3.1 Measuring Economic Activity (GDP, Business cycle, Circular income)

Question 1

circular flow of income

Answer 1

macroeconomic model used to explain how national income and economic activity are determined based on the interactions between economic decision makers

Question 2

How is economic activity generated

Answer 2

• 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

Question 3

leakages in circular flow of income

Answer 3

savings, taxation, imports

Question 4

injections in circular flow of income

Answer 4

investment, government spending, exports

Question 5

equivalence of measures of economic activity

Answer 5

• National income (Y), national output (O), national expenditure
• national income is the return from generating national output that has been purchased by national expenditure

Question 6

GDP

Answer 6

value of all goods and services produced within a country over a year

Question 7

Nominal GDP

Answer 7

measures national output using current prices, the value is not adjusted for inflation and is accurate only at the time of measurement

Question 8

expenditure method

Answer 8

• 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)

Question 9

Gross National income

Answer 9

the total income of a country irrespective of location of factors of production

Question 10

real GDP

Answer 10

• takes inflation into account

- allows more accurate comparisons of economic activity over time

Question 11

circular flow of income

Answer 11

macroeconomic model used to explain how national income and economic activity are determined based on the interactions between economic decision makers

Question 12

how is economic activity generated

Answer 12

• 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

Question 13

equivalence of the measures of production

Answer 13

• 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

Question 14

GDP

Answer 14

measure of all goods and services produced within a country over a yeat

Question 15

nominal GDP

Answer 15

measures national GDP using current prices that are not adjusted for inflation

Question 16

expenditure method

Answer 16

• expenditure becomes income to actors that produce output
• sum of consumption, investment, government spending and net export earnings
• C + I + G + (X-M) = GDP

Question 17

GNI

Answer 17

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

Question 18

real GDP

Answer 18

Real GDP takes inflation into account by using a price deflator to allow for more accurate comparisons of economic activity over time

Question 19

GDP deflator

Answer 19

• 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

Question 20

real GDP formula

Answer 20

nominal GDP / GDP deflator

Question 21

purchasing power parity

Answer 21

• 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

Question 22

business cycle

Answer 22

• 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

Question 23

boom in the business cycle

Answer 23

• economic activity rises
• increase in aggregate demand
• general price level rises due to increased expenditure

Question 24

peak in the business cycle

Answer 24

• economic activity is at its highest level
• unemployment is low
• high confidence

Question 25

recession

Answer 25

- fall in GDP for two consecutive quarters - decline in economic activity caused by business failure and employment issues - uncertainty and reduced confidence

Question 26

slump in the business days

Answer 26

- bottom of a recession - GDP is at its lowest - negative economic growth, business closures, cyclical unemployment

Question 27

Recovery in the business cycle

Answer 27

- occurs when GDP starts to rise after a slump and recession - creates employment - increases confidence

Question 28

economic growth

Answer 28

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

Question 29

Potential Output

Answer 29

highest level of real GDP that can be sustained over a long period of time

Question 30

exogenous shocks

Answer 30

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

Question 31

Counter-cyclical businesses

Answer 31

Businesses that sell inferior goods and as a result thrive during recessions

Question 32

Fall in GDP growth vs fall in GDP

Answer 32

Fall in GDP = recession | fall in GDP growth = still growing, but at a slower rate

Question 33

phases of the business cycle (in order)

Answer 33

1. expansion 2. peak 3. recession 4. slump

Question 34

phases of the business cycle (in order)

Answer 34

1. peak 2. recession 3. slump 4. recovery 5. boom

Question 35

benefits of knowing national income and output

Answer 35

1. asses economic performance over time 2. compare differences between economies 3. establish a basis for policy implementation

Question 36

Formula for GDP deflator

Answer 36

- (nominal GDP / real GDP) x 100 - base year index (usually 100) + rate of inflation - rate of inflation is accumulated, so add all previous years

Question 37

why use GDP to measure well-being

Answer 37

- 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)

Question 38

Limitations of GDP and GNI

Answer 38

- 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

Question 39

Alternatives to GDP and GNI

Answer 39

- Green GDP - OECD Better life index - happiness index - happy planet index

Question 40

OECD better life index

Answer 40

- 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

Question 41

Happiness index

Answer 41

- 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

Question 42

Happy planet index

Answer 42

- 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