M2: National Accounts aggregates and the multiplier
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57 Terms
What is real GDP
Allows us to measure the true value of growth in the economy by adjusting for inflation
What is nominal GDP?
Nominal GDP gives us the value of domestic output at current prices.
What is the system of National accounts (SNA)
Refer to an international standard for collecting data on economic activity and tracking economic output.
The SNA gives guidelines on how to classify the 'accounts' that measure economic output and how it is spread across consumers, businesses, government and the foreign sector.
The SNA makes it possible for countries to measure and analyse economic performance so that governments can make necessary adjustments to their economic planning.
The SNA also makes it easier to make comparisons between the economic performance of different countries.
What are South Africa’s national accounts about?
SA national accounts are a detailed record of the country's economic activity.
Three approaches are used to record economic output, namely:
Production method (also known as the value-added method)
Income method
Expenditure method
What will we see in the national accounts?
The national accounts aggregates are listed as series of tables that summarise domestic production, expenditure and income.
These aggregates are the GDP figures derived by using the three approaches for calculating output. They are referred to as 'National income and production accounts'.
What does aggregate mean?
A sum or total that is calculated by adding together different parts.
GDP figures are listed in both… and …prices. Name these types of prices and explain them?
GDP figures are listed in current or constant prices.
When constant prices are used: a base year is used for reference. The current base year is 2015 and using a base year, it allows for meaningful comparisons of GDP data from one year to another and to measure real economic growth. This is because constant prices make allowance for inflation and give us the real value of GDP.
Current prices give us the nominal value of GDP – the value of GDP at a given time.
What is GDP?
GDP is the measure of the total value of all final goods and services produced within the borders of a country for a specific period. The period is usually the current year, but can also refer to a quarter
What are important facts to know about GDP?
GDP is concerned with the value of production within a specific geographical area, a country. Imports are excluded because production takes place outside the country.
GDP measures the value of production for a specific period, usually a year.
GDP is used to measure current production. Only the value of new goods and services is included.
GDP measures the value of final goods and services. The value of intermediate goods is not included.
Why is GDP important?
Measure economic activity – The value of GDP helps us measure the level of economic output or how big an economy is.
Measure economic growth – Comparing GDP figures from one year to the next allows us to determine whether the economy is expanding or contracting.
Reflect the standard of living in a country when per capita figures are used.
Compare levels of wealth and development between countries.
Guide decisions made by government and businesses
What are the three methods used to calculate GDP
Production or value-added method
Income method
Expenditure method.
What is the relationship between these three methods of calculating GDP
Production = Income = Expenditure
The economic process begins with production. Without goods and services to buy, there can't be any demand. As a result, there would be no expenditure and no income for economic participants.
When businesses produce goods and services, they receive income that is equal to the value of the goods produced (Production = Income). This income is used to pay for the factors of production used during the production process, creating income for households. Households will spend their income on products offered by businesses (Income = Expenditure). The value of spending will be equal to the amount of income received, ceteris paribus.
What is aggregate demand made up off?
Investment spending by businesses, government spending, and net export expenditure (the value of imports minus the value of export).
What is the production method
The production method is also known as the value-added method. This method of calculating GDP tracks the value added at each stage of production. It records the value added to output by the primary, secondary and tertiary sectors. In these calculations, we need to be careful not to account for the value of inputs (intermediate goods) more than once. (double counting)
How can we avoid double counting?
We can avoid double counting in one of the following ways:
GDP calculations should only include the value added at each stage of production.
GDP calculations should only include the final sale value of the good or service (when good is sold to the end consumer).
GDP calculations should only include the amount of income received at each production stage.
How to uses the double counting method?
The value of output produced by each economic sector is expressed as GDP at basic prices. This is the price of a good or service before taxes and subsidies on the product are added. It is important to note that the value of production includes the cost of inputs and the taxes payable for production. Any subsidies received by businesses for production are subtracted.
Examples of gross value added by kind of economic activity at current prices
SEE TABLE
What observations can be made from the table above
The value-added method measures the value of GDP by adding up the total value of production added by each economic sector.
The total value of production from the three economic sectors gives us the gross value added (GVA) at basic prices.
GVA at basic prices includes the value of taxes payable on production and excludes the value of subsidies granted to businesses for production.
To get the value of GDP at market prices (the final price that goods and services are sold for) we need to add taxes payable on the product and subtract the value of subsidies on the product.
What is the difference between taxes and subsides
SEE TABLE
What is the income method?
The income method measures the value of output by calculating the cost businesses pay for using the factors of production. This is the income that would go to the owners of the factors of production. The value of GDP using the income method is expressed at factor cost. This is because the income received by households is equivalent to the cost businesses pay for employing the factors of production.
An example of using income method
SEE TABLE
What observations can be made from the table above?
The income method measures the value of GDP by adding the factor income payable to those who own the factors of production.
GDP at factor cost is the cost to businesses for using the factors of production.
GDP at factor cost excludes taxes on production but includes subsidies on production.
In order to calculate GDP at market prices using the income method, we first need to determine the GDP at basic prices.
The GDP at market prices includes all taxes on production and products and excludes any subsidies on production and products.
What is the expenditure method
The expenditure method measures GDP according to the amount of spending on the goods and services that are produced. Gross domestic expenditure is the total value of all expenditure on final goods and services within the country at a given time. This will exclude spending on imports because that spending is on goods that are produced outside the country.
However, when we calculate GDP we are interested in the value of all final goods and services produced within the borders of a country during a specific period. As a result we will subtract the value of imports and include the value of exports.
The equation to represent GDP: GDP (E) = C + G + I + (X - M)
An example of using expenditure method
SEE TABLE
What observations can be made from this table?
When we use the expenditure method for calculating GDP, we are measuring the amount of expenditure on domestic output.
To get gross domestic expenditure (GDE) we add together the spending of households, government and businesses.
Some of this spending includes spending on imports. We need to keep this in mind when calculating expenditure on GDP.
To calculate expenditure on GDP we add up the expenditure of the four economic participants and subtract spending on imports. This is because imports are produced in other countries and do not form part of domestic output.
The residual item is added (or subtracted) to cancel out any omissions or errors in the calculation of gross domestic expenditure. This is done to prevent differences in the GDP values when using the three methods of calculating GDP
Differentiate between factor, basic and market prices?
Factor price | The cost of factors of production to businesses. |
|---|---|
Basic price | What the business receives for a product. |
Market price | How much the product costs at market. |
How do you convert between factor, basic and market prices
To convert from factor prices to basic or market prices, we need to add taxes and subtract subsidies.
When we start with factor prices, we need to add taxes on production and subtract subsidies on production to get basic prices.
To get from basic prices to market prices, we need to add taxes on products and subtract subsidies on products.
If we want to convert in the opposite direction, from market prices to basic or factor prices, we need to subtract taxes and add subsidies.
Remember, the market price includes the value of taxes, but excludes the value of subsidies. This is because taxes are added to the final sale value of a product, but subsidies are excluded from the final sale value of a product.
This is because taxes increase the cost of production and the price of a product, but subsidies reduce the cost of production and the price of a product.
How to convert nominal GDP to Real GDP
Nominal GDP is also known as GDP at current prices and measure the value of GDP using present-day prices. Real GDP is also known as GDP at constant prices. The value of real GDP is adjusted to remove the impact of inflation on prices. A base year is used to maintain constant prices. The current base year is 2015. This means the real value of goods and services produced in 2022, for example, will be valued at 2015 prices. Constant prices allow us to make meaningful economic growth comparisons from one year to the next by removing the impact of inflation on prices.
To convert nominal GDP to real GDP, we use a GDP deflator. The GDP deflator compares GDP at current prices to GDP at constant prices. We calculate the GDP deflator in the following way:
GDP deflator = 𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝐺𝐷𝑃 / 𝑅𝑒𝑎𝑙 𝐺𝐷𝑃 × 100 |
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State the difference between domestic and national figures
Domestic figures measure the total value of production or income that is produced within the borders of a country by that country's citizens and by citizens of other countries.
National figures measure the total production and income produced by a country's citizens regardless of where production takes place.
National figures only account for the value of economic activity by a county's citizens.
National figures include income and production that a country's citizens produce in other countries.
How to convert GDP(P) to GNP
Gross national product (GNP) measures the value of output produced by a country's citizens and permanent residents in the country and abroad.
Remember, GDP measures the value of domestic output, which includes the production by people who are not permanent residents or citizens of a country.
To get to the value of GNP, we add primary income from the rest of the world and subtract primary income to the rest of the world.
The value of GNP is used to measure the productivity of a country's citizens and can be used as a indicator of how well the economy is performing.
If income from the rest of the world is greater than the income to the rest of the world, GNP will be higher than GDP. This is a positive indicator for the health of the domestic economy because it points to a strong export economy.
How to convert GDP to GNP?
At current prices (2020) | R millions |
|---|---|
GDP at market prices | 5 521 075 |
Plus: Primary income from the rest of the world | 128 877 |
Less: Primary income to the rest of the world | 221 433 |
Gross national product at market prices | 5 428 |
How to convert GDE to GNE
Gross national expenditure (GNE) is the total expenditure of economic participants, including expenditure by South Africans who are living abroad.
GNE is not commonly used as a measure of economic output.
To get the value of GNE, we need to add net factor income from abroad.
The expression for GNE is shown in the table below.
GNE = GDE + net factor expenditure from abroad |
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GNE = GDE + output of factors of production owned by domestic citizens abroad - output of factors of production owned by foreign citizens in the local economy. |
How to convert GDP(I) to GNI
Gross national income (GNI) refers to the income received by a country's permanent residents and citizens for a specific period, regardless of where they are in the world.
To get the value of gross national income, we add primary income from the rest of the world and subtract primary income to the rest of the world.
As with GNP, GNI is useful because we can use it to judge the level of social and economic well-being of a country and its economy.
How to convert GDP to GNI at current prices
At current prices (2020) | R millions |
|---|---|
GDP at market prices | 5 521 075 |
Plus: Primary income from the rest of the world | 128 877 |
Less: Primary income to the rest of the world | 221 433 |
Gross national income at market prices | 5 428 519 |
Formula for real GDP
Real GDP = 𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝐺𝐷𝑃 / 𝐺𝐷𝑃 𝑑𝑒𝑓𝑙𝑎𝑡𝑜𝑟 × 100
In a four-sector economy, which of the following is assumed always to increase when GDP increases?
The model assumes imports increase when output and incomes increase.
What is the multiplier principle?
The multiplier principle is the idea that one person's spending becomes another person's income. The multiplier comes into effect when there is a change in planned expenditure as a result of an increase or decrease in injections (I, G and X) or when factors that are not dependent on changes in income result in a change in spending, such as an increase or decrease in autonomous spending by government or businesses.
What is the multiplier effect
The increase in income would eventually become greater than the initial increase in spending. This is known as the multiplier effect.
E.g of the multiplier principle
Chicken Licken has decided to introduce mobile food trucks to their business. The business decides to invest R100 million in the venture. Some of this money will go towards hiring new employees, who will run the food trucks, creating income for households. Households will spend a portion of this income creating income for businesses, and so the cycle would continue.
The final impact of income will depend on
Size of the multiplier. The extent of the increase or decrease in income will happen over several rounds of receiving income and spending it. The size of the multiplier is determined by the:
Consumer's willingness to spend any additional income – the marginal propensity to consume (mpc).
Another factor determining the extent of the multiplier effect is the marginal propensity to save. This is the consumer's willingness to save any additional income.
What is the multiplier process
Production, income and expenditure are continuous processes. Production creates income for the households and stimulates demand, the income earned by households drives spending and provides income for businesses, and increased spending drives production. So, we can see how one participant's spending becomes another participant's income.
The multiplier process is impacted by leakages and injections. When leakages and injections are equal, the economy is in equilibrium. However, if injections are greater than leakages or there is less income than spending, income will increase. However, if leakages are greater than injections or there is more income than spending, income will decrease.
So, when there is more spending there will be more income in the economy, and when there is less spending there will be less income in the economy.
What multiplier effect focuses on?
The two-sector circular flow model focuses on households and businesses. In the two-sector model, the value of the multiplier depends on the marginal propensity to consume (mpc) and the marginal propensity to save (mps). Investment is the main injection and savings are the main leakage.
Is the financial sector a participant in the circular flow
Although we might not explicitly mention the financial sector, we assume that it is always a participant in the circular flow model.
How does spending and the change of national income affect the multiplier
The cycle of income and spending between households and businesses will enlarge the impact of an injection into the economy. The multiplier shows us the impact of that initial change in spending. Remember, the multiplier effect occurs when a small initial change in spending results in a relatively larger change in national income.
Changes in spending can happen for several reasons including:
Increases in government spending.
Increases in investment spending by businesses.
Increases in exports.
Decreases in taxes, interest rates, or changes in the exchange rate.
How can the multiplier effect be derived?
Remember, the size of the multiplier depends on the share of additional income that consumers either spend or save.
Two main elements make up consumption: induced consumption and autonomous consumption. Induced consumption is spending that depends on the level of income economic participants receive – it will vary with changes in income. Autonomous consumption is spending that does not depend on the level of income economic participants receive – it will not vary with changes in income.
What is the mutltiplier formulae?
The multiplier can be expressed in several ways. It is represented by the letter 'K' or the Greek symbol Alpha '𝞪'.
K = ∆Y ÷ ∆J where ∆Y is the change in income and ∆J is the change in injections.
K = 1 ÷ (1 - mpc) where the mpc is the marginal propensity to consume.
K = 1 ÷ mps where the mps is the marginal propensity to save.
To get the multiplier effect, which is the total impact of the initial change in spending, we will simply multiply K by the initial change in spending (K x J).
How do you calculate the marginal propensity to consume.
mpc = ∆C ÷ ∆Y where ∆C is the change in spending and ∆Y is the change in income. |
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mpc = 1 - mps In the two-sector circular flow model, we assume that income is either spent or saved. As a result, the combined value of the mpc and mps is equal to 1 (mpc + mps = 1). In this model, we do not consider the impact of other leakages and injections such as taxes or government spending. We simply focus on savings and investment. |
What are some important relationships to remember about the mps, mpc and the multiplier effect
The higher the value of the mpc, the larger the multiplier effect.
The lower the value of the mpc, the smaller the multiplier effect.
The higher the value of the mps, the smaller the multiplier effect.
The lower the value of the mps, the larger the multiplier effect.
A higher mpc means a lower mps.
A lower mpc means a higher mps.
DIscuss the impact on level of national income if government increases taxes
Decrease. This is because an increase in taxes means that households and businesses have to spend more money on tax, leaving their disposable income less than it was before.
DIscuss the impact on level of national income if: The Reserve Bank decreases interest rates.
Increase. This is because a decrease in interest rates discourages households and businesses to invest because they will not get more money as interest. This leaves them with more money for spending than saving. Also, a decrease in interest rates encourages households to acquire more money in the form of borrowing because they will pay less interest, leaving them with more money available for spending.
DIscuss the impact on level of national income if: Exports increase.
Increase. This is because the country is selling more goods and services to the outside market in exchange for income.
Discuss the impact on level of national income if: Government reduces spending.
Decrease. This is because when the government decreasses its spending, it eliminates extra income that was generated by the government. This leaves the economy with less income circulating.
Let's assume that income in the economy increased by R600 000. Of that amount, R360 000 was spent on consumption.
a) What is the value of the marginal propensity to consume?
a) In this case, we are given the change in income and the change in consumption. We thus need to use the following equation:
mpc = ∆C ÷ ∆Y = R360 000 ÷ R600 000 = 0,6
The mpc in this economy is 0,6. Consumers are likely to spend 60% of any additional income they receive.
b) What is the value of the marginal propensity to save?
b) We learnt earlier that the mpc and mps need to add up to one.
If mpc = 1 - mps then mps = 1 - mpc.
mps = 1 - 0,6 = 0,4
The mps in this economy is 0,4. Consumers are likely to save 40% of any additional income they receive
Chicken Licken has decided to invest R100 million in a mobile food truck venture for the business. The mpc in the economy is 0,6. Calculate the value of the multiplier and determine the multiplier effect.
Since we have the value of the mpc, we can use the following equation:Part 1: Determine the value of the multiplier. K = 1 ÷ (1 - mpc) K = 1 ÷ (1 - 0,6) K = 1 ÷ 0,4 K = 2,5 Part 2: Determine the multiplier effect. K x J = 2,5 x R100 million = R250 million Therefore an injection of R100 million will result in an increase in aggregate income of R250 million, which is 2,5 times the initial increase in spending. |
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Explain what happens to a multiplier in a three-sector economy
The three-sector circular flow model includes the government as a participant.
Adding the government as a participant to the circular flow model introduces another injection (G – Government expenditure) and another leakage (T – Taxes).
Adding taxes to the leakages in the circular flow model reduces the size of the multiplier.
Explain what happens to a multiplier in a four-sector economy
The four-sector circular flow model includes the foreign sector as a participant.
Adding the foreign sector as a participant to the circular flow model introduces another injection (X – Export income) and another leakage (M – Import expenditure).
Adding import expenditure to the leakages in the circular flow model reduces the size of the multiplier.