Unit 8
Unit 8
Unit 8
Class Economics
Reviewed
Unit 8 1
💡 Households → Resource Markets
Land, Labour, Capital, and Entrepreneurship
This is how the circular flow of income works with no leakages and injections.
Unit 8 2
In the circular flow of income, the income flow from firms to households is equal to
the expenditure flow from houses to firms and the opposite is true as well
The two flows are also equal to the value of the output flow (value of goods and
services)
Savings are consumer income that is not spent, therefore it is considered a leakage
Investment is when firms spend money to finance the production of capital goods
Households place savings in financial markets and financial markets lend it out to
firms
💡 Households → Government
Taxes (leakage)
Unit 8 3
💡 Government → Firms (businesses)
Government spending (injection)
Taxes are leakages because money flows out to the government instead of to the
purchasing of goods and services
Exports are the opposite because foreigners are sending money back into the flow
when they purchase domestically produced goods/services
Unit 8 4
National output is the total output of an economy, also known as
aggregate output. This is often measured by real GDP (RGDP).
Knowing a country’s income and output is useful because it allows economists to:
Compare income and output of the economy to the economies of other nations
Understand what policies can help the economy meet certain objectives/goals
Expenditure approach which sums up all the spending on the purchase of final
goods/services produced in a country over a time period (calculation of the
value of what is produced over the year: spending)
Unit 8 5
Income approach which sums up all income earned through factors of
production that produce the goods/services in a country over a time period
(measure of the value of income generated by production: income earned)
Output approach which sums up the value of all final goods and services that
are produced over a time period
Expenditure approach
Calculation of GDP as market value of final output by summing up expenditures
made on final goods/services
When measuring aggregate output, only purchases of final goods and services are
included
Intermediate goods are not included because if they are, then it would involve
double counting, therefore exaggerating the value of aggregate output
Investment spending (I) which includes spending by firms on capital goods such
as buildings, equipment, and machinery, and spending on new construction
such as housing or other buildings
Net exports (X - M) which is the value of all exports minus the value of all
imports
Unit 8 6
💡 Investment refers to spending by firms or a government on capital goods and
construction. In measuring aggregate output, investment in capital involves
only physical capital, not human, natural, or financial capital.
Income approach
The sum of all income earned by factors of production in a country over a period of
time
Includes wages earned by labour, rent earned from land, interest earned by
capital, and profits from entrepreneurship
This approach is useful in helping economists see relative income shares of factors
of production and compare specific factors to those of other countries
Output approach
Measures value of each good/service produced in the economy over a time period
Value of output for each sector is added together to obtain total value of output
Allows economists to see performance of each sector and compare them to that of
other nations
Unit 8 7
To deal with this, the concepts “domestic” and “national” are used to differentiate
between measures of aggregate output and income
“Domestic” in GDP means the output was produced by factors of production within
the country (domestically) regardless of who owns them
However, since prices change over time, we need to account for that in order to
determine how much the quantity of goods/services has changed
To get rid of the influence of changing prices on the value of output, real values are
used
Real values are measured while accounting for changes in prices over time
For instance, GDP per capita is the GDP divided by the country’s population
Population growth can inflate GDP, so GDP per capita can more accurately
show the changes of GDP for individuals and show the standard of living in a
country
Total values gives a summary of the overall size and performance of an economy
whereas per capita values give a summary of the standard of living in a country
Unit 8 8
Real GDP/GNI per capita and purchasing power parity (PPP)
Since different countries have different price levels, it is important to have a way to
account for different price levels to compare purchasing power across countries
GDP = C + I + G + (X - M)
It is not required to learn how to calculate GDP using income and output
approaches
Calculating GNI
Real GDP measures value of current output using constant (base year) prices
Price deflators are price indices used to convert nominal values into
real values
Unit 8 9
Price indices are measures of average prices in one period relative
to the average prices of a base year
Employment of resources increase and the general price level usually also
begin to rise more rapidly
Peak
Represents the cycle’s max real GDP and is the end of the expansionary phase
Contraction
Unit 8 10
After the peak, the economy begins experiencing a fall in real GDP
If the contractionary phase lasts six months (two quarters) or more, it is called a
recession
Increases in price levels could slow down substantially and it is possible for
prices in some sectors to fall
Trough
The long-term growth trend is the average growth over long periods of time
Shows how output over time grows when the fluctuations are ironed out
Unit 8 11
Output represented by this trend is the potential output
When economies produce at full employment, unemployment still exists, it’s just
that the economy is at the natural rate of unemployment
There will always be at any time people who are in between jobs or out of work
due to various factors
Unit 8 12
National income stats such as GDP and GNI do not accurately measure the true
value of output
Output of some goods/services are not sold in the market and do not
generate income
In developing countries, output often never reaches the market and are
instead used for a household’s own consumption
Can be health with when converting values into a single common currency
using purchasing power parities
Does not matter if they are demerit or merit goods, they are included in
GDP/GNI all the same
Does not consider the time citizens have to enjoy themselves/time off work
Unit 8 13
Some examples of alternatives measures of well-being include:
Happiness Index
Green GDP
Unit 8 14