I went through this graph with my A2 class today. Note that the firm’s short-run supply curve starts at P4. Useful for multiple-choice questions.
Here is a videographic from The Economist showing the top three economies throughout history. Does China have the world’s largest economy? Is China’s economy bigger than America’s? Interesting how history repeats itself.
A new BRICS development bank has been established with its headquarters in Shanghai. The focus of the bank will be on infrastructure in developing countries. China has used infrastructure spending as a extensive part of its own development strategy – China’s national trunk highway system of 35,000km of highways was built between 1992 and 2007 at a cost of $120bn. It has spent 8.5% of its GDP investing in infrastructure from 1992-2011 and according to McKinsey the developing country norm is 2-4% of GDP.
Although it is difficult to measure the precise effect of infrastructure spending, it is the long run impact on an economy that is the most important. The Economist identified two benefits from infrastructure spending:
1. It can generate a rise in incomes if reduced transaction costs promote trade.
2. It can raise growth rates if it leads to greater information sharing and thus improved productivity.
Recent research into the high-altitude railway connecting the Chinese province of Qinghai to Tibet provides a natural experiment. The region was one of the poorest in China meaning that prior growth did not prompt investment. The results showed a 33% increase in GDP/person in counties that got the railway = 12 billion Renminbi extra GDP a year, exceeding its 33 billion Renminbi cost in just 3 years. The main positive out of this railway network was the ability of local manufacturers being able to sell to the national market. However there is a downside as local industry find it hard to compete with goods from more advanced areas and this can lead to a contraction of its economy and ultimately a loss of jobs.
Deflation has emerged as a major risk to the global economy with it being particularly evident in Europe and Japan where leaders have found it hard to come up with any solutions to generate economic growth. In Europe inflation was just 0.3% in September well below the 2% target of the European Central Bank. With this low rate any weakness in the Germany economy could tip the Euro economy over the edge into a deflationary downturn. The extent of the concern with deflation was evident by the ECB’s record low interest rates – 0.05% – and a negative rates for deposits. With austerity measures in place in France and Italy one wonders about their ability to bring about any sort of growth and ultimately some mild inflation.
Why is deflation a concern?
1. Holding back on spending: Consumers may opt to postpone demand if they expect prices to fall further in the future
2. Debts increase:
• The real value of debt rises when the general price level is falling and a
higher real debt mountain can be a drag on confidence
• Mortgage payers on fixed mortgage interest rates will see the real cost of servicing their debt increase
3. The real cost of borrowing increases: Real interest rates will rise if nominal rates of interest do not fall in line with prices
4. Lower profit margins: This can lead to higher unemployment as firms seek to reduce their costs.
5. Confidence and saving: Falling asset prices such as price deflation in the housing market hit personal sector wealth and confidence – leading to further declines in AD. Higher savings can lead to the paradox of thrift
I was surprised to read in the NAB Australian Markets Weekly that for the past three years real income per person in Australia has been falling and is now back to levels that were evident in late 2008. The graph shows the level of real income per person with the recessionary periods marked in grey. From the last recession in 1991 up to the Global Financial Crisis in 2008 Australians have experienced a continued rise in the level of their real incomes. Nevertheless how can it be that with GDP growing at about 3% a year real levels of income have been falling?
1. Growth in aggregate real GDP has been boosted a great deal by the sharp growth in the population – Australia’s population grew 1.7% in 2013.
2. While Australia are seeing good growth in the “volumes” of GDP, particularly as some of the new mining capacity has been coming on stream, they are receiving lower prices for this output due to falling commodity prices.
You will no doubt come across the 3 methods of calculating GDP that is in the macro syllabus of most courses. Here are the main features of each.
National Income measures the value of output produced within the economy over a period of time. One of the key economic objectives of government is to increase the level, and rate of growth, of national income. Before we start to analyse why economic growth is so important, it is important to be able to define the key concepts.
GROSS DOMESTIC PRODUCT (GDP)
Under new definitions introduced in the late 1990s, Gross Domestic Product is also known as Gross Value Added. It is defined as the value of output produced within the domestic boundaries of the NZ over a given period of time, usually a year. It includes the output of foreign owned firms that are located in NZ, such as the majority of Trading Banks in the market – ASB, National, ANZ etc. It does not include output of NZ firms that are located abroad. There are three ways of calculating the value of GDP all of which should sum to the same amount since by identity:
NATIONAL OUTPUT = NATIONAL INCOME = NATIONAL EXPENDITURE
1. THE EXPENDITURE METHOD
This is the sum of the final expenditure on NZ produced goods and services measured at current market prices (not adjusted for inflation). The full equation for calculating GDP using this approach is:
GDP = Consumer expenditure (C) + Investment (I) + Government expenditure (G) + (Exports (X) – Imports (M))
GDP = C + I + G + (X-M)
2. THE INCOME METHOD
This is the sum of total incomes earned from the production of goods and services. By adding together the rewards to the factors of production (land, labour, capital and enterprise), we can see how the flow of income in the economy is distributed. The rewards to the factors of production can be loosely summarised in the following table:
Land – Rent
Labour – Wages and Salaries
Capital – Interest
Enterprise – Profit
Only those incomes generated through the production of a marketed output are included in the calculation of GDP by the income approach. Therefore we exclude from the accounts items such as transfer payments (e.g. government benefits for jobseekers allowance and pensions where no output is produced) and private transfers of money.
The income method tends to underestimate the true value of output in the economy, as incomes earned through the black economy are not recorded.
3. THE OUTPUT MEASURE OF GDP
This measures the value of output produced by each of the productive sectors in the economy (primary, secondary and tertiary) using the concept of value added.
Value added is the increase in the value of a product at each successive stage of the production process. For example, if the raw materials and components used to make a car cost $16,000 and the final selling price of the car is $20,000, then the value added from the production process is $4,000. We use this approach to avoid the problems of double-counting the value of intermediate inputs. GDP will, therefore, be equal to the sum of each individual producer’s value added.
Problems of accuracy:
Officially data on a nation’s GDP tends to understate the true growth of real national income per capita over time e.g. due to the expansion of the shadow economy and the value of unpaid work done by millions of volunteers and people caring for their family members. There may also be errors in calculating the cost of living
The scale of the informal “shadow economy” varies widely across countries at different stages of development. According to the IMF, in developing countries it may be as high as 40% of GDP; in transition countries of central and Eastern Europe it may be up to 30% of GDP and in the leading industrialised countries of the OECD, the shadow economy may be in the region of 15% of GDP.
It is believed that in 2009 Indians held more money is Swiss banks than people from all other countries combined.
– A 2010 study by the World Bank has suggested that India’s shadow economy is equivalent to 20% of GDP.
– Research indicates that 85% of jobs in India are typically cash orientated.
– Only 42,800 people declare income of over 10m rupees a year – only 2.5% of Indians pay income tax.
Mumbai has a huge stock of empty apartments held as investments, their owners unwilling to to sell for fear that the proceeds might enter the formal economy and be taxed.
Source: The Economist. March 23rd 2013
James Surowiecki wrote an interesting piece in the New Yorker about the deadly outbreak of Ebola and the fact there is no real medication to stop it. Ebola was discovered in 1976 and although there has been no drug approved to treat the disease this is not surprising.
A pharmaceutical company is a business and they will direct investment into medication that they see will generate income for them which will ultimately satisfy the shareholders. Therefore it makes sense for them to target higher income groups that have the purchasing power to buy the medication. Furthermore it is in their favour that the medication needs to be ongoing e.g. drugs for lowering your cholesterol. Although this works quite well in developed countries it does lead to significant underinvestment in diseases and certain categories of drugs. Ultimately the big pharmaceutical company does not see the developing world as a potential market for their products. Therefore diseases like malaria and tuberculosis receive less attention from companies than high cholesterol. However initially Ebola looked like a bad investment as it was confined to West Africa but as it has now spread to the developed world investment might start to be more prevalent.
The big question that Surowiecki alludes to is how do we get the drugs we need without transforming the industry. One way would be for the government to make a payment to a company and in exchange the company would give up the right to sell the product and therefore save on all the marketing costs. Furthermore public health officials would be able to control how it was promoted and used. Economists see payments as cost-effective as you only have to pay if the product works and it encourages investment into public goods where the benefits extend not only to the consumer but to third parties – e.g. vaccinations etc.