2.1 THE LEVEL OF OVERALL ECONOMIC ACTIVITY2.3 MACROECONOMIC OBJECTIVESECONOMIC GROWTH

 2.1 The level of overall economic

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

2.1 The level of overall economic

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

resourcesGross 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.Explain, using a diagram, the circular flow of income between households and firms in a closed economy with no government.

National income, output and expenditures are generated by the activities of the two most vital parts of an economy, its households and firms, as the engage in mutually beneficial exchange. The primary economic function of households is to supply domestic firms with needed factors of production – land, human capital, real capital, and enterprise. The function of firms is to supply private goods and services to domestic households and firms, and to households and firms abroad.

1.Explain, using a diagram, the circular flow of income between households and firms in a closed economy with no government.

2. Identify the four factors of production and their respective payments (rent, wages, interest and profit) and explain that these constitute the income flow in the model.

Factors of production: Basic components or inputs which are required in the production of goods and

services

Land: Rent Gifts of nature, this includes everything on the land, under the land, above the

land, or in the sea (e.g., oil, water)

Labor: Wages The human component hired to assist in producing a good or service. Simply the

number of hours of work put in by a person

Capital: Interest Any man-made aid to production. It is physical plant, machinery, equipment and

buildings; it is not the money that you invest in the stock market

Entrepreneurship: Profit Combines the other factors and takes risks recognizing the possibility of gain

from employing these factors in a specific way. An entrepreneur is the one who sees an economic opportunity and mixes land, labor and capital together to produce a product with economic value.

3. Outline that the income flow is numerically equivalent to the expenditure flow and the value of output flow.

Three equivalent measures of national income:Income: takes into account wages and salaries, rent, interest, self-employed income and adds up to make total domestic income. Wages for labor, Interest for capital, Rent for land and Profits for entrepreneurship.

National Income = W+I+R+P

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

Output: Takes into account everything which is produced in an economy. National output = Outputs of the primary sector + the secondary sector + the tertiary sector

3. Outline that the income flow is numerically equivalent to the expenditure flow and the value of output flow.

The circular flow model illustrates the essential idea that all spending in the economy will roughly equal all the income received. Thus we can say that spending on output must, at the same time, represent income to the factor of production. Economist have three main methods of counting national income: The spending (expenditure) approach The income approach The output approach

4. Explain, using a diagram, the circular flow of income in an open economy with government and financial markets, referring to leakages/ withdrawals (savings, taxes and import expenditure) and injections (investment, government expenditure and export revenue).

Injections and Leakages Model:One half of the injections-leakages model is injections, which are non-consumption expenditures on aggregate production. The three injections are investment expenditures, government purchases, and exports. These are termed injections because they are "injected" into the core circular flow of consumption, production, and income.

The other half of the injections-leakages model is leakages, which are non-consumption uses of the income generated from production. The three leakages are saving, taxes, and imports. These are termed leakages because they are "leaked" out of the core circular flow of consumption, production, and income.

Equilibrium in the injections-leakages model relies on a balance between the injections into the core circular flow and leakages out of the flow.

If leakages match injections, then the volume of the core circular flow does not change.

4. Explain, using a diagram, the circular flow of income in an open economy with government and financial markets, referring to leakages/ withdrawals (savings, taxes and import expenditure) and injections (investment, government expenditure and export revenue).

5. Explain how the size of the circular flow will change depending on the relative size of injections and leakages.

The critical implication from the circular flow is that a balance between injections and leakages maintains a constant flow of income, consumption, production, and factor payments moving between the household and business sectors. This is the essence of macroeconomic equilibrium -- the level of aggregate production remains unchanged. However, if injections exceed leakages, then the volume of the basic flow expands and aggregate production increases. Alternatively, if leakages exceed injections, then the volume of the basic flow contracts and aggregate production decreases.

6. Distinguish between GDP and GNP/GNI as measures of economic activity.

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.

6. Distinguish between GDP and GNP/GNI as measures of economic activity.

Gross National Product (GNP)A measure of citizen's activities all over the world. The difference between GNP and GDP is the value of any net property income from abroad.Gross National Income (GNI)The total value of goods and services produced by a country per year plus net income earned abroad by its nationals; formerly called "gross national product."

6. Distinguish between GDP and GNP/GNI as measures of economic activity.

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/ GNI defines its scope according to ownership. GDP is product produced within a country's borders; GNP/ GNI 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/ GNI 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/GNI; 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/GNI but not its GDP.

2.1 The level of overall economicCriticisms of GNP/ GDP:1. 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.

7. Distinguish between the nominal value of GDP and GNP/GNI and the real value of GDP and GNP/GNI

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 Levels where GPD

stands for nominal GDP and Price stands for the price index of GDP.

7. Distinguish between the nominal value of GDP and GNP/GNI and the real value of GDP and GNP/GNI

Real GDP the value of a nation’s output in a particular year adjusted for changes in the price level from a base year..Real GDP Offers a more accurate measure of actual quantity of goods and services a nation’s produces because it adjusts for price changes Nominal GDP is nation’s output produced in a year. (Base year)Real GDP is nation’s output produced in a year minus inflation

8. Distinguish between total GDP and GNP/GNI and per capita GDP and GNP/GNI.

GDP Per capita measures the total GDP of a nation divided by the total population. Gives a more realistic measure of how rich a nation is.

Total GDP is intended to be a measure of total national economic activity—a separate concept from standard of living

8. Distinguish between total GDP and GNP/GNI and per capita GDP and GNP/GNI.

8. Distinguish between total GDP and GNP/GNI and per capita GDP and GNP/GNI.

World GDP Ranking 2015 | Data and Charts

List of countries by GDP (nominal)List of countries by GDP (nominal) per capitaList of countries by real GDP growth rateGDP (current US$) WorldBank

9. Examine the output approach, the income approach and the expenditure approach when measuring national income.

There are three ways of calculating GDP - all of which should sum to the same amount:National Output = National Expenditure (Aggregate Demand) = National IncomeThe Expenditure Method = aggregate demand (AD)The full equation for GDP using this approach is GDP = C + I + G + (X-M) whereC: Household spendingI: Capital Investment spendingG: Government spending X: Exports of Goods and ServicesM: Imports of Goods and Services

9. Examine the output approach, the income approach and the expenditure approach when measuring national income.

The Income Method – adding together factor incomesGDP is the sum of the incomes earned through the production of goods and services. This is: Income from people in jobs and in self-employment (+) Profits of private sector businesses (+) Rent income from the ownership of land (=) Gross Domestic product (by factor incomes)Only those incomes that are come from the production of goods and services are included in the calculation of GDP by the income approach. We exclude: Transfer payments e.g. the state pension; income support for families on

low incomes; the Jobseekers’ Allowance for the unemployed and other welfare assistance such housing benefit

Private transfers of money from one individual to another Income not registered with the tax authorities Every year, billions of

pounds worth of activity is not declared to the tax authorities. This is known as the shadow economy. 

Published figures for GDP by factor incomes will be inaccurate because much activity is not officially recorded – including subsistence farming and barter transactions

9. Examine the output approach, the income approach and the expenditure approach when measuring national income.

Value Added and Contributions to a nation’s GDP:There are three main wealth-generating sectors of the economy – manufacturing and construction, primary (including oil& gas, farming, forestry & fishing) and a wide range of service-sector industries. This measure of GDP adds together the value of output produced by each of the productive sectors in the economy using the concept of value added.  Value added is the increase in the value of goods or services as a result of the production process

Value added = value of production - value of intermediate goods

10. Calculate nominal GDP from sets of national income data, using the expenditure approach.

HOW TO: Nominal GDP is the quantity of output in a particular year multiplied by the prices in that year.

Nominal GDP = C + I + G + NX

11.Calculate GNP/GNI from data HOW TO:

The difference between GDP and GNP is that you must SUBTRACT the value of output produced in a nation by companies based in other nations, but you must ADD the value of output produced in other nations by companies based in the nation you are calculating GNP for.

12. Calculate real GDP, using a price deflator.

HOW TO:

Real GDP is the value of a nation’s output in a particular year measured using the prices from a base year. So you must multiply the quantity from the year in question by the prices from the base year (which should be provided).If you are not given price and quantity data, rather you are given the GDP deflator price index, you can divide the nominal GDP for a particular by the GDP deflator for that year, and multiply by 100 to get the real GDP.If you know the nominal GDP and the real GDP and are asked to calculate the GDP deflator, you simply divide the nominal by the real and multiply by 100.If you have two years’ GDP deflators, and are asked to calculate the inflation between those years, you simply find the percentage change in the GDP deflator price indexes between the years given.

13. Evaluate the use of national income statistics, including their use for making comparisons over time, their use for making comparisons between countries and their use for making conclusions about standards of living.

GDP Overestimates well-being: Adding clearly negative social behaviors and

transactions as net positives for GDP. Under-reporting the loss of natural resources.GDP Underestimates well-being: The fact that people are living longer is not included. Black and underground market activity is not included. GDP does not measure many aspects of quality of life. GDP provides no information about the distribution of

income. GDP, as commonly reported in the news, does not

account for purchasing power.

13. Evaluate the use of national income statistics, including their use for making comparisons over time, their use for making comparisons between countries and their use for making conclusions about standards of living.

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

13. Evaluate the use of national income statistics, including their use for making comparisons over time, their use for making comparisons between countries and their use for making conclusions about standards of living.

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.

13. Evaluate the use of national income statistics, including their use for making comparisons over time, their use for making comparisons between countries and their use for making conclusions about standards of living.

Using GDP as a measure of a nation's economy makes sense because it's essentially a measure of how much buying power a nation has over a given time period. GDP is also used as an indicator of a nation's overall standard of living because, generally, a nation's standard of living increases as GDP increases.GDP is probably the most widely used indicator. It implies a lot about the country. If the figure is high it suggests they have a large number of productive industries producing goods. It also suggests that the service industry is well developed. (Services include things such as hospital and schools. If the figure is low it suggests that the country has few industries and few services so therefore a poor standard of living.)GDP is fairly easy to calculate from official government figures.

14. Explain the meaning and significance of “green GDP”, a measure of GDP that accounts for environmental destruction.

Green GDP is an attempt by economists to measure the growth of an economy compared to the harm production does to the environment. This is done by subtracting the costs of environmental and ecological damage done in a specific period of time from the gross domestic product, or GDP, from that some time. As a result, the damage done to the environment as a whole is factored into the equation to give a clearer picture of the consequences of growing an economy. Unfortunately, green GDP can be difficult to measure because of the problems inherent in trying to quantify the costs of ecological and environmental damage.Environmental concerns have come to the forefront of nearly every aspect of life, as people become increasingly concerned with depleted natural resources and polluted environments. These concerns are often not taken into consideration when measuring the strength of an economy. The gross domestic product, which is a measurement of both the consumption and production within a country, isn't meant to encompass these environmental issues. As a result, green GDP has been at the forefront of efforts to marry economic and environmental concerns.

15. Explain, using a business cycle diagram, that economies typically tend to go through a cyclical pattern characterized by the phases of the business cycle.

15. Explain, using a business cycle diagram, that economies typically tend to go through a cyclical pattern characterized by the phases of 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."

15. Explain, using a business cycle diagram, that economies typically tend to go through a cyclical pattern characterized by the phases of 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.

15. Explain, using a business cycle diagram, that economies typically tend to go through a cyclical pattern characterized by the phases of the business cycle.

To date, economists believe that there are five causes of the business cycle.

The first cause is changes in capital expenditures. When the economy is strong, businesses have expectations of sales growth; they invest heavily in capital goods.

After a while, businesses may decide that they have expanded to their limit, so they begin to pull back on their capital investments and cause an eventual recession.

The second cause of the business cycle is inventory adjustments.

At the first sign of an economy reaching its peak, there are some businesses that cut back their inventories and then build them back up again at the first sign of a trough. Either action causes the real GDP to fluctuate.

15. Explain, using a business cycle diagram, that economies typically tend to go through a cyclical pattern characterized by the phases of the business cycle.

Innovation and imitation are the third causes of the business cycle. Innovations include new products, new inventions, or a new way of performing a task.

When a business innovates, it often gains an edge on its competitors because its costs decrease or its sales increase. Whatever the case, profits increase and the business grows.

If other business in the same industry want to keep up, they then copy what the innovator has done (imitation) or they come up with something better.

Imitation companies usually invest heavily and an investment boom follows. Once the innovation spreads to another industry, the situation changes. Further investments are unnecessary and economic activity may slow.

15. Explain, using a business cycle diagram, that economies typically tend to go through a cyclical pattern characterized by the phases of the business cycle.

The fourth cause of the business cycle are the credit and loan policies of commercial banking.

When "easy money" policies are in effect, interest rates are low and loans are easy to get. They encourage the private sector to borrow and invest, thus stimulating the economy.

Eventually the increased demand for loans causes the interest rates to rise, which discourage new borrowers. As borrowing and spending slow down, the level of economic activity declines.

The economy keeps declining until interest rates fall and the business cycle begins over again.

15. Explain, using a business cycle diagram, that economies typically tend to go through a cyclical pattern characterized by the phases of the business cycle.

The fifth and final cause of the business cycle if external shocks. Shocks such as increases in oil prices, wars, international conflict, and natural disasters have the potential to either drive the economy up, or drive it down. The economy may benefit when a new supply of natural resources is discovered. Such was the case with Great Britain in the 1970's when an oil field was discovered off its coast in the North Sea. The British economy of course profited seeing that world oil prices were at an all time high, but the high prices hurt the United States at the same time.

16. Explain the long-term growth trend in the business cycle diagram as the potential output of the economy.

POTENTIAL REAL GROSS DOMESTIC PRODUCT: The total real output (real gross domestic product) that the economy can produce if resources are fully employed. In theory this means that the economy is operating ON the production possibilities frontier. Full employment is generally indicated by achieving what is termed the natural unemployment rate. If the economy is at full employment then actual real gross domestic product is equal to potential real gross domestic product and the actual unemployment rate is equal to the natural unemployment rate. The macro economy is thus living up to its potential.

16. Explain the long-term growth trend in the business cycle diagram as the potential output of the economy.

Potential output (also referred to as "natural gross domestic product") refers to the highest level of real Gross Domestic Product output that can be sustained over the long term.

OKUN'S LAW:

A relationship that says that the gap between actual and full employment output level of gross domestic product widens by 3.0% for each percentage point increase in the unemployment rate. When Arthur Okun discovered this empirical relationship he was on President Kennedy's Council of Economic Advisers (CEA). Okun cautioned that the relationship was valid only within unemployment rates of 3% and 7.5%.

OKUN'S LAW:

Is an empirically observed relationship relating unemployment to losses in a country's production. The "gap version" states that for every 1% increase in the unemployment rate, a country's GDP will be roughly an additional 2% lower than its potential GDP.

Interpreting Deviations from Okun’s Law

17. Distinguish between a decrease in GDP and a decrease in GDP growth.

The growth rate is the percentage increase or decrease of GDP from the previous measurement cycle. The GDP growth rate is the most important indicator of economic health. If GDP is growing, so will business, jobs and personal income. If GDP is slowing down, then businesses will hold off investing in new purchases and hiring new employees, waiting to see if the economy will improve. This, in turn, can easily further depress GDP and consumers have less money to spend on purchases. If the GDP growth rate actually turns negative, then the U.S. economy is heading towards a recession.

17. Distinguish between a decrease in GDP and a decrease in GDP growth.A decrease in GDP could simply stem from a decline in government spending, which might not be a bad thing for the economy at all, because of what and why the government is changing its spending. (Military needs vs social needs) Alternatively, GDP could decline due to less consumption, even as the society continues to produce, if the excess production is stored rather than being immediately exported.

Of course, it is also possible that a GDP decline suggests exactly what it is often said to suggest - that the economy is doing poorly across the board.

In short, context is needed to interpret GDP.

17. Distinguish between a decrease in GDP and a decrease in GDP growth.GDP growth rate is percentage increase or decrease in GDP from earlier measurement cycle.

Growth rate is annualized for ease of comparing it to previous year’s rate. GDP growth rate is determined by exports, government spending, retail expenditures, and inventory levels.

Ten Reasons for Declining GDP Growth

1. Changing social attitudes towards consumption and debt in all age groups

2. Demographics of an aging workforce

3. A severe lack of high-paying jobs for college graduates

4. Kids fresh out of college have delayed marriage, family formation, and home purchases

5. Many coming out of college are effectively debt slaves having no way to pay back student loans

6. Debt overhang from the housing bust

7. Boomers headed into retirement have insufficient savings

8. Shrinking middle-class plagued by declining real wages

9. Rapidly changing technology negates skills

10. Technology, especially robots, currently eliminates more jobs than it creates

GDP growth (annual %) List of countries by real GDP growth rate List of countries by GDP (real) per capita growth rate

2.3 Macroeconomic objectives: Economic Growth

18. Define economic growth as an increase in real GDP.

Economic growth is the increase in the amount of the goods and services produced by an economy over time. It is conventionally measured as the percent rate of increase in real gross domestic product, or real GDP. Growth is usually calculated in real terms – i.e., inflation-adjusted terms – to eliminate the distorting effect of inflation on the price of goods produced. In economics, "economic growth" or "economic growth theory" typically refers to growth of potential output, i.e., production at "full employment".

19. Calculate the rate of economic growth from a set of data.

World Bank Data Bank is an analysis and visualization tool that contains collections of time series data on a variety of topics. You can create your own queries; generate tables, charts, and maps; and easily save, embed, and share them.

20. Describe, using a production possibilities curve (PPC) diagram, economic growth as an increase in actual output caused by factors including a reduction in unemployment and increases in productive efficiency, leading to a movement of a point inside the PPC to a point closer to the PPC.

21.Explain, using a PPC diagram, economic growth as an increase in production possibilities caused by factors including increases in the quantity and quality of resources, leading to outward PPC shifts.