2.1 THE LEVEL OF OVERALL ECONOMIC
ACTIVITY
2.3 MACROECONOMIC OBJECTIVES
ECONOMIC GROWTH
2.1 The level of overall economic
The five main macroeconomic goals:
 Economic
Growth –a steady rate of increase of
national output
 Employment- a low level of unemployment
 Price Stability- a low and stable rate of inflation
 External Stability- a favorable balance of payments
position
 Income Distribution- an equitable distribution on
income
2.1 The level of overall economic

Economic growth
An increase in real GDP or an increase in the quantity of
resources
Gross Domestic Product (GDP) is often used to measure
economic growth

Economic development
A qualitative measure of a country's standard of living
which takes into account numerous factors such as
education
and health
The Human Development Index is normally used to measure
a country's economic development

Sustainable development
The rate at which a country can develop without
compromising the needs of future generations
1.Explain, using a diagram, the circular flow of income between
households and firms in a closed economy with no government.
National income, output and expenditures are
generated by the activities of the two most vital parts of
an economy, its households and firms, as the engage in
mutually beneficial exchange.
The primary economic function of households is to
supply domestic firms with needed factors of production
– land, human capital, real capital, and enterprise.
The function of firms is to supply private goods and
services to domestic households and firms, and to
households and firms abroad.
1.Explain, using a diagram, the circular flow of income between
households and firms in a closed economy with no government.
2. Identify the four factors of production and their respective
payments (rent, wages, interest and profit) and explain that these
constitute the income flow in the model.
Factors of production:

Basic components or inputs which are required in the production of goods and services
Land:

Gifts of nature, this includes everything on the land, under the land, above the land, or in the
sea (e.g., oil, water)
Labor:

Interest
Any man-made aid to production. It is physical plant, machinery, equipment and buildings; it
is not the money that you invest in the stock market
Entrepreneurship:

Wages
The human component hired to assist in producing a good or service. Simply the number of
hours of work put in by a person
Capital:

Rent
Profit
Combines the other factors and takes risks recognizing the possibility of gain from
employing these factors in a specific way. An entrepreneur is the one who sees an economic
opportunity and mixes land, labor and capital together to produce a product with economic
value.
3. Outline that the income flow is numerically equivalent
to the expenditure flow and the value of output flow.
Three equivalent measures of national income:
Income: takes into account wages and salaries, rent, interest, selfemployed income and adds up to make total domestic income.
Wages for labor, Interest for capital, Rent for land and Profits for
entrepreneurship.
National Income = W+I+R+P
Expenditure: Takes into account all spending in an economy.
National Expenditures = C+I+G+[N-X]
Output: Takes into account everything which is produced in an
economy.
National output = Outputs of the primary sector + the secondary sector
+ the tertiary sector
3. Outline that the income flow is numerically equivalent
to the expenditure flow and the value of output flow.
The circular flow model illustrates the essential idea
that all spending in the economy will roughly equal all
the income received.
Thus we can say that spending on output must, at the
same time, represent income to the factor of
production.
Economist have three main methods of counting national
income:
 The spending (expenditure) approach
 The income approach
 The output approach
4. Explain, using a diagram, the circular flow of income in an open economy with
government and financial markets, referring to leakages/ withdrawals (savings, taxes and
import expenditure) and injections (investment, government expenditure and export revenue).
Injections and Leakages Model:
One half of the injections-leakages model is injections, which are nonconsumption expenditures on aggregate production. The three injections are
investment expenditures, government purchases, and exports. These are
termed injections because they are "injected" into the core circular flow of
consumption, production, and income.
The other half of the injections-leakages model is leakages, which are nonconsumption uses of the income generated from production. The three
leakages are saving, taxes, and imports. These are termed leakages
because they are "leaked" out of the core circular flow of consumption,
production, and income.
Equilibrium in the injections-leakages model relies on a balance between
the injections into the core circular flow and leakages out of the flow.
If leakages match injections, then the volume of the core circular flow does not
change.
4. Explain, using a diagram, the circular flow of income in an open economy with government and
financial markets, referring to leakages/ withdrawals (savings, taxes and import expenditure) and
injections (investment, government expenditure and export revenue).
5. Explain how the size of the circular flow will change
depending on the relative size of injections and leakages.
The critical implication from the circular flow is that a
balance between injections and leakages maintains a
constant flow of income, consumption, production, and factor
payments moving between the household and business
sectors.
This is the essence of macroeconomic equilibrium -- the level
of aggregate production remains unchanged.
However, if injections exceed leakages, then the volume of
the basic flow expands and aggregate production
increases.
Alternatively, if leakages exceed injections, then the volume
of the basic flow contracts and aggregate production
decreases.
6. Distinguish between GDP and GNP/GNI as
measures of economic activity.



Gross domestic product (GDP) is the market value of
all officially recognized final goods and services
produced within a country in a given period.
GDP per capita is often considered an indicator of a
country's standard of living; GDP per capita is not a
measure of personal income.
GDP can be determined in three ways, all of which
should, in principle, give the same result. They are
the product (or output) approach, the income
approach, and the expenditure approach.
6. Distinguish between GDP and GNP/GNI as
measures of economic activity.
Gross National Product (GNP)
A measure of citizen's activities all over the world. The
difference between GNP and GDP is the value of any
net property income from abroad.
Gross National Income (GNI)
The total value of goods and services produced by a
country per year plus net income earned abroad by its
nationals; formerly called "gross national product."
6. Distinguish between GDP and GNP/GNI as
measures of economic activity.
GDP can be contrasted with gross national product (GNP) or gross
national income (GNI). The difference is that GDP defines its scope
according to location, while GNP/ GNI defines its scope according to
ownership.
GDP is product produced within a country's borders; GNP/ GNI is
product produced by enterprises owned by a country's citizens. The
two would be the same if all of the productive enterprises in a country
were owned by its own citizens, but foreign ownership makes GDP and
GNP/ GNI non-identical.
Production within a country's borders, but by an enterprise owned by
somebody outside the country, counts as part of its GDP but not its
GNP/GNI; on the other hand, production by an enterprise located
outside the country, but owned by one of its citizens, counts as part of its
GNP/GNI but not its GDP.
2.1 The level of overall economic
Criticisms of GNP/ GDP:
1. Real national income excludes price changes. A short period
rise in national income during an upswing of an economic
cycle does not constitute economic development.
2. GNP does not factor in a change in the population of a
given nation.
3. GNP does not reveal or factor in the negative externalities
such as pollution.
4. GNP tells nothing about the distribution of a societies
income.
5. Does not factor in other forms of measurement such as
illegal markets, services, etc.
7. Distinguish between the nominal value of GDP and GNP/GNI
and the real value of GDP and GNP/GNI
Real gross domestic product (GDP) is a macroeconomic measure
of the value of output economy adjusted for price changes (that
is, inflation or deflation). The adjustment transforms the moneyvalue measure, called nominal GDP into an index for quantity of
total output.
Nominal gross domestic product is defined as the market value
of all final goods and services produced in a geographical region,
usually a country. That market value depends on two things: the
actual quantities of goods and services produced and their
respective prices .
 The relation between the nominal and real values is given the
following definitional relation:
 Nominal GDP = Real GDP x Price Levels where GPD stands for
nominal GDP and Price stands for the price index of GDP.
7. Distinguish between the nominal value of GDP and
GNP/GNI and the real value of GDP and GNP/GNI
Real GDP the value of a nation’s output in a particular year
adjusted for changes in the price level from a base year..
Real GDP Offers a more accurate measure of actual quantity
of goods and services a nation’s produces because it adjusts
for price changes
Nominal GDP is nation’s output produced in a year. (Base
year)
Real GDP is nation’s output produced in a year minus
inflation
8. Distinguish between total GDP and GNP/GNI and
per capita GDP and GNP/GNI.
GDP Per capita measures the total GDP of a nation divided
by the total population.
Gives a more realistic measure of how rich a nation is.
Total GDP is intended to be a measure of total national
economic activity—a separate concept from standard of
living
8. Distinguish between total GDP and GNP/GNI and
per capita GDP and GNP/GNI.
8. Distinguish between total GDP and GNP/GNI and per
capita GDP and GNP/GNI.
World GDP Ranking 2015 | Data and Charts
List of countries by GDP (nominal)
List of countries by GDP (nominal) per capita
List of countries by real GDP growth rate
GDP (current US$) WorldBank
9. Examine the output approach, the income approach and the
expenditure approach when measuring national income.
There are three ways of calculating GDP - all of which
should sum to the same amount:
National Output = National Expenditure (Aggregate
Demand) = National Income
The Expenditure Method = aggregate demand (AD)
The full equation for GDP using this approach is
GDP = C + I + G + (X-M) where
C: Household spending
I: Capital Investment spending
G: Government spending
X: Exports of Goods and Services
M: Imports of Goods and Services
9. Examine the output approach, the income approach and the
expenditure approach when measuring national income.
The Income Method – adding together factor incomes
GDP is the sum of the incomes earned through the production of goods and services.
This is:
Income from people in jobs and in self-employment (+) Profits of private sector
businesses
(+) Rent income from the ownership of land (=) Gross Domestic product (by factor
incomes)
Only those incomes that are come from the production of goods and services are
included in the calculation of GDP by the income approach. We exclude:
 Transfer payments e.g. the state pension; income support for families on low
incomes; the Jobseekers’ Allowance for the unemployed and other welfare assistance
such housing benefit
 Private transfers of money from one individual to another
 Income not registered with the tax authorities Every year, billions of pounds worth
of activity is not declared to the tax authorities. This is known as the shadow
economy.
 Published figures for GDP by factor incomes will be inaccurate because much activity
is not officially recorded – including subsistence farming and barter transactions
9. Examine the output approach, the income approach and the
expenditure approach when measuring national income.
Value Added and Contributions to a nation’s GDP:
There are three main wealth-generating sectors of the economy –
manufacturing and construction, primary (including oil& gas,
farming, forestry & fishing) and a wide range of service-sector
industries.
This measure of GDP adds together the value of output
produced by each of the productive sectors in the economy using
the concept of value added.
Value added is the increase in the value of goods or services as a
result of the production process
Value added = value of production - value of intermediate
goods
10. Calculate nominal GDP from sets of national
income data, using the expenditure approach.
HOW TO:
Nominal GDP is the quantity of output in a particular year
multiplied by the prices in that year.
Nominal GDP = C + I + G + NX
11. Calculate GNP/GNI from data
HOW TO:
The difference between GDP and GNP is that you must
SUBTRACT the value of output produced in a nation by
companies based in other nations, but you must ADD the
value of output produced in other nations by companies
based in the nation you are calculating GNP for.
12. Calculate real GDP, using a price deflator.
HOW TO:
Real GDP is the value of a nation’s output in a particular year measured
using the prices from a base year. So you must multiply the quantity from the
year in question by the prices from the base year (which should be
provided).
If you are not given price and quantity data, rather you are given the GDP
deflator price index, you can divide the nominal GDP for a particular by the
GDP deflator for that year, and multiply by 100 to get the real GDP.
If you know the nominal GDP and the real GDP and are asked to calculate
the GDP deflator, you simply divide the nominal by the real and multiply by
100.
If you have two years’ GDP deflators, and are asked to calculate the
inflation between those years, you simply find the percentage change in the
GDP deflator price indexes between the years given.
13. Evaluate the use of national income statistics, including their use for making
comparisons over time, their use for making comparisons between countries and
their use for making conclusions about standards of living.
GDP Overestimates well-being:
 Adding clearly negative social behaviors and transactions
as net positives for GDP.
 Under-reporting the loss of natural resources.
GDP Underestimates well-being:
 The fact that people are living longer is not included.
 Black and underground market activity is not included.
 GDP does not measure many aspects of quality of life.
 GDP provides no information about the distribution of
income.
 GDP, as commonly reported in the news, does not account
for purchasing power.
13. Evaluate the use of national income statistics, including their use for making comparisons
over time, their use for making comparisons between countries and their use for making
conclusions about standards of living.
The limitations of using national income statistics
 Inaccuracies:
Various measures of national income come
from a vastly wide range of sources
 Unrecorded or under-recorded economic activityinformal markets:
 External costs: GDP figures do not take into account the
cost of resource depletion.
 Quality of life concerns: GDP may grow because people
are working longer hours, or taking fewer holidays.
 Composition of output: a countries output may not benefit
consumers, such as defense and capital goods
13. Evaluate the use of national income statistics, including their use for making comparisons
over time, their use for making comparisons between countries and their use for making
conclusions about standards of living.
The limitations of using national income statistics







Composition of Output : Does not show what this income is spent on for example Soviet Russia spent
significant amounts on armaments in the cold war, however this does not improve the standard of
living.
Composition of Expenditure: National income figures do not take into account what the incomes are
spent on. For example heating in cooler countries adds nothing to standards of living; however, does
contribute to national incomes.
Exchange Rate Distortions: Exchange rate conversions may not create an accurate representation of
a populations relative purchasing power. Purchasing power parity may take this into account.
Unaccounted for Activity : Parallel markets, such as subsistence living and black market activity are
not taken in GDP.
Distribution of Income: Doesn't take into account how this income is distributed.
Intangible additions to welfare: Doesn't take into account the ability to enjoy fresh air and have
leisure time.
Externalities and environmental damage: Damage to the environment and pollution are not taken
into account.
13. Evaluate the use of national income statistics, including their use for making
comparisons over time, their use for making comparisons between countries and their
use for making conclusions about standards of living.
Using GDP as a measure of a nation's economy makes sense
because it's essentially a measure of how much buying power a
nation has over a given time period.
GDP is also used as an indicator of a nation's overall standard of
living because, generally, a nation's standard of living increases as
GDP increases.
GDP is probably the most widely used indicator.
It implies a lot about the country. If the figure is high it suggests
they have a large number of productive industries producing goods.
It also suggests that the service industry is well developed. (Services
include things such as hospital and schools.
If the figure is low it suggests that the country has few industries and
few services so therefore a poor standard of living.)
GDP is fairly easy to calculate from official government figures.
14. Explain the meaning and significance of “green GDP”, a
measure of GDP that accounts for environmental destruction.
Green GDP is an attempt by economists to measure the growth of an economy
compared to the harm production does to the environment.
This is done by subtracting the costs of environmental and ecological damage done in
a specific period of time from the gross domestic product, or GDP, from that some
time.
As a result, the damage done to the environment as a whole is factored into the
equation to give a clearer picture of the consequences of growing an economy.
Unfortunately, green GDP can be difficult to measure because of the problems
inherent in trying to quantify the costs of ecological and environmental damage.
Environmental concerns have come to the forefront of nearly every aspect of life, as
people become increasingly concerned with depleted natural resources and polluted
environments.
These concerns are often not taken into consideration when measuring the strength of
an economy.
The gross domestic product, which is a measurement of both the consumption and
production within a country, isn't meant to encompass these environmental issues.
As a result, green GDP has been at the forefront of efforts to marry economic and
environmental concerns.
15. Explain, using a business cycle diagram, that economies
typically tend to go through a cyclical pattern characterized by the
phases of the business cycle.
15. Explain, using a business cycle diagram, that economies typically
tend to go through a cyclical pattern characterized by the phases of
the business cycle.
The Stages of the Business Cycle:
 There are four stages that describe the business cycle.
At any point in time you are in one of these stages:
 Contraction - When the economy starts slowing down.
 Trough - When the economy hits bottom, usually in a
recession.
 Expansion - When the economy starts growing again.
 Peak - When the economy is in a state of "irrational
exuberance."
15. Explain, using a business cycle diagram, that economies typically
tend to go through a cyclical pattern characterized by the phases of the
business cycle.
A business cycle is characterized by fluctuations in the overall
economic activity of an economy.
Real GDP does not go up in a straight line. Real GDP growth is
followed by a period of economic slowdown or decline.
So the business cycle is a period of growth followed by contraction –
the cycle then repeats.
Periods of declining (but not necessarily negative) real GDP and rising
unemployment are referred to as recessions.
A widely accepted definition of a recession is two or more consecutive
quarters of a decline in real GDP.
A depression is a very severe recession characterized by negative real
GDP (a very sharp decline in economic activity) and unusually high
unemployment.
Business cycles tend to be irregular in duration and magnitude.
15. Explain, using a business cycle diagram, that economies typically
tend to go through a cyclical pattern characterized by the phases of
the business cycle.
To date, economists believe that there are five causes of the business cycle.
The first cause is changes in capital expenditures. When the
economy is strong, businesses have expectations of sales growth;
they invest heavily in capital goods.
After a while, businesses may decide that they have expanded to
their limit, so they begin to pull back on their capital investments and
cause an eventual recession.
The second cause of the business cycle is inventory adjustments.
At the first sign of an economy reaching its peak, there are some
businesses that cut back their inventories and then build them back
up again at the first sign of a trough. Either action causes the real
GDP to fluctuate.
15. Explain, using a business cycle diagram, that economies typically
tend to go through a cyclical pattern characterized by the phases of
the business cycle.
Innovation and imitation are the third causes of the business cycle.
Innovations include new products, new inventions, or a new way of
performing a task.
When a business innovates, it often gains an edge on its
competitors because its costs decrease or its sales increase.
Whatever the case, profits increase and the business grows.
If other business in the same industry want to keep up, they then
copy what the innovator has done (imitation) or they come up with
something better.
Imitation companies usually invest heavily and an investment boom
follows. Once the innovation spreads to another industry, the
situation changes. Further investments are unnecessary and
economic activity may slow.
15. Explain, using a business cycle diagram, that economies typically
tend to go through a cyclical pattern characterized by the phases of
the business cycle.
The fourth cause of the business cycle are the credit and loan
policies of commercial banking.
When "easy money" policies are in effect, interest rates are low and
loans are easy to get. They encourage the private sector to borrow
and invest, thus stimulating the economy.
Eventually the increased demand for loans causes the interest rates
to rise, which discourage new borrowers. As borrowing and spending
slow down, the level of economic activity declines.
The economy keeps declining until interest rates fall and the business
cycle begins over again.
15. Explain, using a business cycle diagram, that economies typically
tend to go through a cyclical pattern characterized by the phases of
the business cycle.
The fifth and final cause of the business cycle if external
shocks.
Shocks such as increases in oil prices, wars, international
conflict, and natural disasters have the potential to either
drive the economy up, or drive it down.
The economy may benefit when a new supply of natural
resources is discovered. Such was the case with Great Britain
in the 1970's when an oil field was discovered off its coast in
the North Sea. The British economy of course profited seeing
that world oil prices were at an all time high, but the high
prices hurt the United States at the same time.
16. Explain the long-term growth trend in the business
cycle diagram as the potential output of the economy.
POTENTIAL REAL GROSS DOMESTIC PRODUCT:
The total real output (real gross domestic product) that the
economy can produce if resources are fully employed.
In theory this means that the economy is operating ON the
production possibilities frontier.
Full employment is generally indicated by achieving what
is termed the natural unemployment rate.
If the economy is at full employment then actual real gross
domestic product is equal to potential real gross domestic
product and the actual unemployment rate is equal to the
natural unemployment rate.
The macro economy is thus living up to its potential.
16. Explain the long-term growth trend in the business
cycle diagram as the potential output of the economy.
Potential output (also
referred to as "natural
gross domestic product")
refers to the highest level
of real Gross Domestic
Product output that can
be sustained over the
long term.
OKUN'S LAW:
A relationship that says that the gap between actual
and full employment output level of gross domestic
product widens by 3.0% for each percentage point
increase in the unemployment rate.
When Arthur Okun discovered this empirical
relationship he was on President Kennedy's Council of
Economic Advisers (CEA).
Okun cautioned that the relationship was valid only
within unemployment rates of 3% and 7.5%.
OKUN'S LAW:
Is an empirically
observed relationship
relating unemployment to
losses in a country's
production.
The "gap version" states
that for every 1%
increase in the
unemployment rate, a
country's GDP will be
roughly an additional
2% lower than its
Interpreting Deviations from Okun’s Law
potential GDP.
17. Distinguish between a decrease in GDP and
a decrease in GDP growth.
The growth rate is the percentage increase or decrease of
GDP from the previous measurement cycle.
The GDP growth rate is the most important indicator of
economic health.
If GDP is growing, so will business, jobs and personal income.
If GDP is slowing down, then businesses will hold off investing
in new purchases and hiring new employees, waiting to see if
the economy will improve.
This, in turn, can easily further depress GDP and consumers
have less money to spend on purchases.
If the GDP growth rate actually turns negative, then the U.S.
economy is heading towards a recession.
17. Distinguish between a decrease in GDP
and a decrease in GDP growth.
A decrease in GDP could simply stem from a decline in
government spending, which might not be a bad thing for the
economy at all, because of what and why the government is
changing its spending. (Military needs vs social needs)
Alternatively, GDP could decline due to less consumption, even as
the society continues to produce, if the excess production is stored
rather than being immediately exported.
Of course, it is also possible that a GDP decline suggests exactly
what it is often said to suggest - that the economy is doing poorly
across the board.
In short, context is needed to interpret GDP.
17. Distinguish between a decrease in GDP
and a decrease in GDP growth.
GDP growth rate is percentage increase or decrease in GDP from earlier measurement cycle.
Growth rate is annualized for ease of comparing it to previous year’s rate. GDP growth rate is determined by exports,
government spending, retail expenditures, and inventory levels.
Ten Reasons for Declining GDP Growth
1.
Changing social attitudes towards consumption and debt in all age groups
2.
Demographics of an aging workforce
3.
A severe lack of high-paying jobs for college graduates
4.
Kids fresh out of college have delayed marriage, family formation, and home purchases
5.
Many coming out of college are effectively debt slaves having no way to pay back student loans
6.
Debt overhang from the housing bust
7.
Boomers headed into retirement have insufficient savings
8.
Shrinking middle-class plagued by declining real wages
9.
Rapidly changing technology negates skills
10.
Technology, especially robots, currently eliminates more jobs than it creates
GDP growth (annual %) List of countries by real GDP growth rate List of countries by GDP (real) per capita growth
rate
2.3 Macroeconomic objectives: Economic Growth
18. Define economic growth as an
increase in real GDP.
Economic growth is the increase in the amount of the
goods and services produced by an economy over time.
It is conventionally measured as the percent rate of
increase in real gross domestic product, or real GDP.
Growth is usually calculated in real terms – i.e., inflationadjusted terms – to eliminate the distorting effect of
inflation on the price of goods produced.
In economics, "economic growth" or "economic growth
theory" typically refers to growth of potential output, i.e.,
production at "full employment".
19. Calculate the rate of economic growth from a
set of data.
World Bank Data Bank is an analysis and
visualization tool that contains collections of time
series data on a variety of topics. You can create your
own queries; generate tables, charts, and maps; and
easily save, embed, and share them.
20. Describe, using a production possibilities curve (PPC) diagram, economic growth as an
increase in actual output caused by factors including a reduction in unemployment and
increases in productive efficiency, leading to a movement of a point inside the PPC to a
point closer to the PPC.
21.Explain, using a PPC diagram, economic growth as an increase in
production possibilities caused by factors including increases in the
quantity and quality of resources, leading to outward PPC shifts.