Economic Development Learning Module

Week MACROECONOMIC FUNDAMENTALS

Learning Objectives:

To be able to understand the role of the government; Learn about production possibilities;
Identify reasons for economic growth; Appreciate the circular flow model; Comprehend
important concepts and definitions.

Assignment:

Read the following sections (found in Reading Selections in the Lesson Summary
section). Try to answer the activity section based on your own understanding.

Look over the amount of reading before you begin, and make a plan to divide it up so
absorb too much information at once. If you have any questions
about the reading, ask for help or do some extra research on your own.

Lesson Summary:

What is macroeconomics all about? Generally, people would associate it to anything

having to do with money and how to make as much of it as possible. Others claim that it
deals with making choices and facing trade offs, while others associate it with

economic health. Of course, macroeconomics covers all these and other aspects of the
of the economy, like aggregate production, general prices of gods and services, and
employment, among others

The real purpose of macroeconomics is its ability to explain how we can optimally use our
resources in order for us to achieve the highest standard of living possible. Several
definitions of macroeconomic have been formulated. For our purposes, a good definition
given
out available resources of land, labor, and capital, which are transformed by
entrepreneurs into goods and services that we can ultimately consume to satisfy our
needs and wants. Wealth in this definition includes tangibles like cars, houses,
appliances, condominiums, etc. as well as intangibles like more leisure time, cleaner air,
etc.

As you may have noticed, there is quite a disagreement over how a country should go
about accumulating the optimum amount of wealth. Some economists advocate a great
amount of government involvement, price controls, active monetary policy, etc. Others,
on the other hand, believe that government involvement should be minimal and limited to

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tasks related to defending individual rights, national defense and security, maintenance
of peace and order, etc. Many, however, believe that a combination of moderate
government involvement and private initiatives is ideal in achieving the highest standard
of living.

THE ROLE OF GOVERNMENT

The Philippines is a mixed economy with a substantial amount of government involvement

in the form of direct government spending, taxation, regulation, and monetary policies.
Economic conditions were not always like this, though changes in economic policies
happen every now and then, depending on the economic situation brought about by
national and international economic conditions.

THE PRODUCTION POSSIBILITIES FRONTIER

Before we go to the more specific subject matter of macroeconomics, we first review

some of the basic concepts in economics that are essential in our analysis: the production
possibilities frontier.

Since scarcity is a fact of economic life, we need to use our scarce productive resources
as efficiently as possible. If we succeed, we can say that we are operating at full economic
capacity since all resources are utilized in the production of goods and services needed
by the people. Usually there is some economic slack, but every so often we do manage
to operate at peak efficiency. When this happens, we say we are operating on our
production possibilities frontier (or production possibilities curve).

So, what is the production possibilities frontier? The production possibilities frontier
represents the outcome, or the production combination, that can be produced with a given
amount of resources.

For instance, let us say that a very small island country currently availing itself of 100
hectares of land, 20 machineries, and so workers, is so able to produce, maximally, 500
farm tractors and 350 tons of rice with these resources. However, it could also, with the
same number of resources, produce 400 tractors and 500 tons of rice, or 300 tractors and
580 tons of rice. Numerous other combinations, producing fractions of capital goods and
consumer goods, are possible.

THE FIVE GOALS OF MACROECONOMIC POLICY

1. Sustained economic growth

2. Price stability
3. Full employment
4. Trade balance
5. Redistribution of income

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REASONS FOR ECONOMIC GROWTH

in technology lead to economic growth. How does a country achieve significant increases
in capital goods and advances in technology? Let us look at increases in capital stock
first,

Capital goods (like machinery, equipment, factories, etc.) are produced just like any other
consumer goods such as cars, televisions, and food. At one point in time (that is, given
fixed amounts of resources and technology), assuming full-employment condition, some
capital goods can be produced only at the expense of producing fewer of other goods.
Thus, in a two-good economy, more capital goods are produced when fewer consumption
goods are produced, say 500 tractors and 350 tons of rice.

Advances in technology occur because of inventions and innovations in producing goods

and services. Inventions and innovations take place when entrepreneurs have incentives
to produce more efficiently and minimize their costs. When lower costs lead to higher
profits and greater rewards, entrepreneurs are motivated to continue to improve the
production process. Countries that allow entrepreneurs to keep all or most of these
rewards (by limiting taxation and government involvement) have been observed to
experience greater rates of technological growth.

In any case, the economy will experience growth and its production possibility curve will
shift outward. For as long as more new capital goods are produced and/or new technology
is/are utilized in the production of goods and services, then the expansion of the economy
will continue. On the other hand, the economy will not grow if capital goods, and/or
technology is/are lacking.

CIRCULAR FLOW OF GOODS, RESOURCES, AND INCOME

We have already defined in Chapter I that macroeconomics is a branch of economics

which deals with the aggregates in the economy. It specifically measures the economic
activities of a country. In macroeconomics, there are cyclical activities of inflow and
outflow brought about by several participants, not only between households and firms.
We are going to identify these activities using the circular flow model

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MEASUREMENT OF GROWTH

We measure aggregate or total output to determine if a country is improving in terms of

its economic activities and if it is showing signs of economic growth. One measurement
commonly used is called the Gross Domestic Product or GDP. It is the summation of all
goods and services produced in a specific country within a specific period of time. It does
not include factor payments from abroad.

There are three ways by which GDP is measured. For purposes of simplicity, we will be
using the value-added approach as presented in the GDP by industrial origin.

Another measure of economic growth that will be discussed in this section is the GNP per

from abroad. The GNP per capita measures how much of the GNP each member of the
population receives if the GNP were divided equally to the total population.

Per Capita GNP (or GDP)

income GNP/GDP) by the number of populations. According to the National Statistics

Office (NSO) the total population as of August 2007 is 88.57 million. Given the 2007 GNP
at current prices as Php 7,227,312 million, the GNP per capita for 2007 is Php 81,600.

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Per capita GNP = GNP

Total population

or

Per capita GDP = GDP

Total population

However, this measure is highly critized because it is erroneous to claim that each Filipino
received Php 81,600 per annum last 2007.

Difference between GDP and GNP

Based on the formula using the value-added approach, the GNP by industrial origin is:

GDP = A + I + S
GNP = GDP ± NFY

Where: A is agricultural output;

I is industrial output;
S is service; and
NFY is net factor income from abroad.

GNP is the measure of all the final goods within a specific country in a specific time period,
including earnings from abroad. In this formula for GNP, the Net Factor Income (NFY)
from outside the Philippines may be positive or negative. The net factor income is also
the difference between GNP and GDP.

Materials:

N/A

Activity:

Answer the following questions, thoroughly.

1. Why is macroeconomics the biggest branch of economics?

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2. What happen to per capita GNP when population increases?

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3.
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Learning Assessment:
Not yet
Areas of Assessment Developing Achieved Notes
evident
Discuss the role of the
government
Learn about production
possibilities
Identify reasons for
economic growth
Appreciate the circular flow
model

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