ECON CHAPTERS 5-9

Page 1: Basic Circular Flow of Income

• Circular Flow of Income Model: Illustrates the flow of income, expenditure, and output between two main sectors: households and firms.

Key Assumptions:

1. Two Sectors: Only households and firms exist.

2. Closed Economy: No government sector and no foreign trade (exports or imports).

3. No Banks: Savings not considered in the flow.

Income Identity

• National Income can be represented as:

  • Income (National Income) = Expenditure = Output

Factor Market

• Households act as sellers of factors of production.

• Firms act as buyers of factors of production such as labor, land, capital, and enterprise.

• Income comprises: rent, wages, interest, and profit as rewards for providing these factors.

Page 2: Open Economy with Government

• In an open economy involving four sectors (households, firms, government, and foreign), we see Leakages and Injections.

Leakages:

• Savings (S)

• Taxes (T)

• Imports (M)

Injections:

• Investment (I)

• Government Spending (G)

• Exports (X)

Economic Equilibrium:

• The economy is in equilibrium when total leakages equal total injections.

• Condition: If leakages (S + T + M) = Injections (I + G + X), then economic activity remains stable.

• If leakages exceed injections, it leads to decreased economic activity and employment.

Page 3: Gross Domestic Product (GDP)

• Definition of GDP: Total monetary value of all finished goods and services produced within a country's borders in a specified time frame (usually a year).

Included in GDP:

1. New production of goods and services

2. Income generated from production.

3. Production strictly within national borders.

Excluded from GDP:

1. Intermediate goods (used to produce other goods/services).

2. Second-hand or used products.

3. Transfer payments (e.g., unemployment benefits).

4. Money gifts and illegal transactions.

5. Unpaid output and non-market transactions.

Ways to Calculate GDP:

1. Output Method: GDP = Σ (Price x Quantity)

2. Income Method: GDP = Wages + Rent + Interest + Profit

3. Expenditure Method: GDP = C + I + G + X

Page 4: Expenditure Method and Assessing GDP

• Expenditure Method: Calculates GDP by adding all forms of spending.

• Example calculation: GDP = C + I + G + X where C = Consumption, I = Investment, G = Government spending, X = Exports minus Imports.

Reasons for Measuring GDP:

1. Assess overall economic health.

2. Evaluate success of economic policies.

3. Focus on changes related to economic growth, employment, and inflation.

Types of GDP:

• Nominal GDP: Measured in current prices, not adjusted for inflation.

• Real GDP: Adjusted for inflation and reflects the actual growth of output over time.

Page 5: Conversion of Nominal to Real GDP

Real GDP Calculation:

• Formula: Real GDP = Nominal GDP × CPI Adjustment

• Example Calculation for 2016 to base year 2015 included.

Limitations of GDP Measurements:

1. Ignores externalities and social costs.

2. Does not account for quality of life or unpaid work.

3. Excludes grey/underground economy transactions.

4. Does not reflect income distribution within the population.

Page 6: Economic Growth and Business Cycle

Economic Growth:

• Defined as an increase in real GDP or productive capacity over time.

Business Cycle Phases:

1. Expansion/Growth

2. Peak/Boom

3. Recession

4. Trough/Slump

Characteristics:

• Economic activity includes output, employment, and inflation behaviors during each phase.

Page 8: Consequences of Economic Growth

Benefits:

• Improved standards of living, longer life expectancy, improved public services.

Costs:

1. Inflation increases.

2. Risks of economic downturns.

3. Negative externalities such as environmental damage.

4. Rising inequality.

5. Potential long-term unsustainable growth.

Page 9: Policies to Promote Economic Growth

Demand-Side Policies:

• Expansionary Fiscal Policy: Adjustments in tax and spending to stimulate growth.

• Monetary Policy: Adjusting interest rates to influence economic activity.

Supply-Side Policies:

• Enhancements in productivity through education, training, deregulation, and infrastructure improvement.

Page 10: Human Development Index (HDI)

• Measures three components: health (life expectancy), education (years of schooling), and standard of living (GNI per capita).

• Countries ranked based on HDI reflect their developmental status, e.g., developed vs. developing nations.

Page 11: Differences Between Developed and Developing Countries

Characteristics:

• Developed Countries: High GDP, low unemployment, diverse economies.

• Developing Countries: Low GDP, high unemployment, reliance on primary sectors, low education, high population growth.

Page 12: Poverty Definitions

Absolute vs. Relative Poverty:

• Absolute Poverty: Lacking access to essential needs for survival.

• Relative Poverty: Being poorer compared to other groups in society.

Restrictions on Economic Development:

• Address barriers such as lack of resources, reliance on primary sectors, inefficiencies, and corruption.

Page 13: Measures and Policies to Alleviate Poverty

Internal Measures:

• Government strategies aimed at poverty reduction.

External Measures:

• International organization assistance, foreign aid, and interventions from institutions like IMF and World Bank.

Page 14: Population Dynamics

Factors Affecting Population Size:

1. Birth Rate and Death Rate.

2. Net Migration (Immigrants vs. Emigrants).

Page 15: Immigration and Its Effects

• Impacts working population, productivity, gender distribution, and economic remittances.

Page 16: Understanding Population Size and Resources

• Optimum population aligns with available resources to maximize sustaining capabilities.

Page 17: Comparative and Absolute Advantage

• Absolute Advantage: When a country can produce more of a good using the same resources as another country.

• Comparative Advantage: When a country can produce a good at a lower opportunity cost than another.

Page 18: Terms of Trade

• Defined as the ratio of export prices to import prices.

• Significance determined by comparing relative prices in each country.

Page 19: Effects of Free Trade

Advantages:

• Specialization, increased efficiency, and lower prices for consumers.

Disadvantages:

• Risk of dependence and vulnerability during economic downturns.

Page 22: Trade Restrictions and Protectionism

Measures Include:

1. Tariffs: Taxes on imports to protect domestic industries.

2. Quotas: Limits on the quantity of imports allowed.

Page 23: Balancing Trade Restrictions

Pros and Cons of Protectionism:

• Protects domestic jobs and industries but can limit consumer choice and lead to retaliation from other countries.

Page 24: Balance of Payments Overview

Components:

1. Current Account: Trade balance, net income, and net transfers.

2. Capital and Financial Account: Tracks capital transactions and movements of investments.

Page 25: Causes and Consequences of Current Account Deficits

• Issues such as trade imbalances and domestic economic conditions lead to deficits, impacting national economic strength.

Page 26: Current Account Surplus

Causes and Effects:

• Occurs with increased exports and impacts on economic stability and foreign reserves.

Page 27: Conclusion on Current Account Management

• Strategies to correct deficits include policies targeting output enhancement, demand contraction, and trade restrictions.