1. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 1 Chapter 8 The macroeconomic environment and its measurement

2. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 2 Learning objectives 1.Describe the major components of Australia’s national accounts and the measurement and construction of gross domestic product (GDP). 2.Discuss the differences between nominal GDP (GDP at current prices) and real GDP (GDP at constant prices). 3.Explain how GDP figures can be adjusted to account for changes in the price level. 4.Analyse and interpret the nature and structure of the balance of payments (BOP) accounts. 5.Discuss the relationship between the current account balance and the level of national savings.

3. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 3 Learning objectives (cont.) 6.Examine the consequences of the structure of the BOP accounts for achieving external balance. 7.Describe the business cycle—the periodic fluctuations in output, employment and price levels that have characterised our economy. 8.Examine unemployment in detail—its definition and measurement and the structure of unemployment. 9.Discuss the economic and social problems associated with unemployment. 10.Understand the causes and consequences of inflation, a problem that plagued us through the 1970s and 1980s.

4. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 4 Measuring the economy The purpose of national accounts is to: 1. measure the level of production in the economy 2. explain the immediate causes of the level of performance of the economy 3. uncover underlying problems in the economy 4. plot the long-run course of the economy over time 5. provide foundations for public policies.

5. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 5 Gross domestic product GDP is: the total market value of all final goods and services produced in the economy during a specific period. measured in money terms and not in physical units usually measured over a year.

6. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 6 What is included in GDP? Only final goods and services –These are goods and services that are being purchased for final use and are not to be subject to further processing, manufacturing or resale. Intermediate goods are excluded to avoid double counting. To avoid double counting calculate only the value added by each firm. –Value added is the market value of a firm’s output less the value of intermediate components.

7. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 7 What is not included in GDP? GDP excludes non-productive transactions –Transactions where no production of goods or services occurs Two major types of non-productive transactions: 1.Purely financial transactions 2.Sales of second-hand goods

8. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 8 What is not included in GDP? (cont.) Financial transactions are excluded –Public transfer payments –Private transfer payments –Buying and selling of shares and securities Sales of second-hand goods are excluded –Do not reflect current production –Involve double counting

9. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 9 Two sides to GDP Expenditure approach –Measures GDP as the sum of all the expenditures involved in buying up that total output Income approach –Sum of the incomes derived from the production of the GDP

10. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 10 Expenditure approach GDP is derived as a sum of: personal consumption expenditure (C) gross private investment (I) government purchases of goods and services (G) net export expenditures (NX) GDP = C + I + G + NX

11. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 11 Personal consumption expenditure (C) Also called household final consumption, expenditure includes expenditure on durable consumer goods –Cars, refrigerators, videos, etc. Non-durable consumer goods –Milk, bread, shirts, etc. Services –Doctors, mechanics, cleaners, etc.

12. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 12 Gross private investment (I) Defined as: final purchases of machinery, equipment and tools all building and construction changes in stocks (or inventories) does not include financial investment or transfer of paper assets, e.g. buying of shares.

13. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 13 Government purchases of goods (G) Includes all government spending (federal, state and local) on: final government consumption expenditure final government gross fixed capital expenditure increases in stocks of government authorities.

14. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 14 Net exports (NX) Net exports is the: difference between the value of exports (X) and imports (M), or NX. amount by which foreign spending on Australian goods and services exceeds Australian spending on foreign goods and services.

15. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 15 Income approach to GDP GDP(I) is calculated as the sum of all income derived from the production of goods and services. Complicated by two-income charges: –depreciation allowances –indirect taxes.

16. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 16 Compensation of employees Largest component Payments to suppliers of labour, including: –wages –salaries –superannuation –direct pensions –compensation payments.

17. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 17 Gross operating surplus (GOS) Basically put this is rents, interest and profits. Accounts for the fact that rents, interest and profits are difficult to separate out in practice Excess of gross output value over sum of: –intermediate consumption –wages –salaries –supplements –indirect taxes less subsidies.

18. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 18 Net operating surplus GOS less depreciation Depreciation: –The annual charge that estimates the amount of capital equipment used up in each year’s production –Also called capital consumption allowance

19. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 19 Taxes less subsidies Indirect taxes are treated as costs of production by businesses and added to the prices of goods and services. –Indirect business taxes to the government is not earned income. Subsidies are payments to business to encourage production of a particular commodity, or negative indirect taxes.

20. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 20 Non-market transactions Comprise the relatively large and expanding underground economy Engaged in illegal activities such as gambling Also include legal activities that do not fully report their income

21. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 21 Money GDP vs real GDP Money GDP is GDP measured in current prices (nominal GDP). Real GDP is money GDP adjusted for inflation by an implicit price deflator, also called constant price GDP.

22. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 22 Real and nominal GDP Real GDP = Money GDP Price index (as decimal) The formula used for deflating

23. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 23 Inflating and deflating Two indices of price adjustment Consumer price index (CPI) –Measures the price level of a ‘market basket’ of goods and services for a typical family Implicit price deflator (IPD) –Measures the average level of price changes of C, I, G and net exports

24. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 24 Balance of payments Reflected in international balance of payments account –Records all transactions between the entities in Australia and those in foreign nations

25. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 25 Balance of payment accounts Two basic subcategories of accounts: –Current account—reflecting current transactions –Capital and financial accounts

26. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 26 Current account Balance on current account equals sum of: Goods and services balance –Goods and services credits less goods and services debits Primary income balance –Primary income credits less primary income debits Secondary income balance –Secondary income credits less secondary income debits

27. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 27 Current account components 1.Goods and services account –Exports and imports of merchandise goods and services –Balance of merchandise exports and imports sometimes called ‘balance of trade’ 2.Primary income balance –Net interest, dividend payments & re-invested earnings, net investment incomes associated with pensions & life insurance investments plus net payments made to workers employed outside their official country 3. Secondary income balance –Net transfers, both public & private, from the rest of the world to residents of Australia, including monies paid to/from Australia to students and net remittances to/from relatives abroad

28. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 28 Capital account A. Capital account balance = capital transfers credits – debits plus net acquisition of non- produced, non-financial assets The sum of net capital transfers (migrants’ transfers & aid flow related to capital formation) and net sales of patents, copyrights, trademarks, franchises and embassy land (non-produced, non-financial assets)

29. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 29 Financial account B. Financial account balance Direct versus portfolio investment –Direct investment occurs when ‘controlling’ investment is made by non-residents in an Australian company, or when Australians make investment in a foreign company controlled by Australian interests. –Portfolio investment occurs when non-residents buy non-controlling (i.e. less than 10%) shares/bonds from Australian companies, or Australians buy shares in foreign companies. Also includes institutional loans –Net financial derivatives, other net investments & reserve assets –Net errors and omissions Capital & financial account balance = A + B

30. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 30 Australia’s current account problem Three factors –Gradual deterioration in the terms of trade  Terms of trade is the ratio of the average price of the goods and services exported by a country to the average price of its imports. –High freight and transport cost –Dependence on large levels of capital inflow Current account problems in the 1970s, 1980s and 1990s and into the 2000s.

31. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 31 Components of the current account

32. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 32 Components of the capital and financial accounts

33. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 33 National savings National savings represents savings from national income. This is used to finance gross capital formation. Secular fall in household savings in Australia reversed in late 2000s and compensated at times by business saving Government has traditionally been a net borrower in Australia, up until the later part of the 1990s and first half of 2000s, when it moved to be a net saver. Government became a net borrower due to its fiscal response to the global financial crisis in 2008–9

34. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 34 Australia: net national savings

35. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 35 The balance of payments and the concept of external balance A level of the current account consistent with the maintenance of existing (or growing) levels of consumption, employment and national output over the long term.

36. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 36 The Australian business cycle The long-run economic growth in Australia has not been steady. There were ‘ups and downs’ in the level of economic growth over the years. The recurrent, cyclical increases and decreases in the level of economic activity is termed the business cycle.

37. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 37 The Australian business cycle

38. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 38 Phases of the business cycle Peak –Temporary maximum economic activity Recession –Decline in output and employment to low or negative levels –Depression—severe and prolonged recession Trough –Output bottom out at their lowest level Recovery –Output and employment expand towards the full-employment level

39. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 39 Phases of the business cycle (cont.)

40. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 40 Unemployment Types of unemployment Frictional –New entrants and workers ‘between jobs’, temporarily laid off due to seasonality –Inevitable and partly desirable Structural –Mismatch in skills and geographic location –Not employable without additional training, education and/or geographical movement Cyclical –Unemployment caused by the business cycle, or due to insufficient aggregate demand or total spending

41. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 41 Full employment –A situation of labour market balance consistent with output at the economy’s potential output level The full-employment rate of unemployment is called the natural rate of unemployment. –Equals the sum of frictional and structural unemployment –Cyclical unemployment = zero –Domestic output consistent with the natural rate of unemployment is potential output or GDP.

42. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 42 Australia: unemployment rate

43. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 43 Labour market definitions Part-time employment not counted as unemployed –Underemployed: part-time employees who want to work more hours but are unable to do so Discouraged workers –Those who become discouraged and drop out of the labour force but would return if a suitable job prospect arose –‘Hidden unemployed’ –‘Not in labour force’ but not officially classified as unemployed Participation rate = % civilian population in a specified labour force group Unemployment rate =% of labour force who are unemployed

44. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 44 Economic cost of unemployment Economic cost –Output foregone, measured in terms of the GDP gap –Okun’s law shows the quantified relationship between the unemployment rate and the GDP gap.  For every 1% of unemployment above the natural rate, a GDP gap of more than 3.5 per cent is generated.

45. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 45 Inflation Inflation is a continuous rise in the general price level The inflation rate is measured as follows: Inflation rate Current year index – Previous year index Previous year index x 100 =

46. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 46 Theories of inflation Two general causes/theories of inflation Demand-pull inflation –Caused by excess demand for output Cost-push or supply-side inflation –Rise in prices arising from increased cost of production due to:  wage push  profit push.

47. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 47 Range 1 Price level Output and employment Q P 2 Range 2 3 Range 3 Full- employment output Demand-pull inflation

48. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 48 Inflation and redistribution Unanticipated inflation can harm: –fixed-money-income receivers –savers –creditors. Unanticipated inflation can benefit: –debtors. Anticipated inflation –Income outcomes less severe if transactors can adjust their money incomes to compensate for expected inflation

49. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 49 Output effects of inflation Demand-pull inflation can provide real stimulus Cost-push inflation and unemployment –Hyperinflation –Wage-price inflationary spiral Hyperinflation –Sustained, very rapid increase in the level of prices leading to rapid erosion in the value of money

50. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 8- 50 Next chapter Aggregate demand and aggregate supply