3.1 Measuring Economic Activity (GDP, Business cycle, Circular income) Flashcards
circular flow of income
macroeconomic model used to explain how national income and economic activity are determined based on the interactions between economic decision makers
How is economic activity generated
- households provide factors of production in return for income
- factors of production allow firms to generate goods and services for consumption
- income of households is used to consume goods and services, providing firms with income required to pay returns on factors of production
leakages in circular flow of income
savings, taxation, imports
injections in circular flow of income
investment, government spending, exports
equivalence of measures of economic activity
- National income (Y), national output (O), national expenditure
- national income is the return from generating national output that has been purchased by national expenditure
GDP
value of all goods and services produced within a country over a year
Nominal GDP
measures national output using current prices, the value is not adjusted for inflation and is accurate only at the time of measurement
expenditure method
- method of calculating GDP by adding the totals of consumption expenditure (C), investment expenditure (I), government expenditure (G) and net export expenditure (X-M)
- GDP = C + I + G + (X-M)
Gross National income
the total income of a country irrespective of location of factors of production
real GDP
- takes inflation into account
- allows more accurate comparisons of economic activity over time
circular flow of income
macroeconomic model used to explain how national income and economic activity are determined based on the interactions between economic decision makers
how is economic activity generated
- households provide factors of production in exchange for income
- firms use factors of production to produce goods for consumption
- households consume goods, providing firms income that is used to pay returns on factors of production
equivalence of the measures of production
- national income (Y), national output (O), national expenditure (e)
- national income is the return from generating national output that has been purchased by national expenditure
GDP
measure of all goods and services produced within a country over a yeat
nominal GDP
measures national GDP using current prices that are not adjusted for inflation
expenditure method
- expenditure becomes income to actors that produce output
- sum of consumption, investment, government spending and net export earnings
- C + I + G + (X-M) = GDP
GNI
total GDP along with net factor income earned abroad, meaning it refers to the country’s total income irrespective of location of factors of production
real GDP
Real GDP takes inflation into account by using a price deflator to allow for more accurate comparisons of economic activity over time
GDP deflator
- measure of the general level of inflation in a country
- shows extent of changes in price level
- e.g GDP deflator of 106.5 = prices have risen 6.5% from the base year
real GDP formula
nominal GDP / GDP deflator
purchasing power parity
- exchange rate that enables residents to purchase a basket of goods and services in different countries
- equalises the purchasing power of two currencies by considering different inflation and costs of living
business cycle
- describes the periodic fluctuations in the level of economic activity in a country over time
- shows short term fluctuations as well as long term growth trends
- in practice tends to be unpredictable and irregular
boom in the business cycle
- economic activity rises
- increase in aggregate demand
- general price level rises due to increased expenditure
peak in the business cycle
- economic activity is at its highest level
- unemployment is low
- high confidence
recession
- fall in GDP for two consecutive quarters
- decline in economic activity caused by business failure and employment issues
- uncertainty and reduced confidence
slump in the business days
- bottom of a recession
- GDP is at its lowest
- negative economic growth, business closures, cyclical unemployment
Recovery in the business cycle
- occurs when GDP starts to rise after a slump and recession
- creates employment
- increases confidence
economic growth
a condition wherein the level of economic activity rises as measured by the value of real GDP characterised by increase for two consecutive quarters, lower unemployment and higher inflation
Potential Output
highest level of real GDP that can be sustained over a long period of time
exogenous shocks
Unexpected or unpredictable shocks that impact the economy and its components positively or negatively. They can distort the trendline of growth within an economy’s business cycle
Counter-cyclical businesses
Businesses that sell inferior goods and as a result thrive during recessions
Fall in GDP growth vs fall in GDP
Fall in GDP = recession
fall in GDP growth = still growing, but at a slower rate
phases of the business cycle (in order)
- expansion
- peak
- recession
- slump
phases of the business cycle (in order)
- peak
- recession
- slump
- recovery
- boom
benefits of knowing national income and output
- asses economic performance over time
- compare differences between economies
- establish a basis for policy implementation
Formula for GDP deflator
- (nominal GDP / real GDP) x 100
- base year index (usually 100) + rate of inflation
- rate of inflation is accumulated, so add all previous years
why use GDP to measure well-being
- comparisons over time and with other countries
- indication of standard of living (dependent on amount of goods and services the individual is able to consume)
Limitations of GDP and GNI
- do not show distribution of income
- does not reveal varying taxes
- differences in cost of living are ignored
- exchange rate fluctuations male comparisons less meaningful over time
- extent of social welfare varies
- do not reveal the composition of national output
- can be inaccurate or underreported dye to hidden economic activity or a high informal sector
- does not show the extent of negative externalities
Alternatives to GDP and GNI
- Green GDP
- OECD Better life index
- happiness index
- happy planet index
OECD better life index
- organization for economic cooperation and development
- 11 topics identified to be essential in terms of material living conditions and quality of life
- e.g housing, income, jobs, education, safety, governance etc
- like-for-like comparisons difficult
- complex, hard to quantify, somewhat subjective
- more informed policy making
Happiness index
- UN Sustainable Development Solutions Network
- Annual world happiness report
- representative samples of respondents in a country
- 14 indicators of well being
- believe that happiness leads to greater productivity, performance and profits as well as peace, progress and purpose
Happy planet index
- new economics foundation 2006
- measure the extent to which individuals and countries are able to achieve long, happy and sustainable lives
- considers current and future prosperity of individuals and societies
- emphasizes importance of happy, healthy and sustainable lives without jeopardizing
- considers well-being, life expectancy, inequality of outcomes, ecological footprint
- (well-being x life expectancy x inequality) / ecological footprint
