Fundamentals of Economics

9

CHAPTER

INTRODUCTION TO MACROECONOMICS

LEARNING OUTCOMES

At the end of this chapter, you should be able to:
 Interpret the meaning of macroeconomics.
 Distinguish the differences between macroeconomics

and microeconomics.
 State and explain the objectives of macroeconomics

from the conventional and Islamic perspectives.

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INTRODUCTION TO
MACROECONOMICS

Microeconomics • The branch of economies that
studies decision making by a single
individual, household, firm, industry
or level of government

• E.g. How much to produce?, How
price is determine?

Macroeconomics • The branch of economies that studies
decision making for the economy as a
whole.

• E.g. Inflation, unemployment, money
supply, and national income

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INTRODUCTION TO
MACROECONOMICS (cont.)

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OBJECTIVES OF MACROECONOMICS

Objectives of Conventional
Macroeconomics perspective

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OBJECTIVES OF MACROECONOMICS
(cont.)

Macroeconomic Objectives from the Conventional
Perspective

To achieve full employment

To achieve price stability
To achieve economic growth

To achieve an equitable distribution of income

To achieve equilibrium in the foreign sector

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OBJECTIVES OF MACROECONOMICS
(cont.)

(1) To Achieve Full Employment

 Full employment does not mean there is no
unemployed or jobless people in the economy.

 It is difficult to assume that full employment refers to
100% of the labour force is being employed.

 The potential benefits of full employment in an
economy are that it can optimize the available
resources efficiently.

 The crucial consequences of unemployment to the
economy are wastage of available resources and social
problems.

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OBJECTIVES OF MACROECONOMICS
(cont.)

(2) To Achieve Price Stability

 A high degree of inflation rate that is associated with a
sustained increase in the general price level can be
disastrous to an economy.

 To the consumers, inflation directly influences their
purchasing power. The quantity of goods and services
purchased will be less if inflation is high.

 Maintaining price stability is beneficial because it
means uncertainty and disruptions in the economy
are avoided. It means consumers and businesses can
safely pursue long-term consumption and production
plans.

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OBJECTIVES OF MACROECONOMICS
(cont.)

(3) To Achieve Economic Growth

 Economic growth can be described as expansion in
national output over a given period of time.

 As long as a nation achieves economic growth it tells
us that the economic performance is positive.

 However, an economy will not always encounter an
upward trend over time as economies tend to
experience short-term ups and downs in their
performance. This is called a business cycle.

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OBJECTIVES OF MACROECONOMICS
(cont.)

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OBJECTIVES OF MACROECONOMICS
(cont.)

(4) To Achieve an Equitable Distribution of Income

 It is necessary to ensure that the economic growth of
a nation is shared equally among the population

 Generally, policymakers try to ensure that there is no
wide gap between the rich and the poor.

 This is to ensure that all people are equal in terms of
standard of living.

 Disparities of income will create social friction and
bring out many problems.

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OBJECTIVES OF MACROECONOMICS
(cont.)

(5) To Achieve Equilibrium in the Foreign Sector

 Foreign sector means economic transactions or
activities that take place beyond the political
boundaries.

 If a country faces balance of payment (BOP) deficit, it
means that the country will have to borrow from
overseas and leads to high debt problems whereas a
prolonged BOP surplus will lead to inflation.

 Thus it is important for a country to understand and
determine the favourable scale of their BOP.

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OBJECTIVES OF MACROECONOMICS
(cont.)

Macroeconomic Objectives from an Islamic Perspective

Social justice
Equitable distribution of income
Universal education

Optimal rate of economic growth
Maximization of employment generation

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OBJECTIVES OF MACROECONOMICS
(cont.)

(1) Social Justice

 Social justice aims to achieve spiritual salvation to
human happiness.

 It is based on the principle that all existence in the
universe belongs to Allah.

 There is no difference between the rich and the poor,
between the high and the low, or between the white and
the black.

 There is to be no discrimination due to race or colour or
position.

 The only criterion of a man's worth is character, ability
and service to humanity.

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OBJECTIVES OF MACROECONOMICS
(cont.)

(2) Equitable Distribution of Income

 Islam insists on a powerful built-in income-redistribution
mechanism; nevertheless some income inequality is
allowed since it promotes individual initiative.

 Social justice in Islam is rooted in man's faith.

 Income redistribution, voluntary or compulsory, is not
only an economic necessity, but also a means to spiritual
salvation.

 In Islam, happiness is not derived from the possession of
material goods, but from contentment and gratitude.

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OBJECTIVES OF MACROECONOMICS
(cont.)

(3) Universal Education

 Acquisition of knowledge is obligatory in Islam.

 Thus, every child, irrespective of his birth, must receive
an equal opportunity to education.

 Man’s claim to superiority over all creations is based on
this superior knowledge.

 In an Islamic economy, the government must subsidize
or provide free education so that education is available to
equalize man who are endowed differently in terms of
wealth and property.

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OBJECTIVES OF MACROECONOMICS
(cont.)

(4) Optimal Rate of Economic Growth

 Growth in an Islamic economy is comprehensive and
includes moral, spiritual and material aspects of man's
life.

 In terms of capital formation, it includes human capital
and material capital.

 Man is the central to all economic activities. This
consideration should influence the composition of
investment because the expenditure on education is
considered an investment.

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OBJECTIVES OF MACROECONOMICS
(cont.)

(5) Maximization of Employment Generation

 An Islamic economy must ensure that economic
growth results in a maximum contribution to the
creation of new employment opportunities.

 Additional employment in the long run must be
generated in a technically efficient manner with
suitable technology in line with resource endowment.

 Ensuring sufficient employment also includes the
need to provide educational and training opportunities
in specific fields.

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10

CHAPTER

MEASURING NATIONAL INCOME AND
OUTPUT

LEARNING OUTCOMES

At the end of this chapter, you should be able to:
 Describe the circular flow of income in two-, three- and four-

sector economies
 Identify the concepts of measuring national income
 Measure national income by using the three approaches
 Distinguish between personal income and disposable income
 Distinguish between nominal income, real income, per capita

income, and growth rate
 Describe the uses of national income statistics
 Elaborate on the problems in measuring national income

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COMPONENTS OF
MACROECONOMICS

Households Firms

Government Rest of the
world

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CIRCULAR FLOW OF INCOME

 Circular flow of income is an economic model
depicting how money flows through the economy.

 It describes the movement of factors of production and
factors of payment.

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CIRCULAR FLOW OF INCOME (cont.)

 The flow of factors of production from households to firm and the

flow of goods and services from firms to household are matched
by equivalent flows of money—firms paying income to
households (Y) and households paying the firms for consuming

the goods and services (C).

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CIRCULAR FLOW OF INCOME (cont.)

 The government collects taxes from households and firms.
The government also makes payments. It buys goods and
services from firms, pays wages and interest to households,
and makes transfer payments to households.

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CIRCULAR FLOW OF INCOME (cont.)

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CONCEPTS OF NATIONAL INCOME

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CONCEPTS OF NATIONAL INCOME
(cont.)

Market Price Factor Cost

 Market price refers to the  Factor cost is the price of
current price in the output that is valued
market through the forces based on the cost of
of demand and supply. factors of production.

 Market prices are the  Therefore, factor cost is
actual price paid by the known as actual price
consumers. earned by producers or
sellers.

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CONCEPTS OF NATIONAL INCOME
(cont.)

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CONCEPTS OF NATIONAL INCOME
(cont.)

Gross National Income Net National Income

 The term of gross  The term of net national
national income means income means the value of
the value of national national income has been
income has been adjusted by the value of
associated by the value depreciation or net national
of depreciation. income is gross national
income minus depreciation.

NDP at market price = GDP at market price – Depreciation value

NNP at market price = GNP at market price – Depreciation value

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CONCEPTS OF NATIONAL INCOME
(cont.)

Personal Income (PI) Disposable Personal Income (DPI)

 Personal income is the  Disposable personal
real income earned by income is the income
households before they available for personal
pay personal income consumption expenditure
taxes. and personal saving (after
minus tax).

PI = National income + Transfer payments – Corporate income taxes –
Retained earnings – Employee’s Provident Fund (EPF) – Social security
contributions (SOCSO) – Insurance premium

DPI = Personal income – Personal income tax

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METHODS OF MEASURING INCOME

 The accurate meaning of national income is commonly
referred to as the concepts of gross domestic product
(GDP).

 GDP is the total market value of all final goods and
services produced within a given period of time by
factors of production located within a country.

 The GDP can be computed in three ways:

(i) Income approach

(ii) Expenditure approach

(iii) Product or Output approach

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METHODS OF MEASURING INCOME
(cont.)

 Since the income approach, expenditure approach
and product approach are the three methods of
measuring the same thing, they must thus be
identical.

 This can be expressed as accounting identity:

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METHODS OF MEASURING INCOME
(cont.)

Income Approach
 The income approach measures national income by

looking at the GDP from the perspectives of sum of
incomes received from the production of the output.

Components in Income Approach

Compensation Proprietors’ Rental income Corporate Net interest
of employees income profits

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METHODS OF MEASURING INCOME
(cont.)

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METHODS OF MEASURING INCOME
(cont.)

National Income (NI) = NDPfc + Net Factor Income Abroad

Personal Income (PI)= National income + Transfer Payments
Corporate Income Taxes – Retained/Undistributed Earnings –
Employee’s Provident Fund (EPF) – Social Security
Contributions (SOCSO) – Insurance Premium

Disposable Personal Income (DPI) = Personal Income –
Personal Income Tax

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METHODS OF MEASURING INCOME
(cont.)

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METHODS OF MEASURING INCOME
(cont.)

Expenditure Approach
 Expenditure approach measures national income by

looking at the GDP from the perspectives of total spending
on the final goods and services.

Components in Expenditure Approach

Personal Gross Private Government Net Export
Consumption Domestic Expenditure (G) (X – M)
Expenditure (C)
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METHODS OF MEASURING INCOME
(cont.)

GNPmp = GDPmp + Net Factor Income Abroad

GNPfc = GNPmp + Subsidies – Indirect Taxes

National Income (NI) = GNPfc – Depreciation

Personal Income (PI) = National income + Transfer Payments –
Corporate Income Taxes – Retained/Undistributed Earnings –
Employee’s Provident Fund (EPF) – Social Security Contributions
(SOCSO) – Insurance Premium

Disposable Personal Income (DPI) = Personal Income – Personal
Income Tax

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METHODS OF MEASURING INCOME
(cont.)

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METHODS OF MEASURING INCOME
(cont.)

Output Approach
 Under Output or Product or Value Added Approach,

national income is measured by adding up the net value of
all the goods and services produced in the country, sector
by sector during a year.

Three Sector in Output Approach

Primary Secondary Tertiary
Sector Sector Sector

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METHODS OF MEASURING INCOME
(cont.)

GNPfc = GDPfc + Net Factor Income Abroad

National Income (NI) = GNPfc – Depreciation

National Income (NI) = GNPfc – Depreciation

Personal Income (PI) = National income + Transfer Payments –
Corporate Income Taxes – Retained/Undistributed Earnings –
Employee’s Provident Fund (EPF) – Social Security Contributions
(SOCSO) – Insurance Premium

Disposable Personal Income (DPI) = Personal Income – Personal
Income Tax

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METHODS OF MEASURING INCOME
(cont.)

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NOMINAL INCOME VS REAL
INCOME

Nominal Income Real Income

 Nominal income is the  Real income refers to the
national income that is national income that is
measured in the current measured at a constant
price level. price or in a base year.

 Any change in nominal  By comparing the value
income reflects the of production in the two
combined effects of years at the same prices,
change in quantity and the changes in real
change in price level. income reflects only the
changes in real output.

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NOMINAL INCOME VS REAL
INCOME (cont.)

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NOMINAL INCOME VS REAL
INCOME (cont.)

Per Capita Income
 GDP per capita is often used as an indicator of living

standards.
 Per capita income refers to average income per head

of population.

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NOMINAL INCOME VS REAL
INCOME (cont.)

Growth Rate
 Growth rate is the percentage change in quantity of

goods and services produced from one to another.

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USES OF NATIONAL INCOME

(1) Standard of living indicators
 Standard of living reflects the individuals’ welfare
because it shows how much goods and services can

be consumed by each individual in a country. It can

be measured by GDP per capita.

(2) Government planning and policies
 The available statistics of national income can guide
the policy makers in planning for the future. From the
national income data, the government can view the
historical trends and performance of economic
sectors.

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USES OF NATIONAL INCOME (cont.)

(3) Sectoral contributions
 An economy consists of various economic activities.
Hence, with the available statistics of national income
data, the study of the economic sectors can tell us the
relative importance of various parts of the economy and
whether these change with time relatively. It is also
useful in the context of the analysis of specific problems
of an economy.

(4) International comparisons
 With the national income statistics, we not only can
compare the absolute size of one economy relative to
another, but compare how well-off the average individual
is in each country.

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