Economic Development
Module 1: Chapter 23-Measuring a Nation’s Income
 Micro: Small; Macro: Big
 Micro- study on how individual households and firms make decisions; inflation,
unemployment, savings
 Gross Domestic Product (GDP) – measure the total income and expenditures of
everyone in the economy
 Income equals expenditures: every dollar earned is a dollar spent
 The Circular-Flow Diagram illustrates GDP
o Factors of productions: inputs like labors, land, capital, and natural
resources.
o Factor of payments: wages, rent
o 2 markets: Households and Firms
o Goods: consumers goods or business to business goods
o The government is not in the diagram (omits:)
 Collects taxes, buys goods and services
 Financial systems: supply of funds, loans
 Foreign sector: trades, currencies
 GDP is the market value of all goods and services within a country in a given
period of time
o Market value is aka price
o Raw materials are not included because there will be double counting. To
avoid that we only calculate the final market value produce by the country.
o Counting market value should only be within a period of time to avoid
double counting from previous years
o Goods are measures in the same units: dollars or peso
o Housework you do for yourself does not count to have a market value
The Components of GDP
Y= C+I+G+NX
Consumptions- expenditures (goods and services) of a household and it does not includes
purchases of new housing, mortgage payments. Education is included here not on investments
Investments- put money into something with the hope that we will enjoy it in the future.
Purchase of goods that will be used in the future to produced more goods. Capital equipment,
structures, and inventories (goods produced but not yet sold)
Government Purchases- is all spending on the goods and services purchased by the
government. For the services provided such as constructions of bridges and hospitals. It
excludes transfer payments such as insurance benefits. Purchases of raw materials for the
construction of services and salaries of government workers
Net Exports- NX= foreign purchases of domestically produced minus the domestic purchases
of foreign goods (NX= exports – imports). Exports should exceed the imports. There should
be a subtraction of imports because imports are a portion of C, I, and G.
Ex. A Filipino buying a 1M Mitsubishi car (Japanese Company) it will increase
imports=consumption. Thus, it will decrease net exports.
A deduction in NX does not affect the GDP because it this also means an increase to the other
components of the GDP.
Transfer payment is not included in the production because nothing has been produced in
exchange of that payment.
GDP= measuring income and expenditures
Given on quarterly (multiply it by 4 to get the annual GDP) or annually on a basis
Nominal GDP: values output using the current prices. It is not corrected for inflation. not
considering the changes in the prices. The change in nominal GDP reflects both prices and
quantities.
-Current prices x quantities produced
- change in nominal GDP reflects both prices and quantities
Real GDP: values output using prices of a base year (using previous year’s inflation). Real
GDP is corrected for inflation. taking the inflation in consideration. The change in real GDP
is the amount that GDP would change if prices were constant (if zero inflation)
-quantity changes and the prices remain the same
-Real GDP is a measure of the economy’s production of goods and services. It reflects
the economy’s ability to satisfy people’s needs and wants
See power point for illustrations
GDP Deflator- Is a measure of the overall level of prices
GDP deflator= 100x nominal GDP/ real GDP
-one way to measure the economy’s inflation rate is to compute the percentage increase
in the GDP deflator from one year to the next.
- reflects what’s happening to prices but not to quantities
- measures current level of prices relative to the level of prices in the base year. Asa na
ba, ni taas na ba or ni baba ba? Paspas ba ang pag saka sa presyo?
- Deflate opposite of inflate
- If GDP remains the same then the GDP deflator increases
See power point for illustrations
1st QUIZ
For the purpose of calculating GDP,
investment is spending on
If net exports is a negative number for a
particular year, then
The percentage change in the price level
from one period to another is called
Changes in real GDP reflect*
Countries with low GDP per person tend to
have
In a simple circular-flow diagram, firms
use the money they get from a sale to
capital equipment, inventories, and structures,
excluding household purchases of new housing.
capital equipment, inventories, and structures,
including household purchases of new housing.
the value of foreign goods purchased exceeded the
value of goods sold to foreigners during the year.
the inflation rate.
only changes in the amounts being produced.
higher rates of infant mortality.
pay wages to workers.
pay rent to landlords.
pay profit to the firms’ owners.
All of the above are correct.
The underground economy*
The underground economy refers to
economic transactions that are deemed
illegal, either because the goods or services
traded are unlawful in nature, or because
transactions fail to comply with
governmental reporting requirements. The
underground economy is called the shadow
economy, the black market, or the informal
economy.
Which of the following is included in
Singapore’s GDP?*
Which of the following questions is more likely
to be studied by a microeconomist than a
macroeconomist?
excludes the amount of criminal activity in an
economy.
includes otherwise legal transactions that go
unreported or unrecorded.
The value of production by a Filipino working in
Singapore
Why do prices in general rise by more in some
countries than in others?
Why do wages differ across industries?
Some examples of microeconomic issues
are:
 How to reduce pollution from
production.
 How to reduce inequality of income.
 How to deal with monopoly.
 When to harvest (classic microec qst.)
(1) What goods and services should be
produced to meet consumer needs?
(2) How should they be produced, and who
should produce them?
(3) Who should receive goods and services?
The microeconomic questions refer to those (4) How a local business decides to allocate
decisions that are more specific and involve their funds.
day-to-day operations. Or what can be done (5) How a city decides to spend a
yearly, seasonally, and daily to improve the government surplus
economic picture.
Microeconomics focuses on specific daily
operations of a household and a firm
Which of the following is not a question
addressed by macroeconomists?
What is the impact of foreign competition on the
U.S. auto industry?
Gross domestic product includes all*
legal final goods and services, but it excludes illegal
final goods and services.
changes in the prices and quantities of individual
goods and services.
Much of macroeconomics attempts to explain*
Macroeconomics focuses on the
performance of economies – changes in
economic output, inflation, interest and
foreign exchange rates, and the balance of
payments.
GDP does not reflect*
long-run growth and short-run fluctuations in real
GDP (correct answer)
Macroeconomics focus on the general or
overall performance of the economy.
the quality of the environment.
the value of leisure.
the value of goods and services produced at home.
the quality of the environment.
All of the above are correct.
Because every transaction has a buyer
and a seller,*
Which of the following statements about
nominal GDP and real GDP is correct?
GDP is more closely associated with an economy’s
income than it is with an economy’s expenditure.
every transaction contributes equally to an
economy’s income and to its expenditure.
Real GDP is a better gauge of economic well-being
than nominal GDP.
Why Do Economists Favor Real GDP? Real GDP is often favored over nominal GDP as it
accounts for the effects of inflation. Thus, if nominal GDP grew at 4% in a given year,
but the inflation rate was 5%, it actually shrunk by 1% in real (constant-dollar) terms.
GDP is important because it gives information about the size of the economy and how an
economy is performing. The growth rate of real GDP is often used as an indicator of the
general health of the economy. In broad terms, an increase in real GDP is interpreted as
a sign that the economy is doing well.
The consumption component of GDP includes
spending on
Which of the following is a way to compute
GDP?*
durable goods, nondurable goods, and services.
A farmer produces oranges and sells
them to Fresh Juice, which makes
orange juice. The oranges produced by
the farmer are called
Transfer payments are*
intermediate goods
Nominal GDP will definitely increase when*
add up the market values of all final goods and
services
not included in GDP because they are not payments
for currently produced goods or services.
prices increase and output increases.
Goal of GDP: To gauge how well the overall economy is performing
When economist talk about GDP- they mean real GDP
The government will determine the BASE YEAR
-The year should have no erratic (unpredictable) price changes; no abnormal incidents
such as droughts, floods, earthquakes, etc
-The government should not choose a year that there are many incidents in that year
-Base Year can also be change. It is revised periodically to reflect structural changes in
the economy. Such structural changes occur because of the
-availability of sources (demand and supply) or
-the political system (changes in policies), or
-war
PHILIPPINE BASE YEAR: is 2018 (previous one was 2012)
The increase in prices - discourages the people to purchase
GDP and Economic Well-Being
-real GDP per capita: talking about how much is the average GDP per person in the
economy
- the bigger GDP and the smaller the population, the higher GDP per capita
-even though China has higher GDP, USA has higher GDP per capita because USA has
lesser population than China
- real GDP per capita is the main indicator of the average person’s standard of living
(shown on their assets)
- GDP does not value the quality of the environment, leisure time, non-market activity
(child care), and equitable distribution of income
Why do we need a base year?
For us to be able to see if there is a significant increase or decrease on our GDP
Gross National Income
-it does not only include income brought about in the PH but also income abroad. Earn
home and earn abroad are counted in the GNI
-has a better picture about our economy; better measurement of how much the country
has been producing
-GNI is greater than GDP but not for all countries especially for those undeveloped
countries because they do not have the capacity to expand.
GDP excludes income abroad; GNI includes income abroad
Mean age in the Philippine is 27.5 yrs old. Half of the population is 27.5 yrs old and below;
the other half is above 27.5 yrs old
Life Expectancy- Philippines 72.5 yrs old.
Japan has the highest life expectancy and real GDP per capita. Before their progressive
years, they have the highest life expectancy because they know how to take care of
themselves
Adult Literacy is related to real GDP per capita
Cost of living – the amount of money needed to cover basic expenses such as housing, foods,
taxes, and healthcare in a certain place and time period. A significant factor in personal wealth
accumulated because a salary can provide a higher standard of living in a city.
Iceland- the most expensive city in 2023
New York and Singapore- the most expensive city in 2022
You can tell that a person has a high standard of living if he could afford luxuries
US President Salary- 7k US dollar- 408k pesos
PH President Salary- 411k pesos
Module 2: Measuring the Cost of living
Consumer Price Index (CPI)
Measures the typical consumer’s cost of living. Monitor the changes of cost of
living over time. When the consumer price index rises, the typical family has to spend
more money to maintain the same standard of living.
How to Calculate the CPI
When we talk about CPI, we are talking the basket (consumer shopping basket)
1. Fix the basket- in US, the BLS (look into the usual items) surveys the consumers
to determine the basket. PSA in Philippines.
2. Find the prices
3. Compute the basket’s cost
-NSA means not seasonally adjusted while SA means seasonally adjusted.
-The base index is chosen randomly in PH. The current base index is in the year 2018.
- computing the CPI in PH includes all income of all classes (lower, middle, upper)
-Laspeyres over Paasche formula since its much simpler
- we are not only looking into the CPI but also the changes of the inflation rate
-prices changes but the quantities remain the same
-the decrease in quantity is not being considered. The prices are only considered here in
computing the CPI
Problems with the CPI
1. Substitution Bias
-over time, some prices rise faster than others.
- consumers substitute toward goods that become relatively cheaper.
-the CPI misses this substitution because it uses a fixed basket of goods
-Thus, the CPI overstates increases in the cost of living
2. Introduction of new goods
-it increases the choices our of goods
-we can get the value of our money because we get a higher quality of our money
but this is not being included in the CPI
-CPI does not include the rise of the introduction of new goods since it uses a
fixed basket to compute
-Thus, the CPI overstates increases in the cost of living
3. Unmeasured quality change
-an increase in the quality of product and the price remains the same, the value of
money increases
-the quality of change is not measured here
-the quality of a good rises then the prices rise, but it is not measured here
-Thus, the CPI overstates increases in the cost of living
-All of these three factors overstate the cost of living hence, each country has a
different way of measuring their CPI
Formulas
To get the Cost of Basket:
(quantities x price) + (quantities x price)
To get the CPI index:
100x Cost of basket of the current year/ COB of last year
To get the inflation rate:
CPI of the current year- CPI of the last year/ CPI of the last year x 100
To get the % increase in cost of household basket:
(current cost of household – previous cost of household)/previous cost of
household)
Exam: 1st topic, 2nd topic, and 3rd topic next next week
Next week F2F classes
CPI vs GDP
Imported
consumer goods
Capital goods
The basket
Included in CPI
Excluded in GDP deflator
Excluded from CPI
Included in GDP deflator (only domestically produced)
CPI uses fixed basket
GDP deflator uses basket of currently produced goods and services
This matters if different prices are changing by different amounts
Example situations:
A. Starbucks raises the prices of Frappuccinos
The CPI and GDP deflator both rises
B. Caterpillar raises the price of the industrial tractors it manufactures at its Illinois
factory.
The GDP deflator rises, the CPI does not -because it is a capital goods and
capital goods are excluded in CPI
C. Armani raises the prices of the Italian jeans it sells in the US
The CPI rises, the GDP (check ppt)
Correcting Variable for Inflation:
1. Comparing Dollar Figures from Different Times
Here’s the formula:
Amount in today’s dollars= amount in years T dollars x Price level today/ price level in
year T
$7.78 = $1.15 x 211.7/31.3
(answer= factor (e.g. minimum wage, etc) CPI today/ CPI previous year)
-Even after correcting for inflation, tuition and fees were much lowers
2. Indexation
A dollar amount is indexed for inflation it is automatically corrected for inflation by law
or is contract
The increase in the CPI automatically determines
-the COLA in multi-year labor contracts
-the adjustments in social security payments and federal income tax brackets
3. Real vs. Nominal Interest Rates
The nominal interest rate:
- Interest rate is not corrected for inflation
- CPI and inflation are already given by the economists
- The rate of growth in the dollar value of a value
Example:
Real interest rate =Nominal Interest rate- inflation
=9.0% - 3.5% = 5.5%
- The purchasing power of the $1000 deposit has grown 5.5%
- The interest rate that measures the change in dollar as is call the nominal interest
rate.
- The interest rate corrected for inflation Is called the real interest rate
When talking about Interest rate, we will be comparing amounts of money of different
points of time.
- Borrowers has higher interest rate dues to more charges and labor
- If you are a premium client of the bank, you will be given a special interest rate
by the bank
- Good payers have lower interest rates due to assurance that they will pay
- Bank will do their marketing to sustain their interest payables to their clients
- You have to correct for value of inflation
 Your money increased from 1000 to 1,100 but what you can buy with it lessens
or its values lessens
 Nominal income is the face value of the income but the real income is the amount
you can buy with your income.
 The higher the inflation, the smaller the value of money
On Tuesday
Exercises and quiz during f2f
Assignment 2 later