General

Macroeconomic
Analysis: Azerbaijan

Lecture plan:
Economics:

Macroeconomics and
Microeconomics

Definition
The

of GDP

components and measurement of GDP

Nominal

and Real GDP

The

Circular-Flow diagram

GDP

and Human Welfare

Azerbaijan

in figures

Economics: Macroeconomics
and Microeconomics

An Economy (Latinoeconomia, Greekoikonomia) is the large

set of the inter-related production, distribution or trade, and
consumption of goods and services activities of different
agents in a given geographical location.

Economics, briefly, is the study of how society manages its

scarce resources. In broad definition, Economics is a social
science that studies how individuals, firms, governments and
nations make choices on allocating scarce resources to satisfy
their unlimited wants.

Economics: Macroeconomics
and Microeconomics
Definitions of Economics is classified in three
broad approaches:
1.

Wealth definition of Economics (Adam Smith)

2.

Welfare definition of Economics (Alfred

Marshall)

3.

Scarcity definition of Economics (Lionel

Robbins)

Economics: Macroeconomics
and Microeconomics
Two major levels of Economics are Macroeconomics and
Microeconomics as follows:
I.

Macroeconomics (from the Greek prefixmakro-meaning "large"

and economics) is a branch of economics dealing with the
performance, structure, behavior and decision-making of an
economy as a whole, rather than individuals. That includes
national, regional and global economies.

II.

Microeconomics (from Greek prefixmikro-meaning "small") is a

branch of economics that studies the behavior of individuals and
firms in making decisions regarding the allocation of limited
resources.

Definition of GDP

Gross domestic product(GDP) of a country is a

monetarymeasureof the value of all final goods and
services produced within a country`s borders in a specific
time period (quarterly or yearly).

Nominal GDP is the monetary value of all final goods and

services that are produced in the country.

Real GDP is a measure of the quantity of all final goods

and services that are produced. In other words, real GDP
is equal to the economic output adjusted for the effects of
inflation.

The components and

measurement of GDP
There are two major methods of GDP measurements:
1.

Expenditure approach

2.

Income approach

Davis, M. A. (2009).Macroeconomics for MBAs and

masters of finance. Cambridge University Press.

Expenditure method and its

components

In this method, economists find it useful to disaggregate GDP (total

production) into a few key components:

GDP C + I + G + (X M) ,where
C = private consumption;
I = private investment;
G = government spending;
X = exports;
M = imports, and X-M = net-exports.

This is called the expenditure side of measuring GDP, since it subdivides

output into categories based on how the output is spent.

Expenditure method and its

components
- Consumption is anything that, once enjoyed today, cannot be
enjoyed tomorrow.
- Investment is anything we store away that provides us with the
potential for consumption tomorrow. Investment does not provide us
with any utility today.
- Government spendingorexpenditureincludes all government
consumption, investment, and transfer payments.
- Imports are goods and services brought into one country from
another.
- Exports refers to selling goods and services produced in the home
country to other markets.
- Net exports is the value of a country's totalexportsminus the value

Income method and its

components

So far, we have talked about expenditure method. However,

every time a manat spent is a manat is earned. Thus, there
occurred to be income method as well.

Income method is used as the sum of primary incomes

distributed by resident producer units. In other words, This method
measures GDP by adding incomes that firms pay households for
factors of production they hire - wages for labour, interest for
capital, rent for land and profits for entrepreneurship.

Note*: In practice, the expenditure side does not exactly equal the
income side, the difference is called the statistical discrepancy.

Income method and its

components

The formula for this method

is:

Two adjustments must be made to get

GDP:
1.

Adding indirect business taxes,

since those taxes are not really part
of business`s income.

2.

Depreciation (orcapital
consumption allowance) is added to
get from net domestic product to
gross domestic product. Since firms
would have subtracted this amount
from their calculation of profits by
subtracting depreciation as an
expense, we should add them to get
gross domestic product.

NI = W + R + i + PR, where
W Labor income
R Rental income
I Interest income
PR Profits

Income method and its

components

Labor Income (W):

Salaries, wages, and fringe benefits such as health or retirement. This
also includes unemployment insurance and government taxes for Social
Security.

Rental Income (R):

This is income received from property received by households. Royalties
from patents, copyrights and assets as well asimputed rentare included.

Interest Income (i):

Income received by households through the lending of their money to
corporations and business firms. Government and household interest
payments are not included in the national income.

Profits (PR):
The amount firms have left after paying their rent, interest on debt, and
employee compensation. GDP calculation involvesaccounting profitand

Examples for both

calculation methods

Using expenditure method, the C is

represented by Household
Consumption which is 304.
The Grefers to Government
Spending which is 156.
Iis gross private investment
and is 124.
(X - M)is the net exportsand in
the table is shown to be 18.
Therefore:

GDP = 304 + 156 + 124 + 18

Transfer Payments

54 m.

Interest Income

150 m.

Depreciation

36 m.

Wages

67 m.

Gross Private Investment (I)

124 m.

Business Profits

200 m.

Indirect Business Taxes

74 m.

Rental Income

75 m.

Net Exports (X-M)

Government Purchases (G)

GDP = 602 m.
Household Consumption (C)

18 m.
156 m.
304 m.

Examples for both

calculation methods

Using the same table, we can calculate it via the income method as
well. This time, Wis thewages that are represented by67 in the
table.
Rental income is theRand is75.
Interest income isIand is150.
PRarebusiness profits and are200.

Therefore:
NI = 67 + 75 + 150 + 200
NI=492 m.
GDP = 492 + 74 + 36
GDP = 602 m.

Nominal and Real GDP

Once again, to compare those two concepts, the definitions
are:

Nominal GDP is the monetary value of all goods and

services that are produced in the country.

Real GDP is a measure of the quantity of all goods and

services that are produced. In other words, real GDP is
equal to the economic output adjusted for the effects of
inflation.

Nominal and Real GDP

We could see that difference between via the following simple example using just apples
as our unique product in economy:

Suppose everyone picks apples from trees.

Denote the price of an apple in year t as p a,t .

The number of apples picked in year t is given by a t.

Thus, nominal GDP in year t is p a,t*at.

Real GDP in year t is at.

As regarding to our definition, real GDP increases, when the quantity of apples picked
are more plentiful.
However, nominal GDP increases by more than real GDP when the price of apples
increases.

Nominal and Real GDP

Now u can ask, then why and how the real GDP of whole economy is
measured in monetary units?
Here is the procedure.
For some arbitrary year (currently 2000), nominal GDP is set equal to real
GDP. This should tell you right away that the level of real GDP is meaningless
since it is arbitrary.
Year

pa

a*pa

Nom.
GDP

Real GDP
$ value
quantity

2000

20 m.

80 m.

80 m.

80 m.

2001

25 m.

125 m.

125 m.

100 m.

Real GDP2001 = a2001*pa,2000 = 5*20 m.=100 m.

The Circular-Flow diagram

Thecircular flow diagram(also called the circular

flow model) is perhaps the simplest diagram/model of
economics to understand. In essence, the circular flow
diagram displays the relationship of resources and
money between firms and households.

The Circular-Flow diagram

The Circular-Flow diagram

In the model, firms and households interact with one another

in both the product market (or goods market) and the factors
of production market (or factors market). Theproduct
market, as mentioned in the name, is where all products
made by businesses/firms are exchanged.

Thefactors of production marketis where inputs such as

land, labor, capital, and other resources are exchanged.
Households earn money by selling their resources (factors,
most often labor) to businesses in the factor market. In return,
households receive income. The price of the resources the
businesses purchase (labor from households) are the costs.
(wages and rents in the graph)

The Circular-Flow diagram

From the resources provided by households, businesses produce

goods and services, which are then sold in the product
market. Households use their incomes to purchase (spending)
these goods in the product market. In return for the goods,
businesses bring in revenue.

While this may seem like a lot of information, it is actually quite

logical. Even though the graph itself is extremely simple to most
people, it is important to have it completely memorized.

Note*: We can add financial institutions and governments to make

it more complex.

GDP and Human Welfare

Keeping the notations the same from the previous example, to
better understand the relationship, we need to define the growth of
both nominal and real GDPs. So,

Growth in nominal GDP from year t to year t + 1 is:

pa,t+1*at+1/pa,t*at

Growth in real GDP from year t to year t + 1 is:

at+1/at

If we suppose households obtain utility from apples. Then, when

real GDP increases, utility has increased.

So in this simple example, growth in real GDP is informative

about growth in living standards (utility).

Azerbaijan in figures

Azerbaijan in figures

Azerbaijan in figures

Thank you for your

attention!