2.1 Economic activity Flashcards
What does the circular flow of income model illustrate?
the concepts and relationships of macroeconomics
What does a simple and closed economy mean?
simple = no governement
closed = no foreign exchange (imports and exports)
What are the two parties in the circular flow of income?
households (consumers)
firms (businesses)
What are the factors of production?
- land
- labour
- capital
- entrepreneurship
(CELL)
What are the factor rewards (income)?
- rent
- wages
- interest
- profit
(WIRP)
How do the factors of production relate to their rewards?
households supply factors of production to the resource market, in return, firms supply factor rewards for them
capital = interest
entrepreneurship = profit
land = rent
labour = wages
How does household expenditure relate to goods and services?
they are both traded in the product market. Households supply expenditure which is revenue for firms. In return, firms supply the goods and services consumers are buying.
In a closed economy, what is equal?
income flow (from firms to households)
=
expenditure flow (from households to firms)
therefore output of the economy is equal to either one of these flows
What does the closed economy model assume which is unrealistic?
- no government
- no foreign sector
- households spend all that they earn (no savings/investments; no financial sector)
What are the leakages?
- savings (money is not spent)
- taxes (money is paid to the government)
- imports (money is spent beyond the economy)
What are the injections?
- investment (beyond revenue, i.e. from stocks, bonds etc.)
- government spending
- exports (able to trade with foreign markets and bring money into the domestic market)
How do the leakages relate to the injections?
Saving is saved by consumers in the financial market (banks), firms invest into capital goods using funds borrowed from the financial markets
Taxes is paid to the governement, which is later spent and reinvested
Income is lost to foreign markets by importing, but can be rectified by gaining income from foreign markets by exporting
What does an open economy mean?
when there are links to foreign markets i.e. international trade happens
Are leakages and injections equal?
likely unequal.
leakages and injections negate eachother, but not perfectly.
if leakages > injections: income flow becomes smaller.
If injections > leakages: income flow becomes larger.
How is economic activity measured?
national income; aggregate output
What are the different approaches to measuring aggregate output and how does this relate to the circular flow of income?
considering expenditure = income (circular flow)
- expenditure approach, amount spent of goods and services
=
- income approach, amount earned by factors of production
=
- output approach, value of goods and services produced
Components of GDP
- Consumption
- Investment
- Government spending
- Net exports (exports - imports)
Equation for GDP/AD
C + I + G + ( X - M ) = GDP
C + I + G + ( X - M ) = AD
Why is GDP equal to AD?
Output approach (GDP) = expenditure approach (AD)
Difference between nominal GDP and real GDP
nominal does not account for changes in price (inflation)
real does
What does GDP, GNI, GNP stand for?
GDP - Gross Domestic Product
GNI - Gross National Income
GNP - Gross National Product
What does per capita mean?
per person.
e.g. GDP per capital is GDP divided by the population
Why is GDP per capita used?
- to compare production between different population sizes
- evaluating the impact of population growth (increase in labour)
How is GDP different from GNP/GNI?
GDP is about any economic activity WITHIN a region (location; activity)
GNP/GNI is the total output of a country REGARDLESS of its location (nationality; ownership)
How to calculate GNP/GNI?
GNP/GNI = GDP + (income earned from domestic firms abroad - income lost to foreign firms at home)
GNP/GNI = GDP + net property income from abroad
How to calculate real GDP?
Real GDP = (nominal GDP/GDP deflator) x 100
How can you calculate the GDP deflator using nominal and real GDP?
GDP deflator = (nominal GDP/real GDP) x 100
How to calculate GDP deflator using the inflation rate?
GDP deflator = (100 + inflation rate) /100
How to calculate the change in GDP?
(GDP growth rate)
GDP rate = ((GDP-GDPbase)/GDPbase) x 100
(basic percentage change)
NOTE: be careful for change in “real” and “nominal”
How to calculate green GDP?
Green GDP = GDP - the value of environmental damage ( - pollution-induced illnesses)
Reasons why national income statistics may be inaccurate ( + examples)
(6)
- they do not include non-marketed output (actions without trade e.g. self-farming or self-maintenance)
- they do not include underground (parallel) markets which are not recorded (legal goods such as reselling; illegally such as tax avoidance or drugs (however there could be laundering which might account but very uncertain))
- they do not account for improvements in quality (e.g. improved technology sold at lower prices)
- they do not account for the value of externalities (e.g. pollution and by-products)
- they do not take into account for the depletion of natural resources (e.g. deforestation or coarse soils)
- they are problems with comparisons with differing price levels (e.g. same GDP per capita but in one country the price is double than in the other, therefore differ in living standards)
Reasons why national income statistics cannot accurately measure living standards ( + examples)
(5)
- they do not distinguish between the composition of output (e.g. Kuwait has a high GDP from oil, but is not secure with its water supply)
- they cannot reflect achievements in levels of merit goods (e.g. healthcare and education largely improve living standards but are not accounted for/can reduce GDP) - Human Development Index is an alternative
- they provide no information on the distribution of this wealth (income equality e.g. South Africa has high GDP but one of the most unequal countries)
- they do not account for the non-economic quality of life factors (e.g. low stress, a sense of security and peace)
What is the business cycle?
Fluctuations in the growth of real output; of expansion and contractions.
Phases of the business cycle
(4)
- Expansion (output rising)
- Peak (max output after expansion)
- Contraction (output falling)
- Trough (min output after contraction)
When is an economy at potential output?
What does this mean in relation to unemployment?
it is represented as the long-term growth trend of the business cycle
an economy is at potential output when employment is maximised (up to the natural rate of unemployment)
What do cyclical fluctuations mean in relation to the potential output and employment?
the fluctuations in the business cycle are where cyclical unemployment is derived.
when the actual output is below or above the potential output, there is an output gap; unemployment is above or below the natural rate
Why is the business cycle important for macroeconomic objectives?
- reducing the intensity of expansions and contractions (flattening the curve) for price stability and full employment
- the gradient of potential output; positive to grow and steep for a high rate of growth
Macroeconomic objectives
(8)
(In levels of importance)
- high and sustainable economic growth
- low and stable inflation
- low unemployment
- satisfy the balance of payments
- low government borrowing
- stable exchange rate
- minimise inequality
- protect the environment
Possible macroeconomic conflicts (between objectives)
- Economic growth vs inflation
- Unemployment vs inflation
- Economic growth vs balance of payments
- Budget deficit vs economic growth
- Economic growth vs environmental sustainability
What can national income statistics compare?
(2)
- Economies over time (i.e. growth over time)
- Different economies (i.e. different countries)
