Lecture 3 Business Economics

8/7/2019 Lecture 3 Business Economics

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Total RevenueTest(Total revenue TR) is calculated by multiplying price

(P) (per unit and quantity Q) .of the good sold Or TR

= P x Q The total revenue test is a method of estimating the

.price elasticity of demand As Ed will impact the,total revenue we can estimate the Ed by looking at

.the movement of the total revenue

Total Revenue Test>When Ed is 1 , total revenue will decrease as

. .price increases P and TR move in opposite directions Producers can increase total revenue ( =TR Price

)x Quantity .by lowering the price

<When Ed is 1 , total revenue will increase as. .price increases P and TR move in the same direction

Producers can increase total revenue by raising the

.price







Measuring DomesticOutput

Why Calculate national Income- for 3reasons, to

1.Assess the health of the economy by

comparing levels of production atregular intervals

2.Track the long run course of theeconomy to see if it has grown

remained constant or declined3.Formulate policies that will safeguard

and improve the economy’s health

Primary measure of economy’s



Assessing the’Economy s

Performance National Income Accounti• Health of the Economy

• Comparisons Over Time• Formulation of Public Poli

What Are These

AccountingMeasures?



Aggregate Output or GDP

• It is the total market value of all finalgoods and services produced in a givenyear.

• GDP is a monetary measure withoutwhich we can’t compare relative pricesof goods and services produced in aneconomy in different years

• For eg which output is greater, 3computers & 2 sofas or 2 sofas and 3computers? Price tag?

• If rices of sofas o u and of com uters



Measuring GDP

• For accurate measurement goodsshould be counted once and henceonly the market value of finalgoods is included

• Intermediate goods are totallyignored. Why?

• Because the final price already

includes the price of intermediategoods used in them

• Including the value of intermediate

goods would amount to multiplecounting



Multiple Counting

• Example is exhibit 7.2• Firm A sells $120 worth Sheep ranch to

Firm B

•

It paid $120 for wages rent interest &profit(WRIP)

• Firm B Processed wool and sold for $180to Firm C

• It bought for 120 and paid $60 in WRIP

• Firm C manufactures suit and sells towholesaler for $220. It bought for 180

and paid $40 for WRIP



(1)Stage of Production

(2)Sales Valueof Materialsor Product

(3)ValueAdded$ 0

Firm A, Sheep ranch 120 $ 120 (= $ 120 - $ 0)

Firm B, wool

processor

180 60 ( = 180 – 120)

Firm C, suitmanufacturer

220 40 ( = 220 – 180)

Firm D, clothingwholesaler

270 50 ( = 270 – 220)

Firm E, retail clothier 350 80 ( = 350 – 270)

Total sales values $ 1140Value added (totalincome)

$ 350

.E 7 2-e Added in a Five Stage Production Process



Value Added

• If we add all intermediates the totalcomes to 1140. However production &sale generated only $350.

• Alternatively we can add value added ateach stage.

• Value added is Market value of firms

output less value of its inputs. Firm Agot 120 as original value

• Firm B bought for 120 sold for 180 so VA

is $60



Non production Transactions

• GDP excludes NPTs as they havenothing to with generation of finalgoods and services. For eg

• Public transfer payments: socialsecurity, welfare payments, veteranspayments

•

Private transfer payments: moneygiven by father to children, orcharities

• Stock Market transactions: buying and

selling of stocks and bonds is



approaches

•

We just saw two approaches !!!!!!!!!• We looked at final price paid by

consumer and

• We looked at entire WRIP incomes thatwere created in making a suit or valueadded approach

• Similarly GDP can be calculated in

2ways• We can look at GDP as sum of all

money spent in buying goods:expenditure or output approach

• Or we look at GDP as income derived or



• A Monetary Measure• Avoid Multiple Countin• Intermediate Goods

• Final Goods• Value Added

GROSS DOMESTIC PRODUCT

T h e t o t a l m a r k e t

v a l u e o f a l l f i n a l g o o d s a n d s e r v i c e s

p r o d u c e d i n a g i v e n

y e a r



ExpenditureApproach

Add all that was spent to buy total output All final goods produced are

Bought by 3 domesticsectors

,Households businesses or Government Or foreignbuyers

Income Approach Add up all income that was

derived As income from production ofgoods

The total receipts acquired from the sale of the total output are

allocated ,to the suppliers as Wages,Rents

Investments and Profits Consumption by Households+Investment Expenditure by

+Businesses Govt Purchases

+ Expenditure by foreigners+O r C Ig+ +G Xn

+Wages Rents+ +Interest Profits+ Statistical

adjustments+ + + +Or W R I Padjustments



+

+

+

+

+

+

+

GROSS DOMESTIC PRODUCT

Consumption

by Households

Investment

by Businesses

Government

Purchases

Expenditures by Foreigners

E x p en d i t ur e s A p p r o ac h I n c o m e A p p r o a c h

Wages

Rents

Interest

Profits

StatisticalAdjustments

= =G

DP



Expenditure Approach

• Personal Consumption Expenditure alsocalled consumption expenditures byhouseholds

• The term covers all expenditures ondurable consumer goods (Cars, ACsRefrigerators etc), non durable goods

(Bread, Milkm Toothpaste etc) andconsumer expenditures for services(doctors lawyers barbers mechanics

etc)



Expenditure Approach•

Gross Private Domestic Investment (Ig)includes

1.All final purchases of machineryequipment & tools by business

enterprises2.All construction (residential &

commercial)

3.Changes in inventories for productionor as unconsumed output (goodsavailable for sale)

• It does not include non investmenttransactions like transfer of paper



EXPENDITURES APPROACH

Net Investment

Gross Investment

Depreciation-=

StockofCapita

l

Consumptionand

GovernmentSpending

StockofCapita

l

Depreciation

NetInvestment

January 1 ’Year s GDP December 31

Increa

sed

G r o s sI n v e s t m e n t



Expenditure Approach

•Government Purchases or G is 3rd

category of expenditures & includesconsumption and investment bygovernment.

• Government incurs expenditure ongoods & services in providing publicservice (education etc)

•

Govt also spends money on socialcapital like highways and new schoolswhich have long life.

• Govt purchases (Federal Provincial andLocal) include all government



Expenditure Approach•

Net Exports or Xn means “Exports lessImports”

• Money is spent on purchase of importedgoods & on those goods producedlocally & exported abroad thereforeXnavoids overstatement of production

Putting All together GDP = C + Ig + G + Xn



Income Approach•

Items that make up national income• -Compensation of Employees -Rents

-Interest -Proprietors’ income -Corporate Profits

•

Statistical Adjustments required Indirect Business taxes are addedback

depreciation is added back and

finally also add



Net Foreign Factor Income

• Net foreign factor income is thedifference between factor paymentsreceived from the foreign sector bydomestic citizens and factorpayments made to foreign citizens fordomestic production. This is also thekey difference between GDP and GNP.

• Net foreign factor income actuallyrepresents a two-part adjustmentbetween gross domestic product andnational income.




• Suppose that a foreign citizen is employedin the domestic economy. For example,suppose that Auklonavic, a citizen of

Russia works in an assembly plantlocated in Shady Valley, U.S.A and If Aukla earns $15,000 in a given year forhis productive efforts in the U.S. Wacky

Willy factory• Auklonavic’s productive efforts is included

in gross DOMESTIC product, but notgross NATIONAL product. His income

falls under the heading of factor




• Also Suppose that Edgar, a citizen of the United States of America, worksin Russia and earns $20000 there.

• His productive efforts are included ingross NATIONAL product, but notgross DOMESTIC product and his

income falls under the heading of factor payments received from theforeign sector by domestic citizens.

•




• Since Auklonavic earned $15,000 inUSA and Edgar earned $20,000 inRussia therefore Net Factor Foreign

Income is:-• $20000 - $15000 = +5000

• However the GDP of USA is $5,000

less than the GNP of USA.

7 2



Receipts: Expenditures Approach Allocations: Income ApproachPersonal consumption expenditure (C)…......... $ 7304 Compensation of employees ………………………….. $

5977Gross private domestic investment (Ig)............ $ 1593 Rents………………………………………………………

………… 142Government purchases (G) …………………………... $1593

Interest……………………………………………………………… 684

Net exports (Xn)

……………………………………………… $ -424

Proprietor’sincome…………………………………………… 757Corporate incometaxes…………………………………….. 213

Dividends…………………………………………………………… 434Undistributedcorporate profits………………………….141

Nationalincome…………………………………………$ 8348

Indirect businesstaxes………………………………………. 695

Consumption of fixedcapital……………………………… 1393Net foreign factor income earned in the U.s……… 10

Gross domestic product………………..…………… $10,446

Gross domestic product………………………… $10,446

.7 2-e Added in a Five Stage Production Process



= –Net Domestic Product GDP Consumption of fixed capital

– =or 10446 1393

9053

= – ( +National Income NDP NFFI Indirect)Business Taxes

- ( + ) =Or 9053 10 6958348

= –( +Personal Income NI SS contributions Corp+ )taxes RE +

Transfer Payments= -( + + ) +Or Personal Income 8348 748 213 141

=1683 8929

= –Disposable Income Personal Income personal



OTHER NATIONAL ACCOUNTS

Gross Domestic Product (GDP) $10,446Consumption of fixed capital -1,393

Net Domestic Product (NDP) $9,053Net foreign factor income earned in the

U.S. - 10

Indirect business taxes -695National Income (NI) $8,348Social security contributions -748Corporate income taxes -213Undistributed corporate profits -141

Transfer payments +1,683Personal Income (PI) $8,929

Personal Taxes -1,113Disposable Income (DI) $7,816

. . , , , , & ,U S GDP NDP NI PI DI 200



Exports $ 367 Exp Approach

Dividends 60 Inc Approach

Consumption of fixed capital 307 Inc Approach

Wages and salaries 1442 Inc Approach

Government purchases 577 Exp Approach

Rents

33 Inc Approach Indirect business taxes 255 Inc Approach

Wage and salary supplements 280 Inc Approach

Gross private domestic investment 437 Exp Approach

Corporate income taxes 88 Inc Approach Transfer payments

320 Not included in either Interest

201 Inc Approach’Properties income

132 Inc Approach Personal consumption expenditures 1810



Nominal V/s Real GDP

• A GDP based on the prices thatprevailed when the output wasproduced is called Nominal GDP

• A GDP that has been deflated whenprices rose and inflated whenprices fell is called Adjusted GDP or

Real GDP



Year (1)Units of Outputs

(2)Price of PizzaPer Units

(3)Price Index(Year 1 = 100

(4)Unadjusted,Or Nominal,GDP(1) * (2)

(5)Adjusted, orReal, GDP

1 5 $10 100 $50 $502 7 20 200 140 703 8 25 250 200 804 10 30 ____ ____ ____ 5 11 28 ____ ____ ____

.TABLE 7 5 Calculating Real GDP



Method 1Find nominal GDP for each year.2. Computer a GDP price index.3. Divide each year’s nominal GDP by that year’sprice index (in hundredths) to determine real GDP.Method 2Break down nominal GDP into physical quantities of

output and price for each year.2. Findreal GDP for each year by determining thedollar amount that year’s physical output would havesold for if base-year prices had prevailed. (The GDPprice index can then be found by dividing nominalGDP by real GDP)

.LE 7 6 ps for Deriving Real GDP from Nominal GDP



•Adjustment Process

•GDP Price Index•Price Indexin a given

year =Price of market basket

in specific year

Price of same marketbasket in base year

x 100

Real GDP = Nominal GDP

Price Index(in hundredths)

Price Index(in hundredths)= Nominal GDP

Real GDP

A n A l t e r n a t i v e M e t h o d

.NOMINAL GDP vs REAL GDP



(1)Year (2)Nominal GDP,Billions of $

(3)Real GDP,Billions of $

(4)GDP Price Index*(1996 = 100)

1975 1635.2 4084 ____ 1980 2795.6 ____ 57.0541985 4213.0 5717.1 73.691990 5803.2 6707.9 ____ 1995 7400.5 ____ 98.10

1996 7813.2 7813.2 100.002002 10446.2 9439.9 110.66

.7 7, , ,nal GDP Real GDP and GDP Price Index Selected year



• Nonmarket Activities•Leisure• Improved Product Quality• The Underground Economy

• GDP and the Environment• Composition and Distribution

of Output• -Noneconomic Sources of WellBeing

SHORTCOMINGS OF GDP

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Lecture 3 Business Economics