Economics - Module 2 - Unit 1

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Unit 1 - The Economic Cycle

A key

objective of Government is to increase the total output of goods and services

produced and consumed within the economy because this leads to higher

employment and living standards.

This

output is called the Gross Domestic

Product and is calculated by adding up the total output of all producers

within the UK Economy.

The

economy is divided into three sectors:

1. The primary sector - this is the sector involved in the production of raw materials, e.g.:

Farming - food

Fishing - within the Eurozone

Mining - coil, oil, shale gas

Forestry - Northern Europe

This is all mostly imported

2. The secondary sector - includes suppliers who turn raw materials into finished goods. This sector includes:

1) Manufacturing

Cars - Toyota, Jaguar-Land Rover, Honda, VW, Ford, Nissan...

Defence

Aeroplanes - Rolls Royce, Airbus

High tech goods - Toshiba, Panasonic

2) Construction

3. The tertiary sector - includes suppliers who provide any type of service:

Education, Healthcare, Financial, Legal, Law enforcement, Armed forces, Retail & wholesale, Tourism, Media and Personal.

The Growth of the UK Economy:

Economic

growth is the increase in the productive capacity of the UK economy and this

is measured by the change in real GDP.

GDP is

the monetary value of the total output produced in each sector.

This

is measured both quarterly and annually.

The

measure is adjusted for inflation to calculate whether output has risen or

fallen.

The

percentage changes in GDP between

one quarter and the next is the indicator used to measure economic growth.

Economic growth is positive when the

value of GDP growth is above 0 and this implies the output of the economy has

increased over the quarterly period.

Economic growth is negative when the

value of GDP growth is below 0 and this implies the output the economy has

decreased over the quarterly period.

An economic recession occurs when GDP

growth is negative for two consecutive quarters or a period of six months.

Key dates of the two recessions

1990 - Q3 - The economic recession of 1990/91 lasting 5 quarters, where the economy contracted by a total of -2.3%.

2008 - Q2 - The economic recession of 2008/09 lasting 5 quarters, where the economy contracted by a total of -6.2%.

The recession of 2008/09 lasted the same time, but the economy contracted deeper by -3.9%.

The

Economic Cycle:

The economy therefore does not grow at a

constant rate every quarter but fluctuates and is characterised by phases of

-Growth -Recession -Boom -Slump -Upturns -Downturns

-Economic growth is a phase of the

economic cycle when the productive capacity is growing and GDP growth is

positive.

-An economic recession is phase of the economic

cycle when economic growth is negative

for two consecutive quarters and means the productive capacity of the economy

is shrinking.

-A boom

is a phase of the economic cycle when economic growth is growing above its

trend rate of growth which for the UK has been calculated at about 2.25%-2.5%. This means output is above a level that the

economy can be sustained over the long term.

-A slump

or depression is a prolonged recession where GDP

shrinks by more than 10%. The last slump

experienced by the UK was in the 1930’s which lasted from all of this decade

and only came to an end as a result of World War 2. The Wall Street Crash was a signal that the

global economy was entering a severe downturn.

Some are worried that the recent financial crash may signal a slump of

similar proportions.

-An upturn

means economic growth is accelerating and productive capacity (output) is

growing at an increasing rate. A rise

from 0.5% to 1.5% quarterly growth is an example.

-A downturn

means economic growth is slowing down and output is growing at a decreasing

rate. A fall in growth from 2.4% to

1.1% is an example. The economy is still

growing but at a slower rate.

-A double

dip recession means that two periods of negative growth have occurred one

after the other without the economy returning to its trend rate of growth for a

sustained period in between.

How Economic growth affects output

Output can be classified into:

a)

Consumer goods food, clothing and shelter that

satisfy human demand

b)

Capital goods such buildings and machines that

produce consumer goods.

Economic growth can be illustrated using

a production possibility frontier.

The production possibility frontier is

curved to illustrate how there is a limit to the productive capacity of the

economy.

Economic growth is illustrated by an

outward shift of the PPF

Economic recession is illustrated by an

inward shift of the PPF

Investment

in capital goods is the key to generating economic growth.

Consumer goods are favoured in production to capital goods (C1,K1).

Economic growth implies a rise in output, employment and living standards.

The benefits of economic growth

Economic growth is desirable because it generates

benefits for consumers, producers and society:

Economic growth means the productive

capacity of the economy has risen.

1.

This means a higher level of output of good and

services. This can be illustrated by an

increase in the production possibility frontier.

2.

This means that the supply of capital good has

risen and this will result in more consumer goods being available.

3.

This will create more jobs in the economy

leading to higher wages, salaries and consequently living standards.

4.

Technological improvement will result in better

quality goods at cheaper prices.

5.

Consumers will have more disposable income to

spend on consumer durables such as property and services.

6.

Higher tax revenues for the state will allow

higher spending on merit goods such as health and education.

7.

Growth encourages further increases in

enterprise and investment.

8.

Firms benefit from higher profits which can be

used to finance new investment.

Therefore economic growth leads to

higher levels of output, employment, wages, profits and living standards.

Government benefits from higher tax revenues leading

to better public services such as health and education.

GDP

per Capita

GDP per capita is

calculated by dividing GDP by population,

and is a more accurate measure of the increase in living standards because it

provides a crude monetary measure of how resources are divided amongst the

population of that country.

GDP per capita is calculated as: GDP / Population.

In theory, a rise in economic growth would mean a rise in GDP, and therefore a rise in GDP per capita.

However, since 2008 GDP per capita has not seen a significant increase despite a growth in the economy. This is due to the significant population growth was has grown quicker than Real GDP. Factors contributing to population are immigration, a rise in the birth rate and a fall in the death rate.

Economic Growth and the Price Level

Economic growth measures changes in real

GDP and therefore the effects of inflation have been removed.

This means economic growth measures the

change in actual output.

Inflation is a measure of the average

rise in prices. It is calculated by

comparing the price of a basket of goods and services over a period of time.

The

basket includes a selection of goods and services that the typical family buy

on a regular basis.

In

the UK,

an index called the consumer price index (CPI) is used to measure changes in

the average price level.

Value of total output - % Change in GDP - % Change in Inflation

E.g.

In 2010 GDP was £100bn, and in 2011 it was £110bn.

The rise in GDP in money terms = 10%

Inflation during this period was was 6%

Total economic growth = 10% - 6% = 4% GDP.

Therefore,

the value for real GDP or economic

growth will have been adjusted for the increase in prices that will have taken

place during this period.

The use of Index Numbers to express data:

Nominal - GDP NOT adjusted for inflation, and is valued using current prices for that period.

Constant - GDP adjusted for inflation, and so must be expressed according to a base year.

2004: Nominal GDP - £121bn ~ Inflation index - 10% ~ Real GDP - 121/1.1 = £110bn.

2005: Nominal GDP - £136.5bn ~ Inflation index - 5% ~ Real GDP - 136.5/1.05 = £130bn.

Hence, Real GDP = Nominal GDP / Infation Index (as a decimal.)

GDP Growth = Growth / Base Real GDP x 100%.

GDP Growth = £20bn / £110bn x 100% = 18%.

To calculate index:

1. Select a base year e.g. 2010 (£625bn).

2. Use the formula for each year: Current GDP / Base GDP x 100

E.g. 2012 - 667 / 625 x 100 = 107%.

3. Precentage of annual growth = % Change / Previous Index x 100

E.g. 2012 - 4 / 103 x 100 = 3.9%.

The Circular Flow of Income

Macroeconomics is concerned with the

economy as a whole and therefore focuses on output, employment, inflation and

trade.

National output is considered the key

indicator to the health of the economy.

A healthy economy is one when the

national output is growing while an unhealthy economy is one when national

output is contracting.

1.

Households own the factors of production such

as land, labour and capital which they supply to firms in return for an income

in the form of wages, rents and dividends.

2.

Firms produce all the goods and services by

hiring or renting factors of production from households.

3.

Households used their income to buy finished

goods and services from firms.

4. This produces three flows that can be

measured:

a)

The output

of goods and services from firms.

b)

The income

of household.

c)

The expenditure

by households on goods and services.

Income =

Expenditure = Output

It is assumed in this simple model that

all income is spent on buying goods and services.

Injections and Withdrawals

Injections are sources of income that cause the

economy to grow such a:

1.

Investment

spending by firms on

capital goods such as

Factories and warehouses

Equipment and machinery

Buildings and offices.

2.

Government spending on

Education, healthcare, defence, welfare, defence, public order, housing and infastructure.

3.

Exports which are goods produced in the UK but sold

abroad and therefore bring in income such as

Food and drinks

Alcohol and tobacco

Cars and aeroplanes

Drugs and medicine

Oil.

Withdrawals cause the economy to contract such as:

1. Savings

is the part of

disposable consumer income that households choose not to spend, but is invest in

Banks, shares, pensions and bonds.

2. Tax

is that part of gross household income that the

government takes and can be in the form of

Excise tax (alcohol and tobacco)

Value Added Tax (VAT)

National insurance

Council tax, road tax and income tax

Corporation tax.

3. Imports

are that part of

household income that is spent on goods produced outside the UK and therefore

is not received by UK firms. Almost every item The UK exports can also be imported.

Measuring

income, expenditure and output

The value of national income and output

is measured in three simple ways:

1.

The

Office of National Statistics

calculates the value of quarterly GDP

in the following way

Information on sales is collected from 6,000 companies in

manufacturing, 25,000 service

sector firms, 5,000 retailers and 10,000 companies in the construction sector.

Data is also collected from government departments covering

activities such as agriculture, energy,

health and education. This is augmented by a wide range of sources which ensure that activity in

the economy is well covered.

This

method is considered the most accurate in the short term.

2.

The department of Revenue

and Customs is able to provide a measure of national income from

information calculated on tax receipts such as income tax and VAT.

However,

this measure would not be able to provide a

quarterly calculation of GDP because the self employed and firms pay their tax annually.

Economics - Mod 2 - Unit 1