Calculation of GDP through expenditure and income approach

The national accounts of Parchment Paradise are kept on (you guessed it) parchment. A fire destroys the statistics office. The accounts are now incomplete but they contain the following data:

• GDP (income approach): $2,900
• Consumption expenditure: $2,000
• Indirect taxes less subsidies: $100
• Gross income at factor cost: $2,800
• Investment: $800
• Government expenditure: $400
• Wages: $2,000
• Net exports: –$200

1. Calculate GDP using the expenditure approach.

To begin with, the expenditure approach of calculating GDP incorporates the total sum of money used to the purchase goods and services within an economy. It is calculated as Y = C + I + G + (X – M) in the above case it is given as;

Y = $2000 + $800 + $400 – $200

Y = $3000

1. Calculate the sum of total income less wages and the statistical discrepancy.

The total national income is given by the sum of all wages, rents, interests, and profits.

As such, the total national income is given by gross income at factor cost + wages

Total income = $2800 + $2000

= $4800

Statistical discrepancy, on the other hand, is the difference between the GDPs calculated according to the income approach and the expenditure approach and then dividing the figure by two as illustrated below:

Statistical Discrepancy =  =  = $50

As such the total income less wages and the statistical discrepancy is given by

$4800 – $2000 – $50 = $2750

Quantities	2015	2016
Fish	1,000 tonnes	1,100 tonnes
Crabs	500 tonnes	525 tonnes
Prices
Fish	$20 a tonne	$30 a tonne
Crabs	$10 a tonne	$8 a tonne

1. Calculate Maritime Republic’s nominal GDP in 2015 and 2016.

Production	2015	2016
	Quantity*Price	Total	Quantity*Price	Total
Fish	1,000 tonnes*$20	$20000	1,100 tonnes*$30	$33000
Crabs	500 tonnes*$10	$5000	525 tonnes*$8	$4200
Nominal GDP		$25000		37200

1. Calculate Maritime Republic’s chain volume measure of real GDP in 2016 expressed in 2015 dollars.

Quantities	2015	2016
Fish	1,000 tonnes	1,100 tonnes
Crabs	500 tonnes	525 tonnes
Prices
Fish	$20 a tonne	$20 a tonne
Crabs	$10 a tonne	$10 a tonne

For this case, CVM of real GDP = 1100tonnes * $20 +525tonnes * $10

  = $27250

GDP has proved useful in tracking both short-term fluctuations and long-run growth. Which isn’t to say GDP doesn’t miss some things. Amartya Sen, at Harvard, helped create the United Nations’ Human Development Index, which combines health and education data with per capita GDP to give a better measure of the wealth of nations. Joseph Stiglitz, at Columbia, advocates a “green net national product” that takes into account the depletion of natural resources. Others want to include happiness in the measure. These alternative benchmarks have merit but can they be measured with anything like the frequency, reliability and impartiality of GDP?

Source: Time, 21 April 2008

1. Explain the factors that the news clip identifies as limiting the usefulness of GDP as a measure of economic welfare.
   1. According to the clip, GDP does not factor in the contribution of a country’s human capital to the economy based on the human health status and the level of education.
   2. The GDP approach also fails to factor in externalities such as the depletion of the natural resources.
   3. It also fails to measure the happiness levels in the economy, which would be a major contributor to the human welfare.
   4. It does not describe the wealth distribution  
2. What are the challenges involved in trying to incorporate measurements of those factors in an effort to better measure economic welfare?
   1. The human development index fails to consider differences in wealth distribution. Also some measures seem very arbitrary, especially when there are varying measures of health and education.
   2. With regards to the green net national product, it is difficult to develop a standardized market value for some goods. For instance, the non-traded goods have no market value. Also, measuring the depletion of some resources and attaching a monetary value can be very difficult.
   3. With regards to measuring happiness and factoring it in the gross national product, it is difficult to standardize the happiness level among citizens. From an economic perspective, happiness is equated to the satisfaction derived from consumption. As such, the difference in consumer preferences leads to varying satisfaction level and thus the happiness level.
3. What does the ranking of Australia in the Human Development Index imply about the levels of health and education relative to other nations?

In 2015, Australia’s Human Development Index was 0.939, which placed it at the second position out of one hundred and eighty-eight countries. This implies that the health rankings of the nations were above average. In fact, life expectancy at birth increased by about six years. More so, the education level in the citizens increased evidenced by the one and half years increase in the average schooling years and the increased expected years of schooling by three years. This implies that the country has among the healthiest and educated population relative to other countries.

Labor force participation rate and employment-to-population ratio in Australia

Labour force participation rate: 69.6 per cent

Working-age population (in thousands people): 18,429,726

Employment-to-population ratio: 65.2

• Calculate the labour force.  (2 marks)

Labor force = Labor force participation rate * Working- age population

        = .696*18,429,726

        = 12827089.3 ♎ 12827090

• Calculate the employment.  (2 marks)

Employment to population ratio =

Total population =

= 19673450.92 ♎ 19673451

Employment = 12827090

In New South Wales in October 2015, the labour force was 3,803,200 and 200,500 people were unemployed. In November 2015, the labour force decreased by 300 and the number employed increased by 2,900.

• Calculate the unemployment rate in November 2015.(2 marks)

New labor force = 3,803,200-300

= 3,802,900

New number of unemployed people = 200500+2900

      = 203400

Unemployment rate =

    = 5.08%

A typical family on Sandy Island consumes only juice and cloth. Last year, which was the base year, the family spent $40 on juice and $25 on cloth. In the base year, juice was $4 a bottle and cloth was $5 a length. This year, juice is $4 a bottle and cloth is $6 a length.

• Calculate the CPI in the current year  (2 marks)

In this case, we assume that the family’s expenditure remains constant

Percentage of consumption on each good

Juice = 40/ 65*100= 61.54%

Cloth = 25/65*100= 38.46%

Last year’s Weighted average prices = .6154*4+.3846*5 = 4.3847

Current Year’s Weighted Average prices = .6154*4+.3846*6 = 4.7692

CPI = 4.7692/4.3847*100 = 108.77

• Calculate the inflation rate in the current year. What does it indicate on the price level?             (2 marks)

Inflation rate = CPI-100= 8.77%

This implies that the price level has increased by 8.77% in the last one year

The number of job vacancies in Australia rose 3.2 per cent in the three months to August 2011, official statistics show. The number of job vacancies in the private sector was 170,000 in August, a rise of 4.1 per cent from 163,300 in May. There were 17,100 vacancies in the public sector in August, down 4.4 per cent from vacancies recorded three months earlier. Over the same three months, the unemployment rate increased from 5 per cent to 5.3 per cent.

Sources: News.com.au, 29 September 2011 and ABS

• If the labor market is working properly, why are there job vacancies and unemployment? Why don’t all the job vacancies get filled by unemployed workers?(2 marks)

There are several job vacancies and unemployment in Australia because of the dynamic nature of the labour market. For instance, while a job vacancy might exist, the unemployed workers could lack the skills required for the job. As such, unemployment will always exist even when there are job vacancies unless the market operates at full employment level.

• Are the additional workers who couldn’t find jobs in the three months to August 2011 most likely part of the economy’s structural unemployment or part of its cyclical unemployment? Explain your answer. (3 marks)

The additional workers who could not find jobs are most likely part of the economy’s structural employment. In the case of structural unemployment, the market demand for a certain workers may diminish or cease because of technological advancement among other reasons. Some companies may have introduced new machines that increase efficiency and reduce the need for human capital. As such, the works who did not have the skills to work with the new technology could have lost their jobs in the process.

Unemployment rate and job vacancies in Australia

Quantity Expansion (QE) of Money in the European Union (EU)  

On March 9 2015, the European Union (EU) commenced quantity expansion of money, Euro (€). The European Central Bank (ECB) has increased the quantity of money by 60 billion euro every month in the open market in an attempt to support the economy of EU countries. The large increase in the quantity of money is expected to have significant impacts on a range of economic sectors in the EU and global financial markets.  

• Analyse how the quantity expansion of euro money is likely to affect money supply, interest rate, investment and consumption, and economic growth in the EU.  Draw relevant graph(s) for your analysis.  (5 marks)

Based on the quantity theory of money, an increase in the money supply causes an increase in the general price level in the economy. As such, the quantity of money is increased, the interest rate, investment, consumption, and economic growth will be affected. The illustrations below show the effects of increased quantity of money.

The Effect of Quantity Expansion of Euro Money on Money supply and Interest Rates

Interest rate   r    MS₁             MS₂

      Demand for Money

   1 2 Quantity of money

Based on the above diagram, in increase in the quantity of money in the economy will shift the money supply curve from MS₁ to MS_2, which implies an increase in the money supply

Also, an increase in the money supply will cause the demand to increase along the demand curve from point r^*1 to r²2 as a result of the decrease in the interest rate from r^* to r². In other words, the increase in the money supply in the market will cause a decrease in the interest rates.

The Effect of Quantity Expansion of Euro Money on Investment

Interest rate   r       

      Investment Demand

   I₁ I₂ Investment  

Due to the reduced interest rates from r^* to r², the cost of investment will decrease causing an increase in the expected rate of return. As a result, investment demand will increase from point r^*I₁ to r²I_2, which implies an increase in the general investment.

The Effect of Quantity Expansion of Euro Money on Consumption

Interest rate r LM₁

LM₂ r^* r² IS curve Y₁        Y₂ Income Y Consumption C Consumption Curve  C²  C¹     Y₁        Y₂ Income Y

From the diagram, an increase in money supply will cause a decrease in the interest rate and a subsequent increase shift of the LM curves to the right (from LM₁ to LM₂). The overall demand for money will increase. Note that both the speculative and the transaction demand for money will increase. As a result, the income level will increase from Y₁ to Y_2.  As a result of this increase in income, the consumption function, which is a function of income will increase from C¹ to C². As such, the two diagrams shown above illustrate that the consumption level will increase as a result of the increase in the money supply occasioned by the quantity expansion of Euro Money.

Calculation of inflation rate and the effects of price level changes

To explain the effect of quantity expansion of money on economic growth, assume the GDP as an indicator and the expenditure approach as the method of measuring this GDP. Under this approach, the GDP(Y) is a function of consumption, investment, government spending, and net exports. As such, a change in any of the exogenous variables will automatically cause a change in the GDP. In the context of the quantity expansion of Euro Money, the investment, and consumption functions will be directly affected (Vanita, 2010). Government expenditure will also be affected. As established, the investments will increase along with consumption. As such, the increase in the explanatory variables in the national income function will cause an increase in the explained variable (the GDP). As such, the quantity expansion of Euro Money will lead to economic growth.

Global Saving Glut and U.S. Current Account, remarks by Ben Bernanke (when a governor of the Federal Reserve) on 10 March 2005:

The U.S. economy appears to be performing well: Output growth has returned to healthy levels, the labour market is firming, and inflation appears to be under control. But, one aspect of U.S. economic performance still evokes concern: the nation’s large and growing current account deficit (negative net exports). Most forecasters expect the nation’s current account imbalance to decline slowly at best, implying a continued need for foreign credit and a concomitant decline in the U.S. net foreign asset position.

• Why is the United States, with the world’s largest economy, borrowing heavily on international capital markets—rather than lending, as would seem more natural?

First, borrowing from the international capital markets helps the country to take advantage of the floating exchange rates that brings. For instance, this borrowing permits interest rate adjustment to the needs of the domestic economy.

Secondly, borrowing on the international capital helps the country to strengthen its systems. With robust financial systems, the country can effectively enjoy stable interest rates while retaining its strong currency

Thirdly, the use of international capital markets as sources of finance enable that country to effectively manage future crisis. Ideally, the country effectively distributes risks to other countries and thus mitigating the effects of inflation or recession.

• What implications do the U.S. current account deficit (negative net exports) and our reliance on foreign credit have for economic performance of the U.S. economy?

To begin with, the economic forces driving the capital flows are long-term. Home bias has decline as evidenced by portfolio reallocations where firms build operations in other countries in attempts to remain as going concerns. The country is also increasing the risk of currency depreciation that could lead to financial crisis should the investors lose confident in it. The country also risks the value of its foreign currency depreciating causing the value of its foreign liabilities to increase and the burden of servicing the international debt follows suit.

Quantity expansion of euro money in the European Union

However, the US has been lucky because most of its international debts are US dollar denominated. As such, a decline in the foreign exchange value of the dollar has a self-correcting effect on the value of the foreign asset holdings. More so, most of the US investments abroad are US dollar denominated implying that the composition of the international investment account contribute to stability in the US economy.

• What policies, if any, should be used to address this situation?

While the US has among the best policies to mitigate the adverse effects of excessive reliance on the international sources of capital, more policies can be suggested as an improvement. First, the country can reduce domestic consumption and spending on import and encourage production of goods and services for export (Salvatore, 2016). Secondly, the country can develop supply side policies that improve the competitiveness of the domestic industry and exports. More so, the country should develop an agency that closely monitors the foreign currency valuations as well as the effects of foreign currency variation on its currency.

Colombia is the world’s biggest producer of roses. The global demand for roses increases and, at the same time, the central bank in Colombia increases the interest rate. In the foreign exchange market for Colombian pesos, what happens to

1. The demand for pesos?

The demand for pesos will decrease relative to the increase in the interest rates

1. The supply of pesos?

The supply of pesos will remain relatively constant then it will start decreasing as the economy adjusts to the increased interest rates

1. The quantity of pesos demanded?

The quantity demanded of roses from Colombia will increase in the international market because the increased interest rate makes the local currency to be stronger. As such, purchasing the product in Colombia’s local currency and selling it using another currency will be more profitable

1. The quantity of pesos supplied?

The quantity supplied of roses will remain constant for a while. However, there will be a decrease in the velocity of money resulting to the reduced number of transactions.

1. The exchange rate of the pesos against the Australian dollar?

Assuming that the Australian government does not make a decision that alters the value of it’s the Australian dollar, then the peso will increase in value implying that the Australian dollar will be worth less pesos.

The table gives some information about the U.S. international transactions in 2008.

1. Calculate the current account balance.

Item	Billions of U.S. dollars
Imports of goods and services	2,561
Foreign investment in the United States	955
Exports of goods and services	1,853
U.S. investment abroad	300
Net interest income	121
Net transfers	−123
Statistical discrepancy	66

Item Billions USD

Exports 1853

Less imports   (2561)

Add net income 121

Add net transfers (123)

Current Balance (710)

1. Calculate the capital and financial account balance.

Item Billions of US dollars

Foreign investment in the united states 955

Less US investment abroad (300)

Add Statistical Discrepancy 66

Total 721

1. Did U.S. official reserves increase or decrease?

Yes. The U.S official reserves increased by 11billion dollars

1. Was the United States a net borrower or a net lender in this year? Explain your answer.

The US was a net lender in 2008 because the summation of its capital and current accounts produced a positive balance.

References

Arnold, R. A. (2015). Macroeconomics. Boston: Cengage Learning.

Salvatore, D. (2016). International Economics, Binder Ready Version. Hoboken: John Wiley & Sons.

Vanita, A. (2010). Macroeconomics: Theory and Policy. Delhi: Pearson Education India.