powerpoint to accompany chapter 12 gdp, income and economic growth

PowerPoint

to accompany

Chapter 12

GDP, Income and Economic

Growth

Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia

Learning Objectives

1. Explain how total production in an economy is measured.

2. Discuss whether GDP is a good measure of economic wellbeing.

3. Discuss the difference between real and nominal variables.


Learning Objectives

4. Understand how the economic growth rate is measured.

5. Discuss the importance of long-run economic growth and its impact on living standards.

6. Use the economic growth model to explain why economic growth rates differ between countries.


In the long run, the Australian economy has experienced economic growth and rising living standards, and in the short run the economy has experienced a series of business cycles.

Companies such as General Motors Holden, while often experiencing long run growth, are greatly affected by business cycles.

Growth and the business cycle at General Motors Holden


GDP, income and economic growth

Microeconomics: The study of how households and firms make choices, how they interact in markets, and how the government attempts to influence their choices.

Macroeconomics: The study of the economy as a whole, including topics such as inflation, unemployment, and economic growth.

PRELIMINARY DEFINITIONS




Economic growth: The expansion of society’s productive potential. Economic growth is usually measured by the rate of growth in real GDP.

Business cycle: Alternating periods of economic expansion and economic recession.



Expansion: The period of a business cycle during which total production and total employment are increasing.

Recession: The period of a business cycle during which total production and total employment are decreasing.

Inflation rate: The percentage increase in the price level from one year to the next.



Gross domestic product measures total production

Measuring total production: Gross Domestic Product

Gross Domestic Product (GDP): The market value of all final goods and services produced in a country during a period of time.

LEARNING OBJECTIVE 1



GDP is measured using market values, not quantities.

GDP includes only the market value of final goods and services.

Final good or service: A new good or service which is the end product of the production process that is purchased by the final user.

Intermediate good or service: A good or service that is an input into another good or service, such as a tyre on a truck.




GDP includes only current production.

Current production is that which takes place during the indicated time period; GDP does not include the value of used (second-hand) goods.




Measuring GDP by the value-added method

An alternative way to calculate GDP is the value-added method.

Value added: The market value a firm adds to a product.

GDP can be calculated by adding up the value added of every firm involved in the production process of goods and services.




Other measures of total production and total income

Net domestic product (NDP): Calculated by measuring GDP and subtracting the value of depreciation on capital equipment.

Gross National Income (GNI): Australia’s GDP plus income generated overseas by Australian residents and firms, minus the income generated in Australia by non-residents and foreign firms.



Calculating GDP

Examine a simple economy (Economy X) which produces only three goods; sunglasses, suntan lotion and swimming costumes. Use the information in the table below to calculate GDP for this economy.


Production and Price Statistics for Economy X

Product Quantity Price per unit ($)

Sunglasses 1000 20

Suntan lotion 500 10

Swimmers 100 80


STEP 1: Review the chapter material. The problem provides a simple introduction to the calculation of GDP as the sum of the monetary value of the goods and services produced in an economy in a given period. You may like to review the section ‘Measuring total production: Gross Domestic Product’.

STEP 2: Calculate GDP by multiplying the prices times the quantity of all three goods, and then summing the three values. (Note, all the goods in the example are final goods, and therefore all should be included in your calculation).


Calculating GDP


STEP 3: Complete the table.


Calculating GDP


Product Quantity Price per unit ($) Value ($)

Sunglasses 1000 20 20 000

Suntan lotion 500 10 5 000

Swimmers 100 80 8 000

TOTAL (or GDP): $33 000


Methods of measuring GDP

The Australian Bureau of Statistics (ABS) uses three alternative methods to measure GDP:

1. The production method: The sum of the value of all goods and services produced by industries in the economy in a year minus the cost of goods and services used in production – leaving the value added.



Methods of measuring GDP

2. The expenditure method: The sum of the total expenditure on goods and services by households, investors, government and net exports (the value of exports minus the expenditure on imports).

3. The income method: The sum of the income generated in the production of goods and services, including profits, wages and other employee payments, income from rent and interest earned.



Methods of measuring GDPProduction, income and the circular-flow

diagram

The circular-flow diagram shows the flow of spending and money in the economy.

It illustrates the equality between GDP measured from the income and expenditure methods.

The income generated in the production of goods and services is equal to the value of expenditure on these goods and services.



Methods of measuring GDPProduction, income and the circular-flow

diagram

Transfer payments: Payments by the government to individuals for which the government does not receive a good or service in return.

Examples: age pensions, unemployment benefits, family benefit payments.

Transfer payments are not included in GDP.


The circular flow and measurement of GDP: Figure 12.1



Components of GDP The ABS divides GDP into four major

categories of expenditures.

Consumption (C): Spending by households on goods and services, not including spending on new houses.

Investment (I): Spending by firms on new factories, office buildings, machinery, and inventories, and spending by households on new houses.



Components of GDP

Government purchases (G): Spending by federal, state, and local governments on goods and services.

Net exports (NX): The value of exports minus expenditure on imports.

An equation for GDP (where Y = GDP or total output):


Y = C + I + G + NX

Table of components of GDP, 2008: Figure 12.2(a)

Components of GDP, 2008 (millions of dollars)

Consumption 643 284

Investment 282 626

Dwellings 71 019

Buildings and structures 85 690

Equipment 91 178

Other 36 679

Change in inventories -1 940

Government 261 107

Net Exports -3 644

Exports 279 064

Imports 282 708

TOTAL GDP 1 183 373


Graph of components of GDP, 2008: Figure 12.2(b)

-100 000

100 000

200 000

300 000

400 000

500 000

600 000

700 000

Consumption Investment Government Net Exports

Millions of dollars ($)

54.3%

23.9%22.1%

-0.3%



GDP does a good job at measuring production, and provides an indication of wellbeing, but it is not flawless.

Does GDP measure what we want it to measure?



Shortcomings of GDP as a measure of total production. GDP does not include:

Household production: Goods and services people produce for themselves.

Examples: Home cooking, cleaning, child care, gardening, maintenance.

The black economy: Buying and selling of goods and services that is concealed

from the government to avoid taxes or regulations or because the goods and services are illegal.




How the underground economy hurts developing countries

MAKING THE CONNECTION12.1

In some developing countries, more than half the workers may be in the underground economy.


Shortcomings of GDP as a measure of wellbeing.

The distribution of GDP is not captured in GDP measures.

The value of leisure is not included in GDP.

The level, quality of, and access to health care is not measured in GDP.




Shortcomings of GDP as a measure of wellbeing.

GDP is not adjusted for pollution or other negative effects of production.

GDP is not adjusted for changes in crime and other social problems.




Our Choice: Live Longer or Prosper

Is there a trade-off between more income and longevity?



It is important to separate a measured rise in GDP that may be due only to price changes from real quantity changes.

Calculating Real GDP

Nominal GDP: The market value of final goods and services evaluated at current year prices.

Real GDP: The market value of final goods and services evaluated at base year prices.

Real GDP versus nominal GDP



Nominal GDP can change over time due to changes in either price or output.

Real GDP shows changes in output only.

The ABS (or GDP statisticians) select a base year and use this over a specified period.

A simple rule: Real GDP equals the base year prices multiplied by current year

quantities.




A drawback of using base year prices is that prices may change relative to each other.

The ABS uses chain-weighted prices and publishes statistics on real GDP in ‘chained dollars’.

Prices in each year are ‘chained’ to prices in the previous year to minimise the distortion from changes in relative prices.




Return to the example of the simplified economy (Economy X) which produces only three goods; sunglasses, suntan lotion and swimming costumes. Use the information in the table below to calculate real GDP for this economy in 2010, assuming 2009 is the base year.




2009 2010

Product Quantity Price per Unit ($)

Quantity Price per Unit ($)

Sunglasses 1000 20 1500 25

Suntan Lotion 500 10 550 11

Swimmers 100 80 110 80



STEP 1: Review the chapter material in the section ‘Calculating real GDP’. Real GDP is found by holding prices constant at the base year and multiplying these prices by current year quantities.

STEP 2: Calculate real GDP for 2010 by multiplying the prices of each item for 2009 times the quantity of all three goods for 2010, and then summing the three values.






2009 2010

Product Price per Unit ($)

Quantity Value ($)



Swimmers 80 110 8 800

REAL GDP: $44 300


Economic growth rate: The rate of change in real GDP from one year to the next.

Calculating the economic growth rate


100 x GDP Real

GDP Real - GDP Real GrowthEconomic

Previous

PreviousCurrent


Example: Real GDP for Australia was:

In 2006/07: $1 045 674 million.

In 2007/08: $1 083 661 million.

Calculate the economic growth as follows:

$1 083 661 million - $1 045 674 million = $37 987 million

Calculating the economic growth rate


3.63% 100 x 674 045 1

987 37 growthEconomic


GDP also allows us to calculate changes in the price level over time.

Price level: A measure of the average prices of goods and services in the economy.

GDP deflator: A measure of the price level, calculated by dividing nominal GDP by real GDP and multiplying by 100.


The GDP deflator


The formula:


The GDP deflator

100 x GDP Real

GDP Nominal deflator GDP


Calculating the GDP deflator Returning again to the simplified economy (Economy X).

The real GDP calculation from the previous problem is included below. Now use the table to calculate nominal GDP for this economy in 2010, and then calculate the GDP deflator.



2009 2010

Product Quantity Price per Unit ($)

Quantity Price per Unit ($)

Sunglasses 1000 20 1500 25


Swimmers 100 80 110 80

REAL GDP: $44 300


Calculating the GDP deflator

STEP 1: Calculate nominal GDP for 2010 by multiplying the prices of each item for 2010 times the quantity of all three goods for 2010, and then summing the three values.



2010

Product Quantity Price per Unit ($) Value ($)



Swimmers 110 80 8 800

NOMINAL GDP: $52 350


Calculating the GDP deflator

STEP 2: Calculate the GDP deflator by dividing nominal GDP by real GDP and multiplying by 100.


118.17 100 x 300 44

350 52 deflator GDP


The solved problem has derived the GDP deflator for 2010 for a simple economy.

The GDP deflator for the base year will always equal 100, as nominal and real GDP are the same.

The price change between 2009 and 2010 is calculated as follows:


Calculating the price change

18.17% 100 x 100

100 - 118.17 change Price


Long-run economic growth is the key to rising living standards

Long-run economic growth: The process by which rising productivity increases the average standard of living.

Real GDP per capita is used to measure changing living standards over time.


population

GDP Real capita per GDP Real

Real GDP per capita, Australia, 1901-2007: Figure 12.3

0

1000

2000

3000

4000

5000

6000

7000

1901 1911 1921 1931 1941 1951 1961 1971 1981 1991 2001

1966

-67

pri

ces

($)



The connection between economic prosperity and health


Because of technological advance, these children from a low-income country will live longer, be healthier and may work less than their parents and grandparents.


Increases in real GDP per capita depend on increases in labour productivity.

Labour productivity: The quantity of goods and services that can be produced by one worker or by one hour of work.

What determines the rate of long-run growth?



Two key factors determine labour productivity.

1. Increases in capital per hour worked Capital: Manufactured goods that are used to

produce other goods and services; examples are computers, factory buildings, and machine tools.

Human capital: The accumulated knowledge and skills that workers acquire from education and training, or from their life experiences.




2. Technological Change

Accumulating more inputs such as labour, capital, and raw materials will not ensure that an economy experiences economic growth unless technological change also occurs.




Potential real GDP

The concept of potential GDP is useful when taking a long-run perspective of economic growth.

Potential GDP: The level of real GDP attained when all firms are producing at capacity.

Growth in potential real GDP is estimated tobe approximately 3.5% per year. Actual real GDP fluctuates around the long-run

potential due to the business cycle.



Actual and potential quarterly real GDP, Australia, 1960 - 2008: Figure 12.4

50 000

100 000

150 000

200 000

250 000

300 000

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

Rea

l GD

P (

$ m

illio

ns)



Economic growth model: A model that explains changes in real GDP per capita in the long run.

Technological Change: The change in the ability of a firm to produce a given level of output with a given quantity of inputs.

What determines how fast economies grow?



Three main sources of technological change:

Better machinery and equipment. Increases in human capital. Better means of organising and managing

production.




The economic growth model can be illustrated using the per-worker production function.

The Per-Worker Production Function: The relationship between real GDP, or output, per hour worked and capital per hour worked, holding the level of technology constant. L = labour; K = capital Real GDP per hour = Y/L Capital per hour worked = K/L



The per-worker production function: Figure 12.5



Which is more important for economic growth: More capital or technological change?

Technological change is the key to sustaining economic growth.



Technological change increases output per hour worked: Figure 12.6



What explains rapid economic growth in Botswana?

Firms like the Botswana Meat Company benefit from the government policies that protect private property.



Endogenous growth theory: A model of long-run economic growth that emphasises that technological change is influenced by economic incentives, and so is determined by the working of the market system. Developed by economist Paul Romer.

Romer argued that the accumulation of knowledge capital is a key determinant of economic growth.




Is economic growth good or bad?

Is undeniable that economic growth has reduced poverty and increased health, education and many other measures of welfare.

Criticisms of economic growth include:

Globalisation undermines distinctive cultures.

Multi-national firms exploit low wages and poor health, safety and environmental regulations in the developing world.

Economic growth contributes to global warming, deforestation and other environmental problems.




Is economic growth good or bad?

The search for economic growth that is sustainable has come to the forefront of economic policy in high income countries, and also in the rapidly developing countries such as China and India.




Black economy Business cycle Capital Consumption Economic growth Economic growth model Economic growth rate Endogenous growth theory Expansion Final good or service GDP deflator Government purchases Gross domestic product

(GDP) Human capital Inflation rate

Key Terms Intermediate good or service Investment Labour productivity Long-run economic growth Macroeconomics Microeconomics Net Exports Nominal GDP Per-worker production function Potential GDP Price level Real GDP Recession Technological change Transfer payments Value Added


The Australian Bureau of Statistics (ABS) is Australia’s main data collecting body. Go to the ABS website and find information on GDP for recent years.

http://www.abs.gov.au

Has the Australian economy been growing over the past year? Has growth increased or slowed over the past five years? What factors are contributing positively to growth and what factors are having a negative impact?

Get Thinking!


Check Your KnowledgeQ1. In the circular flow diagram, who supplies

factors of production in exchange for income?

a. Households.

b. Firms.

c. The government.

d. All of the above.


Q1. In the circular flow diagram, who supplies factors of production in exchange for income?

a. Households.

b. Firms.

c. The government.

d. All of the above.

Check Your Knowledge


Q2. When accounting for exports and imports in GDP, which of the following is correct?

a. Exports are added to the other categories of expenditures.

b. Imports are added to the other categories of expenditures.

c. Both exports and imports are added to the other categories of expenditures.

d. Both exports and imports are subtracted from the other categories of expenditures.



Check Your KnowledgeQ2. When accounting for exports and imports

in GDP, which of the following is correct?

a. Exports are added to the other categories of expenditures.

b. Imports are added to the other categories of expenditures.

c. Both exports and imports are added to the other categories of expenditures.

d. Both exports and imports are subtracted from the other categories of expenditures.


Q3. Household production and the underground economy:

a. are fully accounted for in GDP figures gathered by the Commerce Department.

b. are not considered formal production of goods and services, and therefore are not included in GDP accounting.

c. are important but unaccounted for in the Commerce Department’s estimate of GDP.

d. are irrelevant because they constitute only a very small fraction of GDP for most countries.



Check Your KnowledgeQ3. Household production and the underground

economy:

a. are fully accounted for in GDP figures gathered by the Commerce Department.

b. are not considered formal production of goods and services; therefore, are not included in GDP accounting.

c. are important but unaccounted for in the Commerce Department’s estimate of GDP.

d. are irrelevant because they constitute only a very small fraction of GDP for most countries.


Q4. Which measure of GDP represents changes strictly in the quantity of goods and services produced in the economy, not the prices?

a. Nominal GDP.

b. Real GDP.

c. The GDP measure that sums up the value of goods and services evaluated at current year prices.

d. None of the above.



Check Your KnowledgeQ4. Which measure of GDP represents

changes strictly in the quantity of goods and services produced in the economy, not the prices?

a. Nominal GDP.

b. Real GDP.

c. The GDP measure that sums up the value of goods and services evaluated at current year prices.

d. None of the above.


Q5. Along the per-worker production function, what happens to real GDP per hour worked as the capital per hour worked increases?

a. It increases at an increasing rate.

b. It increases at a decreasing rate.

c. It decreases at an increasing rate.

d. It decreases at a decreasing rate.


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