Macroeconomics Unit 1 Vocabulary

Macroeconomics

• The study of the economy as a whole.
• Focuses on the 'big picture'.
• Deals with aggregates or totals.
• Uses key economic indicators (refer to http://www.rba.gov.au/snapshots/economy-indicators-snapshot/).

Economic Growth and Gross Domestic Product (GDP)

• Learning Objectives:
  • Relate the concepts of the Circular Flow Model to the business cycle.
  • Understand its phases.
  • Appreciate the importance of the relationship between changes in total spending and the business cycle.
  • Understand the concept of Gross Domestic Product.
  • Understand how Gross Domestic Product is measured.
  • Appreciate the shortcomings in using Gross Domestic Product as a measure of the economic welfare of a country.
  • Learn the difference between Nominal and Real Gross Domestic Product.
  • Appreciate the goals of macroeconomic policy in relation to the business cycle and economic growth.
• Based on the Circular Flow Model:
  • The levels of output, employment, and Income (general level of economic activity) depend directly on total expenditure (aggregate demand- AD) in the economy.
• Definitions:
  • Total expenditure: E = C + I + G + (X - M)
    • Total amount which all sectors of the economy are willing to spend over some given period of time.
  • Total supply: Y
    • Total production of goods and services over some given period of time.
    • Y = Output
• Economic Growth:
  • Refers to the increasing ability of a nation to satisfy the material wants of its people over time.
  • This should mean:
    • An increase in national output over time; more goods and services.
    • Improvement in the standard of living.
  • Economic growth can be measured using the key economic indicator Gross Domestic Product (GDP).
• Gross Domestic Product (GDP):
  • GDP is the total market value of all final goods and services produced in the economy during a period of time.
  • It is a measure of a nation’s economic performance.
  • Measured in money terms and not in physical units.
  • Usually measured over a year and also reported on a quarterly basis.
• Australian Bureau of Statistics (ABS) is the statistical agency of the Government of Australia.
• GDP counts final goods.
• GDP counts only new domestic production of final (finished) goods i.e. goods and services that are bought for final use and are not to be subject to further processing, manufacturing or resale.
• Other GDP approaches:
  • Since Output (O) = Income (Y) = Expenditure (E).
• Measuring GDP:
  • Expenditure approach - Adds all the expenditures for final output during a period of time: GDP = C + I + G + (X-M)
  • Income approach - Adds the incomes of the resources: GDP = Wages + rent + Interest + Profit
  • Output approach - Adds new domestic production of final goods.
• GDP excludes:
  • The value of non-productive transactions e.g. government transfer (welfare) payments, private gifts, second-hand sales, financial transactions like shares.
  • The value of intermediate goods.
  • Only includes the value of goods and services that enter into exchange.
• GDP does not measure:
  • Transactions in the underground (black) economy.
  • Non-paid work e.g. ‘do it yourself’ or ‘homegrown’.

Nominal GDP

• Also called money GDP or GDP at current prices.
• Measures final output in terms of the actual prices existing during the time period of production.
• Cannot be used as a reliable measure of the rate of economic growth.
  • Includes price changes.
  • Example:
    • Year 1: Quantity = 10, Price = $20, Value of output = $200
    • Year 2: Quantity = 20, Price = $20, Value of output = $400
    • Year 3: Quantity = 20, Price = $30, Value of output = $600
    • Year 3: the increase in value is due to higher price only.

Real GDP

• GDP at constant prices.
• Measures the real value of goods and services in any one year by eliminating the effects of price changes from GDP at current prices.
• Based on the prices existing in a selected reference (base) year.
• It is necessary to adjust nominal GDP to real GDP so that it reflects only changes in output and not changes in prices.
• Real GDP Calculation:
  • Real GDP = Current GDP \times \frac{Base Year CPI}{Current Year CPI}
    • CPI = Consumer Price Index.
    • CPI is a measure of changes, over time, in prices of a constant basket of goods and services representative of consumption expenditure by households.

Real GDP Per Capita

• Per capita means per person.
• Adjusts GDP for population changes.
• Shows if there are more goods and services available for each member of the population over time.
• Used to measure/ compare living standards of countries.
• If population increases at a faster rate than increases in real output then real GDP per capita will fall.
• World GDP per Capita.
  • Real GDP per capita = \frac{Real GDP}{Population}
  • Growth Rate = \frac{Current Year - Previous Year}{Previous Year} \times 100

Problems: GDP and Living Standards

• GDP figures do not measure issues of economic welfare:
  • Type of output e.g. guns vs. medicine.
  • Quality of goods and services.
  • Quality of life e.g. work vs. leisure.
  • Distribution of goods and services.
  • Socio-economic conditions (crime, health, education).
  • Environmental effects/ depletion of resources.

Economic Welfare

• A broader way of considering the standard of living.
• GDP per capita only considers the average income of the population.
• Economic Welfare may depend other factors:
  • Education (literacy rates, percentage finishing school).
  • Health (life expectancy, infant mortality).
  • Access to clean water.
  • Crime.
  • Pollution levels.
  • Work hours.
  • Political freedom.

Some Alternative Measures of Economic Welfare

• U.N Human Development Index (HDI).
• Genuine Progress Indicator.
• Net Economic Welfare index.
• Gross National Happiness.
• SMH Well-Being Index.
• The Human Development Index (HDI) is a summary measure of average achievement in key dimensions of human development: a long and healthy life, being knowledgeable and having a decent standard of living. The HDI is the geometric mean of normalized indices for each of the three dimensions.
• The health dimension is assessed by life expectancy at birth, the education dimension is measured by mean of years of schooling for adults aged 25 years and more and expected years of schooling for children of school entering age. The standard of living dimension is measured by gross national income per capita. The HDI uses the logarithm of income, to reflect the diminishing importance of income with increasing GNI. The scores for the three HDI dimension indices are then aggregated into a composite index using geometric mean. Refer to Technical notes for more details.
• The HDI can be used to question national policy choices, asking how two countries with the same level of GNI per capita can end up with different human development outcomes. These contrasts can stimulate debate about government policy priorities.
• The HDI simplifies and captures only part of what human development entails. It does not reflect on inequalities, poverty, human security, empowerment, etc. The HDRO provides other composite indices as broader proxy on some of the key issues of human development, inequality, gender disparity and poverty.
• A fuller picture of a country's level of human development requires analysis of other indicators and information presented in the HDR statistical annex.

Sources of Growth

• Inputs → Output.
  1. Land
  2. Labour
  3. Capital
  4. Enterprise
• Other Growth Factors:
  5. Technological progress.
  6. Increase in aggregate demand.
  7. Cultural values that support growth.
  8. Government policies (e.g. budget deficit).
     • Political stability.
     • Create a favourable climate and optimum conditions for growth.
     • Provide infrastructure.

The Benefits of Economic Growth

• Improved living standards.
• Increased employment opportunities.
• Increased social mobility.
• Increased social welfare.
• Increased leisure time.

The Costs of Economic Growth

• Structural Unemployment.
  • Some workers displaced by technology.
• Inflationary pressures (↑AD).
• Balance of Trade problems (↑M).
• Externalities - social costs.
• Increased social inequality.

The Business Cycle

• The business cycle refers to fluctuations in the circular flow and has periods of expansions and contractions.
• Changes in the level of economic activity as measured by the change in the value of real GDP.
• This gives insight into expenditure, output, employment and income.
• In some years, countries experience higher rates of growth - a boom. In other years, economic growth may be lower or even negative. This cycle of expansions (booms) and contractions (recession) is known as the business cycle – characterised by a boom (peak), downswing (contraction), trough (recession) and upswing (recovery).
• When the economy expands:
  • Production increases - businesses produce more goods and services (output).
  • Unemployment decreases – fewer people are out of work, as businesses need more workers to produce more output.
  • Wages increase - because businesses are doing well, they need to attract and keep workers by offering higher wages.
  • Consumer spending increases - people spend more because they are earning higher wages.
  • Prices increase - prices increase as consumers spend more. This is known as inflation.
• When the economy contracts:
  • Production decreases - businesses produce fewer goods and services (output).
  • Unemployment increases - more people are out of work, as businesses need fewer workers.
  • Wages decrease - because businesses are doing less well, they can attract enough workers at lower wages.
  • Consumer spending decreases - people spend less because they are earning lower wages.
  • Prices decrease - prices decrease as consumers spend less. This is known as deflation.
• If the economy is expanding too quickly, and at risk of overheating, the Reserve Bank may increase interest rates to slow down the economy by encouraging people and businesses to spend less.
• Higher interest rates on deposits and loans provide an incentive for people to save their money, rather than spend it or borrow more.
• If the economy is contracting the Reserve Bank may reduce interest rates to speed up the economy by encouraging people and businesses to spend more.
• Lower interest rates on deposits and loans provide an incentive for people to spend or borrow money, rather than save it.