6. Two Sector Circular Flow of Income Monetary Flow Households RealFlow Good and Services = Output (O) Expenditure on Goods and Services (E) Wages, Rent and Profits (Y) Factors of Production Firms E = O = Y 6
7. Four Sector Circular Flow of Income Leakages (L) Injections (J) Saving (S) Households Investments (I) Income Exports (X) Imports (M) Government Spending (G) Expenditure Taxes (T) Firms O = E = Y 7 Sum J = Sum L
8. Measuring National Income Income Method Output Method Households Good and Services Wages, Rent and Profits Expenditure on Goods and Services Factors of Production Firms Expenditure Method 8
13. GDP GDP = Gross Domestic Product = Total Value of all Spending in an Economy = The Total Value of all final Goods and Services in an Economy regardless of who owns the productive assets. GDP = C + I + G + (X – M) 13
14. GNP GNP = Gross National Product = Total Income Earned by a nation’s factors of production regardless of where the assets are located 14
15. Real GDP Real GDP = Nominal GDP adjusted for inflation 15
16. Calculating Real GDP Real GDP = Nominal GDP of year measured 16 X 100 GDP Deflator
20. What is economic development? Economic Development is a multidimensional concept that includes poverty reduction, provision of education, health care and law and order, civil liberties and civic participation. 20
29. How can development be measured? Important Indicators of development Infant mortality rate Maternal mortality ratio Enrolment in each level of education Literacy Internet users per 1000 29
31. What is aggregate demand (AD)? Aggregate Demand is the aggregate (total) spending on goods and service in a period of time at a given price level. 31
33. What are the components of AD? C = all household consumption on durables, non-durables and services I = firm’s replacement investment(spending on capital to maintain productivity) or induced investment to increase production G = all government spending X-M = spending by foreigners on exports less domestic spending on imports 33
56. The Business Cycle Fluctuations in the growth of real output, consisting of periods of expansion and contraction called business cycles or trade cycles. 56
78. Neoclassical (Free Market) LRAS 78 LRAS perfectly inelastic at Full Employment Level of Output (Ymax) Potential Output = Quantity and Quality of FOPs not Price
89. Keynesian SR/LRAS 89 Segment 1: Spare capacity in the economy, LRAS perfectly elastic
90. Keynesian SR/LRAS Keynes argued that as there is nothing inherent in the economy to move the SR into the LR, then SRAS = LRAS NB In diagrams taking a Keynesian you may see the AS curve labeled Keynesian AS or simply LRAS as long as the diagram’s title makes clear which perspective is being adopted 90
104. The Neoclassical/Monetarist Challenge Argument that discretionary fiscal polices that try to stabilize the economy are so flawed that they actually cause instability Alternative policies Ensure steady supply of money Ensure price and wage flexibility Focus on supply-side policies to achieve economic growth 104
122. The Accelerator Theory & the Combined multiplier/accelerator effect Argues that small changes in GDP produces larger changes in investment spending. These fluctuations interact with the Multiplier effect to increase the momentum of business cycle. 122
145. Measuring Inflation The consumer price index (CPI) compares the value of a basket of goods and services in one year with a same basket in the base year. 145
152. No-classical challenge to the Phillips Curve 6% = NRU Wages set to rise by at least 2% as workers expect this rate of inflation a = Labor Market at equilibrium 152
153. LR Phillips Curve If expansionary policies adopted, inflation would increase to 4% or more. Real wages have fallen and firms hire additional labor. 153
154. LR Phillips Curve Unemployment is now below NRU at 4%. (b) Workers have fallen for the “money illusion” and slow to realize that real wages have fallen because inflation is actually over 4%. 154
155. LR Phillips Curve Once workers realize real wages have fallen they will demand at least a 4% pay rise. Real wages will return to previous levels and firm will fire workers. Unemployment has returned to (c) 155
156. LR Phillips Curve Any attempt to to increase AD will only result in temporary changes to unemployment but increasingly high rates of inflation 156
157. LR Phillips Curve Friedman argued that no trade off exists if governments do not use demand side policies. 157
159. Income Distribution and Equity Vertical Equity = treating people differently to achieve greater fairness e.g. people on low incomes pay less tax than people on high incomes Horizontal Equity = people should be treated the same e.g. people who have the same income should pay the same tax 159
162. Progressive, Proportional and Regressive Taxation Progressive: as income increases, the fraction paid in tax increases Proportional: as income increases the fraction paid in taxes remains constant Regressive: as income increases, the fraction paid in taxes decreases 162
167. Gini Coefficient Gini Coefficient = areas between diagonal and Lorenz Curve/entire area under diagonal Values closer to 0 = greater income equality Values closer to 1 = greater income inequality 167
170. Activity Select one of the OECD economies to study in detail over Section 3 Undertake research to find the following: Real GDP for the last decade Real GDP per Capita for the last decade Real GDP growth for the last decade What conclusions can you draw? 170
171. Activity Visit www.nationmaster.com or any reputable site and gather data on the various measure of development for your OECD country of focus and compare it with the developing nation you chose early in the course. 171
172. Typical Examination Questions 172 These questions focus on Measuring National Income and Macroeconomics Models. Explain the possible limitations of using GDP as a measure to compare welfarebetween countries. Using the circular flow of income diagram, explain the link betweensaving and investment. Use AS/AD diagrams to explain the causes of inflation (or deflation). Identify the components of aggregate demand (or aggregate supply) and briefly explain factors which might determine these components. Evaluate the likely impact on an economy of a substantial rise (or fall) in the level of interest rates (or other components of AD)
173. Typical Examination Questions These questions focus on inflation and deflation: What are the problems associated with measuring inflation? Explain the possible causes of a rise (or fall) in the rate of inflation in an economy. Evaluate the likely effects of a rising (or falling) rate of inflation on the performance of an economy. Explain the costs of inflation and deflation. Evaluate the view that governments should make the control of inflation their highest priority Evaluate the possible impact on economic performance that may result from a government decision to bring inflation under control. 173
174. Typical Examination Questions These questions focus on unemployment: Explain the different types of unemployment. Evaluate polices aimed at achieving full employment in an economy. Explain the costs of unemployment. Discuss the reasons why government find the goal of full employment difficult to achieve. 174
175. Typical Examination Questions These questions focus on monetary and fiscal policy: Discuss the strengths and weaknesses of demand-side policies. Discuss the strengths and weakness of supply-side policies. Explain the purpose of various demand-side (or supply-side) policies. 175
176. Typical Examination Questions These questions focus on income distribution: With the use of examples, explain the difference between a progressive tax and a regressive tax. With the use of examples, explain the difference between direct and indirect taxes. Explain the possible impact on the distribution of income of a government shifting its main source of tax revenue from progressive direct taxes to regressive indirect taxes. Evaluate the methods government use to redistribute income in an economy. 176
177. Typical HL Examination Questions In addition to the questions above, HL students need to prepare for the following: Explain the relationship between the Lorenz Curve and the Gini coefficient. Explain how increasing government spending can lead to crowding out. Use the Phillips curve to explain the concepts of Natural Rate of Unemployment and outline its usefulness. Explain the multiplier and the accelerator effects. Use the Laffer Curve to explain the likely impact of progressive and regressive tax systems. 177
178. On-Line Resources (1) Keynes and Hayek Rap Nationmater is a massive central data source and a handy way to graphically compare nations that compiles data from such sources as the CIA World Factbook, UN, and OECD. CIA Factbook The World Factbook provides information on the history, people, government, economy, geography, communications, transportation, military, and transnational issues for 266 world entities. Gapminder, an excellent way to visual information 178
179. On-Line Resources (2) International Monetary Fund also provides international data. National Council on Economics Education is another excellent source of information. The organization also has worksheets to help student analyze current GDP data. TheEconomist Debates Commanding Heights Triple A Learning Economics Blog 179
