ECS 1601

Learning Unit 5
(Chapter 13)
Measuring the performance of
the economy

Remember, the
best way to learn
is to take notes
and ASK if you
dont understand.

Take out your text book. Keep

How is it
the
South African
next to you!
economy
If
the slide doing?
has a red
Wespeech
can only
say
for sure
bubble that
says if
READ
so-and-so,
hit
we
aresection
able to
MEASURE
pause,
read the section
the
performance
of the
and watch the slide
economy; so lets have a
thereafter!

look.

Content
In this learning unit you will learn more about:
Macroeconomic objectives
Measuring the level of economic activity: gross
domestic product (GDP)
Other measures of production, income and
expenditure
Measuring employment and unemployment
Measuring prices: the consumer price index (CPI)
Measuring the links with the rest of the world:
balance of payments
Measure inequality: distribution of income

Read section
13.1 in
textbook
pp 234-235

13.1 Macroeconomic objectives

There are 5 objectives that are important

for economists:
Economic growth
Full employment
Price stability
External stability
Equitable distribution of income

Do you understand
the meaning of
each of the
Now, how do
objectives?
That is
economist
very important.
measure
Make
surethese
to
goals?
discuss it with
your
e-tutor if you dont
understand.

To see if you have reached your

objectives, you have to be able to
measure it!

13.1 Macroeconomic objectives

In order to measure
economic growth (5.2 & 5.3), economists use
the increase in economic activity. The amount of
economic activity is expressed in GDP.
We will also look at measuring production,
income and expenditure.
full employment (5.4), economists use the
unemployment rate.
price stability (5.5) , economists use the
consumer price index.
external stability (5.6), economists use the
balance of payments.
equitable distribution of income (5.7),
economists use the Lorenz curve, Gini coefficient or

Read section
13.2 in
textbook
pp 235-241

13.2 Measuring the level

of economic activity:
Gross domestic product

Gross domestic product (GDP) is:

total value of all final goods and services
produced within the boundaries of a country
in a particular period (usually a year)

Gross means that economists do not subtract all

the depreciation that happened to all capital goods
in order to generate that years GDP. (Example: pot
holes in roads, rust on machinery, equipment that
broke)
In order to add different final goods together,
economist use the prices of the goods and services.
The prices express the value of the goods.

13.2 Measuring the level

of economic activity:
Gross domestic product
Gross domestic product (GDP) is:
total value of all final goods and services
produced within the boundaries of a country
in a particular period (usually a year)

Note: Only FINAL goods are included in GDP, if all

the goods needed to make bread and all the bread
are counted, then there is DOUBLE COUNTING!
GDP is a geographical concept, that is why it is
called domestic; it is only within one country.
The flow variable, GDP is measured over a certain
time. GDP is only concerned with new goods and
services; all production that happened in this year.

Gross domestic product

There are three methods to calculate GDP:
The production method (use basic prices)
Sum of all the values added in each step of the
production line
The expenditure method (use market prices)
Sum of all the final goods and services only
The income method (use factor costs)
Sum of all the incomes earned by the factors of
production in each step of the production line

All the methods should give the same answer.

They just take different routes to get there!

Market prices, basic prices and

factor cost
These prices differ due to taxes and subsidies.
There are two types of taxes:
Taxes on products (taxes levied on each product)
Other taxes on production (taxes levied on the company
in general)

There are two types of subsidies:

Subsidies on products (subsidies given on each product
produced)
Other subsidies on production (subsidies given to the
company in general)

The diagrams on the next slide explain the

differences between these types of prices:

Market prices, basic prices and

factor cost
Minus
subsidies on
a product
Plus tax on
a product

Basic
price
s

Mark
et
price
s

Minus tax
on a
product
Plus
subsidies
on a

Minus other
subsidies on
production
Plus other tax on
production

Fact
or
cost
s

Basi
c
price
s

Minus other
taxes on
production
Plus other
subsidies on
production

Current prices and constant

prices
Economic growth is measured by the increase
of GDP.
But GDP also increases because of prices that
keep on increasing each year (inflation).
When measuring economic growth, we are only
interested in the increase of GDP due to an
increase in production.
That is why we look at the increase in real GDP
(use constant prices) instead of the growth in
nominal GDP.

What is the difference between real and

nominal values?

Current prices and constant

prices
Study the following bank note
What was its nominal value in 1990?
What is its nominal value in 2015?
Yes, it was R10 in 1990 and still is 2015 because
nominal value only takes into consideration the
amount printed on the note.

What about real value?

Was the real value also the same in 1990 and 2014?
No, because real value only considers the
purchasing power of the money. In 1990, R10 was
worth a lot. Today R10 is worth less! The real value
decreased due to inflation. You cannot buy as much
with a R10 today as in 1990.

Current prices and constant

prices
The difference between nominal and real GDP is
the prices used to calculate the GDP.
Nominal GDP uses the prices of that particular
year.
Real GDP uses prices in the base year in order to
exclude the effects of inflation, meaning to only
see how GDP grew due to an increase in
PRODUCTION and not an increase in the price
level.
Study Box 13-1 and Box 13-2
carefully to fully understand real
and nominal GDP.

Read section
13.3 in textbook
pp 241-244

13.3 Other measures of

production,
income and expenditure: GNI

Gross national income is equal to GDP

minus all the income foreigners in South

Africa receives
plus all the income South Africans abroad
receives
Domestic GDP refers to the borders of the
country.
National GDP considers the nationality of
the citizens, therefore all South Africans
are included no matter where they live.

13.3 Other measures of production,

income and expenditure: GDE
Gross domestic expenditure (GDE) refers to
the spending within the borders of a country.
GDE=GDP
* Minus exports (it is
produced in SA but
bought in another
country)
* Plus imports (it is
produced in another
country but bought in
SA)

Read section
13.4 in
textbook
pp 244-246

13.4 Measuring employment

and unemployment

The unemployed are people who are

willing AND able to work but do not have a job.
The unemployment rate is the ratio between
the number of unemployed persons and the
number of those who are willing and able to
work.
Unemployment is extremely difficult to
calculate.
You will learn more about unemployment in
learning unit 10

Read section
13.5 in textbook

13.5 Measuring prices:

pp 246-249 and
box 13.4 on pThe consumer price index
247

Have you heard this before:

In the good old days you could go to the
movies, buy popcorn and a Coca-Cola for 20
cents! Today it is so expensive!
This is an example of inflation. Inflation is the
constant increase of the general price level.
However, it does not mean that movies are
thousand times more expensive today than in
the past; there is a difference between
nominal and real values.

13.5 Measuring prices:

The consumer price index
How do economists measure inflation?
They use the Consumer Price Index (CPI)
StatsSA does a survey (every 5 years) on what goods and
services an average South African household uses, such as
petrol, electricity, clothing, food. There is also some luxury
goods in the basket like an iPhone or car.
This is called a representative basket of goods
and services.
The year in which the survey is done is called
the base year.
The next step is to see by how much the total
price of the basket increase, and that is one
way to measure inflation. Lets see

13.5 Measuring prices:

The consumer price index
2010
How much
does the
basket
cost (CPI)
Increase
in the
price of
the
basket,
thus the
inflation
rate

R124,
5

2011
In this exampl,e
the
inflation
R132,7
rate of 2010 can
not be
calculated
because we
dont have the
CPI of 2009.
Could not get
the right
answer? Ask
your e-tutor
how!

2012

2013

R139,8

R143,5

5.35%

2.65%
Hit PAUSE and
try to calculate
the inflation
rate of 2012
and 2013. The
answer is

13.6 Measuring the links with the

rest
of the world: balance of payments

Read section
13.6 in
textbook
pp 249-252

The Balance of payments is a record of all the

transactions between South Africa (or any other
country) and the rest of the world.
Recall from learning unit 4.
The balance of payments is used to see if a
countrys relationship with other countries is
stable.
The balance on the current account and the
financial account are added together, and that
total balance causes a change in the countrys
gold and foreign exchange reserves.

Read
section
13.7 in
textbook
pp 252254

13.7 Measuring inequality:

Distribution of income

Distribution of income is how total

wealth is divided amongst all the
citizens of a country and it is
extremely difficult to measure.
Three are three ways to measure it:
Lorenz curve
Gini coefficient
Quantile ratio

1. Assume there is a
country with only 5
people, who, in total
earned $ 100.
2. Lets first draw the
outlines of a Lorenz
curve.
3. It is a weird-looking
graph, but lets
name the axes and
you will understand!

Cumulative percentage of income (%)

13.7 Measuring inequality:

Lorenz curve
100

80

60
40
20

20

40

60

80

100

Cumulative percentage of population

Cumulative percentage of income (%)

13.7 Measuring inequality:

Lorenz curve
4. Then the 5 people
should be
arranged from the
person earning the
least to the person
earning the most.
For example:

John earns $5
Peter earns $10
Susan earns $15
David earns $25
Sophia earns $45

100

80

60
40
20

20

40

60

80

100

Cumulative percentage of population

John earns $5
Peter earns $10
Susan earns $15
David earns $25
Sophia earns $45

Lets look at John. He is the bottom

20% of the population and he earns
5% of the total income.
Lets look at the poorest 40% of the
country. That is John plus Peter.
Together they earn 15% of the total
income.
Lets look at the first 60% of the
country. That is John + Peter + Susan.
Together they earn 30% of the total
income.
Lets look at the first 80% of the
country. That is John + Peter + Susan
+ David. Together they earn 55% of
the total income.
Lets look at the total 100% of the
population. That is John + Peter +
Susan + David + Sophia. Together
they earn 100% of the total income.
Connect the red dots.
Colour the area of deviation.

Cumulative percentage of income (%)

13.7 Measuring inequality:

Lorenz curve
100

80

60
55
40
30
20
15
5
0

20

40

60

80

100

Cumulative percentage of population

Cumulative percentage of income (%)

13.7 Measuring inequality:

Gini coefficient

1. The Lorenz curve is

used to calculate the
Gini coefficient.
2. Divide the pink area
3. by the area of this
triangle
4. It gives a value
between 0 and 1:

0 means a perfect equal

society and 1 means a
perfect unequal society.

5. To get the Gini index,

multiply by 100.

100

80

60
40
20

20

40

60

80

100

Cumulative percentage of population

13.7 Measuring inequality: Quantile

ratio

Quantile
ratio: divide % income of x% richest persons

by % income earned by y% poorest persons.

In our previous example John was the poorest 20% of
the country and Sophia was the richest 20%.
John earned $5 of $100, meaning John earned 5% of
the total income of the country.
Sophia earned $45 of $100, meaning Sophia earned
45% of the total income of the country.
Example of a quantile ratio: divide the percentage
income received by the richest 20% by the income
received by the poorest 20%.
Quantile ratio = = 9
A higher quantile ratio means higher inequality.

Are you able to:

List the five macroeconomic objectives

Define GDP?
Name the three methods to estimate GDP?
Define the unemployment rate?
Define CPI?
Define the balance of payments?
Name three ways to measure inequality?
Explain the difference between nominal and real values?
Explain the difference between market prices, basic prices and
factor prices?
Explain current prices, nominal prices and constant prices?
Explain gross product and net product?
Explain GDP and GDE?
Calculate the change in real and nominal GDP?
Calculate the change in purchasing power?

You are done

with the first
part of ECS
1601. Thats
great!

That is the end of learning unit

5.
A quiz on this work will be
available soon; make sure you
do it and discuss it
with your e-tutor!