Macroeconomic Tools

Circular Flow Model

The circular flow model provides a basis for calculations of GDP and GNI.

As all arrows should be equal to complete the cycle, GDP, which measures economic activity, can be measured by looking at any part of the cycle.

Injections (Inflow) and Leakages (Outflow)

Government

• Taxes (outflow)
• Government spending (inflow)
  

Financial Institutions

• Savings (outflow)
• Investments (inflow)
  

Foreign Countries

• Exports (outflow)
• Imports (inflow)
  

Gross Domestic Product

• The total monetary value of all final goods and services produced domestically within a year.
• The most common tool in macroeconomics, with its various alterations (nominal GDP, real GDP, GDP per capita, etc.) to measure economic growth.

• Problems arise to the MNC (multinational corporations), which may be based in a country, but have operations outside of the country.

GDP does not include:

Intermediate goods

• Goods used in the production of final goods and services.

Non-Production Transactions

• Used goods
• Financial transactions

Illegal Activities

• Black markets
• Unregistered sellers
  

Gross National Income

• Gross National Income, or GNI, is the total income of a nation's people and businesses.
• In most situations, GNI and GDP are equal, if not very similar. This is because of the circular flow model where income, production, and expenditure are equal to one another.
• Differences arise in what GDP and GNI do and don't account for in their measurements.

Measuring GDP

Output Method

• The total value of all of goods and services produced within a nation.

• Firms provide figures for their output during the year.
• Output = actual value of the goods and services produced.
• The output method looks at the production arrows in a circular flow model.

Benefits

• Allows for good statistical data based on sectors.

Problems

• Does not include informal economic activities.

Income Method

• The total income earned within a nation.

• Done by adding up all the income earned by groups when the factors of production are sold in resource markets.
• Income is measured as wages, rent, profit and interest (payment for factors of production),

Benefits

• Relatively simple if all jobs are registered.

Problems

• As before, does not include unregistered payments or "under the table" money.
• Corruption and criminal activities could distort statistics.
• Informal jobs such as babysitting would also not be counted.

Expenditure Method

• The total amount of money spent on goods and services in an economy.

• Done by adding up total sales receipts for goods and services sold in the economy.
• Measures the payment for goods and services in the circular flow economy.
• The most commonly used method.
• It uses the formula C + I + G + (X-M), which is the most common way GDP is defined.

Benefits

• In a closed economy, this the total sales would simply equal consumption.
• However, in an open economy many other variables are at play such as government spending, investment and net export which the expenditure method does account for.

Calculating GDP and GNI

GDP Formula

• GDP = C + I + G + (X-M)

• C = Consumption = Purchases on final goods and services by individuals.
• I = Investment = Business spending on tools and equipment.
• G = Government spending = Schools, roads military
• (X-M) = Net exports
• X = Exports
• M = Imports

GNI Formula

Expenditure method

• GNI = GDP + (incomes* flowing into a country - incomes** flowing out of the country)
• *Income earned by assets abroad
• **Income paid to foreign assets operating domestically

GNI vs GDP

• Whereas GDP measures the total economic activity within a country, GNI measures the total income earned by a country's people and businesses, even if they are abroad.

• Differences in GNI and GDP can show certain things about a country's economy.
• For example countries such as Nigeria might have a decent GDP, but have a bad GNI, as most of their production comes from foreign-owned oil refineries.

Real vs Nominal GDP/GNI

Nominal GDP/GNI

• GDP/GNI measured in current prices that does not acount for inflation
  

Real GDP/GNI

• GDP/GNI that is adjusted for inflation.
• "Real" means that a value has been adjusted for inflation.
• For example, real income is income that has been adjusted for inflation.

• Real GDP/GNI is preferable to nominal GDP/GNI in most cases as it it better shows growth trends.
• For example a country might have significantly growing nominal GDP, as increased prices due to inflation would result in a greater monetary value for products. However, real GDP might grow quite little or be stagnant.
  

Calculating Real GDP/GNI

• Nominal GDP/GNI and a price deflator can be used to determine real GDP/GNI.
• The price deflator is given as an index number, which is a percentage number given as an integer, or a decimal number multiplied by 100.

• A price deflator of 100 means no inflation.
• A price delfator higher than 100 means there is inflation and less than 100 means there is deflation.
• Real GDP/GNI = (Nominal GDP/GNI)/(100/Price deflator)
• It can also be written as:
• Real GDP/GNI = (Nominal GDP/GNI)/(100/100 + Inflation Rate)

Additional Tools

• Even though GDP and GNI can provide a lot of insight into the health and situation of an economy, other tools are used to provide information on more specific metrics which GDP and GNI might struggle to indicate accurately.

Human Development Index

• The human development index or HDI ranks countries based on how they fare in several parameters.
• It measures:

Life expectancy at birth

Mean years of schooling

Expected years of schooling

GNI per capita

Purchasing Power Parity

• Gives an accurate depiction of the size of an economy by its power to purchase goods and services within that country.
• Used to compare productivity and standards of living between countries by looking at relative costs of goods and services.
• You may experience this when you travel. Basic goods and services can be cheaper or more expensive in other countries.

Big Mac Index

• The Big Mac index is a form of finding purchasing power parity. It compares the price of a Big Mac in different countries.

UN Happiness Index

• The UN happiness index consists of measurements conducted by the United Nations.
• It measures:

GDP per capita

Social support

Healthy life expectancy

Freedom to make life choices

Generosity

Freedom from corruption

OECD Better Life Index

• The OECD better life index compares countries based on several different aspects.
• It measures:

Housing

Income

Jobs

Community

Education

Environment

Civic engagement

Health

Safety

Work-Life Balance

Happy Planet Index

• A numerical ranking that uses several variables.
• A higher score means a higher ranking.
• The score is calculated as:
• (Life satisfaction * Life expectancy * Income distribution)/Environmental footprint

GDP PER CAPITA

• GDP divided by population.
• Gives an accurate depiction of the average income per citizen.
• GDP per capita does not account for income disparity, as it only provides an average.
• This means it can be a flawed tool for measuring incomes in a country, as they tend to vary a lot between households.

• GNI per capita can also be found through the same method and has the same properties.

Pros and Cons of GDP/GNI

Advantages

• Easy to compare countries
• Informs policymakers and agendas
• Gives an indication of average income (GDP per capita)

Limitations

• Overestimates quality of life
• Does not account ofr inequality or income disparity
• Difficult to measure and countains inaccuracies
• Does not account for improvement of quality.

Sources

https://www.dyingeconomy.com/circular-flow-model.html