RECALL: A Simple 2-Sector Model (Firms and Households) Wages, Rent, Dividends (Income) Consumption Spending (Expenditure) Goods & Services (Value of Output) Labour The UK economy - performance and policies

Circular Flow of Income Illustrates how output generates income which is then spent, coming full circle through the economy The relationship between governments, households, firms, and the foreign sector Income = Expenditure = Value of Output The UK economy - performance and policies

A Simple 2-Sector Model (Firms and Households) INVESTMENT INJECTIONS Wages, Rent, Dividends (Income) Consumption Spending (Expenditure) Goods & Services (Value of Output) Labour The UK economy - performance and policies

A Simple 2-Sector Model (Firms and Households) Govt Expenditure INJECTIONS Wages, Rent, Dividends (Income) Consumption Spending (Expenditure) Goods & Services (Value of Output) Labour The UK economy - performance and policies

A Simple 2-Sector Model (Firms and Households) Income from Exports INJECTIONS Wages, Rent, Dividends (Income) Consumption Spending (Expenditure) Goods & Services (Value of Output) Labour The UK economy - performance and policies

A Simple 2-Sector Model (Firms and Households) Wages, Rent, Dividends (Income) Consumption Spending (Expenditure) Goods & Services (Value of Output) Labour Leakages Spending on Imports The UK economy - performance and policies

A Simple 2-Sector Model (Firms and Households) Wages, Rent, Dividends (Income) Consumption Spending (Expenditure) Goods & Services (Value of Output) Labour Leakages Taxation The UK economy - performance and policies

A Simple 2-Sector Model (Firms and Households) Wages, Rent, Dividends (Income) Consumption Spending (Expenditure) Goods & Services (Value of Output) Labour Leakages Savings The UK economy - performance and policies

Terminology/Abbreviations Y – Value of Income X – Value of Exports I – Value of Investments G – Value of Government Expenditure C – Value of domestic Consumption T – Value of Taxation S – Value of Savings M – Value of Imports The UK economy - performance and policies

The UK economy - performance and policies A more complex model… Labour, Land, Capital Output of Goods/Services (Income) (Expenditure) Note: injections & withdrawals can happen at any stage in the model The UK economy - performance and policies

The UK economy - performance and policies Opening Activity Match the definition to the Economic measure Economic Measure Definition Gross Domestic Product (GDP) ..the total market value of all goods and services produced by domestic residents plus income that residents have received from abroad, minus income claimed by non-residents. Gross National Product (GNP) ..is GDP plus income paid into the country by other countries for such things as interest and dividends. Gross National Income (GNI) ..is the total market value of all goods and services produced in the country in a given year. It does not include earnings by its residents while outside of the country The UK economy - performance and policies

The UK economy - performance and policies Measurement of GDP GDP = Cd + I + G + (X-M) The UK economy - performance and policies

The UK economy - performance and policies GDP – volume or value? GDP can be measured in nominal or real terms. What does this mean? Nominal GDP measures GDP based on the price at the time the good is produced/sold The value of goods and services produced is calculated by price x quantity for all final goods So if the volume of goods produced does not change over 2 years, but the average price rises by 10%, nominal GDP increases by 10% But we are really interested in whether more goods and services are produced Real GDP strips out the impact of inflation by measuring GDP as if prices have not changed. (Sometimes known as “GDP at constant prices”) If Nominal GDP grows by 5% and inflation is 2% then real growth is 3% The UK economy - performance and policies

Exercise Nominal and Real GDP Consider an economy that produces just Crude Oil - Calculate nominal and real GDP (assume year 0 Oil was $100/barrel) - Calculate change (ie growth) in nominal and real GDP between years 2 & 3 Year Oil Sold (Barrels) Price of Oil / Barrel Value of Oil (Nominal GDP) Real GDP (Base year 0 = $100/Bbl) 900 $100 $90,000 1 1000 2 1100 $90 3 1200 $50 The UK economy - performance and policies

Yearly change in Nominal GDP Results: Nominal GDP NOMINAL GDP - Barrels of Oil Sold * Price of Oil   Year Oil Sold (Barrels) Price of Oil / Barrel Value of Oil Yearly change in Nominal GDP Nominal GDP 900 $ 100 $ 90,000 1 1000 $ 100,000 11% 2 1100 $ 90 $ 99,000 -1% 3 1200 $ 50 $ 60,000 -39% Change in GDP = Economic Growth Barrels of Oil sold x Price of Oil = Nominal GDP Change in GDP = (This Years GDP – Last Years GDP) / Last Years GDP Example: (Year 0 to Year 1) Nominal GDP changed from $90,000 to $100,000 Change in GDP = $100,000 - $90,000 / $90,000 = $10,000 / $90,000 = 0.11 = 11% The UK economy - performance and policies

Results: Real GDP REAL GDP - Barrels of Oil Sold * Price of Oiluse year 0 as a base year Year Oil Sold (Barrels) Price of Oil / Barrel Real GDP Yearly change in Nominal GDP 900 $ 100 $ 90,000   1 1000 $ 100,000 11% 2 1100 $ 110,000 10% 3 1200 $ 120,000 9% Change in GDP = Economic Growth Barrels of Oil sold x FIXED Price of Oil = Nominal GDP Change in GDP calculation is IDENTICAL = (This Years GDP – Last Years GDP) / Last Years GDP Example: (Year 0 to Year 1) Nominal GDP changed from $90,000 to $100,000 Change in GDP = $100,000 - $90,000 / $90,000 = $10,000 / $90,000 = 0.11 = 11% The UK economy - performance and policies

The UK economy - performance and policies Opening activity Please read the attached article – we’ll discuss in the lesson (Check your email for the link pls) http://www.bbc.co.uk/news/business-22277954 The UK economy - performance and policies

The UK economy - performance and policies GDP UK, Italy, China UK – returned to positive growth after GFC (~2% per annum) The UK economy - performance and policies

China – declining economic growth – but still growth! The UK economy - performance and policies

GDP – Italy – “Negative growth” until recently The UK economy - performance and policies

Does GDP measure output accurately Measuring GDP is a very complex process and mistakes may be made Measuring the output of the public sector is difficult If the government wants to reduce money spent on public services without reducing services (so income will fall but output may not…..) Does GDP include all goods and services? Are any missing in developing countries? Home produced goods – subsistence farming – produced for own consumption and therefore not measured Developed countries Hidden economy where cash is paid and incomes not declared DIY What about housework, families looking after children The UK economy - performance and policies

Comparing GDP over time Should only look at real GDP Key issues are eg quality of goods, composition of GDP (defence does not improve the standard of living, whilst investment lowers living standards today) Quality of goods An iPhone 7 today costs about the same today as the original iPhone, yet you all want it. It must be better… Cars are better than 50 years ago, but might even be cheaper in real terms (ie price without including inflation) If public sector output is measured by how much we pay staff, then since wages have risen does this really mean it is better (and for that matter doctors are paid better in other countries) The UK economy - performance and policies

Comparing GDP over time Defence Defence spending may make us feel secure, and allow our economy to grow, but spending many billions on an aircraft carrier adds to GDP but not to living standards Consumption and investment Investment means producing more machinery and equipment (investment is defined as additions to the capital stock) This enables more goods to be produced in the future, but at the expense of goods today The UK economy - performance and policies

Comparing GDP over time Externalities (Theme 1) Economic activity may mean costs which are not taken into account like pollution, or global warming Growth should really be adjusted for this GDP and happiness Does an increase in GDP really make us happier Should/is National Happiness be an objective The UK economy - performance and policies

The UK economy - performance and policies GDP: What is measured GDP measures the total market value of all goods and services produced However, this should be of final goods If I buy some potatoes from a farmer for £500 and produce lots of packets of crisps for £5,000 and sell these to a supermarket which then sells these for £7,000 then GDP is £7,000 not £500 + £5,000 +£7,000 It is only measured when spending is on new goods and services, when a good is produced So measuring income it excludes any transfer payments, such as government payments of pensions, since the recipient does not produce anything It excludes sales of second hand goods (cars, old houses) The UK economy - performance and policies

GDP: Total and per capita If GDP grew by 0.7%, does this mean living standards have increased? If the US economy is about 6 times larger than the UK, does this mean US citizens are better off? Need to adjust for size of population Do this via GDP per person (“GDP/capita”) = GDP/population The UK economy - performance and policies

The UK economy - performance and policies Table Per Capita GDP GDP/Capita NOMINAL GDP/Capita PPP (See Wikipedia) The UK economy - performance and policies

Simple Fraction manipulation A / B = C 12 / 3 = 4 A = B x C 12 = 3 x 4 A / C = B 12 / 4 = 3 Nominal GDP / Real GDP = Deflator Nominal GDP / Deflator = Real GDP Often easier to estimate a deflator and calculate the Real GDP The UK economy - performance and policies

The UK economy - performance and policies $100 GDP Deflator $90 (From previous slide)   Year Oil (Barrels) $/Barrel Nom. GDP Real GDP Deflator 1000 100 $ 100,000 1 2 90 $ 90,000 3 1200 50 $ 60,000 $ 120,000 GDP Nominal GDP (=60,000) Deflator = --------------- x 100 = (Example Year 3) (=120,000) In year 3 convert Nominal GDP to Real GDP using the Deflator of 50   Real GDP = Nominal GDP x 100 = $60,000 / 50 x 100 = $ 120,000 --------------- GDP Deflator The UK economy - performance and policies

Deflator – Fill in the chart  Year Oil (Barrels) $/Barrel Nom. GDP Real GDP Deflator 10 $100   100 1 11 $110 110 2 12 $132 120 3 $120 Remember Real GDP = Nominal GDP x 100 = --------------- GDP Deflator The UK economy - performance and policies