macroeconomics (3.1, 3.2)

economic measures

economic measures

1. Gross Domestic Product (GDP) - economic growth

2. unemployment rate - full employment (limit unemployment)

3. inflation rate - keep prices stable

for an economy as a whole, income must equal expenditure

because

• every transaction has a buyer and a seller

• every dollar of spending by a buyer is a dollar of income for a seller

circular flow of economic activity

households supply resources (land, labour, capital, entrepreneurship) to the resource market and demand goods from businesses

businesses demand household resources and supply goods to the product (factor) market

national income accounting

measure of level of economic activity

refers to monetary value of all goods and services produced in a year

(usually GDP)

gross domestic product

a measure of income and expenditures in an economy

the total market value of all final goods and services produced within a country in a given period of time

not included in GDP

1. intermediate goods

2. non-production transactions

3. non-market (illegal) activities

3 ways of calculating GDP

1. expenditures approach: add up all spending on final g&s produced in a given year

2. income approach: add up all income earned from selling all final g&s produced in a given year

3. value-added approach: add up the dollar value added at each stage of the production process

expenditures approach

4 components of GDP

1. consumer spending (C)

2. investments (I)

3. government spending (G)

4. net exports (Xn)

consumer spending is made up of

1. durable goods

2. non-durable goods

3. services

investment

when businesses buy capital like machines, resources and tools

inventories

goods produced and held in storage in anticipation of later sales

counted the year they are produced, not the year they are sold

government spending

spending made in the “public sector”

includes: payments made by the government for g&s

doesn’t include: transfer payments (welfare and social security subsidies), and interest payment on national debt - non-production costs

net exports

= exports - imports

trade surplus: exporting more than importing (+)

trade deficit: exporting less than importing (-)

GNI

(gross national income)

measures income earned, including income from investments that flow back into the country

GNP

(gross national product)

includes the earnings from all assets owned by residents, omitting the earnings of all foreigners living in the country

nominal GDP

measured in current prices

doesn’t account for inflation

real GDP

expressed in constant or unchanging dollars

adjusted for inflation

the GDP deflator

a measure of the price level

tells us what portion of the rise in nominal GDP that is attributable to a rise in prices rather than a rise in quantities produced

GDP deflator = (nominal GDP / real GDP) x 100

real GDP per capita

(per person)

reflects the size of a nation’s population

identifies, on average, how many products each person makes

business cycle

changes in a nation’s GDP can be illustrated in a simple economic model

there are four stages:

1. recession

2. recovery

3. expansion

4. long term growth trend

recession

a decline in total output, income, employment and trade, lasting 6+ months

unemployment increases

decrease in real GDP

downward pressure on price level

more social problems

recovery

when a recession has ended and national output begins to increase again

expansion

when an economy is growing at a rate beyond its long term growth trend

unemployment decreases

increase in real GDP

increasing price level

fewer social problems

the use of GDP

enables economists to use national income statistics for making comparisons of economic well being over time and between countries

gives an indication of standards of living in a country

alternative measures of well being

• green GDP: adjusts the country’s GDP to account for the value of environmental degradation, damage and destruction associated with economic growth

• OCED better life index: based on topics identified to be essential in terms of material living conditions and quality of life

• happiness index: considers how information technology, governance and social norms influence well being

• happy planet index: measure of sustainable well being

aggregate demand

all the goods and services (real GDP) that buyers are willing and able to purchase at different price levels

AD = C + I + G + Xn

3 reasons why the AD curve slopes down

1. real balance effect: you feel poorer so you spend less → purchasing power declines with inflation

2. interest rate effect: rising prices push up interests rates → lenders need higher interest rates to compensate for decreasing purchasing power of money

3. exchange rate effect: if prices rise, exports decrease and imports increase so Xn decreases

aggregate supply

amount of goods and services (real GDP) that firms produce in an economy at different price levels

AS = R + A + P

(shifters are resource prices, actions of govt., and productivity)

short run aggregate supply

wages and resource prices are sticky (fixed in contract) and will not increase as price levels increase

with higher profits, firms have more incentive to increase production (increase output to maximize profits, because production is more profitable)

sticky wage theory

nominal wages are sticky in the short run (they adjust slowly), due to labour contracts

long run aggregate supply

wages and resource prices are flexible and will change when price level changes

as prices go up, wages have been adjusted so there is no incentive to increase production (price level increases but GDP doesn’t)

vertical because the economy is at full employment output

shift in LRAS

same as for the PPC

1. change in resource quality or quantity

2. change in technology