MODULE 1

MACROECONOMICS: THE BIG PICTURE

INTRODUCTION

Macroeconomics is constantly in the news – on TV, in the daily newspaper, and

elsewhere. The government reports every month on the nation’s unemployment and
inflation rates. The quarterly reports document the nation’s Gross National Product
(GNP). The stock market is in the news almost every day and often is the topic of party
conversation. High unemployment, staggering inflation and high interest rates form the
subject matter of macroeconomics. Is it any surprise that voters insist that government
do something about unemployment rate, or an inflation rate? What is the government’s
responsibility for solving problems such as high unemployment, high inflation, and high
interest rates? To what extent has the government actually caused these problems?
Macroeconomics tries to provide answers to these and many other questions.

COURSE LEARNING OUTCOMES

At the end of the module, students are expected to identify major issues of the
macroeconomic events by following the common scientific practice of examining
cases of academic interest among others, the employment prospects, about the
purchasing power of savings, or the amount of mortgage interest rates, and the task of
defining them and considering the relevance for government policy.

A. MARCO TOPICS AND METHODS

Macroeconomic concepts are often not intuitively obvious. In contrast, in

microeconomics, quantity and price concepts are typically quite easy to understand -
there is nothing complicated about a ton of corn and its price. In macroeconomics, we
aggregate (add together) many different goods so we can work with a few broad
categories of goods and their prices. To appreciate what these concepts mean, we
need to understand how they are defined and how actual economic data are
constructed. We will take up the definitions of concepts as we need them rather than
present a long and forgettable list at the outset.
Macroeconomics is the study of the economy as a whole.

1. Definitions of Macroeconomics Term

Before we can measure and describe a concept such as unemployment, we

have to define what it is. It seems obvious that a person not working is unemployed. But
suppose that person is 12 years old and in school, or 85 years old and retired, or 30 years
old but too ill to work, or 21 years old playboy living off an inherited fortune and is just not
interested in work. We say that these persons are “not in the labor force” rather than
“unemployed”
 Economists have made these intuitive ideas more precise by dividing the total
population of a country into three (3) basic groups – the employed, the unemployed,
and those not in the labor force.
Employed persons - include all those who, during the survey week, worked at all
as paid employees, in their own business or profession, or on their own farm, or who work
12 hours or more as unpaid workers in an enterprise operated by family members.
Unemployed - a person who is not working but for whom there is some clear
evidence of attachment to the labor force. A person temporarily laid off by the employer
and expecting to return to the same job is counted as unemployed, or a person who is
looking for a job by going for a job interviews is counted as unemployed.
Not in the Labor Force - a person who sits in a bar drinking and does nothing toward
finding a job is classified as not in the labor force.

2. DISTINGUISHING MACRO ISSUES FROM MICRO ONES

The economy’s total employment and unemployment is a central topic in

macroeconomics. In contrast, employment in a particular industry – the lumber and
wood products industry is a topic in microeconomics. In microeconomics, we study the
individual household, individual firm, or small groupings of firms. There is obviously a
continuum here as we construct larger and larger groupings of households or firms. For
example, by the time we reach a group as large as all manufacturing firms we are in
macro territory. For example, in 2020 total employment in the Philippines was 41.2 million.
This figure includes the armed forces and is averaged over the 12 months of the year.
Employment in the lumber and wood products industry last year was 41,000 persons or
only 0.1 percent of the total employment. “Total manufacturing” is a larger grouping that
includes the lumber and wood products industry as one of the many industry – total
manufacturing employment in 2020 was 6.2 million persons, or 15 percent of total
employment. At the level of total manufacturing, we are certainly involved in macro
analysis.

3. MACRO INTERACTIONS

In analyzing a macroeconomic problem we looked carefully on the two types of

interactions:

a. Offsets – are economic effects that counteract other effects.

For example, suppose the government increases the tax rate applied to firms
in manufacturing industries and that the effect of this tax increase is a decline
in manufacturing employment. But suppose the same tax also reduces taxes
on firms in service industries. The new tax law then, may reduce employment
in manufacturing industries such as steel, but simultaneously may increase
employment in service industries such as transportation, leaving little or no
effect on total employment. Whenever we analyze an event from a macro
point of view we need to determine whether an obvious visible effect might
be offset by an effect somewhere else that may or may not be so obvious.

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 b. Feedbacks – are secondary economic effects that may reinforce primary
effects.
For example. Suppose the government increases taxes on all corporations.
After examining possible offsets, we need to examine the possibility that the
primary effect – a decline in employment – will reduce the incomes of those
who lose their jobs and so will “feedback” to reduce the demand for
manufacturing goods. After all, with lower incomes, the newly employed will
reduce their purchases of motorcycles, cars, houses, furniture and all other
goods and services people normally buy. Thus, the direct effect of the tax
increase mat be augmented by indirect effects as well.

B. GROSS NATIONAL PRODUCT

What do people produce? The list includes, steel, motorcycles, lectures, repairs,
music, haircuts, medical care, and thousands and thousands of other goods and
services. In microeconomics we can study the supply and demand form individual
goods, like shoes, etc. in macroeconomics we also want to discuss supply and demand,
price and quantity not at an individual good like shoes, but by groupings of goods.

Aggregation – is the process of combining individual items into a group. The total defined
in this way is called an aggregate.

To understand the mass of data on individual goods, we need somehow to group

together individual goods, and add them up. In this way, we can examine the behavior
of the group rather than of the thousands of individual member of the group.
Some aggregates are easy to define. For example, aggregate unemployment is
the sum of those unemployed in each individual industry. However, many aggregates
used in macroeconomics are not so simply defined. Consider the problem of defining
aggregate quantity. How can we add the number of bottled water sold at a grocery
store in a particular year and the number of kilos of rice produce the in the same year?
Of course we can’t; number of bottled water and number of kilos of rice don’t add up.
But the peso value of the bottled water and the peso value of the rice sold can be added
together.

1. A country’s Gross National Product (GNP)

- Is the total value, measured in the country’s currency, of the final goods and
services produced during a certain period, such as year, or a calendar quarter of
a year.

Final Goods – are the end products of the production process and are used by
their buyers in finished form rather than incorporated in further stages of
production.

Intermediate Goods – are goods such as materials, parts, repair services used in
the production of other goods.

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 We count goods sold to final or ultimate users such as households, because it
would not make sense to add together the values of an economy’s production of
iron, steel, and motorcycles. Doing so would involve double-counting. The value
of steel includes the value of the iron ore that goes into the steel, and the value of
a motorcycle includes the value of the steel that goes into the motorcycle. Iron
and steel are intermediate goods.

2. Nominal and Real GNP

a. Nominal GNP – is the value of the year’s production at that year’s price.

The Philippines GNP in 2010 was 588 billion USD. Think about this number are being
derived from a huge table listing all the quantities and prices of all goods produced
for final users in 2010. Multiply price and quantity for each good to obtain the total
2010 value for each good and then add together these values. We get the Nominal
GNP. Now do the same thing for 2019. As compared to 2010, each of the quantities
is different, and each of the prices is different unless they happen to be the same by
statistical fluke. Multiplying price and quantity for all final products in 2019 and adding
up the values yields the nominal GNP for 2019. The number happens to be 1.106 trillion
USD.
Two facts to consider:

I. Suppose that all the 2019 quantities just happen to be the same as in 2010, but
all the prices were higher, Nominal GNP would be higher, but only because
prices were higher.
II. Suppose that all the 2019 prices just happen to be the same as in 2010, but all
the quantities were higher, Nominal GNP would be higher, but this time
because quantities were higher.

The dollar value of the 2019 GNP might be identical in these two facts, but clearly we
would want to distinguish between them. The value obtained in these two facts is
called NOMINAL GNP.

b. Real GNP – for a particular year is the sum of the values of all the final goods
produced in that year, where the values are calculated by multiplying the year’s
quantities by the prices of the goods in a base year.

The easiest way to understand how economists distinguish between changes in the
GNP resulting from changes in prices and those resulting from changes in quantities is
to consider a simple example. Suppose we value the quantity of sardines produced
in 2019 at its 2010 price. Then, when we compare the dollar value of sardines’
production in 2019 with its dollar value in 2010, only the quantity is different because
we have standardized the prices for both years by using the 2010 price. We can
repeat this calculation form all years of interest, multiplying each year’s quantity of
sardines by the 2010 price of sardines. The year 2010 is known as the base year.
This concept is also sometimes called “GNP corrected for inflation” because the
effects of price changes have been removed by using prices held constant to those
of a base year.

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3. Long-run economic growth

Long-run economic growth – is the increase of output and other measures of material
progress over a period of many years.

The study of growth requires both microeconomics and macroeconomics.

Microeconomics is needed because the central topics are rising economic efficiency
and productivity. The tools and analytical methods of microeconomics are well suited
to exploring the ways people manage to obtain more output from given inputs of
labor, machinery, land, and raw materials. The macroeconomic perspective is
required to put together the efficiency enhancing efforts of individual firms and
industries and to understand how the entire economy grows. Long run economic
growth is extremely important because only through growth can a country solve
pressing social problems such as poverty and inadequate health care.
Population growth provides a crude measure of over-all economic growth
because without growing total output the country could not support a growing
population. We know from scattered evidence, however, that output grew
substantially over the nation’s first hundred years.
By dividing real GNP by population, we obtain real GNP per capita. For most
purposes, we are interested in this figure – per capita real GNP – and its growth, for it
is these per capita figures that provide a measure of the standard of living in a country
and are relevant to issues such as the prevalence and severity of poverty. The largest
part of real GNP is used for household consumption (food, clothing, shelter, and so
forth) but some is used for building new factories, machines, bridges, highways, and
other productive capital to increase future output.

4. SIMPLE ALGEBRA of quarterly GNP and its Growth Rate

In tracking the economy’s short-run performance, we often find it useful to compare

real GNP growth with its long-run trend. Using some basic algebra, we can see how
short-run growth is calculated.
Suppose that the peso amounts of real GNP in the first and second quarters of a
particular year are x1 and x2 , respectively. Remember that the numbers reported in
official statistics are at annual rates, or 4x1 and 4x2 . Then, we calculate the
percentage change of real GNP from the first to the second quarters as follows:

4𝑥2 −4𝑥1 𝑥2 − 𝑥1
Percentage Change of x (%∆x) = x 100 = x 100
4𝑥1 𝑥1

Example: Real GNP grew from ₱4,129.7 billion in 1989: III to ₱4, 133.2 billion
in 1989: IV. These numbers are expressed at an annual rate, as they always
are in official GNP reports. What is the percentage change in real GNP for
the quarter? What is the annual percent change in real GNP?

Solution:
a)
₱4,133.2 bn − ₱4,129.7 bn
%∆x = x 100 = 0.08% (quarter rate)
₱4,129.7 bn

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 b) 0.08 x 4 = 0.3% (annual rate)

C. BUSINESS FLUCTUATIONS

Business Fluctuations, often called Business Cycles – are the irregular fluctuations in the
general level of economic activity around its long-run growth path.

Although economic growth is obviously a very important topic, the vast bulk of research
in macroeconomics is concerned with a different topic – that of fluctuations in business
activity. These fluctuations show up clearly in the unemployment rate. Over relatively
short periods, often only a few quarters, real GNP sometimes rises or falls very rapidly and
unemployment can change substantially.
Business cycles are an important economic and social issue. Economists have
been motivated to study business fluctuations because of the waste of lost output during
recessions and because of the obvious distress caused by unemployment. All too often,
responsible, hard-working people find themselves thrown out of their jobs, and their
livelihoods and economic security may be severely threatened if their spells of
unemployment last too long. Many economists hope to contribute to improvements to
government policy that will reduce the severity of unemployment and alleviate the
distress of those who nevertheless do become unemployed.

1. Phases of the BUSINESS CYCLE

Expansion – is the phase of the business cycle during which real GNP is generally rising.

Contraction - is the phase of the business cycle during which real GNP is generally
falling.

Business-cycle peak – is the point at which the expansion ends and the contraction
begins.

Business-cycle trough - is the point at which the contraction ends and the expansion
begins.

Real Peak
GNP

Peak Long-run
Growth Path

Contraction Expansion

DATE
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 An idealized picture of the business cycle shows real GNP fluctuating around its
long-run growth path. The time when real GNP reaches a peak is called the peak.
The bottom of the cycle, when GNP is at its low point, is called the trough. The
period during which GNP is rising is called the expansion, and the period during
which real GNP is falling is called the contraction.

Recession – is a somewhat imprecise term referring to a period of reduced GNP

and alleviated unemployment.

Depression – is a large and protracted recession.

Today, “recession” and “depression” are often used as a synonymous for

“contraction”, but the usage can be confusing. In the early part of an expansion,
just after the trough, we can observe that the economy is still in recession because
unemployment is still high.

2. ECONOMIC INDICATORS

Many measures of business activity are closely associated with the peaks and troughs
of the general business cycle.

Economic Indicator – is any economic variable with peaks and troughs exhibiting
a consistent timing relationship with the peaks and troughs of the general business
cycle.

An economic indicator need not have peaks and troughs exactly congruent with
those of the general business cycle, but the timing should be reasonably consistently
ahead or behind. In fact, indicators that lead the business cycle are especially
valuable because they provide an early warning that the overall economy is about
to change direction.

Leading, coincident, and lagging indicators – are economic variables that turn
ahead of, coincident with, and behind, respectively, the general business cycle.

Economists track a large number of economic indicators. During the expansion,

economists and business analysts are alert to the possibility that the economy will turn
down into a recession. A number of economic variables have been identified as fairly
consistent leading indicators. Economists follow them closely month by month to
obtain advance warning that a recession is coming. Leading indicators however, are
not perfectly consistent. Forecasting the economic outlook would be an easy task
rather than the challenge that it is. Economists also watch coincident and lagging
indicators for confirmation that the economy has entered a new phase of the cycle.

D. INFLATION

General Price Level – is an average of the prices of all the goods and services in
an economy.

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 Inflation (deflation) – is a continual increase (decrease) in the general price level.

A central task of macroeconomics is to explain and understand the general price

level and its rate of change, the inflation rate. To avoid having to talk of both inflation
and deflation, it is often convenient to use the term inflation with the understanding
that inflation can be negative. The general price level is sometimes called the
absolute price level to draw a sharp distinction between it and the relative prices
studied in microeconomics. A central task in microeconomics, is to explain and
understand the prices of individual goods. These are the relative prices – the prices of
individual goods relative to the prices of other goods. A relative price is best
interpreted as the ratio at which the quantity of one good can be exchanged for a
quantity of another good. It is very important not to mix up absolute and relative
prices.
There are a number of statistical measures of the general price level and therefore
of inflation.

Consumer Price Index (CPI) – is an average of the prices of a wide range of goods
purchased by a typical urban family. The index is arbitrarily set equal to 100 in a
base year, which may be changed from time to time.

Producer Price Index (PPI) - is an average of the prices of goods sold by producers.
The index is arbitrarily set equal to 100 in a base year, which may be changed from
time to time.

1. The IMPLICIT GNP PRICE DEFLATOR

Implicit GNP price deflator – is a comprehensive measure of the general price level
that includes the prices of all goods included in GNP. The deflator is calculated as
the ratio of nominal GNP to real GNP, and therefore weight goods’ prices by their
relative contribution to total GNP.

Economists often use a concept of the general price level known as the implicit price
deflator (sometimes called either implicit deflator, or simply deflator). To understand
how the implicit deflator is constructed, we need to review the concepts of nominal
GNP and real GNP. Recall that we obtain nominal GNP for each year by multiplying
the quantity of each final good produced in the year by its price that year. And then
adding together the total values of all the goods. We obtain real GNP by doing the
same thing, except that we standardized the prices for the individual goods for all
years by using prices standardized to a base year. Although real GNP is measured in
terms of money, we think of it as a measure of quantity because by using constant
prices, real GNP can change from one year to another only if the quantities of goods
produced change. Because we have a measure of the total amount spent – nominal
GNP – and a measure of quantity – real GNP – we implicitly also have a measure of
price – the implicit deflator. This price times the quantity gives the total amount spent.

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CALCULATING THE IMPLICIT DEFLATOR

For an individual good, the total money value produced (amount spent) is
simply the price of the good times the quantity produced.

V = P x Q

Total Value is Price times Quantity.

Here the concept of nominal GNP is analogous to V in the expression
above, in fact, the sum of all V’s for individual goods. We have also define
real GNP and have treated the concept of quantity for the economy as a
whole, real GNP is analogous to Q in the expression above. Thus, by
substitution, using the macroeconomics symbols,

Nominal GNP = IPD x real GNP

or

𝑛𝑜𝑚𝑖𝑛𝑎𝑙 𝐺𝑁𝑃
IPD =
𝑟𝑒𝑎𝑙 𝐺𝑁𝑃

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 Learning Activities: (Assignment)

1. Could total employment and unemployment rate both increase in a given year? Explain. (10
pts.)

2. Table 1: (GNP figures in billions of pesos)

________________________________________
Year Nominal GNP Real GNP

1990 2, 732.0 3, 187.1

1991 3, 052.6 3, 248.8
1992 3, 166.0 3, 166.0
1993 3, 405. 7 3, 279.1
1994 3, 772. 2 3, 501.4
1995 4, 014.9 3, 618.7
1996 4, 231.6 3, 717.9
1997 4, 524.3 3, 853.7
1998 4, 880.6 4, 024.4
1999 5, 234. 0 4, 144.1
________________________________________

a. Calculate the annual rate of growth in nominal GNP and real GNP for each year from
1991 to 1996. (10 pts.)
b. Calculate the implicit price deflator (IPD) for each year from 1990 to 1995. (10 pts.)
c. Calculate the annual IPD inflation rate for each year from 1995 to 1999. (10 pts.)

3. Make a list of five final goods and five final services you as a consumer buy. For each of these
goods and services, write down one or more intermediate goods that goes into the production
of the final good. (20 pts.)

4. The gasoline you use for pleasure driving your motor bike is a final product, whereas the
gasoline a business uses for a delivery truck is an intermediate product. Should the gasoline
you use for commuting to work be counted as a final product or an intermediate product? Try
to think of other products you buy for which there is ambiguity about whether the product is
final or intermediate.

5. Suppose during a particular year, the population in the Philippines is 80 million, the number
of people not in the work force is 37 million, and the number of people employed is 40 million.
How many people are in the labor force? Calculate the unemployment rate. (10 pts.)

6. Suppose you invest ₱1 million in a savings account paying 5 percent annual interest. The
inflation rate for the year is 3 percent. How did the purchasing power of your investment
change over the year, given this information? Now suppose the inflation rate was 8 percent.
How would the purchasing power of your investment changed? (10 pts.)
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 ________________________________________________________________________________

REFERENCES:
Fajardo, Feliciano R. ECONOMIC DEVELOPMENT, Manila, National Bookstore,
2004

Henderson, Vernon J. PRINCIPLES OF ECONOMICS, Heath and Company, 2008

Lauron, Maria Theresa N. ECONOMICS, Manila, Ibon Foundation, Inc., 2009

Medina, Roberto G. PRINCIPLES OF ECONOMICS, Rex Bookstore Inc., 2013

Zaida, Sonia LIVING ECONOMICS, 2nd ed., All National Publishing Co.,
Inc. Philippines, 2002

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