2015, Study Session # 5, Reading # 17

“AGGREGATE OUTPUT, PRICE AND ECONOMIC GROWTH”

Los 17.a

GDP = ∑ MV (final goods & services) produced

during a period within the country.

Approach to GDP

Expenditure Approach:
Income Approach:

GDP = ∑ expenditure (cost) on goods & GDP = ∑ income earned by households
services produced in the country within & businesses in the country during a
a specific period. period.

Los 17.b Expenditure Approach

Sum-of-value added:
Value-of-final output:

GDP =∑ value created at each stage of GDP = ∑ value of final goods & services
production & distribution during a produced during the period.
period.

Los 17.c GDP

Nominal GDP:
Real GDP:

GDP = ∑



= ∑
 

Measure goods & services at their Measure current year output using
current cost. base prices.

GDP deflator: Price index which is  

Per capita real GDP =

 

use to convert nominal GDP to real
GDP.

Los 17.d Components of GDP

Consumption (C) Investment (I) Government spending (G) Net Exports (X-M)

Income

National Income:
Personal Income:
Personal Disposable Income:

NI = ∑ Income received by PI = Pre-tax income received by Personal income × (1-tax rate).
factors of production used in households.
the production of final output.

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 2015, Study Session # 5, Reading # 17

Los 17.e

(G-T) = (S-I) – (X-M)

where,
G-T = fiscal balance.
X-M = Trade balance

Thus If;
G-T > 0
⇒X-M < 0 (Trade deficit), or
⇒S-I > 0 (Excess private savings).

Los 17.f

IS curve:

(S-I) = (G-T) + (X-M)

It shows the –ve relationship at each level of real interest rate b/w
real interest rate and levels of aggregate income.

LM Curve:

According to quantity theory of money:
MV = PY
where,
M = Nominal money supply
V = Velocity of money
P = Price level
Y = Real income/expenditure
⇒ M/P = Y × (1/V)

It shows the +ve relationship between real interest rate & level of
real income, for a given level of real Ms, at which real MD= real Ms.

Aggregate demand curve is combination of points where IS & LM

curves intersect each other for different levels of real Ms, keeping
nominal Ms Constant.

Los 17.g

Aggregate Supply Curve:

It shows the relationship b/w price level and quantity of real GDP
supplied, keeping all other factors constant.

SRAS curve is upward sloping.

VRAS curve is perfectly elastic.

LRAS curve is perfectly inelastic (vertical).

LRAS shows potential GDP.

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 2015, Study Session # 5, Reading # 17

Los 17.h Aggregate Demand Curve

Movement: ∆ in price level causes Shift in AD curve:

movement along the curve.
∆ In household wealth.

∆ In consumer & business expectations.

Capacity utilization.

Fiscal & Monetary policy.

Currency exchange rate.

Global economic growth rates.

Aggregate Supply Curve

Movement: ∆ in price level cause Shifts in AS curve:

movement along the curve.
Short-Run:

∆ In nominal wages or other input prices.

Expectations about future prices.

Business taxes & subsidies.

Currency exchange rates.

Factors affecting LRAS.

Long-Run:

∆ In labor supply & quality of labor.

∆ In physical capital supply.

Availability of natural resources.

Level of technology.

Los 17.i Gaps

Recessionary Gap: real GDP <
Inflationary Gap: real GDP > potential
potential GDP ⇒
input prices. GDP ⇒  input prices.

Stagflation:

High unemployment and increasing inflation. (Or) weak economic growth +
high inflation (may be caused by sudden
in short-run AS).


Fixed income investments.


Investment in equities.

 Investment in commodities.

Los 17.j Sources of Economic Growth

Labor Supply Human Capital Physical Capital Stock

Technology Natural Resources

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 2015, Study Session # 5, Reading # 17

Los 17.j

Potential GDP = Agg. Hours worked × labor

productivity (or)
growth in potential GDP = growth in labor-force +
growth in labor-productivity.

Sustainable rate of economic growth
= f (rate of  in labor force, rate of  in labor
productivity).

Los 17.k

Production function:

It shows the relationship between:

Output & labor,

Capital stock.

Productivity

Total factor productivity ⇒ advances in
technology.

Los 17.L

Growth in potential GDP = Growth in technology +  (growth in

labor) +  (growth in capital)
where,
 = Labor’s % share of national income.
 = Capital % share of national income.

Growth in per-capital potential GDP = growth in technology + 
(growth in capital-to-labor ratio)

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