8.

1 Economic activity
CIRCULAR FLOW OF INCOME
The circular flow of income model shows the concepts and relationships of an economy.
The simplest one shows a closed economy, where there is no government and has no
international trade.
The income flow is equal to the expenditure flow in a given time period. These flows
are equal to the value of output flow.
Injections and leakages complicate the circular flow. They are often paired together.
injections leakages
investment saving
govt spending taxes
exports imports
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THE LEVEL OF OVERALL ECONOMIC ACTIVITY
ECONOMICS SL
chapter eight - the level of overall economic activity
Saving - part of consumer income that is not spent. Investment is spending by firms for
capital good production.
When households pay taxes, there is a leakage because the taxes are not used to by
goods and services. When the govt spends money on expenditures, there is an
injection.
Imports are g/s produced by other countries and purchased by domestic buyers.
Exports are g/s produced domestically and bought by other countries. There is an open
economy when there is international trade.
In the graphic below, the red boxes above households are the leakages, and the boxes
below firms are injections.
Leakages are matched by injections. However, if injections are smaller than leakages, the
income flow becomes smaller. If injections > leakages, the income flow increases in size.
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THE LEVEL OF OVERALL ECONOMIC ACTIVITY
8.2 Measures of economic activity
Involves measuring an economys national income (value of output).
Output of economy known as aggregate output. This allows us to:
assess economys performance
compare income/output performance
establish basis for making policies
In macroeconomics, the output is measured in value, and not quantities.
MEASUREMENTS OF ECONOMIC ACTIVITY
Value of aggregate output = total income. National income is used synonymously with
aggregate output.
There are three ways to measure the value of aggregate output.
THE EXPENDITURE APPROACH
Adds up all spending to buy final goods and services produced within a country
Only includes final goods, and not intermediate goods.
Spending is categorized into:
Consumption (C)
all purchases by households on final g/s (but not housing)
Investment (I)
firm spending on capital goods
spending on construction (housing and buildings)
Government spending (G)
spending by govts such as factors of production and government investment
Net exports (X-M)
value of exports (X) minus value of imports (M)
GDP = C+I+G+(XM)
THE INCOME APPROACH
Adds up income earned by factors of production within a country over time period. The
national income isnt same as GDP, and requires adjustment if GDP calculation is wanted.
THE OUTPUT APPROACH
Measures value of each good and service produced in economy over time period and
sums them up. Includes final goods/services to prevent double counting.
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THE LEVEL OF OVERALL ECONOMIC ACTIVITY
DIFFERENT MEASURES OF VALUE OF OUTPUT
Gross domestic product (GDP) - market value of all final goods and services produced
in a country over a time period, regardless of who owns the factors of productions.
value of final goods/service made in a country
Gross national income (GNI) - Total income received by residents of a country equal to
value of all final goods/services produced by factors of production supplied by residents
(regardless of location of factors).
value of final goods/services made by people of a country
REAL AND NOMINAL
Nominal value - value measured of the prices at the time of measurement
Can be affected by changing price because it doesnt account for it
Real value - measure that takes in account of price changes
Used when comparisons are made to eliminate other factors
TOTAL AND PER CAPITA
Per capita - per person; per capita measure of total value divides it by the population of a
country.
More useful than total value when figuring out the standard of living. Two countries with
the same total GDP may have different per capita GDP.
NATIONAL INCOME STATISTICS
GDP and GNI dont measure true value of output because they
dont include non-marketed output
dont include underground market sold output
dont take into account of quality improvements
dont account for negative externalities and resource depletion
dont account for different price levels
GDP and GNI cant measure standards of living because they
dont make distinctions about composition (military & merit goods both count as GDP)
cant reflect education, health, and life expectancy
have no info about distribution of income and output
dont take account increased leisure
dont account for quality of life
Because of the above, even real values can be misleading for comparisons over time and
between countries.
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THE LEVEL OF OVERALL ECONOMIC ACTIVITY
GREEN GDP
GDP and GNI fail to count for the loss of environmental resources and include spending
that is used to clean up pollution.
Green GDP is the proposed method that would account for the environment and
environmental destruction:
Green GDP = GDP - value of environmental degradation
Another way is to also account for costs from cleaning up pollution (P).
Green GDP = GDP value of environmental degradation P.
This would be more accurate, but also will be lower than GDP itself.
8.4 The business cycle
A decrease in GDP is different from a decrease in GDP growth.
BUSINESS CYCLE
The business cycle plots real GDP against time. Each cycle has:
Expansion - positive growth in real GDP. Employment increases and the general price
level rises.
Peak - cycles maximum real GDP, end of expansion. Unemployment falls substantially,
price level rises rapidly. There may be inflation.
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THE LEVEL OF OVERALL ECONOMIC ACTIVITY
actual GDP
Contraction - real GDP begins to fall. If there is a contraction for more than two
quarters, there is a recession. Real GDP falls and unemployment increases. Price levels
slow and may fall down.
Trough - cycles minimum real GDP, end of contraction. Wide spread unemployment
followed by expansion (recovery).
Sometimes called economic fluctuations because they are not predictable.
#TRENDS
Long-term growth trend - the straight line that shows how output grows when the
fluctuations are removed. The output is known as the potential output.
Unemployment falls when real GDP grows (expansion)
firms hire more labor and increase quantity of output
Unemployment increases when real GDP falls (contraction)
firms cut production and have to fire some workers
When an economy experiences full employment, there is still a natural rate of
unemployment.
If actual GDP > potential GDP, unemployment is lower than the natural rate.
If potential GDP > actual GDP, unemployment is greater than the natural rate.
There is a GDP (output) gap if the actual GDP is above/below the potential GDP.
REASONS TO STUDY CYCLE
Real output growth mean that theres a chance to have higher standards of living.
Large fluctuations not desirable, because with expansion, inflation could happen and with
a contraction, unemployment increases.
Some key macroeconomic objectives: rapid economic growth, full employment, and
price stability.
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THE LEVEL OF OVERALL ECONOMIC ACTIVITY