Download a.s 3.4 - GHEconomics

Achievement
Standard 3.4
Describe aggregate economic
activity.
Aggregate?

The amount or total formed from separate units.
Aggregate refers to a total, everything added up.

Aggregate = Total

The economy can be viewed as a series of
aggregates, flowing together to make a working
whole
The Circular Flow Model

Shows the economic transactions that
occur between households, firms and
other sectors in the economy.

Money flows- We will only focus money
flows as it is simpler than trying to account
for the physical flows.
The Circular Flow of Income and
Spending

The simplest form of circular flow
$ Consumption
Goods and Services
Producers
Households
Factors of production
Incomes $ rent wages interest profit
Introduction of the Financial Sector
Financial
Institutions
I (Investment)
d
Ca(Payments for goods
and services)
S (savings)
c
Producers
Households
b
Y (Income)
An Open Economy
Financial
Institutions
Overseas
Sector
I (Investment)
d
X (Export
receipts)
f
M (Import
g
payments)
aC (consumption)
S (Savings)
c
Producers
Households
b
Y (Income)
Role of the Government
Financial
Institutions
Overseas
Sector
I (Investment)
d
X (Export
receipts)
f
M (Import
g
payments)
aC (consumption)
S (Savings)
c
c
G (Government Spending)
Producers
Households
Government
tr
a
(transfers)
b
Y (Income)
T
b
(taxes)
The Circular Flow Model
Financial
Institutions
Overseas
Sector
d
I (Investment)
X (Export
e
receipts)
M (Import
f
payments)
aC (consumption)
S (Savings)
c
G (Government Spending)
i
Producer
Households
Government
tr
h
(transfers)
b
Y (Income)
T
g
(taxes)
The Circular Flow model









Y= Incomes including rent wages interest and profit
C= Consumption spending- the payment for goods and
services
S= Savings – income not spent on consumption this is a
withdrawal from the economy
I= Investment spending-purchase of capital goods. This is
an injection into the economy
X= Export receipts- Money received for exports sold
M= Import payments- Payments made for imports
purchased
G= Government Spending- on collective goods
T= Taxes the government collects from households and
firms. These are used to fund G and Tr.
Tr= Transfer money from one group to another, because of
this transfer payments are not true expenditure.
Page 138
Questions 1-3
The Circular Flow Model
Financial
Institutions
Overseas
Sector
d
I (Investment)
X (Export
e
receipts)
M (Import
f
payments)
aC (consumption)
S (Savings)
c
G (Government Spending)
i
Producer
Households
Government
tr
h
(transfers)
b
Y (Income)
T
g
(taxes)
Calculating National Output



What is national output?
National Output =Total quantity of goods and services
demanded in an economy in a year.
Y= National output
Y = C +I +∆R
Where ∆R is changes in stocks
Stocks are caused from unplanned investment where there
is a build up of inventories/ stocks ready for sale.
Negative unplanned investment also occurs however
when there is a rundown of stocks.
Calculating National Output

The value of incomes always equals the value of what is
produced
National Output= C +I+ ∆R
National Income=C +S
Where national incomes is the total incomes resulting
from the production of goods and services in an economy
in a year.
Because outcome equals income, it follows that
C+S=C+I+ ∆R
S=I + ∆R
Calculating national Output using
the Circular flow model.


Output Y = C + I + ∆R + G + (X-M)
Income Y= C + S +T
Output = Income
I + ∆R + G +X = S + T + M
(Injections= Withdrawals)
For the economy to be in equilibrium planned
injections must equal planned withdrawals.
(∆R=0)
Calculating national Output using
the Circular flow model.

Changes in any of the flows in the circular flow
diagram will result in the changes in national
income.

E.g What do you think would happen if people
saved more?
C would decrease and this would result in a
reduction in national income

Aggregate Demand


What does aggregate mean?
Aggregate refers to a total, everything added up.

Aggregate demand is the total demand in the economy. AD
shows how many goods and services will be demanded in an
economy given the general price level and the level of
income.


Aggregate demand is equivalent to national output
What are the components of national output?
Output Y = C + I + ∆R + G + (X-M)

AD=C+I +G + (X-M)

Components of Aggregate demand
AD=C+I +G + (X-M)
C= Consumption
Total demand for all final goods and services. This is shown
by the household sector through its spending
$ Consumption
Households
Household Consumption Expenditure 1995-2000
Food and
beverages
Clothing and
footwear
Transport
Other G&S
7934
8699
9389
8974
9429
9966
5499
5941
6080
6317
6459
6806
Housing
$ Million
1995
1996
1997
1998
1999
2000
8922
9306
9428
9595
9714
10164
2486
2523
2639
2696
2758
2934
11083
11243
11395
11548
11701
11879
1. In 2000, Real GDP was $102445million. What proportion of the 2000 GDP was
made up of household consumption?
2. Which item of expenditure accounted for the largest proportion of household
consumption spending over the period 1995-2000?
3. Why is savings not on the table?
AD=C+I +G + (X-M)
I=Investment = Expenditure by businesses as
they demand investment/capital goods.
 Investment is exogenous.
It is not influenced by the level of income but by
other elements in the circular flow model.
Three main reasons why firms invest?

•
Expect high demand in the future
Existing capital has depreciated and needs replacing
•
Changes in government policies make it favourable to invest.

The main determinant of the level of investment
is the market interest rate
•
Gross Capital Fixed Formation
Expenditure of producers on investment
on new plant and machinery
 New capital spending by the govt e.g.
motorways, roading
 Investment spending by households on
housing.

$(million)
Capital Goods- 2002 calendar year $ (million)
7000
6000
5000
4000
3000
2000
1000
0
Exports
Imports
Machinery and plant
Transport
equipment
Total
Capital goods
1. What are capital goods?
2. Using the information above, analyse the links between, imports and
investment.
3. Why do you think this link exists?
4. Why do you think Investment is important for economic growth?
AD=C+I +G + (X-M)

G= Government spending as it demands goods and
services.
Also exogenous (not dependent on level of national
income)
The government decides on what it is going to spend the
money on then goes about raising the money necessary.
Major items of expenditure in NZ are
• Health
• Education
• Welfare
AD=C+I +G + (X-M)
(X-M)= Net exports
 We use net exports as we are interested in
what NZ economy produces.
 M>X
(X-M)? + or –
 This is a withdrawal from the circular flow
 M<X
(X-M)? + or  This is an injection from the circular flow.

Gross Domestic Product (GDP)

GDP= the money value of final goods and
services produced in an economy in a year.
Three ways to measure GDP
•
•
•

Production
Income
Expenditure
Why do you think we would want to
measure GDP?
GDP

An economies standard of living is measured by
the number of goods and services that it has
available to use and enjoy.

An economies growth can be measured by the
increase in the number of goods and services it
makes

Why do you think investment and savings are so
important in an economies growth?
Measuring GDP

The Expenditure Approach- by adding up selling prices
of all goods and services bought in the economy then
making allowances for goods and services bought
overseas.

Formula= C + I + ∆R + G + (X-M)

Consumption excludes buying new houses- this is
investment
Investment includes govt investment (Roading)

•
•
Change in inventories are included as these represent goods
available for sale and represent an increase in investment
spending
A decrease in stocks will reduce GDP because they represent
expenditure on goods that were produced in the previous year.
Measuring GDP

The income approach- by adding up incomes generated in the
production process.

Income includes


wages, salaries (Compensation to employees)
profits, dividends, rents, interest (Gross operating surplus)

Then make final adjustments to account for govt intervention. (Add
taxes on production e.g. GST and imports e.g. tariffs then takeaway
subsidies)

Y= C+ S + T
Measuring GDP

The production approach- measures the value added by
producers, by deducting the value of goods and services
used up in the production from the total value of goods
and services produced.

To calculate find the value that each sector/producer
adds to the value of the product during the production
process.

A problem that can occur with this approach is that of
double counting.

We will focus on the other two approaches
Find GDP for the following
data using the income and
expenditure approaches
Values of output at each stage of Bread production
Grower
Miller
Baker
30
45
75
Intermedi ate goods
Sales
30
price
30
75
75
150
Wages
Wheat Grower Miller
Baker
Wages
30
45
75
Intermediate
goods
-
30
75
Sales price
30
75
150
•
The expenditure approach= value of the final
product = $150 million
•The incomes approach totals wages at each
stage of production= 30+45+75=$150million
NSNA

The New Zealand System of National Accounts
(NZSNA) provides an international standard of
measure of GDP that enables international
comparisons

Sometimes there will be a statistical discrepancy
in the NSNA this is
Statistical discrepancy = Income Approach GDP –
Expenditure Approach GDP
Basically it is used to make Income and
Expenditure approaches balance
NZSNA Terminology
Consumption
Final private expenditure
Gross fixed capital formation
Investment
Government Spending
Net Exports
Government final expenditure
Exports of goods and services –
Imports of goods and services.
Table 6.2
NZSNA Terminology
Wages and salaries
Gross Profits
Depreciation
Net Indirect Taxes
Compensation of Employees
Operating Surplus
Consumption of fixed capital
Indirect taxes minus
subsidies.
Table 6.2
Important things to remember when
calculating GDP

Include only G&S produced in NZ economy

Include G&S produced only within that time
period. (inventories included in time period they
were made not when they were sold)

Avoid double counting (second hand goods not
counted)
Questions
What is GDP?
 What is the formula for calculating expenditure on GDP?
 Draw the simple circular flow diagram
 With reference to the model explain three ways GDP can be
measured
 Calculate GDP from the data below using the Income and Expenditure
methods
Item
$m
Item
$m

Exports of G$S
Indirect taxes
Compensation
employees
4000
10000
Gross fixed capital
formation
2500
Subsidies
800
Private spending
12000
Increase in stocks
200
Gross Operating
surplus
7500
Government
spending
3000
Imports of G&S
1000
4000
Nominal GDP VS Real GDP
Quantity of
Pizzas
Price of
pizzas
Quantity of
pies
Price of pies
2000
10
$10
15
$5
2004
20
$12
30
$6
Imagine the economy only produces pizzas and pies.
Calculate GDP in year as the market value of production
GDP 2000=(10pizzasX$10/pizza) +(15piesX$5/pie)=$175
GDP 2004=(20pizzasX$12/pizza) + (30piesX$6/pie)=$420
Looking at these two GDPs what would you conclude?
BUT
Looking closely you can see the quantities produced of pizzas and pies in
2004 are twice that produced in 2000
If eco activity exactly doubled why do the calculated values of GDP show a
greater increase?
Prices as well as quantities rose!
Nominal and Real GDP Notes

Nominal GDP= the actual dollar value of all
goods and services produced in a year

Inflation = Increase’s in the price level

These values cannot be meaningfully compared
from year to year
Consumer Price Index
(CPI)

Measures the price level of a ‘basket’ goods and services purchased
by the average NZ household

The data on prices comes from household surveys conducted by
Statistics New Zealand

CPI is then released quarterly

Used as a general measure of inflation

Indicates the effect of price changes on the purchasing power of
households

To calculate and index =Expenditure Now
Expenditure Base Year
Consumer Price Index
Year
CPI
2002
1000
2003
1222
2004
1300
2005
2300
% price
level
change
22.2%
30%
130%
Measures rate of
change in price level
from the base year
(2002).
Rate of change
between 2003 and
2004 is
1300 – 1222 * 100
1222
6.4%
Change in CPI

An increase in the CPI is called inflation.
The price level increases. The purchasing
power of money decreases.

A decrease in the CPI is called deflation.

Disinflation refers to a decrease in the
inflation rate. The CPI is increasing at a
decreasing rate.
Real Values




Calculated using constant prices. –prices used
for one year is used to calculate values for all
years
Are inflation adjusted.
Can be meaningfully compared from year to
year
Real Income= Nominal Value X 1000
CPI
Real GDP and Nominal GDP

Nominal GDP= the actual dollar value of
all goods and services produced in a year
Real GDP= is nominal GDP adjusted for
inflation.
 This measure allows for comparison of
changes in the value of national output
without price changes distorting the data.

Real GDP

In order to calculate RGDP the effect of price
increases need to be removed.

We will use the CPI index to do this: both the base
year value (1000) and the value for the year we
are calculating the RGDP for.

The part of the equation in which this is taken into
account is the GDP deflator: (taking inflation out of
GDP value)

CPIbase
CPIyear1
Real GDP equation

RGDP = GDPyear1 × CPIbase
CPIyear1
(GDP deflator)
NOTE: Year 1 refers to the year you are calculating
the RGDP for.
Real GDP
Quantity of
Pizzas
Price of
pizzas
Quantity of
pies
Price of pies
2000
10
$10
15
$5
2004
20
$12
30
$6
Using the data in the table above and assume year 2000 is the base year
find real GDP fro years 2000 and 2004
How much did real output grow between 2000 and 2004
Year 2000 real GDP=(10pizzasX$10/pizza) +(15piesX$5/pie)=$175
Year 2004 real GDP=(year 2004 quantity pizza's X year 2000 pizza prices) +
(Year 2004 quantity pies X year 2000 pie prices)
= (20X$10) + (30X$5)
=$350
By using real GDP we have eliminated the effects of price changes and
obtained a reasonable measure of actual change in physical production
Measuring the rate of Economic
Growth

Rate of growth= GDP 2nd year-GDP 1st year x 100
GDP 1ST year
Calculating the rate of inflation

Rate of inflation= CPI 2ND year - CPI 1ST year x 100
CPI 1ST year
Limitations to GDP

In groups give an opinion into how well GDP is as
a measure of the standard of living.

Think about
 Unpaid
work? Non-market activities? If it is not sold it
is not counted
 Merit and demerit goods
 The distribution of wealth.

Standard of living - the degree to which people
have access to goods and services that make
their lives easier, healthier, safer and more
enjoyable
Limitations to GDP as a measure of
Standard of Living

Non market activity

GDP excludes




Relative Merits of production


Voluntary Labour
Cash transactions, barter
Illegal transactions
There is no distinction in GDP whether goods being produced are
merit goods or demerit goods e.g. a dollar spend on cigarettes has the
same weight as a dollar spent on education
Distribution of Income


GDP is a total.
Does not tell us how this total is distributed

e.g. a country may have high GDP but there also may be large numbers
of people living in poverty.
GDP per capita
Use GDP per capita (per head of
population).
 GDP per capita =
GDP
Total Population

Shows how much of the economies total
production each person would receive if it
was divided equally
The Business (Trade Cycle

Over time fluctuations in economic activity
occur.

The trade cycle shows us how fluctuations
in the levels of output, employment,
income and trade affect the level of real
GDP.
A Typical Trade Cycle
Real
GDP
Peak
Recession
Recovery
Boom
Trough/Depression
Time
Trade
Cycles
Boom







Peak (Turning point)


Rising interest rates
High eco activity
“Full” employment
Great optimism
Businesses operating at capacity
Eventually rate of growth must slow down. Even if economy is still
growing t is now doing so at a decreasing rate
Recession


Rising unemployment and business failures
Savings may increase as people fear unemployment
 Business activity slows down
Trade Cycle

Depression (Trough)





Unemployment stabilised
Low level eco activity
Excess capacity
Interest rates low
Low consumption , low saving
Eventually some major piece of capital equipment will need replacinginjection of investment lead to recovery

Recovery




Rise in real GDP slow at first, speeds up
Rehiring of workers as demand increases
Unemployment falls
Consumption increases
Ryan’s Thinker Keys
The Variations Key
How many other ways can you
think of that may be used as a
measure of standard of living if
GDP was not used?
National Income statistics for New
Landzia 2050
National income statistics for Ecotopia
2050
Exports of G$S
51
Exports of G$S
51
Compensation
employees
75
Change in
inventories
7
Gross fixed capital
formation
43
Gross fixed
capital formation
43
Final consumption
expenditure:
private
57
Final
consumption
expenditure:
private
57
Final consumption
expenditure:
government
36
Final
consumption
expenditure:
government
36
Subsidies
8
Imports of goods
and services
54
Gross operating
surplus
76
Statistical
Discrepancy
3
Indirect taxes
30
Taxes on
production and
imports
30

SLO: Describe, Explain and anaylse
Aggregate demand
 The AD curve, reasons for its slope
 Factors that move AD

Aggregate Demand and Aggregate
Supply

The AD/AS model is used to demonstrate equilibrium
national income

Actual level of national income may be above or below
the AD/AS equilibrium but economic forces will act on
national income and force it to equilibrium.

AD/AS can help explain inflation and unemployment and
shows us the impact of



Government policies
Exchange rate
Other influences
Aggregate Demand

AD= is national output and represents total demand in
the economy

AD= C + I + G + (X-M) + ∆ R

Look at your circular flow diagram which half does AD
relate to?

The AD curve shows us the quantity of output demanded
at each price level.
Aggregate Demand Curve
AD curve bows
towards the origin
Price Level
AD should not be
confused with market
demand curve for a
commodity
AD
Real GDP (Y)
The axes are different
and reasons for AD
curves shape very
different.
Reasons for downward sloping of
AD curve

An increase in the price level
 Means
all goods and services are more
expensive. Less can be bough with a given
quaintly of income
C
 Leads to an increase in the rate of interest.
Costs of borrowing increases
C
I
AD
 Exports now relatively more expensive, means
decrease in demand for exports, (X-M) low
Shifts along the AD curve

Change in price level causes
 Movement
along the AD curve
PL1
PL
AD
Y1
Y
Shifts of the AD curve

Change in any variable in the AD equation
(AD=C+ I+ G+ (X-M)) will move the AD
curve itself.
Shift to the
Left
C
G X
Shift to the right
C
G
X
Aggregate Supply

Shows the quantity of national output that all
producers are willing to supply at each price
level.
Aggregate Supply Curve
Price Level
AS
Micro- Price increases
quantity supplied
increases- Upwards
sloping supply curve
Macro- Upwards sloping
also. But it is relatively flat
at low levels and gets
steeper as it approaches
capacity
Real GDP (Y)
Shifts in AS curve
AS
PL1
PL
Y
Y1
A change in the
price level will
cause a
movement along
the supply curve.
Price Level
Aggregate Supply Curve
C
Good Y
Economies Production Possibilities
Curve
C
B
A
B
A
Yf
Real Income (Y) ,output, employment
Good X
1. At very low levels of output there is excess capacity (idle factories,
machinery and unemployed workers). Shown by point A, we are well inside
our PPC curve. Production could be increased with very little cost, meaning
prices don’t need to increase as much
2. As production increases diminishing returns sets in. Output will only rise at
a higher price level shown by upwards sloping of the curve, point B
3. At greater levels of output, businesses are being pushed to their maximum
and production becomes inefficient. Overtime will be paid as there are less
people to be employed as we move towards Yf. The economy is operating
on its PPC. The economy can operate at point C only in the short run.
Shifts of the AS curve
Imported raw
materials
Shift to the
right:
Wages
Imported
raw
materials
Productivity
Productivity
Shift to the left
Wages
Shifts of the AS curve
Any shifts of the AS curve is caused by changes to:
 Wage rates
 Increases

in wages would increase the costs of production.
Imported Factor Costs
 Are
a cost of production. E.G. If cost of Oil increases then
cost of production increases.

Changes in Productivity
 Can
be due to improved technology or processes. This
reduces costs of production and more can be produced at
the existing price.
Long Run AS curve
LRAS
SRAS
Price
level
The SRAS can
operate at a level
above full capacity
for limited periods
of time.
This will lead to
increased
competition for
scarce resources as
producers attempt
to increase output.
This then causes
resource costs to
increase (e.g.
higher wages) and
will Shifts SRAS to
the left back to Yf.
Yf
Y
The Long-run AS
curve is at full
employment level.
Work Books page 151

Questions 1-2
Questions to think about


Which two categories in the National Accounts
make up the investment flow on the circular
flow income model?
Briefly explain the difference between these
two categories
Underlying causes of changes in
AD
We know that AD=C+I+G+(X-M)
 If either of these components increase AD also
increases, but what will cause either of these
components to increase?

Group 1 – Consumption spending will increase if?
Group 2- Investment spending will increase if?
Group 3 – Government spending will increase if?
Group 4 – Expenditure on net exports will increase if?

Report back to the class on your findings in 10mins.



Occurs where AD=AS and the
price level PLe.
Equilibrium
This level also indicates
the level of employment.
Equilibrium AD/AS
Full
employment
(economic
potential)
PLe
Ye
Yf
Equilibrium represents where
the economy will tend to move
towards. Once we are at this
equilibrium the economy will
stay here unless AD or AS
moves
This means that if there is
unemployment at the equilibrium
level, it is likely to be chronic
and will not go away by itself.
Unless AD or As alters, the
unemployment level will stay the
same.
Changes to Equilibrium
A change in either aggregate demand or aggregate supply results in a change in
the equilibrium price level and a change in the level of national income, output
and employment.
An increase in AS
AS’’
Price
Level
AS’
PL ‘’
PL
•A decrease in the price level
•An increase in real income, output
and employment
A decrease in AS
PL’
An increase in the price level
Ye’’ Ye
Ye’
Y
A decrease in real income,
output and employment levels
Changes in AD and AS






What will happen if there is an increase in
AD?
Increase in price level
Increase in real income, output and employment
What will happen if there is a decrease in AD?
A decrease in price level
A decrease in real income, output and
employment.
Disequilibrium
If AD>AS
Lead to an unplanned
rundown of stocks.
Producers will respond by
increasing output but may
also have to pay for more
resources. Goods become
scarce which causes price
to increase.
Price Level
Equilibrium AD/AS
If AD<AS
PLe
Ye
Real Income (Y) ,
output, employment
Lead to an unplanned build
up of stock. Producers will
cut back on production.
Workers will be laid off
causing income to fall. This
leads to prices falling
Actual GDP is below full
employment level of GDP.
There is excess production
because of a lack of demand.
AD is at a point where a price
level of PL1 is needed to
increase demand.
Price
Level
BUT
AS is operating at PL2
PL2
What will be the result?
Pl
Stocks will build up
PL1
Businesses will lay off workers
Ye
Yf
Actual GDP
Y
National output will fall and
unemployment will rise
Page 153 question 3-4
AD/AS analysis of Fiscal and
Monetary Policy.

Full employment is where the economy is
operating on the PPC and all existing
productive capacity is used.

Often this is not the same as Ye
Deflationary Gap
Price
Level
AD and AS meet at a level
of Real GDP that is below
economic capacity.
Therefore we have
unemployment.
Unemployment is shown
by Y being less than Yf
Deflationary Gap
PL
This level of
unemployment is also
called the deflationary
gap.
(As prices will have to fall
to reach full employment)
Y
Yf
Real GDP
In conditions like this the
characteristics of a
recession can be seen!
(also called a
recessionary gap)
How wouldUnemployment
the government
intervene
to
We are operating well
within the PPC.
try and close this gap?
Why is a Recessionary (Defaltionary) gap
unfavourable?

Equilibrium income is below full employment level of income
resulting in
 Unemployment
 Idle Factories

This is a concern to the government because, even though the
economy is in equilibrium there is under-utilised resources in
the economy i.e. unemployed workers
Expansionary Fiscal Policy

The government can run an expansionary
fiscal policy by increasing government
spending and reducing taxes.

This will result in a budget deficit or a
reduction in the surplus.
Tax Cuts


A reduction in income taxes increases
consumers disposable income, leading
to an increase in consumption spending
(C)
A reduction in company taxes enable companies
 to distribute more after tax income to shareholders in the
form of dividend increasing income (Y)
 To increase investment spending (I)
An increase in C and I lead to AD increasing
Expansionary Fiscal
Gap
Lower tax rates or increase in
govt spending to increase
aggregate demand.
This is called operating a budget
deficit
How this deficit is funded will
depend on how much the AD
moves.
Price
Level
PL
Y
Yf
Deflationary Gap
If the govt borrows from the
banks or the public (non
monetised). There will be a
greater transaction demand for
money which will push the
interest rate up. This will then
decrease I and C causing AD to
move back but not as much as
the initial shift left.
Inflationary Gap
Ye is now greater than Yf
The economy is trying to
achieve a level of real GDP
that is beyond its capacity.
AD>AS This gap is called an
output gap.
Inflationary Gap
PL
Yf
Ye
How would the government intervene to
try and close this gap?
Why is a Inflationary gap unfavourable?

National income is temporarily at an overfull level of income, and there is full
employment and inflationary pressure.

This is a concern to the government
because there will be pressure for
resource costs to rise leading to inflation.
Contractionary Fiscal Policy

The government will run a contractionary fiscal policy
by increasing taxes or reducing spending in key areas
such as health, education and cutting benefits.

This will result in a budget surplus or a reduction in
the deficit.

Increases in Tax leads to less disposable income
meaning less consumption.

Lower Government spending and lower consumption
will cause the AD curve to move to the left.
Conctractionary Fiscal Policy
Inflationary Gap
PL
Contractionary fiscal
policy would mean
running a budget
surplus (This is done
through reducing
government spending
or increasing tax)
AD would be reduced
through less consumer
spending and/or less
govt spending
Fiscal Policy



Refers to the governments revenue and expenditure
decisions.
These decisions are shown in the Budget.
The Budget sets out the sources of govt revenue and the
areas of expenditure.
The Impact of Fiscal Policy


The govt raises most of its revenue as taxation
from individuals and firms
Raising revenue through collection of taxes is a
withdrawal from the economy.
T disposable incomes and after tax incomes of
businesses
C
I
So an increase in the tax rate to increase govt revenue
will have a negative effect on economic activity
T increases disposable incomes and after tax incomes
of businesses
C
I
Impact of Fiscal Policy
However, Govt spending has a
considerable impact on the economy.
 Govt spending is an injection into the
economy.

G increases the incomes of individuals and
businesses.
C
I
G decreases the incomes of individuals and
businesses
C
I
How is your Thinking Shaping Up?
Copy one shape into your books and answer the questions.
What is squaring your thinking?
What do you agree with?
What is the most important thing you have learnt?
J.Wilson & K Murdoch 2006,
How to succeed with thinking, Curriculum Corporation
These are answers and your job is
to think of a question for each one


Government revenue and expenditure decisions
Expansionary fiscal gap

Wages increase, cost of imported raw materials increase,
productivity decreases

At very low levels of output there is excess capacity

Will move the AD curve to the right

The government raises most of its revenue through taxation.
LI- Understand the role of the
RBNZ and its implementation of
Monetary Policy.
Define money supply and explain
how financial institutions can
affect this.
Reserve Bank of New Zealand

The RBNZ has five roles
 It
implements Monetary policy aimed at price
stability.
 To issue currency
 It acts as the Governments Banker
 It is the Central Bank. It is the banker for
banks and hold their settlement cash.

 It
Banks can only be called registered banks if they
hold settlement cash with the RBNZ
supervises the banking system
What is Money?
http://www.dailymotion.com/video/x871et_real-world-economicsbarter-bank-no_school
http://www.youtube.com/watch?v=DjTs-rjVkB8&feature=related
Barter Banknotes and Beyond
1.
What was the problem with barter?
1.
2.
What characteristics does money need to have?
1.
2.
3.
4.
3.
Long Lasting
Easily divisible
Reasonably scarce
Easy to store
What other items have been used as money in the past?
1.
2.
3.
4.
4.
Double coincidence of wants
Salt
Cloth
Shells
Tabacco
What was an early problem with money?

Burglars

What were the first banks called?


Name major functions of banks



The bank would go bankrupt
Why would people be no better off if the nation’s money
supply increased?


Look after customers money (Savings)
Lending money to customers
If all depositors wanted their money back from the bank
at once what would happen?


GoldSmiths
If the money supply doubles, the prices will double (inflation) we
would be no better off
What causes the money supply to change?



Banks increasing net lending
Government spending increases
Spending > Taxation ----- Money supply will increase
Money Supply

The official money supply has three measures
1.
M1-Notes and coins in circulation plus other funds that are
immediately accessible by deposit holders without making a
trip to the bank
2.
M2=M1 + other on call funds at registered banks and non-bank
financial institutions (e.g. savings, eftpos)
3.
M3=M2+ term deposits at registered banks and non-bank
financial institutions
Financial Institutions and Money
Supply
 What
determines the amount of
money in the economy?

If the nations money supply consisted entirely of
currency the answer would be simple: The
supply of money would just be equal to the value
of the currency created and circulated by the
government.

However, in modern economies money supply
consists not only just currency but also deposits
balances held at private banks
Example- Gorgonzola land
Originally no commercial banking system
 Barter becomes a problem- Govt directs central
bank to put into circulation $1million.

Printed and distributed to the public
 Money supply
=$1million
 But notes may be
lost or stolenpublic unhappy

Example- Gorgonzola land
In response some people
set up a system of commercial
banks




At first- banks only storage vaults
People need to withdraw $ - physically withdraw
$ or write a cheque gives banks permission to
transfer $
Suppose all $1million is deposited as people
prefer bank deposits to cash
Example- Gorgonzola land
Balance sheet of Gorgonzolan Commercial Banks
Assets
Currency
Liabilities
$1’000’000
Deposits
$1’000’000
Cash held by banks are called bank reserves. In this example banks reserves
for all the banks equal 1000000. Banks hold reserves to meet their depositors
demands for cash withdrawals.
In this situation 100% reserve banking.
Bank reserves are held in vaults rather than circulated among the public and
thus are not counted as part of the money supply.
But bank deposit balances are counted as money.
Money supply= $1million
Example- Gorgonzola land

Commerical banks decide they only need to keep
reserves equal to 10% of deposits. The remaining
90% can be lent out to borrowers to earn interest.
Balance sheet of Gorgonzolan Commercial Banks
Assets
Liabilities
Currency=reserv
es
100’000
Loans
900’000
Deposits
1’000’000
Notice $900,000 have flown out of the banking system into the
hands of the public. We assume citizens prefer bank deposits to
cash ao will redeposit the $900’000
Example- Gorgonzola land
Balance sheet of Gorgonzolan Commercial Banks
Assets
Liabilities
Currency=
reserves
1’000’000
Loans
900’000
Deposits
1’900’000
Money supply now equals $1’900’000!
The existence of the commercial banking system has
permitted the creation of new money
Example- Gorgonzola land




Bankers see they are keeping to many reserves
With deposits of $1’900’000 and a 10% reserve
deposit ratio, banks need only $190’000 in
reserves. $810’000 too much.
Banks lend out an extra $810’000
These are eventually redeposited into banks
Balance sheet of Gorgonzolan Commercial Banks
Assets
Liabilities
Currency=
reserves
1’000’000
Loans
1’710’000
Deposits
2’710’000
Example- Gorgonzola land


Money supply=2’710’000
The process of expansion of loans and deposits
will only end when reserves equal 10% of bank
deposits.
Balance sheet of Gorgonzolan Commercial Banks
Assets
Liabilities
Currency=
reserves
1’000’000
Loans
9’000’000
Deposits
Money supply= 10’000’000
10’000’000
Money supply

Desired reserve-deposit ratio= Bank reserve
Bank deposit
Bank deposits = Bank reserves
Desired reserve-deposit ratio
Bank reserves = $1’000’000
Reserve deposit ratio =0.10
Bank deposits = 10’000’000
Money Supply with both currency
and Deposits
•
•
•
Assumed money is held in the form of deposits
Citizen decide to hold 500’000 in the form of currency and to deposit the rest
into banks
Banks keep reserves equal to 10% of deposits
•
Money supply= sum of currency in the hands of the public and the
bank deposits.
•
•
Currency =500’000
Remaining 500’000 available as bank reserves
500’000/0.10=5’000’000
•
Total money supply= $5’500’000
•
Money Supply=Currency held by public + Bank reserves
Desired reserve-deposit ratio
Questions
Money Aggregates
Transaction account balances
65
NZD funding
20
Currency in circulation
10
Other on call funds
140
1. From the above calculate M1, M2 and M3.
2. Place the following in order in terms of liquidity-from the most liquid to
the least liquid. Term deposit, Cash, Transaction account balance,
On call account balance.
3. Calculate the change in the money supply in each of the following
cases.
a) A new deposit of 20000 and a reserve ratio of 25%
b) A new deposit of $40000 and a reserve ratio of 10%
c) New deposits exceed withdrawals by $100000 and the reserve ratio
is 20%
Questions Fiscal Policy revision
1. What is the name of the gap
shown in the graph?
Price
Level
2. What characteristics are
shown in this graph for you to
recognise that it is the gap you
identified above?
PL
Y
Yf
Y
3. The government decides that it
will implement fiscal policy to
try and close this gap. What
type of fiscal policy will the
government use? Fully explain
the effects this policy will have
on the economy.
Page 170
An increase in Money Supply
(Primary Expansion)

The reserves of the banking system increase
and the money supply increases when
 Deposits
from the public exceed withdrawals
 The govt repays its debt
 The RBNZ engages in Open Market Operations
purchasing of stock

The reserves of the banking system decrease
and the money supply decreases when
Opposite of above occurs
Secondary Expansion

When a primary expansion occurs banks are
holding more reserves than prudence requires.

They are then able to extend lending which is a
secondary expansion in credit.

This lending goes into transaction accounts and
because these form a high proportion of M1 the
money supply is increased.
Demand for money

The demand for money has two parts

1. Transaction demand (For money to make purchases)


. The more purchases that takes place the higher the transaction
demand for money (seen periods high eco activity)
2. Asset demand (Demand on assets used to be sold
later or for precautionary reasons)

Higher dependent on the interest rate. The higher the interest rate
the lower the asset demand for money
Money demand and Money Supply
Interest
rate
Why do you think
MS is a vertical
line?
MS
r
MD
Quantity
The RBNZ
controls the supply
of money and is
fixed at any point
in time. (Market
forces have no
effect)
The NZ Financial System
Government Banks
with
Reserve Bank of New Zealand
(RBNZ)
Registered banks:
The Public Banks
with
e.g. ANZ, BNZ. National
Bank etc
Non-Bank deposit-taking
institutions
e.g. saving institutions,
finance companies
Maintaining Price Stability
• The Reserve Bank ensures that money retains its buying
power.
– It is responsible for maintaining price stability i.e. guarding
against inflation or deflation in order to protect the value of
people’s incomes and savings.
Inflation = an increase in the general level of prices over a
period of time.
Inflation = Change CPI x 100
Original CPI
e.g.
Year
CPI
Inflation = 1010 – 985 x 1000
2006
985
985
2007
1010
= 2.54%
Inflation, Disinflation and Deflation
• Inflation = increase in general price level
• Disinflation = rate of inflation is decreasing
• Deflation = decrease in average price level
% change in price level
+ve
-ve
B
A
C
Years
Text Book Activity C3.6
D
Page 325 10mins
Why do we need stable prices?
• Key reason is to keep export prices competitive.
• Rising prices make NZ exports more expensive compared
with competing products
Low inflation also means
 Businesses can plan for the future
 People are encouraged to save rather than borrow
 Firms more likely to invest in new production
 Wages and prices are consistent
Policy Targets Agreement
• The Reserve Bank’s responsibilities
are set out in the Policy Targets
Agreement: a contract between the
Minister of Finance and the
Governor of the RBNZ
Policy Targets Agreement:
required to keep inflation
between 1% and 3% in the
medium term.
Monetary Policy
• Monetary Policy – Changing interest rates or the
money supply to influence the level of economic
activity.
Official
Cash Rate
Monetary
Policy
Tools
Open
Market
Operations
Moral
Suasion
Monetary Policy
• Official Cash Rate (OCR) – Interest rate set by
the Reserve bank to implement monetary policy,
so as to maintain price stability
The Reserve Bank in NZ now directly influences interest rates using the
OCR.
By setting the OCR the RBNZ is able to substantially influence short term
interest rates.
Short term interest rates have a big impact on
the overall level of economic activity in the
country and therefore on inflation.
Influence on Interest rates by OCR
• The reserve bank pays financial institutions
0.25% below the OCR for money deposited
in the Reserve Bank settlement accounts
• The reserve bank charges interest at 0.25%
above the OCR for overnight cash to banks.
• The Reserve Bank also sets
no limit on the amount of cash
it will take in or let out.
OCR
• The Reserve Bank reviews the OCR eight
times a year.
• Only in exceptional circumstances would
the Reserve Bank make unscheduled
adjustments to the OCR.
• The OCR is much more simpler and easier
understood than earlier systems.
Effects of the OCR
Reserve Bank increases OCR from 2.5% to 3%
Financial Institutions pay 3.25% on loans, up from 2.75%
Financial Institutions get 2.75% on settlement accounts up from 2.25%
Various Financial Institutions will then increase their own interest rates to
consumers and producers.
Consumption rate falls as consumers will begin to save more.
Investment will fall as producers pay more interest on loans
Aggregate demand for goods and services in the economy falls
The Inflation Rate will fall
Monetary Polices
• Loose Monetary Policy
– Lowering the OCR to stimulate the economy
and encourage economic growth
• Tight Monetary Policy
– Increasing the OCR to dampen economic
activity
Open Market Operations (OMO)
• The buying and selling of government securities (bonds) in
the open market in order to expand or contract the amount
of money in the banking system.
Purchases by the government of
government bonds owned by banks
inject money into the banking system and
stimulate growth
Sales of government bonds by the
government withdraw money from the
banking system and contract the economy.
Sell stock to reduce money supply
and buy back stock to increase money
supply
http://www.nzdmo.govt.nz/securities/govtbonds
Moral Suasion
• The Reserve Bank lets the market know about
what its expectations are for the future.
• This then lets markets predict as to what the
RBNZ might do in the future and thus people will
change behaviours to favour themselves in the
future.
• The RBNZ Monetary Policy
Statements are one example
of how the RBNZ tells the
financial markets (banks etc) about its actions.
Building a Cycle way the Length of NZ to Beat the Recession
(2009 external examination)

A national cycle way funded by Central Government at an estimated costs of
$50 million and built throughout the country, would have a multiplied impact
on local economies. For example, the 152km Central Otago Rail Trail
attracted 12000 riders last year and a survey of local businesses estimated
that 90 full-time staff and 240 part-time staff are currently employed in jobs as
a result of the Rail Trail.
(a) Predict the effects of the government spending $50million to build a
national cycle way by ticking the appropriate box in each of the columns in
Table 2 below
Aggregate
Demand
Increase
Aggregate
Supply
Increase
Price Level
Real GDP
Increase
Increase
Decrease
No Change
No Change
b) What type of policy that this government spending on a national cycle way
would best represent? Expansionary Fiscal Policy
c) Based on your predictions in the table above explain the initial impact the
government spending would have on the level of unemployment
c) Based on your predictions in the table above explain
the initial impact the government spending would have on
the level of unemployment

As government spending increases on a cycle way,
workers will be demanded to build the cycle way and
thus more and more people will be employed.
There will also be flow on jobs being created from the
building of the cycle way, as there is likely to be an
increased demand for local businesses products.
Therefore with the creation of jobs due to the
development of a cycle way the initial level of
unemployment in the new Zealand economy will
decrease.
The Money Market and Interest Rates
The RBNZ influences interest rates through OCR
Interest rates have a large impact on economic activity and inflationary pressure
The demand for money is created by those wanting to make transactions or to
hold it as an asset



An increase in GDP or eco
activity
Interest
-Results from an increase in
any component of AD
MS1
-Results in increased
production and sales therefore
transactions
rate
r2
-Increase in transactions
means an increase in demand
for money
r1
MD2
MD1
Quantity of Money
-Increase in interest rates
Interest Rate Changes

An increase in the interest rate will

Decrease household consumption spending


A decrease in business investment spending


as business confidence falls. Sales and revenue may also fall as eco activity
slows
An increase in the exchange rate


as consumer confidence falls and they now prefer to save rather than spend.
Household income may also fall as eco activity slows
which will reduce net exports. Export volumes and receipts decrease while
import volumes and payment may increase.
All of these changes will cause the AD to fall and thus inflation will
fall.
The Money Market and the OCR
ms2 MS1
An increase in the OCR
( Tight Monetary Policy)
Interest rate
Interest rates rise from r1 to r2
r2
r1
MD
As I and C fall
and net exports fall. Causing
a decrease in AD
Quantity of Money
AS
PL
PL’
AD
Y’
Y
AS moves out as the
appreciated exchange rate
causes a fall in imported
materials costs
Money supply decreased, Price
level falls inflationary pressure is
reduced.
A rise in the OCR
Increased retail interest rates
Credit more expensive
Existing borrowers face
increased costs
Increased demand for
the NZD
Appreciation of the
exchange rate
Less new
Higher costs on
existing
borrowing for
investment
Holders of existing
mortgages have
less disposable
income leading to
lower consumption
spending of more
elastic G&S
Increased costs
of production
Adverse effects on
net exports
Lower demand for credit
Investment
spending
Less new
Borrowing for
consumption
AS moves to
the left
Downward pressure on the AD curve
Downward pressure
on AD curve
Reduction in Real GDP
Rising unemployment
A rise in the OCR
Increased retail interest rates
Credit more expensive
Existing borrowers face
increased costs
Increased demand for
the NZD
Appreciation of the
exchange rate
Less new
Higher costs on
existing
borrowing for
investment
Holders of existing
mortgages have
less disposable
income leading to
lower consumption
spending of more
elastic G&S
Increased costs
of production
Adverse effects on
net exports
Lower demand for credit
Investment
spending
Less new
Borrowing for
consumption
AS moves to
the left
Downward pressure on the AD curve
Downward pressure
on AD curve
Reduction in Real GDP
Rising unemployment
Monetary Policy and the
Economic activity is too
Inflationary Gap
high and unsustainable.
There is pressure on price
levels.
Tight Monetary Policy will
be used.
Inflationary Gap
Increase OCR
Interest rates increase
PL
Reduces lending and
increases saving
I and C decrease
Yf
Ye
AD falls
Inflation is reduced
Monetary Policy and the
There is under-utilsed
Deflationary Gap
productive capacity in the
Price Level
economy and therefore
unemployment
AS
Loose Monetary Policy
will be used
Pe’
OCR reduced
PLe
Reduces interest rates
Ad’
AD
Ye
Yf
Real Income,
Output Employment
Reduces saving and
increases lending
Increase in C and I
AD increases
Inflation increases
Official Cash Rate (OCR) decisions
and current rate













Change in OCR
29 July 2010
+0.25
10 June 2010
+0.25
29 April 2010
No change
11 March 2010
No change
28 January 2010
No change
10 December 2009 No change
29 October 2009
No change
10 September 2009 No change
30 July 2009
No change
11 June 2009
No change
30 April 2009
-0.50
12 March 2009
-0.50
29 January 2009
-1.50
OCR rate
3.00
2.75
2.50
2.50
2.50
2.50
2.50
2.50
2.50
2.50
2.50
3.00
3.50
List of Registered Banks in NZ as at 4 May 2010





















Name of registered bank
Registration Date
Name of credit rating agency and rating
ANZ National Bank Limited1 April 1987
ASB Bank Limited 11 May 1989
Australia and New Zealand Banking Group Limited (B)5 January 2009
Bank of Baroda (New Zealand) Limited1 September 2009
Bank of New Zealand1 April 1987
Citibank N A (B)22 July 1987
Commonwealth Bank of Australia (B)23 June 2000
Deutsche Bank A G (B)8 November 1996
JPMorgan Chase Bank NA (B)1 October 2007
Kiwibank Limited29 November 2001
Kookmin Bank (B)14 July 1997
Rabobank Nederland (B)1 April 1996
Rabobank New Zealand Limited 7 July 1999
Southland Building Society7 October 2008
The Bank of Tokyo-Mitsubishi UFJ (B)1 March 2004
The Hongkong and Shanghai Banking Corporation (B)22 July 1987
TSB Bank Limited 8 June 1989
Westpac Banking Corporation (B)1 April 1987
1Westpac New Zealand Limited31 October 2006
AA AA-Aa2
AA -Aa2
AA AA-Aa1
-BBB—
AA-Aa2
A+A+A1
AAAAAa1
A+AA-Aa3
AA-AA-Aa1
AA--A-A1
AAAAA+Aaa
AAA—
-BBBA+AAa2
AAAAAa1
BBB+-AAAAAa
AAAAAa2
Exercises page 170

Questions 1-4
What type of gap would you expect the economy to be in by looking at the
above picture?
What tools are there available for the government to try and close this gap?.
Economic Problem Solving Sheets
Balance of Payments

Where New Zealand's international
transactions are summarised

International transactions include the value
of
 Inflows
and outflows of money
 Financial assets and liabilities
Financial Account
Capital Account
Balance of
Payments
Current Account
Current Account
Balance
on goods
Value of
exported
goods minus
value imported
goods
Usually
positive
Includes all
tangible items
that can be
seen, moved
or stored
Balance
On services
Value exported
services minus
value of imported
services
e.g. Transport,
insurance,
education etc.
Tourists from
overseas who
spend money in
NZ contribute to
our exports of
services
Balance
on income
Value of
investment income
received from
investments
overseas minus
investment income
paid to foreign
investors
e.g. Interest on
savings loans and
dividends on
shares
Balance
on current ‘
transfers
Value of
transfers
received by
NZlanders
minus value
of transfers
paid to others
overseas.
e.g. Money
transfers
from Govt
aid, gifts etc
FORMULA TO CALCULATE
CURRENT ACCOUNTBALANCE
BoG=Xg-Mg
 BoS= Xs-Ms
 BoII= net investment income
 BoCT= net transfers
 CAB=BoG + BoS + BoII + BoCT

Current account balance 1999-2006
Positive balances indicate a surplus, negative balances are in deficit
-The goods balance has gone from a surplus of $2.1 billion in 2001 to a deficit of $4.2
billion in 2006
-- Mainly driven from rising imports
-- Service balance went from deficit to small surplus
-- Investment income deficit increased to over 11billion in 2006
-- result of increasing income earned by foreign investors (high foreign investment)
Ecotonia’s current account statistics, years 1 to 5
Item
Year 1
Year 2
Year 3
Year 4
Year 5
Xg
32
33
32
35
36
Mg
28
29
33
36
38
Xs
18
20
25
29
30
Ms
23
24
24
26
26
Investment
income
-3
-4
-7
-8
-10
Net transfers
2
1.5
2
2.5
1
1. Calculate the current account balances for Ecotania
2. Describe how these events will affect the CA balance
(a) Air NZ buys another plane from the US
(b) There is an economic downturn in NZ’s main export markets
(c) Profits of foreign-owned companies in NZ increase
(d) NZlanders donate large sums to help with disaster relief overseas
Capital Account
Balance of Transfers
made by immigrants
e.g. Aid money
Relatively small impact on the
Overall BOP
Think of capital in an
accounting sense of
transfers of money
Financial Account
Capital Inflows- Capital Outflows
Capital Inflows
Assets brought in NZ by
overseas investors
(Foreign investment)
-NZ borrowing overseas
Capital Outflows
Assets brought overseas
by NZ investors
( NZ Investment Abroad)
-Debt repayment
If NZ sells more assets to foreigners than it buys from
foreigners, there will then be a financial account
surplus.
Financial Account

Is set out using these categories
 Direct investment
 Investments that make up over 10% of the equity in a
company
 Portfolio investment
 Includes investments that make up under 10% of the equity
in a company
 Other capital investment
 All other investment flows (including those from govt)
 Reserve
assets
Current Account Balance
 Is


consistently in deficit.
NZ has experienced current account deficits since the 1970s.
Due to too much domestic demand, a lack of domestic savings and
an over-valued exchange rate

This deficit has to be paid for in some way, from
overseas borrowing, foreign investment or assets sales

Which account do all these components appear in?

Financial Account Balance

Is consistently in surplus – Generally considered undesirable as
these are liabilities that have to be paid in the future.
Thus the current account balance will be the opposite of
the financial account balance.
New Zealand’s Balance of Payments 2005-2009
dollars
Balance of Payments
amounts in millions) Year ended 31 March
2005
2006
2007
2008(1)
2009(1)
Export receipts
31,114
31,581
35,636
38,720
44,259
Import receipts
33,343
35,685
38,464
40,515
45,594
Merchandise BALANCE
(2,228)
(4,104)
(2,828)
(1,796)
(1,337)
Services BALANCE
1,200
522
433
184
(1,119)
Investment income BALANCE (9,384)
(11,065)
(11,906)
(13,343)
(13,035)
Transfers BALANCE
293
144
774
828
919
(10,120)
(14,504)
(13,527)
(14,128)
(14,568)
(6.7)
(9.0)
(8.0)
(7.8)
(7.9)
Foreign investment in NZ
13,870
10,421
23,370
26,795
(8,853)
NZ investment abroad
3,222
(3,790)
11,120
12,500
(16,122)
Reserves
(914)
4,850
6,744
5,763
(9,947)
10,648
14,211
12,250
14,295
7,269
108
(326)
(457)
(773)
(579
Current Account
Current account BALANCE
Deficit as % OF GDP
Financial Account (net)
Financial account
BALANCE
Capital Account
BALANCE OF Capital
Account
Work book page 177 Question 1-4
Trade Accounts

Statistics NZ has upgraded the way it
calculates and presents trade statistics to
bring NZ statistics into line with IMF
guidelines.

NZ stats can be meaningfully compared
with those of other countries.
The Foreign Exchange Market

Foreign currency is required for international trade.


e.g. Before NZ importers can buy a shipment of Japanese cars,
they must first buy Japanese yen.
Forces of demand and supply will interact to establish
the equilibrium quantity and price. Those who create
supply in one foreign exchange market create demand in
another.

e.g. a NZlander travelling to Australia supplies $NZ to the foreign
exchange market and demands $AU.

The price is referred to as the exchange rate

The exchange rate is referred to as how much of another
currency $1 NZ buys
Foreign Exchange Market
 Demand
for $NZ foreign exchange is mainly created
by



Exporters
Foreign tourists
Foreign investors
 Supply



of $NZ foreign exchange is mainly created by
Importers
NZ tourist travelling aboard
NZ investors investing internationally.
Exchange rates
Price of each
NZD in terms
of overseas
currency
If people from overseas
wish to buy our exports or
deposit money in our
banks, they must first buy
our dollars to do this.
Supply
($NZ)
0.72 USD or
62.41JPY or
0.77 AUD
Demand
($NZ)
Q1
Quantity of
NZ dollars
The price of the Australian dollar September
2010
The price of one Australian
dollar is $1.29 NZ.
Price in
NZD
Supply
(AUS $)
$1.29
What would the price of one
NZ dollar cost in Australian
currency?
1AUS
= 1.29 NZ
1.29
= 1.29
0.77AUS= 1NZD
Demand
(AUS $)
Q1
Quantity of
Australian dollars
If a NZ importer wished to
import a shipment worth
$100’000 AUS what would
it cost them in NZD?
100000X 1.29
= $129’000 NZ
Supply and Demand of NZD

The Supply curve of NZD is influenced by
 Demand
for imports (price of imports, incomes etc)
 Investment by NZlanders overseas
 Tourism by NZlandes overseas
 Repayment of overseas debts
 Investment earnings by foreign owned businesses in
NZ
 Business and consumer confidence
Supply and Demand of NZD

Demand of NZD is influenced by
 Demand
for NZ exports (price of exports,
incomes etc)
 Foreign investment in NZ

Influenced by OCR and interest rates
 Overseas
borrowing
 Overseas earning of NZ owned assets
 Overseas confidence in NZ ecnomy
Trade Weighted Index (TWI)

Measures the overall changes in the
exchange rate, of our major trading
partners.
It shows if the NZ $ has appreciated or depreciated overall
against our trading partners. Our dollar could appreciate
against some but depreciate against others.
Appreciation- when the value of $NZ INCREASES against another
currency Could be due to an increase in demand or a reduction in the
supply caused by things like high interest rates, increased demand for
NZ exports, low inflation.
Depreciation- when value of $NZ DECREASES against another
currency. Could be due to a decrease in demand or an increase in
supply. Caused by things like, low interest rates, high inflation.
Impacts on Imports and Exports

Appreciation




This impacts on exports by making them more expensive (to
foreigners) causing exports to reduce
This impacts on imports by making them relatively more cheaper,
as the $NZ now buys more, imports increase
Negative effect on BOP (X-M) as BOP surplus’s are reduced but
BOP deficits will increase.
Deprecation



This impacts on exports by making them cheaper in other
currencies- exports will increase
This impacts on imports by making them more expensive thus
imports will decrease.
Positive effect on BOP (X-M)
What would happen if tourist
numbers to NZ decreased?
1. Show the effects on the graph.
S $NZ
Will the exchange rate
appreciate or
depreciate?
Supply
($NZ)
Explain why falling
tourist numbers cause
this effect?
P
What effect will this have
on the
Demand
($NZ)
Balance of goods
Current Account
Aggregate demand
Q
Q $NZ
Other Factors effecting Imports and
Exports

Demand for exports will depend on
 Price of the product
 Income levels of the countries we export to
 Tastes and preferences for our product
 The price of substitutes and compliments
 Access
to foreign markets (Trade barriers prevent
access) Trade agreements free up access.

Demand for imports will depend on
 The price
 Income levels in NZ
 The price of substitutes
and compliments.
Terms of Trade
Is
an index of export and import prices
Terms of = Total Exports Price Index x 1000
Trade
Total Imports Price Index
• Show
what a given amount of exports can purchase
in the way of imports
•The higher the index the more competitive our
exports are
•If the terms of trade rise (favourable increase) a
given amount of exports can now purchase a greater
amount of imports than before.
Average for
USA
UK
Aust.
Japan
Euro
period ended
Mid-rates all quoted to NZ$1
TWI
TWI
Base June
Monthly
1979 = 100
% change
Aug 2009
0.6754
0.4082
0.8089
64.14
0.4736
62.9
3.7
Sep 2009
0.7024
0.4304
0.8166
64.29
0.4827
64.3
2.3
Oct 2009
0.7383
0.4566
0.8157
66.58
0.4986
66.5
3.4
Nov 2009
0.7309
0.4400
0.7943
65.26
0.4901
65.2
-1.9
Dec 2009
0.7162
0.4407
0.7929
64.15
0.4902
64.7
-0.9
Jan 2010
0.7277
0.4500
0.7959
66.38
0.5092
66.1
2.3
Feb 2010
0.6974
0.4455
0.7868
62.93
0.5094
64.6
-2.3
Mar 2010
0.7032
0.4670
0.7712
63.66
0.5178
65.1
0.8
Apr 2010
0.7124
0.4644
0.7685
66.52
0.5304
66.1
1.6
May 2010
0.6992
0.4761
0.8019
64.36
0.5557
67.0
1.3
Jun 2010
0.6928
0.4696
0.8105
62.96
0.5665
67.1
0.1
Jul 2010
0.7111
0.4657
0.8134
62.31
0.5572
67.2
0.2
Aug 2010
0.7154
0.4566
0.7944
61.17
0.5541
66.6
-0.9
Index
The Fluctuating value of NZD using TWI Base June 1979 = 100
68.0
67.0
66.0
65.0
64.0
63.0
62.0
61.0
60.0
Aug- Sep- Oct- Nov- Dec- Jan- Feb- Mar- Apr- May- Jun- Jul- Aug09 09 09
09 09
10
10 10
10
10 10 10
10
Year