Calculate and explain gross domestic product (GDP) using expenditure and income approaches

Transcription

1 Calculate and explain gross domestic product (GDP) using expenditure and income approaches Prerequisite

2 GDP using income and expenditure methods Gross Domestic Product (GDP) include the following: Market value of final goods and services Value of intermediate goods are not included Transactions within geographical boundaries are only included Transfer payments are not included Goods or services that can be resold are not included Government provided goods and services are included, which are valued GDP is the market value of all final goods and services produced within a country in a given time period GDP can be valued by looking at either the total amount spent on goods and services produced in the economy or the income generated in producing those goods and services.

3 GDP using income and expenditure methods GDP counts only final purchase of newly produced goods and services during the current time period. Transfer payment and capital gains are excluded from GDP Intermediate product are excluded from GDP in order to avoid double counting. GDP can be measured either from the value of final output or by summing the value added at each stage of the production and distribution process. The sum of the value added at each stage is equal to the final selling price of the goods. 3

4 GDP using income and expenditure methods Given GDP as Y = C + I + G + NX, investment is major component of GDP Investment is amount incurred to buy fixed productive assets and inventory which generates income Hence when investment declines less output is generated and less capital is created causing the growth rate in real GDP to fall. Sources of financing for investment are Private Sources National savings Borrowing from foreigners, Government Sources Govt Savings (surplus) = Tax revenue government expenditure 4

5 Compare the sum-of-value-added and valueof-final-output methods of calculating GDP Prerequisite

6 Compare the sum of value added and value of final output method for GDP calculation The Expenditure approach to measuring GDP can be use for both the following methods for calculation of the GDP. Sum of Value Added: The GDP is calculated by summing the addition to value created at each stage of production and distribution. Value of Final Output: GDP is calculated by summing the value of all final goods and services produced during the period. 6

7 Compare nominal and real GDP and calculate and interpret the GDP deflator Prerequisite

8 Nominal and Real GDP, Calculate GDP deflator Nominal GDP: The total value of all goods and services produced by an economy, valued at current market price (price of good i in year t) (quantity of good i producedin year t) Real GDP: Real GDP measure the output of the economy using the prices from base year (price of good i in year t 5) (quantity of goods i producedin year t) GDP Deflator: It is a price index that can be used to convert nominal GDP into real GDP, taking out the effect of change in the overall price level. It is based on the actual mix of goods and services produced in the base year. Nominal GDPin year t 100 value of yeart at year t 5 8

9 Compare GDP, national income, personal income, and personal disposable income Prerequisite

10 GDP, National Income, Personal income and Personal disposable income The major component of real GDP are as follows: Consumption Business Investment Government Purchase Net Export (Export- Import) GDP : National Income+ Capital Consumption + Statical Discrepancy Capital Consumption Allowance: It measure the depreciation of physical capital from the production of goods and services. National Income: It the sum of income received by all factor of production that go into creation of final output 10

11 GDP, National Income, Personal income and Personal disposable income Personal Income: It is the pretax income received by household and is one determinant of cousumer purchasing power and consumption. It include the following: Add: National Income Add: Transfer payment Less: Indirect Business Taxes Less : Corporate Income Taxes Less: Undisputed Corporate profits Personal Disposable income: = Personal Income - Personal Taxes It is the personal disposable income after tax. PDI measure the amount that available to either save or spend on goods and services. 11

12 Explain the fundamental relationship among saving, investment, the fiscal balance, and the trade balance Prerequisite

13 Relationship among the Saving, Investment, Fiscal balance, and Trade balance Fiscal Balance: The balance of government spending, minus a government's tax revenues and any proceeds from asset sales. If the balance is negative the government has a fiscal surplus, if positive a fiscal deficit. 13

14 Relationship among the Saving, Investment, Fiscal balance, and Trade balance Balance of Trade: The balance of trade (or net exports, sometimes symbolized as NX) is the difference between the monetary value of exports and imports of output in an economy over a certain period. It is the relationship between a nation's imports and exports. A positive balance is known as a trade surplus if it consists of exporting more than is imported; a negative balance is referred to as a trade deficit or, informally, a trade gap. 14

15 Relationship among the Saving, Investment, Fiscal balance, and Trade balance Factors that can affect the balance of trade include: The cost of production (land, labor, capital, taxes, incentives, etc.) in the exporting economy vis-à-vis those in the importing economy; The cost and availability of raw materials, intermediate goods and other inputs; Exchange rate movements; Multilateral, bilateral and unilateral taxes or restrictions on trade; Non-tariff barriers such as environmental, health or safety standards; The availability of adequate foreign exchange with which to pay for imports; and Prices of goods manufactured at home (influenced by the responsiveness of supply) 15

16 Relationship among the Saving, Investment, Fiscal balance, and Trade balance Private saving and investment are related to the fiscal balance and the trade balance. A fiscal deficit must be financed by some of a trade deficit or an excess of private saving over private investment. (G-T) = (S-I) (X-M) 16

17 Explain the IS and LM curves and how they combine to generate the aggregate demand curve Prerequisite

18 IS and LM Curve and combine them to generate the aggregate demand Curve The IS curve shows the negative relationship between the real interest rate and level of aggregate income that are equal to planned expenditure at each real interest rate. The LM curve shows, for a given level of the real money supply, a positive relationship between the real interest rate and level of aggregate income at which demand and supply of real money balance are equal. The point at which the IS curve intersect LM curve for different level of the real money supply from the aggregate demand curve. The aggregate demand curve shows the negative relationship between GDP and the price level when all the other factor are constant. 18

19 The IS and LM Curve (cont ) Real interest rate The IS and LM curve LM curve, lower M/P (higher P) A LM Curve B LM curve, higher M/P (lower P) C IS Curve Real income Y A Y B Y C 19

20 Explain the aggregate supply curve in the short run and long run Prerequisite

21 Why LAS is vertical line while SAS is upward sloping SAS is upward slopping as supply increases at higher prices in the short run LAS is vertical as it is not affected by the price level LAS is the potential (full-employment) real output of the economy. 21

22 Price Level Why LAS is vertical line while SAS is upward sloping The level of real GDP on the LAS curve is the economy's level of production when the economy is operating at full employment Over time, the LAS curve may shift: As the full-employment quantity of labor changes, As the amount of available capital in the economy changes, or As technology improves the productivity of capital, labor, or both Long run Aggregate supply (LAS) Short run Aggregate supply (SAS) Real O/P (GDP) Full Employment Real O/P Aggregate supply in Long run and Short run 22

23 SAS curve is upward sloping In short run prices of final goods and services changes while wage rate and the price of other inputs (productive resources) are constant In short run, price of output changes but price of input remains constant When prices of goods and services rise (fall), businesses have an incentive to expand (reduce) production, and real GDP will increase (decrease) above (below) the fullemployment level shown by the LAS curve Hence real GDP is upward sloping function of price level along the SAS curve 23

24 Describe the causes of shifts in and movements along aggregate demand and supply curves Prerequisite

25 Shift in Aggregate Demand curve Aggregate demand curve is downward sloping Change in the price level cause changes in aggregate demand: movement along the curve. AD = C + I + G + (X-M) Factors affecting AD curve: Increase in consumers wealth Business expectations Consumer expectations about future income High capacity utilization Expansionary Monetary Policy Expansionary Fiscal Policy Exchange rates Global economic growth 25

26 Shift in the LAS and SAS curve The factors affecting SAS curve: Labor productivity changes, Input Prices change, Expectation of future output prices Taxes and government subsidies Exchange rates Not all factors that affect SAS affect LAS, factors affecting LAS are: Supply and quality of labor Supply of natural resources Stock of physical capital Technology 26

27 How LAS and SAS curve shifts Effects on LAS and SAS from an increase in fullemployment GDP, due to an increase in labor, capital or an advance in technology. Increase in any of factors cause LAS and SAS to shift to right side LAS 1 LAS 2 Long-run aggregate supply increases to LAS 2 and shortrun aggregate supply increases to SAS 2 P* Price SAS 1 SAS 2 Quantity An Increase in Potential GDP 27

28 Describe how fluctuations in aggregate demand and aggregate supply cause shortrun changes in the economy and the business cycle Prerequisite

29 Long-run Equilibrium Long-run equilibrium is where LAS curve intersects Aggregate Demand curve Price Level (Index) Excess Supply Excess Demand LAS AD An Increase in Potential GDP Real GDP Excess supply (recessionary gap) puts downward pressure on prices causing fall in production which moves the economy toward long-run equilibrium Excess demand (Inflationary gap) causes increasing output and prices which again moves economy toward long-run equilibrium Changes in the price level of final goods and services can move the economy to long-run macroeconomic equilibrium Equilibrium is at a price level of

30 Long-run Equilibrium If we are at a short-run disequilibrium (price level at 115), there is excess supply which puts downward pressure on prices. Businesses will see a build-up of inventories and will decrease both production and prices levels in response moving the economy toward long-run equilibrium (price level of 100) If the price level were 80, there would be excess demand for real goods and services. Businesses will experience unintended decreases in inventories and respond by increasing output and prices. This moves economy along the aggregate demand curve toward long-run equilibrium 30

31 Long-Run Disequilibrium Long-run disequilibrium arises when level of output is above or below full-employment GDP Two situations when economy is in short-run equilibrium but not in long-run equilibrium Recession (below full employment): Short-run equilibrium real GDP (GDP1) is less than full employment GDP (along the LAS curve). It brings downward pressure on money wages and resource prices that will decrease the equilibrium price level from P1 to P* P 1 P* Price Level (Index) LAS SAS 1 Real GDP GDP 1 Long Run equilibrium (below full employment) AD 1 31

32 Long-Run Disequilibrium Expansion (over full employment): In expansion, short-run equilibrium real GDP, GDP1, is above the full- employment level when aggregate demand has grown faster than LAS. The result will be upward pressure on prices that will result in inflation as the general price level increases from P1 to P* P* P 1 Price Level (Index) LAS AD 1 Real GDP GDP 1 Long Run equilibrium (Above full employment) SAS 1 32

33 Adjustment to an Increase in Aggregate Demand (AD) Increase in AD pushes new SR equilibrium at above full employment and real wages to fall Price Level LAS SAS 1 SAS 0 From an initial state of long-run equilibrium at the intersection of AD 0 with LAS, assume that aggregate demand increases to AD 1 The new short-run equilibrium will be at over-full employment with real GDP at GDP1 P LR P SR P 0 AD 1 AD 0 Real O/P GDP GDP* GDP 1 Adjustment to an increase in aggregate demand 33

34 Adjustment to an Increase in Aggregate Demand (AD) The increase in the price level (from P0 to PSR ) at new equilibrium level means that workers' real wages have decreased (holding money wages constant in SR) Increase in demand will have no impact on LR macroeconomic equilibrium Increase in demand will cause businesses to attempt to increase production by hiring more workers increased money wage demands shift in the SAS curve from SAS0 to SAS1 This will restore LR macroeconomic equilibrium at fullemployment real GDP and at a new price level of PLR 34

35 Adjustment to a Decrease in Aggregate Demand Decrease in AD will have opposite impact Decrease in AD from AD0 to AD1 will lead to a new short-run equilibrium with the price level at PSR and real GDP at GDP1 which is less than full-employment GDP (a recession) Resulting excess supply of labor (workers seeking jobs) will put downward pressure on money wage rates and other resource prices shift in SAS to SAS1 (an increase in supply), restoring long-run equilibrium at full-employment GDP along the LAS curve and at a new, lower price level (PLR ) 35 Price Level P 0 P SR P LR SAS 0 SAS 1 LAS AD 1 AD 0 Real O/P GDP GDP 1 GDP* Adjustment to a decrease in aggregate demand

36 Describe the sources, measurement, and sustainability of economic growth Prerequisite

37 Sources, measurement and sustainability of economic growth Important sources of Economic Growth: Labor Supply: The labor force is the number of people over the age of 16 who are either working or available for work and currently unemployed. Human Capital: The education and skill level of a country s labor force. Physical capital stock: A high rate of investment increase a country s stock of physical capital. An increase in the physical capital can increase economic growth. Technology: It improve the productivity as well as the potential GDP of a country. Natural Resources: It include the Renewable and Non renewable resources. 37

38 Sustainability of Economic Growth One way to view Potential GDP : Potential GDP= Aggregate hours worked * Labor Productivity Or in terms of economic growth Growth in Potential GDP: Growth in labor force + Growth in labor Productivity The sustainable rate of economic growth is important because long-term equity returns are highly dependent on economic growth over time. A country s sustainable rate of economic growth is the rate of increase in the economy s productive capacity. 38

39 Describe the production function approach to analyzing the sources of economic growth Prerequisite

40 Production function approach to analyze the sources of economic growth A production function relate economic output to the supply of labor, the supply of capital and the Total factor productivity ( It is a residual factor, which represent that part of economic growth not accounted for by increases in the supply of labor and capital. Increase in the total factor productivity can be attributed to advances in technology which can help in reducing the overall cost of production. 40

41 Production function approach to analyze the sources of economic growth Y = A f(k,l) Y/L = A f(k/l) Labor productivity can be increased either by improving technology or increasing physical capital per worker. Capital deepening investment: increasing physical capital per worker. 41

42 Interaction of monetary and fiscal Policy The monetary and Fiscal policy may each other can be expansionary or contractionary, so their are four possible scenario: Expansionary Fiscal and Monetary Policy Contractionary fiscal and Monetary Policy Expansionary fiscal policy + Contractionary monetary policy Contractionary fiscal Policy + Expansionary monetary policy 42