The Business Cycle & Aggregate Demand/Supply

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Chapter 7

The Circular Flow Model Revisited
Factors of production:
· Land – rent
· Labor – wages
· Capital – interest
· Entrepreneurship – profit

The important principle:
In any given time period, the value of output produced by an economy is equal to the total income that is generated in producing the output, which is equal to the expenditures made to purchase that output Value of output produced = total income generated = expenditure made to purchase

Leakages| Injections|
Saving| Investment|
Taxes| Government Spending|
Imports| Exports|

Saving -> Financial Markets -> Investment
Taxes -> Government -> Government spending
Spending on imports -> Other countries -> Spending on exports

National Income Accounting
Formal definition for GDP:
The market value of all final goods and services produced within a country during a given time period
Expenditure Method:
C + I + G + (X-M) = GDP

Income Method:
Rent + Wages + Interest + Profit

Output Method:
Adding up the value of all final goods and services (to avoid double counting!)

Key Distinctions
Gross investment = net investment + depreciation

Nominal – value measured in terms of current prices
Nominal GDP – measures the value of current output valued at current prices Real – value that takes into account changes in prices over time Real GDP – measures the value of current output valued at constant (base year) prices

Per capita – per person or per head

GDP – produced within the boundaries of a country
Ex. Toyota plant in US is part of US’s GDP
GNP – produced by the factors of production supplied by the residents of a country Ex. Toyota plant in US is part of Japan’s GNP

Economic Growth and Development
Economic growth – a percentage change in real GDP over a specific period of time % change in real GDP = [(final value – initial value) / initial value] * 100
Sources of economic growth:
* Short run: limited growth can be achieved through reductions in unemployment and improvements in productive efficiency * Long run: increased resource quantities, improved resource quality, and technological improvements

Why care?
The enormous cumulative impact that rates of growth have on levels of real GDP and per capita explains why governments around the world focus strongly on factors and policies that will accelerate their rate of growth
Economic development – a process whereby increases in real per capita incomes are accompanied by improvements in levels of living of the population and reductions in poverty and inequalities
Timeline:
* 50s and 60s: focus on economic growth
* 70s: redistribution with growth
* 80s, 90s, and beyond: human development (the process of expanding human freedoms)
Relationship between the two:
* Economic growth can occur without economic development
* Some economic development can occur without economic growth but sustained development requires growth Limitations of GDP
GDP figures understate welfare because:
* GDP does not include non-marketed output
* GDP does not include output sold in underground (informal) markets * GDP does not take into account quality improvements in goods and services * GDP does not take into account increased leisure

GDP figures overstate welfare because:
* GDP does not account for the value of negative externalities and undesirable by-products of production * GDP does not take into account the depletion of natural resources
GDP figures understate or overstate welfare because:
* GDP makes no distinctions regarding the composition of output * GDP provides no information on the distribution of income and output * GDP does not account for quality of life factors
* GDP and differing domestic price levels

Purchasing power parity – the amount of a country’s currency that is needed to buy the same quantity of local goods and services that...
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