2.1: The level of overall economic activity

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    Definitions

     

    1. Macroeconomics is the study of aggregate economic activity. It investigates how an economy as a whole works.
    2. Circular flow of income is a simplified model that shows the flow of money through the economy.
    3. Leakages are income received but not used for financial expenditure on domestic goods and services, i.e. not returning directly to firms.
    4. Injections are income that does not come directly from the households through their spending on goods and services.
    5. Savings are income that is not spend, but stored in a financial institution. Savings are a withdrawal (leakages) from the circular flow of income.
    6. Transfer payment is when a payment is being transferred without the productive service being hindered. There is no increase in output, as it is a transfer of income, rather than an income in exchange for output. Examples include unemployment benefits, old age pensions etc.
    7. National Income is the total value of all goods and services in an economy during a given time period, usually a year.
    8. Gross Domestic Product (GDP) is the total money value of all goods and services in an economy in one year, regardless of who owns the protective assets, or the total value of all spending in an economy.
    9. Gross National Product (GNP)/Gross National Income (GNI) is the total money value of all goods and services in an economy, plus net income property from abroad, i.e. the the total income earned by the country’s factors of production regardless of where the assets are located.
    10. Net National Product (NNP)/Net National Income (NNI) is the total money value of all goods and services in an economy in one year, plus net income property from abroad (GNI) minus depreciation (capital consumption).
    11. Nominal GDP is the total money value of all goods and services produced in an economy in one year, not adjusted for inflation.
    12. Real GDP is the total money value of all goods and services produced in an economy in one year, adjusted for inflation.
    13. GDP per capita is the total money value of all goods and services produced in an economy in one year divided by the size of the population.
    14. Green GDP is a measure of GDP that takes into account any environment costs incurred from the production of goods and services included in the GDP figures.
    15. Economic Development is a multidimensional concept involving improvements in standards of living, reduction in poverty, improved health and education, reduced income inequality and increased economic opportunities. It is also about freedom and economic choice.
    16. Human Development Index (HDI) is a composite index that brings together three variables, namely the measurements of health, education and living standards in order to attempt to measure relative development. Elements of the HDI include life expectancy at birth, adult literacy rate, school enrollment rate and GDP per capita. The indicators are combined to give an index value between 0 and 1.
    17. Business cycle shows fluctuations in the level of economic activity in an economy over time measured by changes in real GDP, and suggests that changes are cyclical. The stages of a business cycle include the trough, recovery, boom, peak and recession.
    18. Recession is two consecutive quarters of negative economic growth, i.e. falling GDP. Characteristics include unemployment and lower rates of inflation, or even deflation.

     

    Five Macroeconomic Objectives

     

    Remember the Acronym: FELLS

     

    1. Favorable balance of payments position.
    2. Equitable distribution of income.
    3. Low level of unemployment.
    4. Low and stable rate of inflation.
    5. Steady rate of economic growth.

     

    Circular Flow of Income

     

    Two Sector and Four Sector Circular Flow of Income

    Measures of national income

     

    1. Output method

    • Measures actual value of goods and services provided.

     

    2. Income method

    • Measures the value of all incomes earned in the economy.
    • This includes wages, rent, interest and profits.

     

    3. Expenditure method

    • Measures the value of all spending on goods and services in the economy.
    • Basically aggregate demand and Gross Domestic Product (GDP)!
    • This includes spending by households, firms, government and foreigners on exports minus imports, which is net exports.

    Why is national income important?

     

    1. Governments use the figures to develop policies.
    2. Economists use the figures to develop models of the economy and make forecasts of the country’s future based on their national income.
    3. Businesses use the figures to make predictions about future demand.
    4. Performance of the economy over time can be analyzed by national income figures.
    5. National Income = Standards of living for a country.
    6. The figures are used to compare between countries.

     

     

     

     

     

     

    Limitations of National Income Data

     

    1. Inaccuracy

    • Figures tend to be more accurate after a while as additional data is included.
    • There are many ways to calculate national income, which might lead to some inaccuracy.

     

    2. Unrecorded or under-recorded economic activity.

    • Some activities aren’t included in a country’s GDP, such as do-it-yourself work and subsistence farming, which is raising food crops by your own.
    • Another economic activity that is unrecorded is called hidden economy, where illegal activities takes place, such as drug trafficking, robberies etc and some people would tend to unrecord some figures to evade paying taxes to the government.

     

    3. External costs

    • GDP doesn’t take into account the negative consequences of pollution, traffic congestion, cutting down trees etc.
    • These would severely affect quality of life, even if GDP increases.

     

    4. Other quality of life concerns

    • Reason for GDP growth might have been longer working hours for employment.
    • Higher incomes doesn’t mean that they aren’t satisfied with their standards of living.
    • People who volunteer will develop a better society, but might not earn high incomes, which may impact economic growth significantly.

     

    5. Comparison of output

    • It’s possible that large part of a country’s output goes towards manufactured products rather than merit products.
    • Therefore, higher GDP doesn’t necessarily mean higher standards of living.

     

    Green GDP

     

    • Measure of GDP that takes into account any environmental costs involved in production of products included in GDP figures.
    • Green GDP = GDP – Environmental costs of production.
    • Environmental production costs involve health, agricultural and industrial costs caused by pollution, waste disposal and costs of cleaning up environmental damage, such as oil spills or spills in nuclear plants.

     

    Business Cycle

    1. Recovery

    • Economic expansion = GDP rapidly increasing → Increasing aggregate demand in an economy as consumption by firms and households increased → Fall in unemployment due to employing many workers after increase in output.
    • There’s an increase in average prices as aggregate demand is constantly increasing.

     

    2. Boom

    • When the economy increases their highest price possible due to increase in consumption.
    • Increase in inflationary pressure → Fall in GDP growth as the economy is near its potential output for their goods and services.
    • Policy makers might impose policies to slow down the growth of the economy → Fall in total demand.

     

    3. Recession

    • Two consecutive quarters of falling GDP.
    • Falling aggregate demand → Increase in unemployment → Low spending → Low rates of inflation or even deflation.

     

    4. Trough

    • Outputs cannot continue to fall as there will always be people to take on jobs to maintain certain level of consumption.
    • Foreigners will demand exports, governments will continue to spend by budget deficits, people will use their savings for expenditure.
    • Low demand for money → Low interest rates → Increase in aggregate demand → Economy enters the recovery phase again

     

    Paper 3 Question

     

    The following data is from the national income accounts of a country: