economy over a given period of time. The price level is

measured in the form of index. For example, if the price index is 100 today and 110 in the next

year, then the rate of inflation would be 10%.

In economics, the “inflation rate is a measure of inflation, the rate of increase of a price index

and it is the percentage rate of change in price level over time” (Sullivan, Arthur; Steven M.

Sheffrin (2003).

It can be calculated as:

Inflation rate = P0 – P -1 X 100 P-1

Interest rate: An interest rate is the rate at which the borrower pays interest for the use of the

lender’s money. For instance a borrower uses the money belonging to a lender in his business

and in return he pays interest at a predetermined rate of interest for deferring the use of funds and

instead lending it to the borrower. Interest rates are normally expressed as a percentage of the

principal for a period of one year (Mankiw, N. Gregory (2009-04-18). The interest rates targets

are a very important tool in the monetary policy and are considered as vital in the calculation and

dealing with the variables like investment, inflation and unemployment. They are a very crucial

part of macro economics. They are calculated as:

Fundamentals of Macroeconomics 5

r = 1 + i -1

1+ p

The aforesaid economic variables are very important tools of Macro Economics and are used in

the calculation of the rate of economic activities and economic growth in an economy over a

period of time.

Purchasing groceries is an activity which involves purchase and sale at a price level. It creates

demand for the groceries at a price which covers the cost of production including wages. If we

take a two sector model of economy, it has the Household and the business. The household owns

the wealth of nation including land, labor, capital used in the production of goods and services,

while the business or the firms produce goods and services by hiring the factors owned by the

households. The households receive payments for hiring their factors, which they spend on the

purchase of groceries from the firms. This generates output which contributes to the GDP, as the

additional output adds to the total output in the current year depending on the withdrawals and

injections into the economy.

When the economy faces a massive lay off of employees, it directly affects the employment and

income, which reduces the aggregate demand bringing down the price level discouraging further

investment in business. This situation deteriorates the production adversely affecting the GDP in

that particular year. This condition continues to prevail unless remedial measures in terms of

monetary and fiscal policies are taken.

When the government decreases the taxation rate, it increases the consumption increasing the

demand and price, which induces the investors to invest more bringing up the level of economic

activities. Employment will also go up raising the income level, which would further increase the

Fundamentals of Macroeconomics 6

aggregate demand. A decrease in taxation therefore causes a rise in the aggregate demand which

would increase the employment, income and other economic activities in an economy. If it

exceeds the limit it may also result in inflation.

Fundamentals of Macroeconomics 7

Reference:

World Bank, Statistical Manual >> National Accounts >> GDP–final output, retrieved January 2012."User's guide: Background information on GDP and GDP deflator". HM Treasury. http://www.hm-treasury.gov.uk/data_gdp_backgd.htm.

"Measuring the Economy: A Primer on GDP and the National Income and Product Accounts" (PDF). Bureau of Economic Analysis. http://www.bea.gov/national/pdf/nipa_primer.pdf.

French President seeks alternatives to GDP , The Guardian European Parliament, Policy Department Economic and Scientific Policy: Beyond GDP

Study Sullivan, arthur ; Steven M. Sheffrin (2003). Economics: Principles in action. Upper

Saddle River, New Jersey 07458: Pearson Prentice Hall. pp. 340. ISBN 0-13-063085-3. http://www.pearsonschool.com/index.cfm?locator=PSZ3R9&PMDbSiteId=2781&PMDbSolutionId=6724&PMDbCategoryId=&PMDbProgramId=12881&level=4

Definition of interest rate from Investorwords.com