Measuring The Level Of Economic Activity PDF

MEASURING THE LEVEL OF ECONOMIC ACTIVITY ALPINE SKI HOUSE 1  Economic activity is where scarce resources are allocated to produce goods & services to satisfy human wants. Macroeconomics is the study of economic activity from a whole economy perspective. This unit...

MEASURING THE LEVEL OF ECONOMIC ACTIVITY ALPINE SKI HOUSE 1  Economic activity is where scarce resources are allocated to produce goods & services to satisfy human wants. Macroeconomics is the study of economic activity from a whole economy perspective. This unit examines how economists measure the level of economic activity in a country and how this can be used to make judgements about a nation’s economy. ALPINE SKI HOUSE What you should know by the end of this chapter: National income accounting as a measure of economic activity Circular flow of income model Income, output and expenditure approaches to national income Gross domestic product (GDP) Calculation of GDP (HL) Gross national income (GNI) Calculation of GNI (HL) Real GDP and real GNI Calculation of real GDP and real GNI(HL) Real GDP/GNI per capita at purchasing power parity (PPP) Business cycle ALPINE SKI HOUSE 3 NATIONAL INCOME AS A MEASURE OF ECONOMIC ACTIVITY ALPINE SKI HOUSE 4  NATIONAL INCOME AS A MEASURE OF ECONOMIC ACTIVITY National income Economic Macroeconomics activityisisthe the where money study scarce of value economic resources of a country’s activity are allocated from output a to whole of produce finaleconomy goods goods services perspective. services produced to satisfy in (1) human year. wants. National income is the money value of a country’s output of final goods & services produced in (1) year. Economic activity is where scarce resources are allocated to produce goods & services to satisfy human wants. Macroeconomics is the study of economic activity from a whole economy perspective. Example: the German economy is well known for its high-performing manufacturing sector with famous names like Volkswagen, Daimler AG, Allianz & BMW. ALPINE SKI HOUSE 5  NATIONAL INCOME AS A MEASURE OF ECONOMIC ACTIVITY Microeconomics Macroeconomics So, any change inallows looks Germany's at usGermany’s to examine manufacturing manufacturing these individual sector has sector businesses a significant in the context and impact theof industries on theitswhole national they economy operate output.where in. it accounts for 47% of the country’s GDP. Microeconomics allows us to examine these individual businesses and the industries they operate in. Macroeconomics looks at Germany’s manufacturing sector in the context of the whole economy where it accounts for 47% of the country’s GDP. So, any change in Germany's manufacturing sector has a significant impact on its national output. ALPINE SKI HOUSE 6 THE CIRCULAR FLOW OF INCOME ALPINE SKI HOUSE 7  AN ECONOMIC MODEL Ancan It Theeconomic model circular be further has flow model been developed model that around isillustrates a useful to since include the aid theto 17th foreign flow economic century, oftrade, money forecasting government was between developed policymaking. firms banking byhouseholds John sectors. Maynard at a macroeconomic Keynes in his book, level. General Theory of Employment, Interest and Money which was published in 1936. An economic model that illustrates the flow of money between firms & households at a macroeconomic level. It can be further developed to include foreign trade, government & banking sectors. The model has been around since the 17th century, & was developed by John Maynard Keynes in his book, General Theory of Employment, Interest and Money which was published in 1936. The circular flow model is a useful aid to economic forecasting & policymaking. ALPINE SKI HOUSE 8 HOW THE MODEL WORKS The model we are going to use in our analysis of the macroeconomy is a simplified version of the model used by institutions such as banks, universities, hedge funds & governments, but it is still very useful as a method of understanding how the macroeconomy works ALPINE SKI HOUSE 9  HOW THE MODEL WORKS It can The flow economy be explained of income can be by is divided illustrated considering intointwo the sectors, following diagram.firms principles: households. The flow of income is illustrated in the diagram. It can be explained by considering the following principles: The economy can be divided into two sectors, firms & households. ALPINE SKI HOUSE 10  HOW THE MODEL WORKS Firmsiscombine This shown bythe thefactors blue flows of production in the circular to produce flow diagram. goods and services and households buy the goods services and consume them. Firms combine the factors of production to produce goods and services and households buy the goods & services and consume them. This is shown by the blue flows in the circular flow diagram. ALPINE SKI HOUSE 11  HOW THE MODEL WORKS To produce This is shown the bygoods the red services flows infirms diagram. need to employ people from the households which include labor entrepreneurs and in return, the firms pay the households an income. To produce the goods & services firms need to employ people from the households which include labor & entrepreneurs and in return, the firms pay the households an income. This is shown by the red flows in diagram. ALPINE SKI HOUSE 12  HOW THE MODEL WORKS Injections ofor Withdrawal funds leakages comeof into funds the from circular theflow circular of anflow economy of income in the goform out in ofthe investment, form of savings, government tax imports. expenditure exports. Injections of funds come into the circular flow of an economy in the form of investment, government expenditure & exports. Withdrawal or leakages of funds from the circular flow of income go out in the form of savings, tax & imports. ALPINE SKI HOUSE 13  INJECTIONS TO THE CIRCULAR FLOW Injections The Investment Government Exports three of are injections goods byexpenditure the businesses services flow are: of funds on to when other public into they countries services thebuy circular capital such leadflow as to such an health that as inflow come new education of buildings from funds. firmsmachinery investing, government spending exports resulting from foreign trade. Injections are the flow of funds into the circular flow that come from firms investing, government spending & exports resulting from foreign trade. The three injections are: Investment by businesses when they buy capital such as new buildings & machinery Government expenditure on public services such as health & education Exports of goods & services to other countries lead to an inflow of funds. ALPINE SKI HOUSE 14  WITHDRAWALS FROM THE CIRCULAR FLOW Withdrawals The Savings Taxation Imports three by bought by withdrawals households governments from by the firms circular are: ofand income on households household flowthey occur do income, when lead not spend tomoney an business outflow onleaves goods profits ofthe funds. services and economy indirect through tax on goods household services savings, taxation by the government and imports resulting from foreign trade. Withdrawals from the circular flow occur when money leaves the economy through household savings, taxation by the government and imports resulting from foreign trade. The three withdrawals are: Savings by households of income they do not spend on goods & services Taxation by governments on household income, business profits and indirect tax on goods & services Imports bought by firms and households lead to an outflow of funds. ALPINE SKI HOUSE 15  APPLICATION OF THE MODEL Like demand The Here the areother somesupply models examples model we of usehelps how in Economics, the us examine circular the flow how, circular model for example, flow can be model used changes lets to analyze usinanalyze household howthe a change causes incomein consequences affect injections price andofwithdrawals output changes in ainmarket. economic affect thevariables. macroeconomy. Like the other models we use in Economics, the circular flow model lets us analyze the causes & consequences of changes in economic variables. The demand & supply model helps us examine how, for example, changes in household income affect price and output in a market. Here are some examples of how the circular flow model can be used to analyze how a change in injections and withdrawals affect the macroeconomy. ALPINE SKI HOUSE 16  APPLICATION OF THE MODEL Consider An in taxation the thevalue following inofthe exports economy examples: by an reduces economy the value the value of funds of funds in theincircular the circular flow. flow This which leads to leads a to in household increases inincomes household consumption, incomes consumption, output by firms output employment. by firms employment. Consider the following examples: An  in the value of exports by an economy  the value of funds in the circular flow which leads to increases in household incomes & consumption, output by firms & employment. An  in taxation in the economy reduces the value of funds in the circular flow. This leads to a  in household incomes & consumption, output by firms & employment. ALPINE SKI HOUSE 17 GROSS DOMESTIC PRODUCT (GDP) ALPINE SKI HOUSE 18  DEFINING GDP A country’s The GDP is ofexpressed aGDP country is theisinmoney normally moneyvalue terms considered ofusing all final the angoods annual country’s and figure, services currency, but economists produced althoughby for and that international governments country incomparison one also year. useItquarterly the is avalue statistic figures in $US used to isto track used. measure economic macroeconomic growth overactivity. time so they can closely monitor what is happening to economic activity. A country’s GDP is the money value of all final goods and services produced by that country in one year. It is a statistic used to measure macroeconomic activity. The GDP of a country is normally considered an annual figure, but economists and governments also use quarterly figures to track economic growth over time so they can closely monitor what is happening to economic activity. The GDP is expressed in money terms using the country’s currency, although for international comparison the value in $US is used. ALPINE SKI HOUSE 19  USING FINAL GOODS & SERVICES When The If you value included the of GDPintermediate the of avalue country ofgoods ais television being such calculated asproduced raw materials onlywhen the value components it is sold of final by theare goods manufacturer notisincluded used. because to a retailer this(an would intermediate lead to ‘double good)counting’. then count it again when it is sold to the consumer as a final good then you would count the value of the television twice. When the GDP of a country is being calculated only the value of final goods is used. The value of intermediate goods such as raw materials & components are not included because this would lead to ‘double counting’. If you included the value of a television produced when it is sold by the manufacturer to a retailer (an intermediate good) & then count it again when it is sold to the consumer as a final good then you would count the value of the television twice. ALPINE SKI HOUSE 20 USING THE CIRCULAR OF INCOME TO MEASURE GDP The circular flow of income gives us 3 ways of measuring the GDP. Income method Output method Expenditure method ALPINE SKI HOUSE 21  INCOME METHOD This Wages Interest Rent Profits It Transfer is important ispaid the and paid paid payments to total dividends to land tonot labor value capital toinclude count paid of income to income pensions, entrepreneurs. earned in the unemployment byform households of transfer benefits in one payments year and student inwhere the form grants, no of: economic etc. activity has been engaged in to generate the income. This is the total value of income earned by households in one year in the form of: Wages paid to labor Interest paid to capital Rent paid to land Profits and dividends paid to entrepreneurs. It is important not to count income in the form of transfer payments where no economic activity has been engaged in to generate the income. Transfer payments include pensions, unemployment benefits and student grants, etc. ALPINE SKI HOUSE 22  OUTPUT METHOD This sectors The Primary Secondary Tertiary is calculated – services commodities –are: manufacturing bysuch taking such as education, the such asvalue-added agricultural as cars, restaurants, mobile goods, of firms phones, tourism mining, in different pharmaceuticals and forestry transport, sectors fishing, ofetc. the clothing, etc. economy. etc. This is calculated by taking the value-added of firms in different sectors of the economy. The sectors are: Primary – commodities such as agricultural goods, mining, forestry & fishing, etc. Secondary – manufacturing such as cars, mobile phones, pharmaceuticals & clothing, etc. Tertiary – services such as education, restaurants, tourism and transport, etc. ALPINE SKI HOUSE 23  OUTPUT METHOD Value If Thea car thevalue-added dealer added manufacturer, takes is theofthe method each for carsector example, they of calculating have is used pays bought tofor GDP calculate the for to$10,000 materials avoid the‘double GDP and components by sells counting’. theitoutput for $14,000 toItproduce approach. is thetheir monetary a car value-added valued difference at $4,000 is $4,000. between sells the thecar purchase to a dealer costfor of the $10,000 material theninputs the value usedadded to produce is $6,000. the good and its selling price. Value added is the method of calculating GDP to avoid ‘double counting’. It is the monetary difference between the purchase cost of the material inputs used to produce the good and its selling price. If a car manufacturer, for example, pays for the materials & components to produce a car valued at $4,000 & sells the car to a dealer for $10,000 then the value added is $6,000. If the dealer takes the car they have bought for $10,000 and sells it for $14,000 their value-added is $4,000. The value-added of each sector is used to calculate the GDP by the output approach. ALPINE SKI HOUSE 24  EXPENDITURE METHOD ThisExports There Consumption Investment Government Net The table is are calculated sets (4)(X-M) (I)(G) types (C) out spending spending by the The of aggregating expenditure: GDP surplus byon by of firms the public households of the on fiveservices capital value total largest on expenditure of equipment final economies exports goods over ofin services different the thevalue world. sectors of imports of the economy. This is calculated by aggregating the total expenditure of different sectors of the economy. There are (4) types of expenditure: Consumption (C) spending by households on final goods & services Investment (I) spending by firms on capital equipment Government (G) spending on public services Net Exports (X-M) The surplus of the value of exports over the value of imports The table sets out the GDP of the five largest economies in the world. ALPINE SKI HOUSE 25 GROSS NATIONAL INCOME (GNI) ALPINE SKI HOUSE 26 CALCULATING GNI The gross national income is the total income generated by a country & is calculated by adding net property income from abroad to the GDP. GDP + net property income = GNI ALPINE SKI HOUSE 27  NET PROPERTY INCOME FROM ABROAD Property Interest Profit Rent Net property on from property on income businesses loans income ismade owned. money isowned income earned on domestic by households assetson owned different overseas assets.that Thisflow income into the comes domestic in the following income less forms: income on foreign assets that flow out of the domestic economy. Property income is money earned by households on different assets. This income comes in the following forms: Interest on loans made Profit from businesses owned Rent on property owned. Net property income is income on domestic assets owned overseas that flow into the domestic income less income on foreign assets that flow out of the domestic economy. ALPINE SKI HOUSE 28  NET PROPERTY INCOME FROM ABROAD Examples Interest Profits Rent paid made onto ofUK UK-owned property byloans a UKmade company income commercial to German inflows in Russia property to companies the UK in economy the US. include income sent back to the UK in the form of: Examples of property income inflows to the UK economy include income sent back to the UK in the form of: Interest on UK loans made to German companies Profits made by a UK company in Russia Rent paid to UK-owned commercial property in the US. ALPINE SKI HOUSE 29  NET PROPERTY INCOME FROM ABROAD Examples Profits Interest Rent paid made paid to of Chinese property on by aloans German owners income madecar by ofoutflows manufacturer luxury an Australian property from the inbank the inUK London. UK to economy UK businesses would include income sent to foreign countries in the form of: Examples of property income outflows from the UK economy would include income sent to foreign countries in the form of: Profits made by a German car manufacturer in the UK Interest paid on loans made by an Australian bank to UK businesses Rent paid to Chinese owners of luxury property in London. ALPINE SKI HOUSE 30 GNI PER CAPITA ALPINE SKI HOUSE 31  GNI PER CAPITA GNI Last 20,840,000 Economists A perper year capita capita thelike million figure GNI isto measuring calculated for use is/ much 328 the GNI US million per smaller as: GNI wascapita GNI per =$20.84 $63,537 than /head population when the trillion ofanalyzing total population. the =GNI GNI population so national per it iscapita anincome of easier the US number data wasbecause 328M to interpret. it allows GNIthem per capita to makeis particularly inter-countryuseful comparisons. when measuring a country’s economic development. GNI per capita is measuring GNI per head of population. GNI per capita is calculated as: GNI / population = GNI per capita Last year the GNI for the US was $20.84 trillion & the population of the US was 328M 20,840,000 million / 328 million = $63,537 Economists like to use GNI per capita when analyzing national income data because it allows them to make inter-country comparisons. A per capita figure is much smaller than the total GNI so it is an easier number to interpret. GNI per capita is particularly useful when measuring a country’s economic development. ALPINE SKI HOUSE 32 ADJUSTING FOR INFLATION ALPINE SKI HOUSE 33  IMPORTANCE OF REAL TERMS The valueGDP Nominal Expressingof economic aiscountry’s expressing values GDP GDP inisreal adjusted withterms no allowance for is important inflation fortoinflation. because turn theinflation GDP in nominal distorts data termsand intomakes GDP initreal difficult terms. to interpret. The value of a country’s GDP is adjusted for inflation to turn the GDP in nominal terms into GDP in real terms. Nominal GDP is expressing GDP with no allowance for inflation. Expressing economic values in real terms is important because inflation distorts data and makes it difficult to interpret. For example, if a country’s GDP rises by 3% this would be an acceptable rate of economic growth. But if that country’s inflation is 3% then the country would not have grown at all. ALPINE SKI HOUSE 34 CALCULATING REAL GDP ALPINE SKI HOUSE 35 CALCULATING REAL GDP Calculating real GDP is done by dividing the nominal GDP by the GDP deflator & multiplying by 100. ALPINE SKI HOUSE 36  NET PROPERTY INCOME FROM ABROAD The2014 For tablethe setsreal outGDP the GDP is: 1792 data/for 96ax country. 100 = 1867 The table sets out the GDP data for a country. For 2014 the real GDP is: 1792 / 96 x 100 = 1867 ALPINE SKI HOUSE 37  NET PROPERTY INCOME FROM ABROAD The2015 For growth thisrate would is calculated be: 1870by– 1867 working / 1867 out xthe 100annual = 0.16% percentage change in real GDP. The growth rate is calculated by working out the annual percentage change in real GDP. For 2015 this would be: 1870 – 1867 / 1867 x 100 = 0.16% ALPINE SKI HOUSE 38 ECONOMIC GROWTH ALPINE SKI HOUSE 39 MEASURING GROWTH Economic growth is the increase in a country’s real GDP over time. The economic growth rate of a country is the %  in its real GDP over one year. GDP figures are released quarterly so a country’s economic activity can be continuously monitored. ALPINE SKI HOUSE 40 MEASURING GROWTH The annual growth rate is calculated by: GDP current year – GDP previous year / GDP previous x 100 = current year growth rate ALPINE SKI HOUSE 41 BUSINESS CYCLE (TRADE CYCLE) Economies The Amongst average more dorate not developed of grow growth at acountries over constant a number (MDCs) rate because ofthe years trend the is called rate rateof ofthe growth growth trendisof rate normally a country of growth. around rises and 2-3%. falls over time this is called the business cycle. Economies do not grow at a constant rate because the rate of growth of a country rises and falls over time & this is called the business cycle. The average rate of growth over a number of years is called the trend rate of growth. Amongst more developed countries (MDCs) the trend rate of growth is normally around 2-3%. ALPINE SKI HOUSE 42  BUSINESS CYCLE (TRADE CYCLE) The diagram Business cycles illustrates are all slightly a conventional different,business but the conventional cycle. cycle normally follows the changes set out below: The diagram illustrates a conventional business cycle. Business cycles are all slightly different, but the conventional cycle normally follows the changes set out below: ALPINE SKI HOUSE 43  CONVENTIONAL BUSINESS CYCLE The High inflation. unemployment, boom rates of phase economic occursgrowth when the in arate boomof growth are normally is above associated the trendwith rate. incomes, The boom phase occurs when the rate of growth is above the trend rate. High rates of economic growth in a boom are normally associated with  incomes,  unemployment, &  inflation. ALPINE SKI HOUSE 44  CONVENTIONAL BUSINESS CYCLE The slowdown Household incomes phasedoofnot therise business as fast,cycle unemployment is when the economy might start goes to rise pastthere its peak is less rate pressure of growth for inflation the growthto increase. rate falls. The slowdown phase of the business cycle is when the economy goes past its peak rate of growth & the growth rate falls. Household incomes do not rise as fast, unemployment might start to rise & there is less pressure for inflation to increase. ALPINE SKI HOUSE 45  CONVENTIONAL BUSINESS CYCLE The A Household recession recession incomes is technically phasemight of the defined fall, cycleunemployment isaswhen a period realof GDP normally twofalls. consecutive increases quarters inflation of falls negative growth in real GDP. The recession phase of the cycle is when real GDP falls. A recession is technically defined as a period of two consecutive quarters of negative growth in real GDP. Household incomes might fall, unemployment normally increases & inflation falls ALPINE SKI HOUSE 46  CONVENTIONAL BUSINESS CYCLE The rate Household recovery of incomes economic phase start ofgrowth thetobusiness rise, is slow unemployment cycle to start is when with starts and the then economy to fall it accelerates. and emerges there is from upward a recession pressureand on inflation. the real GDP starts to increase. The recovery phase of the business cycle is when the economy emerges from a recession and the real GDP starts to increase. The rate of economic growth is slow to start with and then it accelerates. Household incomes start to rise, unemployment starts to fall and there is upward pressure on inflation. ALPINE SKI HOUSE 47 Thinking about a key concept - Interdependence ALPINE SKI HOUSE  The circular flow of income model developed by John Maynard Keynes shows the inter- relationships between firms, households, government & foreign sectors of the economy at a macroeconomic level. The theory that income = output = expenditure clearly shows the interdependence between the variables in the model. This can be illustrated by showing how changes in one variable affect the others. In the Covid19 pandemic 'lock-down' situations output was significantly reduced when certain sectors of the economy could not operate as normal such as tourism, hospitality & airlines. The decline in output directly led to falls in income & expenditure. ALPINE SKI HOUSE INTERDEPENDENCE Think about the way interdependence at a macroeconomic level affect the way economists model the economy. ALPINE SKI HOUSE 50 THANK YOU ALPINE SKI HOUSE