IB EconomicsThe Level of Overall Economic Activity Chapter 13

What do you know?In groups write down what you know about macroeconomicsThink about these things (but dont limit your thoughts to these)What is the difference/link between micro and macroWho are the main players in the macro economy?What does a good economy look like?What is happening in the world economy at the moment?Even if you know words but dont know their meaning write them down!

Learning ObjectivesUnderstand the five main macroeconomic objectives (goals)Understand, describe and illustrate the circular flow of incomeUnderstand the different measures of national incomeCalculate national incomeExplain the meaning and significance of green GDPEvaluate the uses of national statisticsExplain and illustrate the business cycle

What is Macro economics?Before we looked at micro economics We looked at what happened within the firm and within the marketNow add all of those markets together and we get the macro economyWe looked at allocation of resources in a marketMacroeconomics is concerned with the allocation of a nations resourcesThere are five main variablesEconomic growthEmploymentPrice stabilityExternal stabilityIncome distribution

Macro objectivesThere are five objectives that most economies haveA steady increase of national output (growth)A low level of unemploymentA low and stable rate of inflationA favourable balance of payments (Trade - Exports minus Imports)An equitable (fair) distribution of income

The circular flow gameTo understand how an economy works we need to understand the flowsTo do this we will use a really simple modelThere are four households (families) who have been shipwrecked on a desert islandDivide into 4 groupsThe supply of money in the economy is 5 and we assume that all the money will be used to buy good and servicesHousehold A spends 5 and received from household B goods and services in exchange. Household B then spends 5 on goods sold by household C and the process is repeated until all households have participated.Keep count of how much your household spendsKeep count of how much you earn

The circular flow gameIf these 4 families are the entire economy What is the value of national output = ?20What is national income = ?20What is national expenditure = ?20

The circular flow game - summaryIn a simplified model GDP = National Output = National Income = National ExpenditureNot only is this true in a simplified model it is also true (with a few statistical adjustments) for any economyIn a more sophisticated economy households do not trade with each other and we need to add firms

GDP = National Output = national income = national expenditure

Check your understandingNational Income, National Output and National Expenditure should always be equal. Why is this?If a newspaper headline says UK National Income increased last year by 2%, what does this mean in terms of output and expenditure?Changes in flow?Same amount of growth in national output and national expenditureFlow has increasedMore flowing in than out

What circular flows do we have in this 2 sector model?

Leakages and InjectionsThis model is very simplifiedWhat is it not taking into consideration?Do people spend all of their income?No, they save some in the bank or other financial institutionsThis is known as a leakage from the circular flowIf households dont buy all the output that is produced by the firms will have unsold stockThey will reduce their outputThey will use less factors of production and pay less incomeThe amount of income in the economy will fall

Saving: foregoing current consumption to allow for consumption in the future

Leakages and InjectionsThe good thing about savings is that firms will have access to them by borrowing money from banksThey can use the money to increase their stock of capital and expand their outputThis is known as investmentIt is an injection into the circular flow of incomeInvestment allows the amount of income circulating in the economy to rise

Leakages and InjectionsWhy is this model still too simple?An economy is not closedHouseholds can buy goods and services from other countriesWould this be an injection or a leakage?Imports are a leakage this is income that is being spent and not being returned to firmsPeople buy the countries exports of goods and services Are exports leakages or injectionsExports are an Injection because they represent a source of income not coming directly from the households

Leakages and InjectionsWhy is this model still too simple?There are more than two sectorsWe now need to introduce the government sectorWhat injection and leakage can be added to this diagram due to the introduction of the government sector?

Leakages and InjectionsSome of the income earned by the households must be paid to the government in the form of taxesTaxes are a leakageGovernments spend money in the economy on schools, roads, campaigns, hospitals etcGovernment spending is an injectionDont assume that government spending = revenue from taxes

Leakages and InjectionsYou will see later that governments can spend more than they earn to deliberately influence the level of leakages and injections to affect the level of national income

How is national income measured?There are three ways (which we saw before when we played the desert island game) of measuring incomeCan you remember?Output the value of goods and services produced (less the costs of inputs) Income the value of all incomes earned in the economyExpenditure the value of all spending in the economySpending by households known as consumption (C)Spending by firms known as investment (I)Spending by government (G)Spending by foreigners on exports minus spending on imports or net exports (X-M)There is an identity that you will need to learn GDP = C + I + G + (X-M)

How is national income measured?In practice, the data collected to calculate GDP comes from many different and varied sourcesThere are often inaccuraciesThis can be due to timingOften figures have to be revised at later date when full information is collected

Different measures of income

GDP the total of all economic activity in a country regardless of who owns the productive assetsGross National Product (GNP) or Gross National Income (GNI) the total income that is earned by a countrys factors of production regardless of where the assets are locatedGNIGDPincome earned from assets abroadincome paid to foreign assets operating domestically=+-Over time capital gets used up its value depreciates GDP does not take this into consideration. NNI does. NNI = GNI minus depreciationGreen GDP GDP minus environmental costs

Real GDP or nominal GDPTo make a comparison of GDP year on year you need to take into consideration the rise in pricesYou are measuring by the total value of goods and servicesThe goods and services may not have changedInflation may mean that the prices of the same goods and services have gone upWe use a GDP deflator to do thisGDP x 100/(100 + inflation rate) = real GDPIf the inflation rate was 4%Real GDP = GDP x 100/104

Real GDP GDP which has been adjusted for inflationNominal GDP GDP which has not been adjusted for inflation

GDP per capitaTo make a judgement about the progress of a country in comparison with other countries in terms of raising living standards the GDP per capita figure is much more appropriate

GDP per capita GDP divided by the size of the population

Limitations of the dataInaccuracies figures tend to become more accurate after time as they are revisedUnrecorded or under-recorded economic activity (informal markets)DIY in developed countriesCare for elderly or childrenSubsistence farming in developing countriesIllegal activities (alien workers, drug trafficking etc)Work done for cash (and no tax is paid)Countries with higher tax burdens tend to have a larger hidden economyExternal costsGDP does not take into account resource depletion or negative externalitiesQuality of life concernsGDP may grow because people are working longer hoursComposition of outputOutput could be defence that does not benefit consumers

The Business CycleThe business cycle fluctuations in economic activity measured by changes in real GDPFluctuations in practice are highly irregular Recovery: economic expansion largely driven by increase in aggregate demand as households and consumers are encouraged to spend more. Firms increase their output in response to the increase in demand. Newly employed workers spend their income on goods and services

The Business CycleBoom: increased demand for goods and services pushes up average prices (inflation). The rate of growth of GDP will fall as the economy nears its potential output. Policy makers may try to slow growth (to reduce inflation) causing a fall in total demand and recession could begin.Recession: defined as two consecutive quarters of negative GDP growth. Falling aggregate demand will lead firms to lay off workers so unemployment rises. This means less spending leading to lower rates of inflation or deflationTrough: at some point the contraction will come to an end. Aggregate demand will pick up and enter the recovery phase

Long term trend and output gapsNegative output gap (A): the economy is producing below its trend and unemployment is likely to be a problemPositive output gap (B): the economy is producing above its trend and inflation is likely to be a problemEconomies fluctuate but tend to have positive long term growth trends