Topic 1- Circular flow of income and National income Flashcards
What are the terms for positive or negative growth in GDP?
expansion and contraction
What does a quarterly GDP growth chart show compared to annual?
. More accurate as to what is happening
.shows business cycle
What is the circular flow of income? CIF
Framework for examining linkages between different parts of the economy
Shows inputs, outputs and payments between households and firms within an economy
How Can the CIF be used?
. Designing methods to measure Gross Domestic Product (GDP)
. Predicting the impact of various ‘shocks’ on the economy, e.g.
-reduced investment by companies because they think there will be slower growth in sales
-increased government expenditure
What is the framework for the CIF?
. Households own factors of production:
. Firms use factors to produce goods and services. Firms reward households financially for use of factors.
. Households purchase (expenditure) goods & services from firms
. Firms use money from sales to pay (income):
- landowners’ rents
- workers’ wages & salaries
- dividends & interest on borrowed funds
- owners’ profits
What are the factors of production?
land
labour
capital: both physical (e.g. retail space) & financial
enterprise or entrepreneurship → involves risk taking
Define total income (components)
wages + rents + profits + interest
Wages: factor income for supply labour, e.g.
wages, salaries, bonuses
Rent: factor income from supplying land
Profits, interest & dividends on shares: factor
income from supplying entrepreneurship & capital
What is the definition of leakages?
income that is not spent (directly) on goods & services within the economy
What are the types of leakages? explain each
. total or aggregate saving = S
e.g. saving for a new house, for your children’s education etc.
. total taxes = T
e.g. income & tax on dividends etc.
. import expenditure = M
e.g. French wine, oil, machinery
What is the definition of injections?
Additional spending on goods and services that does not come directly from income earned by households
What types of injections are there? explain each
. investment = I
(money from people’s savings)
e.g. in new retail space, new IT equipment, new roads
. government expenditure = G
e.g. tax rev on school education & health care services
. export expenditure = X
e.g. pharmaceuticals, overseas students, banking & other financial services
Define total expenditure (components)
consumption + investment + gov’t expenditure + net exports
. Consumption: households’ spending goods and services
. Investment: spending on capital products by firms
. Gov’t expenditure – Gov’t spending on public goods and services, (e.g. roads, education)
. Net exports: difference between exports and imports
What are the 3 ways of measuring GDP from the CIF model?
. Production (output)
. Income
. Expenditure
They should all equal the same value
What is the expenditure method of measuring GDP?
The total value of spending (aggregate expenditure)on goods & services
What is the formula for the expenditure method? and breakdown of the components
consumption (C) + investment (I) + government (G)
+ exports (X) - imports (M)
. Consumption: by households
. Investment: gross private & public, e.g. machinery & IT software, roads
Government expenditure, e.g. health, education & defence (excludes welfare transfers, e.g. pensions – as it redistributes income)
Exports: goods & services produced in the UK but consumed overseas
Imports: goods & services produced overseas consumed in UK
What is the production/output method?
total value goods & services produced by companies
What issues need to be taken into account when measuring GDP using the production/output method?
. Double counting
. Foreign ownership
. Depreciation
Explain the issue of double-counting for the production/output method
sum the value-added (net output, after deducting goods and services used up during the production period) at each stage of production to calculate GDP
e.g.dealership buys a car from ford for £12 and sells for £13 so £1 +£12=£13
Counting both the £12 and £13 as GDP would be double counting
Explain the issue of foreign ownership for the production/output method
. Toyota owns production facilities in the UK (counts towards GDP) but Tesco income from overseas doesn’t but the flow of profits, interest & dividends from these assets (are property incomes) will go back to home country
. so net property income (balance of flows = income flowing in minus (–) income flowing out ) is taen into account
. So GNP is used as an adjustment of GDP to net property income so that it = income and expenditure method
Explain the issue of depreciation for the production/output method
Producing goods uses plant, machinery, building & retail facilities - these depreciate over time
GNI – depreciation = Net National Income (NNI)
Note:depreciation hard to calculate
What is the income approach to GDP?
total household earnings: e.g. UK 2013
Wages and salaries: 59% of total GDP
Profits, rent and interest: 35% “ “ “
Mixed incomes*: 6% “ “ “
- remuneration for the work carried out by the owner (or by members of his/her family) of an unincorporated enterprise
Explain why GDP needs to take into account price changes?
When GDP increases:
the economy is producing more goods & services
and/or goods & services are being sold at higher prices
so not adjusting to new prices means a potentially misleading GDP
What are the two types of GDP?
Real and nominal
What is real GDP?
the value of goods & services produced this year, valuing them at the prices that prevailed in some year in the past (base year), constant prices
What is nominal GDP?
GDP measured at current prices
How and why does GDP need to take into account population size?
In order to measure the standard of living & consumer demand using GDP per capita.
e.g. China >UK in overall GDP
China
What is the problem with GDP per capita?
Does not take into account cost of living differences & household income inequality (distribution of wealth)
e.g. Switzerand cost of living is much higher and may not mean they are better off
What is the business application of using the GDP level?
. navigating the business cycle: expansion periods (C to A) & contraction periods (A to B) of GDP and therefore aggregate demand
. business owners don’t want to realise a recession or boom in hindsight so capital investments can be managed by using the cycle
Give an example of a firm navigating a contraction of the business cycle
Example: supermarket pricing strategies after 2008 recession
. inferior goods demand increases when income falls
normal goods demand declines
. introduction of basic range by supermarkets & increasing market share of Aldi & Lidl supermarkets (foresight)
What is an example of the business cycle harming a firm with a lack of adaptability?
Pricing strategies should be adaptable - the experience of Poundworld going into admin 2018
. SIngle price point means it is harder to adapt to a changing economic environment
What are the key factors that affect a firms ability to navigate a recession?
. Income elasticities- rise in basic foods
. Pricing-ability to lower prices
. Managing costs-out-sourcing/capacity reduction
. Diversification-products and locations
Explain how firms can use diversification to navigate a contraction/recession
. product diversification- VW has a number of different car brands. Lamborghini, prosche will seel well in boom but SEAT and VW cars in contraction
. Market diversification- Bentley found strategic partner in VW and moved int high growth market (China &middle east)-they gained first-mover advantage of luxury cars=barrier t entry in terms of brand/distribution network
Why do costs need to be managed during a contraction?
Fixed costs or ‘overhead’ costs are independent of sales or goods produced
Problem: sales are likely to fall when GDP contracts
Explain how firms can manage costs in a contraction by reducing capacity
Examples:
- hotels: swimming pools, bars & restaurants - retailers: rents for retail space - all: financial debt
Solution:
- capacity reduction → closure of unprofitable hotels & retail space, reduced hours of opening
e.g. M&S plans to close 100+ stores in 2022
Explain how firms can manage costs in a contraction by out-sourcing intermediate inputs
BMW out-sourced Engines for some motorbike models by Kymco in Taiwan leading to increased profits
How can firms manage expansion period (increasing aggregate demand)?
. Investment projects are more likely to become profitable because they generate extra sales, e.g. retail space, purchase of new machinery
. Willing to take on new risks, e.g. new product development
Taking on more staff to anticipate higher future demand for goods & services
Wage increases? If the economy faces full-employment
What are the limitations of GDP as a measure to inform business decisions?
. GDP growth is a backward looking measure & subject to revisions due to new data
What are some forward-looking measures businesses can use to inform them about the business cycle?
. business experience:
monitoring orders(increase/decrease) & performance of competitors(are they in the same boat)
speaking to clients
. official economic forecasts
. surveys of consumer confidence: less confidence=less spending
What are some examples of economic forecasts that businesses can use?
UK: Office for Budget Responsibility (OBR)
Media: presentation of ‘headline’ data & commentary, Financial Times
Central banks & commercial banks, e.g. Bank of England, European Central Bank, Federal Reserve (USA)
Commercial banks, e.g. Barclays Economic Outlook
Explain what the OBR is?
. OBR (Office for Budget Responsibility) created in 2010
. Official independent ‘watchdog‘ of government finances & measures gov performance
. Provides five-year forecasts for the economy & government finances
. Main publication: Economic and Fiscal Outlook – provides detailed commentary & forecasts for the UK economy:
Explain what consumer confidence surveys are
GfK produces a widely used consumer confidence index on behalf of the European Commission
Asks 16+ age group a variety of questions concerning the general economic situation of the country & their personal finances
Consumer index (CI) > 0% implies ‘optimistic’ consumers in the majority, i.e. percentage of optimists > percentage of pessimists
CI < 0: ‘pessimistic’ in the majority, e.g. 70% pessimistic & 30% optimistic → minus (-) 40% CI
CI = 0%: ‘neutral’
What happened to consumer confidence 2008-2018?
Growing pessimism from the start of 2008: impact of the global financial crisis
Post-Brexit vote in 2016: ‘pessimism’ in the majority but smaller than from 2008 to 2014
Where is most of the UK’s production in?
Approx 80% in services-financial services, education, health, real estate, tourism, restaurants, hotels, transport & communication & retail trade
