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Chapter 16 National income, expenditure and product E $ Y P Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 16-1 Gross Domestic Product • Gross Domestic Product (GDP) = the market value of all final goods and services produced in the economy in a given period (e.g. 1 year) • No double counting. The market value of a final good includes the value added at each stage of production • GDP is a measure of productive activity; it excludes: – – – Second-hand goods Shares and bonds trading Transfer payments (e.g. social security payments ) Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 16-2 Nominal and Real GDP • Nominal (money) GDP = GDP at current prices – • Australia’s GDP in 1997: $529.2 billion Real GDP = GDP at constant prices (adjusted for inflation) – Annual % change in real GDP = economic growth nominal GDP Real GDP 100 GDP deflator Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 16-3 Australia’s Nominal and Real GDP Growth, 1991 to 2003, % p.a. 9.0 8.0 7.0 6.0 4.0 Real GDP 3.0 Nominal GDP 2.0 1.0 2002 2000 1998 1996 –2.0 1994 –1.0 1992 0.0 1990 % p.a. 5.0 Source: Adapted from OECD, Economic Outlook, July 2004. Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 16-4 Measures of GDP • Three different methods of measuring GDP – – – GDP(I) = income approach GDP(E) = expenditure approach GDP(P) = production approach • Statistical identity: Y = E = P • GDP(A) = average of the three measures Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 16-5 Value Added • Market value of the final product, $2, equals the sum of the values added at each stage of the production process • Value added is the value of a firm’s production less the cost of any intermediate goods or services used in production (1) Production stage Firm 1, Tree farm Firm 2, Logging co. Firm 3, Pulp mill Firm 4, Paper manufacturer Firm 5, Retail store (2) Product Trees Logs Pulpwood Writing pad (3) Sale price of product 0.25 0.60 1.00 1.50 (4) Value added 0.25 0.35 0.40 0.50 Retail service 2.00 0.50 Sum of Value Added = Final Sales Price Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 16-6 GDP Calculation • GDP excludes non-productive transactions: – Non-market items such as the activities of charities and homemakers are excluded • GDP also excludes: – – – – Purely financial transactions Buying and selling shares Second-hand sales Public transfer payments (social security payments) Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 16-7 Two Sides to GDP: Expenditure and Income • The amount spent on • Income derived from this year’s output e.g. the production of this year’s output e.g. – – – – Consumption expenditure by households, plus Government purchases of goods and services, plus Investment expenditure by businesses, plus Net export expenditures – – – – – Wages plus Rents plus Interest plus Profits plus Non-income charges or allocations Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 16-8 GDP May Be Expressed As • Output: GDP(O) • Expenditure: GDP(E) • Income: GDP(I) • Average of these three: GDP(A) Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 16-9 Aggregate Demand/GDP(E) • GDP(E) = aggregate demand (AD) = total expenditures on final goods and services = C + I + G + (X – M) • Main components: – – – – Private final consumption (C) = expenditure on consumer goods and services Private investment (I) = spending on capital goods Government spending (G) = spending on final goods and services by government Net exports (X – M) = expenditure by foreigners on our output as well as by our own citizens on foreign items Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 16-10 Personal Consumption Expenditures (C) • Expenditures by households on – – – Durable consumer goods (e.g. cars, refrigerators, videos) Non-durable consumer goods (bread, milk, beer) Services (banking, legal, car repairs) • ‘C’ includes expenditure on imported as well as Australian-produced goods and services (about 60% of total aggregate demand) Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 16-11 Determinants of Personal Consumption (C) • Disposable income • Consumer wealth (e.g. stocks, bonds, real estate) • Consumer expectations/economic circumstances • Credit conditions (interest rates, money supply) • Taxes (e.g. income tax, indirect taxes) • Marketing Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 16-12 Private Investment (I) • Most volatile component (12–19%). Includes – – – All final purchases of machinery, equipment and tools by business enterprises All building and construction Changes in stocks (or inventories) • Main influences – – – – Rates of taxation and government incentives Cost and availability of credit Business confidence/profit expectations Degree of excess capacity Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 16-13 Government Spending (G) • Represents about 20–25 % of GDP(E) • It excludes all government transfer payments (unemployment benefits etc.) • G1 = Current expenditure by the government sector required for the day-to-day operation of government (e.g. wages and salaries of government employees, materials and power) • G2 = Expenditure on capital goods and services by the government sector (e.g. schools, hospitals, transport and telecommunications) (cont.) Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 16-14 Government Spending (G) (cont.) • Main influences – – – The state of the economy Ability to provide funds (e.g. from taxes or borrowings) Political and economic considerations Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 16-15 Net exports (X – M) • Spending by foreigners on Australian goods and services, and • A portion of the totals of C, I and G is for goods and services that have been imported—that is, produced overseas • The total value of imports (M) must be estimated and subtracted from C + I + G + X to avoid an overstatement of total production in Australia Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 16-16 Influences on Net Exports • The world economy (GDP growth in major economies). Exports are to increase in line with GDP growth (and imports) in major partner countries • Cost competitiveness – – Labour productivity and capital efficiency Exchange rates (e.g. a strong Australian dollar will encourage M and discourage X) • Government’s external policies Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 16-17 Australia’s GDP(E), 2001–02, A$ Billion and % of Total Component A$ billion % of Total GDP Private Consumption (C) 419.3 60.2 Private Investment (I) 130.6 18.8 G1 + G 2 151.7 21.8 Exports (X) 150.6 21.6 – Imports (M) –156.2 –22.4 TOTAL GDP 696.0 100.0 Source: Adapted from ABS, Year Book Australia, 2004, p. 771. Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 16-18 International GDP Comparisons ($US Billion) • World Bank Atlas method = conversion of GDP in national currency to US$ using the 3-year average annual exchange rate • Example – – – Australia’s GDP: A$401.4 billion Average annual exchange rate: A$1 = US$0.7031 GDP = A$401.4 x 0.7031 = US$282.2 billion Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 16-19 The World’s Largest Economies (GDP in 2003 US$ Billion), World Atlas Method 1.United States 10 881 9.Canada 834 2.Japan 4326 10. Mexico 626 3.Germany 2401 11.Korea Rep. 605 4. United Kingdom 1795 12.India 599 5. France 1748 13. AUSTRALIA 518 6. Italy 1466 14. Netherlands 512 7. China 1410 15. Brazil 492 8. Spain 836 WORLD GDP: 36 356 Source: Adapted from World Bank, World Development Indicators, 2004, http://www.worldbank.org. Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 16-20 Structure of Aggregate Demand in Asia Pacific, 2001, % (World Bank) Economy/ region Household Government Gross consumption consumption capital expenditure expenditure formation % % % Net exports % East Asia (LDC) 52 12 31 5 Singapore 42 12 24 22 Hong Kong 59 10 26 5 Japan 56 18 25 0 Australia 60 19 23 0 Source: Adapted from the World Bank, World Development Indicators, 2003, Table 4.9. Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 16-21 Related National Income Concepts • Gross National Expenditure (GNE) = C + I + G – Total domestic demand on goods and services. No exports • National Income (NI) = income received by a country’s residents = GDP – (net income paid overseas + depreciation allowances) Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 16-22 The Business Cycle % change Real GDP Peak Expansion Contraction Time Trough Trough Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 16-23 Consumption and Saving • In terms of absolute size, C is the main component • • • • of total spending (AD) with about 62% in 1996–97 Personal saving = that part of disposable income (DI) that is not consumed Average propensity to consume (APC) = the fraction or percentage of total disposable income that is consumed Average propensity to save (APS) = the fraction or proportion of total DI that is saved APC + APS = 1 Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 16-24 The Multiplier • The multiplier = the ratio of the income shift brought about by a change in (investment) spending (See text Figures 16.4 and 16.5, p. 296) change in C Marginal propensity to consume (MPC) change in Y • Example – An income increase of $100 results in an $80 increase in consumption – MPC = 80/100= 0.8 (cont.) Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 16-25 The Multiplier (cont.) change in S Marginal propensity to save (MPS) change in Y • Therefore, MPS = 20/100 = 0.2 1 1 1 The multiplier (M) 5 1 MPC MPS 0.2 • The multiplier (M) is the no. of times by which changes in GDP exceed the initial change in aggregate spending, brought about by changes in income Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 16-26