Economics for Management

GSB728

Topic 7:

National Income and Accounting

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Note: This lecture note was prepared based on the teaching material provided

by the publisher of the textbook Principles of Economics.

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Learning Objectives1. Macroeconomic issues – What are the major issues in

the economy as a whole?

2. The circular flow of income – Why does money go round and round from firms to consumers and back again?

3. Economic growth and the business cycle - Is a country’s economic growth likely to be constant over time?

4. Unemployment – If people want to consume more goods, why are so many people out of work?

5. Inflation – The tendency for prices to rise. 3

Macroeconomic Issues• Microeconomics focuses on individual markets

while macroeconomics examine the economy as a whole.

• The major macroeconomic issues:

– Gross Domestic Product (GDP):• Nominal GDP: Value of the flow of final goods and

services produced over a 12 months period at current prices.

• Real GDP: Nominal GDP adjusted for inflation.

– Economic growth:• Rate of economic growth: Percentage increase in real

GDP over a 12 months period.4

Macroeconomic Issues (contd.)

– Unemployment: ‘People of working age who are without work, but want to work and are available for work at current wage rates’.

• Unemployment rate: Number of unemployed people as a percentage of the labour force.

– Inflation: Persistent rise in the general level of prices of all goods and services.

• Rate of inflation: Annual percentage increase in the price level.

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Macroeconomic Issues (contd.)

– Balance of payments: Record of all transactions between a country and the rest of the world.

• Current account: Record of a country’s imports and exports of goods and services, plus direct flows of income or payments.

• Capital account: Record of transactions between domestic and foreign residents that involve the acquisition of either an asset or liability.

• Financial account: Part of the capital account, which includes the foreign investment.

CAB + KAB = 0

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– Macroeconomic objectives:• High and sustainable economic growth.

• Low unemployment.

• Low inflation.

• Satisfactory balance of payments.

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Macroeconomic Issues (contd.)

Circular Flow of Income– The four macroeconomic objectives are linked.– Aggregate demand can be expressed in the form

of this equation:

AD = C + I + G + X – M

Where AD is aggregate demand; C is consumption of goods and

services; I is investment expenditure; G is government expenditure; X

is exports, other countries’ expenditure of our domestically-produced

goods and services; and M is imports, our expenditure on other

countries’ goods and services.

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• The inner flow, withdrawals and injections– The inner flow is presented in the next slide.

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Circular Flow of Income (contd.)

Firms

Households

Inner Flow of Income

Factor Payments

Consumption of domestically

produced goods and services (Cd)

10Source: Sloman et al. (2014).

– Withdrawals (W):• Net saving (S)

• Net taxes (T)

• Import expenditure (M)

W = S + T + M

– Injections (J):• Investment (I)

• Government expenditure (G)

• Export expenditure (X)

J = I + G + X11

Circular Flow of Income (contd.)

Factor Payments

S T M

Withdrawals

Injections

I G X

BANKS GOVT ABROADCd

Inner Flow of Income, Withdrawals and Injections

12Source: Sloman et al. (2014).

– The circular flow and the four macroeconomic objectives:

• When aggregate demand rises: Economic growth occurs.

Unemployment rate falls.

Inflation tends to rise.

Imports tend to rise, exports tend to fall.

– Equilibrium in the circular flow is achieved when injections equalise withdrawals.

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Circular Flow of Income (contd.)

• The distinction between actual and potential growth:

• Actual growth: Percentage annual increase in national output actually produced.

• Potential growth: Percentage annual increase in the capacity of the economy to produce. The rate of growth of potential output.

• Potential output: Output that could be produced in the economy if there was a full employment of resources (including labour).

Economic Growth and the Business Cycle

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• Economic growth and the business cycle:– Business cycle or trade cycle: Periodic fluctuations of

national output around its long-term trend.– There are fluctuations in actual growth, characterised

by the phases of the business cycle:• Upturn: A stagnant economy begins to recover and

growth in actual output.

• Expansion: Rapid economic growth (the economy is booming).

• Peaking Out: Growth slows down or even ceases.

• Slowdown, Recession or Slump: No growth or decline in output.

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Economic Growth and the Business Cycle (contd.)

0

Nati

onal

out

put

Time

The Business CyclePotentialoutput

Actualoutput

Source: Sloman et al. (2014). 16

0

Nati

onal

out

put

Time

Potential output

Actualoutput

1

2

3

4

Upturn

BoomPeak

Recession

12

3

4

The Business Cycle (contd.)

Source: Sloman et al. (2014). 17

– Long-term output trend.

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Economic Growth and the Business Cycle (contd.)

0

Nati

onal

out

put

Time

Potential output

Actualoutput

Trend output

Source: Sloman et al. (2014).

The Business Cycle (contd.)

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– Business cycle in practice – Irregularity of the cycle:• Length of the phases.

• Magnitude of the phases.

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Economic Growth and the Business Cycle (contd.)

Annu

al g

row

th ra

te (%

)

-1

0

1

2

3

4

5

6

1985 2006

Economic Growth in Australia, 1985-2006

Source: Sloman et al. (2014).

• Causes of fluctuations in actual growth:

– Short-run:• Growth in aggregate demand: It will create shortages

and will stimulate firms to increase output.

– Long-run:• Growth in aggregate demand.

• Growth in potential output.

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Economic Growth and the Business Cycle (contd.)

• Policies to achieve growth:– Demand-side:

• Create sufficient aggregate demand.

– Supply-side:• Increasing potential output:

– Research and development.– Innovation.– Training.

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Economic Growth and the Business Cycle (contd.)

• Benefits of economic growth:

• Increased consumption.

• Easier to redistribute income to the poor.

• Can afford to care more for the environment.

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Economic Growth and the Business Cycle (contd.)

• Costs of economic growth:

• Growth may simply generate extra demands.

• Social effects.

• Environmental costs.

• Non-renewable resources.

• Effects on income distribution.

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Economic Growth and the Business Cycle (contd.)

Unemployment

• The meaning of ‘unemployment’:• Number of unemployed.• Labour force.• Unemployment rate.

• The costs of unemployment:• To the person unemployed.• To family and friends of the unemployed.• To the economy.

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Inflation• The costs of inflation:

– Menu costs: Associated with having to adjust price lists or labels.

– Redistribution: Those on fixed incomes and in a weak bargaining position will be affected.

– Uncertainty and lack of investment.

– Worsen the balance of payments: Exports will become less competitive in world markets.

– Resources used to cope with inflation: Accountants and other financial experts may have to be employed by companies to help them to cope with the uncertainties caused by inflation. 27

• The causes of inflation:

– Demand-pull inflation: Caused by persistent rises in aggregated demand.

– Cost-push inflation: Caused by persistent rises in the costs of production (independent of demand).

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Inflation (contd.)

References

Morales, L. E., Simons, P. and Valle de Souza, S. (2014). GSB728: Economics for Management [Topic Notes]. Armidale, Australia: University of New England, Graduate School of Business.

Sloman, J., Norris, K and Garratt, D. (2014). Principles of Economics (4th ed.). French Forest, Australia: Pearson.

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