1. 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

2. 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

3. 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

4. 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

5. 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

6. 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

7. 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

8. 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

9. 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

10. 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

11. 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

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

13. 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

14. 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

15. 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 $
$ ,000 1
1000
$ ,000
11% 2
1100 $
$ ,000
-1% 3
1200 $
$ ,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

16. 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 $
$ ,000 1
1000
$ ,000
11% 2
1100
$ ,000
10% 3
1200
$ ,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

17. The UK economy - performance and policies
Opening activity
Please read the attached article – we’ll discuss in the lesson (Check your for the link pls)
The UK economy - performance and policies

18. 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

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

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

21. 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

22. 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

23. 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

24. 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

25. 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

26. 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

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

28. 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

29. The UK economy - performance and policies
$100
GDP Deflator
$90
(From previous slide)
Year
Oil (Barrels)
$/Barrel
Nom. GDP
Real GDP
Deflator
1000
100
$ ,000 1 2 90
$ ,000 3
1200 50
$ ,000
$ ,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 =
$ ,000
GDP Deflator
The UK economy - performance and policies

30. 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