3.1 measuring economic activity and illustrating its variations

Question 1

national income

Answer 1

The income earned by the factors of production of an economy, equal to wages plus interest, plus rents, plus profits.

Question 2

circular flow of income

Answer 2

A model that illustrates the interactions between economic agents in an economy. It shows how factors of production, goods and income flow between households, firms, government, the financial sector and the foreign sector.

Question 3

who spends money in an open economy?

Answer 3

• consumers
• govt: build schools, infrastructure, roads etc.
• financial industry: lends to businesses so they can invest capital and expand
• other countries: demand goods and services they do not produce themselves

all these r injectionns

Question 4

injections (def+3e)

Answer 4

the flows of money that come into the circular flow of income from outside:
investments
govt spending
exports

Question 5

leakages (def +3e)

Answer 5

the flows of money that leave the economy/circ flow of income
savings
taxation
imports

Question 6

GDP (def+calculation)

Answer 6

gross domestic product

total monetary value of all final goods and services produced within an economy in a given period of time

GDP = C + I + G + (X-M)
= consumption + investment + govt spending + (exports-imports)

Question 7

MNCs

Answer 7

multinational corporations

companies that operate in many countries w a headquarters based in one to coordinate the global operation

Question 8

GNP/GNI (keyword: national!!)

Answer 8

ie GDP but factoring in net income earned from abroad

GNP: total monetary value of all final goods and services produced by factors owned by the country’s citizens in a given period of time

GNI: refers to the total income of a nation’s people and businesses

Question 9

advantages and disadvantages of GDP as a measure of growth and well-being (3+4)

Answer 9

ADVANTAGES
1. allows comparison across countries -> internationally-agreed method of measuring GDP = can compare relative strength of their own economy with others
2. informs policy makers economic growth is one of primary obj of govt -> econ growth can be measured by calculating %∆ in economic output measured by GDP as GDP published every quarter on national press
3. gives an indication of average income: GDP/population size = average nat. income or GDP per capita.

DISADVANTAGES
1. under/overestimates econ well-being(externalities+expenditure allocation): calculation of GDP takes into account all econ. activity that takes place in country -> incl. activity that shoudl have been previously internalised or previously destroyed (e.g. cleaning up env. degradation and pollution = +GDP)
(rwe: 2018 both brazil and mexico had similar GDP per capita of around 19K. brazil spent more on capita goods while mexico on consumer. mexico>brazil in short term but long term brazil>mexico as brazil has higher production capacity(due to prior investment)
2. does not account for disparity in income distribution: GDP cant show -> doesn’t rep lack of social mobility + concentrations of wealth that are within very small proportion of population + wealth transferred from gen to gen + less wealthy stuck in poverty trap = wellbeing XXX)
3. contains inaccuracies: v, difficult to gather large vol of data to accurately calculate GDP + reliability(are agencies alw accurate? + not in country’s interest to publish negative data)
4. does not account for improvements in quality of output:
companies alw improve prod&services but prices relatively unchanged or decrease as productivity increases

Question 10

elab on advantage of GDP as a measure of growth and econ. well-being : Allows comparison across countries

Answer 10

Having an internationally-agreed method of measuring GDP allows governments to compare the relative strength of their own economy with others. In 1992, the United Nations adopted the ‘Fundamental Principles of Official Statistics’, subsequently endorsed as a global standard by the United Nations Statistical Commission. In an increasingly globalised world, it is important to know the health of economies belonging to your trading partners, neighbouring countries and political allies, both close and sometimes even distant.

Question 11

elab on GDP advantage as measure of growth and well-being: inf orms policy makers

Answer 11

Informs policy makers: Achieving economic growth is one of the primary objectives of government. Economic growth is measured by calculating the percentage change in economic output measured by GDP. It is published every quarter (a three-month period), and its announcement is most likely featured in the national press approximately three weeks into January, April, July and October.

Question 12

elab on GDP advantage as measure of growth and well-being: gives indication of avg, income

Answer 12

When GDP is divided by the population size, we get the average national income or GDP per capita. This should be able to tell us the likely income earned by a citizen of the country. However, it is just an average, and in the case of some nations it may not provide us with a fully accurate result

Question 13

elab on GDP disadvantage as measure of growth and well-being: overestimates quality of life +RWE

Answer 13

QoL = how happy +how much leisure time + health

GDP ignores all of the above

The calculation of GDP accounts for all economic activity that takes place in a country. This includes activity that should have been internalised previously or merely restores what has been destroyed.

e.g. building factories = pollution in long run - pollution is externality that should have been internalised before(msc) -> clearing pollution requires manpower = ^GDP ❌❌❌❌❌❌TERRIBLEEE

For example, spending on cleaning up environmental degradation and pollution is also positively credited to GDP calculations (this relates to Green GDP).

RWE: china rapid industrialisation lead env. degradation, severe air pollution like in major cities like Beijing, and water pollution in many regions. GDP showed econ. growth but did not accurately reflect decline in air and water quality = adverse impacts on public health+QoL

Question 14

elab on GDP disadvantage: does not account for disparity in income distribution

Answer 14

GDP cannot tell us about income distribution in a country. The lack of social mobility is a problem that most countries experience, with large concentrations of wealth distributed among only a very small proportion of the population and transferred from generation to generation. Equally, those who are financially less wealthy can get stuck in a poverty trap. A priority for many governments is to reduce the barriers preventing social mobility by introducing policies such as free education, health care and using transfer payments to try to close the gap between the rich and the poor.

Question 15

elab on GDP disadvantage: contains inaccuracies (3)

Answer 15

1. very difficult to gather large vol. of data necessary to accurately calculate GDP -> depending on efficiency and resources of agency in charge of gathering data in a country
2. information published by agencies not alw accurate +
3. not in country’s interest to publish negative data = might falsify

Question 16

elab on GDP disadvantage: does not account for improvements in quality of output

Answer 16

Companies are constantly trying to improve their products or services, but prices often remain relatively unchanged or sometimes even fall over time as productivity improves. For example, laptop computers have improved greatly in the past couple of decades, but the price of laptops has remained largely the same.

Question 17

3 approaches o measuring national income

Answer 17

1. output method
2. income method
3. expenditure method

Question 18

the output method - calculate nat.Y (def+downside+upside)

Answer 18

def
a method of accounting where firms are surveyed for their output during a given period.
!!the value that is added at each stage of prod is counted and not the full value of all output(if incl intermediate output, it wld be double)

downside
very difficult to measure output in country where large amounts of informal econ. activities take place (e.g. person cooking w/o registering business - econ activity not recorded and incl in GDP stats unless govt gives estimate)

upside
measuring data using this method is valuable as it gives a progress report for different sectors of the economy

Question 19

the income method - calculate nat.Y(def + formula + limitations-2)

Answer 19

def
method of accounting. involves adding up all teh incomes earned by groups when the factors of production are sold in resource markets. owners of FOP are paid in wages, rent, interest and profits.

formula:
income method = rents + interests + wages + profits = nominal gdp

limitations
only effective if econ activity is registered/ cannot account for informal econ activities/does not account for unregistered activities
1. countries w high corruption or where econ activity can be easily hidden -> v difficult to measure (legal—babysitting, stay-at-home parents, illegal— drugs, criminal activity)
2. large proportions of population may not be formally registered(no birth cert, national insurance, social security numbers, passports, registered address etc. -> much of econ. activity unrecorded (e.g. this is reason behind india highest unemployment rate in 1970s -> informal economy accounts for 3/4 of country’s jobs = data undetected or classified as unemployed as workers do periodic work

Question 20

the expenditure method - calculate nat.Y (def+formula+what data is required)

Answer 20

form of income accounting involves adding up total sales receipts for goods and services sold in the economy.

formula:
expenditure method (AD) = C + I + G + (X-M) = nominal GDP

In a closed economy this is the measure of consumption, but in an open economy (as discussed in subtopic 3.2) this also includes government spending, investment and net exports. To construct this measure, statisticians gather sales receipts, credit card statements, utility bills (such as electricity and mobile phone bills), and so on.

Question 21

real GDP (def+calc)

Answer 21

definition
GDP refers to the market value of all final goods and services produced within the borders of a country within a given period of time. real GDP takes into account inflation

calculation
real GDP = nominal GDP/price deflator X 100

Question 22

nominal GDP

Answer 22

this refers to the GDP calculated in a given year without consideration for inflation

Question 23

when inflation is high, GDP growth could be…

Answer 23

overestimated or seem higher than if only the output were considered. It might appear as if the country is producing more, as the sum total increases due to rising prices, but the amount of goods and services might be the same or even less than before. To overcome this problem, economists hold the prices constant to negate the impact of potential price rises. This is called real GDP . When we measure GDP growth in current prices and without accounting for inflation, it is called nominal GDP .

Question 24

real GDP vs nominal GDP

Answer 24

real - takes into account inflation
nominal - does not take into account inflation

Question 25

means of calculating nominal GDP

Answer 25

1. expenditure method
2. income method
3. output method

Question 26

using expenditure method to calculate nominal GDP (def+advantage+formula)

Answer 26

The expenditure method is used when considering all the spending in an economy. This involves measuring consumption, investment, government expenditure and net export spending in the economy. Total expenditure is also known as aggregate demand (AD).

advantage
It is useful to do this because it is important to know how different groups in society (especially households, whose spending makes up most of the GDP) respond in a growing, stagnant or declining economy.

The expenditure method is given by:

GDP = C + I + G + (X – M)

where C is consumption expenditure, I stands for planned investment spending, G is government expenditure, and X – M represents the trade balance (X represents exports expenditure and M imports spending).

Question 27

using output method to calculate nominal GDP

Answer 27

The output method calculates the monetary value of all final goods & services produced within a country over a time period which is the summation of the value of all final goods from the primary sector, goods from the secondary sector and goods & services from the tertiary sector excluding intermediate goods to avoid double-counting.

Question 28

using income method to calculate nominal GDP

Answer 28

The income method considers the incomes from the factors of production or factor payments. These are wages, rent, interest and profits.

sum of all = nom. GDP

Question 29

GNI (def+calc)

Answer 29

gross nat. income

this refers to the total income of a nation’s people and businesses

GNI = GDP +incomes flowing in from other countries - incomes flowing out to other countries

Question 30

deflator

Answer 30

the value that allows data to be measured over time in terms of a base period, usually through a price index

Question 31

real GNI (def+formula)

Answer 31

GNI aft take into account inflation

real GNI = nominal GNI/price deflator X 100

Question 32

GDP per capita

Answer 32

This refers to the GDP divided by the population of a country, giving an average income per citizen.

Question 33

PPP

Answer 33

purchasing power parity
PPP compares economic productivity and standards of living between countries on the basis of relative costs of goods and services.

Question 34

4 phases of business cycle

Answer 34

1. an expansionary phase
2. a peak phase
3. a contractionary phase
4. a trough

Question 35

economic growth

Answer 35

When a country produces more goods and services in one period than in a previous one. It is usually measured by changes in the real GDP.

Question 36

2 kinds of comparisons that can be made using GDP and GNI (when used as a measure of econ well-being)

Answer 36

comparisons over time
To make comparisons of living standards over time, real values of GDP and GNI need to be used. Nominal values are unsuitable. Even using real GDP and real GNI can overestimate or underestimate the population’s economic well-being, as even the real values do not reflect changes in factors such as improved product quality, increases in leisure activities, improvements in education and health care and other factors which affect people’s living standards.

comparisons bet ween countries(over space)

The use of GDP and GNI in comparing economic well-being between countries is limited. For example, one country may have a high GDP per capita but the concentration of income is only among a small percentage of the population, while another country might have a lower GDP per capita but more equally distributed. GDP and GNI measures will not make this distinction and might be misleading on this and other factors related to economic well-being.

Question 37

alternatives measure of wellbeing (besides GDP and GNI)5

Answer 37

• world happiness report
• oecd better life index (11 indicators: housing, income, jobs, community, education, environment, civic engagement, health, life satisfaction, safely, work-life balance)
• gross national happiness
• happy planet index
• green GDP

Question 38

world happiness report

Answer 38

In 2011, the UN General Assembly passed a resolution to include an indicator of people’s happiness in the measures of economic development. This indicator has been published each year in the World Happiness Report to give us an idea of how much happiness plays a role in human and economic development, allowing countries to address any shortfalls, if appropriate. The indicator is measured using the Cantril ladder . It is used to ask citizens of member countries to self-identify their current levels of happiness. Participants are asked to imagine a ladder where the top rung represents their happiest life and the bottom rung is their least happy. They must then measure which rung they are currently on based on that thought experiment. From this, and other measures, a general indicator can be generated.

Question 39

OECD Better Life Index

Answer 39

Another alternative to GDP is the OECD Better Life Index (BLI). The BLI measures 11 indicators across 35 countries which are members of the Organisation for Economic Cooperation and Development, or OECD. These variables are:

housing
income
jobs
community
education
environment
civic engagement
health
life satisfaction
safety
work–life balance.
The data mostly comes from official sources such as the OECD (which already collects most of this data), National Accounts, United Nations Statistics, and National Statistics Offices. From a statistical point of view, the BLI relies on best practices for building composite indicators.

However, the BLI has been criticised as it focuses on a rather narrow set of indicators. It ignores others such as community involvement and degradation of the environment. It is also criticised because the criteria are influenced by the personal preferences of the participant. It is possible to give certain factors more ‘weight’ than others so different criteria can be ranked accordingly. For example, if you wanted to measure Canada versus Belgium in the BLI, you could choose to emphasise the importance of civic engagement and give it more ‘weight’, thereby changing the ranking.

Question 40

gross national happiness

Answer 40

Have you heard of the Gross National Happiness (GNH) indicator? It was developed in the 1970s in Bhutan, and aims to take a more holistic approach in defining what growth and development really mean. It focuses on other factors of progress that are seen to be just as important as economic aspects. It has invited much discussion and further economic research.

The “four pillars” of GNH are good governance, sustainable development, preservation and promotion of culture, and environmental conservation.
The Bhutanese government takes the four pillars of GNH into account when deciding to pass laws.

Question 41

happy planet indicator

Answer 41

The Happy Planet Index (HPI) uses four indicators to demonstrate how efficiently residents of different countries are using environmental resources to lead long, happy lives. These indicators are:

well-being, which is how satisfied people are with the quality of their lives
life expectancy, which is how long people are expected to live for
inequality of outcomes, which measures the inequalities among people within a country and is expressed as a percentage
ecological footprint, which is the average impact that people make on the environment
Unlike the Happiness Index and the OECD Better Life Index, the HPI uses a mathematical equation to determine a country’s score on the index, rather than having weighted composite indicators. That equation is:

Happy Planet Index (approximate) ≈

(life expectancy × experienced well-being x inequality of outcomes) / ecological footprint

You can explore the interactive HPI map and compare countries’ data here. Interestingly, because of the ecological footprint, you may find that many of the wealthier nations of the world do not score highly. In other words, they have large ecological footprints (denominator) compared to the other factors (numerator). Therefore, the equation results in a smaller number as a bigger footprint is created in gaining the desired outcomes. The precise formula used to calculate HPI scores requires some technical adjustments to be made beyond this but this is generally how it works

However, just as with other composite indices, there are criticisms of the HPI. One example is the subjective nature of experienced well-being. In the HPI, this is based on a Gallup Poll in which respondents are asked:

‘Please imagine a ladder with steps numbered from zero at the bottom to 10 at the top. Suppose we say that the top of the ladder represents the best possible life for you; and the bottom of the ladder represents the worst possible life for you. On which step of the ladder do you feel you personally stand at the present time?’

Question 42

green gdp

Answer 42

Green GDP = GDP – Environmental Costs – Social Costs

where the environmental cost typically qualifies:
- Depletion value of natural resources, e.g. oil, coal, natural gas, wood, and metals;
- Degradation cost of ecological environment, e.g. underground water pollution, topsoil erosion, and extinction of wildlife;
- Restoration cost of natural resources, e.g. waste recycling, wetland restoration, and afforestation;
and the

social costs typically include:
- Poverty caused by degradation of environment, e.g. shortage of natural resources after exploitation;
- Extra healthcare expenditure coming with the degradation of ecological environment;
- Above calculations can also be applied to net domestic product (NDP), which deducts the depreciation of produced capital from GDP.

Recently, there has been increasing criticism about the way modern economic activity negatively affects the environment. Economic growth today is damaging prospects for growth in the future. In subtopic 2.8 you learned about negative externalities, or costs that are not internalised into a transaction. GDP functions in a similar way, since it counts production within the country, but not the external costs of pollution, for example. For this reason, therefore, GDP overestimates production and growth. In 1972, economists William Nordhaus and James Tobin first discussed altering GDP to account for unpaid work, household leisure and environmental degradation. Since then many economists have further discussed this measurement and some countries, like China, have notably tried to use it, but without success.

Think about the concept of green GDP this way: when we pay someone to clean up the streets and pick up rubbish, that person earns an income. This income is included in the estimates for GDP. The more people we pay, the higher the GDP; or, in fact, the more rubbish, the higher our GDP! The same applies to all negative economic activities that are paid for, such as, for example, the amount of money spent to mitigate climate change’s impact on coastal cities.

Question 43

factors of production

Answer 43

all resources used to produce goods and services. in econs, they are grouped into 4 cats: land, labour, capital, entrepreneurship

(any of 4 acts can affect GDP)

Question 44

draw circular flow of income

Answer 44

factor payments -> households -> consumer expenditure -> firms

injections-party-withdrawals
1. investment <- financial institutions <- savings
2. govt. expenditure <- other countries <- taxes
3. export <- other countries <- imports