CH. 8. THE LEVEL OF OVERALL ECONOMIC ACTIVITY
CIRCULAR FLOW OF INCOME MODEL
Households are the owners of factors of production (land, labor, capital,
entrepreneurship). These factors of production are given to resource markets, and are
purchased by firms. These firms use these factors of production to produce goods and
services, which they sell to households through product markets.
Money is involved. When households sell factors of production to producers, they get
household income (rent, wages, interest, profit). However, this acts as a cost of
production for firms, which gets turned into household income. This household income
is spent on goods and services in the form of household expenditure. This is then
converted to revenue for firms.
In another income flow, there are leakages and injections.
Leakages are forms of money that are leaked out of the economy and not put back into
the circular flow of income. Injections are flows of money that are added to the circular
flow of income. Leakages can be in the form of savings. When households save money,
they are restricting their household expenditure on goods and services, and hence this
money is lost or leaked out of the circular flow of income as it is not spent on goods and
services. However, these savings are deposited into a bank and are borrowed by firms as
loans, which are used to make investments in their businesses for capital., This is done
by purchasing more factors of production., hence making up for the money lost fro0m
the saving leakage. Furthermore, taxation can be a leakage as it takes out money from
household expenditure, and people spend less on goods. However, this money goes to
the government as tax revenue, which the government uses as govt expenditure to fund
the investments and borrowing of firms, hence acting as an injection for the leakage.
Moreover, imports are a leakage, because they are payments outside of the country, and
hence the money is leaked out of the household expenditure. On the other hand, exports
are people outside the country buying goods, hence acting as household spending.
Measures of economic activity;
Measuring economic activity, such as national income or value of output is called
national income accounting.
Methods of measuring national output:
Expenditure approach: Adding up all spending done on final goods and services over a
time period in an economy.
,Income approach: Adding up all income earned by factors of production that make
goods and services in an economy over a time period.(wages, rent, profit, interest; gives
us national income)
Output approach: Adding the value of all final goods and services produced in an
economy over a period of time
Expenditure method: GDP= CONSUMPTION+INVESTMENT+GOVERNMENT
SPENDING(EXPORT - IMPORT)
Gross domestic product (GDP): Defined as the market value of all final
goods and services produced in an economy over a period of time
GDP: The value of all goods and services produced DOMESTICALLY in a
country over a period of time, regardless of who owns the factors of
production.
GNI: The total income received by the residents of a country, equal to the
value of goods and services produced through factors of production
supplied by the country's residents, regardless of where the factors of
production are.
Nominal values: Values of a good or service that are measured in terms of
prices which are there at the time of measurement only. Meaning, that
nominal gdp or nominal gni is the value of the output in terms of CURRENT
PRICES, without being adjusted for changes in price such as inflation.
Real values: Real values are values that take into account changes in price.
For example, changes in price due to inflation. Therefore, real GDP or GNI
is the measure of economic activity that takes into account the influence of
changes in prices.
GDP per capita: Refers to the GDP per person depending on the population of a country.
This is achieved by dividing the GDP by the population of the country. This is important
to discern between the different population sizes of countries, and also changes in
population. If the population is increasing faster than the gdp, gdp per capita will fall. If
the gdp increases faster than the population, that means the population is the same but
is producing more output, and hence the gdp per capita is increasing. Per capita figures
help us realize the standards of living ofn people in a country as well.
,COMPARISIONS OF GDP PER CAPITA OR GNI PER CAPITA ACROSS COUNTRIES
REQUIRES MEASURE OF PER CAPITA OUTPUT OR INCOME BASED ON
CONVERSIONS OF NATIONAL CURRENCIES INTO US $1 BY THE USE OF PPPs, to
eliminate the influence of price differences on the value of output or income.
CALCULATIONS OF NATIONAL INCOME ACCOUNTING
Formulas: N.B
GNI is basically the income that is received from individuals to a country, no matter
where it is acquired and where the factors of production that gave it are located. The
GNI of the country does not include the money that comes from production in the
country but is sent abroad. However, it does include the income that is produced
abroad, but is sent to the country. Therefore, the formula for GNi is GDP+income from
abroad-income sent abroad.
When the price deflator (used to convert nominal gdp to real gdp) is rising, it means
average prices are rising. However, if the deflator is falling, the prices may be falling too.
BUSINESS CYCLE
Fluctuations in the growth of output of an economy over a period of time, such as
expansion and contraction.
Expansion: Curve sloping upward; more resources are being employed, prices are
possibly rising.
Peak: Represents the cycles maximum real gdp, and end of expansion. Resources are
likely fully employed, pisces are rising rapidly, inflation.
Contraction: Downward sloping curve; Resources are becoming unemployed, falling
GDP, prices in some sectors may fall. If this stage lasts more than 6 months, there is a
recession.
Trough: Lowest point of an economy in the business cycle, prices are low, resources are
severely unemployed. This is followed by a new expansion.
, When actual GDP is greater than the potential gdp, unemployment is lower than natural
rate
When actual gdp is lower than potential gdp,. Unemployment is higher than natural
rate
When the unemployment rate is equal to the natural rate of employment, there is
usually full employment. This is when the actual ut[ut is equal to the potential output.
GDP and GNI may not always be accurate in calculating the true value of output of a
country. This is because:
They do not include non-marketed goods and services (such as self-sufficient
households that don't contribute to the income in an economy as they dont hire
workers for work and hence don't pay for services like home repair)
They do not include underground markets
They do not take into account the differing price levels of different countries. This can
be solved using purchasing power parities.
They don't consider depletion of resources, or negative externali\ties in countries
They don't consider the improvements in the quality of goods and services.
GDP and GNI may not accurately be a display of a country’s standards of living
because:
They don't see the composition of a country's output. The country may have a low gdp
per capita, but it may have better merit and social security than any other country.
They don't consider the healthcare factors, distribution of income or improvements in
leisure and quality of life.
CH 9: AGGREGATE DEMAND AND AGGREGATE SUPPLY
Aggregate demand: Aggregate demand is the total quantity of aggregate output or
real gdp that all four components of buyers (consumers, investors, government, exports)
want to buy at different price levels in an economy. The downward sloping demand
curve shows the negative relationship between the real output demanded and the price
level in the economy over a particular time period.
A movement in the demand curve is caused by changes in the price level.
CIRCULAR FLOW OF INCOME MODEL
Households are the owners of factors of production (land, labor, capital,
entrepreneurship). These factors of production are given to resource markets, and are
purchased by firms. These firms use these factors of production to produce goods and
services, which they sell to households through product markets.
Money is involved. When households sell factors of production to producers, they get
household income (rent, wages, interest, profit). However, this acts as a cost of
production for firms, which gets turned into household income. This household income
is spent on goods and services in the form of household expenditure. This is then
converted to revenue for firms.
In another income flow, there are leakages and injections.
Leakages are forms of money that are leaked out of the economy and not put back into
the circular flow of income. Injections are flows of money that are added to the circular
flow of income. Leakages can be in the form of savings. When households save money,
they are restricting their household expenditure on goods and services, and hence this
money is lost or leaked out of the circular flow of income as it is not spent on goods and
services. However, these savings are deposited into a bank and are borrowed by firms as
loans, which are used to make investments in their businesses for capital., This is done
by purchasing more factors of production., hence making up for the money lost fro0m
the saving leakage. Furthermore, taxation can be a leakage as it takes out money from
household expenditure, and people spend less on goods. However, this money goes to
the government as tax revenue, which the government uses as govt expenditure to fund
the investments and borrowing of firms, hence acting as an injection for the leakage.
Moreover, imports are a leakage, because they are payments outside of the country, and
hence the money is leaked out of the household expenditure. On the other hand, exports
are people outside the country buying goods, hence acting as household spending.
Measures of economic activity;
Measuring economic activity, such as national income or value of output is called
national income accounting.
Methods of measuring national output:
Expenditure approach: Adding up all spending done on final goods and services over a
time period in an economy.
,Income approach: Adding up all income earned by factors of production that make
goods and services in an economy over a time period.(wages, rent, profit, interest; gives
us national income)
Output approach: Adding the value of all final goods and services produced in an
economy over a period of time
Expenditure method: GDP= CONSUMPTION+INVESTMENT+GOVERNMENT
SPENDING(EXPORT - IMPORT)
Gross domestic product (GDP): Defined as the market value of all final
goods and services produced in an economy over a period of time
GDP: The value of all goods and services produced DOMESTICALLY in a
country over a period of time, regardless of who owns the factors of
production.
GNI: The total income received by the residents of a country, equal to the
value of goods and services produced through factors of production
supplied by the country's residents, regardless of where the factors of
production are.
Nominal values: Values of a good or service that are measured in terms of
prices which are there at the time of measurement only. Meaning, that
nominal gdp or nominal gni is the value of the output in terms of CURRENT
PRICES, without being adjusted for changes in price such as inflation.
Real values: Real values are values that take into account changes in price.
For example, changes in price due to inflation. Therefore, real GDP or GNI
is the measure of economic activity that takes into account the influence of
changes in prices.
GDP per capita: Refers to the GDP per person depending on the population of a country.
This is achieved by dividing the GDP by the population of the country. This is important
to discern between the different population sizes of countries, and also changes in
population. If the population is increasing faster than the gdp, gdp per capita will fall. If
the gdp increases faster than the population, that means the population is the same but
is producing more output, and hence the gdp per capita is increasing. Per capita figures
help us realize the standards of living ofn people in a country as well.
,COMPARISIONS OF GDP PER CAPITA OR GNI PER CAPITA ACROSS COUNTRIES
REQUIRES MEASURE OF PER CAPITA OUTPUT OR INCOME BASED ON
CONVERSIONS OF NATIONAL CURRENCIES INTO US $1 BY THE USE OF PPPs, to
eliminate the influence of price differences on the value of output or income.
CALCULATIONS OF NATIONAL INCOME ACCOUNTING
Formulas: N.B
GNI is basically the income that is received from individuals to a country, no matter
where it is acquired and where the factors of production that gave it are located. The
GNI of the country does not include the money that comes from production in the
country but is sent abroad. However, it does include the income that is produced
abroad, but is sent to the country. Therefore, the formula for GNi is GDP+income from
abroad-income sent abroad.
When the price deflator (used to convert nominal gdp to real gdp) is rising, it means
average prices are rising. However, if the deflator is falling, the prices may be falling too.
BUSINESS CYCLE
Fluctuations in the growth of output of an economy over a period of time, such as
expansion and contraction.
Expansion: Curve sloping upward; more resources are being employed, prices are
possibly rising.
Peak: Represents the cycles maximum real gdp, and end of expansion. Resources are
likely fully employed, pisces are rising rapidly, inflation.
Contraction: Downward sloping curve; Resources are becoming unemployed, falling
GDP, prices in some sectors may fall. If this stage lasts more than 6 months, there is a
recession.
Trough: Lowest point of an economy in the business cycle, prices are low, resources are
severely unemployed. This is followed by a new expansion.
, When actual GDP is greater than the potential gdp, unemployment is lower than natural
rate
When actual gdp is lower than potential gdp,. Unemployment is higher than natural
rate
When the unemployment rate is equal to the natural rate of employment, there is
usually full employment. This is when the actual ut[ut is equal to the potential output.
GDP and GNI may not always be accurate in calculating the true value of output of a
country. This is because:
They do not include non-marketed goods and services (such as self-sufficient
households that don't contribute to the income in an economy as they dont hire
workers for work and hence don't pay for services like home repair)
They do not include underground markets
They do not take into account the differing price levels of different countries. This can
be solved using purchasing power parities.
They don't consider depletion of resources, or negative externali\ties in countries
They don't consider the improvements in the quality of goods and services.
GDP and GNI may not accurately be a display of a country’s standards of living
because:
They don't see the composition of a country's output. The country may have a low gdp
per capita, but it may have better merit and social security than any other country.
They don't consider the healthcare factors, distribution of income or improvements in
leisure and quality of life.
CH 9: AGGREGATE DEMAND AND AGGREGATE SUPPLY
Aggregate demand: Aggregate demand is the total quantity of aggregate output or
real gdp that all four components of buyers (consumers, investors, government, exports)
want to buy at different price levels in an economy. The downward sloping demand
curve shows the negative relationship between the real output demanded and the price
level in the economy over a particular time period.
A movement in the demand curve is caused by changes in the price level.
