Unit+13+ +Level+of+Overall+Economic+Activity+ (1) 2

Unit 13
Level of overall economic activity.

IB Economics - Francisca Echezarreta
Macroeconomics
Study of the national economy. Is concerned about the allocation of a

nation’s resources and about five main variables:
The circular ﬂow of income model
It is a SIMPLIFIED model
• Illustrates a closed economy (‘closed’ to international trade).

• The simplest version shows an economy with no government.
• It is assumed that the only decision-makers are households
(consumers) and firms (or businesses)
• Households and firms are linked together through two markets:
product markets and resource markets.
Clockwise analysis:
• Households own the factors of production:

land, labour, capital and entrepreneurship.
• Firms buy the factors of production in

resource markets and use them to produce
goods and services.
• They then sell the goods and services to

consumers in product markets.
Counter clockwise analysis
There is a flow of money used as payment in sales

and purchases.
• When households sell their factors of production
to firms, they receive payments
• Rent (for land), Wages (for labour), Interest (for
capital), Profit (for entrepreneurship).
• These payments are the income of households.
• Households then use that income to buy goods
and services, known as household expenditures
(income for the firms)
Adding leakages and injections to
arrive to a closer picture of the real
world.
LEAKAGES: Not all money from

households goes to firms.
INJECTIONS: There is extra money

going into firms that does not come
from households.
Measuring Economic Activity
Most countries have a system of national income
accounting, in order to measure economic activity and
then assess the performance of their economies.
The Gross Domestic Product (GDP) and Gross National
Income (GNI) are the most often used indicators to
measure economic activity. However, they are not
always the most appropriate measure, especially when
assessing well-being.
Gross Domestic Product
value: quantity x price
final: those ready
for use.
• GDP is the total value of all final goods and services
goods and services produced within a country over a time period

are produced within
the physical borders (usually a year), regardless of who owns the factors
of the country
of production.
Uruguay
Let’s look at Uruguay’s GDP

growth from 1961 to 2021
How is GDP measured?
● The output approach: adds up the value of all final goods and
services produced by each economic sector (banking,
agriculture, etc.)
GDP = sector 1 + sector 2 + … + sector n
● The expenditure approach: measures total amount spent on

domestic output. Consumption spending (C), Investment
spending (I), Government spending (G) and Net exports (X-M)
(exports - imports).
GDP = C + I + G + (X-M)
● The income approach: adds up all the income generated in the

production process by the factors of production in the economy.
GDP = rents + wages + interest + profit
Gross National Income
• GNI is the total income received by the residents of
a country (factors of production), regardless where
the factors are located. It focuses on the nationality
of the factors of production involved and the income
they earn, independently of their location.
GNI = GDP + factor income from abroad - factor income sent abroad.
Remember:
value is quantity
multiplied by the
price.
Nominal vs Real
Nominal value is the value measured in terms of
prices that exist at the time of the measurement.
Real value is the nominal value adjusted for price

changes (inflation)
Per capita
Per capita figures provide an indication of average
or per person output or income in the economy.
Dividing GDP and GNI by the population of a country
gives GDP per capita and GNI per capita,
respectively.
National Income Statistics
● They can be seen as a report card for a country. Economic growth
(increase in the real GDP) is a stated objective of governments.
Therefore, these statistics can be used to judge the success of a
government in achieving economic growth.
● They are used to develop policies.
● To develop models of the economy and make forecasts.
● To analyze the performance of an economy.
● To evaluate living standards or quality of life.
● To compare between countries.
Weaknesses
1. They do not include non-marketed output
• GDP measures the value of goods and services that are traded in the
marketplace. Yet some output of goods and services is not sold in the market
and does not generate any income. An example is one’s own work on repairing
and improving one’s home. In less developed countries households are often
quite self-sufficient. Non-marketed output therefore is likely to be far greater in
less developed countries compared to more developed ones. This type of
improvements are not reflected in the GDP
Weaknesses
2. GDP does not include output sold in underground
(parallel) markets
‘Underground market’ exists whenever a buying/selling
transaction is unrecorded. Estimates of the size of
underground markets can be made, and when added to the
official (or recorded) economy, can arrive at a closer
approximation of ‘true’ GDP.
Weaknesses
3. GDP and GNI do not take into account quality improvements

in goods and services.
4. GDP does not take into account the value of negative
externalities
5. GDP does not take into account the depletion of natural
resources
Weaknesses
6. GDP and differing price levels.

Goods and services often sell for very different prices in different
countries.
Example: BIG MAC index.

https://www.economist.com/big-mac-index
Weaknesses
7. GDP makes no distinctions about the composition of output.

•Whether a country produces military goods or merit goods
(education, health care, clean water supplies, and other services) or
any other type of goods.
Weaknesses
8. GDP does not reflect achievements in levels of education,
health and life expectancy.
An alternative and broader measure, the Human Development
Index has been developed to reflect a society’s achievements in
the areas of health and education as well as income levels.
9. GDP provides no information on the distribution of income

and output
Weaknesses
Alternative measures
Better Life Index (BLI): includes income, wealth and

inequality, jobs and earning, housing conditions,
health status, work and life balance, education and
skills, social connections, civic engagement and
governance, environmental quality, personal security
and subjective well-being.
Alternative measures
Happy Planet Index (HPI): made up of average life

expectancy, average subjective well-being and
ecological footprint.
Surprisinglym the top five countries in the HPI

ranking have GDP per capita levels below $10,000.
For example, Costa Rica.
Business Cycle
Business Cycle
Output growth in uneven and irregular. In
some years or months, real output may
grow rapidly. In other periods, more slowly.
A business cycle plots real GDP on the

vertical axis against time on the horizontal
axis. GDP is measured in real terms, so Business cycles consist of short-term
that the vertical axis measures changes in fluctuations in the growth of real output,
the volume of output produced after the which are alternating periods of expansion
influence of price-level changes has been (increasing real output) and contraction
eliminated. (decreasing real output).
Business Cycle
Phases:
● Expansion: there is positive growth in the real GDP. Employment of resources increases
and the general price level of the economy begins to rise more rapidly.
● Peak: cycle’s maximum real GDP and marks the end of an expansion. Unemployment of
resources has fallen substantially and the general price level may be rising rapidly, the
economy is likely to have inflation.
● Contraction: falling real GDP. If the contraction lasts
six months or more is termed as recession. Growing
unemployment of resources.
● Trough: cycle’s minimum GDP, the end of contraction.

Widespread unemployment.
Business Cycle
● The average growth over long periods of time (many years) is known as the
long-term growth trend. The long-term growth trend shows how output
grows over time when cyclical fluctuations are balanced out.
● Real GDP actually achieved fluctuates around potential output.
Potential Output (full employment level of output)

• The term ‘full employment’ does not mean that all resources are employed.
• There is still some unemployment: the natural rate of unemployment
• When actual GDP is greater than potential GDP, unemployment is lower than
the natural rate
• When actual GDP is less than potential GDP, unemployment is greater than
the natural rate.
Business Cycle
● When actual GDP lies above potential GDP or below potential GDP there
results a GDP gap, also known as an output gap.
Examination Questions
Calculations
https://app.kognity.com/study/app/2023-y5-grx-economics-s
t/sid-187-cid-154554/book/real-gdp-and-real-gni-id-31197/
Calculations using: takes into account
how much prices
inflated by that year.
Calculations using:

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Unit 13

Level of overall economic activity.

Study of the national economy. Is concerned about the allocation of a

• Illustrates a closed economy (‘closed’ to international trade).

• Households own the factors of production:

• Firms buy the factors of production in

• They then sell the goods and services to

There is a flow of money used as payment in sales

LEAKAGES: Not all money from

INJECTIONS: There is extra money

• GDP is the total value of all final goods and services

goods and services produced within a country over a time period

Let’s look at Uruguay’s GDP

● The expenditure approach: measures total amount spent on

● The income approach: adds up all the income generated in the

Real value is the nominal value adjusted for price

3. GDP and GNI do not take into account quality improvements

6. GDP and differing price levels.

Example: BIG MAC index.

7. GDP makes no distinctions about the composition of output.

9. GDP provides no information on the distribution of income

Better Life Index (BLI): includes income, wealth and

Happy Planet Index (HPI): made up of average life

Surprisinglym the top five countries in the HPI

A business cycle plots real GDP on the

● Trough: cycle’s minimum GDP, the end of contraction.

● Real GDP actually achieved fluctuates around potential output.

Potential Output (full employment level of output)

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