3.1 Measuring Economic Activity

Circular Flow of Income Model

Expenditure Approach

Measures total amount of spending to buy final goods and services in a country (1 year)

C+G+I+(X-M)=GDP

Output Approach

Measures total value of all goods and services produced in the economy over a time period (1 year)

*Final means that it only considers the price at which the good is sold at

GDP

Total value of all final goods and services produced within the country over a time period, regardless of who owns the factors of production.

Indonesian domestic helper in HK. GDP? GNI?

Income goes to Indonesia’s GNI

Output goes to HK’s GDP

GNI

Total income recieved by the residents of the country, regardless where they are located.

GNI Formula

GNI= GDP + Net income from abroad.

E.g Indonesia’s GNI includes it’s domestic output of goods + the income of domestic helpers in HK as well

Nominal GDP

GDP expressed in the price level of that year.

Real GDP

GDP adjusted for the changes in price level from a base year.

If base year, then GDP deflator is 100

Real GDP formula

Nominal GDP/Price Deflator * 100

GDP per capita (formula + use)

Provides indication of how much total output in the economy corresponds to each person in population on average.

Limitations of GDP (5 args.)

1. Doesn’t include non-market goods/services (e.g volunteer work, trading). Therefore, GDP is under-reported in less developed countries as they make their own goods

2. Underground OR informal Economy (e.g drugs, HK wet market, taxi services using cash)

3. Does not reflect improved product quality (better, more efficient machines = goods are higher quality, but also can be sold at lower prices)

4. Doesn’t account for environmental damage, distribution of income, quality of life

5. Differing domestic price levels

Alternate Measures of Wellbeing

1. OECD Better Life Index

2. Happiness Index

3. Happy Planet Index

Business Cycle

Fluctuations in growth of real output, consists of periods of expansion and contraction

Expansion stage (feature + effects)

• Trough —> Peak

• Real GDP higher than Potential GDP

Effects:

• Unemployment ↓

• Price Level ↑

• Consumer + Business Confidence ↑

Peak

• Highest point inbetween expansion and contraction

Effects:

• Saturation point (max)

• Resource allocation efficiency ↑↑

• Unemployment ↓↓

Recession

• Decrease in Real GDP/Negative economic growth for 2 consecutive quarters

Effects:

• Resource allocation efficiency ↓

• Unemployment ↑

• Price Level ↓

• Demand for goods/services ↓

Trough

• Minimum of business cycle

Effects:

• Uncertainty ↑↑

• Unemployment ↑↑

• Confidence ↓↓

Recessionary Gap (unemployment, gdp)

• Potential GDP > Real GDP

• UR > NRU

Inflationary Gap (unemployment, gdp)

• Real GDP > Potential GDP

• NRU > UR