Chapter 14
Answers to Questions in Chapter 14
Note: No. before Ø indicates a page number
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322 Ø Would this argument still hold if prices rose?
Money incomes would remain unchanged, but fewer goods could be purchased with it. Thus real incomes and output would fall. To keep output and real incomes the same (given that prices were rising), then either money would have to circulate faster, or extra money would have to be injected into the flow.
324 Ø Are the following net injections, net withdrawals or neither? If there is uncertainty, explain your assumptions.
(a) Firms are forced to take a cut in profits in order to give a pay rise.
(b) Firms spend money on research.
(c) The government increases unemployment benefits.
(d) The general public invests more money in credit unions.
(e) Australian investors earn higher dividends on overseas investments.
(f) The government purchases US military aircraft.
(g) People draw on their savings to finance holidays overseas.
(h) People draw on their savings to finance holidays in Australia.
(i) The government runs a budget deficit (spends more than it receives in tax revenues) and finances it by borrowing from the general public.
(j) The government runs a budget deficit and finances it by printing more money.
(a) Neither, there is merely a redistribution of factor payments on the left-hand side of the inner flow. (The only exception to this would be if a smaller proportion of wages were saved than of profits. In this case there would be a net reduction in withdrawals.)
(b) Increase in injections (investment).
(c) Decrease in withdrawals (net taxes).
(d) Increase in withdrawals (saving). Note that `investing' in credit unions is really savings not investment.
(e) Fall in withdrawals (a reduction in net outflow abroad from the household sector).
(f) Neither. The inner flow is unaffected. If, however, this were financed from higher taxes, it would result in an increase in withdrawals.
(g) Neither. The inner flow is unaffected. The consumption of domestically produced goods and services remains the same.
(h) Decrease in withdrawals (saving).
(i) Neither. An increase in government expenditure (or decrease in taxes, or both) is offset by an increase in saving (i.e. people buying government securities).
(j) Net injections. An increase in government expenditure (or decrease in taxes, or both) is not offset by changes elsewhere. Extra money is printed to finance the net injection.
323 Ø What effect will there be on the four objectives of an initial excess of withdrawals over injections?
If withdrawals exceed injections, national income will fall. Other things being equal, this will have the following effects on the four objectives:
• Growth will be negative.
• Unemployment will rise.
• Inflation will fall.
• The current account of the balance of payments will tend to `improve'. The deficit will be reduced, or eliminated, or be transformed into a surplus. If it was already in surplus, the surplus would increase.
327 Ø (Box 14.1) The following table shows Australian nominal GDP for the years 1990/91, 1992/93, 1994/95 and 1999/2000. It also shows the GDP deflator with 1989/90 = 100. Work out the real GDP for each year at 1989/90 prices. How much did real GDP grow between 1990/91 and 1992/93, between 1992/93 and 1994/95, and between 1994/95 and 1999/2000?
1990/91 / 1992/93 / 1994/95 / 1999/2000Nominal GDP ($bn at current prices) / 361.1 / 391.4 / 441.7 / 632.0
GDP deflator (1989/90=100) / 103.1 / 106.4 / 109.2 / 116.2
1990/91 Real GDP at 1989/90 prices =
= 350.2
1992/93 “ =
= 367.9
1994/95 “ =
=404.5
1999/2000 “ =
Growth of real GDP: 1990/91 and 1992/93 = 11.8%
1992/93 and 1994/95 = 9.9%
1994/95 and 1999/2000 = 5.8%
(note these are not annual rates of growth)
328 Ø By what would we need to divide GDP in order to get a measure of labour productivity per hour?
The total number of hours worked in the year throughout the country.
329 Ø Name some external benefits that are not included in GNP statistics?
Three examples are: the pleasure people get from seeing other people's attractive houses and gardens, aesthetically pleasing architecture, improved health from a better diet.
329 Ø (Box 14.2) 1. Is the size of the underground economy likely to increase or decrease as the level of unemployment rises?
It could rise or fall depending on which of two effects is the larger. On the one hand, if a certain proportion of unemployed people claim benefit and work in the underground economy, then, with a higher official level of unemployed, the size of the underground economy is likely to be bigger. On the other hand, if the economy is in recession, it is likely that the size of the underground economy will shrink along with the rest of the economy.
329 Ø (Box 14.2) 2. If the amount of cash used in the economy falls, does this mean that the size of the underground economy must have fallen?
No. It could mean that the amount of cash used in the remainder of the economy has fallen, for example, with increased use of credit cards or debit cards).
332 Ø (Box 14.3) 1. Is a constrained optimisation approach a practical solution to the possible costs of economic growth?
Yes. But there still remains the question of what level of constraints should be applied. For example, does the government apply rigorous environmental standards or more lax ones?
332 Ø (Box 14.3) 2. Are worries about the consequences of economic growth a `luxury' that only rich countries can afford?
This is a very cynical way of looking at the issue. The point is that the marginal benefit of increased output in a poor country is likely to be much higher than in a rich country (given the diminishing marginal utility of income). This does not mean that the cost should be ignored.
333 Ø If the average percentage (as opposed to the average level) of potential output that was unutilised remained constant, would the trend line have the same slope as the potential output line?
No, the two lines would diverge, that is get further and further apart. As ‘national output’ rises the absolute value of, for example, 5% of national output will increase.
335 Ø 1. At what phases of the business cycle do points w, x and y occur in Figure 14.5?
w: phase 4, the recession.
x: phase 1, the upturn (growth is becoming positive again)
y: phase 3, the boom (growth is at its most rapid).
335 Ø 2. How long was the average duration of the cycle from peak to peak between 1970 and 2000?
Approximately 6 years. Note, however, the sustained period of growth since the early 1990s.
336 Ø For what reasons might the productivity of land increase over time?
Because of the increase in quantity and quality of complementary factors. Thus a hectare of land yields more agricultural output today than 100 years ago because of the increased mechanisation of agriculture and the increased amount of chemicals used.
336 Ø (Box 14.4) Make out a case against using ISEW.. How would an advocate of the use of ISEW reply to your points?
There are three major criticisms of ISEW.
The first concerns its use as a substitute for GDP. GDP is not meant to be a true measure of living standards, both now and sustainable into the future. Instead it is primarily a measure of output that involves exchange, an important measure when attempting to understand the relationship between aggregate demand (as expressed through exchange relationships) and aggregate supply.
The second criticism concerns the selection of items that should be included. Any list could be criticised for including too many or too few items. For example, it could be argued that various forms of public expenditure should be included (other than on health and education, which are already included). On the other hand, various forms of ‘services of household labour’ are not clearly production. They could be seen as a form of consumption. For example, does time spent gardening constitute work or pleasure? We would not include watching television or sitting relaxing as production, so should we include gardening or any other hobbies as production which generates pleasure when consumed or merely as pure consumption? Similarly, do relationships between people constitute the ‘provision of services’ or is it rather mere joint consumption?
The third and perhaps the most serious criticism concerns measurement. How, for example, should the depletion, of non-renewable resources or long-term environmental damage be measured? Such measurement entails various value judgements about the relationship between present and future costs. In fact, the value placed on all non-marked items is likely to be highly controversial (more so than marketed items, where corrections for market distortions could relatively easily be made).
An advocate of ISEW would reply that ISEW, as its name says, is meant to be a measure of sustainable economic welfare, and not a measure of marketed output and is thus doing something (different from the conventional use of GDP. If GDP is used, not for its original purpose, but as a measure of welfare, then ISEW is superior. As far as the selection of items and their measurement is concerned, there will inevitably be disagreement, because people have different values. But here the advocate of ISEW would reply with the last two sentences of the box.
340 Ø If a retailer buys a product from a wholesaler for $80 and sells it to a consumer for $100, then the $20 of value that has been added will go partly in wages, partly in rent and partly in profits. Thus $20 of income has been generated at the retail stage. But the good actually contributes a total of $100 to GDP. Where then is the remaining $80 worth of income recorded?
At the wholesale stage and earlier. Each stage adds value - value that is partly in wages, partly in rent, etc. When the values added at all the stages are summed, this gives the final value of the good.
342 Ø Should the sale of houses that are not new be included in the GDP statistics?
No. Because it has not involved production. It is merely the transfer of an asset from one person to another. The only exception to this is old houses that have been improved. Strictly speaking, the value of the improvements, if they have not already been counted in a previous year's GDP, should be included
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