Economics Notes

The Government and the economy

In order to manage the economy, the government requires a great deal of information about the
present state of the country. They would need the following facts and figures:

a. Ways in which the total output of goods and services have been changing (National Income)
b. Changes in employment and unemployment (Unemployment)
c. The extent to which the price of goods and services have been increasing. (Inflation)
d. Whether exports have been increasing slower or more rapidly than imports. (International
Trade)
e. Recent changes in money income and real income (Consumer Income/Spending)
f. Which industries have been expanding/declining (Economic Growth)
g. Rate at which firms have been investing in new capital goods (Investment)

There are three ways that the government can measure annual output of goods and services:

1. Gross Domestic Product (GDP) => This describes the total output produced by the factors of
production located within a country every year.

2. “GDP per capita” represents the average output (income) which each person in the country has.
It is calculated as follows:

GDP ÷ Population

3.. Gross National Product (GNP) => This represents the total output produced for a particular country
whether they happen to be located home or abroad. It is calculated
as follows:

Property Income earned abroad $80,000

Property income paid abroad (expenses) $ 30,000
Net property income from abroad $50,000

Assume: GDP of $40,000

We calculate GNP as follows:

GNP = GDP + Net Property Income from abroad
GNP = $40,000 + $50,000
GNP = $90,000

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4. Net National Product (NNP) => During the course of a year, the nations fixed assets of building,
(National Income NI) equipment and machinery will depreciate in value as they become
(Net National Income NNI) worn out.
Each year some part of the GNP is required to replace those worn
out obsolete capital assets.
The value of depreciation is deducted from the GNP to obtain the
Net National Product or National Income.

Note: If we assume depreciation of $10,000, we can calculate National Income as follows:

National Income = GNP – Depreciation

= $90,000 - $10,000
= $80,000

Real National Income => refers to the actual quantities of goods and services produced.

The National Income represents a measure of the total flow of goods and services for a year. There are
three methods used to measure National Income:

1. The Output method => This is a measure of the value of output of all the different
industries in the country per year.

2. The Income Method => This is a measure of the money value of all the goods and
services produced in the country per year.

3. The Expenditure Method => This is the total amount spent on goods produced whether
they are sold or not per.

Types of output
Nominal Output => The level of output produced in a country for a given year, measured in price for that
year.

Real Output => The level of output produced in a country for a given year, measured in price for a base
year.

Potential Output => level of output that an economy is capable of producing when all its factors of
production are fully employed. (Production Possibility curve.)

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So the National Income is a money measure of a country’s total output, total income or total
expenditures
Why do we measure National Income

1. To provide the government with up to date information, which will enable them to make major
decisions.

2. To indicate changes in the standard of living. (National Income ÷ Population)

3. To compare our standard of living with other countries.

Calculating GDP and National Income.

a) GDP @ Market Price:

Consumption 500
Investment 1100
Gov. Expenditure 1375
Exports 400
Less: Imports (425)
GDP @ Market Price $2950

b) GDP @ Cost:
GDP @ Market 2950
Less: Taxes (30)
Plus: Subsidies 20
GDP @ Cost $2940

c) National Income
GDP @ cost 2940
Less: Net Property (220)
Income from Abroad
GNP $2720
Less: Capital Consumption (25)
National Income or NNP $2695

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What is the Standard of Living
The term standard of living refers to the quality of life that the people of that country have eg. types of
houses; quality of food, clothes they wear; work they do; wages they receive and the level of education,
Health care etc. This will also reflect the average life span of the people living in the country.

The size of the population also affects the standard of living of a country. The more working people in
the country the greater the country’s standard of living. However the reverse is also true. If the working
population has a large number of unemployed, if there are a lot of elderly and very young to support,
then the standard of living will decline.

Factors that affect a country’s standard of living

i) Limited Income will indicate the quantity and quality of what the population can buy.
ii) Inflation (a general rise in the prices over a period which means that the value of money is falling) will
mean that your money will buy less goods and services that it did last year.
iii) Government can influence the standard of living in the way that they manage and administer the
budget. They may take deliberate measures to improve the standard of living by increasing output or
reducing taxes in order to increase the spending power of the population.
iv) Exporting more than is being imported mean that a country is becoming richer because you will have
a favorable Balance of payment and therefore a favorable growth in the country’s standard of living.
v) Devaluation refers to the decrease in the value of a country’s currency. This has the effect of making
your exports cheaper and your imports more expensive on the international market.

The COST OF LIVING gives some indication of the quality of life of the people and how it is changing
from one year to another and refers to how much can be bought with a person’s net income,(so it
shows whether real income is changing).
One way of measuring the cost of living is by using a price index known as a “Consumer Price Index”.
This index is made up of prices of goods and services purchased by consumers. The object of this is to
ensure that workers wages maintain a constant or increasing value in ‘real’ terms.

Economic growth
ECONOMIC GROWTH refers to the increase in the output we consume, use, invest or produce. To have
Economic growth it is important that a country is increasing its wealth and improving its standard of
living. One way to access economic growth is through measuring the national income.

The National Income is arrived at or measured by using one of three methods:

i) calculating the country’s Income which will include personal income, profit from companies, rent etc.
ii) total Output produced from every form of production, but care must be taken not to count output

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 twice.
iii) calculate all expenditures made by consumers, firms and the government in the country.

Some of the problems associated with measuring national income are:

i) Money terms=> the measures must be expressed in terms of money which may be difficult as
currency value is constantly changing due to inflation.
Solution: Use the real increase in National Income. To establish this requires allowances
to be made for the changing value of money.
ii) Double-counting=> This is generally associated with output eg. if the value of timber is counted
as output, then you cannot once again add the value of furniture made from the timber.
Solution: You only count the value added to the products by its activities.
iii) The informal economy => There are some jobs that are done on the side eg. baby sitting,
driving a taxi, mechanic etc. whose revenue is not declared for tax purposes and are not
included in National Income. Activities such as these are sometimes called “hidden” or
“underground” revenue and so are a part of the informal economy. (It has been estimated
that these jobs account for almost a third of some country’s GDP.)

The statistics from the National Income may be used to:

a) Indicate changes in the living standards
b) Make comparison with other countries
c) Compare the country’s economic growth from one year to the next.
d) As an instrument in the country’s economic plans.

A country may have a high standard of living and still have many poor people. This may be due to the
fact that the majority of the wealth is held by only a few persons. This can increase the country’s
standard of living, because the rich are heavily taxed and the government uses the money to develop the
country.

We tend to believe that a rise in the National Income (NI) means that we are better off because more
goods and services are being produced. However some problems may arise that may include the
following:

1. If the population rises more quickly than the NI, then there will be fewer goods for each person.
2. A rise in NI may make only a few persons better off, without helping the majority of the population.
3. The NI is measured in money terms, so if prices are rising, NI will rise even if the country is not
producing any more goods and services.
4. The NI can rise as a result of the production of goods and services that do not directly make us feel
better off eg. Investing in weapons for the armed forces.
5. The NI or output of the whole economy is very difficult to measure accurately, so a small change in NI
may simply be due to inaccurate measurements.

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Although per capita income may be a useful indicator of the standard of living in a country, there are
some short comings:
a) There may be differences in prices from one year to another and from one country to
another.
b) It does not take into account the effect of government spending has on National
Income.
c) It is possible that the increase in National Income may come from working additional
hours.

Factors affecting National Income include Natural Resources, Industrial Development, quality of the
labor force, Economic stability and Political Stability.
National income
The amount of wealth or GNP that a country generates each year is referred to as the “Consolidated
Fund” or in some cases, the ‘National Cake’ . This consolidate fund is made up of financial contributions
from various sources such as: taxes from businesses (corporate taxes), taxes from the people, (VAT.),
funds are then taken out to be used in education, health care, agriculture, construction, fishing, tourism,
banking etc.

(The “Consolidated Fund Act” is an act passed by Parliament which allows the Bahamian Treasury to
issue funds out of the Consolidated Fund. All governments expenditure is made from this fund except
“exceptional items.” No money can be withdrawn from this fund without the Parliament’s approval.)

Whenever expenditures are to be made, funds are taken out of the consolidated fund. If we compared it
to a cake, the ingredients that go into it are taxes and money from various sources. This cake is cut into
slices and given to the various sectors/ministries, such as education, health, tourism etc.

Consequently, if one area is given a large slice of the cake, or more money, then there will be less for
everyone else, e.g. If the government gives Tourism a large sum/piece of the cake, then this will mean
that other ministries will receive less.

National Expenditure is the sum of the following:

a) Private expenditure by consumers
b) Public expenditure by the government
c) Gross Domestic Capital Formation (GDCF), which is capital used to purchase company’s
assets.
d) Overseas trading – the net difference between the company’s imports and exports.

Growth and Development

Growth refers to the all-around expansion of the economy. It is concerned with the country’s output
and is measured by changes in GDP. A NEGATIVE GROWTH means that the country is not doing as well

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as last year, while ZERO GROWTH indicates that there have been no changes when compared with
previous years. POSITIVE GROWTH country is doing better than last year.

Development is not the same as growth and is concerned more with the pattern of economic change. It
refers to the provisions of the facilities that enable growth to take place. Highly developed countries are
better able to exploit their natural resources than underdeveloped countries and may experience major
economic growth.

Third world (Developing/Under Develop) countries tend to have the following features:
a) Poor economic performance
b) High rate of population growth
c) Low standard of living
d) Relatively short life expectancy
e) High unemployment
f) Considerable dependency upon agriculture
g) Poor educational opportunities
h) Poor Health care

Economic growth is the goal of all governments and is affected by Investment, technical progress,
balance of payments and government expenditure.
Education plays a very important part in the growth and development of a country. The main
contribution that education makes to growth and development are:

a) It helps to improve the knowledge and skills of the work force

b) Better educated people are more able to adapt to the changes that are necessary in a
developing economy.
c) Education makes a person more literate which is important in modern world communication.
d) Entrepreneurs who tend to come from the better educated sector of society are essential factor
in economic development.

The broad aim of government economic policy is:

i) a high level of employment
ii) relatively stable price level
iii) a satisfactory Balance of Payment position
iv) a rising standard of living
v) a more equal distribution of income and wealth

To carry out its policies, the government can use Fiscal Policies; Monetary Policies; Direct
Controls and Nationalization.

Fiscal Policy

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 When the government deliberately changes the rates of taxation and the amount of its own
government spending in order to bring about changes in the economy.

Monetary Policy
When the government tries to influence the economy by changing the rate of interest and by
controlling the bank’s ability to make loans.

Direct Controls
The government has the power to place legal controls on such things as wages, prices, rents and
dividends. They can use this power to control the number, type and location of buildings and
businesses.

Public Ownership (NATIONALIZATION)

When the government own a lot of nationalized companies, they would be able to control the
economy more efficiently. They can create jobs by investing heavily in these industries. They can
also affect the cost of production in other industries by controlling the prices charge eg:
electricity.

A major problem of economic management is the fact that one aim of economic policy may
conflict with another.

Economic Dualism=> results from a situation in which the economy of a country is divided into
2 distinct sectors; one advance and one that is backward. Eg. Haiti

Circular Flow of Income

Spending/Consumption Revenue
Product Market
Purchases
(Household buy)
Goods/Services Goods/Services
(Firm Sells)
Sold

Household leakages
Firm

Injections

Factors of Labor needed

Production (Labor) for Production

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 Factors Market
Income (Household Sells) Wages

(Firm Buys)

-The Circular Flow of Income shows the continuous flow of goods and services bought and sold
between the producer (firm) and the consumer (household) in an economy.

- There is also a continuous flow of income between these sectors. The exchange takes place in
the Product/Factors Markets.

Product Market – Place where the firm sells their goods and services and the household goes to

buy goods and services. (Stores).

Factors Market – Place where the household goes to sell their labour, and the firm goes to buy

labour. (Job Market or Employment Agencies).

Household - This is where the consumer, who sells his labour to the firm in exchange for wages

live. The wages he receives is in turn used to purchase goods and services

produced by the firm.

Firm - These businesses purchase labour from the household and in return pay them wages.

The goods and services produced in the firm is then sold back to the household,

(paid for by the wages they earned).

Leakages from the circular flow – Represents a withdrawal of money from the circular flow

(economy). This is done through: Taxes, Imports, Savings.

Injection into the circular flow – This represents additional inflow of money into the economy:

Government Spending, Export, Investment , Loans

Government & the Economy Classwork assignment

1. Give 3 reasons why it is important for the government to collect information about their
country. (3)

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2. What are GDP and GNP and how do they differ. (5)

3. What is another name for National Income and what does it measure? (3)

4. Give 3 reasons why we need to measure the National Income (NI) of a country. (3)

5. Briefly explain the methods used by the country to measure NI. (6)

6. Name 3 problems that may come about as a result of measuring NI. (3)

7. What is meant by a country’s Standard of Living and why would it differ from country to
country? (4)

8. Name 3 main factors that would determine a country’s standard of living. (3)

Homework Assignment
9. What does the Cost of Living tell you about a country and how is this measured? (3)

10. What is meant by the term “National Cake”? (2)

11. Give the names of 3 types of National Expenditures. (3)

12. What is Economic Growth of a country, and why is negative growth discouraged? (4)

13. List 4 characteristics of an underdeveloped country. (4)

14. What factors will assist in economic growth of a country? (2)

15. Why is education so important for the economic growth of a country? (2)

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