General Economics and Taxation with Financial Literacy

MODULE 5: Introduction to Macroeconomics Instructor: Maria Idora C. Lemoneras, CPA

Objectives:
At the end of this module, the students will be able to:
1. Determine the phases of business cycle
2. Understand the circular flow of an economic activity
3. Classify the factors to sustain growth and development
4. Discuss the employment and unemployment theory

Phases of Business Cycle

Any economy, whether local, national, or international, follows the four phases of business cycle.
1. Prosperity
2. Recession
3. Depression
4. Recovery

The time frame of each phase depends on various factors that affect an economy. For instance,
insufficient supply of oil leads to increase prices and eventually may lead to worse economic situation for
importing countries. Also, the calamities hitting many countries in the world are dragging down the economy to
depression.

Prosperity

Depression

Figure 1: The Business Cycle

Circular Flow of an Economic Activity

Economic model is a simplification of economic reality. It can be presented into the following forms:
a. Mathematical equations
b. Set of diagrams
c. Scheme of flow charts

Macroeconomic models provide a systematic guide that permits the complexities of the operations of
the economy as a whole for understanding and interpretation.

Macroeconomic analysis aims to diagnose the reason for failure in achieving economic goals and to
point the way toward better performance in the future.

In Figure 2, the consumers provide economic resources to the business firms. These economic
resources or inputs of production are utilized to produce goods and services. These will in turn be passed on to
the consumers.

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 The flow of physical goods is accompanied by a flow of income. The consumers deliver the economic
resources to the producers with corresponding payments. These payments are in the form of wages and
salaries, interest and rent. On the other hand, the goods and services produced by the firms will be passed on
to the consumers thru payments too, called consumption expenditures.

Figure 2: Circular flow of economic activity reflecting the outflows and inflows
The incomes received by the consumers are spent for the purchase of goods and services. If there is
an equilibrium, which is the total demand of the consumers equals the amount of goods and services produced
by the business firms then everything is reverted back into the system. However, the consumers do not always
spend all the income they received. A portion of the income is saved. This amount saved is not returned into
the system. Thus, savings have the effect of decreasing the level of economic activity in the flow. Savings
constitute the first outflow from the stream.

The existence of the government in the model shows that from the income derived by the consumers, a
portion of it goes to the government in the form of taxes. Taxes lessen the disposable income of the
consumers thereby decreasing the amount for spending. Taxes therefore decrease the level of economic
activity and constitute the second outflow.

When we import foreign goods and services, such amount paid flowed out of the system. Hence,
imports lessen the economic activity and constitute the third outflow.

If there is a continuous outflow in the economy, recession sets in and eventually led to depression.
Siphoning back the lost funds can offset this situation. When consumers save, normally in banks, such amount
can be reverted back to the system if the banks will invest such funds. Banks can lend the said funds to the
business sectors so that the latter will have money to produce goods and services. If investment is equal to
savings, it offsets the outflow caused by the savings of consumers.

When the government collects taxes, these are used to defray expenses such as infrastructure, social
services, education, and many others. In doing so, the amounts are spent back into the system and offsets the
outflow in the form of taxes.

When the Philippines imports goods, it expects that other countries reciprocate by buying our goods.
When these countries buy our goods, funds flow back into the system. Hence, export offsets import.

Equilibrium condition: Outflows = Inflows

Leakages = Injections
S+T+M =I+G+X

When the outflow equals the inflow, the level of economic activity is maintained. An excess inflow over
the outflow results to expansionary. A contracting economy follows if the outflow exceeds the inflow.
Manipulating the outflow an inflow can affect the level of economic activity. However, the outflows are difficult
to control because they are dependent on income. When income increases, savings, taxes and imports tend to

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increase too. In contrast, inflows are easier to manipulate. Therefore, proper government policy can encourage
exports and investments.

In order to manipulate the inflows and outflows, various policies can be implemented. Monetary policy
can affect savings and investment. Fiscal policy can control taxes and government expenditures. While, trade
policy can affect the country’s exports and imports.

The economic model above can be expressed in mathematical form:

Y = C + I + G + (X – M)
Where Y = National Income
C = Consumption Expenditures
I = Investment
G = Government Expenditures
X = Export
M = Import

The economic performance of a nation can be gauged by using indicators like Gross National Product
(GNP), Gross Domestic Product (GDP), Per Capita Income (PCI) and Per Capita GNP.

Economic Growth and Business Cycle

No economy can sustain growth and development over long period of time. This is because every
business is affected by various factors classified as:

1. Exogenous – forces outside the economic system like natural calamities, political crisis, wars or
technological changes. No economy can sustain development if natural calamities, war or any
exogenous factors hits the country.
2. Endogenous – forces within economic system like multiplier, accelerator, monetary policies or
innovations.

Employment and Unemployment

Employment rate is one indicator used in determining the four (4) phases of business cycle. Prosperity
for instance is determined if there is full employment. There is full employment when there is available job for
every person who is willing and able to work. This definition does not necessarily mean zero unemployment.
Even if about 6% of the labor force are unemployed, this can still be considered as full employment. (Fajardo,
1990).

Unemployment is categorized as follows:

1. Frictional unemployment - a situation where workers look for other jobs or are laid off due to
some reasons like friction against co-workers, employers, or environment.

2. Structural unemployment - Innovations and technological changes render the skills and talents of
some workers obsolete. Hence, they were laid off.

3. Cyclical unemployment – When the economy starts to fall, more companies and businesses close
shop. This results to unemployment of the workers.

4. Seasonal unemployment - Like in agriculture, during the planting season, the employment
reaches the highest; but once the field is planted with crop, the employment starts to decline and
many become unemployed. Similarly, in the industrial sector, Christmas season, class opening, or
summer or rainy seasons affects many production and corresponding, employment.

5. Societal unemployment – People like ex-convict, disabled and ex-mental patients have difficulty in
looking for a job because society believes that they are not worthy to be trusted.

There are two theories of employment.

1. Classical theory of employment (by Adam Smith). This theory is based on the supply and
demand principle. It says that there is more employment at a lower wage rate. If wage hikes,
employers will tend to lay off their workers. The theory claims that there is widespread
unemployment because people do not want a lower wage.

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 2. Keynesian theory of employment (by John Maynard Keynes). This is considered the modern
theory of employment. It explains that employment is triggered by the aggregate demand for goods
and services. As demand gets higher, production increases giving rise to more employment. This
theory further argues the contention of the classical theorist regarding the unemployment due to
stubborn acceptance of lower wages. This is not true if there is depression. Even a meager income
will be accepted by anyone to have employment during depression.

References
Carlos L. Manapat and Fernando R. Pedrosa (c 2018): Economics, Taxation, and Agrarian Reform Second
Edition, C&E Publishing, Inc.

Elsa T. Silon, Ramon A. Bernardo and Melani C. Quilloy (c2009): Manual for Economics with Work Exercises,
Rex Book Store

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