Basic concepts of macroeconomics

The essentials

Macroeconomics groups the millions of goods produced in an economy into a few broad classes. A final good is one that has crossed the boundary of production and is ready for use by its final user; it will not be processed further by a producer in that year. An intermediate good is used up as a raw material or input in producing other goods, such as steel bought by a car maker. Whether a good is final or intermediate depends on its use, not on what it is: milk bought by a household is final, milk bought by a sweet shop is intermediate.

Final goods are of two kinds. Consumption goods (food, clothes, services like a haircut) satisfy wants directly. Capital goods (machines, buildings, tools) are durable final goods used to produce other goods over many years; they are not used up in one cycle of production.

Key points

• Stock: a quantity measured at a point of time, such as wealth, capital or money supply on 31 March.
• Flow: a quantity measured over a period of time, such as income, investment, output or depreciation per year.
• Investment (capital formation): addition to the stock of capital during a period, including change in inventories.
• Depreciation (consumption of fixed capital): the fall in the value of fixed capital due to normal wear and tear and expected obsolescence.
• Net investment = Gross investment − Depreciation.
• Inventory: stock of unsold finished goods, semi-finished goods and raw materials; a change in inventory over a year is a flow and counts as investment.

Exam tips

Ask "what is it used for?" before classifying a good. Ask "does it have a time dimension like per year?" to separate flows from stocks.

Common mistakes

• Calling all machines capital goods even when bought by a household for personal use (a car for family use is a consumer durable).
• Treating depreciation as a stock; it is a flow measured over a period.