# Chapter 13 Notes English

```CHAPTER 13: MEASURING ECONOMIC PERFORMANCE
Introduction
We will begin our semester by taking a closer look at how economists measure whether an
economy is doing well, or doing poorly.
This chapter will give you more insights into commonly heard statistics and measurements
that economists regularly discuss on the news, such as economic growth, unemployment,
inflation and inequality.
In particular, we will look more closely at 5 macro-economic goals for any economy. These
are:
1.
2.
3.
4.
5.
Economic growth (See section 13.2-13.3)
Full employment (See section 13.4)
Price stability (See section 13.5)
External stability (See section 13.6)
Equitable distribution of income (See section 13.7)
1. GOAL: ECONOMIC GROWTH
Economic growth is the increase of an economy’s production from one period of time to
another.
You will recall from your first semester that we can illustrate this on the production
possibilities frontier as follows:
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Economists measure economic growth by looking at a country’s gross domestic product
(GDP). If GDP has increased from one year to the next, or from one quarter to a next, we say
that the economy has grown.
Gross domestic product (GDP) is defined as:
The total value of all final goods and services produced within a specific time period within
the borders of a country.
Remember the circular flow of the economy from your first semester? In line with the 3 major
flows of that circle, we calculate GDP according to 3 methods:
1. The expenditure approach: Add up the value of all final goods and services produced
(this is equal to the sum of the final market price for all goods and services.)
2. The production approach: We calculate total value added to the economy by
subtracting the purchasing price of inputs from the selling price of the final product.
3. The income approach: Add up the value of all income earned by the factors of
production in the production process (namely wages, interest, rent and profit.)
IMPORTANT: Remember, from the circular flow, that all of these values in the economy are
equal to one another. Therefore, when you calculate GDP according to each of these 3
methods, you must check to ensure that all 3 approaches give you the same answer.
Table 1: Comparing the expenditure, production and income approaches to GDP
The table below summarises each approach, based on the following example:
Suppose a very simple economy, which consists of a farmer, a miller, a baker and a bakery
shop owner and her customers.
The farmer produces 1 000 tons of grain and sells it to the miller at R10 per ton. The miller in
turn mills the grain in order to produce flour, which she sells to the baker for R12 500. The
baker bakes bread and sells it to the bakery shop owner for R18 000. The bakery shop owner
sells the bread to customers in her shop for a total of R21 000.
Expenditure approach
The
final
value
of
expenditure on all goods and
services.
This
can
easily
be
‘calculated’
simply
by
looking at the final market
price of all goods and
services. For instance, in this
Production approach
Also sometimes referred to
as
the
value
up the value added in each
step of the production
process by different role
players.
The
value
is
calculated as:
price
For instance, in this
example:
Income approach
The total income earned by all
4 the production factors in the
economy.
The total income is calculated
as:
Wages + interest + rent +
profit
For instance, in this example:
LECTURER NOTES | AAAA 126 CHAPTER 13
what amount the
product
eventually
sold
customers.
final The farmer did not make any
was purchases, but sold the grain
to for R10 000 (1 000 tons of
grain x R10 per ton).
was: R10 000 – R0= R10 000.
Similarly, miller
(R12 500 – R10 000) =
R2 500 of value
The baker added (R18 000 –
R12 500) = R5 500 of value
The bakery shop owner
added (R21 000 – R18 000) =
R3 000 of value.
to customers for a total of value that each producer in
R21 000.
product, we get to the total
value of production:
R10 000 + R2 500 + R5 500 +
R3 000 = R21 000
Therefore, customers’ total So, adding up the total
very small economy was that occurred in the
R21 000 and that gives us economy shows us that the
the GDP according to the GDP according to the
expenditure approach.
production approach was
R21 000 – same as for the
expenditure approach.
No information on wages,
interest or rent is given, but it
is possible for us to calculate
each producer’s profit as:
Profit = Total revenue – Total
cost
So, each producer’s profit was:
Farmer: R10 000 – R0 =
R10 000
Miller: R12 500 – R10 000 =
R2 500
Baker: R18 000 – R12 500 =
R5 500
Bakery shop: R21 000 –
R18 000 = R3 000
profit in this very simple
economy, we get the total
income earned by each
producer:
R10 000 + R2 500 + R5 500 + R3
000 = R21 000
By adding up the total income
earned by the production
factors in the economy, we can
see that the GDP according to
the income approach is
R21 000 – same as for the
expenditure and production
approach.
Additionally, economists calculate GDP at market prices or at factor prices:


GDP @ market price = GDP @ factor price – taxes + subsidies
GDP @ factor price = GDP @ market price + taxes - subsidies
Finally, sometimes economists want to take a look specifically at what is happening for
citizens of a particular country.
Though GDP is defined as the value of production within the borders of a country – we must
remember that many of those inputs used within the borders of a country are imported from
elsewhere.
To control for this factor, economists will often look at gross national income (GNI). This
allows us to see what the living standard of South Africans is, no matter where in the world
they are living. The formula for GNI is:
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GNI = GDP – primary income payments to rest of world + primary income receipts to South
Africans
We have covered the most important ways to calculate GDP here. Additionally, the lessons in
eFundi go through some other important calculations, such as how to calculate net national
product. The image below summarises how to do these various calculations.
Gross Domestic
Expenditure (fp)
• To get from Gross to
Net: -d
• To get from
Domestic to
National: -FP+FI
• To get from
Expenditure to
Production: +X-Z
• To get from Market
Price to Factor Price:
-t+s
Net National Production
(fp)
• To get back from Net
to Gross: +d
• To get back from
National to
Domestic: +FP-FI
• To get back from
Production to
Expenditure: -X+Z
• To get back from
factor price to
market price:+t-s
Furthermore, economists make a very important distinction between nominal and real
GDP:


Nominal GDP shows us GDP at today’s prices – the value of GDP now (this is why we
also call it GDP@current prices). This means that the value of the GDP still includes
inflation: we have not yet controlled for any changes in purchasing power since we
last measured GDP. To determine nominal GDP, we use the formula: Price current year x
Quantity current year (Sum these all together)
Real GDP shows us GDP at constant prices, meaning that we have measured the GDP
relative to a base year so that we have excluded any possible increases that may have
occurred due to changes in purchasing power since we last measured GDP. To
determine real GDP, we use the formula: Price base year x Quantity current year (Sum these
all together)
2. GOAL: FULL EMPLOYMENT
As South Africans, we are very aware of the issue of unemployment. Ideally, a country would
strive to achieve full employment – a situation in which all production factors are fully
employed.
We know, however, that this is not always the case. So how do economists measure
unemployment? Firstly, remember the following important definitions.
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


Employment – number of people who have jobs at time of measurement.
Labour force – number of people who are willing and able to work, measured
as:
o Between 15 and 65 years
o Unemployed + employed
o Excluded: pensioners, children (&lt;15 years), persons who cannot work,
discouraged workers
Unemployment – number of people who do not have jobs
Note the relationship between the goals of economic growth and full employment: Economic
growth is important to reduce the unemployment rate, but will not necessarily guarantee full
employment. Yes, we need to produce more in order to employ more people (the economy
must grow); but it is possible that the economy grows in such a way that unemployment does
not decrease (new technology improves production, but requires less labour).
3. GOAL: PRICE STABILITY
Prices change from time to time. When the general prices of goods and services in an
economy continually increase, this is called inflation.
Measuring prices is important to economists because it gives us an idea of people’s
purchasing power: given the level of prices, how much can you actually buy with the money
you have?
Achieving price stability does not mean that prices never change – it simply means that
increases in prices are not of such a nature that they seriously disrupt the economy.
Economists measure inflation by determining a growth rate in the consumer price index (CPI).
The CPI is an index of a representative basket of consumer goods and services compiled by
StatsSA.
Remember to always state your inflation answer as a rate (in percentage form %)
Inflation 2002 
CPI CPI2002  CPI2001

CPI
CPI 2001
4. GOAL: EXTERNAL STABILITY
In today’s globalised economy, international trade is very important. Countries are constantly
importing from and exporting to one another. When the South African economy imports from
other countries, we owe them money (we have to pay them for goods and services.) When
the South African economy exports to other countries, they owe us money (they have to pay
us for goods and services.)
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External stability means that this owing of money to other countries and getting money from
other countries is more or less balanced. Economists measure this by looking at a country’s
balance of payments account.
Balance of payments: A summary of all the transactions between one country’s
households, firms and government and foreign households, firms and government
during a particular time period (usually one year)
The balance of payments consists of 2 accounts:
1. Current account. The value of all imports, exports, primary factor payments and
primary factor receipts is recorded here. If the current account is in surplus, then the
country’s exports in that particular year exceeded its imports. Similarly, if the current
account is in a deficit, then that country imported more than it exported in that year.
2. The financial account. All financial flows from and to a country are recorded here (for
example, sales of stocks in that country). If the financial account is in surplus, then
more financial flows entered the country than left it during that year. If the financial
account is in deficit, then more money left that country than entered it.
Adding the balance of both these two accounts gives us the net changes in gold and other
foreign reserves.
5. GOAL: EQUITABLE DISTRIBUTION OF INCOME
Income inequality is a big talking point for South Africans – we often hear that the distribution
of income in our country is very unequal. How do economists measure this?
We will look at 3 measurements:
1. Lorenz curve
2. Gini coefficient
3. Quantile distribution
1. The Lorenz curve presents a graphical illustration of the distribution of income in an
economy.
LECTURER NOTES | AAAA 126 CHAPTER 13
Lorenz curve
Interpretation
 Line 0B represents a hypothetical
perfect distribution of income in
an economy, where there is no
inequality.
 The further the curved line
(0abcdB) is away from this line, the
greater the level of inequality.
 The yellow shaded area is known
as the area of inequality.
2. The Gini coefficient is a coefficient between 0 and 1 that indicates the level of income
inequality in a country.
The Gini coefficient is calculated based on the Lorenz curve – by calculating how much of the
area of triangle 0AB is covered by the area of inequality (don’t worry, you don’t need to be
able to do this calculation.)
It is important that you know how to interpret the Gini coefficient:



A Gini coefficient of 0 would hypothetically mean that there is no income inequality in
a given economy.
A Gini coefficient of 1 would mean that there is 100% income inequality (only one
person having all the income)
Therefore: The closer the Gini is to 1, the higher the level of income inequality, and the
closer it is to 0, the lower the income inequality.
3. The quantile distribution represents the relationship between the percentage of income
earned by the highest x percent of the population and the percentage of income earned by
the lowest y percentage of the population.
For example:
We can compare the income earned by the top 20% of the population with the income earned
by the lowest 20% of the population. Suppose that the richest 20% of the population earn
50% of the income, while the poorest 20% earn only 3% of the income. That gives us a quantile
relationship of (50/3) = 16.7. The higher this number, the higher is the inequality in a country.
LECTURER NOTES | AAAA 126 CHAPTER 13
VERY IMPORTANT! Complete the QR quiz for Chapter 13. See eFundi &gt;&gt; Study Guide &gt;&gt;