Economic Growth - A Few Hard Questions (1 Viewer)

[swagmeister]

Hey,

Thought I had nailed economic growth but evidently not as well as I had wanted to. A few quick questions:


1. Economic growth is measured through changes in the level of GDP over time. GDP (or aggregate demand or national income) = C + I + G + (X - M), and then when we look at it supply side Y / AS = C + S + T. This seems to contradict eachother because 1) S + T = I, 2) for AD we have I + G, 3) but T (taxation) results in G but can also be summed up in I so it is almost 'duplicated' in AD?

2. How does a higher MPS affect economic growth? My (flawed) answer is that it doesn't, because all savings is invested anyways, so if people are saving more then more will be invested.

3. The simple expenditure multiplier (K) is the extent to which an initial change in the autonomous components of AD will lead to a larger change in national income, generating economic growth. OK, so based on this we are saying that changes in AD will not result in EXACT changes in national income, but does this mean that GDP almost has a lag affect in matching real national income because of the time it takes for the multiplier to occur? Why do we use AD to measure national income if the multiplier effect occurs, doesn't this distort things?

I'll give an example for this one. Say that we have a new building project, increased government expenditure of 100 million. Based on the simple multiplier, ∆Y = k × ∆AD (where k = 1 / MPS). So Assuming the MPS is 0.2, then to work out the increase in Y (national income) we do ∆Y = 1/0.2 × 100million ∴ ∆Y = 500million. So, here we can see that an increase in AD of 100 million (which is how GDP is measured) has actually lead to an increase in national income of 500 million, and because of this I get confused how we are reflecting true economic growth...

4. My textbook seems to suggest that economic growth is based on leakages and injections, if injections are greater than leakages we have growth and vice versa. However, this is where it confuses me - say we look at the financial sector, the leakage of saving HAS TO occur in order for the injection of investment. In this sense it kind of confuses me a little bit, leakages are good because they result in injections (in most cases, not the case of all saving though (if you don't deposit in the bank) or imports - I think this is why AD is X-M (Injection - Leakage) whereas for all the other components it is just Injection (government expenditure, investment, consumption).

5. Economic growth refers to increases in a countries productive capacity. So sure if AD increases that is going to help because with increased investment etc. we can produce more, but why do we look at it in terms of changes in AD over time?

I have a feeling that I need to differentiate my knowledge of Y (equilibrium national income) with economic growth and that is why some of this stuff is confusing me, and also that similarly looking at it demand way and supply way are separate and maybe they form an equilibrium to calculate total productive capacity...

Any insight into this would be very helpful!

Cheers

 

[swagmeister]

Anyone?

 

[astab]

Hey bro, not too sure about the first one. The MPS influences the multiplier, which influences the resulting change in national income through changes to aggregate demand. Say consumption and investment rise because the government has loosened MP, or the government takes an expansionary fiscal stance and increases expenditure, AD will rise. But if everybody is savings, the resulting change in national income through the multiplier is low and thus, the economy doesn't grow as rapidly. So higher savings -> smaller multiplier -> smaller level of EG.

 

[astab]

3. More money is being passed around. Less is saved more is spent. Thus, a greater amount of income than what was initially injected is being passed around to many bodies of the economy. Because their incomes increase, they spend more, which stimulates economic activity to a greater extent than the initial change to AD.

 

[swagmeister]

Hey bro, not too sure about the first one. The MPS influences the multiplier, which influences the resulting change in national income through changes to aggregate demand. Say consumption and investment rise because the government has loosened MP, or the government takes an expansionary fiscal stance and increases expenditure, AD will rise. But if everybody is savings, the resulting change in national income through the multiplier is low and thus, the economy doesn't grow as rapidly. So higher savings -> smaller multiplier -> smaller level of EG.

I get his all, except for the fact that the multiplier influences the resulting change in national income through changes in AD.

This implies that with a higher multiplier, national income can increase heaps while AD only does by the initial amount. I had thought that AD and national income were the same thing? AD = Y? Or are we just using Y because of the time lag nature of the multiplier effect?

 

[sy37]

2: Higher MPS = money around the economy is saved at a greater proportion each time i.e. initial injections will see diminishing returns

3: I sort of understand what you're getting at. I don't think 'time' lag is taken into account, but the value of *K*, the multiplier can be thought of to take into account time lag if that makes sense. It checks out experimentally.

4: It's not just about leakages > injections thus economic growth. If leakages > injections by a large amount, then inflation occurs. What you want is the balance.

5: Just convenience I suppose, you wouldn't measure the success of your business every 2 days would you?

I either answered all your questions, or none. Either way I'm going to go sleep now. It's 3 am what i am doing

 

[swagmeister]

2: Higher MPS = money around the economy is saved at a greater proportion each time i.e. initial injections will see diminishing returns

3: I sort of understand what you're getting at. I don't think 'time' lag is taken into account, but the value of *K*, the multiplier can be thought of to take into account time lag if that makes sense. It checks out experimentally.

4: It's not just about leakages > injections thus economic growth. If leakages > injections by a large amount, then inflation occurs. What you want is the balance.

5: Just convenience I suppose, you wouldn't measure the success of your business every 2 days would you?

I either answered all your questions, or none. Either way I'm going to go sleep now. It's 3 am what i am doing

Thanks, that helps I think

So I guess what we are saying is that GDP is not measured in terms of AD but in terms of the equilibrium, and the multiplier can mean that GDP is pushed across more on the horizontal axis them the total expenditure increase on the vertical (if you look up the aggregate demand aggregate supply model)?

 

[Ekman]

Ill try my best not to confuse you

1. I am not sure where you got the formula of S+T=I, because that might be the issue there. I am not sure how you considered I to be investment made by the government from Taxation, because that would be classified as G rather than I. Investment in the circular flow of income model mainly refers to entrepreneur investment into establishing businesses. G is the expenditure made by the government from taxation, and that expenditure can be used as investing into industries but nonetheless is still classified as G. Hence you would get the formula S+T = I + G, which handles the duplication.

2. Having high levels of economic growth is characterised as having higher levels of consumption. As consumption increases so does income levels, as modelled by the Keynesian curve. However if the economy has high levels of MPS, that means as income increases, there is a higher percentage of that increase being saved, hence it will slow down the economic growth. This is essentially what the RBA does in controlling economic growth, as they increase interest rates to encourage saving rather than spending, which slows down the economic growth.

3. First of all, GDP is not measured by national income, its measured by the total value of goods and services produced in a given period of time. Secondly, the simple multiplier is theoretical as everyone has varying levels of MPS, it is just used to mathematically model the increase in national income through changes in AD.

4. You are thinking about a closed economy here, by saying that we must have savings in order to have investment. Foreign investors can invest, which boosts our economic growth and makes injections>leakages. Banks can borrow overseas in order to maintain a level of domestic savings, if the government decided to finance its deficit (which causes the 'crowding out' effect), which does not contribute to the leakages, as people are not necessarily saving, the banks are just borrowing overseas which has other impacts such as the CAD, exchange rates, etc. In a closed economy, what you are saying is correct, but every economy's financial sector are pretty much open to global factors.

5. It is kind of hard to explain but ill use an example. What happens to milk farmers when they overproduce milk, after supermarkets such as Woolworths and Coles bought as much as they needed from them? There would be some milk left, and so the milk farmers would have to store these products and wait until Woolworths or Coles demands more stock from them. However, since milk is a perishable good, the milk farmers would have to produce another new batch of milk for when Woolworths and Coles demand it again, as the initial milk they overproduced will go off. Hence why would farmers overproduce a specific good if they wont sell all of it, it is just adding to their costs. Hence we look at AD, as we can produce as much as we want, it is up to the consumers to demand it, which results in economic growth.

I hope that answers all of your concerns

 

[swagmeister]

Ill try my best not to confuse you

1. I am not sure where you got the formula of S+T=I, because that might be the issue there. I am not sure how you considered I to be investment made by the government from Taxation, because that would be classified as G rather than I. Investment in the circular flow of income model mainly refers to entrepreneur investment into establishing businesses. G is the expenditure made by the government from taxation, and that expenditure can be used as investing into industries but nonetheless is still classified as G. Hence you would get the formula S+T = I + G, which handles the duplication.

2. Having high levels of economic growth is characterised as having higher levels of consumption. As consumption increases so does income levels, as modelled by the Keynesian curve. However if the economy has high levels of MPS, that means as income increases, there is a higher percentage of that increase being saved, hence it will slow down the economic growth. This is essentially what the RBA does in controlling economic growth, as they increase interest rates to encourage saving rather than spending, which slows down the economic growth.

3. First of all, GDP is not measured by national income, its measured by the total value of goods and services produced in a given period of time. Secondly, the simple multiplier is theoretical as everyone has varying levels of MPS, it is just used to mathematically model the increase in national income through changes in AD.

4. You are thinking about a closed economy here, by saying that we must have savings in order to have investment. Foreign investors can invest, which boosts our economic growth and makes injections>leakages. Banks can borrow overseas in order to maintain a level of domestic savings, if the government decided to finance its deficit (which causes the 'crowding out' effect), which does not contribute to the leakages, as people are not necessarily saving, the banks are just borrowing overseas which has other impacts such as the CAD, exchange rates, etc. In a closed economy, what you are saying is correct, but every economy's financial sector are pretty much open to global factors.

5. It is kind of hard to explain but ill use an example. What happens to milk farmers when they overproduce milk, after supermarkets such as Woolworths and Coles bought as much as they needed from them? There would be some milk left, and so the milk farmers would have to store these products and wait until Woolworths or Coles demands more stock from them. However, since milk is a perishable good, the milk farmers would have to produce another new batch of milk for when Woolworths and Coles demand it again, as the initial milk they overproduced will go off. Hence why would farmers overproduce a specific good if they wont sell all of it, it is just adding to their costs. Hence we look at AD, as we can produce as much as we want, it is up to the consumers to demand it, which results in economic growth.

I hope that answers all of your concerns

Helped heaps!!! Especially how I was thinking of the closed economy thing, man that's such a good insight.

One small thing I disagree with; under equilibrium conditions GDP is the same as national income (Y). Basically another way of looking at GDP is the sum of all the income received for contributing resources to GDP, known as national income, and this will be the same thing as total output. Check out the Keynesian income-expenditure model (really helped it make sense for me) and let me know what you think

 

[Ekman]

Helped heaps!!! Especially how I was thinking of the closed economy thing, man that's such a good insight.

One small thing I disagree with; under equilibrium conditions GDP is the same as national income (Y). Basically another way of looking at GDP is the sum of all the income received for contributing resources to GDP, known as national income, and this will be the same thing as total output. Check out the Keynesian income-expenditure model (really helped it make sense for me) and let me know what you think

GDP and national income are exactly the same if and only if when there is an equilibrium between supply and demand, as the total value of goods and services being produced is equal to the income levels, as consumers are purchasing these products, hence giving income for the suppliers. These are under ideal conditions within a closed economy which are not true in the real world, as each country has a different comparative advantage in producing a particular good. For example, Australian consumers now need to import manufactured goods because our current industries are inefficient (there may be some manufacturing industries here and still are producing, but they aren't selling much due to international competitiveness, hence GDP>National income). So the reason why we differentiate GDP with national income is because aggregate supply and aggregate demand are not in equilibrium due to many global and structural factors, hence income fluctuates due to these factors.

 

[swagmeister]

GDP and national income are exactly the same if and only if when there is an equilibrium between supply and demand, as the total value of goods and services being produced is equal to the income levels, as consumers are purchasing these products, hence giving income for the suppliers. These are under ideal conditions within a closed economy which are not true in the real world, as each country has a different comparative advantage in producing a particular good. For example, Australian consumers now need to import manufactured goods because our current industries are inefficient (there may be some manufacturing industries here and still are producing, but they aren't selling much due to international competitiveness, hence GDP>National income). So the reason why we differentiate GDP with national income is because aggregate supply and aggregate demand are not in equilibrium due to many global and structural factors, hence income fluctuates due to these factors.

I thought equilibrium was automatically reached? The price will lower if they produce too much and demand isn't there

Also with your example, importing has a neutral affect on AD (subtracted in X - M but added to consumption) and sure if they are producing but not selling that could be the case but workers are still going to be paid.

 

[Ekman]

I thought equilibrium was automatically reached? The price will lower if they produce too much and demand isn't there

Also with your example, importing has a neutral affect on AD (subtracted in X - M but added to consumption) and sure if they are producing but not selling that could be the case but workers are still going to be paid.

Again as I said, reaching equilibrium between aggregate supply and demand is all within a closed economy, however since our economies are open, our supply and demand curve will look a bit like this, where there are no hopes of reaching market equilibrium:

And in regards to producing but not selling, how do the businesses gain income/profits to pay their workers? Through selling what they produce. Over time businesses will die out because their costs will be greater than their profits, hence reducing the national income.

 

[swagmeister]

Again as I said, reaching equilibrium between aggregate supply and demand is all within a closed economy, however since our economies are open, our supply and demand curve will look a bit like this, where there are no hopes of reaching market equilibrium:

And in regards to producing but not selling, how do the businesses gain income/profits to pay their workers? Through selling what they produce. Over time businesses will die out because their costs will be greater than their profits, hence reducing the national income.

That's true, but since our economies are open, I guess you could assume restructuring, and plus we are looking at it overall for the average thing in the economy. You do make a good point though, and I do struggle to understand how it works, but even based on the ABS (this link), they can calculate GDP based on national income, and thus it must be reaching equilibrium. Heck, even in the syllabus aggregate demand is expressed as Y = C + I + G + X - M, and Y stands for national income - they could have just used AD if they wanted to.

Maybe it's because with the real GDP on the horizontal axis, it's more about how much can be produced domestically in the first place? I mean, the Keynesian income-expenditure model is fundamentally centred on demand, as Keynes has a law that "demand creates it's own supply" (only sustainably up to potential GDP though). Besides, aggregate expenditure takes into account the marginal propensity to import anyway...

Maybe with the AD and AS model where you are looking at both sides then you could consider something similar to the free trade diagram? Even then thought not sure how it would fully work and it is probably more centred on the domestic economy anyway (in fact imports aren't part of AD in the first place...)

PS sorry if the image is a bit big

 

[Ekman]

Just out of curiosity, what textbook are you using for economics?

 

[swagmeister]

Just out of curiosity, what textbook are you using for economics?

The Dixon one, but I have been supplementing my knowledge with a uni-level macro textbook. Probably taking things a bit to far but I think it is worth it for that holistic understanding

 

[Ekman]

That's true, but since our economies are open, I guess you could assume restructuring, and plus we are looking at it overall for the average thing in the economy. You do make a good point though, and I do struggle to understand how it works, but even based on the ABS (this link), they can calculate GDP based on national income, and thus it must be reaching equilibrium. Heck, even in the syllabus aggregate demand is expressed as Y = C + I + G + X - M, and Y stands for national income - they could have just used AD if they wanted to.

Maybe it's because with the real GDP on the horizontal axis, it's more about how much can be produced domestically in the first place? I mean, the Keynesian income-expenditure model is fundamentally centred on demand, as Keynes has a law that "demand creates it's own supply" (only sustainably up to potential GDP though). Besides, aggregate expenditure takes into account the marginal propensity to import anyway...

Maybe with the AD and AS model where you are looking at both sides then you could consider something similar to the free trade diagram? Even then thought not sure how it would fully work and it is probably more centred on the domestic economy anyway (in fact imports aren't part of AD in the first place...)

PS sorry if the image is a bit big

I love how deep and unnecessary we are going into economic growth but whatever.

I had a read of the link about ABS, and they do say they take national income into consideration, but they do the same with total amount of expenditure (AD). Afterwards I went to search how others calculated GDP, and most sources said they take the total amount of expenditure into account more than national income.

In terms of the formula for income and AD, here is a table from the Dixon textbook:

And that is what I have been learning off from. In the HSC they wont ask you to recall the formulas (For example: "What is the AD and income formula" - 2 marks) so it isn't entirely too important.

Also about the Keynesian model and graph, all Keynes did was model the relationship between income and AD, so im not entirely sure how you got that graph or what it is supposed to mean so I cant really explain it.

 

[Ekman]

The Dixon one, but I have been supplementing my knowledge with a uni-level macro textbook. Probably taking things a bit to far but I think it is worth it for that holistic understanding

In terms of knowing economic growth on a HSC level, we are taking it a bit too far, as we will be only asked calculation questions on the simple multiplier as well as how factors impact economic growth for essay questions (essentially you will be talking about AD and AS), and how this further impacts national income (insert the Keynesian graph).

 

[swagmeister]

In terms of knowing economic growth on a HSC level, we are taking it a bit too far, as we will be only asked calculation questions on the simple multiplier as well as how factors impact economic growth for essay questions (essentially you will be talking about AD and AS), and how this further impacts national income (insert the Keynesian graph).

I was thinking that, I find it pretty interesting stuff though. Good discussion definitely either way.

/thread