When we include earnings from overseas investments, we can define gross national disposable income GNDY as:. National savings in the amount of income remaining after deducting consumption and government expenditure. Hence g ross national saving S can be written as:. Thus, in an open economy, when the Australian economy saves a dollar, it can invest in domestic capital I or foreign capital NFI.
It does not have to invest only in domestic capital I. In summary, if a country runs a trade surplus, net exports NX are positive, domestic saving is greater than domestic investment and net foreign investment NFI is positive.
If a country runs a trade deficit, net exports NX are negative, domestic saving is less than domestic investment and net foreign investment NFI is negative. If a country has balanced trade, net exports NX are zero, domestic saving is equal to domestic investment and net foreign investment NFI is zero. The nominal exchange rate is the rate at which people can trade one currency for another currency. An exchange rate between dollars and any foreign currency can be expressed in two ways: foreign currency per dollar; or dollars per unit of foreign currency.
For example, if 80 yen are equal to 1 dollar, the nominal exchange rate is 80 yen per dollar or. Here we will always express exchange rates as foreign currency per dollar. When the dollar buys more foreign currency, there has been an appreciation of the dollar. When the dollar buys less foreign currency, there has been a depreciation of the dollar. Because there are so many currencies in the world, the dollar exchange rate is often expressed by an exchange rate index that compares a group of currencies to the dollar.
The real exchange rate is the rate at which people can trade the goods and services of one country for the goods and services of another. Two things are considered when we directly compare the value of goods in one country to those in another: the relative values of the currencies nominal exchange rate ; and the relative prices of the goods to be traded.
The real exchange rate is defined as:. Just as the nominal exchange rate is expressed as units of foreign currency per unit of domestic currency, the real exchange rate is expressed as units of foreign goods per unit of domestic goods.
The real exchange rate of Mexican beer to Australian beer is:. Since macroeconomists are concerned with the economy as a whole, they are concerned with overall prices rather than individual prices. Therefore, instead of using the price of beer to compute the real exchange rate, macroeconomists use each country's price index:. In this case, goods are traded for goods and at the end of the term, the trade balance is equal.
When countries import less than they export or import more than they export, the situation becomes significantly more complicated. Now let's examine the case when a country imports more than it exports. If Country A exports 0. In this case, Country A owes Country B money for the imported bananas beyond the 0. If this is a short-term debt, nothing of consequence would occur since Country A has the ability to export more coconuts quickly to make up for the difference.
If the debt is long term, however, Country A must somehow repay Country B for the imported bananas. Governments spend money on equipment, infrastructure, and payroll. This may occur in the wake of a recession, for example. Investment refers to private domestic investment or capital expenditures.
Businesses spend money to invest in their business activities. For example, a business may buy machinery. Business investment is a critical component of GDP since it increases the productive capacity of an economy and boosts employment levels. All expenditures by companies located in a given country, even if they are foreign companies, are included in this calculation. The production approach is essentially the reverse of the expenditure approach.
Instead of measuring the input costs that contribute to economic activity, the production approach estimates the total value of economic output and deducts the cost of intermediate goods that are consumed in the process like those of materials and services. Whereas the expenditure approach projects forward from costs, the production approach looks backward from the vantage point of a state of completed economic activity.
The income approach represents a kind of middle ground between the two other approaches to calculating GDP. The income approach calculates the income earned by all the factors of production in an economy, including the wages paid to labor, the rent earned by land, the return on capital in the form of interest, and corporate profits.
The income approach factors in some adjustments for those items that are not considered payments made to factors of production. For one, there are some taxes—such as sales taxes and property taxes —that are classified as indirect business taxes. In addition, depreciation —a reserve that businesses set aside to account for the replacement of equipment that tends to wear down with use—is also added to the national income. Although GDP is a widely used metric, there are other ways of measuring the economic growth of a country.
While GDP measures the economic activity within the physical borders of a country whether the producers are native to that country or foreign-owned entities , gross national product GNP is a measurement of the overall production of people or corporations native to a country, including those based abroad. GNP excludes domestic production by foreigners.
Gross national income GNI is another measure of economic growth. It is the sum of all income earned by citizens or nationals of a country regardless of whether the underlying economic activity takes place domestically or abroad.
With GNI, the income of a country is calculated as its domestic income, plus its indirect business taxes and depreciation as well as its net foreign factor income. The figure for net foreign factor income is calculated by subtracting all payments made to foreign companies and individuals from all payments made to domestic businesses. In an increasingly global economy, GNI has been put forward as a potentially better metric for overall economic health than GDP.
Because certain countries have most of their income withdrawn abroad by foreign corporations and individuals, their GDP figure is much higher than the figure that represents their GNI. On the contrary, in the U. In , U. Part of the reason for this is that population size and cost of living are not consistent around the world.
For example, comparing the nominal GDP of China to the nominal GDP of Ireland would not provide much meaningful information about the realities of living in those countries because China has approximately times the population of Ireland. To help solve this problem, statisticians sometimes compare GDP per capita between countries. Even so, the measure is still imperfect.
Purchasing power parity PPP attempts to solve this problem by comparing how many goods and services an exchange-rate-adjusted unit of money can purchase in different countries—comparing the price of an item, or basket of items, in two countries after adjusting for the exchange rate between the two, in effect. Real per-capita GDP, adjusted for purchasing power parity, is a heavily refined statistic to measure true income, which is an important element of well-being.
In nominal terms, the worker in Ireland is better off. Most nations release GDP data every month and quarter. The BEA releases are exhaustive and contain a wealth of detail, enabling economists and investors to obtain information and insights on various aspects of the economy.
However, GDP data can have an impact on markets if the actual numbers differ considerably from expectations. Because GDP provides a direct indication of the health and growth of the economy, businesses can use GDP as a guide to their business strategy. Government entities, such as the Fed in the U. If the growth rate is slowing, they might implement an expansionary monetary policy to try to boost the economy. If the growth rate is robust, they might use monetary policy to slow things down to try to ward off inflation.
Real GDP is the indicator that says the most about the health of the economy. It is widely followed and discussed by economists, analysts, investors, and policy-makers. The advance release of the latest data will almost always move markets, although that impact can be limited, as noted above. Investors watch GDP since it provides a framework for decision-making.
Comparing the GDP growth rates of different countries can play a part in asset allocation, aiding decisions about whether to invest in fast-growing economies abroad—and if so, which ones.
One interesting metric that investors can use to get some sense of the valuation of an equity market is the ratio of total market capitalization to GDP , expressed as a percentage.
Aggregate Expenditure — Equilibrium : In this graph, equilibrium is reached when the total demand AD equals the total amount of output Y. The equilibrium point is where the blue line intersects with the black line. This idea stems from the belief that wages, prices, and interest rage were all flexible. Classical economics states that the factor payments wage and rental payments made during the production process create enough income in the economy to create a demand for the products that were produced.
Classical Aggregate Expenditure : This graph shows the classical aggregate expenditure where C is consumption expenditure and I is aggregate investment. The aggregate expenditure equals the aggregate consumption plus planned investment. Classical economics assumes that the economy works on a full-employment equilibrium, which is not always true.
In reality, many economists argue that the economy operates at an under-employment equilibrium. An economy is said to be at equilibrium when the aggregate expenditure is equal to the aggregate supply production in the economy. Demonstrate how aggregate demand and aggregate supply determine output and price level by using the AD-AS model. In economics, the aggregate supply AS is the total supply of goods and services that firms in an economy produce during a specific time period.
It represents the total amount of goods and services that firms are willing to sell at a given price level. The aggregate supply curve is graphed as a backwards L-shape in the short-run and vertical in the long-run. Aggregate demand AD is the total demand for final goods and services in the economy at a given time and price level. It shows the amounts of goods and services that will be purchased at all the possible price levels.
When aggregate demand increases its graph shifts to the right. It shifts to the left when it decreases which shows a fall in output and prices. The aggregate supply and aggregate demand determine the output and price for goods and services. The AD-AS model is used to graph the aggregate expenditure and the point of equilibrium. The model is used to show how increases in aggregate demand leads to increases in prices inflation and in output.
The aggregate expenditure equals the sum of the household consumption C , investments I , government spending G , and net exports NX. The AD-AS model is used to graph the aggregate expenditure at the point of equilibrium.
The AD-AS model includes price changes.
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