14230_circular flow of income n price indices

CIRCULAR FLOW OF INCOME CIRCULAR FLOW OF INCOME and SPENDINGand SPENDING

Lecture OutlineLecture Outline

• National Income and National OutputNational Income and National Output• The Circular Flow ModelThe Circular Flow Model• The Two Sector Model – Simple and ComplexThe Two Sector Model – Simple and Complex• Injections and Withdrawals (Leakages)Injections and Withdrawals (Leakages)• The Three Sector ModelThe Three Sector Model• The Four Sector ModelThe Four Sector Model• Nominal GDP and Real GDPNominal GDP and Real GDP• Index NumbersIndex Numbers• The Equation of ExchangeThe Equation of Exchange

National Income and National OutputNational Income and National Output

In units 1 -12 our focus was on micro-economic issuesIn units 1 -12 our focus was on micro-economic issues However, from this unit 13 until the end of this course our However, from this unit 13 until the end of this course our

discussion will be focusing on macro-economicsdiscussion will be focusing on macro-economics That is, discussion of issues related to the welfare of the That is, discussion of issues related to the welfare of the

whole economy or the national economywhole economy or the national economy A key issue in macro-economics is the measurement of A key issue in macro-economics is the measurement of

national income and national outputnational income and national output National Income and National Output are simply define as National Income and National Output are simply define as

follow:follow:– national incomenational income – total amount of money generated by an economy – total amount of money generated by an economy

in a period of time (usually a year)in a period of time (usually a year)– national outputnational output – total monetary value of goods and services – total monetary value of goods and services

produced by an economy in a period time (usually a year)produced by an economy in a period time (usually a year)


To understand well how national income and national To understand well how national income and national output is measured must study or analyse the output is measured must study or analyse the relationships between different sectors of the economyrelationships between different sectors of the economy

Two types of economy Two types of economy 1)1) close economy – no international tradeclose economy – no international trade2)2) open economy – there is international tradeopen economy – there is international trade

A A close economyclose economy has three sectors: has three sectors:i.i. Households – individuals (i.e. consumers/labourers - owners of Households – individuals (i.e. consumers/labourers - owners of

resources)resources)ii.ii. Firms – businesses (i.e., sellers/ employers/producers – users of Firms – businesses (i.e., sellers/ employers/producers – users of

resources)resources)iii.iii. Government – law & order, tax and provider of collective goods Government – law & order, tax and provider of collective goods

and servicesand services


An An open economyopen economy has four sectors: has four sectors:i.i. HouseholdsHouseholds

ii.ii. FirmsFirms

iii.iii. GovernmentGovernment

iv.iv. Foreign SectorForeign Sector

The relationship between these sectors are used to The relationship between these sectors are used to measure national income and national outputmeasure national income and national output

The Circular Flow ModelThe Circular Flow Model

The relationship between the different sectors in an The relationship between the different sectors in an economy is better understood by the using of a economy is better understood by the using of a circular circular flow modelflow model

A Circular Flow Model A Circular Flow Model – shows the relationship between different sectors of an economyshows the relationship between different sectors of an economy

Different circular flow models discussed in this course are: Different circular flow models discussed in this course are: 1)1) Two sector model – households and firmsTwo sector model – households and firms

2)2) Three sector model – households, firms and governmentThree sector model – households, firms and government

3)3) Four sector model – households, firms, government and the Four sector model – households, firms, government and the foreign sectorforeign sector

Two Sector ModelTwo Sector Model

A two sector model can be a simple or a complex oneA two sector model can be a simple or a complex one

1)1) The simple circular flow modelThe simple circular flow model Shows money flows and real flows between households Shows money flows and real flows between households

and firmsand firms• HouseholdsHouseholds – the owner of resources – land, labour, capital and – the owner of resources – land, labour, capital and

enterprise (inputs or factors of production)enterprise (inputs or factors of production)• Firms Firms – the users of resources (producing goods and services)– the users of resources (producing goods and services)

TheThe Simple Circular Flow Model Simple Circular Flow Model

Money flows:Money flows:– from households to firms in the consumption of goods and servicesfrom households to firms in the consumption of goods and services– from firms to households to pay wages, rents or profits (factor from firms to households to pay wages, rents or profits (factor

reward/income)reward/income)

Real Flows:Real Flows:– goods and services supplied by firms to householdsgoods and services supplied by firms to households– economic resources of land, capital and labour (factor inputs) economic resources of land, capital and labour (factor inputs)

supplied by households to firmssupplied by households to firms

The Simple Circular Flow ModelThe Simple Circular Flow Model

Under the simple two sector model we assume that:Under the simple two sector model we assume that:– all money earned (income) by households are used in consumption all money earned (income) by households are used in consumption

– to buy goods and services– to buy goods and services– all money earned by firms are used to produce goods and servicesall money earned by firms are used to produce goods and services– households consumption ( C) = Firms spending or expenditure (E)households consumption ( C) = Firms spending or expenditure (E)

Must able to differentiate between money and incomeMust able to differentiate between money and income– MoneyMoney – a stock of dollars at a certain point in time and is – a stock of dollars at a certain point in time and is

sometimes referred to as the money supplysometimes referred to as the money supply– IncomeIncome – a flow generated as money travels around the circular – a flow generated as money travels around the circular

flow. Involves velocity of circulation.flow. Involves velocity of circulation.– Velocity of circulationVelocity of circulation – the number of times one unit of money – the number of times one unit of money

circulates in the circular flow in a given timecirculates in the circular flow in a given time


For example – velocity of circulationFor example – velocity of circulation– if on average each dollar travels 5 times from Households to Firms if on average each dollar travels 5 times from Households to Firms

and back in one year, then each dollar generates $5 of income and and back in one year, then each dollar generates $5 of income and output for this economy. output for this economy.

– therefore velocity of circulation is equal to 5therefore velocity of circulation is equal to 5

Measurement of National Income and Output under a Measurement of National Income and Output under a Simple Two Sector Flow ModelSimple Two Sector Flow Model

– National Income – total national income generated in a periodNational Income – total national income generated in a period– National output – also known as the Gross Domestic Product National output – also known as the Gross Domestic Product

(GDP). Total money value of all goods and services produced in a (GDP). Total money value of all goods and services produced in a periodperiod


Under a simple two sector flow model:Under a simple two sector flow model:– all money received by Firms are used in producing goods and all money received by Firms are used in producing goods and

services services – all money received by Households are consumed or used to buy all money received by Households are consumed or used to buy

goods and servicesgoods and services

Due to the above assumptions, therefore the value of:Due to the above assumptions, therefore the value of:

– the National output (GDP) - is the total amount obtained by the the National output (GDP) - is the total amount obtained by the Firms when producing goods and servicesFirms when producing goods and services

– the National income (NI) - is the total amount earned by the National income (NI) - is the total amount earned by Households from factor inputsHouseholds from factor inputs


Example – National OutputExample – National Output Consider a very simple economy that produces cassava Consider a very simple economy that produces cassava

and taroand taro Production:Production:

– cassava: 20 thousands tons, sold at $400 per toncassava: 20 thousands tons, sold at $400 per ton– taro: 30 thousands tons, sold at $500 per tontaro: 30 thousands tons, sold at $500 per ton

– National output (GDP) = expenditure on cassava + expenditure on National output (GDP) = expenditure on cassava + expenditure on tarotaro

– = ( $400 x 20 000) + ($500 x 30 000)= ( $400 x 20 000) + ($500 x 30 000)– = $8 m + $15m= $8 m + $15m– = $= $23 million23 million– Thus, the national output is $23millionThus, the national output is $23million


Example – National IncomeExample – National Income Assume that $16 million is paid to workers who produce Assume that $16 million is paid to workers who produce

cassava and tarocassava and taro The difference between the revenue from sales and costs The difference between the revenue from sales and costs

of productions or wages is called of productions or wages is called operating surplusoperating surplus

Operating surplusOperating surplus – profits which may be paid out as – profits which may be paid out as dividends or as income to entrepreneursdividends or as income to entrepreneurs

– Operating surplus = revenue – costsOperating surplus = revenue – costs

= $23 m - $16m= $23 m - $16m

= = $7m$7m

The Simple Circular Flow ModelThe Simple Circular Flow Model Households as workers receive income in the form of Households as workers receive income in the form of

wages and owners of capital or as entrepreneurs they wages and owners of capital or as entrepreneurs they receive profitsreceive profits

Thus, the National Income is:Thus, the National Income is: = wages + dividends (profits)= wages + dividends (profits) = $16 m + $7m= $16 m + $7m = = $23m$23m

Conclusion:Conclusion: National Output (GDP) equals National IncomeNational Output (GDP) equals National Income

$23m = $23 m$23m = $23 m value of national output = income earned by households value of national output = income earned by households

( (wages +profits)wages +profits)


HOUSEHOLDS FIRMS

A – factors of production

B – factor reward/income

(wages, profit, rent etc)

C – goods and services

D – payments for goods and services

Money flows – B & D

Real flows – A & C

National Output (GDP) – measured using flow D ($23m –from example)

National Income – measured using flow B ($23m from example)

The Simple Circular Flow ModelThe Simple Circular Flow Model Points to note:Points to note: People produce output and are paid income for producing People produce output and are paid income for producing

outputoutput People then buy the output from the firms (national People then buy the output from the firms (national

expenditure)expenditure) The value of output (national output) must equal to the value The value of output (national output) must equal to the value

of incomes earned (national income)of incomes earned (national income) Therefore the following equilibrium holds:Therefore the following equilibrium holds:

NATIONAL OUTPUT (GDP) = NATIONAL INCOME = NATIONAL EXPENDITURENATIONAL OUTPUT (GDP) = NATIONAL INCOME = NATIONAL EXPENDITURE

Two Sector Model – Complex Circular Two Sector Model – Complex Circular Flow ModelFlow Model

Now, assume that Households can Now, assume that Households can savesave part of their part of their income earnedincome earned

And the Firms changed the composition of output by And the Firms changed the composition of output by making consumer goods and capital goods (investments)making consumer goods and capital goods (investments)

– consumer goods – commodities that satisfy consumer’s immediate consumer goods – commodities that satisfy consumer’s immediate needsneeds

– capital goods – long lived man-made resources that are used to capital goods – long lived man-made resources that are used to produce consumer goods. Also known as investment goodsproduce consumer goods. Also known as investment goods

Because of these changes there is Because of these changes there is injectionsinjections into the into the circular flow and circular flow and withdrawalswithdrawals from the circular flow from the circular flow

Injections and WithdrawalsInjections and Withdrawals

WithdrawalsWithdrawals – amounts taken out of the circular flow – amounts taken out of the circular flow Example of withdrawals for now is savings by HouseholdExample of withdrawals for now is savings by Household Savings (S):Savings (S):

• amount set aside by Households for future consumptionamount set aside by Households for future consumption• reasons for savings include:reasons for savings include:

– an emergencyan emergency– retirementretirement– future purchase of consumer goodsfuture purchase of consumer goods– future expensesfuture expenses

Households can save their money at home or more Households can save their money at home or more commonly nowadays in the bankcommonly nowadays in the bank


Since the amounts saved are not used in consumption Since the amounts saved are not used in consumption these amounts are not put back to the circular spending these amounts are not put back to the circular spending flow, therefore savings is regarded as a withdrawal from flow, therefore savings is regarded as a withdrawal from the circular flowthe circular flow

InjectionsInjections – amounts put back into the circular flow – amounts put back into the circular flow Example of injections for now is investments (capital Example of injections for now is investments (capital

creation)creation) Investments (I):Investments (I):

– buying of new or additional plants and machineries (new buying of new or additional plants and machineries (new investment)investment)

– replacing of worn out capital (replacement investment)replacing of worn out capital (replacement investment)


AssumptionAssumption InjectionsInjections always equals always equals WithdrawalsWithdrawals Why?Why? Assume for now that the money saved by households in Assume for now that the money saved by households in

the bank are borrowed by producers solely for the purpose the bank are borrowed by producers solely for the purpose of investments or capital creationof investments or capital creation

That is the Households That is the Households save (S)save (S) and the Firms and the Firms invest (I)invest (I)


Problem:Problem: If the Households loan direct to Firms in the forms of If the Households loan direct to Firms in the forms of

buying of shares then no problem with our assumption buying of shares then no problem with our assumption aboveabove

But in reality, Households can deposit their money in the But in reality, Households can deposit their money in the bank or sometimes save it in a safety box at homebank or sometimes save it in a safety box at home

This causes problems especially if the banks may not lend This causes problems especially if the banks may not lend all money to firmsall money to firms

Also savings and investments are done by different peopleAlso savings and investments are done by different people Thus Thus planned savingsplanned savings may not always equal may not always equal planned planned

investmentinvestment

Injections and WithdrawalsInjections and Withdrawals For example:For example: If savings higher than investments , this will result in:If savings higher than investments , this will result in:

– not all goods produced are consumed, unplanned stock results in not all goods produced are consumed, unplanned stock results in piling up of unsold goods (inventories)piling up of unsold goods (inventories)

– firms cannot sell all their goods and cut back productionfirms cannot sell all their goods and cut back production– workers may lose their jobs and income fallworkers may lose their jobs and income fall– as income fall, savings fallas income fall, savings fall

Therefore for equilibrium to exist (injections = withdrawals)Therefore for equilibrium to exist (injections = withdrawals) The following conditions are assumed:The following conditions are assumed:

1)1) Investment is exogenous (fixed or does not depend on income)Investment is exogenous (fixed or does not depend on income)

2)2) Savings are a constant percentage of incomeSavings are a constant percentage of income


In equation format:In equation format: Let Let Y Y = = national outputnational output = = national incomenational income National output (Y) = the sum of consumption goods + National output (Y) = the sum of consumption goods +

investment goods (I) + changes in investment goods (I) + changes in stocks (unplanned investment) stocks (unplanned investment) ((ΔΔR)R)

Thus: output is Thus: output is Y = C + I + Y = C + I + ΔΔR R (1)(1)

National Income (Y) = consumptions (C) + savings (S)National Income (Y) = consumptions (C) + savings (S)

Thus: income is Thus: income is Y = C + SY = C + S (2)(2)


Assume price is constant and other values are in real termsAssume price is constant and other values are in real terms Then output = income, implies that:Then output = income, implies that:

C + I + C + I + ΔΔR = C + S, R = C + S, follows that:follows that:

I + I + ΔΔR = S, R = S, and if and if ΔΔR = 0, R = 0, then it follows that:then it follows that:

I = SI = S (3) - this is always true, as long as (3) - this is always true, as long as ΔΔRR is zero is zero

That is planned investment (I) = planned savings (S)That is planned investment (I) = planned savings (S)

Two Sector Model – Complex Circular Two Sector Model – Complex Circular Flow ModelFlow Model

Households Firms

Factor income – wages, profits etc (Y)

Consumption – consumer spending (C)

Banks

Producers

Savings (S)

Investments (I) Injection

Withdrawal

As long as there is no unplanned investments (ΔΔRR = 0), and given everything else remains the same (ceteris paribus) withdrawals always equal injections

That is planned savings (S) (withdrawals) = planned investments ( I )(injections)

Equation:

Output = incomeOutput = income

I + I + ΔΔR +C = C + SR +C = C + S

I + I + ΔΔR = SR = S

If If ΔΔR =0, thenR =0, then

I = S I = S (3)(3)

Three Sector Model – Government Three Sector Model – Government Include in Circular FlowInclude in Circular Flow

In a three sector model the Government sector is included In a three sector model the Government sector is included as part of the circular flow modelas part of the circular flow model

How does the Government affect the equilibrium in the How does the Government affect the equilibrium in the circular flow model?circular flow model?1)1) Withdraw amounts from the circular flow through taxes (T) – Withdraw amounts from the circular flow through taxes (T) –

transfer paymentstransfer payments

2)2) Inject amounts into the circular flow through government Inject amounts into the circular flow through government purchases - expenditurepurchases - expenditure

These Government actions affect both Households and These Government actions affect both Households and FirmsFirms


Points to note:Points to note: Taxes gain by Government is the net of taxes after Taxes gain by Government is the net of taxes after

transfers has been deductedtransfers has been deducted That is: Net taxes = T = Taxes – Transfer paymentsThat is: Net taxes = T = Taxes – Transfer payments Why transfer payments are not included in government Why transfer payments are not included in government

purchases? purchases? – transfer payments do not require that the recipient produce a good transfer payments do not require that the recipient produce a good

or service in order to receive themor service in order to receive them– examples of transfers payments include social security, welfare, examples of transfers payments include social security, welfare,

and unemployment benefitsand unemployment benefits– these are regarded as compensation and are not counted in these are regarded as compensation and are not counted in

government purchasesgovernment purchases


Points to note:Points to note: Transfer payments and government purchases are both Transfer payments and government purchases are both

parts of government spendingparts of government spending

But government purchases are represented on a circular But government purchases are represented on a circular flow diagram as flows of money from government to firms flow diagram as flows of money from government to firms and goods and services from firms to governmentand goods and services from firms to government

Government Purchases Government Purchases - are the sum of purchases of - are the sum of purchases of goods and services from firms by government agencies, goods and services from firms by government agencies, plus the total value of output produced by government plus the total value of output produced by government agenciesagencies


The Government sector is now included in the circular flow The Government sector is now included in the circular flow model but the equilibrium condition of withdrawals = model but the equilibrium condition of withdrawals = injections remains (i.e., income = output)injections remains (i.e., income = output)

Thus equation (1) & (2) are extended to include Thus equation (1) & (2) are extended to include Government purchases (G) and Government net taxes (T)Government purchases (G) and Government net taxes (T)

Output: Output: Y = C + I + Y = C + I + ΔΔR + GR + G (Injections) (4) (Injections) (4)

Income: Income: Y = C + S + TY = C + S + T (Withdrawals) (5) (Withdrawals) (5)


And since Output = Income, and with further manipulations And since Output = Income, and with further manipulations and assuming and assuming ΔΔRR is is zerozero we arrive at the following we arrive at the following equation (6)equation (6)

S + T = I + GS + T = I + G (6) (withdrawals = injections) (6) (withdrawals = injections)


Households Firms



Banks

Producers

Savings (S)


Withdrawal

Equation:

Output = income

Injections = withdrawalsInjections = withdrawals

I + I + ΔΔR +C+ G = C + S +TR +C+ G = C + S +T

I + I + ΔΔR + G = S + TR + G = S + T


I + G = S + T I + G = S + T (6)(6)

Government

(Net taxes (T))

Purchases/spending (G)

Transfers Taxes

withdrawal

Four Sector Model – Foreign Sector Four Sector Model – Foreign Sector Include in Circular FlowInclude in Circular Flow

In a four sector model the Foreign sector is included as part In a four sector model the Foreign sector is included as part of the circular flow modelof the circular flow model

How does the Foreign sector affect the equilibrium in the How does the Foreign sector affect the equilibrium in the circular flow model?circular flow model?

1)1) Withdraw amounts from the circular flow through import payments (M)Withdraw amounts from the circular flow through import payments (M)

2)2) Inject amounts into the circular flow through export receipts (X)Inject amounts into the circular flow through export receipts (X)


The Foreign sector is now included in the circular flow The Foreign sector is now included in the circular flow model but the equilibrium condition of withdrawals = model but the equilibrium condition of withdrawals = injections remains (i.e., income = output)injections remains (i.e., income = output)

Thus equation (4) & (5) are extended to include Export Thus equation (4) & (5) are extended to include Export receipts (X) and import payments (M)receipts (X) and import payments (M)

Output: Output: Y = C + I + Y = C + I + ΔΔR + G + XR + G + X (Injections) (7) (Injections) (7)

Income: Income: Y = C + S + T + MY = C + S + T + M (Withdrawals) (8) (Withdrawals) (8)


And since Output = Income, and with further manipulations And since Output = Income, and with further manipulations and assuming and assuming ΔΔRR is is zerozero we arrive at the following we arrive at the following equation (9)equation (9)

S + T + M = I + G + XS + T + M = I + G + X (9) (withdrawals = injections) (9) (withdrawals = injections)


Households Firms



Banks

Producers

Savings (S)


Withdrawal

Equation:

Output = incomeOutput = income

Injections = withdrawalsInjections = withdrawals

I + I + ΔΔR +C+ G + X = C + S +T + MR +C+ G + X = C + S +T + M

I + I + ΔΔR + G + X = S + T + MR + G + X = S + T + M


I + G + M = S + T +I + G + M = S + T + X (9) X (9)

Government

(Net taxes (T))

Purchases/spending (G)

Transfers Taxes

withdrawal

Foreign Sector

Import payments (M)

Export receipts (X)

Nominal GDP and Real GDPNominal GDP and Real GDP

The most common measure of National output (Y) is the Gross The most common measure of National output (Y) is the Gross Domestic Product (GDP)Domestic Product (GDP)

GDP – total number of goods and services a country produced in a GDP – total number of goods and services a country produced in a yearyear

GDP has two values:GDP has two values:1)1) Nominal GDPNominal GDP

– the current market value of national output in a yearthe current market value of national output in a year– not yet adjusted for price changesnot yet adjusted for price changes

2)2) Real GDPReal GDP– the value of national output adjusted for changes in price level or in fact the value of national output adjusted for changes in price level or in fact

adjusted for inflationadjusted for inflation– nominal values are corrected (deflated) using price index numbers nominal values are corrected (deflated) using price index numbers – because of the above reason because of the above reason Real GDP is a better measureReal GDP is a better measure of national of national

output than Nominal GDPoutput than Nominal GDP


Real GDP is usually calculated by:Real GDP is usually calculated by:

Real GDP (base year dollars) = Real GDP (base year dollars) = Nominal GDPNominal GDP x Base Year Price Index x Base Year Price Index

Price IndexPrice Index

• Base year – a year chosen as a standard of measurement of priceBase year – a year chosen as a standard of measurement of price• Base year price index are usually expressed in 100 or 1000Base year price index are usually expressed in 100 or 1000• This formula is only used if the price index numbers are givenThis formula is only used if the price index numbers are given

ExampleExample• If the Nominal GDP for Fiji in 2005 is $20m, base year is 2000, and the If the Nominal GDP for Fiji in 2005 is $20m, base year is 2000, and the

price index for Fiji in 2005 is 1450price index for Fiji in 2005 is 1450• Then Fiji’s Real GDP for 2005 in 2000 prices is:Then Fiji’s Real GDP for 2005 in 2000 prices is:

= = $20m$20m x x 10001000

1450 11450 1

= = $13.8m$13.8m


Nominal/Real GDP per capitaNominal/Real GDP per capita • the GDP values divided by population numberthe GDP values divided by population number• For exampleFor example• If the population of Fiji in 2005 is 1 million people, and the nominal If the population of Fiji in 2005 is 1 million people, and the nominal

GDP is $200m, the nominal GDP per capita is:GDP is $200m, the nominal GDP per capita is:

= $ = $ 200,000,000200,000,000

1,000, 0001,000, 000

= = $200 per capita$200 per capita

Real GDP per capitaReal GDP per capita – the nominal GDP value must be – the nominal GDP value must be adjusted for price changesadjusted for price changes

Comparison of Nominal and Real GDPComparison of Nominal and Real GDP

A more direct approach to the calculation of Nominal GDP and Real GDP is A more direct approach to the calculation of Nominal GDP and Real GDP is given in the example belowgiven in the example below

Example:Example: Nomuka, a hypothetical island in the South Pacific produces two items as Nomuka, a hypothetical island in the South Pacific produces two items as

shown in the table belowshown in the table below• Calculate the value of the Nominal GDP and Real GDP in 1999 and 2002. Calculate the value of the Nominal GDP and Real GDP in 1999 and 2002.

Comment on your results.Comment on your results.

ItemsItems 1999(Base)1999(Base) 2002 (Current)2002 (Current)

Qty (kg)Qty (kg) PricePrice

($/kg)($/kg)

Qty (kg)Qty (kg) PricePrice

($/kg)($/kg)

Item AItem A 30003000 2.502.50 35003500 3.003.00

Item BItem B 32003200 3.403.40 33003300 3.603.60

Nominal and Real GDP - Calculation and Nominal and Real GDP - Calculation and ComparisonComparison

Nominal GDPNominal GDP:: Current Year Price x Current Year Qty Current Year Price x Current Year Qty

1999:1999: Item A: 3000 x $2.50 = $7500Item A: 3000 x $2.50 = $7500 Item B: 3200 x $3.40 = $10880Item B: 3200 x $3.40 = $10880 = = $18,380$18,380 20022002 Item A: 3500 x $3.00 = $10500Item A: 3500 x $3.00 = $10500 Item B: 3300 x $3.60 = $11880Item B: 3300 x $3.60 = $11880 = = $22380$22380

Increase in GDP is due to increase in Increase in GDP is due to increase in price level (check with same quantity price level (check with same quantity and different prices)and different prices)

Real GDPReal GDP:: Base Year Price x Current Year QtyBase Year Price x Current Year Qty

19991999::Item A: 3000 x $2.50 = $7500Item A: 3000 x $2.50 = $7500Item B: 3200 x $3.40 = $10880Item B: 3200 x $3.40 = $10880 = = $18,380$18,380

20022002Item A: 3500 x $2.50 = $8750Item A: 3500 x $2.50 = $8750Item B: 3300 x $3.40 = $11880Item B: 3300 x $3.40 = $11880 = = $19970$19970

Increase in GDP is due to increase in the Increase in GDP is due to increase in the number of goods and services producednumber of goods and services produced

The increase in Real GDP is the one The increase in Real GDP is the one economists interested ineconomists interested in

Index NumbersIndex Numbers Shows the change of prices from year to year of a given basket of Shows the change of prices from year to year of a given basket of

commoditiescommodities Basket of commoditiesBasket of commodities – items with the same nature put together – items with the same nature put together

• Egs – A Food basket: consists of taro, rice , cassava etcEgs – A Food basket: consists of taro, rice , cassava etc

Home appliance basket: consists of fridges, stoves, microwaves etcHome appliance basket: consists of fridges, stoves, microwaves etc Different values of each commodities included in the basket, are Different values of each commodities included in the basket, are

weighted according to amount spend on themweighted according to amount spend on them Commonly used price indexes are:Commonly used price indexes are:

1)1) Consumer Price Index (CPI)Consumer Price Index (CPI)– use to measure the changes in the prices of goods typically bought by use to measure the changes in the prices of goods typically bought by

consumersconsumers

• Read and do the student activity on page 231 of Study Guide on how to Read and do the student activity on page 231 of Study Guide on how to calculate the CPIcalculate the CPI

Index NumbersIndex Numbers

2)2) Producers Price Index (PPI)Producers Price Index (PPI)– measures changes in input and output prices of goods bough and measures changes in input and output prices of goods bough and

sold by producerssold by producers

3)3) GDP Deflator GDP Deflator – an implicit index used to calculate the Real GDPan implicit index used to calculate the Real GDP

4)4) Other Price Indexes:Other Price Indexes:i.i. Export and Import Price IndexesExport and Import Price Indexes

– measure changes in export and import pricesmeasure changes in export and import prices

ii.ii. Wage rate index Wage rate index – measure movements in wagesmeasure movements in wages

iii.iii. Real disposal indexesReal disposal indexes– measure changes in spending power of individualmeasure changes in spending power of individual

14230_circular flow of income n price indices

Documents

national economy

circular flow of income

sector model households

year national income

measurement of national

national income ni

period national output

sector model simple