Economics Chapter 1 National Income Measuring indicators l

Economics Chapter 1 National Income

Measuring indicators l l Do you think Hong Kong is a rich city? Why? In what way do we measure the economic performance of a city? l Indicators l l l l Income Employment / Unemployment Production Consumption Price level Living standard Freedom

Price ($) l S In microeconomics, l l Price Quantity P D 0 l In macroeconomics, l l General price level Aggregate output Q General price level ($) Quantity (units) AS P AD 0 Q Aggregate output (units)

Macroeconomics l Studies the aggregate measures l l l Price level National income or output Unemployment l Money market l Gov’t economic policies l International trade

1. 1 National income l Measurement of output l Output or income a region gets from production within a period of time (usually one year) l Measure the aggregate output by adding up the market values of different outputs l It shows: l l economic development quality of life

Stock and flow concepts l Stock l Value of output = a quantity measured at a certain point of time l l 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 l Flow l 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 l Investment and depreciation = increase and decrease in the value capital owned in a certain period of time l http: //www. reffonomics. com/TRB/chapter 21/GDP/realgdp 4. swf l E. g. l l l 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 l Measurement of aggregate output l GDP = Gross domestic product l GNP = Gross national product

1. 2 Gross Domestic Products (GDP) I. Measuring the total value of final goods l The total value of production of all resident producing units of a region in a specific period (usually a year or quarter). or l It is the market value of all final goods and services produced inside a country in a year (or a quarter).

1. 2 Gross Domestic Products (GDP) II. Resident producing units of a region l Individuals: l l l Organizations: l l l People who normally live in the region E. g. HK citizens Companies taking the region as the centre of economic interest E. g. 7 -Eleven Imported goods are excluded

1. 2 Gross Domestic Products (GDP) l Total value of final goods and services. Intermediate good Fish: $400 Final goods Sushi: $1000 Pay: $1000 Earn: $400 l l Earn: $1000 - $400 = $600 Value of final goods = $1, 000 If value of intermediate and final goods are counted ($400+$1000), it will be double counting ($400)

Items not counted in GDP 1. Past inventories l l 2. Second-hand goods l l 3. Not produced within the period Already counted in the GDP in previous period Already counted when produced in the first time Double counting Unpaid household services for selfconsumption within household l l Housework Caring of own children

Items not counted in GDP Intermediate products 4. Goods and services used up as inputs E. g. l l Raw materials Semi-finished goods Financial assets 5. l l Shares and bonds Futures and options Transfer payment 6. l l Transfer of wealth, no production involve E. g. Gov’t subsidy, CSSA Capital gain 7. l l Increase in the market value of an asset, but not production E. g. Selling the flat with a higher price

Should the following be included in calculation of GDP in 2010? l l l l Stock of MP 3 players produced in 2008 Stock of MP 3 players produced in 2010 Sony α 3 camera resold in Yahoo! Auction Canon D 5 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 $1000 million from selling the flats in a new estate Yes / No Yes / No Yes / No Yes / No

PEQ - HKCEE 1998 MC 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 1995 MC 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 1992 MC 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 Paper Mr. 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: l His income is counted in HK’s GDP (1) l because it is derived from the current production carried out by a resident producing unit in Hong Kong. (2) 18

B. Basic concept of measuring GDP Income = $50 Output value = $50 Expenditure = $50 Output value = Expenditure = Income

B. Basic concept of measuring GDP I. Three approaches for GDP 1. Expenditure approach l 2. Production approach l 3. Final goods Output value of producing units Income approach l Factor income

Basic concept of measuring GDP II. GDP at market price and factor cost GDPMP = GDPFC + Indirect taxes – Subsidies Given: Unit tax = $1200 and Subsidy = $200 Output value $3000 Expenditure $4000 GDPFC GDPMP Income $3000 Tax $1200 Subsidy $200

III. Expenditure approach 1. 2. Total expenditure on final goods Subtract (not include) the value of imports GDP = C + I + G + X - M Import Export Gov’t expenditure Gross Investment expenditure Private consumption expenditure

III. Expenditure approach C - Private consumption expenditure (C) l Household expenditure on goods and services G - Government consumption expenditure l l l Compensation of civil servants (e. g. salary) Purchasing good or services Not include: transfer payment

III. Expenditure approach I - Gross investment expenditure (I) l Capital formation Change in inventories Depreciation included l Gross investment (I) l l = 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 l l Selling goods or services to foreign countries Total exports = Xgoods + Xservices + Xre-exports M - Imports l l Purchasing goods or services from foreign countries Total import = Mgoods + Mservices Net exports (NX) = X - M

III. Expenditure approach l The net domestic product (NDP) l l Equals the gross domestic product (GDP) minus depreciation on a country's capital goods. Capital that has been consumed over the year l l Capital consumption allowance l l in the form of housing, vehicle, or machinery deterioration. the amount of capital that would be needed to replace those depreciated assets. NDP = GDP - Depreciation

Try it. Is it included in the GDP? C I G 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 X M + + -

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 GDP Components $ 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 GDP Components $ 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

IV. Production (Value added) approach l l l 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 $500 Value added by C $800 B = $800 – $500 = $300

IV. Production (Value added) approach l E. g. $200 Carpenter $850 Factory Value of timber sold from carpenter to factory $1800 Shop Value of sofa sold from factory to retailer Household Value of sofa sold from retailer to household 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 2005 MC A production chain is shown below. The contribution of the above production chain to Hong Kong's GDP is Calculation: A. $1 400 HK’s GDP = ($700 + $800 - $200) + ($1400 - $700) + ($1200 - $800) B. $1 700 = $2400 C. $2 400 D. $2 600 33

PEQ - HKCEE 2004 MC The 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? Calculation: A. $1 600 Amy’s contribution = ($4300 + $2000) - ($600 + $400) B. $3 700 = $5300 C. $5 300 D. $5 900 34

IV. Production (Value added) approach l E. g. $850 $300 Farmer Factory Smoker $200 l l l 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 Tax to Gov’t Consider production only: GDPFC = Sum of value added of all resident production units Consider the market value GDPMP = GDPFC + Indirect tax - Subsidies

GDP from value added and expenditure approaches Export (X) [Goods and services] GDPMP = GDPFC+ Indirect tax - Subsidies in C, I, Government consumption expenditure (G) ontents GDPMP Import c GDPFC Value added of all producing units Gross investment expenditure (I) G and X Private consumption expenditure (C) Indirect tax less subsidies GDPMP = C + I + G + X - M

Advantages of value added approach 1. Difficult to distinguish final goods and intermediate goods l E. g. A chef buys a fish. The fish can be: l l l 2. 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 Avoid double counting l All value added are counted for once.

Example (p. 20) l l The diagram below shows the operation of C&K Furniture. Its total sales revenue is $6, 600. Local made furniture $3, 000 Imported furniture $1, 000 C&K Furniture Change in inventory - $800 Local consumers Sales revenue $6, 600 (indirect tax inclusive) 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 = ?

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. l Consider the market value GDPMP = GDPFC + Indirect tax - Subsidies 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

PEQ - HKCEE 2006 MC The following table shows the statistical data of an economy. The GDP at factor cost (in $mn) is Calculation: A. $ 950 Step 1: GDPMP = C + I + G + NX B. $ 970 = $(200 + 300 -70 + 50 +150 + 300) mn = $930 mn C. $ 1050 Step 2: GDPMP = GNPFC + Indirect tax - Subsidies D. $ 1190 GDPFC = GDPMP - Indirect tax + Subsidies GNPFC = $(930 – 0 + 120)mn = $1050 mn 40

III. Income approach (out of syllabus) l The sum of all factor incomes l Compensation l l l Return for the labour resources E. g. Salaries, bonus, commission, housing allowance… Gross operating surplus l l Return to company’s capital and entrepreneurship E. g. Dividends, interests, shares…

IV. Per capita GDP l GDP divided by population l l l 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 l E. g. Given in country A: l l GDP = $5000 million Population = 10 million persons

V. Growth rate l % gain or lose in GDP l l To study the economic growth To forecast the economic situation, so that to make appropriate decisions l E. g. Given in country A: l GDP 2010 = $5000 million and GDP 2009 = $4000 million l l Economy with GDP growth rate > 10% is consider well economic growth PRC Gov’t aims at 8% growth in recently years

1. 3 Gross National Product (GNP) Gross Domestic Product (GDP) of HK HK citizen Foreigner Production in HK Gross National Product (GNP) of HK HK citizen Production in HK and Production in other countries

1. 3 Gross National Product (GNP) l The total income earned by residents from engaging in economic activities in a given period of time. l Assume GNP of Hong Kong in 2010: All income earned by Hong Kong residents (both living in or outside HK) in year 2010. l GDP = Income of local residents in HK + Income of foreigners in HK GNP = Income of local residents in HK + Income of residents overseas l

B. The relationship between GDP and GNP l So, when calculating GNP, income of HK residents (living in HK) income of HK residents (living overseas) GNP = GDP + Factor income from abroad - Factor income paid abroad income of foreigners who’re living in HK (< 2 yrs)

B. The relationship between GDP and GNP = GDP + Factor income from abroad - Factor income paid abroad Net factor income from abroad

C. Factor income from and paid abroad l Factor income from abroad (inflow) l l l 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) l l 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 l Factor income from abroad (inflow) l l l 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) l l 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 l l Assume GDP of HK in 2010 is $100 million. Inflow l l l Outflow l l l HK citizens gain $30 million profit from investment in US HK salesmen earn $5 million income from a short-term contract in Japan 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

Gross National Product (GNP) $ Million Private consumption 200 Gross Investment 250 Gov’t expenditure 100 Exports 80 Imports 30 Indirect business tax 10 Subsidies Net income from abroad GDP at market price =C+I+G+X–M = ($200+$250+$100+$80 -$30)million = $600 million 5 15 GNP = GDP + Net income from abroad = ($600 + $15) million = $615 million GDPMP = GDPFC + Indirect taxes – Subsidies $600 million = GDPFC + ($10 - $5)million GDPFC = ($600 - $10 + $5) million So, GDP at factor cost = $595 million

PEQ - HKCEE 1996 MC The GDP at factor cost is: Calculation: A. $ 95 Step one: GNPMP = GNPFC + Indirect tax - Subsidies B. $ 105 GNPFC = GNPMP - Indirect tax + Subsidies GNPFC = $100 - $25 + $35 = $110 C. $ 115 Step two: GNPFC = GDPFC + Net income from abroad D. $ 125 GDPFC = GNPFC - Net income from abroad GDPFC = $110 – (-$5) = $115 52

1. 4 Nominal and Real GDP A. Basic concept of nominal GDP l In principle l l GDP = total market value at market price Measures “of the current period” l l i. e. GDP at current market prices Specified as: Nominal GDP General formula = P x Q where P=Current price Year Output (units) Price ($) Nominal GDP ($) (Price x Output) 2000 10 $10 x 100 = $1000 2001 100 12 $12 x 100 = $1200 2002 100 14 $14 x 100 = $1400 From above date l l Nominal GDP but overall production remains unchanged

1. 4 Nominal and Real GDP B. Calculation of real GDP l To compare the output of different period l Assume the price is constant l l i. e. GDP at constant market prices Specified as: Real GDP General formula = P 0 x Q where P 0= Price in the base year Year Output (units) Price ($) P 0 ($) Real GDP ($) (Price x Output) 2000 10 10 $10 x 100 = $1000 2001 100 12 10 $10 x 100 = $1000 2002 100 14 10 $10 x 100 = $1000 From above date, Real GDP remains unchanged even though the current price

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 l l l l GDP of 2000 at current market price = $10 x 2, 000 + $20 x 2, 000 = $60000 GDP of 2004 at current market price = $15 x 1, 000 + $25 x 1, 800 = $60000 Nominal GDP 2004 = Nominal GDP 2000 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 GDP of 2004 at constant price Real GDP 2004 < Real GDP 2000 = $10 x 2, 000 + $20 x 2, 000 = $60, 000 = $10 x 1, 000 + $20 x 1, 800 = $46, 000

Finding Real GDP from Nominal GDP l Year Price index Nominal GDP ($billion) 2006 100 $20 2007 110 $22 Quantity

Example (textbook p. 29) l Year 2007 2008 Price index 100 105 Nominal output value ($) 12, 000 12, 810 Quantity

Example (textbook p. 29)

Further explanation l

1. 5 A Uses of national income statistics 1. To assess the economic performance of an economy l Real GDP l measures the change of aggregate output. l Growth rate of real GDP l the economic growth. l how fast an economy expends l if negative, shows financial crisis l Investment expenditure l prediction to boost future consumption l evaluate economic development

1. 5 A Uses of national income statistics 2. Understand economic structure and changes Industries % of GDP in 1986 % of GDP in 2006 � / � 0. 52% 0. 06% Significant � 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 � 66. 57% 87. 91% Sharp � Agriculture, fishery, mining and quarrying Manufacturing Service l From above data, importance of tertiary production importance of primary and secondary production

1. 5 A Uses of national income statistics 3. To reflect the economic welfare l Per capita GDP l aggregate output a person can enjoy on average l Components in expenditure approach l how aggregate output is used for: § § § 4. Private consumption? Public consumption? Net export? To facilitate international comparison l Real GDP l which countries / regions have good economic performance?

1. 5 A Uses of national income statistics 5. To provide information for the gov’t in making economic policies l Growth rate of real GDP l more intensive polices to stimulate economic growth l Components in expenditure approach l which components show difficulties? § § 6. Private consumption Tax allowance to stimulate consumption Net export formulate international trading policies, e. g. CEPA To help firms make production and investment decision l Growth rate of value-added of different economic sectors l make business plan and efficient investment

1. 5 B Limitations of national income statistics 1. Differences in population, price and components of goods l Consider GDP only: l l l Assume nominal GDP = $10 million 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. 5 B Limitations of national income statistics 2. Exclusion of unpaid household services for self consumption l Production does improve living standard l GDP under-estimates economic welfare 3. Underground (or hidden) economic activities l illegal production (e. g. smuggling and piracy) l unreported production (e. g. retailing of hawker and private tutoring) l Non-marketed production (e. g. farming for self-consumption) l GDP may not fully reflect economic welfare

1. 5 B Limitations of national income statistics 4. The value of leisure time l not included in GDP calculation l GDP can’t reflect the living standard l if Country A and B have the same figure, more the leisure time higher the living standard 5. Difference in income distribution l uneven income distribution l per capita GDP over-estimates the general living standard of the poor

1. 5 B Limitations of national income statistics 6. Externalities l GDP does not reflect external cost from production (e. g. pollution) l GDP over-estimates the living standard 7. Changes in price level l Nominal GDP does not take away the effect of inflation l Nominal GDP over-estimates the living standard l Need to make use of real GDP, but more complicated in calculation 8. Composition of output l � Private and public consumption better living standard l � investment or net export no effect on improving living standard l GDP as a figure can’t fully reflect the living standard