Economic Presentation

THE DISTRIBUTION OF GAINS BETWEEN INVESTING AND BORROWING COUNTRIES
H.W. Singer, May 1950

- International trade is very important to underdeveloped countries.
- Benefits that they derive from trade and variations in trade affect their national incomes deeply.

Reasons why Foreign Trade is important:

- Foreign trade ( FT) most important when incomes are lowest.
- Fluctuations in value and volume tend to be more violent and thus have an important relationship with national income
- Due to the small margin of income over subsistence needs which form the source of capital formation.


- Opposite view held by many economists is that trade in underdeveloped countries is not very important

Why the author believes it’s not important:

- Caused by confusion between the absolute amount of foreign trade and the ratio of foreign trade to national income.
- Also because there is a huge discrepancy in the productivity of labour in underdeveloped countries between those catering for export and those catering for domestic.
- Export industries tend to be capital intensive and highly technologic. By comparison domestic industries (food, clothes) are very primitive and subsistence-like.
- Leads to a ‘dualistic economic structure’: high productivity in export sector coexisting with low productivity in domestic sector.
- Employment stats don’t show true lower importance of foreign trade -although the numbers employed in export are multiples of those employed in domestic, overall employment figures for underdeveloped countries tend to be lower than those for industrialised countries.
- Because there are large self-contained groups existing outside the monetary system in underdeveloped countries, foreign trade doesn’t affect such groups at all, thus reducing overall importance of foreign trade to such countries.


Does foreign trade increase the ‘wealth’ of underdeveloped countries?

- Initially it appears as though foreign trade would raise productivity, change economies towards monetary economies, spread knowledge, introduce capital-intensive methods of production and technology etc.
- However, most are companies located in underdeveloped countries are multinational corporations (MNCs) and therefore foreign owned, meaning that the benefits are often repatriated to the parent country. They never become a real part of the internal economic structure except in a geographical and physical sense. Thus the multiplier effects are negated here.
- Given the second multiplier effect – cumulative additions to income, employment, capital, technical knowledge, growth of external countries etc – foreign investment should actually be considered domestic investment on the part of industrialised countries.

Opportunity Costs of Specialisation:

- If we apply opportunity costs to the developing nations of having capital imported into them in order to make them providers of food and raw materials for industrialised countries, we see importation of such capital may have actually harmed the underdeveloped countries.
- This is because the underdeveloped countries become so specialised in specific areas (e.g. tea plantations in Ceylon, oil wells in Iran) that other domestic industries have failed to grow up. In this case, the theoretical question of what might have been arises - has the specialisation of industry outweighed the possible benefits of the domestic industry that might have appeared in its absence?
- Could it be that the export development has absorbed what little entrepreneurial initiative and domestic investment there was, and even tempted domestic savings abroad? (NOTE: such questions are purely speculative)

Why do UC seek Manufacturing Industry?

- Concept of ‘one thing leads to another’ – the most important contribution of an industry is not its immediate product, or it’s effects on other industries or social benefits but its effect on the general level of education, skill, way of live, inventiveness, habits, store of technology, creation of new demand etc.
- Manufacturing industries provide growing points for all the above social benefits in a way far superior than industries such as commerce, farming, plantation and agriculture have proved capable of.

Summarise position thus far:

- Specialisation of underdeveloped countries into food and raw materials as a result of investment from industrialised countries has had unfortunate outcomes for the former because:
o It removed the secondary and cumulative benefits of investment from the country in which the investment took place.
o Diverted the underdeveloped countries into activities offering less scope for additional benefits for the underdeveloped countries themselves.

Importance of Trade:

- Since the 1970’s, the trend of prices has been set against the sellers of food and raw materials and in favour of the sellers of manufactured articles. What is the meaning of these changing price relations?
o The idea that the changing price relations reflect increased costs of manufactured exports in relation to the costs of food and raw material exports can be dismissed.
o All indications point out that the productivity of food and raw materials has increased more slowly than that of manufactured goods, even in industrialised countries.
o Given that the standard of living has increased faster in these countries than in underdeveloped countries, this negates the argument that changing prices reflect relative trends in productivity.
- One possible explanation is that the fruits of technical progress may be distributed to either producers (in the form of rising incomes) or to consumers (in the form of lower prices). In relation to manufacturing the former occurs whilst in terms of food and raw materials the latter applies.
o If one considers foreign trade the position changes. The producers are at home whilst the consumers are abroad. Rising incomes of producers to the extent that they exceed increased productivity levels become a burden on the foreign consumer.
o They lose part or all of the potential fruits of technical progress in the form of lower prices.
o On the other hand where the fruits of technical progress have been passed on through lower prices the foreign consumer benefits alongside with the home consumer.

Other factors of falling prices:

- Technical progress has not the same effect on food and raw materials. In the case of food, demand is not very sensitive to increases in real income. In the case of raw materials, technical progress actually reduces the amount of raw materials required.
- This lack of an automatic multiplication in demand, coupled with low price elasticity of demand, results in large price falls.

NB: The industrialised countries have had the best of both worlds -are consumers of primary commodities and producers of manufactured articles. Underdeveloped countries have had the worst of both worlds - are consumers of manufactured articles and producers of raw materials.

Benefits of FT to Developed Countries:

- Build up of exports of manufactures, thus allowing them to transfer their population from low-productivity to high-productivity occupations
- Use of internal economies of expanded manufacturing industries
- Use of the general dynamic impulse radiating from industries in a progressive society
- Fruits of technical progress in primary production as the main consumers of primary commodities
- Contribution from foreign consumers of manufactured articles


Benefits of FT to UC:

- None of note!

Position in 1950:

- The traditional investment system broke down in 1929 and 1930.
- Industrialised countries tried to ‘get their money back’ (on top of the benefits received above) and this was seen as trying to demand double payment.
- World seemed to be under the impression that the trend towards deteriorating price relations for primary producers has been sharply reversed since pre-war days (the impression was at it’s strongest in 1948).
- But how accurate was this impression?
o US
§ Idea appeared primarily due to imports of primary commodities at higher prices into the US immediately post-war (e.g. sharp price increases were observed in commodities such as coffee).
§ Idea existed that foreign trade was simply an exchange of primary commodities for capital goods. However, capital goods required too much domestic investment in underdeveloped countries and therefore this exchange was not a fair one.
o Britain
§ Another reason is the deterioration in British terms of trade, exacerbated due to Britain’s importance in the network of world trade.
§ This deterioration brought about an increase in quantity exported, which led to price decreases and an increase in quantity imported, which led to price increases.
§ This can be seen as a reflection of the diminishing bargaining strength of Britain.
- Why price relations didn’t actually reverse
o Major portion of imports by UC were manufactured food and textile manufactures and manufactured consumer goods. Prices rose so heavily post-war that any advantage the UC had from favourable prices on primary commodities was wiped out.

Ambivalence of foreign trade price relations:

- Good prices for goods and a rise in quantities required gave underdeveloped countries the means to import capital goods and finance their own development. Yet, due to a lack of foresight, they see no incentive to do so while prices are so high for food, raw materials etc.
- Thus when a price decrease occurs, the desire for industrialisation sharpens. Yet the means of doing so are also reduced.
- Results in such countries “failing to industrialise in a boom because things are as good as they are, and failing to industrialise in a slump because things are as bad as they are”.

So does the argument hold up?

- If the view that foreign investment was only “foreign” in the geographical sense, can we conclude that it has failed in its primary function?
- We should take the opportunity here to consider third party countries as well
- Example: European investment was the instrument by which industrialisation was brought to North America.
- Due to the supplies flowing into Europe, were able to feed, clothe, educate and train large numbers of emigrants who the went overseas to US and Canada therefore passing on the benefits of trade to these countries

Suggested economic policies and measures:

- Purpose of foreign investment and trade should be redefined as producing gradual changes in structure of comparative advantages and endowment of the different countries
- Underdeveloped countries need to develop a method of income absorption to ensure the results of technical progress are retained within the country (in the same way they are in the industrial ones)
- Need reinvestment of profits in undeveloped countries through:
o Absorption of profits by fiscal measures so they are used for economic development
o Absorption of increasing productivity in primary production into rising real wages and other incomes and the increment used to increase domestic savings and market growth so domestic industries can be developed.

BUT – higher standards of wages and social welfare are not necessarily the solution to bad terms of trade unless increment leads to domestic savings and investment.

- If introduced prematurely and applied indiscriminately to export and domestic industries, can hinder economic development and undermine bargaining power of primary producers
- Must have absorption for reinvestment – absorption alone is not sufficient.

Overall Conclusion:

- The flow of international investment will only benefit underdeveloped countries if it is absorbed into their economic system and used to generate complementary domestic investment.





Additional Papers:

Paper 1
Cross-National Evidence of the Effects of Foreign Investment and Aid on Economic Growth and Inequality: A Survey of Findings and a Reanalysis Authors: Volker Bornschier; Christopher Chase-Dunn; Richard Rubinson
The American Journal of Sociology, Vol. 84, No. 3. (Nov., 1978), pp. 651-683

(1) The effect of direct foreign investment and foreign aid has been to increase economic inequality within countries. This effect holds for income inequality, land
inequality, and sectoral income inequality.

(2) Flows of direct foreign investment and foreign aid have had a short-term effect of increasing the relative rate of economic growth of countries.

(3) Stocks of direct foreign investment and foreign aid have had the cumulative effect of decreasing the relative rate of economic growth of countries. This effect is small in the short run (1-5 years) and gets larger in the long run (5-20 years).

(4)
This relationship, however, has been conditional on the level of development of countries. Foreign investment and aid have had negative effects in both richer and poorer developing countries, but the effect is stronger in the richer than in the poorer countries.

(5) These relationships hold independent of geographical area.

Paper 2
"Effects of Investment Dependence on Economic Growth: The Role of Internal Structural Characteristics." Mimeographed. Stanford, California: Stanford University, Department of Sociology. Authors: Gobalet, Jeanne G., and Larry J. Diamond. 1977.

It seems possible that the effects of foreign investment and aid on growth and inequality may be conditional on whether the world economy is in a period of relative expansion or contraction.

For example, they found some evidence that the negative effects of foreign investment on economic growth are significantly greater from 1965 to 1975 than from 1955 to 1965. Since the earlier period was one of worldwide economic expansion and the later period has been one of worldwide relative economic contraction, their study suggests that foreign investment may have more negative effects in periods of economic contraction.

Glossary of Terms

- Underdeveloped Country
A nation which, comparative to others, lacks industrialisation, infrastructure, developed agriculture and developed natural resources and suffers from a low per capita income as a result.

- Developed Country
Used to categorised countries with developed economies with a high per capita/GDP. Examples include, North America, Australia, and Western Europe.

- International Trade
Exchange of goods and services across international borders.

Chapter 4: Government Money with Portfolio Choice

• Introduction
  
  Model PC (Portfolio Choice) introduces government bills, interest payments and the central bank into model SIM.
  Households may now hold money or bills.
  Money+Bills = Private Debt
  Net Worth of Households = Net Worth of Private Sector
  Counterpart to Private Sector: Public Debt
  Public Debt = Outstanding Bills issued to Households and the Central Bank by Government
  Assets of Central Bank: Government Bills. Liabilities: Money provided to households.
  The current account of the central bank describes the inflows and outflows from current operations. The capital account describes any changes in the central bank’s balance sheet.
  
  Equation of model PC
  
  The main assumption in Model PC is that producers sell whatever is demanded.
  -Production = consumption + government expenditure.
  -Disposable income increased by interest on government debt.
  -Taxable income increases with interest payments on bills held by households.
  
  Portfolio Decision
  The household sector makes decisions in two stages. Firstly, households decide how much to save and then how to allocate their wealth. The difference between disposable income and consumption is equals the change in total wealth and the new consumption function now contains total wealth.
  
  Households hold some of their wealth in the form of bills and some in the form of money. The proportion held in the form of bills is negatively related to the interest rate and positively related to the level of disposable income. The interest rate must equalize the supply and demand for bills. Holdings of money are the difference between total household wealth and their demand for bills
  
  The Endogeneity of the Money Supply
  
  The government budget constraint represents total government expenses less government revenues. The capital account of the central bank states that additions to the stock of high powered money equal the additions in the demand for bills. The central bank purchases the bills issued by government that households are not willing to hold given the interest rate (residual purchaser).
  
  Expectations
  
  If realized disposable income is greater than expected, the additional disposable income will be saved in the form of cash money balances. Money balances provide flexibility in a monetary system of production and act as a buffer to absorb unexpected cash flows. Households invest in bills on the basis of the expectations they make in relation to their disposable income at the start of the period.
  
  The Steady State Solution
  
  In Model PC, the interest rate plays a greater role. Higher interest rates induce households to hold more interest paying bills. This decrease in the liquidity preference of households leads to an increase in national income as the issuance of more bills means government debt has increased. Therefore, higher interest rates generate higher economic activity. This contradicts previous economic thought that high interest rates stunt economic growth.
  
  Results
  
  An increase in the permanent level of government spending increases the stationary level of income and disposable income; dY*/dG >0. Any permanent decrease in the overall tax rate Q has the same effect; dY*/dQ <0.>0 where a3 = (1-a1)/ a2. Thus if households decide to save larger amounts of both their current income and past wealth than what is consumed then the level of steady state income will be higher.
  
  These results contradict a ‘paradox of thrift’ that has been put forth by Keynesians for years. Keynesians stated that higher saving levels lead to higher stationary levels of income because households were seeking a higher overall wealth target for a given income. However, this implies higher interest payments on government debt and thus a higher steady state income has been achieved.
  
  
  Graphical Analysis
  
  The effect of an increase in the propensity to consume out of disposable income is that GDP increases in the short run but decreases in the long run leading to a lower steady state.
  
  The behaviour of national income can be explained as follows. As households increase consumption out of current income there is an initial increase in national income due to an increase in aggregate demand. However, savings decrease, depleting the stock of wealth. This eventually overtakes the positives of higher levels of consumption out of current income. Wealth and consumption drop until national income reaches a new lower steady state level.
  As households are spending more government tax revenues increase and the government goes into a surplus allowing them to pay off some of their debt.
  
  Figure 4.7 shows the effect of an increase in the rate of interest set by the central bank. Any increase in the rate of interest or the tendency to consume leads to a temporary increase in disposable and national incomes. The target level of wealth also increases, suggesting an increase in savings and demand for bills by households. In the next period, consumption and income rises leading to a higher steady state.
  
  Figure 4.8 shows the effect of a decrease in the tendency to consume. Here, the target wealth to income ratio would rise. There would be an initial fall in national income but there would also be a discrepancy between current wealth and target levels of wealth, enticing households to purchase bills.
  
  The Puzzling Impact of Interest Rates Reconsidered
  
  Here we assume the MPC is not constant, and assumes a value which depends negatively on the interest rate on bills. The initial impact of the increased interest rate on the economic activity is negative, causing a fall in consumption, disposable income and national income.
  
  A reduction in the MPC increases the target wealth to income ratio, leading to an increase in the stock of wealth. If households’ wealth keeps increasing consumption demand is lower than disposable income.
  
  There is also an increase in government debt. The short term recession caused by the negative impact of the higher interest rates forces government tax revenues down. This negative effect is reinforced by an overall increase in government expenditures as a result of the higher cost of servicing their debt. The total effect is a government deficit. This shrinks as government expenditures and taxes continue to increase up to stationary level. Here the government budget is balanced, and eventually the deficit flow is wiped out by rising consumption expenditures.
  
  
  A Government Target for the Debt to Income Ratio
  
  Relative amount of Public Debt = V/Y (Wealth of Households/GDP)
  The steady-state wealth to disposable income ratio is determined by the behavior of households, which equals the α3 ratio. Governments can do nothing to alter the debt to disposable income ratio. Government and credit rating agencies are more concerned with public debt as a ratio of GDP, which is easier to modify. If households are targeting too high a wealth ratio, the government can reduce its stationary debt to GDP ratio. If government wishes to decrease this, they need to increase tax rates or reduce interest rates, resulting in a reduced level of stationary income. Thus, the debt to income ratio must be disregarded to sustain full employment income.
  

Summary of Godley Chapter 3

SUMMARY OF GODLEY CHAPTER 3: THE SIMPLEST MODEL WITH GOVERNMENT MONEY:

The Model SIM is based on the following assumptions:

• The only money in the economy is government money (represented in the model by H) i.e. that issued by central banks.
• The economy is closed i.e. no imports, exports or foreign capital flows.
• No inventories, capital equipment or profits – it is a pure labour economy.
• Production is demand-led - whatever is demanded will be produced.

It is introduced using a balance sheet matrix describing each sector’s financial assets and liabilities. These are inter-related i.e. what is a financial asset (represented by a +) for one sector is a financial liability (represented by a -) for another. All rows and columns in the matrix therefore sum to zero. There are three columns – households, production and government – and six rows – consumption, government expenditure, output, factor income (wages), taxes and changes in money stocks. Eleven equations then complete Model SIM:

• The first four equate supply and demand for consumption (Cs=Cd), government expenditure (Gs=Gd), taxes (Ts=Td) and employment (Ns=Nd) in line with earlier assumptions that whatever is demanded will be supplied within the period.
• Disposable income is defined as the wage bill earned minus taxes paid – YD=W.Ns–Ts.
• Tax paid is defined as Td=θxW.Ns, where θ is the tax rate imposed by government.
• Consumption function is defined as Cd=α1YD+α2Hh-1. Hh-1 represents stocks of money inherited from previous periods - α1 and α2 represent respectively the portion of disposable income and accumulated wealth spent on consumption.
• The budget constraint of the government is defined as ΔHs=Hs–Hs-1=Gd–Td and of households as ΔHh=Hh–Hh-1=YD–Cd. As there is no investment or saving in the model, overall saving must be zero and these terms must be equal.
• The determination of output and the determination of employment is described by the national income identity – Y=Cs+Gs (or from point of view of income as Y=W.Nd)

The evolution of such models is usually described by the standard Keynesian multiplier process i.e. that injections into the economy have ripple effects through all sectors. However, this view lacks coherence here because such a process is modelled on the short run equilibrium, therefore isn’t considered a steady state. Our model here is based on a steady state. This is one where key variables remain in a constant relationship to each other, including both flows and stocks (not flows only as seen with short run equilibria).

The Model SIM also omits growth, holding all other levels in the state constant, i.e. is a stationary steady state. In such state:

• There is no change in the stock of money
• Government expenditure must equal tax receipts and therefore there is neither a government surplus nor deficit.
• Consumption must be equal to disposable income.
• Household saving converges to zero.

When the consumption function was first presented, it was viewed as a decision based on flows of income and stocks of wealth. However, it can also be viewed in terms of a wealth accumulation function i.e. households will save at a certain rate so they can accrue a target portion of wealth. When this target wealth is higher than actual wealth, households reduce consumption.

Model SIM was based on the assumption consumers have perfect foresight as to their income but we now introduce uncertainty thus substituting actual income for expected income. This assumes households estimate the income they will receive and base consumption over the current period on this. Money stocks that will be held at the end of the period are also estimated. As the level of consumption has already been decided upon, any additional income received will be saved to cash balances.

The inclusion of uncertainty yields a more recursive picture of system and allows us to define model SIMEX. Here, as periods succeed periods, people amend their consumption decisions as they find their wealth stocks unexpectedly excessive or depleted, and as expectations about future income get revised.

The graphical representation of Model SIM seeks to determine the level of production compatible with aggregate demand, given consumption and fiscal policy constraints. From the graph we can see that the accumulated wealth of households increases due to saving causing consumption demand in the next period to increase and the aggregate demand curve to shift upward. Total income and disposable income also increase. This allows the economy to move towards the steady state. This is seen in the second quadrant of the graph. Here, the target level of wealth and actual wealth are equal and there is no need to save.

In conclusion, we now know how money enters and leaves the system. It is the way that people receive income, settle debts pay taxes and store wealth. Thus money is an asset which always has a corresponding liability and each time period is linked to the previous one.

MPC Calculation

Marginal Propensity to Consume Calculation


Injections and Withdrawals

The first part of the calculation was to determine the size of the injections and withdrawals in the economy. The injection figures came from the random number generator in the Excel program. According to the Circular Flow of Income, in a closed economy, injections always equal withdrawals. Therefore, the withdrawals equal the injections.


Aggregate Expenditure

According to Keynesian macroeconomics, aggregate expenditure is the sum of income, consumption and injections, less withdrawals. This was the method used to calculate this variable. The formula is shown below:
E= (Y+CD+J) – W


MPC Calculation

The Marginal Propensity to Consume (MPC) is defined as the proportion of every extra unit of income received that is spent on consumption. It is calculated by dividing the change in consumption from one year to the next by the change in income.

MPC = dC Change in Consumption
dY Change in Income

In Excel, the MPC was calculated as 0.73, meaning that €0.73 of every extra €1 received is spent on consumption.


Equilibrium Level of Income

At equilibrium, income and aggregate expenditure are equal. Therefore, in order to find this level of income, one adjusts the withdrawals figure until income equals aggregate expenditure.

Week 5: Problem 4

Week 5: Problem 4

Q1

1.1: Why must the Vertical Columns sum to zero?

The change in the amount of money held by the sector must equal the difference between receipts and the payments made by the different sectors, i.e. the households and the Government.

1.2: Why must the Horizontal Rows sum to zero?

Each component of the matrix must have an equivalent component elsewhere in the matrix, in line with the Circular Flow of Income theory.

Q2

2. Production: Cs and Gs both represent sources of revenues i.e. the income that is collected by the production sector. They represent the sales of consumption and government services in the economy. The sum of these two figures (i.e. total production – [Y]) defines the national income identity and appears in brackets as it doesn’t represent a transaction between sectors. The production sector then supplies the household sector and the government with services and demands a certain volume of employment (Nd) at a given wage rate (W). This figure appears as a negative here as it is seen as a cost for the sector.

3. Government: Here, Gd represents the purchase of government services and therefore appears as a negative figure as it represents a cash outflow. Taxes are levied by the government as some proportion of household and production income – Td. Td represents a source of revenue for the sector and therefore appears as a positive figure. Hs represents the change in the stock of money issued by the government. Hs is given by the difference between government receipts and outlays during the period. As the change in Hs (ΔHs) is said to be equal to Gd-Td, the column therefore sums to zero.

Q1. Week 4

Recorder: Ailbhe Bruen
Reporter: Joan Doherty


Wages:

Broadly speaking they are a kind of return to labour. Specifically, income to a person in current employment, or expenditure by businesses to their employees, varies depending on hours worked, qualifications of the individual etc.

Wages = Unit of labour * hours worked * productivity

(Income, Expenditure)


Consumption:

Expenditure by private individuals on goods and services. Income for the provider of the good or service.

(Expenditure, Income)


Rent:

Income paid to the owner of an asset in exchange for use of the asset for a specified period of time. It is expenditure by the person paying the rent, but income for the person receiving it.

(Income, Expenditure)


Government Expenditure:

Money paid out by the government to finance the day to day running of the country.

C + I + G = Y

I= purchase of public goods such as roads, universities, transport etc.
C= consumption as defined above.
G= government expenditure as defined above

(Expenditure)


Manufacturing Output:

The end product of industrial activity, to meet aggregate demand.

(Output)


Interest Payments:

Are the costs of acquiring capital by private individuals or businesses. It can also be a source of income through interest on deposits.

Financial institutions view interest as income both on loans and deposits. However, it is also expenditure for the financial institutions as they must pay out interest to individuals on their private savings.

Interest can be considered output; the output of an economy is a sum of the money made by all the individuals in the economy.

(Income, Expenditure, Output)


Loans:

A sum of money borrowed from financial institutions in order to finance economic activities of individuals and businesses, based on agreed lending terms.

Can also be considered a stock, i.e. a stock of cash (when not being used, known as reserves or deposits, reserves are the legally required levels of money that banks must hold). It can be turned into an asset class to be made available for lending out.

(Income, Expenditure, Output)

[Borrowing should only be used to finance future (not current) expenditure]


Bank Deposits:

Money held by banks on behalf of businesses and private individuals, on which interest is paid.

Liability for the bank because the bank must pay them back.

(Income, Expenditure)




Bonds:

Debt instruments issued, usually for a period of longer than a year, as a method of raising external finance. Governments, cities, corporations and many other institutions sell bonds. The bond holder receives payments known as coupons throughout the maturity of the bond, and at maturity the Issuer repays the principal amount .

(Income, Expenditure)


Equities:

Shares of ownership issued by an institution, in the form of preferred stock or common stock.

(Income, Expenditure)


Money Balances:

Balances of money, consumers and firms actually hold at a given moment. It represents the wealth in the form of readily available purchasing power.

(Income)





Class Questions:

Recorder: Catherine Davis

Q1: What is growth rate?

Rate of change in economic activity from one year to the next. (Using a base period)


Q2: Name 2 measures of Economic Performance

GDP – Gross Domestic Product – Value of all final goods produced in an economy
Employment – The more people employed the more an economy can produce
Others include; inflation, trade surplus, GNP etc

Q3: Describe the GDP Deflator

Strips out the influence of price changes over a price index. Allows for continuous assessment and comparability.


Q4: Define Inflation

Rate of change in the consumer price index (bundle of goods)

Note: What are the side effects of inflation? Harms people on fixed incomes, harms the value of equity

Q5: Name 2 leakages from the circular flow

Savings
Imports

Q6: How do we measure unemployment?

The amount of people actively seeking work but unable to find it and divide by the working population.

summary chapter 7

Chapter 7

Saving and Investment have previously been defined as merely different aspects of the same thing.

Saving is the excess of income over consumption spending. Investment, generally, means the purchase of a capital asset, of any kind, using the income of an individual or a corporation. Investment includes the increment of capital equipment, whether it consists of fixed capital, working capital or liquid capital. In terms of liquid capital, Keynes prefers to emphasise the total change of effective demand rather than part of the change. Moreover, in the case of fixed capital, the change of unused capacity is in accordance with the change of unsold stocks in its effect on producing decisions. It is concluded by the Austrian School of Economics, that capital formation and capital consumption are not identical. The former occurs when there is a lengthening of the period of production, whereas the latter occurs where there is no net decrease in capital equipment.

Keynes recognised the divergence between saving and investment as the excess of normal profit over consumption, meaning that the Entrepreneur’s output is an earning less than normal profit from his ownership of the capital equipment. Employment, as a kind of working capital, is of fixed volume as the Entrepreneur tries to maximise profits. This volume then depends on aggregate demand.

Keynes believes that an expectation of increases in the excess of investment over saving, as a way of handling profit changes, will encourage the Entrepreneur to introduce increases in the volume of output and employment. Therefore, an expected change of investment relative to saving is defined as being a criterion for an effective demand. In addition, it is said by Mr. Roberston that saving can exceed investment. When the income is falling, the excess of saving is exactly equal to the decline of income. Current expectations depend on yesterday’s realised results; whereas today’s effective demand would be equal to yesterday’s income. Such a hypothesis is vital for causal analysis between effective demand and income.

It is evident that a change in the volume of output and employment will cause a change in income. Meanwhile, changes in the quantity of money may result in a change in the volume and distribution of income, through their effect on the interest rate, perhaps leading to saving. Any increase in employment is said to involve some sacrifice of real income, however attempts to quantify are not likely to be successful.

Saving and investment can differ from one another. The banking system allows the savings of one individual to become available as investment for another. Bank-credit then allows investment to take place where “no genuine saving” corresponds. The public will exercise “a free choice” where they divide their increase of income between saving and consumption, so it is impossible the rate investment can increase faster than the rate of saving.

Although the old-fashioned view that saving always involves investment is sounder, its inference that individual saving will increase his/her aggregate investment by an equal amount is plausible and unrecognized. The reason is that increased aggregate wealth caused by individual saving might fail to allow for the possibility that an act of individual saving may react on someone else’s savings and hence on someone else’s wealth. The reconciliation between saving and investment is a two-sided affair, which the amount of money people choose to hold is not independent of their incomes or of the prices of the things, the purchase of which is the natural alternative to holding money; individual balances add up to be exactly equal to the amount of cash which the banking system has created. That is the fundamental of monetary theory.

summary chapter 6

Chapter 6

INCOME

The income generated by an entrepreneur can be given by A+G-A1 where A is the output for the period and A1 is the purchases for the period. G then is the value of capital equipment and finished stocks at the end of the period. Confusion arises over the value of G as some is derived from equipment held from previous periods. Once this can be deduced a clear definition of income arises.

There are two methods of deriving G, the production method and the consumption method. During the period the value of G is affected by maintenance and improvements carried out by the entrepreneur and by depreciation as a result of producing output.

The production method takes maintenance and improvement (B’) into account, by subtracting it from G, giving maximum net value (G’). Under the production method income is defined as the excess of the value of finished output sold during the period over prime cost. Prime cost is the sum of user cost (U) and factor costs (F). U is the maximum net value minus the excess potential value of equipment over G – A1 of what has been sacrificed to produce A. Factor costs are what the entrepreneurs pays other factors of production for their services.

The consumption method takes into account the involuntary loss (or gain) in the value of his capital equipment. Some of these losses are involuntary but not unexpected and are known as supplementary costs (V). Aggregate net income is then equal to A – U – V. Supplementary costs are those deductions from income which a typical entrepreneur makes before reckoning what he considers to be his income. Supplementary costs are important as they affect everyone’s consumption not just entrepreneurs. Unforeseen changes are known as windfall losses; however these losses have a less fundamental effect and are therefore less significant.

Income can then be defined as the excess value of finished output sold during the period over his prime cost. This definition of income is similar to that of Marshall’s. However, Professor Hayek suggested that it is a mistake to put all the emphasis on net income which only refers to consumption aspects as opposed to income proper which includes production issues.


SAVING AND INVESTMENT
Saving is said to equal excess income over consumption and therefore doubts about the definition of saving must arise from doubts about the meaning of these two terms. Income is already defined. Consumption is simply the value of goods sold to consumers, but who is a consumer? Is there a difference between a consumer-purchaser and an investor-purchaser? We need to draw the line between consumers and entrepreneurs and defining A1 (i.e. what one entrepreneur buys from another) allows us to do this. As consumption is defined as A-A1 and income as A-U, it follows that saving is equal to A1-U and net saving (i.e. net income minus consumption) to A1-U-V.
Investment refers additions to the value of capital equipment resulting from activity during the period i.e. the part of income that hasn’t yet been consumed and therefore equal to what has previously been defined as saving. Net investment is therefore equal to A1-U-V. While saving results from consumer behaviour and investment from entrepreneurial behaviour, both are equal to excess income over consumption and therefore to each other. Equivalence arises from the bilateral character of transactions between producers and consumers i.e. aggregate amount individuals decide to save is equal to aggregate amount individuals invest and occurs because psychological habits allow the market to settle at an equilibrium level where readiness to buy equals readiness to sell.

team members

Ailbhe Bruen 0249106
yang liu 0625329
Joan Doherty 0603147
Catherine Davis 0224235
Ciara Ni Guriallais 0616664
wang lei 0381756