Ch.20 - Well-being and the price level of a nation

Question 1

Macroeconomics

Answer 1

the study of the economy as a whole.

Question 2

what is the goal of macroeconomics?

Answer 2

to explain the economic changes that affect many households, firms and markets simultaneously.

Question 3

subjective well-being

Answer 3

the way in which people evaluate their own happiness.

Question 4

objective well-being

Answer 4

measures of the quality of life and uses indicators such as educational attainment, measures of the standard of living, life expectancy.

Question 5

total income must equal..

Answer 5

= expenditure

Question 6

why must income = expenditure

Answer 6

• Every transaction has a buyer and a seller
• Every pound of spending by some buyer is a pound of income for some seller.
  ◦ The equality of income and expenditure can be illustrated with the circular-flow diagram.

Question 7

When households receive income, some of the income is saved (S) providing funds for financial institutions. Some is taxed (T). The taxes can be used by the government in making purchases (G) such as education, health and infrastructure.
o Some products and services may be purchased from other countries as imports (M) and some services and products maybe sold abroad as exports (X).
o Some businesses will invest (I) in new capital.

Answer 7

saved = S
taxed = T
taxes used by govt to make pruchases = G
imports = M
exports = X
invest = I

Question 8

Leakages are T + S + M

Answer 8

taxes + savings + imports

Question 9

define GDP

Answer 9

Gross domestic product = a measure of the income and expenditures of an economy.

Question 10

GDP is the market value..

Answer 10

GDP is the market value of all final goods and services produced within a country in a given period of time.

Question 11

GNP def

Answer 11

Gross national product = the total income earned by a nation’s permanent residents (called nationals)

Question 12

NNP

Answer 12

Net national product = the total income of a nation’s residents (GNP) minus losses from depreciation.

Question 13

what is depreciation?

Answer 13

the wear and tear on the economy’s stock of equipment and structures, such as lorries rusting and computers becoming obsolete.

Question 14

NY def

Answer 14

National income = the total income earned by a nation’s residents in the production of goods and services

Question 15

personal income

Answer 15

the income that households and non-corporate businesses receive.

Question 16

disposable personal income

Answer 16

the income that households and non-corporate businesses have left after satisfying all their obligations to the government.

Question 17

What Is Not Counted in GDP?

Answer 17

• GDP excludes most items that are produced and consumed at home and that never enter the marketplace.
• It excludes items produced and sold illicitly, such as illegal drugs.

Question 18

formula for calculating GDP (Y)

Answer 18

Y = C + I + G + NX

Y = GDP
C = consumption
I = investment
G = govt purchases
NX = net exports

Question 19

what is consumption (C)?

Answer 19

The spending by households on goods and services, with the exception of purchases of new housing.

Question 20

investment (I) def

Answer 20

The spending on capital equipment, inventories, and structures, including new housing.

Question 21

govt spending (G)

Answer 21

The spending on goods and services by local and central governments.
◦ Does not include transfer payments because they are not made in exchange for currently produced goods or services.

Question 22

net exports (NX)

Answer 22

Exports minus imports.

Question 23

How to calculate GDP per capita?

Answer 23

gross domestic product divided by the population of a country to give a measure of national income per head.

GDP per capita = GDP/population (of country)

Question 24

How is GDP affected by changes in prices (inflation) and how can this be corrected?

Answer 24

changes in total expenditure can rise because:
- The economy may be producing a larger output of goods and services.
- Goods and services could be selling at higher prices.

so economists use a measure called Real GDP

Question 25

what is Real GDP?

Answer 25

the production of goods and services valued at constant prices

• it answers the hypothetical q: what would be the value of the goods/services produced this year if we valued them at the prices that prevailed in some specific year in the past?

Question 26

How are Nominal GDP and Real GDP calculated and how do they compare?

Answer 26

Real GDP values the production of goods and services at constant prices.
–> It takes changes in price over time into account.

Nominal GDP values the production of goods and services at current prices.
–> Calculated by multiplying output by prices.
{ouput x price}

Question 27

GDP at constant prices

Answer 27

uses prices that existed in the base year; takes into account changes in inflation

Question 28

GDP at current or market prices

Answer 28

calculation: output of goods/services x price of these goods/services in the reporting year

Question 29

What is the GDP deflator?

Answer 29

a measure of the price level calculated as the ratio of nominal GDP to real GDP times 100.

(nominal GDP/ real GDP) x100

Question 30

what does the GDP deflator tell us?

Answer 30

It tells us the rise in nominal GDP that is attributable to a rise in prices rather than a rise in the quantities produced.

Question 31

What can GDP tell us?

Answer 31

• the mean income and expenditure of the people in the economy.
• Higher GDP per person indicates a higher standard of living.

Question 32

Is GDP a good measure of society’s well-being?

Answer 32

As a measure of well-being, GDP is well established, however it is not a perfect measure of the happiness or quality of life of a society

• critics suggest that GDP is too focused on material possessions and income, and they argue that there many things that GDP omits that actually contribute to the quality of life and economic well-being

Question 33

What are the main criticisms of GDP as a measure of well-being?

Answer 33

◦ The value of leisure - if all worked and did not take time for leisure GDP would rise, yet despite the increase in GDP we cannot conclude that well-being will improve

◦ Work in the home and volunteer work - The value of almost all activity that takes place outside of markets, such as the value of the time parents spend with their children and the value of volunteer work.

◦ The value of a clean environment - if environmental regulations were scrapped and firms could produce goods/services without considering pollution, GDP might rise, but wel-being would most likely fall

◦ The distribution of income - some people earn more than others, some suffer far more than others - GDP is a measure of the average person, but behind the average lies a large variety of personal experiences

Question 34

What other measures have been proposed to improve on GDP?

Answer 34

• ONS (UK) publishes annual reports on personal well-being using four ‘high level’ measures and 41 headline measures. the report is produced through a survery and answers are given on scale of 0-10

–> ‘high level’ measures are questions like “overall, how satisfied are you with your life?; to what extent do you feel things you do in your life are worthwhile?; how happy did you feel yday?; how anxious did you feel yday?”
–> Headline measures include: personal health, finances ; environment, relationships; where people live;education and skills; the economy and governance.

• Eurostat’s Quality of Life indicators include similar categories to ONS reports

Question 35

cost of living def

Answer 35

refers to how much money people need to maintain certain standards of living in terms of the goods and services they can afford to buy.

Question 36

Price level def

Answer 36

a snapshot of the prices of goods/services in an economy at a particular period of time

Question 37

inflation def

Answer 37

the term used to describe a situation in which the economy’s overall price level is rising.

Question 38

inflation rate def

Answer 38

the percentage change in the price level from the previous period.

Question 39

Consumer price index (CPI) def, and use?

Answer 39

= measures the overall cost of the goods and services bought by a typical consumer.

• It is used to monitor changes in the cost of living over time.

–> When the CPI rises, the typical family has to spend more money to maintain the same standard of living.

Question 40

How to calculate the CPI?

Answer 40

5 steps:

1) fix the basket: Determine what prices are most important to the typical consumer. –> The Office of National Statistics (ONS) identifies a market basket of goods and services the typical consumer buys.

2) Find the prices: Find the prices of each of the goods and services in the basket for each point in time.

3) Compute the Basket’s Cost: Use the data on prices to calculate the cost of the basket of goods and services at different times

4) Choose a Base Year and Compute the Index

5) Compute the inflation rate: The inflation rate is the percentage change in the price index from the preceding period.

Question 41

what is the producer price index?

Answer 41

a measure of the cost of a basket of goods and services bought by firms.

Question 42

what is producer price index useful for?

Answer 42

Because firms eventually pass on higher costs to consumers in the form of higher prices on products, the producer price index is believed to be helpful in predicting changes in the CPI.

Question 43

What are the limitations of the CPI?

Answer 43

① Substitution bias - Consumers substitute toward goods that have become relatively less expensive. The index overstates the increase in cost of living by not considering consumer substitution.

② Introduction of new goods - The basket does not reflect the change in purchasing power brought on by the introduction of new products.

③ Unmeasured quality changes - If the quality of a good rises from one year to the next, the value of a euro rises, even if the price of the good stays the same.

Question 44

How can we use the CPI to compare monetary amounts from different years?

Answer 44

To compare money figures over a period of time, we need to know the level of prices in both the historical year and the level of prices today.
- need to inflate the historical figure into today’s currency

Formula:
Amount in today’s currency = Amount in year T currency x price level today/price level in year T