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GECO6400
Lecturer



Mr Paul Morris
Email: Paul.Morris@newcastle.edu.au
Consultation: Wednesday 4-5pm
Introduction to course

Course Outline

Prescribed Textbook
○
Jackson, John and Ron McIver (2007),
Macroeconomics (8th ed.), McGraw-Hill Australia,
Sydney

Assessment

Class Test 1 (10%): Wednesday 17 September, 2008

Class Test 2 (10%): Wednesday 8 October, 2008

Class Exam (25%): Wednesday 5 November, 2008

Research Essay (15%): Thursday 20 November, 2008

Final Exam (40%): Exam Period
The Asia-Pacific Region
 Geography
 Economies
 Asia-Pacific Economic Co-operation
Macroeconomic Goals and Concepts
 The Circular Flow of Income
 Gross Domestic Product
Information Sources

Textbooks



Prescribed
Supplementary
World-wide Web

Asia-Pacific Economic Co-operation
o www.apec.org

Pacific Economic Co-operation Council
o www.pecc.org

International Monetary Fund
o www.imf.org
Why Study Macroeconomics?
Viewed over time, macroeconomic statistics show
the health of an economy and the quality of
macroeconomic management.
Viewed across countries, they reveal the many
varied patterns of development. Together they
inform citizens, businesses, and governments of
the results of their efforts and guide them in their
future choices.
Important macroeconomic variables:
 Output
 Employment
 Inflation
 External Accounts
Macroeconomic analysis examines the size and change of
these variables.
This analysis informs Macroeconomic policy which
attempts to determine courses of action to be taken to
maintain the variables according to accepted goals. Eg.,
high growth in output and employment, low inflation and
stable international trade and financial flows.
The Asia-Pacific Region generally includes the following countries:
Australia
Bangladesh
Brunei
Cambodia
Federated States of Micronesia
Fiji
India
Indonesia
Japan
Kiribati
Laos
Malaysia
Marshall Islands
Myanmar
Nauru
Nepal
New Zealand
North Korea
Pakistan
Palau
Papua New Guinea
Philippines
Samoa
Singapore
Solomon Islands
South Korea
Sri Lanka
Thailand
Timor-Leste
Tonga
Taiwan
Thailand
Tuvalu
Vanuatu
Vietnam
Chinese Territories
People's Republic of China
Hong Kong
Macau
United States Territories
American Samoa
Guam
Northern Mariana Islands
Other
Mongolia
Russia
Asia Pacific Economic Co-operation (APEC)
Inaugurated in Australia in 1989
APEC Member
Australia
Brunei Darussalam
Canada
Chile
People's Republic of China
Hong Kong, China
Indonesia
Japan
Republic of Korea
Malaysia
Mexico
Date Joined
6-7 Nov 1989
6-7 Nov 1989
6-7 Nov 1989
11-12 Nov 1994
12-14 Nov 1991
12-14 Nov 1991
6-7 Nov 1989
6-7 Nov 1989
6-7 Nov 1989
6-7 Nov 1989
17-19 Nov 1993
APEC Member
New Zealand
Papua New
Guinea
Peru
Philippines
Russia
Singapore
Chinese Taipei
Thailand
United States
Viet Nam
Date Joined
6-7 Nov 1989
17-19 Nov 1993
14-15 Nov 1998
6-7 Nov 1989
14-15 Nov 1998
6-7 Nov 1989
12-14 Nov 1991
6-7 Nov 1989
6-7 Nov 1989
14-15 Nov 1998
Culturally, socially, politically and economically diverse
area:
 ‘Emerging Asia’ refers to China, India, Hong Kong
SAR, Korea, Singapore, Taiwan Province of China,
Indonesia, Malaysia, the Philippines, Thailand, and
Vietnam.
 ‘Industrial Asia’ refers to Japan, Australia, and New
Zealand.
 Low-income countries in Asia include Bangladesh,
Cambodia, Lao P.D.R., Mongolia, Sri Lanka, and
Vietnam.
Diverse region linked by:
 Economic activity: trade and capital flows
 Political interaction
 Political and economic organisations such as:
APEC
 Association of South-East Asian Nations (ASEAN)
 Pacific Economic Co-operation Council (PECC)
 Pacific Basin Economic Council (PBEC)
 Asia-Pacific Parliamentary Forum (APPF)

Write 2 paragraphs:
 In the first paragraph discuss what sort of
understanding you hope to achieve by doing
GECO6400.
 In the second paragraph, explain how by
studying this subject you can become a better
business manager.
The Economic Problem arises due to the existence
of:
Unlimited Wants
Limited Resources
Choices must therefore be made to allocate scarce
resources to provide for society’s wants.
Macroeconomics deals with the economic problem
on a large scale.
The Circular Flow of Income depicts the 5
sectors of a macroeconomy and their interaction in
the pursuit of solving the economic problem.
The sectors are:
1.Household Sector
2.Business Sector
3.Financial Sector
4.Government Sector
5.International Sector
Government
Sector
Taxes
Government
Expenditure
Labour
Export
Income
International
Sector
Import
Expenditure
Goods & Services
FIRMS
HOUSEHOLDS
Consumption
Wages
Savings
Investment
Financial
Sector
Physical Flow
Injection
Financial Flow
Leakage
1. Households




Provide factor services in exchange for
wages.
Wages less taxes (plus welfare) equals
disposable income (YD = Y-T).
Disposable income is either consumed (C)
or saved (S)
Consumption (C) is expenditure on local &
imported goods and services.
2. Firms



Businesses hire factors of production to make
goods & services.
Sell output domestically & via exports for
profit.
Firms undertake Investment (I) in capital
goods to increase productive capacity.
3. Financial Sector



Mediate between borrowers & lenders.
Households will deposit saving with finance
sector.
Firms (& government) will borrow funds from
finance sector for investment.
4. Government Sector




Collects Taxes (T) & undertakes Government
Expenditure (G).
Employs factors to produce goods & services.
Purchases goods & services.
Regulates the economy via policy instruments
(government expenditure & taxes make up
fiscal policy).
5. International Sector



The balance of payments records a nation’s
transactions with the rest of the world.
Selling goods & services to the rest of the
world is recorded as Exports (X).
Buying goods & services from the rest of the
world is recorded as Imports (M).
LEAKAGES and INJECTIONS
Leakages from the circular flow are any part of domestic
income not directly spent on the goods & services produced
by domestic firms and include:
* taxes
* saving
* imports
Injections into the circular flow are any expenditures on
domestically produced goods & services not sourced directly
from households:
* government expenditure
* investment
* exports
How can we be sure that the circular flow will
balance?



The circular flow is used as the framework
for the National Accounts.
But the National Accounts always deal with
actual data (backward looking – what
actually happened as distinct from what you
might have planned to happen).
So we can make the actual data balance by
introducing 2 special assumptions.
How can we be sure that the circular flow will
balance?
First assumption:
 define Investment to mean capital goods +
change in inventories of finished products.
 This means that if households do not buy all
the goods produced those finished goods
will be added to investment.
How can we be sure that the circular flow will
balance?
Second assumption:
 profit is always a residual income.
 This means that we will work out profit after
wages, rent and interest.
 Profit can be positive or negative (loss) and
that too will help to balance the circular flow.
Gross Domestic Product (GDP)
Gross Domestic Product (GDP) measures the
market value of all final goods and services
produced in the current year
 Gross: no deduction for depreciation
 Domestic: includes exports, not imports
 Product: goods and services
Market Value
 Market transactions included


eg. textbook sold for $100 from the Co-op Bookshop
luxury goods department.
Non-market transactions excluded

blood donations to Red Cross Blood Bank
Current Production
 cars produced this year but not sold would
be part of current production & included as
investment expenditure.
 computers produced last year & sold this
year would NOT be included - counted in
previous year’s GDP.
 Second hand jacket from Op shop - not
included NOT current production.
Domestic
 wool exports to China would be included as
produced in Australia.
 imported cars from Japan - not domestic
production & deducted from GDP.
Final
 intermediate goods - those goods that under
go further changes as part of production of
goods & services.


eg. paint sold to an interior decorator for a client
job.
final goods - goods at end of product chain no further value added.

eg. groceries sold to householder.
Some handy tips:
 avoid double counting - counting the same
output twice.
 calculate Value Added = Sales less
intermediate goods.
 calculate Profit = Value Added less (wages +
interest + rent) OR
 calculate Profit = Total sales - (intermediate +
wages + interest + rent).
Measuring GDP is based on the conceptual
framework derived from the Circular Flow of Income.
3 approaches are used in the National Accounts:
Production:
value-added
Income: wages, rent, profit
Expenditure: C+I+G+(X-M)
a. Value of PRODUCTION of
goods and services
=
=
b. The sum of all factor INCOME
c. EXPENDITURE on final goods
and services
These three
measures must be
equal by definition.
This is the
NATIONAL
ACCOUNTING
IDENTITY.
National Accounting Identity and Estimates of GDP
The National Accounting Identity says that it must be true by
definition that the following measures of GDP must always be
equal:
1) Value of production of all sectors (as measured by VA).
2) Sum of all incomes (wages, profits, rent)
3) Expenditure on Final Goods and Services
National Accounting Identity and Estimates of GDP
For 2004-05, Australian GDP (03-04 prices) was:
Expenditure ($M) Production ($M)
859 192
859 192
Statistical Discrepancy
1152
-948
GDP estimates between the 3 approaches rarely come out
as the same number because their components are
estimated using largely independent and less-than-perfect
source data. They therefore need to be adjusted using a
statistical discrepancy.
Farmer Alf grows $5000 worth of apples. He sells $2000
to Cider Sid, exports $2000 & sells the remainder to the
public. Alf pays wages of $3000.
Cider Sid produces $4000 worth of cider. He sells
$3000 of cider to Betty’s Bar and $1000 is sold to the
public. Sid pays rent of $1000 & wages of $2000.
Betty’s Bar sells $6000 of cider drinks. She sells $4000
worth of cider drinks to the public and the government
buys $2000. Betty pays wages of $1000.
Production Method
Calculate value-added:
 Alf: $5,000
 Sid: $4,000-$2,000=$2,000
 Betty: $6,000-$3,000=$3,000
GDP=$5,000+$2,000+$3,000=$10,000
Income Method
Add wages, rent and profit*
 Wages: $3,000 (Alf)+$2,000 (Sid)+$1,000 (Betty)=$6,000
 Rent: $0 (Alf)+ $1,000 (Sid)+$0 (Betty)=$1,000
 Profit: $2,000 (Alf)-$1,000 (Sid)+$2,000 (Betty)=$3,000
GDP=$6,000+$1,000+$3,000=$10,000
*Note: Profit=Value-added-(wages+rent)
Expenditure Method
Add C+I+G+X
 C=$1,000+$1,000+$4,000=$6,000
 I: $0
 G: $2,000
 X: $2,000
GDP=$6,000+$0+$2,000+$2,000=$10,000
1. Value-added=5000+2000+3000=10,000
2. Income=6000(wages)+1000(rent)+3000(profit)=10,000
3. Expenditure=6000(C)+0(I)+2000(G)+2000(X)–0(M)=10,000
Production Method=Income Method=Expenditure Method
The National Accounts
Expenditure
Income
Consumption
Wages and salaries
Investment
Rent
Gross Fixed Expenditure
Change in Stocks
Profit
Government Expenditure
GDP at Factor Cost
Net Exports
plus indirect taxes
minus subsidies
Exports - Imports
GDP at Market Prices
GDP at Market Prices
Adjustment for Indirect Taxes and subsidies is
necessary because indirect taxes (sales taxes)
increase the market price of goods without
increasing income (profits).
Subsidies have the opposite effect; they allow
firms to lower market prices without affecting
income (profit).
The National Accounts
Expenditure
Income
C
6000
Wages
6000
I
G
0
2000
Rent
1000
X
2000
Profit
3000
less M
0
GDP at
market prices
10,000
GDP at factor cost
GDP at
market prices
10,000
10,000
Adding Indirect Taxes
Suppose govt adds 10% sales tax on consumption
& all of tax is passed on to consumers.
 C increases by $6,000*10%=$600
 G increases by $600
Suppose govt uses revenue to pay wages to road
builders.
 Wages increase by $600
The National Accounts
Expenditure
Income
C
6,600
Wages
6,600
I
G
0
2,600
Rent
1,000
X
2,000
Profit
3,000
less M
0
GDP at factor cost
plus net indirect
taxes
GDP
11,200
GDP
10,600
600
11,200
Nominal GDP measures the dollar value of final goods and
services produced in a given year at the prices at which
they were actually sold in that year. It makes no allowance
for inflation and is referred to as GDP at current prices.
Real GDP measures the dollar value of final goods and
services sold in a given year in terms of the prices at which
those goods sold in some base or benchmark year. It has
been adjusted to remove the influence of inflation and is
referred to as GDP at constant prices.
The GDP Deflator is a price index and is used to convert
nominal GDP to real GDP.
How do we calculate price indexes?
In simple terms:
Price index =
Price in any given year
Price in base year
X 100
For example:
 In base year, price index = 100 ([$10/$10]*100)
 In year 3, price index = 280 ([$28/$10]*100)
GDP Deflator
The GDP Deflator is a price index which compares Nominal
GDP with Real GDP in a given period:
GDP Deflator =
Nominal GDP
Real GDP
X 100
The GDP Deflator differs from another common measure of
inflation - the Consumer Price Index (CPI) - in that it covers
all goods and service produced whereas CPI only covers
goods and services consumed by households.
GDP Deflator
Note that we can rearrange this equation as:
Nominal
GDP
Real GDP =
GDP Deflator
And:
Nominal GDP= Real GDP X GDP Deflator
Calculating Real GDP
Year
Units Price
of X of X
(1)
(2)
Nom
GDP
(1) X (2)
Price
index
(Yr 1 =
100)
Real GDP
(= Nom GDP/Price
index)*100
1
8
10
80
1.0
80 (=80/1.00)
2
12
20
240
2.0
120 (=240/2.00)
3
15
28
420
2.8
150 (=420/2.80)
Calculating the GDP Deflator and Inflation Rate
YEAR
2004
2005
2006
2007
NOMINAL
GDP
2800
2950
3460
3970
REAL
GDP
2900
2950
3240
3750
GDP
DEFLATOR
96.6
100.0
106.8
105.9
INFLATION
RATE (%)
n/a
3.5
6.8
-0.8
GDP deflator = Nominal GDP/Real GDP x 100
For 2007 = 3970/3750=1.05 x 100 = 105.9
Calculating the inflation Rate:
This is the percentage change in GDP deflator from one year to the next.
For 2007 = [(105.9-106.8)/106.8] * 100 = -0.8%
Note it is NOT calculated by taking the absolute change in the deflator.
Uses & Limitations of GDP
 GDP measures the value of goods & services.
 valued in $ terms - nominal & real
 market exchange - excludes non-market
transactions
 excludes value of leisure
 excludes externalities
 excludes measures of stocks - infrastructure; skills;
natural resources.
 ignores issues of distribution GDP per capita
 changes in quality hard to capture.
Uses & Limitations of GDP
3 main uses of Real GDP estimates are:
1. Measure of domestic production of goods &
services:
2. Analysis of the business cycle: and
3. Time series & cross-country economic welfare
comparisons.
Uses & Limitations of GDP
Real GDP not accurate measure of goods & services
produced in domestic economy.
Over-adjustment for inflation, when quality rises & price
increases.
Household production not included, but shift away from
domestic production of meals & child care, as well as rise home
services.
Black economy output not included – hard to measure,
estimate of 1-15% of GDP. If stable share then not a problem.
Uses & Limitations of GDP
GDP does not indicate a nation’s state of economic well-being, or
economic welfare. It does not take account of:
1. Composition of goods and services produced. Eg. 20% of GDP could
be associated with cleaning up the environment.
2. Health & life expectancy
3. Leisure time.
4. Environmental quality.
5. Political freedom & social justice.
6. Distribution of income
The United Nations Human Development Index (UN HDI)
The UN HDI was developed in 1990 and is a composite measure
of social welfare which includes:
1. average life expectancy
2. educational attainment
3. real GDP per capita
United Nations
The UN HDI is considered a better measure of living
standards than GDP per capita on its own
UN HDI

The UN HDI combines life expectancy at birth, adult
literacy, school enrolment and GDP per capita.

It can alter the rankings of economies according to their
state of human welfare as opposed to their state of
economic development.

Thus Vietnam has same GDP per capita as Pakistan but
higher HDI due to higher life expectancy and literacy.

HDI takes the maximum value of 1.
HDI 2002
Source: GRID-Arendal United Nations Environment Programme (UNEP)
www.grida.no
HDI in the Asia-Pacific
Country
HDI
Country
HDI
Australia
Japan
New Zealand
Hong Kong
Singapore
South Korea
Brunei
China
0.962
0.953
0.943
0.937
0.922
0.921
0.894
0.777
Laos
Cambodia
Myanmar
Pakistan
Bangladesh
Nepal
Papua New Guinea
East Timor
0.601
0.598
0.583
0.551
0.547
0.534
0.530
0.514
HDI
Human Development Index
1
0.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0
1975
Australia
USA
Japan
Indonesia
Tanzania
Congo
Ethiopia
1985
1995
2005
Years
Source: UN Human Development Report, The State of Human Development, 2004
Genuine Progress Indicator (GPI)
Conceived in 1995 to measure the genuine progress of the United
States.
The GPI indicator takes everything the GDP uses into account, but
also adds other figures that represent the cost of the negative effects
related to economic activity. It nets the positive and negative results of
economic growth to examine whether or not it has benefited people
overall.
The GPI developed out of the theories of green economics which
views the economic market as one component within an entire
ecosystem.
Proponents of the GPI see it as a better measure of the sustainability
of an economy when compared to the GDP measure.
Genuine Progress Indicator (GPI)
The GPI takes into consideration factors ignored by
GDP such as:
 the cost of resource depletion
 Crime
 Ozone depletion
 Family breakdown
 Air-water-noise pollution
 Loss of farmland and wetland.
The GPI also gives value to unpaid work (like volunteer time
and unpaid household work) which is ignored in GDP
because no money changes hands.
In-class tutorial exercise:
Adjusting GDP for inflation
•GDPDeflator
=(Nom GDP/Real GDP) x 100
•GDPt
=Nom GDPt-1 x (1+ % change)
•% change
=[(End value- Start value)/Start value] x 100
In-class tutorial exercise:
Adjusting GDP for inflation
YEAR
Nominal
GDP
%
change
Real
GDP
%
change
1990
1000
na
1200.0
na
10.0%
1260.0
1991
1992
1400
1993
1700
GDP
Deflator
%
change
na
1300.0
120.0
In-class tutorial exercise:
Adjusting GDP for inflation
Check your answers
YEAR
Nominal
GDP
%
change
Real
GDP
%
change
GDP
Deflator
%
change
1990
1000
na
1200.0
na
83.3
na
1991
1100
10.0%
1260.0
5.0%
87.3
4.8%
1992
1400
27.3%
1300.0
3.2%
107.7
23.4%
1993
1700
21.4%
1416.7
9.0%
120.0
11.4%

Jackson & McIver, Chapter 4.