Economics Chapter 1 National Income. Measuring indicators Do you think Hong Kong is a rich city? Why? In what way do we measure the economic performance.

Economics

Chapter 1

National Income

Measuring indicators

Do you think Hong Kong is a rich city? Why? In what way do we measure the economic

performance of a city? Indicators

Income Employment / Unemployment Production Consumption Price level Living standard Freedom

In microeconomics, Price Quantity

In macroeconomics, General price level Aggregate output

Price ($)

0

D

S

Quantity(units)

P

Q

General price level ($)

0

AD

AS

Aggregate output(units)

P

Q

Macroeconomics Studies the aggregate measures

Price level National income or output Unemployment

Money market

Gov’t economic policies

International trade

1.1 National income

Measurement of output Output or income a region gets from production

within a period of time (usually one year)

Measure the aggregate output by adding up the market values of different outputs

It shows: economic development quality of life

Stock and flow concepts

Stock Value of output = a quantity measured

at a certain point of time Wealth = market value of one’s possessions at a

certain point of time Capital stock = value of capital owned by a firm at a

certain point of time

Stock and flow concepts Flow

Value of output = a quantity measured in a period of time (i.e. rate)

Income & expenditure = inflow and outflow of money in a certain period of

time Investment and depreciation

= increase and decrease in the value capital owned in a certain period of time

http://www.reffonomics.com/TRB/chapter21/GDP/realgdp4.swf

E.g. Investment of the year (increase in capital owned) Depreciation (decrease in capital owned)

GDP is a flow, because it is measured yearly or quarterly.

National income

Measurement of aggregate output

GDP = Gross domestic product

GNP = Gross national product

1.2 Gross Domestic Products (GDP)I. Measuring the total value of final goods

The total value of production of all resident producing units of a region in a specific period (usually a year or quarter).

or

It is the market value of all final goods and services produced inside a country in a year (or a quarter).

II. Resident producing units of a region Individuals:

People who normally live in the region E.g. HK citizens

Organizations: Companies taking the region as the centre of economic

interest E.g. 7-Eleven

Imported goods are excluded

1.2 Gross Domestic Products (GDP)

Total value of final goods and services.

Value of final goods = $1,000 If value of intermediate and final goods are counted

($400+$1000), it will be double counting ($400)

Intermediate goodFish: $400

Final goodsSushi: $1000

Earn: $1000 - $400 = $600Earn: $400

Pay: $1000

1.2 Gross Domestic Products (GDP)

Items not counted in GDP1. Past inventories

Not produced within the period Already counted in the GDP in previous period

2. Second-hand goods Already counted when produced in the first time Double counting

3. Unpaid household services for self-consumption within household

Housework Caring of own children

Items not counted in GDP4. Intermediate products

Goods and services used up as inputs E.g.

Raw materials Semi-finished goods

5. Financial assets Shares and bonds Futures and options

6. Transfer payment Transfer of wealth, no production involve E.g. Gov’t subsidy, CSSA

7. Capital gain Increase in the market value of an asset, but not production E.g. Selling the flat with a higher price

Stock of MP3 players produced in 2008 Stock of MP3 players produced in 2010 Sony α3 camera resold in Yahoo! Auction Canon D5 camera sold in Broadway Hourly paid private tutor help you revising Economics You help your brother understanding his Math problems Adidas football you bought for fun Adidas football South China Athletics Asso. bought for training

the football players HSBC shares Commission to an agent from buying and selling HSBC shares Clinical voucher (醫療劵 ) given by the gov’t (without using it) Clinical voucher (醫療劵 ) given by the gov’t (after using it) A person has $2 million gain from selling his ancient flask Cheung Kong (Holdings) Ltd. gain $1000million from selling the

flats in a new estate

Yes / No

Yes / No

Yes / No

Yes / No

Yes / No

Yes / No

Yes / No

Yes / No

Yes / No

Yes / No

Yes / No Yes / No

Yes / No

Yes / No

Should the following be included in calculation of GDP in 2010?

PEQ - HKCEE 1998MC

Which of the following would be considered as part of the national income?

A. Commissions received by salesmen selling second-hand cars

B. A gift cheque to a bride for an invitation to her wedding banquet

C. Insurance compensation to injured workers

D. Scholarships to students with good results in schools.

15

PEQ - HKCEE 1995MC

Which of the following will NOT be included in Hong Kong’s GDP?

A. profits earned by individual investors from buying and selling shares in the Hong Kong stock market

B. bonuses paid by the Stock Exchange of Hong Kong Limited to its staff

C. stamp duty levied on the shares bought and sold in the Hong Kong stock market

D. commissions paid to the brokers for transactions in the Hong Kong stock market

16

PEQ - HKCEE 1992MC

The expenditure by the Hong Kong government on Vietnamese boat people _____ included in Hong Kong’s GDP because _____

A. should be; goods and services are produced in Hong Kong

B. should be; part of the expenditure will be paid back by the United Nations

C. should NOT be; goods and services are spent on foreigners

D. should NOT be; Vietnamese boat people do not produce goods and services

17

PEQ - HKDSE Practice PaperMr. Richardson, a British civil engineer, has worked for a large Hong Kong construction company for the past few years. He is earning an annual income of HK$800 000 and he remits part of his income to his family in Britain. Is Mr. Richardson’s income counted in HK’s gross domestic product (GDP)? Explain

your answer. (3 marks)

Answer: His income is counted in HK’s GDP (1) because it is derived from the current production carried

out by a resident producing unit in Hong Kong. (2)

18

Output value = $50

Expenditure = $50

Income = $50

Output value = Expenditure = Income

B. Basic concept of measuring GDP

I. Three approaches for GDP

1. Expenditure approach Final goods

2. Production approach Output value of producing units

3. Income approach Factor income

B. Basic concept of measuring GDP

II. GDP at market price and factor cost

Given: Unit tax = $1200 and Subsidy = $200

Basic concept of measuring GDP

GDPMP = GDPFC + Indirect taxes – Subsidies

Expenditure$4000

Output value$3000

Income$3000

Tax$1200

Subsidy$200

Tax$1200

Subsidy$200

GDPMP

GDP FC

1. Total expenditure on final goods

2. Subtract (not include) the value of imports

GDP = C + I + G + X - M

III. Expenditure approach

Import

Export

Gov’t expenditure

Gross Investment expenditure

Private consumption expenditure

C - Private consumption expenditure (C) Household expenditure on goods and services

G - Government consumption expenditure Compensation of civil servants (e.g. salary) Purchasing good or services Not include: transfer payment

III. Expenditure approach

I - Gross investment expenditure (I) Capital formation Change in inventories Depreciation included

Gross investment (I) = Gross domestic fixed capital formation + Change in inventory

= Net domestic fixed capital formation + Depreciation + Change in inventory

= Net investment + Depreciation

III. Expenditure approach

X - Exports Selling goods or services to foreign countries Total exports = Xgoods + Xservices + Xre-exports

M - Imports Purchasing goods or services from foreign countries Total import = Mgoods + Mservices

Net exports (NX) = X - M

III. Expenditure approach

The net domestic product (NDP) Equals the gross domestic product (GDP) minus

depreciation on a country's capital goods. Capital that has been consumed over the year

in the form of housing, vehicle, or machinery deterioration.

Capital consumption allowance the amount of capital that would be needed to replace

those depreciated assets.

NDP = GDP - Depreciation

III. Expenditure approach

Try it.

Is it included in the GDP?

C I G X M

a. Commission paid for the purchase of a second-hand private car

Yes / No +

b. Expenditure on shares Yes / No

c. Market value of a T-shirt produced last year but which remained unsold this year

Yes / No -

d. Expenditure of a firm on a sewing machine currently produced (investment)

Yes / No +

e. Compensation (Services provided) paid to a traffic accident victim

Yes / No +

f. Foreign expenditure on domestic exports of toys

Yes / No +

g. Expenditure on an imported computer Yes / No -

Calculate GDP (p.16)Components $ Billion

Private consumption expenditure 80

Government consumption expenditure 20

Gross domestic capital formation 15

Changes in inventories -8

Total domestic exports of goods 100

Total re-exports of goods 15

Total imports of goods 80

Total exports of services 13

Total imports of services 20

Indirect taxes less subsidies 4

Net exports = X – M = (Xgoods + Xservices + Xre-exports )– (Mgoods + Mservices) = $[(100 + 13 + 15 ) – (80 + 20)] billion= $28 billion

GDP = C + I + G + X – M = $ ( 80 + 15 - 8 + 20 + 100 + 15 + 13 – 80 – 20 ) billion = $ 135 billion

Calculate GDPComponents $ Billion

Private consumption expenditure 230

Government consumption expenditure 120

Gross domestic fixed capital formation 90

Changes in inventories -30

Domestic exports of goods 100

Re-exports of goods 220

Imports of goods 350

Exports of services 90

Imports of services 110

Indirect taxes less subsidies 20

GDP = C + I + G + X – M = $ ( 230 + 90 – 30 + 120 + 100 + 220 – 350 + 90 – 110 ) billion = $ 135 billion

Calculate GDPComponents $ Million

Private consumption expenditure 500

Government consumption expenditure 100

Net domestic fixed capital formation 250

Changes in inventories 30

Total exports of goods 800

Re-exports of goods 200

Imports of goods 900

Exports of services 300

Imports of services 150

Depreciation 60(HKCEE 2001)

GDP = C + I + G + X – M = $ ( 500 + 250 + 30 + 60 + 100 + 800 – 900 + 300 – 150 ) billion = $ 990 billion

The sum of value added of all resident producing unit.

Counting of value from one production stage to another The value of intermediate goods will be counted.

Value added = Gross output value – Intermediate consumption

A B C

Value added by = $800 – $500 = $300 B

$500 $800

IV. Production (Value added) approach

E.g.

IV. Production (Value added) approach

Factory ShopHousehold

Value of timber sold from carpenter to factory

$200

Value of sofa sold from factory to retailer

$850

Value of sofa sold from retailer to household

$1800

Carpenter

Gross output value

- Intermediate consumption = Value added

Carpenter $200 - $0 = $200

Factory $850 - $200 = $650

Shop $1800 - $850 = $950

GDP = Value added of all producing units = Expense on the final product = $1800

PEQ - HKCEE 2005MCA production chain is shown below.

The contribution of the above production chain to Hong Kong's GDP is

A. $1 400

B. $1 700

C. $2 400

D. $2 60033

Calculation:HK’s GDP = ($700 + $800 - $200) + ($1400 - $700)

+ ($1200 - $800) = $2400

PEQ - HKCEE 2004MCThe following diagram shows a production process of an economy.

What is the contribution of Amy's garment factory to the national income of the economy?

A. $1 600

B. $3 700

C. $5 300

D. $5 900 34

Calculation:Amy’s contribution = ($4300 + $2000) - ($600 + $400)

= $5300

E.g.

Factory

$300 $850

Tax to Gov’t

SmokerFarmer

$200 Market price of cigar = $850,

Tax to Gov’t = $200 Factory receives from smoker

= $850-$200 = $650 Value added by the factory =

$650 - $300 = $350 Consider production only:

GDPFC = $300 + $350 = $650 Consider also the tax:

GDPMP = $300 + $350 + $200 = $850

Consider production only:GDPFC = Sum of value added of all resident production units

Consider the market valueGDPMP = GDPFC + Indirect tax - Subsidies

IV. Production (Value added) approach

GDP from value added and expenditure approaches

Private consumption expenditure (C)

Gross investment expenditure (I)

Government consumption expenditure (G)

Export (X)[Goods and services]

Indirect tax less subsidies

Value added of all producing units

Imp

ort

co

nte

nts

in C

, I, G

an

d X

GDPFC

GDPMP = C + I + G + X - M

GDPMP

GDPMP = GDPFC+ Indirect tax - Subsidies

1. Difficult to distinguish final goods and intermediate goods E.g. A chef buys a fish. The fish can be:

Final goods – if the chef enjoy himself. Intermediate goods – if he cook the fish and sell it.

So, value added is better than expenditure approach

2. Avoid double counting All value added are counted for once.

Advantages of value added approach

Example (p.20) The diagram below shows the operation of C&K Furniture. Its total sales revenue is $6,600.

1. a. GDP contributed by C&K = ?

b. Why the contribution is lower than the total revenue?

2. Tax rate = 10% of the sales. Indirect tax = ? C&K’s contribution to GDPFC = ?

Local made furniture$3,000

Imported furniture$1,000

Local consumersC&K Furniture

Change in inventory - $800 Sales revenue

$6,600(indirect tax inclusive)

Example (p.20) The diagram below shows the operation of C&K Furniture.

Q.1

a. GDP contributed by C&K

= $6,600 - $800 - $3,000 - $1,000

= $1,800

b. The value added of other producing units (local and foreign furniture suppliers) and the value of the sold inventories must be subtracted from the total sales to get C&K’s contribution to GDP.

Q.2

Let y be the sales (or value of goods)

Market value = Sales + Tax = $6,600

y + (y x 10%) = 6600

y = 6000, Indirect tax = $6000 x 10% = $600

GDPFC (contributed by C&K) = GDPMP (by C&K) – Indirect tax

= $1,800 - $600 = $1,200

Consider the market valueGDPMP = GDPFC + Indirect tax - Subsidies

PEQ - HKCEE 2006MCThe following table shows the statistical data of an economy.

The GDP at factor cost (in $mn) is

A. $ 950

B. $ 970

C. $ 1050

D. $ 119040

Calculation:Step 1: GDPMP = C + I + G + NX

= $(200 + 300 -70 + 50 +150 + 300) mn= $930mn

Step 2:GDPMP = GNPFC + Indirect tax - SubsidiesGDPFC = GDPMP - Indirect tax + SubsidiesGNPFC = $(930 – 0 + 120)mn = $1050mn

The sum of all factor incomes Compensation

Return for the labour resources E.g. Salaries, bonus, commission, housing allowance…

Gross operating surplus Return to company’s capital and entrepreneurship E.g. Dividends, interests, shares…

III. Income approach (out of syllabus)

GDP divided by population to study the living standard of the region to eliminate the factor of population difference can reflect the amount every person can get on average

E.g. Given in country A: GDP = $5000 million Population = 10 million persons

IV. Per capita GDP

% gain or lose in GDP To study the economic growth To forecast the economic situation, so that to make

appropriate decisions

E.g. Given in country A: GDP2010 = $5000 million and GDP2009 = $4000 million

Economy with GDP growth rate > 10% is consider well economic growth

PRC Gov’t aims at 8% growth in recently years

V. Growth rate

Gross Domestic Product (GDP) of HK

HK citizen Foreigner

Production in HK

Gross National Product (GNP) of HK

HK citizen

Production in HK

HK citizen

Production in other countriesand

1.3 Gross National Product (GNP)

The total income earned by residents from engaging in economic activities in a given period of time.

Assume GNP of Hong Kong in 2010:All income earned by Hong Kong residents (both living in or outside HK) in year 2010.

GDP= Income of local residents in HK + Income of foreigners in HK

GNP= Income of local residents in HK + Income of residents overseas

1.3 Gross National Product (GNP)

So, when calculating GNP, income of HK residents (living in HK)income of HK residents (living overseas)

income of foreigners who’re living in HK (< 2 yrs)

= +GNP GDPFactor income from abroad

Factor income paid abroad

-

B. The relationship between GDP and GNP

= +GNP GDPFactor income from abroad

Factor income paid abroad

-

= +GNP GDP Net factor income from abroad

B. The relationship between GDP and GNP

Factor income from abroad (inflow) Compensation of employees (domestic residents working overseas) E.g.

HK people working in Japan with short-term contract(income not included in GDP, but in GNP)

Factor income paid abroad (outflow) Compensation of employees (foreign residents working in local) E.g.

US lecturer working in HK for 6 months(income included in GDP, but not in GNP)

C. Factor income from and paid abroad

Factor income from abroad (inflow) Investment income (domestic residents invest overseas) E.g.

HK people gain profits from selling flats in US(income not included in GDP, but in GNP of HK)

Factor income paid abroad (outflow) Investment income (foreign residents invest in local) E.g.

US investor earn profit from his computer retailer shop in HK(income included in GDP, but not in GNP of HK)

C. Factor income from and paid abroad

Assume GDP of HK in 2010 is $100 million. Inflow

HK citizens gain $30million profit from investment in US HK salesmen earn $5 million income from a short-term contract in Japan

Outflow A UK citizen earn $1 million income for lecturing in HK University An Italian business gain $10 million by investing a restaurant in HK

GNP = GDP + Income from abroad – Income paid abroad

= [$100 + ($30 + $5) – ($1 + $10) ]million = $124 million

C. Factor income from and paid abroad

GDP at market price= C + I + G + X – M= ($200+$250+$100+$80-$30)million= $600 million

Gross National Product (GNP)$ Million

Private consumption 200

Gross Investment 250

Gov’t expenditure 100

Exports 80

Imports 30

Indirect business tax 10

Subsidies 5

Net income from abroad 15

GNP = GDP + Net income from abroad= ($600 + $15) million= $615 million

GDPMP = GDPFC + Indirect taxes – Subsidies

$600million = GDPFC + ($10 - $5)million GDPFC = ($600 - $10 + $5) millionSo, GDP at factor cost = $595 million

PEQ - HKCEE 1996MC

The GDP at factor cost is:

A. $ 95

B. $ 105

C. $ 115

D. $ 125

52

Calculation:Step one: GNPMP = GNPFC + Indirect tax - SubsidiesGNPFC = GNPMP - Indirect tax + SubsidiesGNPFC = $100 - $25 + $35 = $110Step two:GNPFC = GDPFC + Net income from abroadGDPFC = GNPFC - Net income from abroadGDPFC = $110 – (-$5) = $115

A. Basic concept of nominal GDP In principle

GDP = total market value at market price Measures “of the current period”

i.e. GDP at current market prices

Specified as: Nominal GDP General formula = P x Q where P=Current price

From above date Nominal GDP but overall production remains unchanged

1.4 Nominal and Real GDP

Year Output(units)

Price($)

Nominal GDP ($)(Price x Output)

2000 100 10 $10 x 100 = $1000

2001 100 12 $12 x 100 = $1200

2002 100 14 $14 x 100 = $1400

B. Calculation of real GDP To compare the output of different period Assume the price is constant

i.e. GDP at constant market prices

Specified as: Real GDP General formula = P0 x Q where P0= Price in the base year

From above date, Real GDP remains unchanged even though the current price

Year Output(units)

Price($)

P0

($)Real GDP ($)

(Price x Output)

2000 100 10 10 $10 x 100 = $1000

2001 100 12 10 $10 x 100 = $1000

2002 100 14 10 $10 x 100 = $1000

1.4 Nominal and Real GDP

GDP of 2000 at current market price = $10x2,000 + $20x2,000 = $60000 GDP of 2004 at current market price = $15x1,000 + $25x1,800 = $60000 Nominal GDP2004 = Nominal GDP2000

It can’t reflect changes in output because changes in price also affect GDP at current market price

Base year = 2000 GDP of 2000 at constant price = $10x2,000 + $20x2,000 =

$60,000 GDP of 2004 at constant price = $10x1,000 + $20x1,800 =

$46,000 Real GDP2004 < Real GDP2000

Real GDP (textbook p.28)Year Apple output

(units)Price($)

Watermelon output(units)

Price($)

2000 2,000 10 2,000 20

2004 1,000 15 1,800 25

Finding Real GDP from Nominal GDP

Year Price index Nominal GDP ($billion)

2006 100 $20

2007 110 $22

Quantity

Example (textbook p.29)

Year 2007 2008

Price index 100 105

Nominal output value ($) 12,000 12,810

Quantity

Example (textbook p.29) Q.2 If real GDP increases by 1.4% and nominal GDP

decreases by 2%, how will the price index change?

Answer:

Real GDP = Nominal GDP x

=

=

Price index of current year= = 96.65

Price index decreases by = 100 – 96.65 = 3.35

 Further explanation

1. To assess the economic performance of an economy Real GDP

measures the change of aggregate output. Growth rate of real GDP

the economic growth. how fast an economy expends if negative, shows financial crisis

Investment expenditure prediction to boost future consumption evaluate economic development

1.5A Uses of national income statistics

2. Understand economic structure and changes

From above data, importance of tertiary production importance of primary and secondary production

Industries % of GDP in 1986 % of GDP in 2006 /

Agriculture, fishery, mining and quarrying

0.52% 0.06% Significant

Manufacturing 20.57% 3.10% Sharp

Electricity, fuel gas and water supply

2.83% 2.73% More or less the same

Construction 4.42% 2.62% Significant

Service 66.57% 87.91% Sharp

1.5A Uses of national income statistics

3. To reflect the economic welfare Per capita GDP

aggregate output a person can enjoy on average Components in expenditure approach

how aggregate output is used for: Private consumption? Public consumption? Net export?

4. To facilitate international comparison Real GDP

which countries / regions have good economic performance?

1.5A Uses of national income statistics

5. To provide information for the gov’t in making economic policies Growth rate of real GDP

more intensive polices to stimulate economic growth Components in expenditure approach

which components show difficulties? Private consumption Tax allowance to stimulate consumption Net export formulate international trading policies, e.g. CEPA

6. To help firms make production and investment decision Growth rate of value-added of different economic sectors

make business plan and efficient investment

1.5A Uses of national income statistics

1. Differences in population, price and components of goods Consider GDP only:

Assume nominal GDP = $10million in both economy Population of Country A = 5,000 persons Population of Country B = 100,000 persons Country A has better living standard.

Case study on textbook p.33

1.5B Limitations of national income statistics

2. Exclusion of unpaid household services for self consumption Production does improve living standard GDP under-estimates economic welfare

3. Underground (or hidden) economic activities illegal production (e.g. smuggling and piracy) unreported production (e.g. retailing of hawker and private tutoring) Non-marketed production (e.g. farming for self-consumption) GDP may not fully reflect economic welfare

1.5B Limitations of national income statistics

4. The value of leisure time not included in GDP calculation GDP can’t reflect the living standard if Country A and B have the same figure,

more the leisure time higher the living standard

5. Difference in income distribution uneven income distribution per capita GDP over-estimates the general living standard of the

poor

1.5B Limitations of national income statistics

6. Externalities GDP does not reflect external cost from production (e.g. pollution) GDP over-estimates the living standard

7. Changes in price level Nominal GDP does not take away the effect of inflation Nominal GDP over-estimates the living standard Need to make use of real GDP, but more complicated in calculation

8. Composition of output Private and public consumption better living standard investment or net export no effect on improving living standard GDP as a figure can’t fully reflect the living standard

1.5B Limitations of national income statistics