Chapter 13: Measuring The Performance Of The Economy PDF

© VAN SCHAIK PUBLISHERS Chapter 13: Measuring the performance of the economy  Learning outcomes Once you have studied this chapter you should be able to Explain the five main macroeconomic objectives Explain what the national accounts represent Defin...

© VAN SCHAIK PUBLISHERS Chapter 13: Measuring the performance of the economy  Learning outcomes Once you have studied this chapter you should be able to Explain the five main macroeconomic objectives Explain what the national accounts represent Define the most important national accounting concepts Show how the basic national accounting concepts are linked Define the unemployment rate Define and interpret the consumer price index (CPI) Explain the balance of payments Explain a Lorenz curve and the Gini coefficient © VAN SCHAIK PUBLISHERS  Macroeconomic objectives Economic growth an increase in the production of economic goods and services, compared from one period of time to another Full employment factors of production especially labour should be fully employed. It is an economic situation in which all available labour resources are being used in the most efficient way possible. Price stability keeping inflation as low as possible Balance of payments stability external stability in exports and imports Equitable distribution of income it ensures distributing welfare to ensure fairness and allowing members of the economy to have the same opportunity to accumulate wealth. © VAN SCHAIK PUBLISHERS Why measure the performance of the economy The economy is measured in order to: To see how the economy is performing (overall/ macroeconomic performance) To forecast the future To see what, how and when to improve To have an insight on how to achieve macroeconomic objectives Measuring the economy is done by Statistics South Africa (StatsSA) and South African Reserve Bank (SARB). It involves adding the total production of goods and services in a particular period. GDP (Gross Domestic Product) is the total value of all final goods and services produced within the boundaries of a country. Nominal GDP-raw measurement of GDP using current prices. Real GDP- adjusts the value of GDP to price changes. Measuring the level of economic activity: gross domestic product Table 13-1 Calculating value added: a simple example of the production and distribution of bread (Textbook page 235) © VAN SCHAIK PUBLISHERS  Measuring the level of economic activity: gross domestic product We have different sectors in the economy and all these contribute to the overall production in the economy. The output of one industry may be the input of the next industry and so caution needs be taken so as to avoid double counting. Therefore only the final goods/services produced, or much easily the value added by each sector in producing the final product, is considered. Any goods/services purchased for resell or processing are referred to as intermediate goods/services and are not included in GDP calculations e.g. the flour the baker bought from the miller is an input for further processing. Final goods and services refers to the goods/services that have reached their final destination e.g. the loaf of bread the shopkeeper sales to consumers. It is the final goods that are considered in GDP calculations to avoid double counting.  Three methods of calculating GDP The example we just did shows us three different ways/methods of calculation GDP and they give the same answer. They measure the same thing at different points in the circular flow of income. 1. Production method (value added) 2. Expenditure method (final goods and services) the shopkeeper’s sales. 3. Income method (incomes of the factors of production) one needs to know all factors of production employed and the reward they got e.g. labour-wages/salaries. Measurement at market prices, basic prices and factor cost The 3 methods of calculating GDP will give the same answer only if they are calculated using the same set of prices. We have market prices, basic prices and factor cost/factor income. These three differ because of various taxes and subsidies on goods/services. 1. Market prices are used usually when using the expenditure method: GDP at market price= GDP at basic price + tax on products – subsidies. 2. Basic prices are normally used when the production method is used: GDP at basic prices= GDP at market prices – tax on products + subsidies. 3. Factor prices are used when using the income method. GDP at factor prices= GDP at basic prices – other taxes on production - subsidies on products. There are two types of tax and subsidy : i) Taxes and subsidies on products e.g. value added tax and subsidizing a certain product per unit sold. ii) Taxes and subsidies on production e.g. payroll taxes and subsidies linked to a specific good like transport subsidy. Measurement at current prices and at constant prices Nominal GDP -raw measurement of GDP using current prices, face value, monetary value. Real GDP- adjusts the value of GDP to price changes, actual value, e.g. the purchasing power of salary. Real GDP allows us to see the actual growth/change in output in an economy and not change in prices. It is the one that will have meaning to measuring economic growth as it looks at actual increase or decrease in value of output produced and not increase caused by inflation. Other measures of production, income and expenditure Gross national income (GNI) or gross national product (GNP) GDP restricts the measurement of total production to the boarders of a country but we have some foreign owned firms in SA and we also have SA owned firms in other nations. If we subtract all income earned by foreign-owned factors of production in SA and add all income earned by South African factors of production in other countries we get national income, i.e. income of all permanent residents of the country and this is called GNI which is equal to = GNP. GNI= GDP + profits, dividends and other incomes from investments abroad owned by SA citizens & wages received by SA citizens working abroad - profits, dividends and other incomes made by firms in SA owned by non-South Africans e.g. BMW, Unilever etc. & wages paid to foreigners working in SA. Expenditure on GDP The expenditure approach adds together spending by the different sectors in the economy: Households consumption spending C Firms spending on investment I Government spending G Foreign sector (net exports) X-Z The above gives us: GDP= C + I + G + X – Z Gross domestic expenditure (GDE) Expenditure GDP does not reflect the total value of spending within the borders of SA. GDE will show us the spending that happened in SA: -GDE= C+I+G whilst GDP= C+I+G+X-Z. -GDP will show us net exports. GDE will only show us spending done within the borders of SA. Note it also include imports since they are consumed within the borders of the country. A summary of the basic national accounting totals the relationship that exists between national accounting concepts helps in the calculations. GDE = C+I+G GDP = GDE + X-Z which is C+I+G+X-Z @ mkt prices GNI = GDP – Net primary income payments consider the table that follows:  Other measures of production, income and expenditure Gross national income or gross national product Expenditure on GDP Table 13-3 Composition of expenditure on GDP in South Africa, 2013 (Textbook page 243) © VAN SCHAIK PUBLISHERS  Other measures of production, income and expenditure Gross domestic expenditure (GDE) A summary of the basic national accounting totals Table 13-4 National accounting totals in South Africa in 2013 (Textbook page 244) © VAN SCHAIK PUBLISHERS  Measuring employment and unemployment Full employment is another macro economic objective. Unemployment is calculated as a percentage of the total number of people willing and able to work but cannot find jobs. This percentage is called the unemployment rate. There are two definitions of unemployment: 1. Strict definition- only counts those who are unemployed and have made an effort to look for jobs. 2. Expanded definition – includes those actively looking for jobs and those that just wants to work but have not done anything to look for jobs. Employment also normally refers to formal employment but those in the formal sector may be involved in the informal sector and earn income. Informal sector is the shadow economy which is not recorded. Box 13-3 The informal sector (Textbook page 245) © VAN SCHAIK PUBLISHERS  Measuring prices: the consumer price index Prices and purchasing power The other macro economic objective is that of price stability-reducing inflation -When price increases it erodes the purchasing power of money -StatsSA uses the consumer price index (CPI) to measure prices -Economists are interested in what is happening to the prices of goods and services. They also need information about price movements to be able to distinguish between nominal and real values. When the prices of goods and services increase, the purchasing power of our income decreases. The consumer price index (CPI) Its an index of the price of a representative basket of consumer goods and services. The StatsSA selects goods and services they see as basics, assign weights to each good, decide on a base year, decides on the formula formula to calculate CPI and collects prices every month and compute CPI monthly. © VAN SCHAIK PUBLISHERS  The consumer price index (CPI) Box 13-5 Constructing a price index: a simple example (Textbook page 246) CPI=Cost of basket in current period/Cost of basket in base period x 100  Measuring prices: the consumer price index Prices and purchasing power Box 13-4 Index numbers (Textbook page 246) The consumer price index (CPI) Box 13-5 Constructing a price index: a simple example (Textbook page 246) Table 13-5 The South African consumer price index (all urban areas), 2012 and 2013 (December 2012 = 100), seasonally adjusted (Textbook page 248) Box 13-6 Changes in purchasing power (Textbook page 249) © VAN SCHAIK PUBLISHERS  Measuring the links with the rest of the world: the balance of payments The 4th macroeconomic objective is of Balance of payments (BOP) stability, i.e. the link of a country with other countries. Every country keeps a record of all its transactions with other countries in an account called the BOP account compiled by the reserve bank. The BOP account has two major accounts: 1) The current account records all purchases of goods/services (imports) as well as all sale (exports). -A surplus in this account means X > Z and a deficit means Z > X. 2) The financial account records all financial flows, in and out, of the country e.g. sales and purchases of bonds and shares. -A surplus in this account means more funds flowed into the country than those that flowed out (the country had a net inflow of foreign capital). -A deficit indicates that more funds flowed out of the country than those that flowed in (net outflow of foreign capital). Box 13-7 All transactions with the rest of the world are recorded in the balance of payments (Textbook page 250) Table 13-6 South Africa’s balance of payments, 2012 and 2013 (Textbook page 251) © VAN SCHAIK PUBLISHERS  Measuring the links with the rest of the world: the balance of payments Current account Shows the rand value of goods exported and imported during a period, together with net gold exports they give the trade balance. Services will be shown as service receipts and payments for services. Services includes transportation of goods and people, constructions, insurance, money spent by tourists etc. We also have income receipts and income payments in the current account Income receipts is income earned by SA citizens in other countries (primary income from the rest of the world) and income payments refer to all income earned by people in SA that are not South Africans (primary income to the rest of the world). Income flows can be compensation of employees e.g. wages, and investment income e.g. dividends or profits. The current account also has current transfers which includes social security contributions and benefits, taxes imposed by government, immigrants remittances, gifts etc. These are money or goods transferred without anything being received in return e.g. a Malawian man working in SA may send his family money back home this will be a current transfer payment, if its coming into SA it is current transfer receipts. © VAN SCHAIK PUBLISHERS  Financial account Records international transactions in assets and liabilities. It has three main components: 1. Direct investment includes transactions for the purpose of investor to control or manage the company/business. 2. Portfolio investment is purchase of shares or bonds with investor only interested in gaining a return and not controlling the firm 3. Other investment will capture all financial transactions that are not included in the two categories above. E.g. loans. The balance of the financial accounts is obtained by adding net direct investments, net portfolio investments and net other investments. Unrecorded transactions The BOP also has the section that records all errors and omissions in recording. This is a balancing figure that ensures that the BOP balances, i.e. the total of the financial account and the current account should equal the gold and other foreign reserve total. Unrecorded transactions caters for any differences. Gold and other foreign reserves The sum of current account, capital transfers balance, financial account balance and unrecorded transactions is shown in the foreign reserves. The gold reserve will show gold production held by the reserve bank. TABLE 13-6 South Africa’s balance of payments, 2012 and 2013  Measuring inequality: the distribution of income The other macroeconomic objective is of distribution of income in the economy. Researchers use tax data and census information to try and see the distribution of income and then use certain criteria to measure degree of equality/inequality. We look at 3 of the measures used: 1. Lorenz curve It is a graphical representation of the distribution of income and wealth. It plots cumulative income on the vertical axis and percentile of the population according to income on the horizontal axis. The straight diagonal line (serves as reference point) represents perfect equality in income distribution and the Lorenz curve lies beneath it showing the actual distribution. To construct the curve, the population has to be divided/ranked from poorest to richest on a cumulative percentage basis.  Measuring inequality: the distribution of income 2. Gini coefficient Another measure of inequality is called Gini ratio and is linked to the Lorenz curve. The Gini ratio is obtained by dividing the area of inequality shown by the Lorenz curve by the area of a right triangle formed by the axes and the diagonal line which in our Lorenz curve is triangle 0AB. The Gini coefficient ranges between 0 and 1 and when multiplied by 100 it gives the Gini index varying from 0 to 100. If there is perfectly equal distribution of income the Gini ratio will be 0 in which case the Lorenz line will be the same as the diagonal line. A higher Gini ratio means higher inequality. 3. Quantile ratio It is a ratio of the percentage of income received by the highest percent of the population to the percentage of income received by the lowest percent of the population. E.g. top 20 per cent population receives 50 and lowest 20 receives 3 (table 13-7) the quantile ratio will be 16,7 (50/3). The higher the ratio the greater the degree of inequality. Measuring inequality: the distribution of income Lorenz curve Table 13-7 A hypothetical income distribution (Textbook page 253) © VAN SCHAIK PUBLISHERS  Measuring inequality: the distribution of income Lorenz curve Figure 13-1 A Lorenz curve (Textbook page 253) The straight line indicates perfectly equal distribution of income. The degree of inequality is shown by the deviation from the diagonal (distance between the straight line and the Lorenz curve). The greater the distance the greater the degree of inequality shown by the shaded area(area of inequality). © VAN SCHAIK PUBLISHERS  Important concepts Economic growth Income method Full employment/ Market prices unemployment Basic prices Price stability/inflation Factor cost Balance of payments (or Current prices external) stability Constant prices Distribution of income Nominal GDP Gross domestic product Real GDP (GDP) Gross national income (GNI) Final and intermediate goods Net primary income payments Value added Consumption of fixed capital Production method Gross domestic expenditure Expenditure method (GDE) © VAN SCHAIK PUBLISHERS  Important concepts Purchasing power Portfolio investment Specific index Other investment General (composite) index Unrecorded transactions Consumer price index Gold and other foreign Balance of payments reserves Current account Gross reserves Financial account Net reserves Trade balance Lorenz curve Direct investment Gini coefficient Gini index © VAN SCHAIK PUBLISHERS