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GDP (GROSS DOMESTIC PRODUCT)

NATIONAL INCOME STATISTICSREFERENCE : AS and A level Economics by COLLIN BAMFORD

• Governments measure the total output of the country in order to assess the performance of the economy.

Governments use a variety of measures of the

country’s output. These are collectively known as NATIONAL INCOME statistics.

This is because the total output of the country is equal to total income (and total expenditure).

National output = National Income = National expenditure.

OTHER MEASURES OF NATIONAL INCOME(NI)REF: Introduction to Economics and finance for CA by Abdul Hakeem Khwaja

• GDP plus NET PROPERTY INCOME FROM ABROAD gives GROSS NATIONAL PRODUCT (GNP)

• GNP minus capital consumption gives NET NATIONAL PRODUCT(NNP)

• GDP minus capital consumption gives NET DOMESTIC PRODUCT (NDP)

GROSS DOMESTIC PRODUCTREF: Introduction to Economics and finance for CA by Abdul Hakeem Khwaja

• The most widely used measure of National Income is known as GROSS DOMESTIC PRODUCT (GDP)

• GROSS means total,• DOMESTIC refers to home economy,• PRODUCT means output.

• E.g. Pakistan’s GDP is the measure of total output by the factors of production based in Pakistan

GROSS DOMESTIC PRODUCTREFERENCE : AS and A level Economics by COLLIN BAMFORD

• GDP is calculated by adding up consumer’s spending, government spending on goods and services, total investment, and the difference between exports and imports.

• NI = C + I +G + (X – M)

INCOME DETERMINATIONREF: LETTS STUDY GUIDE FOR A LEVEL BY RAY POWELL

• The level of income in an economy is determined where aggregate expenditure is equal to output. If aggregate expenditure exceeds current output, firms will seek to produce more.

• They will employ more factors of production and so will cause GDP to rise.

• If aggregate expenditure is below current output, firms will reduce production. So output will change until it matches aggregate expenditure as shown.

INCOME DETERMINATION REF: LETTS STUDY GUIDE FOR A LEVEL BY RAY POWELL

• This diagram is referred to as Keynes 45 degrees diagram.

• It measures money GDP on X axis and aggregate expenditure on Y axis.

• The 45 degrees line shows points at which aggregate expenditure equals national income (GDP). So output is determined where C+I+G+(X-M) cuts the 45 degree line.

INCOME DETERMINATION REF: LETTS STUDY GUIDE FOR A LEVEL BY RAY POWELL

• If for e.g. C and I increases because consumers and entrepreneurs are more optimistic about future,

• Aggregate expenditure will rise and output will increase from Q to Q1.

• Figure illustrates rise in GDP.

MEASURING GDPREF: Introduction to Economics and finance for CA by Abdul Hakeem Khwaja

• There are three ways of calculating GDP,

• THE OUTPUT• THE INCOME MEASURE• THE EXPENDITURE MEASURE

• They should give the same total because they all measure the flow of income produced in an economy.

THE CIRCULAR FLOW OF INCOME IN A SIMPLE ECONOMY

• 1. National Output. Output is produce by firms.

• 2. National Income. Firms have to pay workers to produce the output. Therefore income flows from firms to households

• 3. National Expenditure. With wages from work, households can they buy goods produced by firms. Therefore, the spending goes back to firms.

THE OUTPUT MEASURE REF: LETTS STUDY GUIDE FOR A LEVEL BY RAY POWELL

• The output method measures the value of output produced by industries including, manufacturing, construction, distributive, hotel , catering and agricultural industries.

• In using this measure it is important to avoid the same output twice.

OUTPUT MEASURE REF: LETTS STUDY GUIDE FOR A LEVEL BY RAY POWELL

• E.g., value of cars sold by car manufacturers is added to the value of output of tyre firms, double counting will occur.

• Value added is the difference between the sales revenue received and the cost of raw materials used.

OUTPUT MEASURE REF: LETTS STUDY GUIDE FOR A LEVEL BY RAY POWELL

• If a TV manufacturing firm buys components costing $60,000 and uses them to make TVs which it sells for $130,000, it has added $70,000 to the output. It is this $70,000 which will be included in the measure of output.

THE OUTPUT MEASUREREF: INTRODUCTORY ECONOMICS BY STANLAKE

• This method is very important to avoid double counting

• Adding up the total outputs of all the firms In the economy will give a total many times greater than the true value of the national output.

• The problem of double counting arises because outputs of some firms are the inputs of others firms.


• Suppose the annual output of the flour mills sells for $15m and the value of the output of the bakeries is $25m.

• Added together they give a total output of $40m, but the value of the flour has been counted twice. If the value of the wheat output from the farms, the flour output from the mills and the bread from the bakeries added together the value of the wheat would be counted three times.


• National output can be measured by adding the values of the final products, or by totaling the values added at each stage of production.

• In the given above the bakeries added $10m to the value of the flour they purchased from the mill – this is the true measure of their outputs. The total of the value added at each stage will be exactly the same as the total value of the final products.


• Value added and bread production.

• Table shows the value added at each stage of the production of the bread.

Value of output

Cost of intermediate goods

Value added

farmers 10 0 10

Millers 15 10 5

Bakers 25 15 10

Retailers

30 25 5

30


• Intermediate goods and materials are the material inputs at the various stages of production- the goods each firm purchases from other producers.

• It can be seen that the value of final product (which includes additions to stock ) is exactly the same as the total of the values added by the various production processes.

• In addition if general price level has changed it is necessary to make an adjustments for the purely monetary changes in the value stocks.

THE INCOME MEASURE REF: LETTS STUDY GUIDE FOR A LEVEL BY RAY POWELL

• The value of output produced is based on the costs involved in producing that output.

• These costs include wages, rent, interest and profit. All these payments represent income paid to factors of production .

• For instance workers receive wages and entrepreneurs receive profits.

THE INCOME MEASURE REF: LETTS STUDY GUIDE FOR A LEVEL BY RAY POWELL

• In using this measure it is important to include only payments received in return for providing a good or service.

• So transfer payments , which are transfer of income from taxpayers to groups of individuals for welfare payments are not included.

THE EXPENDITURE MEASURE

REF: INTRODUCTORY ECONOMICS BY STANLAKE

• As stated early, the total amount spent in a year should equal total output and also total income.

output = income = expenditure What is produced in a year will either be sold or

added to stocks, so if additions to stocks are added to expenditure

on goods and services, a measure is obtained which will equal output and income.

THE EXPENDITURE MEASURE REF: INTRODUCTORY ECONOMICS BY STANLAKE

• In using this method it is necessary to add expenditure on exports and deduct expenditure on imports.

• This is because the sale of exports represents the country’s output and creates income in the country,

whereas expenditure on imports is spending on goods and services made in foreign countries and creates income for people in those countries

THE EXPENDITURE MEASURE REF: INTRODUCTORY ECONOMICS BY STANLAKE

• It is also necessary to deduct indirect taxes and subsidies in order to get a value which corresponds to the income generated in the production of the output.

MONEY AND REAL GDP,

THE CIRCULAR FLOW OF INCOME

AND

KEYNESIAN AND MONETARISTS

Real GDP: is simply GDP valued in constant prices of a base year

Money GDP: Money GDP is GDP valued in prices of a current year.

(samuelson)

MONEY AND REAL GDP

MONEY AND REAL GDPREF: Introduction to Economics and finance for CA by Abdul Hakeem Khwaja

• Money (or nominal) GDP is the GDP measured in terms of the prices operating in the year in which the output is produced.

• This is sometimes referred to GDP at current prices and is a measure which has not been adjusted for inflation.


• Money GDP may give a misleading impression of how well a country is performing.

• This is because the value of money GDP may rise not because more goods and services are being produced but merely because prices have risen.


• For example , if 100 million products are produced at an average price of $5, GDP will be $500 million. If in the next year the same output of 100 million products is produced but the average price rises to $6, Money GDP will rise to $600 million.

• So to get a truer picture of output, economists convert money into REAL GDP.


• The economists do this by measuring GDP at constant prices, that is at prices operating in a selected base year. By doing this they remove the distorting effect of inflation.

How to remove effect of inflation on Nominal GDP

to get Real GDP

• Real GDP = Nominal GDP * 100

• Price Index

• Real GDP= 50 * 100

• 50

• Real GDP = 100


• The price index used to convert money into real GDP is the GDP deflator, which means the prices of products produced rather than consumed in a country.

• The difference between the growth of Nominal GDP and Real GDP is the growth in the prices of GDP, sometimes called the GDP deflator. (Economics by P.A Samuelson)

To Calculate the GDP Deflator we use this formula

• GDP deflator = Nominal GDP *100 Real GDP

Examples

• Suppose the economy produces only computers, chairs and apples in the current period Nominal GDP is $12600 and current period the Real GDP is $10500.so the GDP deflator is 120%

• The GDP deflator is 100.A GDP deflator of 120% tells us that the price level in current period is 20%

(Economics by Michael Parkin)

THE CIRCULAR FLOW OF INCOME REF: INTRODUCTORY ECONOMICS BY STANLAKE

• When government spend more than they raise in taxation, they add to the circular flow of income.

KEYNESIAN AND MONETARISTSREFERENCE : AS and A level Economics by COLLIN BAMFORD

• Keynes believe that if left to market forces there is no guarantee that the economy will achieve the full employment level of GDP.

• They favor government intervention to influence the level of economic activity.


• If there is high unemployment they argue that the government should engage in deficit financing to raise the level of spending in the economy.

• For most Keynesian, the avoidance of unemployment is the key priority.


• In contrast, for monetarists, the control of inflation is seen s the top priority for a government.

• They argue that inflation is the result of n excessive growth of money supply. So they believe that the main role of government is to control money supply.


• They also maintain that attempts to reduce unemployment by increasing government spending will only raise inflation in the long run.

• They think that the economy is stable unless disturbed by changes in growth on money supply.

CONSUMPTIONCONSUMPTION

‘AGGREGATE EXPENDITUREREFERENCE : AS and A level Economics by COLLIN BAMFORD

• AGGREGATE EXPENDITURE is the total amount which will be spent at different levels of income in a given time period.

• This total spending is made up of: Consumption ( C ) Investment (I ) Government spending (G) Net exports i.e. exports – imports ( X – M )

CONSUMPTION REF: Introduction to Economics and finance for CA by Abdul Hakeem Khwaja

• In Macro Economics, aggregate consumption is the part of aggregate income which is spend on consumer goods.

e.g. wheat , rice, cloth etc by people living in a country in one year.

Keynes refer to income as real income and consumption as consumption as consumption and not the money income and money consumption as stated by classical economists.


• CONSUMPTION FUNCTION:• Consumption is a function of income as both are

positively co-related with each other, i.e. an income level rise, consumption level also rises and vice versa.

• Hence, C = f (Y)


• DIFFERENCE BETWEEN CONSUMPTION AND CONSUMPTION FUNCTION:

• A point on the consumption curve determines the amount of consumption out of a given level of income, whereas, consumption curve gives a whole set of consumption levels at different levels of income.


• Hence the difference between the consumption and consumption function is that is a difference between a point on consumption function and whole consumption function as shown in the diagram.


• In the given diagram CC is a short run consumption function as given by Keynes.

• This slopes upwards to the right indicating a positive correlation between income and consumption.


• Point R shows the amount of consumption at certain levels of income whereas the whole CC curve is a consumption function.

• It should be noted that the rate of increase in consumption is less than the rate of increase in income so that savings take place for investments


• Keynes believe that short run consumption function is a straight line consumption function. Hence this function can bee explained by with the help of a linear equation.

• i.e. C= a + cY


• C = a + cY• C= consumption • a= autonomous consumption• c = MPC• Y = income

• Autonomous consumption is the money spent even when income is zero and which does not vary with income.

• Induced Consumption is the consumption which varies with income.


e.g. In line with this equation the CC function of the diagram can be written as

C = 30 +0.5 Y

With the help of this equation we can calculate the amount of consumption at any level of income, e.g. when income is 100 consumption is

C= 30+0.5 (100)

C = 30 + 50

C = 80


• There are two concepts in connection with fundamental relationship between income and consumption. These two concepts are :

A) Average propensity to consume (APC)

B) Marginal propensity to consume (MPC)


• The ratio of aggregate consumption expenditure to aggregate income is known as the Average propensity to consume (APC).

• It may be expressed as the ratio of consumption to income, which can be stated as follows :

APC = C

Y = C : Y


• We can calculate APC at any point on the consumption function as shown.

• This diagram shows that the CC function is the schedule of propensity to consume as draw before.

• At different points on the CC line APC can be measured as C/ Y


At point E APC = 40/20 = 2At point G APC = 60/60 = 1At point H APC = 80/100 = 0.8


• The measure of APC on the CC line shows at that consumption function slopes upward to the right, APC falls.

• This is so because increases C also increases but increase in C is less than the increase in Y and the gap between C and Y (i.e. savings widens at higher levels of income


Income and consumption are both variables. When income changes consumption also changes. Thus marginal propensity to consume (MPC) is the ratio of change in consumption to change in income or in other words

• MPC = ∆C/ ∆Y


• As we move from point R to point Z , we find that there is an increase in the level of income from 100 to 120 and an increase in the level of consumption from 80 to 90 ,

• therefore ∆Y=20, ∆C=10

MPC= 10/20 = 0.5


• The concept of MPC leads us to the concept of MPS as 1- MPC= MPS

MPS = ∆S/ ∆Y

MPS = 1- 0.5

= 0.5

• INFLUENCES ON CONSUMPTION:

• INCOME• WEALTH• AVAILABILITY AND COST OF CREDIT• DISTRIBUTION OF INCOME• AGE STRUCTURE• INFLATION• INDIRECT TAXES• RANGE OF GOODS AND SERVICES

CONSUMPTIONREFERENCE : AS and A level Economics by COLLIN BAMFORD

SAVINGSAVING

SAVING REF: Introduction to Economics and finance for CA by Abdul Hakeem Khwaja

• Saving is the part of national income which is in excess of consumption expenditure.

• Saving is a function of income i.e.

S = f (Y)

e.g. if national income = Rs 100bn and consumption expenditure = Rs 80bn then saving = Rs 20 bn


• The diagram shows savings at different levels of income

• Income on horizontal• Saving on vertical axis

• The SS curve represents the propensity to save at different levels of income.


• The level of income is Rs 60bn and the level of consumption is also Rs 60bn therefore, there is no saving.

• When the level of income is less than Rs 60bn there saving becomes negative.


• With each increase in the level of income from 60bn upwards , the level of savings become positive s shown at points R,Z and L

• Hence there is a positive relationship between saving and income as indicated by the saving function.


• Like Propensity to consume we have two related concepts of propensity to save. These are:

A) Average propensity to save (APS)

B) Marginal propensity to save (MPS)


• Average propensity to save (APS):• It is the amount of aggregate saving out of the

aggregate income or in other words, it is the ratio of savings to income.

APS = S / Y

• E.g. the national income = Rs 100bn and saving =Rs 20bn

therefore APS 20 / 100 = 0.2


• Since APS + APC = 1 ,

therefore APS = 1 – APC

Suppose that APC = 0.8 ,

APS = 1 – 0.8=0.2


• Marginal propensity to save (MPS):• Incomes and savings are both variables and the

ratio of change in saving to the change in income is called MPS

MPS = ∆S/ ∆Y Suppose the national income increases from Rs

100bn to Rs 120 bn and that savings increase from Rs 20bn to Rs 30bn, hence

MPS = 10 / 20 =0.5


• Since MPS + MPC = 1 ,

therefore MPS = 1 – MPC

and suppose that MPC = 0.5

therefore MPS =1 - 0.5 = 0.5


• The concepts of APS and MPS together:

• The SS curve represents the schedule of propensity to save at different levels of income.


• Each point on the SS curve represents the APS, e.g. at point Z national income = 60 and saving = 0,

• Anywhere below point Z, saving is negative.


• However anywhere above point Z saving is positive and thus APS is positive,

• e.g. when national income = Rs 100bn , saving = Rs 20bn as shown at point R, but when national income increases from Rs 20bn to 120bn savings also increases from Rs 20bn to Rs 30bn as shown at point l


• but when national income increases from Rs 20bn to 120bn savings also increases from Rs 20bn to Rs 30bn as shown at point L.

thus,

MPS = 10 / 20 = 0.5


• Note that SS curve slopes upward from left to right and then it is a straight line.

• This shows that at a higher level of income, more is saved. Hence APS increases.

• Since the SS curve is a straight line this shows that MPS remains constant at 0.5

SAVINGREFERENCE : AS and A level Economics by COLLIN BAMFORD

• Influences on saving:

• INCOME• SOCIAL ATTITUDES• THE RANGE OF FINANCIAL INSTITUTIONS• THE RATE OF INTEREST• INFLATION• HABIT• CONTRACTS • TARGETS• CORPORTE SAVING• GOVERNMENT SAVING

INVESTMENT REF: INTRODUCTORY ECONOMICS BY STANLAKE

• Investment is spending by firms on capital goods such as factories, offices, machinery and delivery vehicles.

• There are a number of influences on private sector investment. These are:

• THE RATE OF INTEREST:• Firms invest when the expected yield from investment

exceeds the expected cost. The expected yield is sometimes referred to as the Marginal Efficiency Of Investment or Marginal Efficiency Of Capital.

INVESTMENT REF: LETTS STUDY GUIDE FOR A LEVEL BY RAY POWELL

• Figure shows the relationship between the marginal efficiency of capital (MEC) and the rate of interest.

• When the rate of Interest is R, the firm will expand its capital stock to Q.


• Any further additions to the capital stock would only reduce the firm’s profit because the cost incurred in acquiring the capital (interest charges) would exceed the annual returns from the extra units of capital.


• If the rate of interest falls to R1, the demand for capital increases to Q1.

• Investment projects (QQ1) which appeared unprofitable at the higher interest rate will now offer the prospect of profitable employment.

• Similarly an increase in the rate of interest will reduce the demand for capital goods.


• This analysis applies whether the firm is borrowing money or using its own savings.

• The MEC indicates what quantity of capital will be demanded at any given price and it is, therefore the Demand curve for Capital

INVESTMENT REF: INTRODUCTORY ECONOMICS BY STANLAKE

• Causes of shift in MEC:

• Changes in Technology• Changes in Cost of Capital• Expectations• Corporate Tax• Profit levels• Government Incentives.

GOVERNMENT SPENDING

&

NET EXPORT

GOVERNMENT SPENDING REF: INTRODUCTORY ECONOMICS BY STANLAKE

• The government expenditure is spending by the public sector.

• Government expenditure can be divided into four main categories.

• Current expenditure: spending on day to day running of the public services.

• Capital expenditure: spending on social infrastructure.• Transfer payments: payments to pensioners,

unemployed and subsidies to poor.• Debt interest: payment to the holders of government

debt.

GOVERNMENT SPENDING


• Functions of Government expenditure:

• The provision of merit goods and services.

• The provision of social security.

• The regulation of economic activity.

• Improving the efficiency of allocation of resources.

• Influencing the level of economic activity.

GOVERNMENT SPENDING


Influences on the level of government spending

• Cyclical influences

• Demographic influences

• Social changes

• Demand for government , finance, public and merit

goods.

• Demand for private goods

• Changes in technology

• Political views

• The rate of interest

• Increases in real wages

• The risk of conflicts

• Political cycles

GOVERNMENT SPENDING REF: INTRODUCTORY ECONOMICS BY STANLAKE

• Government expenditure is financed in various ways:

• Taxes levied by central government.• Taxes levied by local authorities.• Borrowing• Sale of assets

• NET EXPORTS

NET EXPORTS REF: INTRODUCTORY ECONOMICS BY STANLAKE

• The amount earned from exports and the amount spent on imports are influenced by a range of factors including:

• The price of domestic goods and services relative to the price of foreign goods and services.

• The quality of domestic goods and services relative to the quality of foreign goods and services

NET EXPORTS REF: INTRODUCTORY ECONOMICS BY STANLAKE

• Exchange rates.

• Income levels at home and abroad.

• The effectiveness of the marketing of domestic goods and services relative to the effectiveness of the marketing of foreign goods and services.

WITHDRAWALS AND

INJECTIONS

&

INFLATIONARY AND DEFLATIONARY GAPS

WITHDRAWALS AND INJECTIONS REF: LETTS STUDY GUIDE FOR A LEVEL BY RAY POWELL

• For Income to be in equilibrium it is also necessary for injections of extra spending into the circular flow of income to equal withdrawals. Also called leakages from the circular flow.

• Injections into the circular flow are :

Investment (I)

Government Spending (G)

Exports (X)


• Possible withdrawals are:

saving (S)

taxation (T)

imports (M)

Figure shows equilibrium in two sector economy (households and firms)


• A rise in investment would cause a rise in GDP as shown


• A fall in saving would have a similar effect.

• Figure shows equilibrium income where

• I+G+X = S+T+M, in a four sector economy (households, firms, government and foreign trade sector)


• If tax rates rise without any change in government spending, GDP will fall s shown


REFERENCE : AS and A level Economics by COLLIN BAMFORD

• Keynes argue that in the short run and long run , an economy my not achieve full employment.

• An INFLATIONARY GAP will occur if aggregate expenditure exceeds the potential output of the economy.

• In such situation not all demand can be met as there are not enough resources . As a result the excess demand drives up the price level.



• Fig shows that the economy is in equilibrium at a GDP of Q, which is above the level of output X, that could be achieved with the full employment of resources.

• The distance ab represents the inflationary gap.



• A cut in government spending may move the economy back to full employment level as shown.



• The equilibrium level of GDP may also be below the full employment level. In this case there is said to be a DEFLATIONARY GAP.

• Fig shows lack of aggregate expenditure results in an equilibrium level at a GDP of Q, below the full employment level of X,. There is a deflationary gap of vw

INFLATIONARY AND DEFLATIONARY GAPSREFERENCE : AS and A level Economics by COLLIN BAMFORD

• Keynes solution to deflationary gap is increased government spending financed by borrowing.

• Fig shows an increase in government spending eliminating deflationary gap.

THANK YOU

123

Education

Transcript of 123