Transcript Chapter 2

Chapter 2
The Measurement
of Income, Prices,
and Unemployment
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We assume a simple economy with households and business firms.
• Firms sell goods and services.Households sell their work(labor).
• These are purchased by households for their own use.
• We call this action consumption expenditures.
• In order to purchase some good or service the households need
to have an income.
• They generate this income by working for the firms.
• So there are flows between households and firms.
• The green flows from the firms to households represent what
the firms pay to them so that is an income for them(households).
• The red flows from the households to firsm represent what they
spend on consumption so that is a source of income for the
firms.In this example every party spend exactly what they get
from each.
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Figure 2-1 The Circular Flow of Income
and Consumption Expenditures
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In the next slide things get a little complicated..
• Now households do not spend all of their income on
consumption.
• They save the part of their income they do NOT spend.
• This saving may occur in the form of buying the shares (stocks)
of the firms.
• Or this saving may be in the form of money deposited in a bank.
• In the first case, the households pay money- for each share they
buy – to firms.
• In the second case, the bank lend the money deposited to the
firms.
• The firms use the money they obtain to buy investment goods.
• Households spend the rest of their income on consumption
goods that they buy from the firms.
• Now you see that in addition to household and firm sectors there
is a capital market sector.
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Figure 2-2 Introduction of Saving and
Investment to the Circular Flow Diagram
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In the next slide things get even more complicated..because now we put
the government in the picture...
• Now, in addition to HH, firms, capital market we introduce the
government.
• Government will now take the part of the income that goes to the
HH in the form of taxes.
• Taxes-we may not like to pay them- are a source of revenue for
the government.
• But, government is not that bad, sometimes government may
make payments to the HH....such as social security,
unemployment ,pension etc...
• These payments are called transfer payments.
• Government also makes spending on purchases of goods and
services...such as schools, highways, defence...
• Now, let us see the new flows....
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Figure 2-3
Introduction of
Taxation,
Government
Spending, and
the Foreign Sector
to the Circular
Flow Diagram
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Moreover, we have the foreign sector added now..
• When government purchases exceed its income (taxes
collected) , it is in deficit.
• Government can finance this deficit by borrowing in the capital
market. Example: what do you think the treasury bills are for?
• By the way, let us remember that HH are not ONLY composed of
people who work for firms, the OWNERS of the firms are also
part of households. So... HH = People who work for salary +
people who are the owners of the firms which hire workers.
• The income the owners make is called ... PROFIT.
• The income the salaried people make is called wages(salaries).
• Let us go back to government...now that $100.000 is borrowed it
can be used to finance its purchses (same amount).
• When you add up C + I + G what do you find it is equal to ?
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Important issues to remember..
• Distinguish the flows from the stocks; a flow magnitude is any
money payment, physical good or service that flows from one
economic unit to another per unit of time.
• For example, consumption, investment, government purchases
are flows.
• On the other hand, money, debt or depreciation are stock type of
variables.We say Money stock, debt stock etc...
• In calculating GDP, we use only final goods, that is, goods that
are NOT used as inputs in the production goods.
• For instance, bread is a FINAL good, but flour is an
INTERMEDIATE good.
• We use flour as input in the production of bread..
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In the next slide, we see how we can find some aggregates such
disposable income, personal income from GDP.
• To find Net domestic product (NDP) we subtract depreciation
from the GDP.
• Depreciation expenditures are the part of the investment made
for the replacement of old buildings and equipment.
• Subtract indirect business taxes from NDP, and we find domestic
income.
• Subtract undistributed profits and social security payments from
domestic income add transfer payments and we find personal
income.
• But personal income is still not usable (disposable) income. To
find this latter we subtract personal income taxes.
• The amounts we subtract are called leakages because we take
them out to find what is left as available for households.
• Now take a look at the following...
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Table 2-1 Households Get
What Remains After All the Leakages
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Leakages can be of different type...
• For example, depreciation, undistributed profits and personal
savings can ALL be considered as leakages into SAVING.
• When companies decide not to distribute their profits these are
retained, (not given to company shareholders) so this is a
LEAKAGE from the expenditure system into a kind of saving.
• The income is the source of the expenditure remember?
• When the people are deprived of their extra income in the form
of undistributed profits, they also have to arrange their spending
accordingly.
• All types of taxes, whether income taxes or personal taxes are
LEAKAGES into taxes. That is these amounts are taken away
from people’s incomes, so LESS is available for SPENDING.
• ALL the money spent, enters into economic system. Remember
the golden rule: Someone’s spending (expenditures) is also
somebody else’s income.
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So, anything that is not spend and witheld is a LEAKAGE
• All taxes are leakages, beacuse they are taken away from the
income which is the main source of our expenditures.
• If we pay more taxes, less is left for sepnding.
• Same for savings, these are the amounts not spent but puıt
aside for later use.
• Transfer payments are INJECTIONS into economic system.
• Beacuse these are the amount that the government transfer to
the people.
• Example: Pensions, tax rebates, subsidies.
• All these ADD to people’s income. Even when transfer payment
is made to the firms, it is still an addition to the income, because
people(households) are the OWNERS of the firms as well.
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Equality between income and expenditure
•
Y = E (İncome equals expenditures)
•
E =C+I+G+NX (Expenditures may be of different types)
•
Y +F = C+S+R (Income plus transfer payments are split between
different USES: these are consumption, saving and tax payments, after
you pay out your taxes out of your income, the rest is split between
consumption and saving).
•
Carry the F to right hand side, since F can be seen as negative
taxes.Now define R –F as net taxes (T) so:
•
Y = C +S +T
•
C+S+T = C+I+G+NX and subtract C from both sides:
•
S+T = I+G+NX (leakages must be balanced by injections)
•
If there is a deficit: T-G<0, then I+NX-S <0---> I+NX<S.
•
If there is surplus: T-G>0, then I+NX-S>0.
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The Magic Equation
•
The magic equation shows how the funds resulting from a budget
surplus are used.
•
1993 : T-G = -1.8 and I=17.6, NX=-1.0, S=18.4.
•
Saving is larger than investment (excess saving) and net exports are
negative that is imports are greater the exports so the difference
between them can only be financed by foreign borrowing.
•
So: -1.8 = (17.6-1.0)-18.4
•
1994: T-G = 4.4 (now there is a surplus), I=20.8, NX=-4.0, S=12.4.
•
The surplus over expenditures and STILL foreign borrowing (a minus
net exports greater than before)help to finance a bigger amount of
investment now.
•
So: 4.4 =(20.8-4.0)-12.4.
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Now let us look at the difference between Nominal and Real GDP
• Real GDP is the GDP expressed in constant prices.
• We are concerned with the physical volumes and not the price
effects if we consider the Real GDP.
• If in a country the GDP say, last year was $100 million and the
this year $110 million, this does not mean the economy has
grown.
• Because there may have been price increases of the goods and
services. So the nominal values may not tell whether the
increase is due to price increase or quantity increases.
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Figure 2-4 Nominal GDP, Real GDP, and
the Implicit GDP Deflator, 1900–2004
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Table 2-2
Calculation of
Fixed-weight and
Chain-weighted
Real GDP and GDP
Deflators in an
Imaginary Economy
Producing Only
Oranges and Apples
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Figure 2-5 Employment From the Household
and Payroll Survey, 1990–2004
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