3.1 MEASURING NATIONAL INCOME (GNP/GDP, CIRCULAR FLOW)3.4 UNEMPLOYMENT AND INFLATION

 3.1 MEASURING NATIONAL INCOME

List the five main macroeconomic goals Economic Growth –a steady rate of increase of

national output Employment- a low level of unemployment Price Stability- a low and stable rate of

inflation External Stability- a favorable balance of

payments position Income Distribution- an equitable distribution

on income

3.1 MEASURING NATIONAL INCOME

Illustrate the circular flow of income model of the economy Household provide factor services and consumer

spending to firms. Firms provide income and goods and services. Household income (Y) is spent on domestic firms’ output (O), country imports (M),

taxes (T) to the government, and a portion is placed in the form of savings (S) in financial institutions, i.e.

banks. T, S, and M’s are all termed leakages (L). These L’s are countered by injections (J) which is

comprised of: government spending (G), investment expenditure (I), and export expenditure (X). Since L must always ultimately equal J it is a circular flow.

3.1 MEASURING NATIONAL INCOME

GROSS DOMESTIC PRODUCT

Gross domestic product (GDP) is the market value of all officially recognized final goods and services produced within a country in a given period.

GDP per capita is often considered an indicator of a country's standard of living; GDP per capita is not a measure of personal income.

GDP can be determined in three ways, all of which should, in principle, give the same result. They are the product (or output) approach, the income approach, and the expenditure approach.

3.1 MEASURING NATIONAL INCOME

Distinguish between three equivalent measures of national income Income: Income takes into account wages

and salaries, rent, interest, self-employed income and adds up to make total domestic income.

Expenditure: Takes into account all spending in an economy. GDP=C+I+G+[N-X]

Output: Takes into account everything which is produced in an economy.

1.1 BASIC DEFINITIONS

Economic growthAn increase in real GDP or an increase in the quantity of

resources Gross Domestic Product (GDP) is often used to measure

economic growth Economic development

A qualitative measure of a country's standard of living which takes into account numerous factors such as education and health The Human Development Index is normally used to measure

a country's economic development Sustainable development

The rate at which a country can develop without compromising the needs of future generations

1.1 BASIC DEFINITIONS

The Green Gross Domestic Product (green GDP) is an index of economic growth with the environmental consequences of that growth factored in. Green GDP monetizes the loss of biodiversity, and accounts for costs caused by climate change. Some environmental experts prefer physical indicators (such as "waste per capita" or "carbon dioxide emissions per year"), which may be aggregated to indices such as the "Sustainable Development Index".

3.1 MEASURING NATIONAL INCOME Define and distinguish between gross national

product (GNP) and gross domestic product (GDP) GDP can be contrasted with gross national product

(GNP) or gross national income (GNI). The difference is that GDP defines its scope according to location, while GNP defines its scope according to ownership.

GDP is product produced within a country's borders; GNP is product produced by enterprises owned by a country's citizens. The two would be the same if all of the productive enterprises in a country were owned by its own citizens, but foreign ownership makes GDP and GNP non-identical.

Production within a country's borders, but by an enterprise owned by somebody outside the country, counts as part of its GDP but not its GNP; on the other hand, production by an enterprise located outside the country, but owned by one of its citizens, counts as part of its GNP but not its GDP.

3.1 MEASURING NATIONAL INCOME

Criticisms of GNP/ GDP1. Real national income excludes price changes. A short

period rise in national income during an upswing of an economic cycle does not constitute economic development.

2. GNP does not factor in a change in the population of a given nation.

3. GNP does not reveal or factor in the negative externalities such as pollution.

4. GNP tells nothing about the distribution of a societies income.

5. Does not factor in other forms of measurement such as illegal markets, services, etc.

3.1 MEASURING NATIONAL INCOME Define and distinguish between gross national

product (GNP) and net national product (NNP) The net domestic product (NDP) equals the gross

domestic product (GDP) minus depreciation on a country's capital goods.

Net domestic product accounts for capital that has been consumed over the year in the form of housing, vehicle, or machinery deterioration. The depreciation accounted for is often referred to as "capital consumption allowance" and represents the amount of capital that would be needed to replace those depreciated assets.

Thus, NDP estimates how much the country has to spend to maintain the current GDP. If the country is not able to replace the capital stock lost through depreciation, then GDP will fall. In addition, a growing gap between GDP and NDP indicates increasing obsolescence of capital goods, while a narrowing gap means that the condition of capital stock in the country is improving.

3.1 MEASURING NATIONAL INCOME Define and distinguish between nominal GDP and

real GDP Real gross domestic product (GDP) is a macroeconomic

measure of the value of output economy adjusted for price changes (that is, inflation or deflation). The adjustment transforms the money-value measure, called nominal GDP into an index for quantity of total output.

Nominal gross domestic product is defined as the market value of all final goods and services produced in a geographical region, usually a country. That market value depends on two things: the actual quantities of goods and services produced and their respective prices .

The relation between the nominal and real values is given the following definitional relation:

Nominal GDP = Real GDP x Price where GPD stands for nominal GDP and Price stands for the price index of GDP.

GDP NOMINAL PER CAPITA WORLD MAP IMF 2009

GDP REAL GROWTH RATE 2007 CIA FACTBOOK

3.1 MEASURING NATIONAL INCOME

Explain the uses of national income statistics Every country has an organization that is

responsible for calculating and reporting on the country’s national accounts.

National income statistics can be seen as a “report card” for a country. Can be uses to judge whether a government has been successful in achieving its macroeconomic objectives.

Governments use the statistics to develop policies

3.1 MEASURING NATIONAL INCOME Explain the limitations of using national

income statistics Inaccuracies: Various measures of national

income come from a vastly wide range of sources Unrecorded or under-recorded economic

activity- informal markets: External costs: GDP figures do not take into

account the cost of resource depletion. Quality of life concerns: GDP may grow

because people are working longer hours, or taking fewer holidays.

Composition of output: a countries output may not benefit consumers, such as defense and capital goods

3.1 MEASURING NATIONAL INCOME Explain the limitations of using national income statistics Composition of Output : Does not show what this income is

spent on for example Soviet Russia spent significant amounts on armaments in the cold war, however this does not improve the standard of living.

Composition of Expenditure: National income figures do not take into account what the incomes are spent on. For example heating in cooler countries adds nothing to standards of living; however, does contribute to national incomes.

Exchange Rate Distortions: Exchange rate conversions may not create an accurate representation of a populations relative purchasing power. Purchasing power parity may take this into account.

Unaccounted for Activity : Parallel markets, such as subsistence living and black market activity are not taken in GDP.

Distribution of Income: Doesn't take into account how this income is distributed.

Intangible additions to welfare: Doesn't take into account the ability to enjoy fresh air and have leisure time.

Externalities and environmental damage: Damage to the environment and pollution are not taken into account.

3.1 MEASURING NATIONAL INCOME

Explain the uses of national income statistics Economists use the statistics to develop

models and make forecasts of the future Businesses use statistics to make

forecasts about the future An economy over time can be used to

evaluating the standard of living or quality of life of a country

Can be used to compare different countries

3.4 UNEMPLOYMENT AND INFLATION Explain the concepts of inflation

and deflation Inflation is defined as a sustained rise

in the average price level and a fall in the value of money.

Deflation is defined as a sustained fall in the average price level and a rise in the value of money.

3.4 UNEMPLOYMENT AND INFLATION Explain the concepts of inflation

and deflation Inflation is defined as a sustained rise

in the average price level and a fall in the value of money.

Deflation is defined as a sustained fall in the average price level and a rise in the value of money.

3.4 UNEMPLOYMENT AND INFLATION Discuss the costs of inflation

and deflation Costs of inflation

Loss of purchasing power Effects on savings Effects on interest rates Effects on international competitiveness Uncertainty Labor unrest

3.4 UNEMPLOYMENT AND INFLATION Discuss the costs of inflation and deflation Costs of deflation

Unemployment- less demand so workers are layoff

Effects on investment- less confidence so less business spending for the future

Cost to debtors- less income so harder to pay off loans

3.4 UNEMPLOYMENT AND INFLATION Explain the causes of inflation and

deflation Causes of inflation

Demand-Pull Inflation: results from an increase in aggregate demand when the economy is at or near full-employment.

Cost-Push Inflation: results from an increase in the cost of production. (energy or labor mostly) Seen by an inward shift of the aggregate supply.

Inflation due to excess monetary growth: With more money in the system there is more demand and spending which increases aggregate demand.

3.4 UNEMPLOYMENT AND INFLATION Explain the causes of inflation and deflation

Causes of deflation Good type of deflation: comes about from improvements in the supply side of the economy and/ or increase in productivity. This results in an increase in real output and a fall in unemployment.

Bad type of deflation: comes about from a fall in aggregate demand which reduces prices but with an increase in unemployment because of a fall in real output.

3.4 UNEMPLOYMENT AND INFLATION Explain the measures that may

be taken to reduce inflation For Demand-pull inflation, the

approach would be to either reduce aggregate demand with either deflationary fiscal policy and/ or deflationary monetary policy. Policies to increase aggregate supply would also be used to increase real output and lower price levels.

3.4 UNEMPLOYMENT AND INFLATION Explain how inflation is measured The Consumer price index (CPI) / retail price index (RPI)

measures changes in the average prices of goods and services that the average consumer sees.

The GDP deflator is measured as the ratio of the value of total domestic output at current prices divided by the same quantity of output valued at the constant prices of a selected base year

The tax and price index (TPI) attempts to measure the changes in income before tax that the average consumer would need to maintain their purchasing power

The producer price index (PPI) measures changes in the average prices of goods sold in primary markets by producers of commodities in all stages of processing

All price indices suffer from certain inaccuracies. For example, they have a hard time taking into account quality changes, and the “basket” may not always be entirely representative of the purchases actually made.

3.4 UNEMPLOYMENT AND INFLATION Discuss the problems in measuring inflation

The “basket” may not always be entirely representative of the purchases actually made.

There may be errors in the collection of data that limits the accuracy of the final results.

It takes time for the basket to change to the changes that the consumer makes in the market place.

Countries measure their rate of inflation in different ways.

Prices may change for a variety of reasons that are not sustained.

They have a hard time taking into account quality changes,

3.4 UNEMPLOYMENT AND INFLATION Stagflation

In economics, the term stagflation refers to the situation when both the inflation rate and the unemployment rate are high. It is a difficult economic condition for a country, as both inflation and economic stagnation occur simultaneously and no macroeconomic policy can address both of these problems at the same time.

3.4 UNEMPLOYMENT AND INFLATION Disinflation is a decrease in the rate of

inflation – a slowdown in the rate of increase of the general price level of goods and services in a nation's gross domestic product over time.

For example if the annual inflation rate one month is 5% and it is 4% the following month, prices disinflated by 1% but are still increasing at a 4% annual rate.

WORLD INFLATION RATE 2007

3.4 UNEMPLOYMENT AND INFLATION Explain that is meant by unemployment Full employment and Underemployment: A society is

almost never fully employed, but one of the goals is to reach full employment. Full employment has two conditions: Everyone who wants to work is working, and the rate of inflation is stable. When the economy is at full employment, there is no cyclical unemployment but still frictional and structural unemployment. This is defined as natural unemployment.

You are only classified as unemployed if you go and register with the government as available for work.

The labor force is defined as those of 16 years of age or older who are employed plus all those who are unemployed seeking work.

Unemployment rate : the number of people with no work expressed as % of the labor force

3.4 UNEMPLOYMENT AND INFLATION Define the different measures of

unemployment and explain the limitations to their validity Unemployment data may be based on

people who are registered as unemployed. Alternatively, it may be calculated as the number of people who are claiming unemployment benefits,.

There may be problems measuring the true numbers of people unemployed. For example, the incentive to register as unemployed is likely to depend on the availability of unemployment benefits. A person who is not entitled to any benefits is not likely to register as unemployed.

3.4 UNEMPLOYMENT AND INFLATION

There is also discouraged workers. These people are long-term unemployed who have given up the search for work and are no longer eligible for benefits. As soon as they give up the search, they are no longer part of the unemployed.

Distribution of unemployment: A national unemployment rate establishes an

average for a whole country, and this is very likely to mask inequalities among different groups within an economy.

Typical disparities: Geographical disparities Age disparities Ethnic differences Gender disparities

3.4 UNEMPLOYMENT AND INFLATION Discuss the costs of unemployment Cost To Individual

lower income and quality of life lower self-esteem, leading to stress and erosion of mental health

Cost To Society areas with high unemployment can see increased crime,

vandalism and gang activity. Cost To The Economy

the average unemployed person costs the British government 8000 pounds a year

loss of output diminished tax base increased transfer payments increased taxes, increased burden increased difficulty for labor market entrants - employers have

more choices, they favor experienced workers unemployed workers lose their skills

3.4 UNEMPLOYMENT AND INFLATION Distinguish between the different causes of

unemployment Classical Unemployment: (Real-Wage ) your wage is too high, the price

of the good goes up and no one buys it so the firm moves to a cheaper country

Structural: Unemployment caused by the demand for your product falling e.g. coalmining, we use oil now. Some skills are no longer needed e.g. you are a trained draughtsman but we use computers now

Frictional: This is the desirable process of finding work, employers looking for the right worker. In order to help accelerate this process, governments assist people looking for jobs with programs and qualification surveys.

Seasonal: Unemployment caused by changes in season’s. e.g Santa Clause only works a few weeks a year

Cyclical/Demand-deficient: Unemployment resulting from business recessions that occur when total demand is insufficient to create full employment.

Regional Unemployment: if there is a coalmining area which closes down there will be large unemployment in that area

Voluntary Unemployment: you are unemployed by choice, you get money from the government anyway

3.4 UNEMPLOYMENT AND INFLATION Evaluate the measures that may be

taken to reduce unemployment Classical Unemployment: (Real-Wage )

Reduce Union labor power and/or reduce or eliminate national minimum wages laws.

Structural: Enhance occupational mobility of people, so that they are more able to take available jobs. Re-trains programs, subsidies to firms that train workers, tax breaks to move to where the jobs are, support more apprenticeships programs.

3.4 UNEMPLOYMENT AND INFLATION Evaluate the measures that may be

taken to reduce unemployment Frictional: The government should lower

unemployment benefits to encourage unemployed workers to take the jobs that are available rather than allow them to wait for a better one to come along. Also, by improving the flow of information from potential employers to people looking for jobs.

Seasonal: Reduce unemployment benefits and a greater flow of information of jobs available in the off season.

3.4 UNEMPLOYMENT AND INFLATION Evaluate the measures that may be

taken to reduce unemployment Cyclical/Demand-deficient: Increase in

aggregate demand through the use of fiscal or monetary policies

Regional Unemployment: same solution as structural unemployment.

Voluntary Unemployment: same as above.

WORLD MAP OF COUNTRIES BY RATE OF UNEMPLOYMENT

THE BUSINESS CYCLE

THE BUSINESS CYCLE

The Stages of the Business Cycle There are four stages that describe the business

cycle. At any point in time you are in one of these stages:

Contraction - When the economy starts slowing down.

Trough - When the economy hits bottom, usually in a recession.

Expansion - When the economy starts growing again.

Peak - When the economy is in a state of "irrational exuberance."

THE BUSINESS CYCLE

A business cycle is characterized by fluctuations in the overall economic activity of an economy.

Real GDP does not go up in a straight line. Real GDP growth is followed by a period of economic slowdown or decline.

So the business cycle is a period of growth followed by contraction – the cycle then repeats. Periods of declining (but not necessarily negative) real GDP and rising unemployment are referred to as recessions. A widely accepted definition of a recession is two or more consecutive quarters of a decline in real GDP. A depression is a very severe recession characterized by negative real GDP (a very sharp decline in economic activity) and unusually high unemployment. Business cycles tend to be irregular in duration and magnitude.

THE BUSINESS CYCLE

What Causes the Business Cycle? The business cycle is affected by all the forces

of supply and demand. When consumers are confident, they buy now knowing there will be income in the future from better jobs, higher homes values and increasing stock prices. Even a little healthy inflation can trigger demand by spurring shoppers to buy now before prices go up. As demand increases, businesses hire new workers, which further stimulates more demand. This is the Expansion phase.

THE BUSINESS CYCLE

What Causes the Business Cycle? In the Contraction phase, confidence

is replaced by fear or even panic. Consumers sell their homes, and stop buying. Businesses lay off workers, and hoard cash. Confidence must be restored to before the Trough can be hit, and the economy re-enters a new Expansion phase.