3 The government of New Holland is experiencing lower energy costs due to new technology in extracting energy sources such as gas and oil. Use the supply and demand model (and a diagram) for saving and investment to explain the likely effect on national saving, investment and the real interest rate in New Holland when its economy is closed. Explain the effects on employment of the new technology.
Explain three different approaches that can be used to calculate GDP. Briefly indiciate why all three approaches should give the same estimate for GDP
The three different approaches are
Production Method
Expenditure Method
Expenditure on goods and services by final users must equal the value of their production
Hence we must add,
Consumption + Investment + Government + Net Exports Y = C + I + G + NX
Income Method
GDP also equals to aggregate incomes paid to labour and capital
GDP = Labour Income + Capital Income
Three approaches should give the same rough figure for GDP as economic staticians assume such that all produced goods and services are consumed, and hence the production and expenditure method are entirely the same. The Income method also gives us the same rough figure as the revenue from the sale of the good or service is distributed to the workers and the owners of the capital involved in the production of the good and services.
Is GDP a good measure of a country’s economic welfare? Discuss.
The GDP is an imperfect measure of economic wellbeing as it only captures those goods and services that are priced and sold in markets. Some factors that are omitted from GDP is
Leisure time
Household production
Environmental degradation
Quality of life
Economic inequality
However, the GDP is closely related to:
Variety of goods and services
Health and education
Life expectancy
Consider the following national accounts data for the calendar year 2010
a. Use the above date to calculate GDP for 2010. Explain how you arrive at your figure for GDP
b. Use the above data to calculate national savings in 2010. Explain how you arrive at your figure for national savings
c. Use the above data to calculate private savings in2010. Explain how you arrive at your figure for private savings.
Explain why the CPI may give a biased measure of the ‘true’ rate of inflation or cost of living?
Quality adjustment and new goods bias
Quality improvement may show up as higher prices for goods and services
New goods are often not included until CPI is rebased
This is the failure to adjust adequately for improvements in the quality of goods and services
Substitution bias
Use of a fixed basket means that no allowance is made for consumers, as most would substitute towards relatively less expensive goods.
This is the failure to take in to account peoples substitution to less expensive goods.
Identify and briefly explain the various economic costs associated with inflation.
Shoe leather costs
Inflation reduces the real purchasing power of a given amount of money
People would not want to keep money, but rather invest in something where their money will outrun the inflation
Menu costs
The actual costs of changing prices
New menus, new price tags,
Introduces noise into the price mechanism
As high prices are normally the cause of a high demand, high prices through inflation distorts this information and make the price system more difficult to interpret.
Distorts tax systems (if not indexed to inflation)
Reduces an individual income, due to the fact that if they receive a higher wage from their employers to compensate for inflation / higher living costs, their income tax might be shifted to the next bracket, hence defeating the purpose of the “real” income increase.
Unexpected redistribution of wealth
Creditor and lender, if a family borrows money, and inflation rises, then it would take him less amount of money to pay back the loan due to the inflation.
What factors might cause households to under-save relative to some rationally optimal level?
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