Achievement Standard 3.4

1. Achievement Standard 3.4 Describe aggregate economic activity.

2. Aggregate? • The amount or total formed from separate units. Aggregate refers to a total, everything added up. • Aggregate = Total • The economy can be viewed as a series of aggregates, flowing together to make a working whole

3. The Circular Flow Model • Shows the economic transactions that occur between households, firms and other sectors in the economy. • Money flows- We will only focus money flows as it is simpler than trying to account for the physical flows.

4. The Circular Flow of Income and Spending • The simplest form of circular flow $ Consumption Goods and Services Producers Households Factors of production Incomes $ rent wages interest profit

5. Introduction of the Financial Sector I (Investment) d Financial Institutions C (Payments for goods and services) a S (savings) c Producers Households b Y (Income)

6. An Open Economy Overseas Sector I (Investment) d Financial Institutions X (Export receipts) f M (Import payments) C (consumption) a g S (Savings) c Producers Households b Y (Income)

7. Role of the Government Overseas Sector I (Investment) d Financial Institutions X (Export receipts) f M (Import payments) C (consumption) a g S (Savings) c c G (Government Spending) Producers Households Government T (taxes) tr (transfers) b a b Y (Income)

8. The Circular Flow Model Overseas Sector d Financial Institutions I (Investment) X (Export receipts) e M (Import payments) C (consumption) a f S (Savings) c G (Government Spending) i Producer Households Government T (taxes) tr (transfers) g h b Y (Income)

9. The Circular Flow model • Y= Incomes including rent wages interest and profit • C= Consumption spending- the payment for goods and services • S= Savings – income not spent on consumption this is a withdrawal from the economy • I= Investment spending-purchase of capital goods. This is an injection into the economy • X= Export receipts- Money received for exports sold • M= Import payments- Payments made for imports purchased • G= Government Spending- on collective goods • T= Taxes the government collects from households and firms. These are used to fund G and Tr. • Tr= Transfer money from one group to another, because of this transfer payments are not true expenditure.

10. Page 138 Questions 1-3

11. The Circular Flow Model Overseas Sector d Financial Institutions I (Investment) X (Export receipts) e M (Import payments) C (consumption) a f S (Savings) c G (Government Spending) i Producer Households Government T (taxes) tr (transfers) g h b Y (Income)

12. Calculating National Output • What is national output? • National Output =Total quantity of goods and services demanded in an economy in a year. • Y= National output Y = C +I +∆R Where ∆R is changes in stocks Stocks are caused from unplanned investment where there is a build up of inventories/ stocks ready for sale. Negative unplanned investment also occurs however when there is a rundown of stocks.

13. Calculating National Output • The value of incomes always equals the value of what is produced National Output= C +I+ ∆R National Income=C +S Where national incomes is the total incomes resulting from the production of goods and services in an economy in a year. Because outcome equals income, it follows that C+S=C+I+ ∆R S=I + ∆R

14. Calculating national Output using the Circular flow model. • Output Y = C + I + ∆R + G + (X-M) • Income Y= C + S +T Output = Income I + ∆R + G +X = S + T + M (Injections= Withdrawals) For the economy to be in equilibrium planned injections must equal planned withdrawals. (∆R=0)

15. Calculating national Output using the Circular flow model. • Changes in any of the flows in the circular flow diagram will result in the changes in national income. • E.g What do you think would happen if people saved more? • C would decrease and this would result in a reduction in national income

16. Aggregate Demand • What does aggregate mean? • Aggregate refers to a total, everything added up. • Aggregate demand is the total demand in the economy. AD shows how many goods and services will be demanded in an economy given the general price level and the level of income. • Aggregate demand is equivalent to national output • What are the components of national output? • Output Y = C + I + ∆R + G + (X-M) • AD=C+I +G + (X-M)

17. Components of Aggregate demand AD=C+I +G + (X-M) C= Consumption Total demand for all final goods and services. This is shown by the household sector through its spending $ Consumption Households

18. In 2000, Real GDP was $102445million. What proportion of the 2000 GDP was made up of household consumption? • Which item of expenditure accounted for the largest proportion of household consumption spending over the period 1995-2000? • Why is savings not on the table?

19. AD=C+I +G + (X-M) • I=Investment = Expenditure by businesses as they demand investment/capital goods. • Investment is exogenous. It is not influenced by the level of income but by other elements in the circular flow model. Three main reasons why firms invest? • Expect high demand in the future • Existing capital has depreciated and needs replacing • Changes in government policies make it favourable to invest. • The main determinant of the level of investment is the market interest rate

20. Gross Capital Fixed Formation • Expenditure of producers on investment on new plant and machinery • New capital spending by the govt e.g. motorways, roading • Investment spending by households on housing.

21. What are capital goods? • Using the information above, analyse the links between, imports and investment. • Why do you think this link exists? • Why do you think Investment is important for economic growth?

22. AD=C+I +G + (X-M) • G= Government spending as it demands goods and services. Also exogenous (not dependent on level of national income) The government decides on what it is going to spend the money on then goes about raising the money necessary. Major items of expenditure in NZ are • Health • Education • Welfare

23. AD=C+I +G + (X-M) • (X-M)= Net exports • We use net exports as we are interested in what NZ economy produces. • M>X (X-M)? + or – • This is a withdrawal from the circular flow • M<X (X-M)? + or - • This is an injection from the circular flow.

24. Gross Domestic Product (GDP) • GDP= the money value of final goods and services produced in an economy in a year. Three ways to measure GDP • Production • Income • Expenditure • Why do you think we would want to measure GDP?

25. GDP • An economies standard of living is measured by the number of goods and services that it has available to use and enjoy. • An economies growth can be measured by the increase in the number of goods and services it makes • Why do you think investment and savings are so important in an economies growth?

26. Measuring GDP • The Expenditure Approach- by adding up selling prices of all goods and services bought in the economy then making allowances for goods and services bought overseas. • Formula= C + I + ∆R + G + (X-M) • Consumption excludes buying new houses- this is investment • Investment includes govt investment (Roading) • Change in inventories are included as these represent goods available for sale and represent an increase in investment spending • A decrease in stocks will reduce GDP because they represent expenditure on goods that were produced in the previous year.

27. Measuring GDP • The income approach- by adding up incomes generated in the production process. • Income includes • wages, salaries (Compensation to employees) • profits, dividends, rents, interest (Gross operating surplus) • Then make final adjustments to account for govt intervention. (Add taxes on production e.g. GST and imports e.g. tariffs then takeaway subsidies) • Y= C+ S + T

28. Measuring GDP • The production approach- measures the value added by producers, by deducting the value of goods and services used up in the production from the total value of goods and services produced. • To calculate find the value that each sector/producer adds to the value of the product during the production process. • A problem that can occur with this approach is that of double counting. • We will focus on the other two approaches

29. Find GDP for the following data using the income and expenditure approaches Values of output at each stage of Bread production

30. The expenditure approach= value of the final product = $150 million • The incomes approach totals wages at each stage of production= 30+45+75=$150million

31. NSNA • The New Zealand System of National Accounts (NZSNA) provides an international standard of measure of GDP that enables international comparisons • Sometimes there will be a statistical discrepancy in the NSNA this is Basically it is used to make Income and Expenditure approaches balance Statistical discrepancy = Income Approach GDP – Expenditure Approach GDP

32. NZSNA Terminology Final private expenditure Consumption Gross fixed capital formation Investment Government final expenditure Government Spending Exports of goods and services – Imports of goods and services. Net Exports Table 6.2

33. NZSNA Terminology Compensation of Employees Wages and salaries Operating Surplus Gross Profits Consumption of fixed capital Depreciation Indirect taxes minus subsidies. Net Indirect Taxes Table 6.2

34. Important things to remember when calculating GDP • Include only G&S produced in NZ economy • Include G&S produced only within that time period. (inventories included in time period they were made not when they were sold) • Avoid double counting (second hand goods not counted)

35. Questions • What is GDP? • What is the formula for calculating expenditure on GDP? • Draw the simple circular flow diagram • With reference to the model explain three ways GDP can be measured • Calculate GDP from the data below using the Income and Expenditure methods

36. Nominal GDP VS Real GDP Imagine the economy only produces pizzas and pies. Calculate GDP in year as the market value of production GDP 2000=(10pizzasX$10/pizza) +(15piesX$5/pie)=$175 GDP 2004=(20pizzasX$12/pizza) + (30piesX$6/pie)=$420 Looking at these two GDPs what would you conclude? BUT Looking closely you can see the quantities produced of pizzas and pies in 2004 are twice that produced in 2000 If eco activity exactly doubled why do the calculated values of GDP show a greater increase? Prices as well as quantities rose!

37. Nominal and Real GDP Notes • Nominal GDP= the actual dollar value of all goods and services produced in a year • Inflation = • These values cannot be meaningfully compared from year to year Increase’s in the price level

38. Consumer Price Index (CPI) • Measures the price level of a ‘basket’ goods and services purchased by the average NZ household • The data on prices comes from household surveys conducted by Statistics New Zealand • CPI is then released quarterly • Used as a general measure of inflation • Indicates the effect of price changes on the purchasing power of households • To calculate and index =Expenditure Now Expenditure Base Year

39. Consumer Price Index Measures rate of change in price level from the base year (2002). Rate of change between 2003 and 2004 is 1300 – 1222 * 100 1222 6.4% 22.2% 30% 130%

40. Change in CPI • An increase in the CPI is called inflation. The price level increases. The purchasing power of money decreases. • A decrease in the CPI is called deflation. • Disinflation refers to a decrease in the inflation rate. The CPI is increasing at a decreasing rate.

41. Real Values • Calculated using constant prices. –prices used for one year is used to calculate values for all years • Are inflation adjusted. • Can be meaningfully compared from year to year • Real Income= Nominal Value X 1000 CPI

42. Real GDP and Nominal GDP • Nominal GDP= the actual dollar value of all goods and services produced in a year • Real GDP= is nominal GDP adjusted for inflation. • This measure allows for comparison of changes in the value of national output without price changes distorting the data.

43. Real GDP • In order to calculate RGDP the effect of price increases need to be removed. • We will use the CPI index to do this: both the base year value (1000) and the value for the year we are calculating the RGDP for. • The part of the equation in which this is taken into account is the GDP deflator: (taking inflation out of GDP value) • CPIbase CPIyear1

44. Real GDP equation • RGDP = GDPyear1×CPIbase(GDP deflator) CPIyear1 NOTE: Year 1 refers to the year you are calculating the RGDP for.

45. Real GDP Using the data in the table above and assume year 2000 is the base year find real GDP fro years 2000 and 2004 How much did real output grow between 2000 and 2004 Year 2000 real GDP=(10pizzasX$10/pizza) +(15piesX$5/pie)=$175 Year 2004 real GDP=(year 2004 quantity pizza's X year 2000 pizza prices) + (Year 2004 quantity pies X year 2000 pie prices) = (20X$10) + (30X$5) =$350 By using real GDP we have eliminated the effects of price changes and obtained a reasonable measure of actual change in physical production

46. Measuring the rate of Economic Growth • Rate of growth= GDP 2nd year-GDP 1st year x 100 GDP 1ST year Calculating the rate of inflation • Rate of inflation= CPI 2ND year - CPI 1ST year x 100 CPI 1ST year

47. Limitations to GDP • In groups give an opinion into how well GDP is as a measure of the standard of living. • Think about • Unpaid work? Non-market activities? If it is not sold it is not counted • Merit and demerit goods • The distribution of wealth. • Standard of living - the degree to which people have access to goods and services that make their lives easier, healthier, safer and more enjoyable

48. Limitations to GDP as a measure of Standard of Living • Non market activity • GDP excludes • Voluntary Labour • Cash transactions, barter • Illegal transactions • Relative Merits of production • There is no distinction in GDP whether goods being produced are merit goods or demerit goods e.g. a dollar spend on cigarettes has the same weight as a dollar spent on education • Distribution of Income • GDP is a total. • Does not tell us how this total is distributed • e.g. a country may have high GDP but there also may be large numbers of people living in poverty.

49. GDP per capita • Use GDP per capita (per head of population). • GDP per capita = GDP Total Population Shows how much of the economies total production each person would receive if it was divided equally

50. The Business (Trade Cycle • Over time fluctuations in economic activity occur. • The trade cycle shows us how fluctuations in the levels of output, employment, income and trade affect the level of real GDP.