Macroeconomy: how economists keep track of everything. Flashcards
Name the accounting apparatus used by economists to measure economic activity and its functions.
The national account (internationally known as the National Income and Product Accounts or NIPA).
This allows economists to study the processes of production, distribution and consumption with in-depth understanding - allowing them to keep track of how much is being produced, as well as where it all ends up.
What is GDP?
Gross domestic product is a statistic that calculates the value of all goods and services produced in a given country in a given time period.
In the UK, it is calculated by the Office of National Statistics (revised on a regular basis), giving us an idea of how much economic activity took place in the previous quarter or year.
Because people like to consume goods and services, measuring GDP allows economists to quantify, in some sense, how well a country is doing at maximising its citizens’ happiness given the country’s limited resources.
A rising GDP indicates that a country is working out ways to provide more goods and services that make people happy.
What things does GDP not take into account?
The GDP statistic only takes into account the transactions that involve money, so if you look after your elderly parents or if a mother stays at home to take care of an infant that economic activity - although very productive and socially beneficial - doesn’t get counted in GDP.
Also in rural farming societies, most production is for consumption within the household, meaning that the output never makes it to the official GDP statistic. So as these societies change from rural economies to market economies, the GDP appears to rise because a lot of output is being counted for the first time which can be misleading when comparing GDP’S with other countries.
Describe the circular flow of income model.
Economists simplify life by saying that all the resources or factors of production (land, labour and capital) are owned by households - which can be made up of individuals or families.
Firms buy or rent the factors of production from the households and use them to produce goods and services, which are then sold back to the household thus setting up a circular flow for resources moving from households to firms, and goods and services moving back the other way.
Moving in the opposite direction are the payments in pounds. When the firms buy factors of production from households, they have to pay money to the households. That money is income to the households. And when households buy goods and services from the firms they pay for those with money.
A key point to understand is that firms are owned by households, either directly in the case of smaller businesses or via investment funding from banks or pension funds. In turn, any money that a firm makes when it sells goods and services flows on as income to some individual or group of individuals. Because of this flow, income must equal expenditures.
What are the four categories that income in the economy flows into?
1) Labour receives wages.
Workers charge wages for the labour services that they provide.
2) Land receives rent.
Owners of buildings and land chargen rents to tenants for the services that real estate and physical structures provide.
3) Capital receives interest.
i. e. the cost of obtaining the services of a £1000 piece of capital equipment is the interest payments that a firm must make on a £1000 loan to buy that piece of equipment.
4)Entrepreneurship receives profits.
The firm’s profits must flow to the entrepreneurs and owners of the firm, who take on the risk that the firm may do badly or even go bankrupt.
What is an asset?
An asset is something durable that isn’t directly consumed but that gives off a flow of services that you do consume.
An asset is considered a stock, while the services it provides are considered a flow.
i.e. a house is an asset because it provides shelter services. You don’t consume the house, you consume the services it provides. Similarly, a car is an asset because, although you don’t consume the car itself, it provides transportation services.
What are the three markets of the more DETAILED circular flow diagram?
1) Markets for factors of production: are where money is exchanged to purchase or rent the land, labor, capital and entrepreneurship used in production.
2) Financial Markets: are where people who want to lend money (savers) interact with those who want to borrow money (borrowers). In this market the supply and demand for loans determine the interest rate, which is the price you have to pay to get someone to lend you their money for a while. Because most governments run deficits and have to borrow a lot of money, they’re major players in the financial markets.
3) Markets for goods and services: are where people and the government buy the stuff that firms make.
When is newly produced output counted as part of GDP?
Newly produced output is counted as part of GDP as soon as it is produced, even before the output is sold.
i.e. as soon as construction on a new house is completed, its market value of £300,000 is estimated and counted as part of GDP right then. Suppose construction finished in 2009 adding £300,000 to 2009’s GDP. If the house isn’t sold until 2010, it doesn’t count in 2010’s GDP because double counting isn’t allowed.
The fact that output is counted when produced rather than when sold, is a red flag when intrepreting GDP stats to gauge the health of the economy.
Which is why Economists who try to forecast where the economy is going pay much more attention to inventory levels than they do to last quarter’s GDP.
name some further downfalls of GDP.
All things increase GDP.
Higher GDP is usually better than low GDP = higher living standards. But GDP doesn’t guarantee that happiness is increasing because GDP often goes up when bad things happen.
Ex. A major flood destroys a city = GDP goes up as reconstruction kicks into gear producing much more output (but everyone would have preferred it if there were no flood)
Ex. GDP doesn’t count the value of leisure. Many of your favourite times have probably come about when you weren’t producing or consuming anything that would count in GDP. Moreover, an increase in GDP often comes at the price of sacrificing these leisure activities.
So, although the policies that raise GDP are generally beneficial for society, the costs involved in creating the rising output must always be examined.
When was the Keynesian Model first developed?
In 1936, by Cambridge University economist John Maynard Keynes in his first book The General Theory of Employment, Interest and Money.
It led to Macroeconomics becoming a seperate field of study for economists.
It was in response to the Great Depression of the 1930’s.
What is the equation for totalling up GDP?
Y = C + I + G + NX
It adds up the four traditional expenditure categories - Consumption, Investment, Government and Net Exports to equal the value in £’s of all goods and services produced domestically in that period, or the GDP (Y).
What does C stand for?
Consumption expenditure made by households on goods and services, whether domestically produced or produced abroad.
Consumption spending accounts for 67% of GDP - far more than the other three combined.
How do macroeconomists model consumption?
Macroeconomists model consumption very simply, as a function of people’s after-tax, or disposable, incomes.
What is the 3 step process used to derive disposable income algebraically?
1) Start with Y, the total income in the economy: in Keynes equation, income equals expenditure. Therefore, an money expended by you is income to someone else.
2) Figure out how much tax people have to pay. Ex. imagine an income tax (t)= 0.25. This means 25% of people’s incomes are taxed. And so, the total tax people pay, T, is given by T = t x Y.
3) Subtract people’s taxes, T, from their incomes, Y, to figure out their after tax income - which Economists call DISPOSABLE INCOME = Yd.
How do you express algabraically taxes subtracted from incomes?
Yd = Y -T = Y - t x Y = (1 - t) x Y
After you derive disposable income, you use a very simple model to figure out consumption expenditures made by households.
According to the model, what is Consumption a function of?
The model says that consumption, C, is a function of disposable income and a couple of other variables, Co and c.
In the formula C = Co + c x Yd, what does the lowercase c stand for?
Lowercase c is called the marginal propensity to consume, or MPC, where c is always a number between 0 and 1 that indicates the rate at which you choose to consume income rather than save it.
Ex. if c = 0.9, you consume 90 pence of every £ of disposable income that you have after paying taxes (you save the other 10p).
What is the actual value of the MPC?
The actual value is determined by the individual and varies from person to person depending on how much of their disposable incomes they like to save.
What is Co?
Think of it as how much people consume even if they have zero disposable income this year ( if you assume that Yd = 0 in the equation C = Co + c x Yd, that equation reduces to C = Co).
But where does the money come from to pay for Co, if you have zero disposable income? It comes from your personal savings, which you have piled up over the years. Economists call this dis-saving.
What does the overall equation C = Co + c x Yd say about your total consumption expenditure?
It says that your total consumption expenditure in an economy is your emergency level (when you have zero income) Co plus a part of your disposable income given by c x Yd.
The equation isn’t perfectly realistic, but it does show that consumption is reduced by higher tax rates and that people makes decisions about how much of their disposable incomes to save or consume.
The equation allows us to analyse the effects of policies that change tax rates and the effects of other policies that encourage people to spend higher or lower fractions of their incomes.
