Download 13 Overall economic Activity

IB Economics
The Level of Overall Economic
Activity
Chapter 13
What do you know?
In groups write down what you know
about macroeconomics
Think about these things (but don’t
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 don’t
know their meaning write them down!
Learning Objectives
Understand 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
What is Macro economics?
Before we looked at micro economics
We looked at what happened within the
firm and within the market
Now add all of those markets together
and we get the macro economy
We looked at allocation of resources in
a market
Macroeconomics is concerned with the
allocation of a nation’s resources
There are five main variables
Economic growth
Employment
Price stability
External stability
Income distribution
Macro objectives
There 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 of
payments (Trade - Exports minus
Imports)
An equitable (fair) distribution of
income
The circular flow game
To understand how an economy works we
need to understand the flows
To do this we will use a really simple model
There are four households (families) who
have been shipwrecked on a desert island
Divide into 4 groups
The supply of money in the economy is £5
and we assume that all the money will be
used to buy good and services
Household A spends £5 and received from
household B goods and services in exchange.
Household B then spends £5 on goods sold
by household C and the process is repeated
until all households have participated.
Keep count of how much your household
spends
Keep count of how much you earn
The circular flow game
If these 4 families
are the entire
economy
What is the value of
national output = ?
£20
What is national
income = ?
£20
What is national
expenditure = ?
£20
The circular flow game summary
In a simplified model
GDP = National Output =
National Income = National
Expenditure
Not only is this true in a
simplified model it is also
true (with a few statistical
adjustments) for any
economy
In a more sophisticated
economy households do
not trade with each other
and we need to add firms
GDP =
National
Output =
national
income =
national
expenditure
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 last
year by 2%’, what does this mean
in terms of
 output and expenditure?
 Changes in flow?
 Same amount of growth in
national output and national
expenditure
 Flow has increased
 More flowing in than out
What circular
flows do we
have in this 2
sector model?
Leakages and Injections
This model is very simplified
What is it not taking into
consideration?
Do people spend all of their
income?
No, they save some in the
bank or other financial
institutions
This is known as a leakage
from the circular flow
If households don’t buy all the
output that is produced by the
firms will have unsold stock
They will reduce their output
They will use less factors of
production and pay less income
The amount of income in the
economy will fall
Saving: foregoing current
consumption to allow for
consumption in the future
Leakages and Injections
The good thing about savings
is that firms will have access to
them by borrowing money from
banks
They can use the money to
increase their stock of capital
and expand their output
This is known as investment
It is an injection into the
circular flow of income
Investment allows the amount
of income circulating in the
economy to rise
Leakages and Injections
Why is this model still too simple?
An economy is not closed
Households can buy goods and
services from other countries
Would this be an injection or a
leakage?
Imports are a leakage – this is
income that is being spent and not
being returned to firms
People buy the countries exports
of goods and services
Are exports leakages or injections
Exports are an Injection because
they represent a source of income
not coming directly from the
households
Leakages and Injections
Why 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 the
introduction of the government sector?
Leakages and Injections
Some of the income earned by the households must be paid to the
government 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
Don’t assume that government
spending = revenue from taxes
Leakages and Injections
You will see later that governments can spend more than they earn to
deliberately influence the level of leakages and injections to affect the level of
national income
How is national income
measured?
There are three ways (which we saw before
when we played the desert island game) of
measuring income
Can you remember?
Output – the value of goods and services
produced (less the costs of inputs)
Income – the value of all incomes earned in
the economy
Expenditure – the value of all spending in the
economy
Spending by households known as
consumption (C)
Spending by firms known as investment (I)
Spending by government (G)
Spending by foreigners on exports minus
spending on imports or net exports (X-M)
There is an identity that you will need to
learn GDP = C + I + G + (X-M)
How is national
income
measured?
In practice, the
data collected to
calculate GDP
comes from many
different and varied
sources
There are often
inaccuracies
This can be due to
timing
Often figures have
to be revised at later
date when full
information is
collected
Different measures of
income
GDP – the total of all
economic activity in a
country regardless of
who owns the
productive assets
GNI
=
Green GDP – GDP
minus environmental
costs
GDP
Gross National
Product (GNP) or
Gross National
Income (GNI) – the
total income that is
earned by a country’s
factors of production
regardless of where
the assets are
located
+
income
earned
from
assets
abroad
-
Over time capital
gets used up – it’s
value depreciates
GDP does not take
this into
consideration. NNI
does. NNI = GNI
minus depreciation
income paid to
foreign assets
operating
domestically
Real GDP or nominal GDP
To make a comparison of GDP year on
year you need to take into consideration
the rise in prices
You are measuring by the total value of
goods and services
The goods and services may not have
changed
Inflation may mean that the prices of
the same goods and services have gone
up
We use a GDP deflator to do this
GDP x 100/(100 + inflation rate) = real
GDP
If the inflation rate was 4%
Real GDP = GDP x 100/104
Real GDP – GDP
which has been
adjusted for inflation
Nominal GDP –
GDP which has not
been adjusted for
inflation
GDP per capita
To make a judgement about the
progress of a country in comparison with
other countries in terms of raising living
standards the GDP per capita figure is
much more appropriate
GDP per capita –
GDP divided by the
size of the population
Limitations of the data
Inaccuracies – figures tend to become more accurate after
time as they are revised
Unrecorded or 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 larger
hidden economy
External costs
GDP does not take into account resource depletion or
negative externalities
Quality of life concerns
GDP may grow because people are working longer hours
Composition of output
Output could be defence that does not benefit consumers
The
Business
Cycle
The business
cycle
fluctuations in
economic
activity
measured by
changes in real
GDP
Fluctuations
in practice are
highly 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
The
Business
Cycle
Trough: at some point the
contraction will come to an
end. Aggregate demand will
pick up and enter the
recovery phase
Recession: defined as
two consecutive
quarters of negative
GDP growth. Falling
aggregate demand will
lead firms to lay off
workers so
unemployment rises.
This means less
spending leading to
lower rates of inflation
or deflation
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 recession could begin.
Long term trend
and output gaps
Economies fluctuate but
tend to have positive long
term growth trends
Negative output gap (A):
the economy is producing
below its trend and
unemployment is likely to be
a problem
Positive output gap (B):
the economy is producing
above its trend and inflation
is likely to be a problem