genuine%20 %2002%20-%20 national%20income%20accounting

DEPARTMENT OF FINANCEDEPARTMENT OF FINANCEUniversity Of Dar Es Salaam University Of Dar Es Salaam

Business SchoolBusiness SchoolFN 101: Principles of Macroeconomics

Lecture 2:National Income

Accounting

Genuine MartinB. Com, M.A. (Economics)

2

Measures of OutputMeasures of Output Total output: array of produced goods and

services. Prices are used to measure value. National Income Accounting: process of

measuring aggregate economic activity (national income and its components).

How possible to add oranges and mangoes? Using monetary terms (prices), aggregates

all output produced in the economy.

3

Measures of OutputMeasures of Output National income and product accounts -

data collected and published by government to describe various components of national income and output in the economy.

The data is collected and compiled by the National Bureau of Statistics (NBS).

4

Measures of OutputMeasures of Output GDP: total market value of all final goods and

services produced within national borders in given time period.

GDP – output within Tanzanian borders. GNP – output produced by Tanzanians anywhere they

are located. GNP calculation is complex and less dependable.

Why? Factors of production and ownership move across

borders in global economy. GDP is geographically focused.

5

Measures of OutputMeasures of Output GDP aids international comparison. GDP per Capita: national GDP divided by

population size. What a single person shares in national GDP. Suggests standard of living. However, comparison among nations is abstract

and lifeless. Lack: how GDP is distributed, access to

education, health, infrastructure, water, electricity, quality of environment, peace and security.

6

Measures of OutputMeasures of Output Per capita would be a measure of relative

standard of living: when countries are similar in structure, institutions, and above items.

7

Measures of OutputMeasures of Output GDP in Tanzania was 23.87 billion USD in

2011. It is 0.04% of the world output.

8

Measures of Output, GDP Measures of Output, GDP (IMF, 2012 Data)(IMF, 2012 Data)

Rank Country GDP PPP ($ Billion) Share (%)— World 82,762 100— European Union 16,074 19.41 United States 15,653 18.92 China 12,383 15.03 India 4,711 5.74 Japan 4,617 5.65 Germany 3,194 3.96 Russia 2,512 3.07 Brazil 2,366 2.98 United Kingdom 2,316 2.8

http://en.wikipedia.org/wiki/Gross_world_product

http://en.wikipedia.org/wiki/European_Union

http://en.wikipedia.org/wiki/United_States

http://en.wikipedia.org/wiki/China

http://en.wikipedia.org/wiki/India

http://en.wikipedia.org/wiki/Japan

http://en.wikipedia.org/wiki/Germany

http://en.wikipedia.org/wiki/Russia

http://en.wikipedia.org/wiki/Brazil

http://en.wikipedia.org/wiki/United_Kingdom

9

Measures of Output, GDP Measures of Output, GDP (IMF, 2012 Data)(IMF, 2012 Data)

Rank Country GDP PPP ($ Billion) Share (%)— World 82,762 100— European Union 16,074 19.49 France 2,253 2.710 Italy 1,834 2.280 Tanzania 67.9 0.1182 Tuvalu 0.037 0.000045

http://en.wikipedia.org/wiki/Gross_world_product

http://en.wikipedia.org/wiki/European_Union

http://en.wikipedia.org/wiki/France

http://en.wikipedia.org/wiki/Italy

http://en.wikipedia.org/wiki/Tanzania

http://en.wikipedia.org/wiki/Tuvalu

10

Measures of Output, GDP per Measures of Output, GDP per Capita (IMF, 2010-11 Data)Capita (IMF, 2010-11 Data)

Rank Country GDP per Capita ($)1 Qatar 98,9482 Luxembourg 80,5593 Singapore 59,7104 Norway 53,3965 Brunei 49,536— Hong Kong 49,4176 United States 48,3287 United Arab Emirates 47,7298 Switzerland 44,452

http://en.wikipedia.org/wiki/Qatar

http://en.wikipedia.org/wiki/Luxembourg

http://en.wikipedia.org/wiki/Singapore

http://en.wikipedia.org/wiki/Norway

11

Measures of Output, GDP per Measures of Output, GDP per Capita (IMF, 2010-11 Data)Capita (IMF, 2010-11 Data)

Rank Country GDP per Capita ($)9 San Marino 43,09010 Netherlands 42,023160 Tanzania 1,610185 Congo, Dem. Rep. 349

12

Measures of Output (GDP in Measures of Output (GDP in Billion $ for Tanzania, WB)Billion $ for Tanzania, WB)

13

Measures of Output (GDP per Measures of Output (GDP per Capita $ for Tanzania, WB)Capita $ for Tanzania, WB)

14

Measurement ProblemsMeasurement Problems Nonmarket activities – produced but not sold

in markets, e.g. works of homemaker, housewives, friend’s help, etc.

Unreported income – tax evasion (underground economy, e.g. mow lawns, clean houses, paint walls, childcare) and illegal activities (drug dealers, prostitution, gambling, organized crime).

15

Value AddedValue Added GDP – market value of final goods/services. If every stage of production is counted, same

commodity would be counted twice (double counting).

How do we measure final value? 1) Include only final market values. 2) First stage value plus added value each next

stage (intermediate goods). Intermediate goods – purchased for use of

producing final goods.

16

Value AddedValue Added Value added – increase in market value of

product at each stage of production.No Stages of Production Value of

Transaction

Value

Added

1 Farmer grows wheat, sells it to a miller Tshs. 192 Tshs. 192

2 Miller converts wheat to flour, sells it to

baker

448 256

3 Baker bakes bagel, sells it to bagel store 960 512

4 Bagel store sells bagel to consumer 1,200 240

Total Tshs. 2,800 Tshs. 1,200

17

Real vs Nominal GDPReal vs Nominal GDP Nominal GDP = Sum of Price x Output for all

goods/services. Sources of change in GDP: change in output

(level of production) and change in prices. Changes in prices distort real/actual changes in

level of production. Rise in GDP could result from increasing prices,

not production. To take off this price distortion, we use real GDP.

18

Real vs Nominal GDPReal vs Nominal GDP Nominal GDP – value of final output measured in

current prices. Real GDP – value of final output measured in

constant prices. To get Real GDP from Nominal GDP, we deflate

Nominal GDP using GDP Deflator. GDP Deflator is the general average price level

for whole economy. Note: For base year, real and nominal GDP are

same.

19

Real vs Nominal GDPReal vs Nominal GDP

The percentage change in GDP Deflator gives inflation rate for whole economy.

DeflatorGDPNGDP

RGDP tt

100XRGDPNGDP

DeflatorGDPt

t

20


Item 2007 2008

1 Nominal GDP in trillion shillings 81.11 84.99

2 Change in nominal GDP 3.88 (4.78%)

3 Change in price level from 2007 to 2008 4.0%

4 Real GDP in 2007 shillings 81.11 81.72

5 Change in real GDP 0.61 (0.75%)

)04.199.84(

21


Nominal GDP in 2008 – Tshs. 2,679 billion

Nominal GDP in 2009 – Tshs. 3,004

Product A B C D Total

Output Q (mns) 18 12 38 59

Price Q (thousands) 17 40 11 25

P x Q (billions) 306 480 418 1,475 2,679


Output Q (mns) 20 19 31 48


P x Q (billions) 420 741 403 1,440 3,004

22


Real GDP in 2009 – Tshs. 2,641. Real GDP declined by -1.42% (recall: nominal

GDP increased by 12.13%).


Output Q (mns) 20 19 31 48


P x Q (billions) 340 760 341 1,200 2,641

100XRGDPNGDP

DeflatorGDPt

t

7.1131002,6413,004

XDeflatorGDP

23

Real vs Nominal GDPReal vs Nominal GDP 2008 base year, GDP Deflator 100; 2009 GDP

Deflator is 113.7.

10008

0809 XDeflatorGDP

DeflatorGDPDeflatorGDPInflation

%7.13100100

1007.113

XInflation

24

GDP Deflators used by NBSGDP Deflators used by NBS

25

Real vs Nominal GDP Data in Real vs Nominal GDP Data in Tanzania (NBS, Tshs. Billion)Tanzania (NBS, Tshs. Billion)

Type 2009 2010 2011

Nominal GDP 28,213 32,293 37,533

Real GDP 14,664 15,700 16,712

GDP Deflator 192.40 205.69 224.59

Inflation Rate - 6.9 9.2

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Net Domestic Product (NDP)Net Domestic Product (NDP) Real GPD changes show how output is growing. Production uses factors of production and

technology, leaving us with fewer resources to use for next year’s production.

Future production possibilities shrink. Plant and equipment used wears and tears

(depreciation). Thus reducing next year’s resources. NDP is amount of output within next year’s

production possibilities.

27

Net Domestic Product (NDP)Net Domestic Product (NDP) Thus NDP = GDP – depreciation. To maintain same production possibilities, replace

capital by producing new plant and equipment (gross investment).

When this stock depreciates, we are left with net investment.

Net investment = Gross investment – Depreciation. To maintain same stock of capital, net investment

should be positive, i.e. gross investment > depreciation.

28

Net Domestic Product (NDP)Net Domestic Product (NDP) Stock of gross capital at a time is given as: G.Capitalt = G.Capitalt-1 + G.Investmentt –

Depreciation

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Uses of OutputUses of Output Where GDP is used/spent – mix of output

selected. Used by four market participants: consumers,

firms, government, and foreigners. 1) Consumption (C) – goods and services

purchased by households in product markets. 2) Investment (I) – plant, machinery and

equipment produced, net changes in inventories and residential constructions.

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Uses of OutputUses of Output 3) Government Spending (G) – central and

local government purchases and spending, e.g. police, teachers, law making, building infrastructure, etc.

4) Net Exports (X-M): exports – imports. Exports are goods/services sold to foreigners, and imports are bought from foreigners.

GDP can be computed as: GDP = C + I + G + (X – M)

GDP C I G X M ( )

31

Share of GDP by Expenditure Share of GDP by Expenditure Category (NBS)Category (NBS)

Expenditure Category 2001 2006 2011GDP at market Prices 100 100 100Final consumption expenditure 75.0 68.0 66.1Government expenditure 11.9 17.5 16.4Gross capital formation 17.5 27.6 36.7Exports 17.0 22.6 31.1Imports -21.3 -35.7 -50.2

32

Share of GDP by Economic Share of GDP by Economic Activity (NBS, 2011)Activity (NBS, 2011)

33

Measures of OutputMeasures of Output Every transaction has buyers and sellers. In exchange, shilling spent by buyers is

income to sellers. Thus, Income = Expenditure. GDP accounts have two sides. Expenditure – demand side. Income – supply side. Factors of production (factor markets) are

supplied to firms, and owners get paid income.

34

Measures of OutputMeasures of Output i.e. Labourers (wage & salaries), Landlords

(rent), Lenders (interest), Business Firms (profit and depreciation allowance) & Government (taxes).

They in turn spend their income buying goods and services in product markets.

35

Measures of OutputMeasures of Output i.e. GDP can be computed in two ways: The expenditure approach: A method of

computing GDP that measures the amount spent on all final goods during a given period.

The income approach: A method of computing GDP that measures the income—wages, rents, interest, and profits—received by all factors of production in producing final goods.

36

The Income ApproachThe Income Approach i.e. i.e. GDP can be computed in two ways:GDP can be computed in two ways: National Income - tNational Income - the total income earned by

the factors of production owned by a country’s citizens.

Income approach breaks down Income approach breaks down GDPGDP into four into four income components: rents, interest, wages, income components: rents, interest, wages, and profits. and profits.

37

Measures of OutputMeasures of Output

Product

market

Factor

market

Consumer spending

VALUE OF OUTPUT

Investment spending

Government spending

Net exports

Profits

Wages

Interest

Rent

VALUE OF INCOME

Sales Taxes Depreciation

38

Measures of OutputMeasures of Output Table gives summary of expenditure and

income sides.

39

Measures of OutputMeasures of OutputExpenditure (billion of shillings) Income (billion of shillings)

Consumer goods and services 5808 Wages and salaries 4981

Investment in plant, equipment,

and inventory

1367 Corporate profits 825

Government goods and services 1487 Proprietors’’ income 548

Exports 959 Farm income 29

Imports (1110) Rents 163

Interest 449

Sales taxes 608

Depreciation 908

Total value of output 8511 Total value of income 8511

40

Measures of OutputMeasures of Output Who actually gets these Tshs. 8511 billion of

income??? GDP is Tshs. 8511 How is it distributed then? 1) Depreciation – sales revenue is

immediately diverted in form of depreciation charges (wear and tear of capital plant & equipment).

NDP = GDP – Depreciation.

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Measures of OutputMeasures of Output• 2) Indirect Business Taxes – when goods are

sold in market, sales tax are paid to government (VAT, Cess tax).

• The remaining income goes to factors of production, i.e. National Income (NI).

• NI = NDP – Indirect Business Taxes.• National Income is earned by households

(consumers) and corporations (households are shareholders).

• Diversions continue.

42

Measures of OutputMeasures of Output First, corporations pay corporate tax to

government on profit (30% in Tz). Second, part of profit is retained back to

businesses (retained earnings, RE) for further expansion and cash needs.

The remaining balance goes to consumers. Consumers pay Social Security Tax (NSSF,

PPF, PSPF). Again, consumers receive some payment from

government (transfer payments, added back)

43

Measures of OutputMeasures of Output Lastly, consumers receive interest payment in

excess of what they pay (own capital, and borrowers; net interest).

What is left is Personal Income (PI). PI = NI – Corporate Taxes – RE – Social Security

Taxes + Transfer Payments + Net Interest Out of Personal Income, consumers pay personal

income taxes (PAYE). Amount left is called Disposable Income (DI). DI = PI – Personal Taxes.

44

Measures of OutputMeasures of Output Lastly, DI can be spent (consumed) or saved

(S). DI = C + S

45

Composition of Net Disposable Composition of Net Disposable Income at 2001 prices (NBS)Income at 2001 prices (NBS)

46


Income flow Amount (billion shillings)

Gross domestic product (GDP) 8511

Less depreciation (908)

Net domestic product (NDP) 7603

Less indirect business taxes (608)

National income (NI) 6995

Less corporate taxes (240)

47


Income flow Amount (billion shillings)

Less retained earnings (299)

Less Social Security taxes (768)

Plus transfer payments 1122

Plus net interest 316

Personal income (PI) 7126

Less personal taxes (1098)

Disposable income (DI) 6028

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Measures of OutputMeasures of OutputVariable Billion Shillings

GDP 9,299.2 Plus: receipts of factor income from the rest of the world + 305.9 Less: payments of factor income to the rest of the world - 316.9 Equals: GNP 9,288.2 Less: depreciation - 1,161.0 Equals: net national product (NNP) 8,127.1 Less: indirect taxes minus subsidies plus other - 675.5 Equals: national income 7,469.7 Less: corporate profits minus dividends - 485.7 Less: social insurance payments - 662.1 Plus: personal interest income received from the government and consumers + 456.6 Plus: transfer payments to persons +1,011.0 Equals: personal income 7,789.6 Less: personal taxes - 1,152.0 Equals: disposable personal income 6,637.7

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Circular Flow of IncomeCircular Flow of Income Every shilling spent on goods/services flows into

somebody’s hands (income). This is summarized in circular flow of income. One half explain income flow, and another half –

expenditure flow; in monetary terms. Flow of income, starting as GDP ends up in market

as consumption, investment, government purchases, and net exports.

Simplified Version

50

Circular Flow of IncomeCircular Flow of Income

Households

(Owners of

Factors of

Production)

Firms

(Producers of

Goods and

Services) Markets f or Factors

of Production

Markets f or Goods and Services

Consumption

Income Factor Payments

Firm Revenues

51

Circular Flow of IncomeCircular Flow of Income Households (owners of land, labour, capital,

entrepreneurship) supply factors to firms (factor markets), and get paid income (rent, wages, interest, profit).

Firms use factors to produce goods/services, sell them to households and get paid revenue income.

Shades boxes represent economic actors (households, firms).

Un-shaded boxes represent types of markets (product and factor markets).

52

Circular Flow of IncomeCircular Flow of Income Arrows represent flow of money. More Realist Circular Flow

53

Circular Flow of IncomeCircular Flow of Income

Households Firms (Producers

of Goods

and

Services)

Investment (IA)

Governments

Government Purchases (G)

Government Borrowing

Aggregate Income = GDP

Transfer Payments

Taxes (T)

Consumption (C)

Rest of the World

Financial Markets Saving (S)

1 Disposable Income Yd=GDP-NT

2

10

9

7 6

5

4

3

C+IA+G+(X-M)=GDP

Imports (M)

Exports (E)

8

54

Circular Flow of IncomeCircular Flow of Income Households supply labour, capital, land, and

entrepreneurship to firms and get paid wages, interest, rent and profit (1).

Out of that return, government collects taxes and returns transfer payment (2 & 3).

Amount left is disposable income. Yd = GDP – NT That is income side. In expenditure side, out of disposable income,

households consume some (4) and save others (S).

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Circular Flow of IncomeCircular Flow of Income Yd = C + S Savings flow in financial markets which pool them and

lend to firms, governments, and households (6 & 7). Firms borrow and make investment (IA). Governments spend money received from taxes and

borrowing (8). Households, firms and government spend on imports

9). Rest of world spend on our goods and services

(exports) (10).

© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair

The Components of the The Components of the MacroeconomyMacroeconomy

Everyone’sEveryone’sExpendituresExpendituresGoGosomewhere. somewhere. Every Every transaction transaction must havemust havetwo sides.two sides.

57

Injections-Leakages EqualityInjections-Leakages Equality Leakage – diversion of income from domestic

spending stream (savings, taxes, imports). Injections – any payment of income other than by

firms or any spending other than by domestic households (investment, government, exports).

Economic equilibrium: Expenditure = Income Leakages = Injections Intuitions? Savings divert income and investment brings it

back.

58

Injections-Leakages EqualityInjections-Leakages Equality Imports divert income, and exports bring it back. Government taxes divert income and government

spending brings it back. Economic equilibrium: Expenditure = Income Y = AE = C + I + G + X – M, subtract taxes both

sides, Y – T = C + I + G – T + X – M, bring the

consumption variable to the left, Y – T – C = I + G – T + X – M, recall Y – T = Yd,

and Yd – C = S.

59

Injections-Leakages EqualityInjections-Leakages Equality S = I + G – T + X – M, bring the negative terms

to the left hand side, S + T + M = I + G + X.

60

Real GDP and Economic Real GDP and Economic Well-BeingWell-Being

GDP captures goods/services ONLY priced and sold to markets.

Thus imperfect measure of economic well-being. Many factors that contribute to economic well-

being are omitted. 1) Leisure time – time spent by workers on

family and friends, sports & hobbies, cultural and educational activities are not priced in markets and included in GDP.

61


2) Nonmarket economic activities – e.g. unpaid housekeeping, volunteer services, underground activities e.g. informal babysitting, part-time house cleaners, painters (legal) and organized crime (illegal) are not captured.

3) Environmental quality and resource depletion – economic growth is accompanied by severe decline in air and water quality, exploitation of finite resources not taken into account in GDP computation.

62


Efforts to conserve environment and benefits of quality environment are not priced.

4) Quality of life – low crime rate, minimal traffic congestion, active civic organizations, open spaces are not sold in markets and included in GDP.

5) Aggregation problem – GDP is expressed in aggregate money terms, doesn’t distinguish a shilling spent on books & cigarettes/military.

63


6) GDP ignores depreciation – wear and tear in capital is not taken into account, takes gross values BUT NDP does.

Recall: NDP = GDP – depreciation. However, depreciation is a not a very precise

measure, thus ignored. 7) Poverty and economic inequality – GDP

does not tell about income distribution.

64

Business CyclesBusiness Cycles Ups and downs in economic activities. Affect jobs, prices, economic growth, international

trade, and balances. Before the Great Depression (1929-33), economists

thought market economy was inherently stable and no need of government intervention.

After it, macroeconomics was born. Much interest to understand causes, nature, effects

and management of business cycles arose.

65

Business CyclesBusiness Cycles Business Cycles – economy-wide short-term

fluctuations in production, trade, economic activity in general over several months/years, occurring around a long-term trend, and tends to recur after certain length of time.

Measured using growth rate of real GDP. Have four phases: boom, recession, depression, and

recovery. 1) Boom – real GDP is at the peak. Economy operates at or beyond full capacity. Shortage of skilled people and raw materials.

66

Business CyclesBusiness Cycles Period of excess demand. Prices rise faster than costs, profits and investors are

optimistic. If people don’t replace capital used, economy turns

into slump and lead to fall in spending. 2) Recession – real GDP growth rate declines and

unemployment rises. Signalled by two quarters of consecutive output

decline. Output and employment declines from peak to trough.

67

Business CyclesBusiness Cycles Job creation rate is typically slower, than number

of people entering job markets. 3) Depression/Trough - real GDP is at the

bottom. A severe form of recession. A prolonged and deep recession becomes a

depression. Depression results when there is financial panic

during recession. .

68

Business CyclesBusiness Cycles Associated with high unemployment and unused

productive capacity (unemployed capital). Capacity utilization rates drop significantly. Business profits are low, and investors are

pessimistic. 4) Recovery – real GDP climbs from trough to

peak. Output and employment rises. After depression, capital wears out and households

and businesses start to replace it.

69

Business CyclesBusiness Cycles Spending picks up and we enter a recovery. As sales and profits pick up, investors become

more optimistic.

70

Business CyclesBusiness Cycles

© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair71

Figure 1 A Look At Short-Run Economic Fluctuations

Billions of1996 Dollars

Real GDP

(a) Real GDP

$10,000

9,000

8,000

7,000

6,000

5,000

4,000

3,000

2,0001965 1970 1975 1980 1985 1990 1995 2000

Copyright © 2004 South-Western

72

Business CyclesBusiness Cycles Issue – does recurring exist? What causes it? Three major facts about business cycles: 1) Irregular and unpredictable. 2) Most macroeconomic variables fluctuate

together. Income or production measures. May fluctuate at different amounts. 3) As output falls, unemployment rises. Changes in real GDP are inversely related to

changes in unemployment rate.


Real GDP, 1970 I-1997 II Real GDP, 1970 I-1997 II


Unemployment Rate, 1970 I-1997 II


Percentage Change in the GDP Price Percentage Change in the GDP Price Index (Four-Quarter Average), 1970 I-1997 Index (Four-Quarter Average), 1970 I-1997

IIII

76

Indicators of CyclesIndicators of Cycles Issue – does recurring exist? What causes it? Capacity utilization rates - show the percentage

of factory capacity being used in recession. In normal times, 15% of capital is being repaired

or replaced and the average utilization rate is around 85%.

During boom times the capacity utilization rate rises to as high as 92%.

Recession, falls to as low as 70%.


Real GDP and Unemployment Rates,1929-1933

Real GDP and Unemployment Rates, 1929–1933Real GDP and Unemployment Rates, 1929–1933THE EARLY PART OF THE GREAT DEPRESSION, 1929–1933THE EARLY PART OF THE GREAT DEPRESSION, 1929–1933

PERCENTAGE PERCENTAGE CHANGECHANGEIN REALIN REAL

GDPGDPUNEMPLOYMENTUNEMPLOYMENT

RATERATE

NUMBER OFNUMBER OFUNEMPLOYEDUNEMPLOYED

(MILLIONS)(MILLIONS)19291929 3.23.2 1.51.5

19301930 8.68.6 8.98.9 4.34.3

19311931 6.46.4 16.316.3 8.08.0

19321932 13.013.0 24.124.1 12.112.1

19331933 .4.4 25.225.2 12.812.8Note:Note: Percentage fall in real GDP between 1929 and 1933 was 26.6 percent. Percentage fall in real GDP between 1929 and 1933 was 26.6 percent.


Real GDP and Unemployment Rates,Real GDP and Unemployment Rates,1980-19821980-1982

Real GDP and Unemployment Rates, 1980–1982Real GDP and Unemployment Rates, 1980–1982THE RECESSION OF 1980–1982THE RECESSION OF 1980–1982

PERCENTAGE PERCENTAGE CHANGECHANGEIN REALIN REAL

GDPGDPUNEMPLOYMENTUNEMPLOYMENT

RATERATE

NUMBER OFNUMBER OFUNEMPLOYEDUNEMPLOYED

(MILLIONS)(MILLIONS)

CAPACITYCAPACITYUTILIZATIONUTILIZATION

(PERCENTAGE)(PERCENTAGE)19791979 5.85.8 6.16.1 85.285.2

19801980 0.20.2 7.17.1 7.67.6 80.980.9

19811981 2.52.5 7.67.6 8.38.3 79.979.9

19821982 2.02.0 9.79.7 10.710.7 72.172.1Note:Note: Percentage increase in real GDP between 1979 and 1982 was 0.1 percent. Percentage increase in real GDP between 1979 and 1982 was 0.1 percent.Sources: Historical Statistics of the United StatesSources: Historical Statistics of the United States and U.S. Department of Commerce, Bureau of Economic Analysis. and U.S. Department of Commerce, Bureau of Economic Analysis.

79

Economic Growth – Average Economic Growth – Average Growth of Real GDP at 2001 pricesGrowth of Real GDP at 2001 prices

80

Economic GrowthEconomic Growth Most rich countries grow at 1.5 to 2% per year. It takes 40-50 years to double income per person. There are growth miracles with growth rates

above 5%. It takes 12 years to double income per person. All of the growth miracles were middle income

countries in 1960. There are growth disasters with negative growth

rates. All of these are in Africa and South America.

81

GDP Growth Rate for GDP Growth Rate for Tanzania, WBTanzania, WB

82

Countries Growth Rate of Real Countries Growth Rate of Real GDP, CIA World Fact Book, 2012 GDP, CIA World Fact Book, 2012

Rank Country Growth Rate in %1 Ethiopia 11.22 Panama 8.53 Laos 8.34 Ghana 8.25 Cote d'Ivoire 8.124 Tanzania 6.5205 Greece -6.0206 Anguilla -8.5 (2009 est.)207 Sudan -11.2208 South Sudan -55.0

83

Economic GrowthEconomic Growth Economic growth – expansion of a country’s

potential GDP or national output. Central objective of national policy. PPF shifts outwards. Measured by growth rate of real GDP. Also considers percentage change in GDP per

capita which suggests growth in living standards. GPD per capita grows when growth rate of real

GDP exceeds growth rate of population.

84

Economic GrowthEconomic Growth For most countries, the engine of economic growth

rides on four wheels: labour, land, capital, and technology/entrepreneurship.

Britain, Japan, China, India, USA, South East Asia etc. needed these four wheels.

The issue is how to coordinate wheels movement. 1) Human resources – labour supply, education,

discipline, & motivation. 2) Natural resources – land, minerals, fuels,

environmental quality.

85

Economic GrowthEconomic Growth 3) Capital formation – machines, factories, roads,

electricity, well developed financial sector. 4) Technology and entrepreneurship – science,

engineering, management; initiative & risks taking; creative and innovative manpower.

How to drive the four wheels? Combine factors of production?

Production function - technical combination of inputs and maximum possible output to be produced.

86

Economic GrowthEconomic Growth Micro-foundation, aggregation of production

functions gives national output (GDP). Q = A.F(K, L, R) Q = output, K = capital, L = labour, R = natural

resources, A = technology. Technology auguments productivity of inputs

(output to weighted average of inputs). With technology improvement, more output is

produced using same level of inputs. Policies to raise rate of economic growth:

87

Economic GrowthEconomic Growth 1) Increase human capital – support education,

training, & skills development. Skilled and well-educated workforce is more

productive. 2) Promote saving and investment – capital

improves labour productivity. Encourage saving and investment using tax code,

invest in infrastructure (roads, bridges, airports, dams, energy and communication networks).

88

Economic GrowthEconomic Growth 3) Research and Development – technology

enhances productivity, basic scientific knowledge, management skills, military and space (GPS), entrepreneurship, industrialization, agri-technology.

4) Legal and political framework – conducive environment for private sector operations, property rights, legal system, political stability, motivating entrepreneurship, free and open exchange of ideas.

© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair

Economic GrowthEconomic Growth• The production possibility The production possibility

frontier shows all the frontier shows all the combinations of output combinations of output that can be produced if all that can be produced if all society’s scarce resources society’s scarce resources are fully and efficiently are fully and efficiently employed.employed.

• Economic growth Economic growth shifts society’s shifts society’s production possibility production possibility frontier up and to the frontier up and to the right.right.

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Economic GrowthEconomic Growth Is growth good or bad? Pro-Growth Arguments: Advocates of growth believe growth is progress. New technologies and production methods lead to new

and better products. Capital accumulation and new technology improve the

quality of life. In 1995, real GDP per capita was more than twice what

it was in 1950. Since the 1950s, incomes have grown twice as fast as prices.

Growth gives us more choices.

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Economic GrowthEconomic Growth Growth saves the most valuable commodity—

time. Growth produces jobs and higher incomes. With

higher incomes we can better afford the sacrifices needed to help the poor.

Anti-Growth Arguments: When population growth is not accompanied by

growth in output, unemployment and poverty increase.

Growth has negative effects on the quality of life.

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Economic GrowthEconomic Growth Growth encourages the creation of artificial

needs (consumerism). Growth means the rapid depletion of a finite

quantity of resources. Growth requires an unfair income distribution

and propagates it.

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Economic DevelopmentEconomic Development Economic development – sustained socio-

economic growth that promotes standard of living and economic health of a specific area.

Reflects quantitative and qualitative changes in an economy.

It cuts across areas of human capital, infrastructure, competitiveness, environment, sustainability, social inclusion and income distribution, health, safety literacy, and other initiatives.

How does it differ from economic growth?

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Economic DevelopmentEconomic Development Economic growth reflects market productivity and a

rise in real GDP. Economic development reflects economic and social

well-being of people. Economic development parameters classify countries

into developed, developing, or less developed countries.

Developing countries (LDC) – low per capita income, low living standard, low HDI relative to others, poor health, short life expectancy, low levels of literacy, malnutrition, etc.

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Economic DevelopmentEconomic Development Economic development indicators combine

economic and social parameters. E.g. Human Development Index (HDI)

developed by UNDP (Amartya Sen & Gustav Ranis).

It includes four indices; per capital real GDP, life expectancy at birth, school enrolment, and adult literacy.

Intuition: economic growth should enrich people’s health and education.

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Country Ranks by HDI in Country Ranks by HDI in 2013 (Source: UNDP)2013 (Source: UNDP)

Rank Country HDI Group1 Norway 0.955 Very High2 Australia 0.938 Very High

3 United States 0.937 Very High

4 Netherlands 0.921 Very High8 Bahrain 0.796 High49 Bahamas 0.794 High50 Belarus 0.793 High

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Country Ranks by HDI in Country Ranks by HDI in 2013 (Source: UNDP)2013 (Source: UNDP)

Rank Country HDI Group51 Uruguay 0.792 High95 Tonga 0.710 Medium96 Belize 0.702 Medium96 Dominican Republic 0.702 Medium96 Fiji 0.702 Medium142 Congo 0.534 Low143 Solomon Islands 0.530 Low144 São Tomé and Príncipe 0.525 Low145 Kenya 0.519 Low152 Tanzania 0.476 Low

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Economic DevelopmentEconomic Development As table suggests, a strong connection As table suggests, a strong connection

between economic and social parameters exist.between economic and social parameters exist.

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Economic DevelopmentEconomic Development

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Economic DevelopmentEconomic Development Economic development occurs if there is a

reduction in poverty, inequality, and unemployment.

Also increase in access to improved food, shelter, health and protection under law.

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Categories of Countries Categories of Countries Based on Economic DevptBased on Economic Devpt

Data Source: World Economic Situation and Prospects (WESP).

Income Classification: based on Per Capita GNI. Low-Income Countries: PCGNI < $1005. Lower Middle Income Countries: $1,006 <

PCGNI < $3,975. Upper Middle Income Countries: $3,976 <

PCGNI < $12,275. High-Income Countries: PCGNI > $12,276.

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Developed Economies: EU-15: Austria, Belgium, Denmark, Finland, France,

Germany, Greece, Ireland, Italy, Luxembourg, Netherlands, Portugal, Spain, Sweden, and United Kingdom.

New EU Members: Bulgaria, Cyprus, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Romania, Slovakia & Slovenia.

Other Europe: Iceland, Norway, & Switzerland. Other Countries: Australia, Canada, Japan, New

Zealand, & United States.

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Developed Economies: G7: Canada, Japan, France, Germany, Italy, United

Kingdom, & United States. Economies in Transition: South-Eastern Europe: Albania, Bosnia and

Herzegovina, Croatia, Montenegro, Serbia, & Macedonia,

Commonwealth of Independent States: Armenia, Azerbaijan, Belarus, Georgia, Kazakhstan, Kyrgyzstan, Republic of Moldova, Russian Federation, Tajikistan, Turkmenistan, Ukraine, & Uzbekistan.

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Per Capita GNI: High-Income: Australia, Austria, Bahrain, Barbados,

Belgium, Brunei Darussalam, Canada, Croatia, Cyprus, Czech Republic, Denmark, Equatorial Guinea, Estonia, Finland, France, Germany, Greece, Hong Kong SAR, Hungary, Iceland, Ireland, Israel, Italy, Japan, Kuwait, Montenegro, Luxembourg, Malta, Netherlands, New Zealand, Norway, Oman, Poland, Portugal, Qatar, Republic of Korea, Saudi Arabia, Singapore, Slovakia, Slovenia, Spain, Sweden,

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Per Capita GNI: High-Income: Switzerland, Taiwan Province of China,

Trinidad and Tobago, United Arab Emirates, United Kingdom, & United States.

Upper-Middle Income: Albania, Algeria, Argentina, Azerbaijan, Belarus, Bosnia and Herzegovina, Botswana, Brazil, Bulgaria, Chile, China, Colombia, Costa Rica, Cuba, Dominican Republic, Ecuador, Gabon, Iran, Jamaica, Jordan, Kazakhstan, Latvia, Lebanon, Libya, Lithuania, Malaysia, Mauritius, Mexico,

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Per Capita GNI: Upper-Middle Income: Papua New Guinea,

Namibia, Panama, Peru, Romania, Russian Federation, Serbia, South Africa, Thailand, The former Yugoslav, Republic of Macedonia, Tunisia, Turkey, Uruguay, & Venezuela.

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Per Capita GNI: Lower-Middle Income: Angola, Armenia, Bolivia,

Cameroon, Cape Verde, Congo, Côte d’Ivoire, Djibouti, Egypt, El Salvador, Georgia, Ghana, Guatemala, Guyana, Honduras, India, Indonesia, Iraq, Lesotho, Mauritania, Morocco, Nicaragua, Nigeria, Pakistan, Paraguay, Philippines, Republic of Moldova, Sao Tome and Principe, Senegal, Sri Lanka, Sudan, Syrian, Turkmenistan, Ukraine, Uzbekistan, Viet Nam, Yemen, & Zambia.

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Per Capita GNI: Low-Income: Bangladesh, Benin, Burkina

Faso, Burundi, Central African Republic, Chad, Comoros, DRC, Eritrea, Ethiopia, Gambia, Guinea, Guinea-Bissau, Haiti, Kenya, Kyrgyzstan, Liberia, Madagascar, Malawi, Mali, Mozambique, Myanmar, Nepal, Niger, Rwanda, Sierra Leone, Somalia, Tajikistan, Togo, Uganda, Tanzania, & Zimbabwe.

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LDCs: Africa: Angola, Benin, Burkina Faso, Burundi, Central

African Republic, Chad, Comoros, DRC, Djibouti, Equatorial Guinea, Eritrea, Ethiopia, Gambia, Guinea, Guinea-Bissau, Lesotho, Liberia, Madagascar, Malawi, Mali, Mauritania, Mozambique, Niger, Rwanda, Sao Tome and Principe, Senegal, Sierra Leone, Somalia, Sudan, Togo, Uganda, Tanzania & Zambia.

East Asia: Cambodia, Kiribati, Lao People’s Democratic Republica, Myanmar, Samoa,

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East Asia: Solomon Islands, Timor Leste, Tuvalu, & Vanuatu.

South Asia: Afghanistan, Bangladesh, Bhutana & Nepal.

West Asia: Yemen. Caribbean: Haiti.

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Income Distribution Income Distribution MeasuresMeasures

Lorenz curve - measures the percent of income received by a given proportion of the population.

Generally divides the population into quintiles (20%) and portray the income earned by the bottom 20% up to the top 20%.

The percentage of households is plotted on the x axis, the percentage of income on the y axis.

A perfectly equal income distribution in a society would be one in which every person has the same income.

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In this case, the bottom 20% of society would always have 20% of the income.

Thus a perfectly equal distribution can be depicted by the straight line which is called the line of perfect equality (AB).

A perfectly unequal distribution, by contrast, would be one in which one person has all the income and everyone else has none.

In that case, the curve would be at income =0 for 99% of the population, and income would equal 100% for the last person.

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This would give rise to the line of perfect inequality (ACB).

It is impossible for the Lorenz curve to rise above the line of perfect equality, or sink below the line of perfect inequality, which means the curve must always be increasing (it is below the line of perfect equality).

In the diagram you can see that the bottom 20% of the population only receives 10% of the income.

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20% 100%Population

Inco

me

A

B

C

20%

10%

100%

Lorenz curve

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Gini coefficient - provides a measure of inequality and is usually expressed as a number between 0 and 1.

Where 0 means perfect equality (everyone has the same income).

Where 1 means perfect inequality (one person has all the income, everyone else has nothing).

The Lorenz curve can provide us with a useful way of calculating the Gini coefficient.

Take the area between the Lorenz curve and the line of perfect equality (AB).

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Divide this by the triangular area: ABC. If there is perfect equality, the area between the

line of perfect equality and the Lorenz curve would be equal to zero and the calculation would yield 0.

If there was perfect inequality, the area between the Lorenz curve and the line of perfect equality would be exactly the same and the calculation would yield 1.

We express Gini coefficient as a decimal or percentage.

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Gini Coefficient of Countries in Gini Coefficient of Countries in 2010 (CIA World Fact Book)2010 (CIA World Fact Book)

Rank Country Gini Index Year1 Namibia 70.7 20032 South Africa 65.0 20053 Lesotho 63.2 19954 Botswana 63.0 19935 Sierra Leone 62.9 198953 Kenya 42.5 2008 est.54 Burundi 42.4 199889 Tanzania 34.6 200090 Egypt 34.4 2001127 Malta 26.0 2007

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Gini Coefficient of Countries in Gini Coefficient of Countries in 2010 (CIA World Fact Book)2010 (CIA World Fact Book)

Rank Country Gini Index Year128 Slovakia 26.0 2005129 Czech Republic 26.0 2005130 Iceland 25.0 2005131 Norway 25.0 2008132 Denmark 24.0 2005133 Slovenia 24.0 2005134 Sweden 23.0 2005

genuine%20 %2002%20-%20 national%20income%20accounting

Education