3.1 Measuring economic activity and illustrating its variations

Macroeconomics (definition and goals)

The study of the economy on a country level

Goals:

- Low unemployment

- Low and stable inflation

-Equity

- Economic growth

How is economy measured?

1. Using the output method

2. Expenditure approach

3. Income method

Using the output method

RGDP: The actual value of all final goods and services produced within the economy each year

- RGDP does not include goods that are resold, or components, underground maarkets

- measures the value of all finished goods/services in a country in a year

- to prevent double counting, only the final product is measured not the manufacturing process

Expenditure approach

C+I+G+(X-M)

- measures the value of all spending in a country in a year

- Note that investments here means "capital expenditure on goods", not stocks and securities.

Income method

Measures economic activity by calculating the value of all incomes in the country in a year.

sum of the results of FOP: wages + rent + interest + profit

= all these values should be equal

GDP deflator

Nominal GDP/Real GDP x 100

- also known as price index

Total vs Per capital

Per capita:

Total GDP / population

Purchasing power parity vs Exchange rates:

GDP is measured in the domestic currency. This makes it difficult to compare different countries

PPP: Adjusts the value of the GDP based on the buying power of $1 in the given country based on the same basket of goods

- PPP exchange rates is adjusted to reflect this discrepancy and the GDP will reflect this

Exchange rates:

Using exchange rates to equate the value of GDP to USD helps but it has issues because the buying power of $1 is different in different countries

Green GDP

Green GDP accounts for environmental destruction.

- The method of measuring GDP deducts the cost of environmental destruction from GDP

- Green GDP = GDP - the value of environmental destruction

Gross domestic product:

- counts whatever is produced in the country

- Use the expenditure method to calculate

GDP = value of all goods and services produced in an economy (regardless of who owns them)

If foreign countries invest a lot into one country GDP is greater, but money could be sent back to their own country = increasing GNI

Nominal GDP

Real GDP:

Real GDP per capita

Real GDP Per Capita at Purchasing Power Parity

Gross national income (GNI)

measure of the ownership of the factors of production

Income earned from all residents of a country regardless of where they earn the money (as long as it is sent home) but minus money earned by foreign workers/firms in your country

Net income from abroad = income sent back from residents abroad - income sent abroad from foreign countries

Nominal GDP/GNI

value of all final output of goods/services in a given in a year. Nominal GDP measures this using current prices of all goods/services

inflation is not taken into account

GNI

- Counts all income generated by a country's citizens and companies, no matter in what country they are

GNI = GDP + net income from abroad

Real GDP/GNI:

Nominal GDP + adjusted for inflation

measures all final output of goods and services in a given economy in a given year, but uses constant prices, which adjusts for inflation

This calculation is done by using a price deflator → using price deflator can calculate real GDP

Real GDP = Nominal GDP / Price Deflator

GNI:

GNI value adjusted for inflation = using price deflator

Real GDP/GNI per capita

Nominal GDP + adjusted for inflation + adjusted per person

GDP per capital is a country's GDP/number of people in a country

Useful to see how productive an average persion is in that economy

Real GDP Per Capita = Real GDP / Population

GNI:

Nominal GNI + adjusted for inflation + adjusted per person

useful to see productivity

Real GNI per capita = GNI/population size

Real GDP/GNI Per Capita at Purchasing Power Parity

Nominal GDP + adjusted for inflation + adjusted per person + adjusted for how much money can get you

purchasing power parity (PPP) = how many goods/services the GDP will actually get you

indicates what the economy's size actually means

Useful to see what the economy's size can actually do

Nominal GNI + adjusted for inflation + adjusted per person + adjusted for how much money you get

Disadvantages of GDP and GNI

- GDP and GNI don't accurately reflect the well-being of people in the country.

-> eg, China's GDP has multiplied by 40 in the last 30 years, but people are not 40 times happier.

- They don't show the distribution of wealth in an economy.

- Because of currency exchange rates, international comparisons are often not accurate.

- Social welfare is ignored.

- Shadow economies or black markets don't count, which are huge parts (up to 50%) of economies in certain countries.

- They do not account for negative externalities such as environmental costs.

Comparisons over time

Nominal GDP/GNI negatively reflect an economy's past as it is not adjusting for inflation.

Therefore, real GDP is a better value for an economy when comparing it to its historical past.

Comparisons to other countries

Because some countries have higher costs of living and production, nominal and real GDP/GNI positively reflect such countries.

Therefore, adjustments to PPP is a better value for comparing economies.

Alternative measures for wellbeing

1. OECD Better Life Index

2. Happiness Index

3. The Happy Planet Index

1. OECD Better Life Index

- The Better Life Index is based on material living conditions such as housing and income, and qualities of life such as health, life satisfaction, and safety.

- only measured for OECD countries (35 of the most developed countries in the world), so it's not a very good universal measurement

2. Happiness Index

- measures how happy a sample of people is in every country. - measured by asking people how happy they are with factors like emotional well-being, health, work, and business/economy.

- (+) reflects the well-being of people rather than just an economic number.

- (-)but since the factors are quite subjective, it is hard to measure a value.

3. The Happy Planet Index

-measure human well-being but also considers ecological footprints.

- countries with low footprints tend to come out on top.

- Shady countries that are relatively bad to live in rank high just because they have low ecological footprints. eg. Costa Rica, Vanuatu, and Colombia rank as the top 3

The business cycle (draw the graph)

Business cycle: A model that describes the fluctuations in the level of economic activity of a country over time, thus creating a long term trend of economic growth in the economy

Parts of the business cycle

1. Contraction/recession

2. Expansion

3. Peak

4. Trough

Contraction/ recession (characteristics)

After the peak = the economy shrinks which is a downturn or a decrease in the rate of economic growth

- Recession: When a fall in GDP for two consecutive quarters (6 months)

Characteristics:

- Reduced consumer spending

- Job losses

- Falling stock markets

- Credit crunch

Expansion (characteristics)

boom where the economy shows a sustained increase in levels of GDP, employment and output

- Boom: A phase when the level of economic activity rises = increase in aggregate demand

(Characteristics)

- Increased production

- Employment growth

- Rising stock markets

- Consumer optimism

Peak (Characteristics)

When economic activity is highest → Economies transition from the end of growth to the beginning of contraction

Characteristics:

- Maximum output

- Inflationary pressures: High QD, prices rise = potential inflation

-Overconfidence: overenthusiastic investments, not always backed by real demand or value

Trough (Characteristics)

When economic activity is highest → Economies transition from the end of growth to the beginning of contraction

-Stabilising employment and production: The rate of layoffs and production cuts may begin to slow

-Lowest GDP levels: The economy's output is at its minimum in the cycle

-Potential for renewed confidence: Condition does NOT worsen = consumers/business grow hopeful to revisit monetary policies

Long-term growth trend in the business

Over time, potential real GDP is increasing

⇒ The most recent trough is higher than the previous = indicating a general growth trend over time.

Long-term growth trend = potential GDP = full employment level of output (represented by LRAS on the AD/AS diagram)

Potential output

Level the economy can produce at, no cyclical unemployment

- Corresponds to the natural rate of unemployment where the unemployment rate in the country is equal to frictional + structural + seasonal

Output gap

The difference between actual output and potential output

- Actual output = RGP at that moment in time

How can Actual output > potential output?

The rate of unemployment can be lower than the natural rate of unemployment IF actual output > potential output

This happens as prices increase, businesses are employing more people People could be working additional time or jobs = over-employed = the ACTUAL rate of unemployment is less than the natural rate of unemployment

This level is unsustainable in the long run → contraction at some point to bring output down to potential