Unit 3.1(1): Measuring the level of economic activity

Economic activity

Scarce resources (limited amount) are allocated to produce goods and services to satisfy human wants (unlimited wants)

→ we assume all resources are scarce

National income

Monetary value - measures the total value of all goods and services produced in a country in money terms

The circular flow of income

economic model that illustrates the flow of money between firms and households at a macroeconomic level.

→ added: foreign trades, government, banking sectors

→ policy making and economic forecasting

Flow of money around different sectors

Economy divided into two sectors

Firms combine the factors of production to produce goods and services, and households buy and consume the goods and services

Red flow in the diagram presents

combine the factors of production to produce goods and services, and households buy and consume the goods and services

→ Injections of funds, such as investment, government expenditure, and exports, enter the circular flow of an economy.

→ Withdrawals or leakages of funds from the circular flow of income occur in the form of savings, taxes, and imports.

Injections to the circular flow

Money entering the economy from outside the basic household firm cycle, they add to the flow of money and boost economic activity

come from firms investing, government spending and exports resulting from foreign trade

• 3 injections:

1. Investment by businesses when they buy capital such as new buildings and machinery - enters the economy helps it grow money

2. Government expenditure on public services such as health and education

3. Exports of goods and services to other countries lead to an inflow of funds.

Withdrawals from the circular flow

Leakages - money leaves the cycle temporarily

3 main withdrawals:

1. Savings - when households save money (banks) they’re not spending it on goods and services. It’s temporarily out of circular flow

2. Taxes - money paid to the gov. When households or firms pay taxes this money goes to the gov instead of back to firms

3. Imports - money spend on g/s produced in other countries

→ buying this good causes money leaves the domestic economy to another

Circular flow use

1. Analyse the cause and consequences of changes in economic variables

   → visualise how spending, income and production are linked in the economy and how changes in injections and withdrawals affect economic activity

GDP

monetary value of all final goods and services produced by that country in one year. It is a statistic used to measure macroeconomic activity. The GDP of a country is normally considered an annual figure

GDP only includes final goods and services

1. Ready for commotion and investment

2. Not to be counting things twice - to avoid double counting and an accurate picture of economic activity

3 ways to measure the gdp using the circular flow

1. Income method

→ This is the total value of income earned by households in one year in the form of:

• Wages paid to labour

• Interest paid to capital

• Rent paid to land

• Profits and dividends paid to entrepreneurs.

2. Output method

→ calculated by taking the value-added of firms in different sectors of the economy. The sectors are:

• Primary – commodities

• Secondary

Tertiary – services such as education, restaurants, tourism, transport,

→ difference between value (selling) and value (costs)

3. Expenditure method
This is calculated by aggregating the total expenditure (money spending) of different sectors of the economy.

• Consumption (C) spending by households on final goods and services

• Investment (I) spending by firms on capital equipment

• Government (G) spending on public services

• Net Exports (X-M) The surplus of the value of exports over the value of imports

GNI

Total income earned by country’s residents and businesses, both domestically and abroad in a year

GNI = GDP + net income from abroad

NET INCOME from abroad

GNI per capita

Divided by total population

→ average income per person

Useful to compare living standards or economic wellbeing between countries or over time

Economic growth

Increase in a country’s real GDP over time

Business cycle

Shows that economies do not grow at a constant rate because the rate of growth rises and falls over time

Trend rate of growth - avg rate f growth over a numb of years

Conventional business cycle

• boom phase (growth rate above trend rate) - income rising, falling unemployment, rising inflation

• Slowdown phase - economy goes past its peak rate of growth and the growth rate falls - household incomes do not rise as fast, unemployment might rise, inflation less pressure

• Recession phase - real GDP falls

→ household incomes might fall, unemployment increases, inflation falls

• recovery phase

→ economy emerges from a recession and real GDP starts to increase

→ unemployments starts to fall, household income rise, upward pressure on inflation

Explain business cycle

The business cycle sets out how the actual GDP of a country change over time as it moves through the different phases of economic growth. The phases are boom, slowdown, recession and recovery.