Economic Activity-lecture 3

8/10/2019 Economic Activity-lecture 3

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The Level of Overall

Economic Activity


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What do you know?In groups write down what you know

about macroeconomics

Think about these things (but dont

limit your thoughts to these)

What is the difference/link

between micro and macro

Who are the main players in the

macro economy?

What does a good economy look

like?

What is happening in the world

economy at the moment?

Even if you know words but dont

know their meaning write them down!


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Learning ObjectivesUnderstand the five main

macroeconomic objectives (goals)

Understand, describe and illustrate

the circular flow of income

Understand the different measures

of national income

Calculate national income

Explain the meaning and

significance of green GDP

Evaluate the uses of national

statistics

Explain and illustrate the business

cycle


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What is Macro economics?Before we looked at micro economics

We looked at what happened within the

firm and within the marketNow add all of those markets togetherand we get the macro economy

We looked at allocation of resources in

a marketMacroeconomics is concerned with theallocation of a nations resources

There are five main variablesEconomic growth

Employment

Price stability

External stability

Income distribution


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Macro objectivesThere are five objectives that most

economies have

A steady increase of national

output (growth)

A low level of unemployment

A low and stable rate of inflation

A favourable balance ofpayments (Trade - Exports minus

Imports)

An equitable (fair) distribution of

income


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Macroeconomic policies

Government actions designed to affect the

performance of the economy as a whole

Types of macroeconomic policies

Monetary policydetermination of the

nations money supply

Fiscal policydecisions determine the

governments budget, including the amountand composition of government expenditures

and government revenues


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Macroeconomic policies

Structural policygovernment policies

aimed at changing the underlying

structure, or institutions, of the nations

economy


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The circular flow gameTo understand how an economy works weneed to understand the flows

To do this we will use a really simple model

There are four households (families) whohave been shipwrecked on a desert island

Divide into 4 groups

The supply of money in the economy is 5and we assume that all the money will be

used to buy good and servicesHousehold A spends 5 and received fromhousehold B goods and services in exchange.

Household B then spends 5 on goods soldby household C and the process is repeateduntil all households have participated.

Keep count of how much your householdspends

Keep count of how much you earn


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The circular flow game

If these 4 families

are the entireeconomy

What is the value ofnational output = ?

20What is nationalincome = ?

20

What is nationalexpenditure = ?

20


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The circular flow game -summary

In a simplified modelGDP = National Output =

National Income = NationalExpenditure

Not only is this true in asimplified model it is alsotrue (with a few statisticaladjustments) for any

economyIn a more sophisticatedeconomy households donot trade with each other

and we need to add firms

GDP =

National

Output =

nationalincome =

national

expenditure


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Check your understanding National Income, National Output

and National Expenditure should

always be equal. Why is this? If a newspaper headline says UK

National Income increased lastyear by 2%, what does this meanin terms of

output and expenditure? Changes in flow?

Same amount of growth innational output and national

expenditure Flow has increased

More flowing in than out


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What circular

flows do we

have in this 2

sector model?


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Leakages and Injections

This model is very simplified

What is it not taking intoconsideration?

Do people spend all of theirincome?

No, they save some in thebank or other financialinstitutions

This is known as a leakagefrom the circular flow

If households dont buy all theoutput that is produced by thefirms will have unsold stock

They will reduce their output

They will use less factors ofproduction and pay less income

The amount of income in the

economy will fall

Saving: foregoing current

consumption to allow for

consumption in the future


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Leakages and InjectionsThe good thing about savingsis that firms will have access to

them by borrowing money frombanks

They can use the money toincrease their stock of capitaland expand their output

This is known as investmentIt is an injection into thecircular flow of income

Investment allows the amount

of income circulating in theeconomy to rise


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Leakages and InjectionsWhy is this model still too simple?

An economy is not closed

Households can buy goods andservices from other countries

Would this be an injection or aleakage?

Imports are a leakagethis isincome that is being spent and not

being returned to firms

People buy the countries exportsof goods and services

Are exports leakages or injectionsExports are an Injection becausethey represent a source of incomenot coming directly from the

households

L k d I j ti


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Leakages and InjectionsWhy is this model still too simple?

There are more than two sectors

We now need to introduce the government sector

What injection and leakage can be added to this diagram due to theintroduction of the government sector?

Leakages and Injections


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Leakages and InjectionsSome of the income earned by the households must be paid to thegovernment in the form of taxes

Taxes are a leakage

Governments spend money in the economy on schools, roads, campaigns,hospitals etc

Government spending is an injection

Dont assume that governmentspending = revenue from taxes


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Leakages and InjectionsYou will see later that governments can spend more than they earn todeliberately influence the level of leakages and injections to affect the level ofnational income


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How is national incomemeasured?There are three ways (which we saw beforewhen we played the desert island game) ofmeasuring income

Can you remember?

Outputthe value of goods and servicesproduced (less the costs of inputs)

Incomethe value of all incomes earned in

the economyExpenditurethe value of all spending in theeconomy

Spending by households known asconsumption (C)

Spending by firms known as investment (I)Spending by government (G)

Spending by foreigners on exports minusspending on imports or net exports (X-M)

There is an identity that you will need to

learn GDP = C + I + G + (X-M)


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Different measures ofincome

GDPthe total of alleconomic activity in a

country regardless of

who owns the

productive assets

Gross National

Product (GNP) or

Gross National

Income (GNI)the

total income that is

earned by a countrys

factors of production

regardless of where

the assets arelocated

GNI GDP income

earned

from

assets

abroad

income paid to

foreign assets

operating

domestically

= + -

Over time capital

gets used upits

value depreciatesGDP does not take

this into

consideration. NNI

does. NNI = GNI

minus depreciation

Green GDPGDP

minus environmental

costs


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Real GDP or nominal GDPTo make a comparison of GDP year onyear you need to take into consideration

the rise in pricesYou are measuring by the total value ofgoods and services

The goods and services may not havechanged

Inflation may mean that the prices ofthe same goods and services have goneup

We use a GDP deflatorto do this

GDP x 100/(100 + inflation rate) = realGDP

If the inflation rate was 4%

Real GDP = GDP x 100/104

Real GDPGDP

which has been

adjusted for inflation

Nominal GDP

GDP which has not

been adjusted for

inflation


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GDP per capitaTo make a judgement about theprogress of a country in comparison with

other countries in terms of raising livingstandards the GDP per capita figure ismuch more appropriate

GDP per capita

GDP divided by the

size of the population

Li it ti f th d t


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Limitations of the dataInaccuraciesfigures tend to become more accurate aftertime as they are revised

Unrecordedor under-recorded economic activity (informal

markets)DIY in developed countries

Care for elderly or children

Subsistence farming in developing countries

Illegal activities (alien workers, drug trafficking etc)

Work done for cash (and no tax is paid)Countries with higher tax burdens tend to have a largerhidden economy

External costs

GDP does not take into account resource depletion or

negative externalitiesQuality of life concerns

GDP may grow because people are working longer hours

Composition of output

Output could be defence that does not benefit consumers


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TheBusinessCycle

The businesscyclefluctuations ineconomicactivity

measured bychanges in realGDP

Fluctuationsin practice arehighly irregular

Recovery: economic expansion largely driven by increase in aggregate

demand as households and consumers are encouraged to spend more.

Firms increase their output in response to the increase in demand. Newly

employed workers spend their income on goods and services


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TheBusinessCycle

Boom: increased demand for goods and services pushes up average prices

(inflation). The rate of growth of GDP will fall as the economy nears its

potential output. Policy makers may try to slow growth (to reduce inflation)

causing a fall in total demand and recessioncould begin.

Recession: defined as

two consecutive

quarters of negative

GDP growth. Falling

aggregate demand will

lead firms to lay offworkers so

unemployment rises.

This means less

spending leading to

lower rates of inflation

or deflation

Trough: at some point the

contraction will come to an

end. Aggregate demand will

pick up and enter the

recovery phase


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Negative output gap (A):

the economy is producing

below its trend and

unemployment is likely to be

a problem

Long term trendand output gaps

Positive output gap (B):

the economy is producing

above its trend and inflation

is likely to be a problem

Economies fluctuate but

tend to have positive longterm growth trends

Economic Activity-lecture 3

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