Chapter 7 2019 Winter PDF

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Download Chapter 7 2019 Winter PDF

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Chapter 7! Circular flow model! - used to measure the economic activity and flows inside the macroeconomy. ! - seen as the “skeleton” of the macroeconomy! Two-by-two-by-two! - two types of actors ! - households and firms! - Households will spend and firms will earn in the G&S (outputs) market and the inverse in the factor (inputs) market! - two types of flows denominated in $! - income from goods and services rendered! - expenditure on goods and services purchased! - two types of markets! - factor incomes market! - goods and services market! National accounting! - expenditure approach! - GDP = C + I + G + NX! - C: consumption spending, which includes new G&S bought by individuals or households! - I: investment/inventory, which involves spending on productive inputs that will generate G&S in the future (factories, equipments, etc.) and does NOT include stocks, bonds, etc as they are qualified as transfer payments! - G: government spending, which includes spending on G&S and excludes transfer payments such as employment insurance, pension plans, etc.! - NX: net exports, which is exports-imports in the domestic macroeconomy! - factor incomes approach! - Y = NDP + depreciation! - NDP = factor incomes + indirect taxes! - NDP: net domestic product! - factor incomes include wages and salaries, rent, interest on dividends, profits, etc.! - indirect taxes are PST, HST, GST, excise taxes that fill the gap between factor costs and market value! - depreciation is what is required to maintain inventory in its current condition! Nominal and real GDP! - GDP deflators! - GDP deflators allow nominal GDP in current dollars to be deflated into real GDP in constant dollars to account for inflation rates over time periods! - allows us to measure the VALUE of the economy! - GDP deflator = (nominal GDP/real GDP) x 100! - real GDP = (nominal GDP/deflator) x 100! - a deflator is the weighted average of all individual price changes in the economy! Problems with GDP as a measure of economic welfare! - doesn’t account for quality change, leisure time, technological innovation, wealth distribution (GDP per capita)! - Doesn’t include underground economy and non-market activities! - Doesn’t account for externalities such as environmental impacts, traffic, etc.!

CHAPTER 7 textbook learning objectives! LO 7.1 ! Justify the importance of using the market value of final goods and services to calculate GDP and explain why each component of GDP is important! - to calculate GDP we must use the final market value of all goods and services in order to avoid re-counting the values and over-estimating GDP. if we were to count the intermediate prices of products instead of, or as well as, the final market value, GDP would be calculated as much higher than it truly is.! - consumption spending accounts for the biggest part of GDP and includes spending on the goods and services produced domestically, thus paying the market value of the final goods and services, and contributing to GDP after its creation. investment contributes to GDP as it increases future production of goods and services and inventory being included in GDP ensures that goods and services created in one fiscal year will not be recounted in the following year’s GDP when they are sold. government spending is included in GDP as it involves spending on goods and services produced domestically and net exports account for outflow and inflow of spending of goods and services produced abroad and domestic goods and services sold to foreign economies.! LO 7.2! Explain the equivalence of the expenditure and income approaches to valuing an economy! - expenditure approach accounts for all the spending done in an economy. as we know that someone’s spending becomes income for another, spending = income. the income approach looks at overall income in the economy and therefore must be equal to the expenditure approach.! LO 7.3! Explain the three approaches that are used to calculate GDP, and list the categories of spending that are included in the expenditure approach! - the three approaches to calculating GDP are the expenditure approach, the income approach and the value-added approach. the expenditure approach looks at overall spending in the macroeconomy and includes consumption spending, investment spending, government spending and net exports. the income approach looks at overall income in the economy and the GDP calculations of the expenditure and income approach must be equal. finally, the value-added approach involves adding the incremental additions to total value of a good or service in each step of its creation instead of solely accounting for the final market value of a good or service.! LO 7.4! Explain the difference between real and nominal GDP and calculate the GDP deflator! - real GDP and nominal GDP are different because real GDP accounts for inflation over periods of time and allows us to have a better insight into overall economic growth (value of GDP) without the bias of increasing prices due to inflation. real GDP = nominal GDP inflation.! - GDP deflators allows economists to deflate nominal values into real ones. a deflator is a weighted average of all the price changes of goods and services in an economy and the GDP deflator = (nominal GDP/real GDP) x 100! LO 7.5! Calculate and explain the meanings of GDP per capita and the real GDP annual growth rate! - GDP per capita = GDP/population size and shows the output per person in an economy. it is also a general indicator of an economy’s size, allowing us to compare economies worldwide. furthermore it is also an indicator of economic welfare!

- real GDP annual growth rate = (nominal GDP growth rate - inflation rate)/population growth rate and shows the growth of an economy over time while taking into account population growth and inflation rates which could falsely enlarge GDP. if the growth rate is negative, the economy is in a recession or a depression! ! LO 7.6! Discuss some limitations to GDP, including its measurement of home production, the underground economy, environmental degradation and well being.! - GDP does not factor in home production and underground economic activity as they are sources of output and income that are not reported. this means that GDP could underestimate the true size of a country’s economy.! - GDP also doesn’t take into account the importance of well being, which could involve leisure time that increases well being while not contributing as much to GDP. it also doesn’t include negative externalities resulting from activities that contribute to GDP such as pollution, traffic, environmental degradation, etc. hence the size of the economy could also be overestimated by GDP calculations.! CHAPTER 7 textbook review questions! Question 1! Canadian car dealers sell both used cars and new cars each year. however, only the sales of the new cars count toward GDP. why does the sale of used cars not count?! - The sale of used cars doesn’t count in the current years calculation of GDP as it was already counted in the year of the initial sale. if the sale of the used car was counted in GDP, it would be considered double-counting! Question 2! There is an old saying, “you can’t compare apples and oranges”. when economists calculate ! GDP, are the comparing apples and oranges? Explain! - no. everything being compared is either being compared in terms of expenditure or income and not in terms of the true identity of the goods and services bought or rendered! Question 3! When canadians buy goods produced in the US, americans earn income from canadian expenditures. is the value of this American output and canadian expenditure counted in the gdp of canada or the united states? why?! - the market value of goods and services will be counted in the gdp of the economy in which it was produced, not to which it was sold because GDP is the total market value of all final goods and services produced domestically over a set time period. thus, in this case, the expenditure counts toward the gdp of the united states.! Question 4! Economists sometimes describe the economy as having a circular flow. in the most basic form of the circular flow model, companies hire workers and pay them wages. workers then use these wages to buy goods and services from companies. how does the circular flow model explain the equivalence of the expenditure and income methods of valuing an economy?! - in the circular flow model, in a goods and services market, expenditure on goods and services by households and individuals becomes income for the firms. hence, expenditure spent by some individuals becomes income for other individuals. In the factor market, individuals and households sell inputs to firms, and once again, the expenditure of firms becomes income for the individuals and households that are selling. this is why income must always equal expenditure when valuing an economy.!

Question 5! In 2013, the average baseball player earned $3.4 million per year. Suppose that these baseball players spend all their income on goods and services each year and save nothing. Argue why the sum of the incomes of all baseball players must equal the sum of expenditures made by the baseball players.! - if all the baseball players are spending every single dollar of their income and not paying taxes, or saving any part of it, their level of income will be entirely spent in the form of expenditure on goods and services thus income = expenditure of baseball players! Question 6! Determine whether each of the following counts as consumption, investment, government purchases, net exports, or none of these under the expenditure approach to calculating GDP! - a) construction of a court house : investment! - b) taxicab ride : consumption spending! - c) purchase of a taxicab by a taxicab company : investment! - d) student buying a textbook : consumption spending! - e) trading of municipal bonds : none as it is seen as a set of transfer payments! - f) a company’s purchase of foreign minerals : net exports, as it will be counted as an import! Question 7! If car companies produce a lot of cars this year but hold the new models back in the warehouses until they release them in the new model year, will this year’s GDP be higher, lower, or the same as it would have been if the cars had been sold right away? why? does the choice to reserve the cars for a year change which category of expenditures they fall under?! - the GDP will be the same as if they were sold that year as they will be counted in the GDP in the year they were produced. however, instead of counting as consumption spending, they will be included in inventory which falls under investment spending.! Question 8! The value-added method involves taking the price of intermediate outputs and subtracting the cost of producing each one. in this way, only the value that is added at each step is summed up. explain why this method gives us the same result as the standard method, which counts only the value of final goods and services! Question 10! At a press conference, the president of a small country displays a chart showing that GDP has risen by 10% every year for five years. he argues that this growth shows the brilliance of his economic policy. however his chart uses nominal GDP numbers. what might be wrong with this chart? If you were a reporter at the press conference, what questions could you ask to get a more accurate picture of the country’s economic growth.! - if he is using nominal GDP numbers to establish growth rate over the past 5 years, we are unable to see the effects that inflation rates may have had on the GDP numbers over this time period. it would therefore be important to ask what the inflation rate has been over the period of time spoken about and, for further view of the real GDP growth rate, we need to take into account potential population growth that could raise nominal GDP levels.! Question 11! Suppose that the GDP deflator grew by 10 % from last year to this year. that is, the inflation rate this year is 10%. in words, what does this mean happened in the economy? what does this inflation rate imply about growth rate in real GDP?! - a GDP deflator and inflation rate of 10% imply that the average prices of goods and services in the economy have increased by 10%. this could affect the growth rate in real GDP if the nominal GDP growth rate is lower or higher than 10%. if it is higher, the growth rate in real GDP

will remain positive, however, if it is lower than 10%, the real GDP growth rate will be negative, signalling a recession or depression in the economy.! Question 12! An inexperienced researcher wants to examine the average standard of living in two countries. in order to do so, she compares the nominal GDPs in those two countries. what are two reasons why this comparison does not lead to an accurate measure of the countries’ average standards of living?! - 1) nominal GDP does not indicate trends in average standards of living over the years. it also does not take into account differences in population size between the two countries being compared, nor does it account for ! - 2) nominal GDP does not account for environmental externalities such as environmental degradation, pollution, and traffic which could all lead to a decreased level of standards of living even though the calculated GDP is high ! Question 13! In 2013, according to the IMF, India had the world’s 10th highest nominal GDP, the 140th highest nominal GDP per capita and the 43rd highest real GDP growth rate. what does each of the indicators tell us about the Indian economy and about how life in India compares to life in other countries?! - nominal GDP per capita can indicate the average income per capita in current dollars. this can help establish a brief idea of economic welfare in the country. however it is only an average and does not show the distribution of the welfare! - real gdp growth rate tells us that the country’s economy is growing relatively quickly compared to other countries, on a year by year basis in constant dollars.! Question 14! China is a rapidly growing country. it has high levels of bureaucracy and business regulation, low levels of environmental regulation and a strong tradition of entrepreneurship. discuss several reasons why official estimates in china might miss significant portions of the country’s economic activity.! - the GDP calculation doesn’t factor in home production or underground economic activity as these are two sources of output that aren’t reported by individuals, households or firms. if these are present in the Chinese economy, the economic activity could be underestimated. ! Question 15! Suppose a college student is texting while driving and gets into a car accident causing $2000 worth of damage to his car. assuming the student repairs the car, does GDP rise, fall, or stay constant with this accident? what does the answer suggest about using GDP as a measure of well being?! - the GDP will rise by at least $2000 as the student will pay this in service costs to a mechanic or car garage. furthermore, the student will likely have an increased insurance premium after an accident, increasing consumption spending. this shows that although GDP increases, the well being is decreasing due to incurred costs that the student may not be able to afford and may encounter difficulty finding sources for payment/incur stress.!...