26
A2 ECONOMICS
THE MACROECONOMY
(NATIONAL INCOME STATISTICS)
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
GROSS DOMESTIC PRODUCT

A final good or service is one that is sold to the final or end user.

An intermediate good or service is one that is bought from one firm by another
firm to be used as inputs into the production process.

Gross Domestic Product (GDP) is the total market value of all final goods and
services produced in an economy during a given period, usually a year.

There are 3 approaches to the calculation of GDP:

The expenditure approach

The income approach

The value-added approach
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
THE EXPENDITURE APPROACH

The expenditure approach to calculating GDP is to add up aggregate spending
on domestically produced final goods and services in the economy.

Aggregate Spending is the sum of Consumer spending (C), Investment
spending (I), Government purchases of goods & services (G) and Exports (X)
minus Imports (M).

Net Exports (NX) are the difference between the value of X and the value of M.

When calculating GDP using spending data, we must subtract spending on
imports because not all final spending goes towards domestically produced
goods and services.
GDP = C + I + G + X - M
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
THE EXPENDITURE APPROACH

When calculating GDP with the expenditure approach, it is important to avoid
double counting.

Therefore, we only count the market value of sales to end users.

In other words, we omit the sales of inputs from one business to another
because they are not final goods.

Remark: Investment spending is not spending on stocks and bonds.
Investment spending involves the purchase of machinery, equipment, tools,
changes in business inventories and construction.

Question: Would an auto company’s purchase of steel be considered counted in
GDP? What if it purchases machinery for its factory?
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
THE INCOME APPROACH

The income approach consists in adding up the total factor income earned by
households from firms in the economy (e.g. rent, wage, interest & profit).

This meaure is known as Gross Domestic Income (GDI).

Nb: In using the income approach, it is important to include only payments
received in return for providing a good or service so transfer payments are not
included.
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
THE VALUE-ADDED APPROACH

The Value-Added (VA) of a producer is the difference between the value of
sales and the value of the inputs it purchases from other businesses.

The VA approach to calculating GDP is to survey firms and add up their
contributions to the final value of goods and services (i.e. the value added by
each firm in the production process).

The calculation excludes the value of intermediate goods and services in
order to avoid double counting.

Example: If we added the total sales of the car company and the tire company,
then we would in effect be counting the value of tires twice (i.e. once when they
is sold by the tire company to the car company and again when the car is
equipped with the tires and sold to consumers).
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
CALCULATING GDP
American
Ore, Inc.
American
Steel, Inc.
American
Motors, Inc.
$4,200 (ore)
$9,000 (steel)
$21,500 (car)
Wages
$2,000
$3,700
$10,000
Interest payments
$1,000
$6,00
$1,000
Rent
$200
$300
$500
Value of sales
Total Factor
Income
Intermediate goods
Profit
Value added
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
CALCULATING GDP
American
Ore, Inc.
American
Steel, Inc.
American
Motors, Inc.
Value of sales
$4,200 (ore)
$9,000 (steel)
$21,500 (car)
Intermediate goods
$0
$4,200 (ore)
$9,000 (steel)
Wages
$2,000
$3,700
$10,000
Interest payments
$1,000
$6,00
$1,000
Rent
$200
$300
$500
Total Factor
Income
Profit
Value added
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
CALCULATING GDP
American
Ore, Inc.
American
Steel, Inc.
American
Motors, Inc.
Value of sales
$4,200 (ore)
$9,000 (steel)
$21,500 (car)
Intermediate goods
$0
$4,200 (ore)
$9,000 (steel)
Wages
$2,000
$3,700
$10,000
Interest payments
$1,000
$6,00
$1,000
Rent
$200
$300
$500
Profit
$1,000
$200
$1,000
Total Factor
Income
Value added
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
CALCULATING GDP
American
Ore, Inc.
American
Steel, Inc.
American
Motors, Inc.
Value of sales
$4,200 (ore)
$9,000 (steel)
$21,500 (car)
Intermediate goods
$0
$4,200 (ore)
$9,000 (steel)
Wages
$2,000
$3,700
$10,000
Interest payments
$1,000
$6,00
$1,000
Rent
$200
$300
$500
Profit
$1,000
$200
$1,000
Total Factor
Income
Value added
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
CALCULATING GDP
American
Ore, Inc.
American
Steel, Inc.
American
Motors, Inc.
Total Factor
Income
Value of sales
$4,200 (ore)
$9,000 (steel)
$21,500 (car)
Intermediate goods
$0
$4,200 (ore)
$9,000 (steel)
Wages
$2,000
$3,700
$10,000
$15,700
Interest payments
$1,000
$6,00
$1,000
$2,600
Rent
$200
$300
$500
$1,000
Profit
$1,000
$200
$1,000
$2,200
Value added
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
CALCULATING GDP
American
Ore, Inc.
American
Steel, Inc.
American
Motors, Inc.
Total Factor
Income
Value of sales
$4,200 (ore)
$9,000 (steel)
$21,500 (car)
Intermediate goods
$0
$4,200 (ore)
$9,000 (steel)
Wages
$2,000
$3,700
$10,000
$15,700
Interest payments
$1,000
$6,00
$1,000
$2,600
Rent
$200
$300
$500
$1,000
Profit
$1,000
$200
$1,000
$2,200
Value added
$4,200
$4,800
$12,500
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
CALCULATING GDP
American
Ore, Inc.
American
Steel, Inc.
American
Motors, Inc.
Total Factor
Income
Value of sales
$4,200 (ore)
$9,000 (steel)
$21,500 (car)
Intermediate goods
$0
$4,200 (ore)
$9,000 (steel)
Wages
$2,000
$3,700
$10,000
$15,700
Interest payments
$1,000
$6,00
$1,000
$2,600
Rent
$200
$300
$500
$1,000
Profit
$1,000
$200
$1,000
$2,200
Value added
$4,200
$4,800
$12,500
SUM OF VALUE ADDED = $21,500
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
CALCULATING GDP
American
Ore, Inc.
American
Steel, Inc.
American
Motors, Inc.
Total Factor
Income
Value of sales
$4,200 (ore)
$9,000 (steel)
$21,500 (car)
Intermediate goods
$0
$4,200 (ore)
$9,000 (steel)
Wages
$2,000
$3,700
$10,000
$15,700
Interest payments
$1,000
$6,00
$1,000
$2,600
Rent
$200
$300
$500
$1,000
Profit
$1,000
$200
$1,000
$2,200
Value added
$4,200
$4,800
$12,500
TOTAL PAYMENTS TO FACTORS = $21,500
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
CALCULATING GDP
American
Ore, Inc.
American
Steel, Inc.
American
Motors, Inc.
Total Factor
Income
Value of sales
$4,200 (ore)
$9,000 (steel)
$21,500 (car)
Intermediate goods
$0
$4,200 (ore)
$9,000 (steel)
Wages
$2,000
$3,700
$10,000
$15,700
Interest payments
$1,000
$6,00
$1,000
$2,600
Rent
$200
$300
$500
$1,000
Profit
$1,000
$200
$1,000
$2,200
Value added
$4,200
$4,800
$12,500
EXPENDITURE ON DOMESTICALLY PRODUCED
FINAL GOODS AND SERVICES = $21,500
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
GDP: WHAT’S IN AND WHAT’S OUT?

GDP COUNTS all domestically produced final goods and services, including
capital goods, new construction of structures and changes to inventories.

Spending on inputs, including intermediate goods, are NOT INCLUDED in GDP.

Financial assets (e.g. stocks, bonds, etc.) and transfer payments are NOT
INCLUDED in GDP because they neither represent the production nor the sale of final
goods or services.

Foreign-produced goods and services are NOT INCLUDED in GDP.

Used goods are NOT INCLUDED in GDP (i.e. counting them once when sold as new
and again when sold as used)
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
PRACTICE TIME!

Task: Indicate whether each of the following is counted in the U.S. GDP for the current
year. Explain.

A. The value of radios used in the production of new automobiles build in the current year.

B. Commissions earned by a realtor in the current year for selling a home built 4 years ago.

C. The value of a used-cell phone purchased on e-Bay.

D. The value of headsets produced entirely in the U.S. by a Chinese company.

E. The value of stock purchase on the NYSE.
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
PRACTICE TIME!

Task: Indicate whether each of the following is counted in the U.S. GDP for the current
year. Explain.

A. The value of radios used in the production of new automobiles build in the current year.
NOT COUNTED: Intermediate good

B. Commissions earned by a realtor in the current year for selling a home built 4 years ago.

C. The value of a used-cell phone purchased on e-Bay.

D. The value of headsets produced entirely in the U.S. by a Chinese company.

E. The value of stock purchase on the NYSE.
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
PRACTICE TIME!

Task: Indicate whether each of the following is counted in the U.S. GDP for the current
year. Explain.

A. The value of radios used in the production of new automobiles build in the current year.
NOT COUNTED: Intermediate good

B. Commissions earned by a realtor in the current year for selling a home built 4 years ago.
COUNTED: New service provided in the current year

C. The value of a used-cell phone purchased on e-Bay.

D. The value of headsets produced entirely in the U.S. by a Chinese company.

E. The value of stock purchase on the NYSE.
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
PRACTICE TIME!

Task: Indicate whether each of the following is counted in the U.S. GDP for the current
year. Explain.

A. The value of radios used in the production of new automobiles build in the current year.
NOT COUNTED: Intermediate good

B. Commissions earned by a realtor in the current year for selling a home built 4 years ago.
COUNTED: New service provided in the current year

C. The value of a used-cell phone purchased on e-Bay. NOT COUNTED: Used good

D. The value of headsets produced entirely in the U.S. by a Chinese company.

E. The value of stock purchase on the NYSE.
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
PRACTICE TIME!

Task: Indicate whether each of the following is counted in the U.S. GDP for the current
year. Explain.

A. The value of radios used in the production of new automobiles build in the current year.
NOT COUNTED: Intermediate good

B. Commissions earned by a realtor in the current year for selling a home built 4 years ago.
COUNTED: New service provided in the current year

C. The value of a used-cell phone purchased on e-Bay. NOT COUNTED: Used good

D. The value of headsets produced entirely in the U.S. by a Chinese company. COUNTED:
New good made entirely in the U.S

E. The value of stock purchase on the NYSE.
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
PRACTICE TIME!

Task: Indicate whether each of the following is counted in the U.S. GDP for the current
year. Explain.

A. The value of radios used in the production of new automobiles build in the current year.
NOT COUNTED: Intermediate good

B. Commissions earned by a realtor in the current year for selling a home built 4 years ago.
COUNTED: New service provided in the current year

C. The value of a used-cell phone purchased on e-Bay. NOT COUNTED: Used good

D. The value of headsets produced entirely in the U.S. by a Chinese company. COUNTED:
New good made entirely in the U.S

E. The value of stock purchase on the NYSE. NOT COUNTED: Financial transaction
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
NOMINAL GDP

Nominal GDP (nGDP), or GDP at current prices, is the total value of all final
goods and services produced in the economy during a given year, calculated
with the prices current in the year in which the output is produced.

Nominal GDP is not a good measure of the economy’s growth over time
because part of the change in the value of the nominal GDP over time represents
changes in the prices of goods and services rather than changes in the
economy’s output.
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
NOMINAL GDP

Nominal GDP can grow because the economy’s output grows, but it can also
grow simply because of inflation.

In this latter case, changes in nominal GDP will overstate the true growth of
the economy’s output.

Nominal GDP can fall because the economy’s output falls, but it can also grow
simply because of deflation.

In this latter case, changes in nominal GDP will understate the true growth of
the economy’s output.

Finally, even though the economy’s output does not change, nominal GDP
will go up (resp. go down) during periods of inflation (resp. deflation).
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
REAL GDP

By comparing the economy’s output over time using a common set of prices,
we are able to eliminate the influence of changes in the price level and to focus
on the changes in the economy’s output.

That is, we avoid the problem of changes in prices distorting the value of
changes in production over time.

Real GDP (rGDP), or GDP at constant prices, is the total value of all final
goods and services produced in the economy during a given year, calculated
as if prices had stayed constant at the level of some given base year.

Unlike nominal GDP, we say that real GDP is adjusted for the effect of changes
in price level.
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
CALCULATING REAL GDP
YEAR 1
YEAR 2
Quantity of apples
2,000
2,200
Price of an apple
$0.25
$0.3
Quantity of oranges
1,000
1,200
Price of an orange
$0.5
$0.7
Nominal GDP
Real GDP (Year 1 $)
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
CALCULATING REAL GDP
YEAR 1
YEAR 2
Quantity of apples
2,000
2,200
Price of an apple
$0.25
$0.3
Quantity of oranges
1,000
1,200
Price of an orange
$0.5
$0.7
Nominal GDP
Real GDP (Year 1 $)
NOMINAL GDP GROWTH RATE = 50%
REAL GDP GROWTH RATE = 15%
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
CALCULATING REAL GDP
YEAR 1
YEAR 2
Quantity of apples
2,000
2,200
Price of an apple
$0.25
$0.3
Quantity of oranges
1,000
1,200
Price of an orange
$0.5
$0.7
Nominal GDP
$1,000
Real GDP (Year 1 $)
NOMINAL GDP GROWTH RATE = 50%
REAL GDP GROWTH RATE = 15%
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
CALCULATING REAL GDP
YEAR 1
YEAR 2
Quantity of apples
2,000
2,200
Price of an apple
$0.25
$0.3
Quantity of oranges
1,000
1,200
Price of an orange
$0.5
$0.7
Nominal GDP
$1,000
$1,500
Real GDP (Year 1 $)
NOMINAL GDP GROWTH RATE = 50%
REAL GDP GROWTH RATE = 15%
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
CALCULATING REAL GDP
YEAR 1
YEAR 2
Quantity of apples
2,000
2,200
Price of an apple
$0.25
$0.3
Quantity of oranges
1,000
1,200
Price of an orange
$0.5
$0.7
Nominal GDP
$1,000
$1,500
Real GDP (Year 1 $)
NOMINAL GDP GROWTH RATE = 50%
REAL GDP GROWTH RATE = 15%
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
CALCULATING REAL GDP
YEAR 1
YEAR 2
Quantity of apples
2,000
2,200
Price of an apple
$0.25
$0.3
Quantity of oranges
1,000
1,200
Price of an orange
$0.5
$0.7
Nominal GDP
$1,000
$1,500
Real GDP (Year 1 $)
$1,000
NOMINAL GDP GROWTH RATE = 50%
REAL GDP GROWTH RATE = 15%
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
CALCULATING REAL GDP
YEAR 1
YEAR 2
Quantity of apples
2,000
2,200
Price of an apple
$0.25
$0.3
Quantity of oranges
1,000
1,200
Price of an orange
$0.5
$0.7
Nominal GDP
$1,000
$1,500
Real GDP (Year 1 $)
$1,000
$1,150
NOMINAL GDP GROWTH RATE = 50%
REAL GDP GROWTH RATE = 15%
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
CALCULATING REAL GDP
YEAR 1
YEAR 2
Quantity of apples
2,000
2,200
Price of an apple
$0.25
$0.3
Quantity of oranges
1,000
1,200
Price of an orange
$0.5
$0.7
Nominal GDP
$1,000
$1,500
Real GDP (Year 1 $)
$1,000
$1,150
NOMINAL GDP GROWTH RATE = 50%
REAL GDP GROWTH RATE = 15%
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
CALCULATING REAL GDP
YEAR 1
YEAR 2
Quantity of apples
2,000
2,200
Price of an apple
$0.25
$0.3
Quantity of oranges
1,000
1,200
Price of an orange
$0.5
$0.7
Nominal GDP
Real GDP (Year 2 $)
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
CALCULATING REAL GDP
YEAR 1
YEAR 2
Quantity of apples
2,000
2,200
Price of an apple
$0.25
$0.3
Quantity of oranges
1,000
1,200
Price of an orange
$0.5
$0.7
Nominal GDP
Real GDP (Year 2 $)
NOMINAL GDP GROWTH RATE = 50%
REAL GDP GROWTH RATE = 15.4%
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
CALCULATING REAL GDP
YEAR 1
YEAR 2
Quantity of apples
2,000
2,200
Price of an apple
$0.25
$0.3
Quantity of oranges
1,000
1,200
Price of an orange
$0.5
$0.7
Nominal GDP
$1,000
Real GDP (Year 2 $)
NOMINAL GDP GROWTH RATE = 50%
REAL GDP GROWTH RATE = 15.4%
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
CALCULATING REAL GDP
YEAR 1
YEAR 2
Quantity of apples
2,000
2,200
Price of an apple
$0.25
$0.3
Quantity of oranges
1,000
1,200
Price of an orange
$0.5
$0.7
Nominal GDP
$1,000
$1,500
Real GDP (Year 2 $)
NOMINAL GDP GROWTH RATE = 50%
REAL GDP GROWTH RATE = 15.4%
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
CALCULATING REAL GDP
YEAR 1
YEAR 2
Quantity of apples
2,000
2,200
Price of an apple
$0.25
$0.3
Quantity of oranges
1,000
1,200
Price of an orange
$0.5
$0.7
Nominal GDP
$1,000
$1,500
Real GDP (Year 2 $)
NOMINAL GDP GROWTH RATE = 50%
REAL GDP GROWTH RATE = 15.4%
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
CALCULATING REAL GDP
YEAR 1
YEAR 2
Quantity of apples
2,000
2,200
Price of an apple
$0.25
$0.3
Quantity of oranges
1,000
1,200
Price of an orange
$0.5
$0.7
Nominal GDP
$1,000
$1,500
Real GDP (Year 2 $)
$1,300
NOMINAL GDP GROWTH RATE = 50%
REAL GDP GROWTH RATE = 15.4%
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
CALCULATING REAL GDP
YEAR 1
YEAR 2
Quantity of apples
2,000
2,200
Price of an apple
$0.25
$0.3
Quantity of oranges
1,000
1,200
Price of an orange
$0.5
$0.7
Nominal GDP
$1,000
$1,500
Real GDP (Year 2 $)
$1,300
$1,500
NOMINAL GDP GROWTH RATE = 50%
REAL GDP GROWTH RATE = 15.4%
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
CALCULATING REAL GDP
YEAR 1
YEAR 2
Quantity of apples
2,000
2,200
Price of an apple
$0.25
$0.3
Quantity of oranges
1,000
1,200
Price of an orange
$0.5
$0.7
Nominal GDP
$1,000
$1,500
Real GDP (Year 2 $)
$1,300
$1,500
NOMINAL GDP GROWTH RATE = 50%
REAL GDP GROWTH RATE = 15.4%
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PRACTICE TIME!


Bigtown uses its resources to produce apples, peaches and pears, as shown in
the table on the next slide. Assuming that year 1 is the base year, calculate each
of the following:

The nominal GDP in year 1

The nominal GDP in year 2

The percentage change in nominal GDP from year 1 to year 2

The real GDP in year 1

The real GDP in year 2

The percentage change in real GDP from year 1 to year 2
Replicate the exercise under the assumption that year 2 is the base year.
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PRACTICE TIME!
YEAR 1
YEAR 2
Quantity of apples
20
25
Price of an apple
$1
$2
Quantity of oranges
30
20
Price of an orange
$3
$6
Quantity of pears
10
25
Price of a pear
$4
$4
NOMINAL GDP
GROWTH RATE = 80%
REAL GDP
GROWTH RATE = 23.3%
Nominal GDP
Real GDP (Year 1 $)
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PRACTICE TIME!
YEAR 1
YEAR 2
Quantity of apples
20
25
Price of an apple
$1
$2
Quantity of oranges
30
20
Price of an orange
$3
$6
Quantity of pears
10
25
Price of a pear
$4
$4
Nominal GDP
$150
NOMINAL GDP
GROWTH RATE = 80%
REAL GDP
GROWTH RATE = 23.3%
Real GDP (Year 1 $)
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PRACTICE TIME!
YEAR 1
YEAR 2
Quantity of apples
20
25
Price of an apple
$1
$2
Quantity of oranges
30
20
Price of an orange
$3
$6
Quantity of pears
10
25
Price of a pear
$4
$4
Nominal GDP
$150
$270
NOMINAL GDP
GROWTH RATE = 80%
REAL GDP
GROWTH RATE = 23.3%
Real GDP (Year 1 $)
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PRACTICE TIME!
YEAR 1
YEAR 2
Quantity of apples
20
25
Price of an apple
$1
$2
Quantity of oranges
30
20
Price of an orange
$3
$6
Quantity of pears
10
25
Price of a pear
$4
$4
Nominal GDP
$150
$270
NOMINAL GDP
GROWTH RATE = 80%
REAL GDP
GROWTH RATE = 23.3%
Real GDP (Year 1 $)
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PRACTICE TIME!
YEAR 1
YEAR 2
Quantity of apples
20
25
Price of an apple
$1
$2
Quantity of oranges
30
20
Price of an orange
$3
$6
Quantity of pears
10
25
Price of a pear
$4
$4
Nominal GDP
$150
$270
Real GDP (Year 1 $)
$150
NOMINAL GDP
GROWTH RATE = 80%
REAL GDP
GROWTH RATE = 23.3%
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PRACTICE TIME!
YEAR 1
YEAR 2
Quantity of apples
20
25
Price of an apple
$1
$2
Quantity of oranges
30
20
Price of an orange
$3
$6
Quantity of pears
10
25
Price of a pear
$4
$4
Nominal GDP
$150
$270
Real GDP (Year 1 $)
$150
$185
NOMINAL GDP
GROWTH RATE = 80%
REAL GDP
GROWTH RATE = 23.3%
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PRACTICE TIME!
YEAR 1
YEAR 2
Quantity of apples
20
25
Price of an apple
$1
$2
Quantity of oranges
30
20
Price of an orange
$3
$6
Quantity of pears
10
25
Price of a pear
$4
$4
Nominal GDP
$150
$270
Real GDP (Year 1 $)
$150
$185
NOMINAL GDP
GROWTH RATE = 80%
REAL GDP
GROWTH RATE = 23.3%
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PRACTICE TIME!
YEAR 1
YEAR 2
Quantity of apples
20
25
Price of an apple
$1
$2
Quantity of oranges
30
20
Price of an orange
$3
$6
Quantity of pears
10
25
Price of a pear
$4
$4
NOMINAL GDP
GROWTH RATE = 80%
REAL GDP
GROWTH RATE = 3.8%
Nominal GDP
Real GDP (Year 2 $)
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PRACTICE TIME!
YEAR 1
YEAR 2
Quantity of apples
20
25
Price of an apple
$1
$2
Quantity of oranges
30
20
Price of an orange
$3
$6
Quantity of pears
10
25
Price of a pear
$4
$4
Nominal GDP
$150
NOMINAL GDP
GROWTH RATE = 80%
REAL GDP
GROWTH RATE = 3.8%
Real GDP (Year 2 $)
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PRACTICE TIME!
YEAR 1
YEAR 2
Quantity of apples
20
25
Price of an apple
$1
$2
Quantity of oranges
30
20
Price of an orange
$3
$6
Quantity of pears
10
25
Price of a pear
$4
$4
Nominal GDP
$150
$270
NOMINAL GDP
GROWTH RATE = 80%
REAL GDP
GROWTH RATE = 3.8%
Real GDP (Year 2 $)
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PRACTICE TIME!
YEAR 1
YEAR 2
Quantity of apples
20
25
Price of an apple
$1
$2
Quantity of oranges
30
20
Price of an orange
$3
$6
Quantity of pears
10
25
Price of a pear
$4
$4
Nominal GDP
$150
$270
NOMINAL GDP
GROWTH RATE = 80%
REAL GDP
GROWTH RATE = 3.8%
Real GDP (Year 2 $)
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PRACTICE TIME!
YEAR 1
YEAR 2
Quantity of apples
20
25
Price of an apple
$1
$2
Quantity of oranges
30
20
Price of an orange
$3
$6
Quantity of pears
10
25
Price of a pear
$4
$4
Nominal GDP
$150
$270
Real GDP (Year 2 $)
NOMINAL GDP
GROWTH RATE = 80%
REAL GDP
GROWTH RATE = 3.8%
$270
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PRACTICE TIME!
YEAR 1
YEAR 2
Quantity of apples
20
25
Price of an apple
$1
$2
Quantity of oranges
30
20
Price of an orange
$3
$6
Quantity of pears
10
25
Price of a pear
$4
$4
Nominal GDP
$150
$270
Real GDP (Year 2 $)
$260
$270
NOMINAL GDP
GROWTH RATE = 80%
REAL GDP
GROWTH RATE = 3.8%
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PRACTICE TIME!
YEAR 1
YEAR 2
Quantity of apples
20
25
Price of an apple
$1
$2
Quantity of oranges
30
20
Price of an orange
$3
$6
Quantity of pears
10
25
Price of a pear
$4
$4
Nominal GDP
$150
$270
Real GDP (Year 2 $)
$260
$270
NOMINAL GDP
GROWTH RATE = 80%
REAL GDP
GROWTH RATE = 3.8%
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U.S. NOMINAL GDP VS REAL GDP
YEAR
NOMINAL GDP
REAL GDP
(2005 DOLLARS)
2000
$9,951
$11,286
2005
$12,683
$12,683
2013
$16,803
$14,504
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INDEX NUMBERS
R
REMINDERS

In economics, it is common to convert time series data into index numbers.

The first step of the conversion process consists in choosing a base year.

Nb: It can also be a base day, week or month depending on the type of data we
are dealing with.

Then, in order to convert Year X value into an index number, we apply the
following formula:
Year X Index Number = Year X Value / Base Year Value x 100
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INDEX NUMBERS
R
REMINDERS

Nb: Index numbers have no units (e.g. £, € or $).

Remark: By definition, the base year value always has an index number of 100.

Index numbers are useful because they normalize the data and because they
make it easier to compute the percentage change in the economic indicator with
respect to its base year value.

Namely, the percentage change in the economic indicator with respect to its
base year value is simply equal to Year X index number minus 100.
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PRACTICE

R
TIME!
REMINDERS
2011 is taken as the base year. Convert each year’s figure into an index
number and indicate the percentage change in the average income in
Chile with respect to the base year.
Year
Average Income
in Chile
2008
US$15,600
2009
US$16,900
2010
US$17,400
2011
US$17,600
2012
US$18,500
2013
US$19,100
Index
(Base 2011)
Percentage
change
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PRACTICE

R
TIME!
REMINDERS
2011 is taken as the base year. Convert each year’s figure into an index
number and indicate the percentage change in the average income in
Chile with respect to the base year.
Year
Average Income
in Chile
Index
(Base 2011)
2008
US$15,600
89
2009
US$16,900
96
2010
US$17,400
99
2011
US$17,600
100
2012
US$18,500
105
2013
US$19,100
109
Percentage
change
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PRACTICE

R
TIME!
REMINDERS
2011 is taken as the base year. Convert each year’s figure into an index
number and indicate the percentage change in the average income in
Chile with respect to the base year.
Year
Average Income
in Chile
Index
(Base 2011)
Percentage
change
2008
US$15,600
89
-11%
2009
US$16,900
96
-4%
2010
US$17,400
99
-1%
2011
US$17,600
100
0%
2012
US$18,500
105
5%
2013
US$19,100
109
9%
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THE GDP DEFLATOR

Year X GDP deflator is the ratio of Year X nominal GDP to Year X real GDP in that
year times 100.
Year X GDP Deflator = nGDP / rGDP x 100

Nb: By definition, the base year GDP Deflator is equal to 100

Inflation leads to an increase in the GDP deflator, whereas deflation leads a
decrease in the GDP deflator.

Examples:

If Nominal GDP rises by 5% when the inflation rate is 2%, then Real GDP rises by less
then 5% so the GDP Deflator rises.

If Nominal GDP falls by 4% when the inflation rate is -3%, then Real GDP falls by less
than 4% so the GDP deflator falls.
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REAL VS NOMINAL GDP
R
REMINDERS

Tracking changes in nominal GDP over time is not suitable when attempting
to measure changes in the standards of living.

This is because part of the change in nominal GDP is driven by changes in the
overall price level in the economy.

In order to measure changes in the standards of living, we should instead
track changes in real GDP so that the distortionary effect of inflation has
been taken out.
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REAL GDP
PER CAPITA

Still, real GDP is not a suitable indicator when attemptng to compare
economies across space or time.

This is because real GDP is not adjusted for the population size and its
changes over time.

Example 1: The UK and India have comparable GDPs but their populations
clearly do not enjoy the same standards of living.

Example 2: An 2% increase in real GDP is likely to lead to a greater
improvement in the standards of living in Moldova (-1.06% population
growth rate) than in Ethiopia (2.83% population growth rate).
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REAL GDP

PER CAPITA
In order to take out the distortionary effect of the population size and its
changes over time, we should instead focus on real GDP per capita (or per
head).
Real GDP per capita = Real GDP / Population Size

Nb: Real GDP per capita increases whenever the percentage change in real
GDP is larger than the percentage change in population.
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REAL GDP
PER CAPITA IN THE
UK
United Kingdom Real GDP per head (Constant 2010 USD)
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AVERAGE ANNUAL REAL GDP PC GROWTH RATES
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PURCHASING POWER PARITY

When comparing GDP per capita of various countries, we need to express
them into a common unit.

One solution consists in using nominal exchange rates to convert the GDP per
capita of all countries into USD.

However, this methodology does not acknowledge the fact that the purchasing
power of $1 (i.e. the quantity of goods and services that it can purchase) can
vary drastically from one country to the other.

In particular, $1 usually has a stronger purchasing power in developing
countries than in developed countries.
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PURCHASING POWER PARITY

Therefore, comparing the standards of living of the residents of a developed
country with those of a developing country on the basis on their GDP per capita
expressed in $US is misleading.

Specifically, this method exaggerates the gap in living standards between the 2
countries because it understates the purchasing power of the residents of the
developing country.

The alternative is to use Purchasing Power Parity (PPP) exchange rates rather
than nominal exchange rates.

To that end, we start by defining a basket of standardized products that can be
found in all countries (e.g. Big Mac, iPad, etc).
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PURCHASING POWER PARITY

Then, the cost of the basket is measured in the US in $US and in any given country
X in terms of its own currency.

Next, the PPP exchange rate between the US and Country X is calculated by
dividing the cost of the basket in Country X by the cost of the basket in the US.

Finally, we can use that PPP exchange rate to convert the GDP per capita of
Country X into what is known as international dollars (Int$).

By construction, Int$1 has the same purchasing power in the US and in Country X.

Besides, the PPP exchange rate between US$1 and Int$1 always equals 1 so that
US GDP pc ($US) = US GDP pc (Int$).
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PURCHASING POWER PARITY

Nominal GDP per capita (2017):

US: $59,792

China: ¥82,075

Given that $1 = ¥6.76 (12/31/2017), China’s GDP per capita is equal to $12,141.

It might then appear that residents of the USA have, on average, a purchasing
power that is 4.92 greater than residents of China.

However, if $1 can buy more goods and services in China than in the USA, then
using the nominal exchange rate actually understates the purchasing power of
Chinese residents.
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PURCHASING POWER PARITY

In 2017, a Big Mac sells, on average, for $5.51 in the USA and for ¥21.96 in China.

Therefore, we can establish that the PPP exchange rate between China and the US
is such that 1$ = ¥3.99.

Let us now use this PPP exchange rate in order to convert China’s 2017 GDP per
capita into international dollars.

Namely, China’s 2017 GDP per capita equals Int$20,570.

It follows that the residents of the USA have a purchasing power that is “only” 2.91
times greater than the residents of China.
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COUNTRIES BY GDP (PPP) PER CAPITA
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COUNTRIES BY GDP (PPP) PER CAPITA
QATAR
$124,927
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COUNTRIES BY GDP (PPP) PER CAPITA
USA
$59,495
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COUNTRIES BY GDP (PPP) PER CAPITA
CHINA
$16,807
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COUNTRIES BY GDP (PPP) PER CAPITA
CENTRAL AFRICAN
REPUBLIC
$700
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COMPARING LIVING STANDARDS ACROSS COUNTRIES

Comparing the living standards between countries can be made difficult,
even when using real GDP per capita.

First, this indicator measures the average purchasing power of a country’s
residents, but it does not account for income distribution.

Second, the accuracy with which data is collected might not be consistent
across countries (i.e. some data collection agencies may be more reliable
than others).

Last, the size of unrecorded economic activity differs from one country to
another (e.g. subsistence agriculture, DIYs, housework, etc.).
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COMPARING LIVING STANDARDS OVER TIME

Comparing the living standards over time can be made difficult, even when
using real GDP per capita.

First, as was the case earlier, changes in real GDP per capita fail to account
for changes in income distribution.

Second, there can be changes in the method used to compute national
income statistics.

Last, changes in real GDP per capita fail to account for changes in the types
of goods and services which are produced (e.g. the standard of living is
likely to fall when a war breaks out, but real GDP per capita may actually rise
because more weapons are being produced).
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REAL GDP PER CAPITA VS STANDARD
OF
LIVING

Overall, real GDP per capita is useful because it provides a rather accurate
measurement of the average income of a country’s residents.

However, real GDP per capita is too narrow to provide a reliable measure of
the standard of living.

This is because the concept of standard of living is multi-dimensional and
encompasses all the factors that contribute to the quality of life.
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REAL GDP PER CAPITA VS STANDARD
OF
LIVING

Clearly, income is an important factor in measuring the standard of living but
this is not the only one.

Namely, the standard of living is determined by other factors such as the
availability of health care, the access to education, the quality of the
environment, etc.

It follows that an increase in GDP per capita (i.e. higher average income) is not
necessarily accompanied with an increase in the standard of living.
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GROSS NATIONAL PRODUCT

Gross National Product (GNP) is the total value of all final goods and services
produced during a given period, usually a year, with resources owned by a
country’s residents.

Unlike GDP, which measures national income on the basis of the location of
production of production, GNP measures national income on the basis of
location of ownership.
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GROSS NATIONAL PRODUCT

Example: If a German-owned company has a factory in the United States, the
output of this factory would be included in U.S. GDP, but in German GNP.

Net Foreign Factor Income (NFFI) is equal to the difference between income
received by residents from other countries - notably interest and dividends and income earned within the domestic economy by overseas residents

GNP is equal to GDP plus Net Foreign Factor Income (NFFI)
GNP = GDP + NFFI
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GROSS VS NET

The value of a country’s capital stock depreciates over time as it wears out and
is used up.

This decrease in value is known as depreciation (D) or capital consumption.

Neither Gross Domestic Product nor Gross National Product account for
depreciation.

However, both Net Domestic Product (NDP) and Net National Product (NNP)
account for depreciation.
NDP = GDP – D ; NNP = GNP – D
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MARKET PRICES VS FACTOR COST

As we explained earlier, there are 3 approaches to the calculation of GDP: the
expenditure approach, the value-added approach and the income approach.

We stressed that these 3 approaches are equivalent and should lead to the same
result.

This is true given that the government neither imposes indirect taxes nor grants
indirect subsidies.

If it does, the price paid by consumers will be different from the price received by
producers.
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GDP
AT
MARKET PRICES VS
AT
FACTOR COST

In the case of indirect taxes, the price paid by consumers is higher than the
price received by producers.

In the case of indirect subsidies, the price paid by consumers is lower than the
price received by producers.

The expenditure approach measures GDP at market prices (i.e. the price paid
by consumers).

However, the income approach measures GDP at factor cost, or basic prices
(i.e. the price received by producers).

Nb: The value-added approach is more complicated to analyse, let’s leave it aside.
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GDP
AT
MARKET PRICES VS
AT
FACTOR COST

On the one hand, if the government introduces an indirect tax in a market, the
total expenditure will exceed the total factor payments (i.e. the factor cost) by
an amount equal to the tax revenue.

On the other hand, if the government introduces an indirect subsidy in a market,
the total factor payments will exceed the total expenditure by an amount equal
to the subsidy expenditure.

Overall, the GDP at factor cost (or at basic prices) is equal to the GDP at
market prices minus indirect tax revenue plus indirect subsidy expenditure.
GDP at Factor Cost = GDP at Market Prices - Indirect Taxes + Indirect Subsidies
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MARKET PRICES VS FACTOR COST
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MARKET PRICES VS FACTOR COST
PRICE OF
ORANGE JUICE
QUANTITY OF
ORANGE JUICE
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MARKET PRICES VS FACTOR COST
PRICE OF
ORANGE JUICE
S1
QUANTITY OF
ORANGE JUICE
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
MARKET PRICES VS FACTOR COST
PRICE OF
ORANGE JUICE
S1
D
QUANTITY OF
ORANGE JUICE
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
MARKET PRICES VS FACTOR COST
PRICE OF
ORANGE JUICE
S1
10
D
100
QUANTITY OF
ORANGE JUICE
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
MARKET PRICES VS FACTOR COST
S2 = S1 + T
PRICE OF
ORANGE JUICE
S1
10
D
100
QUANTITY OF
ORANGE JUICE
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
MARKET PRICES VS FACTOR COST
S2 = S1 + T
PRICE OF
ORANGE JUICE
S1
12
10
D
90
100
QUANTITY OF
ORANGE JUICE
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
MARKET PRICES VS FACTOR COST
S2 = S1 + T
PRICE OF
ORANGE JUICE
S1
12
T = $5
10
7
D
90
100
QUANTITY OF
ORANGE JUICE
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
MARKET PRICES VS FACTOR COST
S2 = S1 + T
PRICE OF
ORANGE JUICE
S1
12
T = $5
10
7
CONSUMER
SPENDING
= $1,080
D
90
100
QUANTITY OF
ORANGE JUICE
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
MARKET PRICES VS FACTOR COST
S2 = S1 + T
PRICE OF
ORANGE JUICE
S1
CONTRIBUTION TO
GDP AT MARKET PRICES:
12
T = $5
$1,080
10
7
CONSUMER
SPENDING
= $1,080
D
90
100
QUANTITY OF
ORANGE JUICE
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
MARKET PRICES VS FACTOR COST
S2 = S1 + T
PRICE OF
ORANGE JUICE
S1
12
T = $5
10
TAX
REVENUE
= $450
7
D
90
100
QUANTITY OF
ORANGE JUICE
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
MARKET PRICES VS FACTOR COST
S2 = S1 + T
PRICE OF
ORANGE JUICE
S1
12
T = $5
10
TAX
REVENUE
= $450
7
FACTOR
PAYMENTS
= $630
D
90
100
QUANTITY OF
ORANGE JUICE
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
MARKET PRICES VS FACTOR COST
S2 = S1 + T
PRICE OF
ORANGE JUICE
S1
CONTRIBUTION TO
GDP AT FACTOR COST:
12
T = $5
10
TAX
REVENUE
= $450
$630
7
FACTOR
PAYMENTS
= $630
D
90
100
QUANTITY OF
ORANGE JUICE
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
MARKET PRICES VS FACTOR COST
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
MARKET PRICES VS FACTOR COST
PRICE OF
ORANGE JUICE
QUANTITY OF
ORANGE JUICE
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
MARKET PRICES VS FACTOR COST
PRICE OF
ORANGE JUICE
S1
QUANTITY OF
ORANGE JUICE
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
MARKET PRICES VS FACTOR COST
S1
PRICE OF
ORANGE JUICE
D
QUANTITY OF
ORANGE JUICE
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
MARKET PRICES VS FACTOR COST
S1
PRICE OF
ORANGE JUICE
12
D
100
QUANTITY OF
ORANGE JUICE
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
MARKET PRICES VS FACTOR COST
S1
PRICE OF
ORANGE JUICE
S2 = S1 + T
12
D
100
QUANTITY OF
ORANGE JUICE
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
MARKET PRICES VS FACTOR COST
S1
PRICE OF
ORANGE JUICE
S2 = S1 + T
12
10
D
100 120
QUANTITY OF
ORANGE JUICE
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
MARKET PRICES VS FACTOR COST
S1
PRICE OF
ORANGE JUICE
S2 = S1 + T
15
S = $5
12
10
D
100 120
QUANTITY OF
ORANGE JUICE
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
MARKET PRICES VS FACTOR COST
S1
PRICE OF
ORANGE JUICE
S2 = S1 + T
15
S = $5
12
SUBSIDY
EXPENDITURE
= $600
10
D
100 120
QUANTITY OF
ORANGE JUICE
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
MARKET PRICES VS FACTOR COST
S1
PRICE OF
ORANGE JUICE
S2 = S1 + T
15
S = $5
12
SUBSIDY
EXPENDITURE
= $600
10
CONSUMER
SPENDING
= $1,200
D
100 120
QUANTITY OF
ORANGE JUICE
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
MARKET PRICES VS FACTOR COST
S1
PRICE OF
ORANGE JUICE
S2 = S1 + T
15
S = $5
12
SUBSIDY
EXPENDITURE
= $600
CONTRIBUTION TO
GDP AT MARKET PRICES:
10
$1,200
CONSUMER
SPENDING
= $1,200
D
100 120
QUANTITY OF
ORANGE JUICE
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
MARKET PRICES VS FACTOR COST
S1
PRICE OF
ORANGE JUICE
S2 = S1 + T
15
S = $5
12
10
FACTOR
PAYMENTS
= $1,800
D
100 120
QUANTITY OF
ORANGE JUICE
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
MARKET PRICES VS FACTOR COST
S1
PRICE OF
ORANGE JUICE
S2 = S1 + T
15
S = $5
12
CONTRIBUTION TO
GDP AT FACTOR COST:
10
$1,800
FACTOR
PAYMENTS
= $1,800
D
100 120
QUANTITY OF
ORANGE JUICE
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
GOVERNMENT BUDGET

The budget balance is the difference between the government’s tax revenue
and its spending, both on goods and services and on government transfers,
in a given fiscal year.

If government spending is smaller than tax revenue (i.e. positive budget
balance), then a budget surplus is said to exist.

If government spending is equal to tax revenue, then the government budget
is said to be balanced.

If government spending is larger than tax revenue (i.e. negative budget
balance), then a budget deficit is said to exist.
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GOVERNMENT BUDGET

Nb: In the UK, the size of a government budget deficit is known as the Public
Sector Net Cash Requirement (PSNCR).

Other things being equal, expansionary fiscal policies reduce the budget
balance for that fiscal year (i.e. make a budget surplus smaller or a budget
deficit larger).

Other things being equal, contractionary fiscal policies increase the budget
balance for that fiscal year (i.e. make a budget surplus larger or a budget
deficit lower).

Due to the automatic stabilizers, there is a strong relationship between the
business cycle and the budget balance.
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GOVERNMENT BUDGET

In particular, the workings of the automatic stabilizers suggest that the
government budget tends to move toward surplus during economic
expansions and toward deficit during economic downturns, even without any
deliberate action on the part of policy makers.

A budget deficit caused by the business cycle is known as a cyclical deficit (or
cyclical budget position).

However, if the budget is always in deficit, regardless of the economy’s
position on the trade cycle, then the deficit is said to be structural.
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BUDGET BALANCE & BUSINESS CYCLE
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BUDGET BALANCE & BUSINESS CYCLE
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PUBLIC DEBT

In order to finance a budget deficit, governments usually borrow funds by
selling government securities (e.g. bills, bonds, etc.).

The stock of all former budget deficits financed by borrowing and which
have not been repaid yet is known as the public (or national) debt.

National debt is not the same as external debt as some of the debt will be
owed to residents of the country.

In particular, it is more likely that a country’s public debt is concerning if a
large proportion is owed to foreign lenders.
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PUBLIC DEBT

The change in national debt is connected to budget deficits and budget
surpluses.

If a government has a budget deficit in one year, then it will add to the
country’s national debt.

If a government has a budget surplus in one year, then the extra revenue can
be used to pay off part of the national debt.

Therefore, the national debt tends to increase during economic downturns
and to decrease during economic expansions due to the automatic stabilizers.
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
PUBLIC DEBT

A government that runs persistent budget deficits experiences rising levels of
public debt.

The increase in public debt is accompanied by an increase in interest
payments.

Remark: The payment of interests on the public debt involves an opportunity
cost in the sense that the government revenue used to service the debt could
have been used for other purposes.

The increase in interest payments places an additional financial pressure on
future budgets.
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
PUBLIC DEBT

As a result, unless the government responds by raising taxes or cutting
spending, budget deficits are likely to persist.

In that case, it will have no choice but to borrow even more, pushing itself even
deeper into debt.

This process can eventually push the government to the point at which lenders
question its ability to repay.

In order to borrow more funds, the government will then have to pay higher
interest rates to compensate for the risk of default.
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
PUBLIC DEBT

This may create a snowball effect that increases the burden of the public debt
and can even make it get out of control.

Eventually, the government might be forced to default on its debt.

Default creates havoc in a country’s financial markets and badly shakes
public confidence in both the government and the economy.

Finally, note that the existence of a public debt raises the issue of
intergenerational equity.
Dr. Sylvain Hours - postmaster@econdoctor.com - Wechat: sylvainhoursCN - www.econdoctor.com
THE DEBT-GDP RATIO

The debt-GDP ratio is the public debt as a percentage of GDP.

The debt-GDP ratio is useful because it is a good indicator of the actual burden
of the debt.

This is because the larger the GDP, the greater the tax revenue that can be
collected by the government in order to repay the debt.

If the public debt grows more slowly than GDP, the public debt burden
actually falls.

If the public debt grows faster than GDP, the public debt burden actually
increases.
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DEFICITS AND DEBT IN PRACTICE
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DEFICITS AND DEBT IN PRACTICE
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NATIONAL DEBT
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NATIONAL DEBT
JAPAN
237.9%
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NATIONAL DEBT
GREECE
158.5%
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NATIONAL DEBT
ITALY
127.0%
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NATIONAL DEBT
SINGAPORE
111.0%
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NATIONAL DEBT
USA
106.71%
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NATIONAL DEBT
FRANCE
90.3%
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NATIONAL DEBT
UK
84.9%
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NATIONAL DEBT
CHINA
65.7%
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MCQS
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MCQS
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MCQS
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MCQS
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MCQS
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MCQS
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MCQS
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MCQS
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MCQS
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MCQS
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MCQS
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MCQS
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MCQS
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MCQS
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MCQS
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MCQS
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MCQS
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ESSAY QUESTIONS
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ESSAY QUESTIONS
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ESSAY QUESTIONS
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ESSAY QUESTIONS
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ESSAY QUESTIONS
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