MACROECONOMI

CS1 MODULEEC104

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er:MhereF +263775149774
DepartmentofEconomics
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ce46,GroundFloor
.
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ceBlock,GSBL

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ttenbyGi
ya.
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.Sandsubst
ant
ial
lyr
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sedand
edi
tedbyNdl
ovu.
E
DEPARTMENTOFECONOMI CS
MIDLANDSSTATEUNIVERSITY

©2005
 CHAPTERONE

I
NTRODUCTI
ON

Macr
oeconomi
cs
Macr
oeconomi
cs i
s concer
ned wi
tht
he st
udy of t
he whol
e economy.
Macr
oeconomi
csi
sconcer
nedwi
tht
hest
udyofeconomywi
deaggr
egat
es,
suchast
heanal
ysi
soft
otalout
putandempl
oyment
,tot
alconsumpt
ion,t
otal
i
nvest
mentand nat
ionalpr
oduct
.(Vai
sh,
1995)
.Iti
s concer
ned wi
tht
he
behavi
ouroft
he economy as a whol
e-wi
th booms and r
ecessi
ons,t
he
economy’
stot
alout
putofgoodsandser
vicesandgr
owt
hofout
[put
,ther
ates
ofi
nfl
ati
on and unempl
oyment
,bal
ance ofpayment
s,exchange r
ates et
c.
Becausei
tiscl
osel
yrel
atedt
orealwor
ldi
ssues,
macr
oeconomi
csal
soi
nvol
ves
manynon-
economi
cfact
orssuchaspol
it
ical
,hi
stor
ic,cul
tur
alandsoci
ologi
cal
f
act
ors.( nbuschetal
Dor ,1998)
.

Macr
oeconomi
cPr
obl
ems
Thesear
isewhent
heeconomysuf
fer
sfr
om hi
ghunempl
oyment
,inf
lat
ion,ora
bal
ance ofpayment
s def
ici
t.Ther
efor
ethe gover
nmentset
sit
sel
fcer
tai
n
macr
oeconomi
cobj
ect
ives:

 Lowunempl
oyment
 Lowi
nfl
ati
on
 Abal
anceofpayment
ssur
plus
 Economi
cgr
owt
h
Macr
oeconomi
csandMi
croeconomi
cs

Thel
inebet
weenmacr
oeconomi
csandmi
croeconomi
csi
slessshar
pthani
t
usedt
obe,
buti
tisst
il
lther
e.

Whatmakest
hismodul
edi
ff
erenti
sthatwef
ocusont
heeconomyasawhol
e.
 I
nstead oftal
king aboutt
he demand and
suppl
yof(
say)pi
zza,
wet
alkaboutthedemandandsupplyofout
put.

1
  I
nsteadoftalki
ngaboutwhatdeterminest
he
demand f
orworkersinthe pi
zza indust
ry,we t
alk aboutwhat
det
ermi
nesthet
otal
demandforworkers.

BUSI
NESSCYCLE
Busi
nessCycl
es(
ort
radecycl
e)
Abusi
nesscycl
eist
hemor
eorl
essr
egul
arpat
ter
nofexpansi
on(
recover
y)and
cont
ract
ion(
recessi
on)i
neconomi
cact
ivi
tyar
oundagr
owt
htr
end(
Dor
nbusch
etal
,1998)
.Busi
nesscycl
escanal
sobedescr
ibedast
heper
iodi
cboomsand
sl
umpsi
neconomi
cact
ivi
ti
es.Theupsanddownsi
ntheeconomyar
eref
lect
ed
byt
hef
luct
uat
ionsi
naggr
egat
eeconomi
cmagni
tudes,suchas,pr
oduct
ion,
i
nvest
ment
,empl
oyment
,pr
ices,wages,bankcr
edi
ts et
c.The upwar
d and
downwar
d movement
sint
hese magni
tudes show di
ff
erentphases ofa
busi
nesscycl
e(Dwi
vedi
,1996)
.Basi
cal
lyt
her
ear
eonl
ytwophasesi
nacycl
e,
namel
y pr
osper
it
y and depr
essi
on.Consi
der
ing t
he i
nter
medi
ate st
ages
bet
weenpr
osper
it
yanddepr
essi
on,t
hevar
iousphasesoft
radecycl
emaybe
enumer
atedasf
oll
ows:
1)Expansi
on
2)Peak
3)Recessi
on;
4)Trough
5)Recoveryandexpansi
on

PhaseofBusi
nessCycl
es
l
ineofcycl
e

Peak st
eadygr
owt
hli
ne
Growth
Rates pr
osper
it
y depressi
on
expansi
on t
rough
peak r
ecover
y
t
rough

Ti
me

2
 Expansi
onorpr
osper
it
y(orboom)
Thi
sboom i
schar
act
eri
sedbyi
ncr
easei
nout
put
,empl
oyment
,invest
ment
,
aggr
egat
edemand,sal
es,pr
ofi
ts,bankcr
edi
ts,whol
esal
eandr
etai
lpr
icesper
capi
taout
putandar
isei
nst
andar
dofl
ivi
ng.Thegr
owt
hrat
eevent
ual
lysl
ows
downandr
eachest
hepeak.However
:

 A boom i
ncr
easesspendi
ngoni
mpor
ts,causi
ngbal
anceofpayment
s
pr
obl
ems.
 Oncehighlevel
sofemploymenthavebeenr eached,out
putcannotbe
i
ncr
easedanyfurt
herandt
heboom causesi
nfl
ati
on.

Peak
 Thi
sischaracter
izedbysl
acki
ngintheexpansi
onrat
e,thehighestl
evel
ofprosper
it
y,anddownwardsli
deint
heeconomicact
ivi
ti
esfrom t
hepeak.

Recessi
on
Thephasebegi
nswhent
hedownwar
dsl
idei
nthegr
owt
hrat
ebecomesr
api
d
andst
eady.Out
put
,empl
oyment
,pr
ices,
etc.r
egi
sterar
api
ddecl
ine,
thought
he
r
eal
isedgr
owt
hrat
emayst
il
lremai
nabovet
hest
eadygr
owt
hli
ne.Sol
ongas
gr
owt
hrat
eexceedsorequal
stheexpect
edst
eadygr
owt
hrat
e,t
heeconomy
enj
oyst
heper
iodofpr
osper
it
y,hi
ghandl
ow.Whent
hegr
owt
hrat
egoesbel
ow
t
hest
eadygr
owt
hrat
e,i
tmar
kst
hebegi
nni
ngofdepr
essi
oni
ntheeconomy.
Depr
essi
onbegi
nswhengr
owt
hrat
eisl
esst
hanzer
oi.
e.t
het
otalout
put
,
empl
oyment
,pr
ices,
bankadvanceset
c.decl
inedur
ingt
hesubsequentper
iods.
I
not
herwor
dst
her
eisasl
umpi
ntheeconomy.[
Asl
umpr
educesspendi
ngon
i
mpor
ts,t
husi
mpr
ovi
ng t
hebal
anceofpayment
s.Reduced t
otalspendi
ng
l
ower
sinf
lat
ionar
ypr
essur
e.]Thespanofdepr
essi
onspr
eadsovert
heper
iod
gr
owt
hrat
est
aysbel
ow t
hesecul
argr
owt
hrat
eorzer
o gr
owt
hrat
eina
st
agnat
edeconomy.

Tr
ough
Thi
sist
hephasedur
ingwhi
cht
hedownt
rendi
ntheeconomysl
owsdownand
event
ual
lyst
opsandt
heeconomi
cact
ivi
ti
esonceagai
nregi
steranupwar
d

3
movement
.Tr
oughi
stheper
iodofmostsever
est
rai
nont
heeconomy.

Recover
y
Whent
heeconomyr egi
ster
sacont
inuousandr
api
dupwar
dtr
endi
nout
put
,
empl
oyment
,et
c,i
tent
erst
hephaseofr
ecover
ythought
hegr
owt
hrat
e.Wheni
t
exceedst
hisr
ate,t
heeconomyonceagai
nent
erst
hephaseofexpansi
onand
pr
osper
it
y.I
feconomi
cfl
uct
uat
ionsar
enotcont
rol
ledbyt
hegover
nment
,the
busi
nesscycl
escont
inuet
orecurasst
atedabove.

Whyworryaboutbusi
nesscycl
es?
Busi
nesscycl
es,causenotonlyharmt obusi
nessbutal
somi
ser
ytohuman
bei
ngsbycr
eat
ingunempl
oymentandpover
ty.Gover
nment
sinmanycount
ri
es
assumet
her
oleofakeypl
ayeri
nempl
oymentandst
abi
li
zat
ion.St
abi
li
zat
ion
br
oadl
ymeanspr
event
ing t
heext
remesofupsand downsorboomsand
depr
essi
oni
ntheeconomywi
thoutpr
event
ingf
act
orsofeconomi
cgr
owt
hto
oper
ate.

Tr
adeCycl
esorbusi
nesscycl
es-si
mpl
if
ieddi
agr
am

Gover
nmentMacr
oeconomi
cPol
ici
es
Macr
oeconomi
cPol
icyObj
ect
ives

Al
lgover
nment
sli
ket
oachi
evet
hef
oll
owi
ng4maj
ormacr
oeconomi
cpol
i
cy
obj
ect
ives:

4
(
a)Ful
lempl
oymentofl
abourf
orce.

(
b)Ast
abl
epr
icel
evel
.

(
c)B.
O.Pequi
li
bri
um (sur
plusi
sdesi
rabl
e)

(
d)Asat
isf
act
oryr
ateofeconomi
cgr
owt
h.

Onf
ullempl
oyment
,ofl
abourf
orcei
tisnotpossi
blet
oachi
evet
hisi
nthe
st
ri
ctestsense.Theuseofof
fi
cialunempl
oymentst
ati
sti
csasbasi
sforset
ti
ng
pol
icyobj
ect
ivesi
sal
sosuspect
.Thel
istbygover
nmenti
ncl
udest
hosedef
ined
asbei
ngunempl
oyedbygover
nmentr
athert
hant
hosewhowoul
dbewi
ll
ingt
o
t
akeuppai
dempl
oymentshoul
ditbecomeavai
labl
e.Somepeopl
eont
he
r
egi
stermaybeunempl
oyabl
e-aged,
disabl
ed,
cri
minal
sandt
hosenoti
ntendi
ng
t
owor
k.

Tabl
ebel
ow showssomeoft
hepol
ici
est
hegover
nmentcanuset
otr
ytoget
f
ullempl
oyment
,st
abl
epr
iceset
c.

Pol
icy Descr
ipt
ion
Changes i
n gover
nment expendi
tur
e and
Fi
scal
t
axat
ion
Monet
ary Changesi
nthemoneysuppl
yandi
nter
estr
ates
Pr
ices andLegalorvol
unt
aryl
imi
ts on pr
ice and wage
i
ncomes i
ncr
eases
Regi
onal Measur
est
ohel
pdepr
essedar
eas
I
ndust
ri
al Gover
nmentpl
anni
ngofi
ndust
ry
Commer
cial Quot
as,
tar
if
fs,
exchangecont
rol
sorf
reet
rade
Encour
agi
ngadepr
eci
ati
onorappr
eci
ati
onof
Exchanger
ate
st
erl
ing

Pr
obl
emsofPol
icyTi
ming
Thet
imi
ngofpol
icyevent
smaybecr
uci
alt
otheef
fi
ciencyandef
fect
ivenessof
pol
ici
es.Ther
ear
ebasi
cal
lyt
hreef
ormsoft
imel
agt
oconsi
deri
nrel
ati
ont
othe
behavi
ourofpol
icymaker
sandoper
ati
onoft
heeconomy.
(
a)Recogni
ti
onl
ag-aut
hor
it
iesper
cei
vepr
obl
emsaf
tersomet
ime.

5
(
b)Admi
nist
rat
ion l
ag-i
ttakest
imet
o setup t
henecessar
yadmi
nist
rat
ive
machi
ner
yin mot
ion.For exampl
e Par
li
ament appr
oves i
ncome t
ax
measur
esaf
terdebat
ebutmonet
arypol
icyopt
ionst
akedaysorhour
sto
i
mpl
ement
.
(
c)I
mpl
ement
ati
onl
ag-byt
het
imet
hepol
icyi
simpl
ement
ed,newi
ssueshave
ar
isenhencenewpol
ici
eshavet
obei
mpl
ement
ed/
for
mul
atedoradaptt
he
pol
icyi
nst
rument
sint
roduced.

Chi
efI
nst
rument
sofEconomi
cPol
icy
Thet
woi
mpor
tantsubdi
visi
onsofeconomi
cpol
icyar
ethemonet
arypol
icyand
t
hef
iscalpol
icy.Theset
wopol
ici
esar
eappl
i
edasmut
ual
lycompl
ement
ary
pol
ici
est
oser
veasi
nst
rument
sofgover
nment
’seconomi
cpol
icywhi
chi
s
appl
iedt
oachi
evecer
tai
nsoci
algoal
s.Of
tent
het
woover
lap,becausei
tis
al
mosti
mpossi
blet
oenvi
sageanymaj
orf
iscalormonet
arymeasur
ewhi
ch
doesnotaf
fectt
heot
her
.
A.Fi
scalPol
icy.Thi
sist
he pol
icyofgover
nmentwi
thr
egar
dtol
evelof
gover
nmentspendi
ngandt
axst
ruct
ure.Gover
nmentexpendi
tur
eincl
udes
t
ransf
erpayment
s,gover
nmentcur
rentexpendi
tur
esandbudget
arybal
ance
(
ext
entofbor
rowi
ng)
.Taxat
ion(
i)pr
ovi
dest
hef
undst
ofi
nanceexpendi
tur
e.
(
ii
)Canal
sobeusedf
ori
ncomer
edi
str
ibut
ion.Taxesar
esubdi
videdi
nto
di
rectandi
ndi
r .(
ect i
)Di
rectt
axes–t
hesear
elevi
eddi
rect
lyonper
sons/
cor
por
atesandi
ncl
udei
ncomet
ax,cor
por
atet
ax,pol
ltaxandi
nher
it
ance
t
axes,i
mpor
tdut
ies.Typi
calusesf
ort
hisi
nst
rumentar
ear
educt
ioni
n
i
ncome i
nequal
it
ies,r
egul
ate aggr
egat
e demand,pr
otect
ion ofdomest
ic
pr
oducer
s,r
educepover
ty,and pr
ovi
sion ofi
nfr
ast
ruct
ureand t
o adj
ust
bal
ancebet
weenaggr
egat
edemandandsuppl
y.I
mpor
tdut
iesar
eimpor
tant
sour
cesofr
evenuei
nmanyAf
ri
cancount
ri
es.Count
ri
esi
mposei
mpor
t
t
ari
ff
sforsomeoral
loft
hef
oll
owi
ngr
easons:(
a)Revenue,pr
otect
iont
o
l
ocalpr
oducer
s,(
b)di
scr
imi
nat
ebet
weenessent
ialandnon-
essent
ialgoods
and(
c)B.
O. poses.(
Ppur ii
)I
ndi
rectt
axi
slevi
edonat
hingandi
spai
dbyan
i
ndi
vidualbyvi
rt
ueofassoci
ati
onwi
tht
hatt
hing,
e.g.l
ocalr
atesonpr
oper
ty,

6
 sal
est
axesandexci
sedut
ies.Taxst
ruct
urecanber
egr
essi
vepr
opor
ti
onal
orpr
ogr
essi
ve.Taxi
ncent
ivesmaybegi
ven-i
nvest
mental
lowances,t
ax
hol
idays,accel
erat
ed depr
eci
ati
on al
lowances,dut
y-f
ree i
mpor
ts;no-
tax
concessi
onsmaybegi
venbygover
nmentf
ore.
g.pr
ovi
sionofr
oads,wat
er
and power
.In some Af
ri
can count
ri
es r
uralt
axat
ion-was used e.
g.
Camer
oon,
Mal
iandSudan.

Pr
obl
emsofFi
scalAdmi
nist
rat
ion
(
a)Taxevasi
on
(
b)Shor
tageoft
rai
nedandexper
iencedst
aff
.
(
c)Cor
rupt
ion.
(
d)at
ti
tudest
owar
dspaymentoft
axes.
(
e)poorco-
ordi
nat
ionofbudget
swi
thdevel
opmentpl
ans.

B.Monet
aryPol
icy-t
hemani
pul
ati
onoft
hevol
umeofcr
edi
t,i
nter
estr
atesand
ot
hermonet
aryvar
iabl
es.Monet
arypol
icyi
sapol
icywhi
chempl
oyscent
ral
bank’
scont
rolovert
hesuppl
y,costanduseofmoneyasani
nst
rumentf
or
achi
evi
ngcer
tai
ngi
venobj
ect
ivesofeconomi
cpol
icy.Thepol
icyi
susedt
o
i
mpr
ovecr
edi
tandsavi
ngf
aci
li
ti
esandt
oregul
atemacr
oeconomi
cbal
ance
oft
heeconomy.Al
lgover
nment
srundef
ici
tsi
nthatt
hei
rtot
alspendi
ng
exceedst
heval
ueoft
hei
rtaxandot
hercur
rentr
ecei
pts.Thedef
ici
tis
f
inanced byl
ong-
ter
m bor
rowi
ng f
rom abr
oad and f
rom l
ocalr
esi
dent
s.
Somet
imest
hel
ong-
ter
m bor
rowi
ngswi
llnotcovert
hegapwhi
chmeansi
t
hast
obef
inancedbyot
hermeans.Gover
nmentusual
lyf
il
lst
hegapbyshor
t
-
ter
m bor
rowi
ngf
rom t
hecent
ralandcommer
cialbanks.Thi
sbor
rowi
ng
f
rom t
hebanki
ngsyst
em (
def
ici
tfi
nanci
ng)usual
lyhashi
ghl
yexpansi
onar
y
ef
fect
sonmoneysuppl
y.I
not
herwor
dsi
tincr
easest
hemoneysuppl
yby
t
heamountoft
hedef
ici
tbuti
sli
kel
yal
sot
oresul
tinsecondar
yincr
easesi
n
moneysuppl
ybyi
ncr
easi
ngt
hecashbaseoft
hebanki
ngsyst
em andhence
i
tsabi
li
tyt
olendmor
etopr
ivat
ebor
rower
s.(
N.B.Expansi
onar
ydoesnot
mean i
nfl
ati
onar
y).Monet
ary pol
icy can be used f
or ant
i-
inf
lat
ionar
y

7
 pur
poses.Muchi
ndust
ri
alandcommer
cialexpansi
oni
sfi
nancedbybank
cr
edi
t(especi
all
yforwor
kingcapi
tal
)sot
orest
ri
ctbankl
endi
ngi
sli
abl
eto
pl
aceabr
akeonnewi
nvest
mentandeconomi
cexpansi
on.I
tispossi
blef
or
cr
edi
trest
ri
cti
onst
obepushedt
otheext
entoff
orci
ngadef
lat
ionont
he
economy,wi
thser
iousavoi
dabl
elosesofout
putandempl
oyment
.Some
economi
stshavear
guedi
nfavouroft
heuseofhi
ghi
nter
estr
atest
ocur
b
aggr
egat
edemand.Theef
fectofamoveal
ongt
hesel
inesi
stoencour
age
t
hehol
dingofl
argermoneybal
ances,r
educi
ngt
hepr
essur
eofdemandf
or
commodi
ti
es.
Cr
it
iqueoft
hei
nter
estr
ateReser
vat
ionst
othei
nter
estr
atei
ssuehavebeen
r
aised:
(
a)Hi
gheri
nter
estr
atesmaydi
scour
agei
nvest
mentandt
husi
mpedet
he
devel
opmentoft
he economy.I
tcan be count
erar
gued t
hathi
gher
i
nter
estr
ateswi
llr
aiset
hepr
oduct
ivi
tyofnewi
nvest
ment
sbecausenow
onl
ypr
oject
swhi
chpr
omi
sel
arger
etur
nswi
llbeunder
taken.Hencei
t
maybepossi
blet
osust
aint
heover
allr
ateofeconomygr
owt
hevenf
rom
ar
educedvol
umeofi
nvest
ment
.
(
b)Asuccessf
uli
nduct
ionofpeopl
etosubst
ant
ial
lyi
ncr
easet
hei
rmoney
hol
dings may due t
othe wi
thdr
awalof pur
chasi
ng power f
rom
commodi
tymar
ket
smaybedef
lat
ionar
y.
(
c)Sever
alst
udi
eshavef
oundt
heel
ast
ici
tyofdemandf
ormoneywi
th
r
espectt
othecostofhol
dingi
ttober
athersmal
l.I
fthi
sist
hecase,i
t
woul
dtakea ver
ylar
ger
isei
nint
erestr
atest
o af
fecta si
gni
fi
cant
i
ncr
easei
nthedemandf
ormoney.

Li
mit
ati
onsoft
hest
atei
nachi
evi
ngMacr
oeconomi
cPol
icyObj
ect
ives
(
i) t
oomanymi
nist
ri
es,of
tenwi
thcompet
ingi
nter
est
s,t
oomanypubl
ic
cor
por
ati
onsandt
oomanyboar
dsofoneki
ndoranot
her
.
(
ii
) Toomuchcor
rupt
ionofci
vilser
vice,
civi
lser
vant
sbadl
ymot
ivat
ed.
(
ii
i) Toomuchr
edt
ape.
(
iv) Toomuchpol
it
icali
nst
abi
li
tywi
thgover
nment
sof
tenchangedby

8
mi
li
tar
ycoupsandot
herunconst
it
uti
onalmeans.Gover
nment
sar
e
t
her
efor
epr
eoccupi
edwi
tht
asksofmai
ntai
ningt
hei
rownpopul
ari
ty,
aut
hor
it
yandpower
.

9
 CHAPTERTWO
NATI
ONALI
NCOMEACCOUNTI
NG
Nat
ionalI
ncomei
stheout
comeort
heendr
esul
tofal
leconomi
cact
ivi
ti
es.
Economi
cact
ivi
ti
esgener
atet
woki
ndsoff
lows(
i)moneyf
lows-t
hesear
ein
exchangef
orser
vicesoff
act
orsofpr
oduct
ioni
nthef
orm off
lows-t
hesear
ein
exchangef
orser
vicesoff
act
orsofpr
oduct
ioni
nthef
orm ofwages,r
ent
,
i
nter
estand pr
ofi
ts (
i.
efact
orear
nings)(
ii
)Pr
oductf
lows,ar
efl
ows of
consumergoods and ser
vices and pr
oduct
ive asset
s.Al
lhuman act
ivi
ti
es
whi
chcr
eat
egoodsandser
vicest
hatcanbeval
uedatmar
ketpr
icear
ebr
oadl
y
t
heeconomi
cact
ivi
ti
es.

Macr
oeconomi
csdeal
swi
thanumberofl
arget
otal
soraggr
egat
es,whi
char
e
usedt
oconcept
ual
izeandmeasur
ekeycomponent
soft
heeconomy.Themost
f
undament
aloft
hesei
sthet
otalout
putofgoodsandser
vices,convent
ional
ly
r
efer
redt
oast
henat
ionali
ncome.(
Off
ici
aldat
ainmostcount
ri
esi
snow
act
ual
l
yrepor
tedona"
domest
ic"r
athert
hana"
nat
ional
"basi
s.Thedi
sti
nct
ion,
whi
chi
suni
mpor
tantf
ormostpur
poses,r
elat
est
othet
reat
mentofi
nvest
ment
i
ncome r
ecei
ved f
rom non-
resi
dent
s and pai
dto non-
resi
dent
s."
Domest
ic
i
ncome"i
sthatpr
oducedwi
thi
nacount
rybyal
lpr
oducer
soper
ati
ngt
her
e,
whet
herf
orei
gnornot
."Nat
ionali
ncome"i
sthatpr
oducedonl
yby"
nat
ional
s"of
t
hatcount
ry,
whet
hert
heyar
epr
oduci
ngi
tther
eorel
sewher
e.)

Ther
eisnot
hingi
nconsi
stenti
nref
err
ingt
otot
alout
putasi
ncome.Al
though
whati
sear
nedasi
ncomecanbemeasur
edsepar
atel
yfr
om whati
spr
oduced,
t
het
woaggr
egat
esar
enecessar
il
ythesamei
namount
.Bef
oregoi
ngont
osee
why,
not
ethati
nei
thercasesuchl
arget
otal
scanbeexpr
essedonl
yint
ermsof
money,
notphysi
calpr
oduct
sassuch.I
tisi
mpr
act
icalt
otr
ytomeasur
eout
put
ori
ncomei
nreal
,physi
calt
erms,
simpl
ybecausei
tisi
mpossi
blet
osum appl
es
andor
angesoranyoft
hemi
ll
ionsofgoodsandser
viceswhi
char
epr
oduced
andr
ecei
vedasi
ncomei
namoder
neconomy.I
nst
ead,
physi
calquant
it
iesmust
beconver
tedt
oacommonmeasur
eandt
hemeasur
eusedf
ort
hispur
posei
s
t
henat
ionaluni
tofaccount
,thedol
lar
,pound,
orot
hercur
rency.

Theval
ueoft
otalout
putori
ncomei
naneconomydur
ingsomeaccount
ing
per
iod,
usual
lyayearorquar
terofayear
,isasi
gni
fi
cantst
ati
sti
c.I
tisgener
all
y

1
0
usedasani
ndi
cat
oroft
heeconomy’
sper
for
mance.Becauseal
argerout
putor
i
ncome i
s equat
ed wi
thar
ise i
nthe economi
c wel
lbei
ng ofa count
ry’
s
popul
ati
on,ahi
gherout
putori
ncomei
sconsi
der
eddesi
rabl
eandal
owerone
undesi
rabl
e.Theeconomy’
sover
allper
for
mancei
str
ackedbyt
hechangi
ng
val
ueoft
het
otalout
putori
ncomest
ati
sti
c.Si
mil
arl
y,compar
isonsofr
elat
ive
wel
l
-bei
ngamongdi
ff
erentcount
ri
esar
ebasedont
hesest
ati
sti
csandahostof
pol
it
icalandsoci
alaswel
laseconomi
cimpl
icat
ionsf
lowf
rom t
hei
rbehavi
our
overt
ime.
TheCi
rcul
arFl
ow

Amoder
neconomycanbesi
mpl
ymodel
edi
ntheaggr
egat
ebyt
hinki
ngofi
tas
compr
isi
ngt
wokeysect
ors,househol
dswhi
chconsumepr
oducedgoodsand
ser
vicesandwhi
chsuppl
ylabourandot
herpr
oduct
iveser
vi of
cest i
rms,whi
ch
uset
hel
abourandot
herpr
oduct
iveser
vicessuppl
iedbyhousehol
dst
opr
oduce
t
he goods and ser
vices t
he househol
ds consume.Househol
ds suppl
ythe
ser
vicesofpr
oduct
ivef
act
ors(
land,l
abour
,capi
tal
,et
c.)andt
hef
ir
msconver
t
t
hesei
nput
sint
opr
oducedgoodsandser
viceswhi
chr
etur
ntot
hehousehol
ds.
Owner
soff
ir
msar
e,ofcour
se,al
sopar
toft
hehousehol
dsect
orwher
ethey
f
unct
ioni
nthei
rot
hercapaci
tyasconsumer
sofgoodsandser
vices.

Ther
ealf
lowsofpr
oduct
iveser
vicesandpr
oducedout
put
shavecor
respondi
ng
f
lowsofmoneypayment
sassoci
atedwi
tht
hem.Fi
rmspayoutwagesand
sal
ari
esi
nret
urnf
orl
abourser
vices,r
ent
stoowner
sofl
andandot
hernat
ural
r
esour
ce i
nput
s,and i
nter
est and pr
ofi
tst
o suppl
ier
s of capi
tal and
ent
repr
eneur
iali
nput
s.Househol
der
sconsequent
lyhavemoneyi
ncomewi
th
whi
cht
opayf
ort
hepr
oducedgoodsandser
vicest
hatf
lowt
othem f
rom f
ir
ms.
Thus,t
her
ear
emoneyfl
ows cor
respondi
ngt
other
ealf
lows,butt
heymove,of
cour
se,
int
heopposi
tedi
rect
ion.

Ci
rcul
arFl
owofI
ncome

Ser
vicesoff
act
orsofPr
oduct
ion

Goodsandser
vices

H/
HOLDS FI
RMS

1
1
 Spendi
ng

I
ncomes

Becauset
hef
lowsofpayment
sforpr
oducedgoodsandser
vicesandpayment
s
f
orf
act
ori
nput
sar
econt
inuous,aggr
egat
eincome/
out
puti
nthi
ssi
mpl
emodel
coul
dbemeasur
edatanypoi
nt,met
eri
ngt
hef
low anywher
eint
heci
rcui
t.I
f
measur
edi
nter
msofspendi
ngonpr
oducedgoodsandser
vices,i
twoul
dbe
nat
uralt
ocal
lthi
sameasur
eoft
otalspendi
ngort
otalexpendi
tur
e.I
fmeasur
ed
i
nter
msofout
laysmadef
ort
heser
vicesofpr
oduct
ivef
act
ori
nput
s,i
twoul
dbe
t
otali
ncome(
from t
hepoi
ntofvi
ew oft
heowner
soft
hosef
act
ori
nput
s).
Obvi
ousl
ythet
wot
otal
swoul
dhavet
obet
hesame.

Thi
sisagr
eat
lysi
mpl
if
iedmodel
.Onet
hingmi
ssi
ngi
sthepossi
bil
it
yofsavi
ng.
I
fhousehol
dsdonotspendal
lthei
rincomeonpr
oducedgoodsandser
vices,
buthol
dsomeofi
tbackassavi
ngs,
ever
yti
mei
ncomef
lowsi
ntot
hehousehol
d
sect
ort
hef
lowofpayment
smadet
opr
oducer
swi
lldi
mini
sh.Thi
sisa"
leakage"
ofi
ncome/
spendi
ng f
rom t
he syst
em and t
he vol
ume oft
he f
low woul
d
di
mini
sh—t
hel
evelofnat
ionali
ncomewoul
dfal
l.Buti
fther
ear
esavi
ngs,t
her
e
coul
d al
so be new i
nvest
ment
.Ifbusi
nesses bor
rowed i
ncome saved by
househol
ds and used i
ttof
inance t
he bui
ldi
ng ofnew pl
antorf
orot
her
busi
nesspur
poses,i
twoul
dbei
nject
edbacki
ntot
hei
ncomest
ream (
int
he
f
orm ofpayment
sto wor
ker
s and ot
herf
act
orowner
s who suppl
ied t
he
necessar
yreali
nput
sneededt
opr
oducet
henew capi
tal
).Banksandot
her
f
inanci
ali
nter
medi
ari
es ser
ve as t
he nexus t
hrough whi
ch savi
ngs ar
e
conver
tedi
ntoi
nvest
mentspendi
ngandr
etur
nedt
othei
ncomest
ream.

I
nthesi
mpl
eeconomyabovewecanwr
it
ethei
dent
it
yofout
putpr
oducedand
out
putsol
dasY≡ C+I
.Thati
sal
lout
putpr
oducedi
sei
therconsumedor
i
nvest
ed.Thecor
respondi
ngi
dent
it
yfort
hedi
sposi
ti
onofper
sonali
ncomei
s
t
hatt
hei
ncomei
sal
locat
edonC(
Consumpt
ion)andpar
tissaved(
S).Thi
s
i
mpl
iest
hatY≡ C+S.I
tal
sof
lowst
hatC+I≡ Y≡ C+S.Subt
ract
ingCf
rom
bot
hsi
desgi
vesI≡ Y-C≡ Swhi
chshowst
hatsavi
ngi
sal
soi
ncomel
ess
consumpt
ionandal
soi
nvest
menti
sident
ical
lyequalt
osavi
ng.

1
2
I
fanot
hercompl
icat
ion,gover
nment
,isaddedt
othesi
mpl
emodel
,anot
her
pot
ent
ialf
oral
eakageofi
ncomef
rom t
hesyst
em i
sint
roduced.Gover
nment
s
i
mposet
axes(
T)onhousehol
ds(
andf
ir
ms)andt
hisr
esul
tsi
nadi
ver
sionof
i
ncomef
rom t
hepr
ivat
esect
ort
ogover
nment
.Thi
sisanot
herl
eakageandi
t
t
oo hasacor
respondi
ng pot
ent
ialf
ori
nject
ing such i
ncomebacki
ntot
he
st
ream,t
hist
imei
nthef
orm ofgover
nmentspendi
ngonpr
oducedgoodsand
ser
vices.Taxat
ionr
educesdi
sposabl
eincome.Di
sposabl
eincomei
sgi
venby
Yd≡ Y-
Tandal
soYd≡ C+S.ThusC+S≡ Yd≡ Y-
T

Fi
nal
ly,
mostr
ealwor
ldeconomi
esar
enotcl
osedl
oops.I
nst
eadt
heyar
e"open"
t
other
estoft
hewor
ld,
wit
hleakagesf
rom domest
ici
ncome/
expendi
tur
efl
ows
i
nthe f
orm ofpayment
s made f
orgoods and ser
vices pr
oduced abr
oad
(i
mpor
ts,M)andi
nject
ionsofi
ncomebacki
ntot
hedomest
icf
lowsasar
esul
t
ofsal
esofgoodsbydomest
icf
ir
mst
oconsumer
sabr
oad(
expor
ts,X)
.As
al
readyseen,t
her
ecanal
sobei
mpor
tantf
lowsofsavi
ngsandi
nvest
ment
bet
weenonecount
ryandt
her
estoft
hewor
ld.

Ci
rcul
arFl
owofI
ncome
Ser
vicesoff
act
orsofPr
oduct
ion

Goodsandser
vices

H/
HOLDS FI
RMS

Spendi
ng

I
ncomes

LEAKAGES/
WITHDRAWALS I
NJECTIONS
Savi
ngs Invest
ments
Taxat
ion GovernmentExpendi
tur
e
Impor
ts Exports

Fr
om t
hedi
agr
am Y=C+I+G+(
X-M)=C+S+T

Thei
mpor
tanti
deast
ounder
standatt
hispoi
ntar
ethatnat
ionali
ncomeor
expendi
tur
ecanbet
houghtofasacont
inuousf
lowwhi
chcanbemeasur
edi
n

1
3
di
ff
erentways(Pr
oduct≡ i
ncome≡ expendi
tur
eont
hepr
oduct
)andt
hatt
his
si
mpl
epr
ocessi
scompl
icat
edbyt
hepossi
bil
i
tiesofl
eakagesandi
nject
ions
ar
isi
ngf
rom pr
ivat
esavi
ngandi
nvest
ing;gover
nmentt
axat
ionandspendi
ng;
andf
orei
gnt
radeandcapi
tal
movement
s.

THENATI
ONALACCOUNTS

Al
ltheeconomi
est
odaymeasur
ethevol
umeofaggr
egat
eincome,usual
ly
def
inedasGr
ossDomest
icPr
oduct
,inmucht
hesameway.

Gr
ossDomest
icPr
oduct(
GDP)

Ref
erst
othet
otalmonet
aryval
ueofal
lgoodsandser
vicespr
oducedwi
thi
nthe
geogr
aphi
cboundar
iesofanat
iondur
ingagi
venyear
.Thewor
d“domest
ic”
i
mpl
iest
hatonl
ythei
ncomepr
oducedi
nthatcount
ryi
saccount
edf
or.The
i
ncomet
hatar
isesf
rom i
nvest
ment
sandpossessi
onsownedabr
oadi
sthus
noti
ncl
udedi
ntheGDPest
imat
es.

Cal
cul
ati
onofGDP

-
cal
cul
atedsi
mpl
ybyval
uingt
heout
put
sofal
l“f
inal
”goodsandser
vicesat
“
mar
ket
”pr
ices(i
.e.act
ualpr
icesatwhi
cht
heyar
eboughtandsol
d)andt
hen
addi
ngt
het
otal
.N.
B.Themar
ketval
ueofal
lint
ermedi
atepr
oduct
s-t
hoseused
t
opr
oducet
hef
inalout
puti
sexcl
udedf
rom t
hecal
cul
ati
onofGDPsi
ncet
he
val
uesofi
nter
medi
ategoodsar
eal
readyi
mpl
ici
tl
yincl
udedi
nthemar
ketpr
ices
oft
hef
inalgoods.“
Gross”i
mpl
iesnotal
lout
putwasavai
labl
eforpr
ivat
e/publ
ic
consumpt
ionandi
nvest
ment
,par
twentt
orepl
aceormai
ntai
nwor
noutcapi
tal
equi
pment
.

Nomi
nalandRealGDP

Twomeasur
esofGDPar
egi
ven:nomi
nalGDP(
alsocal
ledcur
rentdol
larGDP)
andr
eal(
const
antdol
lar
)GDP.Nomi
nalGDPmeasur
est
heval
ueofout
putat
t
hepr
icespr
evai
li
ngatt
het
imeofpr
oduct
ion,whi
ler
ealGDPmeasur
est
he
out
putpr
oducedi
nanyoneper
iodatt
hepr
icesofsomebaseyear
.Thegr
owt
h
r
ateoft
heeconomyi
susual
lyt
aken t
o bet
her
ateatwhi
ch r
ealGDP i
s
i
ncr
easi
ng.

1
4
What
evert
hei
rmi
nordi
ff
erences,
allnat
ionalaccount
ingconvent
ionsf
oll
owt
he
basi
cpat
ter
nident
if
ied i
nthepr
ecedi
ng di
scussi
on oft
heci
rcul
arf
low of
i
ncomeandexpendi
tur
e.Ther
ear
eal
waysatl
eastt
womai
ncal
cul
ati
ons,one
whi
chsumst
otalexpendi
tur
esongoodsandser
vicespr
oduced,t
heot
herof
t
otali
ncomer
ecei
vedasar
esul
tofpr
oduci
ngt
hosesamegoodsandser
vices.
Becausebot
har
emeasur
esoft
hesamet
hingt
heymust
,bydef
ini
ti
on,
yiel
dthe
samet
otal
.

I
nnat
ionalaccount
ingi
nex-
postsenseexpendi
tur
eonpr
oduct
ioni
sal
ways
equalt
opr
oduct
ionandi
ncome.Pr
oduct≡ I
ncome≡ Expendi
tur
eont
he
pr
oduct

Whyt
womeasur
esi
fthet
otalmustbet
hesame?Oner
easoni
sthatt
wo
est
imat
espr
ovi
deacheckononeanot
herwi
thr
espectt
oaccur
acy.Anot
heri
s
t
hatt
het
womeasur
esbr
eakdowni
ntodi
ff
erentcomponent
s,someofwhi
ch
ar
emor
eusef
ulf
orcer
tai
npur
posest
hanot
her
s.
GROSSNATI
ONALPRODUCT(
GNP)

Thi
sist
hemosti
mpor
tantandwi
del
yusedmeasur
eofnat
ionali
ncome.I
tist
he
mostcompr
ehensi
vemeasur
eofanat
ion’
spr
oduct
iveact
ivi
ti
es.I
tisdef
inedas
t
heval
ueofal
lfi
nalgoodsandser
vicespr
oduceddur
ingaspeci
fi
cper
iod,
usual
lyoneyear(
Dwi
vedi
,1996)
.Inot
herwor
dsi
tref
erst
othatpar
toft
heGDP
t
hati
sact
ual
lypr
oducedandear
nedbyort
ransf
err
edt
oresi
dentnat
ional
sof
t
hatcount
ry.Ear
ningsoff
orei
gner
swhi
char
iseoutoft
hei
rdomest
iceconomi
c
act
ivi
ti
esar
ethusexcl
uded.ForZi
mbabweanswor
kingabr
oadt
hei
rincomei
s
i
ncl
uded i
nthe GNP of Zi
mbabwe.Wher
ether
eis subst
ant
ialf
orei
gn
par
ti
cipat
ioni
ntheeconomyandal
argepar
toft
otaldomest
ici
ncomei
sear
ned
andr
epat
ri
atedbyf
orei
gner
sandf
orei
gncompani
esasi
nmanyLDCs,
GDPwi
ll
bemuchl
argert
hanGNP.Asar
esul
tst
ati
sti
csofGDPgr
owt
hmaygi
veaf
alse
i
mpr
essi
onoft
heeconomi
cper
for
manceofapar
ti
cul
ardevel
opi
ngnat
ion.GNP
i
sther
efor
eamor
eappr
opr
iat
emeasur
eofnat
ional
income.

NETNATI
ONALPRODUCT(
NETNATI
ONALPRODUCT)

NetNat
ionalPr
oduct=Gr
ossNat
ionalPr
oduct
– Depr
eci
ati
on.NetNat
ional
Pr
oduct(
NNP)i
scal
cul
atedbydeduct
ingf
rom GNPt
hedepr
eci
ati
onofexi
sti
ng

1
5
capi
talst
ockovert
hecour
seoft
heper
iod.
Thepr
oduct
ionofGNPcauseswear
andt
eart
otheexi
sti
ngcapi
talst
ock,f
orexampl
e,machi
neswearoutast
hey
ar
eused.I
tisamor
eaccur
atemeasur
eofnat
ionalpr
oductbuti
nreall
if
eGNP
i
smost
lybecauseneti
nvest
ment(
GrossI
nvest
ment–Depr
eci
ati
on)i
sdi
ff
icul
t
t
o measur
e especi
all
y as r
ate ofdepr
eci
ati
on i
s notknown (
str
aightl
ine,
decl
ini
ng orr
educi
ng bal
ance?
)ormay be qui
tei
naccur
ate.Depr
eci
ati
on
est
imat
esmayal
sonotbequi
ckl
yavai
labl
e.

MEASUREMENTOFNATI
ONALI
NCOME
Ther
ear
ethr
eemet
hodsorappr
oachesf
ormeasur
ingt
otalout
put
,namel
y:

1)
.Expendi
tur
e

2)
.Incomemet
hod

3)
.Val
ueAddedorOut
putappr
oach

A.TheExpendi
tur
eAppr
oach
Measur
ingt
otalout
putbyt
heexpendi
tur
emet
hodi
nvol
vesbr
eaki
ngdownt
otal
spendi
ng on al
lgoods and ser
vices pr
oduced i
ntof
our cat
egor
ies:(
a)
Expendi
tur
esbyconsumer
songoodsandser
vices(
abbr
evi
atedsi
mpl
ytot
he
l
ett
erC)
;(b)
Expendi
tur
esbybusi
nesseson capi
talgoods(
tot
ali
nvest
ment
spendi
ng,I
);(
c)Expendi
tur
ebygover
nmentongoodsandser
vices,G)
;and(
d)
Netexpor
ts(
thet
otalval
ueofexpor
tsmi
nust
het
otalval
ueofi
mpor
ts,X-
M).
Becauseal
lspendi
ngdonei
nthecount
ryf
all
sint
ooneorot
heroft
hesef
our
cat
egor
i hatt
es,wecansayt otalexpendi
tur
eist
hesum ofC+I
+G+(
X-M)
.We
nowexami
neeachoft
hesef
ourmai
ncomponent
soft
otalspendi
ng.

Consumpt
ion(
C)

Consumpt
ionspendi
ngi
sthet
otalofal
lout
laysmadebyhousehol
dsonf
inal
goodsandser
vices.I
nal
lcount
ri
esi
tisbyf
art
hel
argestcomponentoft
otal
spendi
ng.I
tcover
sspendi
ngonanenor
mousr
angeofi
tems,
incl
udi
ngdur
abl
e
goodsl
iket
elevi
sionset
sandcar
s,non-
dur
abl
egoodsl
ikef
oodandcl
othi
ng,
andper
sonalser
vicessuchasl
egaladvi
ce,
hai
rdr
essi
ng,
anddent
alcar
e.Buti
t
usual
lyexcl
udesspendi
ngonhouses,whi
chi
scust
omar
il
y(andar
bit
rar
il
y)
t
reat
edasi
nvest
mentexpendi
tur
e.Cal
soexcl
udespur
chasesofsecond-
hand

1
6
goodst
hatwer
epr
oducedi
nsomeear
li
eraccount
ingper
iodsoasnott
odoubl
e
countt
heval
ueofsuchout
put
.

Gover
nmentExpendi
tur
eonGoodsandSer
vices(
G)

Al
lgover
nment
spayment
stof
act
orsofpr
oduct
ioni
nret
urnf
orf
act
orser
vices
r
ender
ed ar
ecount
ed aspar
toft
heGDP.Much oft
hespendi
ng doneby
gover
nment
sint
he devel
oped count
ri
es t
oday t
akes t
he f
orm ofsi
mpl
e
t
ransf
ersofi
ncomef
rom t
axpayer
stot
hoseel
igi
blef
ort
hewi
der
angeof
i
ncome suppl
ement
s avai
labl
eto assi
st t
he el
der
ly,t
he si
ck and t
he
unempl
oyed,oraspayment
sofi
nter
estt
ohol
der
soft
hepubl
icdebt
.Such
t
ransf
erpayment
s do notr
epr
esentspendi
ng on cur
rentpr
oduct
ion and
consequent
ly,ar
e notcount
ed i
n nat
ionali
ncome det
ermi
nat
ion.Whati
s
count
edi
sgover ngongoodsandser
nmentspendi vices,manyofwhi
char
e
boughtbyt
hegover
nmentonbehal
foft
hepubl
icandwhi
char
eul
ti
mat
ely
"
consumed"byhousehol
ds:educat
ion,heal
thcar
eser
vices,nat
ionaldef
ence,
r
oads,wat
erandsewagesyst
ems,post
alser
vices.Becausesomanyoft
hese
goodsandser
vicesar
epr
ovi
ded"
free"ori
not
herwayst
hatbypassmar
ket
s,i
t
i
sdi
ff
icul
ttodet
ermi
net
hei
rval
uei
nthesamewayt
hatt
heval
ueoft
heot
her
i
temsent
eri
ng i
nto C woul
d bedet
ermi
ned.Consequent
ly,nat
ionali
ncome
account
ant
sval
uegover
nmentspendi
ngont
hebasi
sofwhatt
hegover
nment
paysf
ort
hegoodsandser
vicesi
trequi
res.

Anot
hercompl
icat
ionwi
thgover
nmentspendi
ngongoodsandser
vicesi
sthat
suchspendi
ngi
sof
tendoneont
hingsl
ikehi
ghwayswhi
char
ethemsel
ves
capabl
eofbei
ngusedt
oassi
sti
nthepr
oduct
ionofot
hergoods.Logi
cal
ly,
such
spendi
ngshoul
dbet
houghtofasi
nvest
mentspendi
ngandi
ncl
udedi
nthenext
cat
egor
ytobedi
scussed.Somecount
ri
espr
oducet
hei
raccount
sinsucha
f
ormt
hatgover
nmentspendi
ngcanbesepar
atedi
ntot
wocat
egor
ies,cur
rent
spendi
ngongoodsandser
vices,andi
nvest
mentspendi
ng,buti
fthemai
n
concer
nist
ounder
standt
hecausesofyear
-t
o-yearcycl
icalf
luct
uat
ionsi
nthe
l
evelofnat
ionali
ncomer
athert
hant
hecausesofi
tsl
ongert
erm gr
owt
h(whi
ch
maybest
rongl
yaf
fect
edbyt
hel
evelofi
nvest
mentasopposedt
ocur
rent

1
7
spendi
ng)i
tisconveni
entt
ost
ickwi
tht
het
radi
ti
onalcat
egor
iesofspendi
ng
whi
chemphasi
zet
hedi
ff
erentmot
ivat
ionsdr
ivi
ngt
hespendi
ngdeci
sionsof
or
dinar
y consumer
s,pr
ivat
einvest
ors and gover
nment
s.Her
e,i
nvest
ment
spendi
ngr
efer
stopr
ivat
einvest
mentspendi
ngunl
essot
her
wisest
ated.

I
nvest
ment(
I)

I
nvest
menti
sthepr
oduct
ionofgoodst
hatar
enotf
ori
mmedi
ateconsumpt
ion.
Thegoodsar
ecal
ledi
nvest
mentgoods(
invent
ori
esandcapi
talgoodsi
ncl
udi
ng
r
esi
dent
ialhousi
ng)The t
otali
nvest
menti
n an economy i
s cal
led Gr
oss
I
nvest
ment
.

Wecountt
heconst
ruct
ionofnew housesaspar
tofGDP,butwedonotadd
t
radei
nexi
sti
nghouses.Wedohowever
,countt
heval
ueoft
heest
ateagent
s
commi
ssi
oni
nthesal
eofexi
sti
nghousesaspar
tofGDP.Theest
ateagent
pr
ovi
desacur
rentser
vicei
nbr
ingi
ngbuyerandsel
lert
oget
her
,andt
hati
s
appr
opr
iat
elypar
tofcur
rentout
put
.

Tot
alorgr
ossi
nvest
mentExpendi
tur
emaybedi
videdi
ntot
womai
ncat
egor
ies:

(
i) Expendi
tur
eoncapi
talgoods—pur
chasesofpl
antandequi
pmentei
ther
t
orepl
aceexi
sti
ngcapaci
tyt
hati
swear
ingoutort
oincr
easecapaci
ty.
Thi
sisof
tencal
ledf
ixedcapi
talf
ormat
ion.

(
ii
) Expendi
tur
e on i
nvent
ori
es.Many busi
nesses f
ind i
tconveni
entor
necessar
ytohol
dcer
tai
nsuppl
iesofgoodsonhand,i
nwhi
chcase
i
nvest
menti
ninvent
ori
esmaybeconsi
der
edvol
unt
ary.Butbusi
ness
condi
ti
onsar
euncer
tai
nandsof
ir
msmayal
sof
indt
hemsel
veshol
ding
st
ocksbecauset
heymi
scal
cul
ateddemand.I
nei
thercase,f
ir
msar
e
consi
der
edt
obei
nvest
ingwhent
heyaccumul
atei
nvent
ori
es.Ont
he
ot
herhand,
ift
hei
rinvent
ori
esdecr
easet
heyar
e"di
sinvest
ing.
"Invent
ory
i
nvest
ment i
s hi
ghl
y vol
ati
le, changi
ng gr
eat
ly i
n amount and
composi
ti
onf
rom yeart
oyear
.

Gr
ossi
nvest
ment
,then,i
sthet
otalamountof(
usual
lypr
ivat
e)spendi
ngdur
ing
t
heaccount
ingper
iodoncapi
talgoods(
def
inedasst
ruct
ures,machi
ner
yand

1
8
equi
pment
,andi
nvent
ori
es)
.Becausecapi
talbyi
tsnat
ureconsi
stsoft
hings
t
hatar
eusedi
nthepr
oduct
ionofot
hergoodsandser
vices,
iti
sinevi
tabl
ethati
t
wi
llwearoutor"
depr
eci
ate.
"Theamountnecessar
yforr
epl
acementi
scal
led
Depr
eci
ati
on or capi
tal consumpt
ion al
lowance. Gr
oss I
nvest
ment –
Depr
eci
ati
on=NetI
nvest
ment
.Unl
essi
tiscont
inual
lyr
enewed,t
hest
ockof
capi
tali
ntheeconomywi
llgr
adual
lybedepl
eted.

Handl
i
ngdepr
eci
ati
oni
soneoft
hemor
edi
ff
icul
tpar
tsofnat
ionali
ncome
account
ing.Agai
n,t
hebestt
reat
mentdependsonwhatt
hedat
aar
emeantt
obe
usedf
or.I
ftheconcer
niswi
tht
hel
ong-
ter
m gr
owt
hoft
heeconomy,net
i
nvest
ment(
tot
ali
nvest
mentdur
ingt
heaccount
ingper
iodmi
nusdepr
eci
ati
on)
i
sthei
mpor
tantconceptbecausei
tmeasur
est
hegr
owt
hoft
heeconomy’
s
capi
talst
ockovert
ime.Buti
fthepur
posei
stounder
standshor
tter
m,annual
f
luct
uat
ions i
nthe l
eveloft
otalspendi
ng i
tis bet
tert
o wor
k wi
th gr
oss
i
nvest
ment
.

NetExpor
ts(
X-M)

Asi
gni
fi
cantpar
toft
otalspendi
ngi
nmostcount
ri
esgoest
owar
dthepur
chase
ofgoodspr
oducedabr
oadr
athert
handomest
ical
ly.Asnot
edi
ndi
scussi
ngt
he
ci
rcul
arf
low,suchout
laysr
epr
esentspendi
ngwhi
chl
eaksf
rom t
hedomest
ic
economyt
other
estoft
hewor
ldandi
sconsequent
lyt
reat
edasanegat
iveent
ry
i
nmeasur
esoft
otaldomest
icspendi
ng.Buti
tisof
fsett
oagr
eat
erorl
esser
degr
eebyt
hespendi
ngofnon-
resi
dent
songoodspr
oducedandexpor
tedt
o
i
nter
nat
ionalmar
ket
s.I
tis of
ten conveni
ent
,ther
efor
e,t
otake domest
ic
spendi
ngoni
mpor
tsandf
orei
gnspendi
ngonexpor
tsasacombi
nedval
ue,
usual
lycal
lednetexpor
ts,aval
uewhi
chmaybeposi
ti
veornegat
ivei
nany
account
ingper
ioddependi
ngonwhi
chcomponent
,expor
tsori
mpor
ts,
isl
arger
.

Summi
ng t
hese f
ourexpendi
tur
e component
s,C+I
+G+(
X-M)
,gi
ves a si
ngl
e
f
igur
e,t
het
otalamountofspendi
ngdonei
ntheeconomydur
ingt
heaccount
ing
per
iod.I
tshoul
dbepossi
blet
oar
ri
veatexact
lyt
hesamef
igur
ebysummi
ngal
l
i
ncomer
ecei
vedi
ntheeconomydur
ingt
heaccount
ingper
iod. (
GDP=Y=
C+I
+G+(
X-M)
,

B.Measur
ingTot
alOut
putbyt
heI
ncomeMet
hod
Asseeni
ndi
scussi
ngt
heci
rcul
arf
low,whatt
hef
ir
mspr
oduci
ngt
henat
ional

1
9
out
putseeascost
sofpr
oduct
ion,
owner
sofpr
oduct
ivef
act
orsseeasi
ncome.
Fact
orcost
sandf
act
ori
ncomesar
econsequent
lyt
hesamet
hingvi
ewedf
rom
di
ff
erentper
spect
ives.

GDP=wages+r
ent
s+i
nter
est+non-
incomechar
ges

Quant
it
ati
vel
y,byf
art
hemosti
mpor
tantandcer
tai
nlyt
hesi
mpl
estf
act
orcost
s
t
omeasur
ear
ethepayment
smadebyempl
oyer
sforl
abourser
vices.These
payment
sar
eusual
lyr
epor
tedi
ntheof
fi
cialst
ati
sti
csunderaheadi
ngsuchas
"
Wages,sal
ari
es,and suppl
ement
aryl
abouri
ncome,
"wi
tht
he l
att
ert
erm
r
efer
ri
ng t
o empl
oyee benef
it
s such as pensi
ons,wor
ker
s’compensat
ion
benef
it
s,andempl
oyercont
ri
but
ionst
ounempl
oymenti
nsur
ancef
undsorot
her
wor
kersoci
alsecur
it
yschemes.Mostot
herf
act
orpayment
s,however
,ar
e
muchmor
edi
ff
icul
ttot
rack.Consi
deraf
armi
ngoper
ati
on.Howshoul
danynet
i
ncomeder
ivedf
rom f
armi
ngbecl
assi
fi
ed?Par
tofi
tmustbear
etur
ntot
he
ser
vicesofl
andt
hef
armeri
susi
ng(r
ent
).Par
tmustbear
etur
ntot
hef
armer
’s
owni
nputofl
abour(
wages)
.Par
tmi
ghtbeconsi
der
edar
etur
ntoset
ti
ngupand
oper
ati
ngt
hebusi
ness(
prof
it
).Thesear
edi
ff
icul
ttosepar
ate.Becauseofsuch
pr
obl
ems,t
henat
ionalaccount
stypi
cal
lyusedef
ini
ti
onsoff
act
orpayment
s
whi
chowemor
etoconveni
encet
hant
othel
ogi
coff
act
orcl
assi
fi
cat
ion:net
i
ncomeoff
arm oper
ator
s,cor
por
ati
onpr
ofi
ts,neti
ncomeofuni
ncor
por
ated
busi
ness,andi
nter
estandot
heri
nvest
menti
ncome.Summi
ngal
lthesei
tems
yi
eldst
het
otalamountr
ecei
veddur
ingt
heaccount
ingper
iodbyt
heowner
sof
pr
oduct
ivef
act
ors.Buti
fthi
sfi
gur
eforf
act
orcost
sori
ncomei
scompar
edwi
th
t
het
otalar
ri
vedatbyt
heexpendi
tur
emet
hod,i
tfal
lsconsi
der
abl
yshor
toft
he
amountexpect
ed.

I
ndi
rectt
axesandsubsi
diesr
esul
tinadi
scr
epancybet
weent
hemar
ketpr
ice
andt
hef
act
orcostofgoodsandser
vices.Themar
ketpr
iceofmostgoodsand
ser
vicesi
ncl
udesi
ndi
rectt
axes,
suchasgener
alsal
est
ax,
val
ue-addedt
axand
exci
set
axeswi
tht
her
esul
tthatt
hemar
ketpr
icei
sgr
eat
ert
hant
hepr
icet
he
sel
leroft
hegoodorser
vicer
ecei
ves.Ont
heot
herhand,subsi
diespai
dto
pr
oducer
stokeept
hemar
ketpr
iceofcer
tai
ngoodsandser
vicesl
owert
hani
t
woul
dot
her
wisebe,r
esul
tint
hepr
oducer
s’i
ncomebei
nggr
eat
ert
hant
he
mar
ketpr
ice.Tocal
cul
atet
heGDPatf
act
orcost
,i.
e.t
heamountr
ecei
vedby
t
hef
act
orsofpr
oduct
iont
hatpr
oducedt
hegoodsandser
vicesconcer
ned,we

2
0
t
her
efor
ehavet
odeducti
ndi
rectt
axesf
rom t
heGDPatmar
ketpr
icesandadd
backsubsi
dies.Thus:f
act
orcost≡ mar
ketpr
ice–i
ndi
rectt
axes+subsi
dies.
Thi
spoi
ntbecomesi
mpor
tantwhenr
elat
eGDPt
othei
ncomesr
ecei
vedbyt
he
f
act
orsofpr
oduct
ion.

C.Out
putAppr
oachort
heVal
ueAddedMet
hod
At
hir
dmet
hodi
savai
labl
eforest
imat
ingt
het
otalout
putoft
heeconomyandi
t
i
scal
ledt
he"
val
ueaddedmet
hod"becausei
tsi
mpl
ysumst
henetval
ueoft
he
out
putpr
oducedbyal
lthef
ir
msi
ntheeconomy.GDPi
stheval
ueoff
inalgoods
andser
vicespr
oduced.Thei
nsi
stenceonf
inalgoodsi
ssi
mpl
ytomakesur
e
t
hatwedonotdoubl
ecountThi
sappr
oachmeasur
esGDPi
nter
msofval
ues
addedbyeachoft
hesect
orsoft
heeconomy.Thi
sisconcept
ual
lysi
mpl
e,buti
n
pr
act
icecompl
exbecauseoft
heneedt
oavoi
ddoubl
ecount
ing.Ther
ear
emany
i
nter
act
ionsamongf
ir
msi
namoder
neconomy.Manypr
oducegoodst
hatar
e
sol
dnott
ofi
naluser
sasconsumergoods,butt
oot
herf
ir
ms.Consi
deraf
ir
m
pr
oduci
ng powersuppl
ydevi
ces f
orcomput
ers.I
tbuys component
sfr
om
suppl
i
ers,
assembl
est
hem,
andsel
lst
hef
ini
shedpr
oductt
oanot
herf
ir
m whi
ch
i
ncor
por
ates i
tint
o a comput
er.I
fthe val
ue oft
he powersuppl
ies was
measur
edwhent
heywer
epr
oducedandagai
naspar
toft
hepr
iceoft
he
f
ini
shedcomput
er,t
otalout
putwoul
dobvi
ousl
ybeexagger
ated.Deal
ingwi
th
t
hisr
equi
rest
hatt
heval
ueofeachf
ir
m’sout
putber
educedbyt
heamountofal
l
payment
smadebyt
hatf
ir
mtoobt
aini
nput
s.Thi
sinvol
vesconsi
der
abl
ewor
k,
butt
her
esul
ti
ngdat
aar
eof
tenver
yusef
ulbecauset
heyyi
eldabr
eakdownof
nat
ionalout
putonani
ndust
ry-
by-
indust
rybasi
s.I
nfor
mul
ater
ms:

Val
ueAdded=out
putoff
ir
m -out
putpur
chasedf
rom ot
herf
ir
ms.

I
fwef
oll
owt
hecour
seoft
hispr
ocess,
wewi
llseet
hatt
hesum ofval
uesadded
ateachst
ageofpr
ocessi
sequalt
othef
inalval
ueoft
hei
tem sol
d.Val
ueadded
i
sal
sot
hebasi
sfort
heVal
ueaddedTax(
VAT)
.

Apr
obl
em associ
atedwi
tht
heval
ueaddedappr
oachi
sval
uat
ionofi
nvent
ori
es
ofgoodspr
oducedbutunsol
d.Unsol
dinvent
ori
esar
eval
uedatmar
ketpr
ices
yetpr
ofi
ts(orl
osses)havenotbeenr
eal
ised;pr
icesmayf
allorr
ise;goodsmay

2
1
notbesol
d.Thi
smeanst
hatar
isei
nmar
ketpr
icescausesar
isei
nval
ueoft
he
exi
sti
ngi
nvent
ori
es.Toavoi
dthi
sdi
stor
ti
onacor
rect
ioni
smadet
oel
imi
nat
e
changes i
nthe val
ue ofi
nvent
ori
es due t
o pr
ice changes;t
hati
s st
ock
appr
eci
ati
onshoul
dbededuct
edf
rom t
heval
ue.

Thet
abl
ebel
owsummar
izest
her
elat
ionshi
ps.Forexampl
efr
om t
het
hir
dand
f
our
thcol
umnsNNPatmar
ketpr
ices–i
ndi
rectt
axesaddsubsi
dies=nat
ional
i
ncomeatf
act
orcost
.
Netfact
or
payments

Depr
eci
ati
on

Indir
ect
taxes
GDPat GNP l
ess
market atmarket subsidi
es
pr
ices pri
ces NNPat
market National Vari
ous*
pr
ices Income i
tems
at
factor Per
sonal Personal
cost I
ncome Tax
Personal
Disposabl
e
i
ncome
*i
ncl
udesi
ncomet
hatdoesnotaccr
uet
oper
sonalsect
ore.
g.cor
por
atet
axat
ionandcor
por
atesavi
ng

UsesofNat
ionalI
ncomeAccount
ing

1.Assi
sts gover
nmenti
n pl
anni
ng t
he economy.The account
s wi
llshow
gr
owt
horst
agnat
ioni
ntheeconomy,al
ert
ingpol
icymaker
stot
hesor
tof
act
ionwhi
choughtt
obet
aken.Si
ncenat
ionali
ncomeaccount
sbr
eakt
he
per
for
manceoft
heeconomydowni
ntoi
tscomponentpar
ts,t
heypr
ovi
de
pol
icymaker
s wi
th speci
fi
cinf
ormat
ion r
egar
ding t
he f
ormul
ati
on and
appl
icat
ionofeconomi
cpol
icy.

2.Per
mit
sust
omeasur
ethel
evelofpr
oduct
ioni
ntheeconomyoveragi
ven
per
iod oft
ime and t
o expl
aint
he i
mmedi
ate causes oft
hatl
evelof
per
for
mance.

2
2
3.Bycompar
ingt
henat
ionali
ncomeaccount
soveraper
iodoft
ime,t
hel
ong-
r
uncour
sewhi
cht
heeconomyhasbeenf
oll
owi
ngcanbepl
ott
ed.

4.Tocompar
est
andar
dsofl
ivi
ngofdi
ff
erentcount
ri
es-t
hepr
obl
em i
sthe
count
ri
esbei
ngcompar
edusedi
ff
erentcur
renci
es.Thesi
mpl
estmeansof
deal
ingwi
tht
hepr
obl
em i
stouset
heExchanger
atesbet
weencount
ri
est
o
conver
ttheGNP ofeachnat
iont
oacommoncur
rencye.
g.US$.Most
i
nter
nat
ionalcompar
isonsuset
hismet
hod.Thesecondmet
hodusedi
s
Pur
chasi
ng PowerPar
it
y.(
a)Exchange r
ate conver
sion-t
he met
hod i
s
si
mpl
eandst
rai
ght
for
war
dbutt
hisdoesnotmeetourneedsf
ull
y.Wear
e
seeki
ng t
o measur
edi
ff
erencesi
n st
andar
d ofl
ivi
ng among ar
eas,but
exchanger
ater
efl
ect
spur
chasi
ngpowerofcur
renci
esf
orgoodst
radedi
n
i
nter
nat
ionalmar
ket
s.Goodsandser
vicesnott
radedoni
nter
nat
ionalmar
ket
maynotbecor
rect
lyt
akeni
ntoaccount
.(b)Pur
chasi
ngpowerpar
it
y-t
he
met
hodi
nvol
vesdet
ermi
nat
ionoft
her
elat
ivepur
chasi
ngpowerofeach
cur
rencybycompar
ingt
heamountofeachcur
rencyr
equi
redt
opur
chasea
common bundl
e ofgoods and ser
vices i
nthe domest
ic mar
ketoft
he
cur
rency’
scount
ryofor
igi
n.Thi
sinf
ormat
ioni
sthenusedt
oconver
tthe
GNP of each nat
ion t
o a common monet
ary uni
t.Est
imat
es usi
ng
Pur
chasi
ng Power Par
it
y met
hod ar
e a mor
e accur
atei
ndi
cat
or of
i
nter
nat
ionaldi
ff
erencesi
npercapi
taGNPt
hanexchanger
ateconver
sion
met
hod.

5.Asameasur
eofwel
far
eandnat
ionaldevel
opment
,GNPpercapi
tamaybe
r
isi
ng overa per
iod oft
ime i
mpl
ying a r
ise i
n economi
c wel
far
e and
economi
cdevel
opment
.Cr
it
ici
smsi
ncl
udet
hef
oll
owi
ng-out
putofweaponr
y
mayr
ise,cr
imemayr
ise(
useofmor
epol
ice)
,mot
orvehi
clepr
oduct
ion
(
mor
epol
lut
ion)mayal
sor
ise(
showi
ngi
ncr
easi
ngGNP)yeti
nter
mst
he
peopl
ear
enotbet
terof
forevenwor
seof
f.Out
putmayal
sohavebeenof
capi
talgoods.GNPpercapi
tagi
vesnoi
ndi
cat
ionofhownat
ionali
ncomei
s
act
ual
lydi
str
ibut
edandwhoi
sbenef
it
ingf
rom gr
owt
hofpr
oduct
ion.A
r
isi
ngl
evelofabsol
uteandpercapi
taGNPmayobscur
ether
eal
it
ythatt
he
poorar
eno bet
terof
fthan bef
ore.Asan i
ndexofi
mpr
oved economi
c

2
3
 wel
far
eGNP gr
owt
hrat
esar
einadequat
efort
hegener
ali
ty.Despi
tei
ts
shor
tcomi
ngs, GNP pr
ovi
des a usef
ul measur
e especi
all
y i
fiti
s
accompani
ed by i
ndi
cat
orsl
ike l
if
e expect
ancy,i
nfantmor
tal
it
yrat
es,
educat
ion,
li
ter
acyandi
ncomedi
str
ibut
ion.

6.For sol
ici
ti
ng i
nter
nat
ional ai
d f
rom ot
her count
ri
es or mul
ti
lat
eral
or
gani
zat
ions.

7.Nat
ionali
ncome and pr
oductest
imat
es bysect
orofor
igi
n ofnat
ional
pr
oductr
eveal
cont
ri
but
ionsmadebydi
ff
erentsect
orsoft
heeconomy.

PROBLEMSOFGDPMEASUREMENT
GDPdataar
efarf
rom per
fectmeasur
esofei
thereconomi
cout
putorwel
far
e.
Pr
obl
emsofGDPmeasur
ementar
e:
(
1)Badl
ymeasur
edout
put
s-someout
put
sdonotgot
hrought
hemar
ket
,e.
g.
gover
nmentout
put(
suchasdef
ence)i
snotsol
dint
hemar
ket
.Al
sot
her
eis
not
hingcompar
abl
eavai
labl
ethatwoul
dmakei
tpossi
blet
oest
imat
ethe
val
ueofgover
nmentout
put
.Iti
sther
efor
eval
uedatcost
.Ot
hernon-
mar
ket
act
ivi
ti
es,i
ncl
udi
ngdo-
it
-your
sel
fwor
kandvol
unt
eeract
ivi
ti
es,ar
eal
so
excl
udedf
rom GDP.
(
2)Unr
ecor
dedeconomy-manyt
ransact
ionst
hatgot
hrought
hemar
ketescape
measur
ement
.e.
g.paymentf
orahandyman’
sser
vicesi
snotr
ecor
dedi
nthe
GDPdat
aasi
tisunl
ikel
ytobedecl
ared,i
ll
egalt
raf
fi
cindr
ugs.Themai
n
pr
obl
em i
sthatt
her
elat
ivei
mpor
tanceofsuchact
ivi
ti
esmayhavebeen
changi
ng.I
fsuch act
ivi
ti
es become mor
eimpor
tantovert
ime ,t
hen
measur
edr
ealGDP wi
llunder
stat
ether
ateofgr
owt
hoft
otaleconomi
c
act
ivi
ty.Whyt
her
emi
ghthavebeenani
ncr
easei
nunr
ecor
dedt
ransact
ions
(
i)r
isi
ngt
axr
ates(
whi
chmakei
tmor
etempt
ingnott
odecl
aresal
esor
i
ncome,
)andt
hegr
owi
ngi
mpor
tanceoft
hesocal
ledi
nfor
malact
ivi
ti
es
out
sidet
hemoder
nsect
oroft
heeconomy.
(
3)Dat
arevi
sions-whent
heyf
ir
stappear
,GDPdat
aar
enotf
ir
m est
imat
es.The
r
easoni
sthatmanyoft
hedat
aar
enotmeasur
eddi
rect
ly,butar
ebasedon
sur
veysandguesses.Consi
der
ingt
heGDP i
ssupposedt
omeasur
ethe
val
ueofal
lpr
oduct
ionofgoodsandser
vicesi
ntheeconomy,i
tisnot

2
4
 sur
pri
singt
hatnotal
lthedat
aar
eavai
labl
ewi
thi
naf
ew weeksaf
tert
he
per
iodofpr
oduct
ion.Thedat
aar
erevi
sedasnew f
igur
escomei
n,ast
he
CSOandRBZi
mpr
ovet
hei
rdat
acol
lect
ionmet
hodsandest
imat
es.

Adj
ust
ingNat
ionalI
ncomeDat
atoAl
lowf
orPr
iceChanges

Onedi
ff
icul
tywi
thusi
ngmoneyval
uest
oexpr
essnat
ionalaccount
ing
magni
tudesi
sthatt
heval
ueofmoneymaychangeovert
ime.I
fther
eisa
gener
alr
isei
nal
lpr
ices,
oraf
alli
nal
lpr
ices,
themonet
aryuni
tei
therdecr
eases
ori
ncr
easesi
nval
ue.Tr
yingt
omeasur
edi
stancewi
thar
ulert
hatshr
ankor
expandedsi
gni
fi
cant
lybet
weenmeasur
ement
swoul
dobvi
ousl
ybeaf
rust
rat
ing
andnotver
yusef
ulact
ivi
ty.I
nfl
ati
on,
def
inedasagener
alr
isei
nthepr
icel
evel
,
ordef
lat
ion,
agener
alf
alli
nthepr
icel
evel
,ar
ecommonenought
omakei
t
necessar
ytoadj
ustnat
ionali
ncomedat
ator
emovet
heef
fectofchangesi
nthe
pur
chasi
ngpoweroft
hedol
larorot
hermonet
aryuni
tbei
ngusedt
omeasur
e
t
heval
ueoft
otal
out
put
.Thi
sisdonebydevel
opi
ngi
ndexeswhi
chshowhow
t
hepr
icesoft
hegoodsandser
vicespr
oducedi
nanyoneyearhavechanged
r
elat
ivet
othepr
icesoft
hosegoodsandser
vicesi
nsomeot
heryear
.Set
ti
ngup
t
hesei
ndexesofpr
icesi
snotdi
ff
icul
tinpr
inci
ple,
alt
houghi
tcanbean
expensi
ve,
time-
consumi
ngt
aski
npr
act
ice.Consi
derasi
mpl
eexampl
ein
whi
chonl
yasi
ngl
ecommodi
tyi
sthesubj
ectofi
nter
est
,men’
sshoes.I
nthe
f
oll
owi
ngt
abl
ethepr
iceofmen’
sshoesi
neachyeari
scompar
edwi
tht
hepr
ice
pr
evai
li
ngi
nonepar
ti
cul
aryear
.Thebaseyeari
ntheexampl
eisyear2000,
(thi
s
canbewr
it
tenas2000=100)al
thoughi
tcoul
dhavebeenanyoneoft
hef
ive
year
s.Thepr
icei
nanypar
ti
cul
aryeari
sthendi
videdbyt
hepr
icei
nthebase
yeart
ogett
her
ati
oofpr
icesshowni
nthet
hir
dcol
umn.Becauset
heser
ati
os
ar
eusual
lyexpr
essedasper
cent
ages,
theyar
ethenmul
ti
pli
edby100t
oobt
ain
t
hepr
icei
ndexnumber
sshowni
nthel
astcol
umn.

Year 1999 2000 2001 2002 2003

2
5
 Pr
ice(
$) 20 40 50 60 80

Pr
iceRat
io 20/
40=0.
5 40/
40=1 50/
40=1.
25 60/
40=1.
5 80/
40=2

Pr
iceI
ndex 50 100 125 150 200

Thesei
ndexnumber
scannowbeusedt
oadj
ustt
hedat
aont
heval
ueofmen’
s
shoespr
oducedi
neachyear
,ther
ebyel
imi
nat
ingt
heef
fectofpr
icechanges
f
rom t
heser
ies.Supposet
hef
oll
owi
ngpr
oduct
ioni
nfor
mat
ioni
savai
labl
e.

Year 1999 2000 2001 2002 2003

Out
puti
nCur
rent$ 5 20 30 50 90

Out
put i
n 10 20 24 33.
3 45
Const
ant
$

Thecur
rentdol
larval
uesshowni
nthesecondcol
umnt
urnoutt
obequi
te
mi
sleadi
ngasani
ndi
cat
oroft
her
ealchangesi
nout
put
.Becausepr
iceswer
e
l
oweri
nYear1999t
hani
nthebaseyear(
Year2000)
,theout
puti
nYear1999
wasunder
stat
ed,wher
eas,becausepr
icesi
nYear
s2000,2001,and2003wer
e
hi
ghert
hani
nthebaseyear
,thecur
rentdol
larpr
oduct
ionval
uesover
stat
edt
he
vol
umeofout
put
.Theconver
siont
o(Year2000)const
antdol
lar
sint
het
hir
d
col
umnwasdonebydi
vidi
ngt
hecur
rentdol
larval
uesofout
putf
oreachyearby
t
her
elevanti
ndexnumber(
expr
essedasaper
cent
age)
.

Men’
sshoesar
eonl
yoneoft
housandsofcommodi
ti
eswhi
char
eincl
udedi
n
t
het
otalnat
ionali
ncomeand,i
npr
act
ice,i
tisnotf
easi
blet
odevel
oppr
ice
i
ndexesf
oreachi
tem i
nthi
sway.I
nst
ead,pr
icei
ndexesar
ebui
ltupf
orgr
oups

2
6
ofcommodi
ti
es whi
ch ar
e of
ten def
ined i
nter
ms ofwho buys t
hem.For
exampl
e,a commonl
y used i
ndex measur
es changes i
n t
he amount
s
househol
dsspendonasel
ect
edbundl
eofgoodsandser
vices.Oneoft
he
pr
obl
emswi
tht
hiski
ndofi
ndexi
sthati
tisver
ycost
lyt
odet
ermi
newhi
ch
goods shoul
d be i
ncl
uded i
n such a bundl
e.Sur
veys mustbe made of
househol
dbuyi
nghabi
tst
odet
ermi
newhi
chgoodshousehol
dsar
ebuyi
ngi
n
si
gni
fi
cantquant
it
iesandt
her
elat
ivei
mpor
tanceofvar
iousgoodsi
ntypi
cal
househol
dbudget
s.Becauseoft
his,
year
smayel
apsebet
weenr
edef
ini
ti
onsof
t
hegoodswhi
char
eincl
udedi
nthei
ndexwhi
chmakest
hei
nfor
mat
iont
he
i
ndexpr
ovi
desofdubi
ousval
uet
owar
dtheendoft
her
edef
ini
ti
oncycl
e.

Whenconst
ruct
ingl
argepr
icei
ndexesf
oradj
ust
ingnat
ionali
ncomedat
a,most
st
ati
sti
calagenci
esbui
ldupagener
ali
ndexf
rom al
argenumberofspeci
fi
c
commodi
tygr
oupi
ndexes,sot
hatchangesi
nexpendi
tur
epat
ter
nswi
thi
nthe
componentgr
oupswi
llnotser
iousl
yaf
fectt
heout
come.Thi
scomposi
tei
ndex
i
sknownasagr
ossdomest
icpr
oductdef
lat
or.I
tcanbeusedt
oconver
tany
cur
rentdol
larval
ueofgr
ossdomest
icpr
oductt
oaconst
antdol
larbasi
susi
ng
t
her
elat
ion:

Nomi
nalGDP/
RealGDPx100=GDPDef
lat
or
GDPpr
icedef
lat
ori
sani
ndexcal
cul
atedf
rom nomi
nalandr
ealGDP.Thus,
if
t
hedef
lat
ori
sknownt
ohaveaval
ueof125andnomi
nal(
cur
rentdol
lar
)gr
oss
domest
ici
ncomei
s50bi
ll
iondol
lar
s,r
ealgr
ossdomest
ici
ncomei
s$40bi
ll
ion.

Themeasurementofpercapi
taincome
Al
lcount
ri
es have adopt
ed t
he conventi
ons (
the Uni
ted Nat
ions St
andar
d
Nat
ionalAccount
s)f
ort
hecal
cul
ati
onsofGr
ossNat
ionalPr
oduct(
GNP)and
Gr
ossDomest
icPr
oduct(
GDP)
,andGNPorGDPpercapi
tai
sthecommonest
i
ndi
cat
oroft
hel
evelofdevel
opment
.Economi
cgr
owt
href
erst
oani
ncr
easei
n
ei
theroft
hesei
ndi
cat
ors.Ther
ear
ehoweverwel
lknownpr
obl
emsassoci
ated
wi
tht
hecal
cul
ati
onofnat
ionali
ncomei
npoorcount
ri
esandi
tsuseasan
i
ndi
cat
orofdevel
opment
:

1.Thenecessar
ydat
aar
eof
teni
ncompl
ete,
unr
eli
abl
eornotavai
labl
e

2
7
 2.Theaccount
ingconvent
ionsar
enotnecessar
il
yappr
opr
iat
e;t
heser
vices
ofwomenwor
kingi
nthehousehol
dar
eexcl
udedf
rom nat
ionalst
ati
sti
cs
yeti
nmanypoorcount
ri
es,especi
all
yinsub–Sahar
anAf
ri
ca,women
ar
eof
tenr
esponsi
blef
orr
unni
ngt
hef
ami
lyf
arm aswel
laswor
kingi
n
t
hehousehol
d.
3.I
nmostpoorcount
ri
es,t
her
eisal
argesubsi
stencesect
or– t
hati
s,
f
armer
smaywel
lconsumeal
lorl
argepr
opor
ti
onofwhatt
heypr
oduce,
r
athert
hansendi
ngi
ttot
hemar
ketwher
eitwoul
dbecount
edf
ort
he
pur
poses of cal
cul
ati
ng nat
ional i
ncome. St
ati
sti
cians make an
al
lowancef
ort
hisnon-mar
ket
edcomponentofout
put
,andf
orr
ural
capi
talf
ormat
ion t
hatmaynotent
ert
henat
ionalaccount
s– house
bui
ldi
ng,i
rr
igat
iondi
tches–buti
tisgener
all
yaccept
edt
hatt
heval
ueof
t
heact
ivi
ti
esi
sunder
est
imat
ed,t
husbi
asi
ngdownwar
dst
henat
ional
i
ncomef
igur
esf
orpoorcount
ri
es.
4.I
ncomemaybeover
stat
edf
ordevel
opedeconomi
esbecauseanumber
ofi
temst
hatar
eincl
udedasi
ncomemi
ghtbet
terbeseenascost
sand
henceexcl
udedf
rom i
ncome-t
hecostoft
ravel
li
ngt
owor
k,f
orexampl
e,
ort
hecostofheat
ingt
hehomei
ntemper
atecl
imat
es.
5.Percapi
ta(
aver
age)i
ncomest
ellusnot
hingaboutt
hedi
str
ibut
ionof
i
ncome.Twocount
ri
eswi
thsi
mil
arpercapi
tai
ncomedi
str
ibut
ions,wi
th
i
mpor
tanti
mpl
icat
ionsf
ort
hewel
far
eoft
hei
rpopul
ati
onsandt
henat
ure
andchar
act
eri
sti
csoft
hedevel
opmentpr
ocess.

Si
gni
fi
cantpr
obl
emsar
isewheni
nter
nat
ionalcompar
isonsofi
ncomel
evel
sar
e
made.I
ncomedat
ameasur
edi
nnat
ionalcur
renci
eshavet
obeconver
tedi
ntoa
commoncur
rency,
usual
lyt
heUSdol
lar
,andanexchanger
atemustbechosen.
I
fpoorcount
ri
esar
ti
fi
cial
lymai
ntai
nover
val
uedexchanger
ates(
thati
s,t
he
pr
iceoff
orei
gncur
renci
esi
nter
msoft
hei
rdomest
iccur
rencyi
stool
ow)
,thi
s
wi
llover
stat
ethei
ncomeoft
hecount
ryexpr
essedi
nUSdol
lar
s.Of
fset
ti
ngt
his,
however
,ist
hef
actt
hatmanygoodsandser
vicesi
npoorcount
ri
esar
enot
t
raded and hence have no i
mpacton t
he exchange r
ate.Many oft
hese

2
8
necessi
ti
esofl
if
einpoorcount
ri
es–basi
cfoodst
uff
sforexampl
e-ar
ever
ylow
pr
icedi
ndol
l
art
erms,
andahai
rcuti
nZi
mbabwewi
llcostl
esst
hanonei
nPar
is
orLondon.

Accor
dingt
oWor
ldBankdat
a:
 Mozambi
quewi
thanest
imat
edGNPpercapi
taofUS60i
n1992wast
he
poor
estcount
ryi
nthewor
ld;
 Swi
tzer
land,
wit
haGNPpercapi
taofUS$36080,
wast
her
ichest

I
stheaver
ageSwi
ssci
ti
zen600t
imesbet
terof
fthant
heaver
ageMozambi
can?
Toputt
hatquest
ionsl
ight
lydi
ff
erent
ly,doesi
tmakesenset
ost
atet
hati
n
Mozambi
que,
onaver
age,
peopl
eli
veon16cent
saday?
Cl
ear
lynobodyi
nadevel
opedeconomycoul
dsur
viveonsuchal
ow i
ncome.
Gi
vent
hatt
hemaj
ori
tyofMozambi
cansdosur
vive,
itmustbet
hecaset
hatt
he
necessi
ti
esessent
ialf
orsur
vivalcostl
essi
nMozambi
quet
hanf
orexampl
ein
Swi
tzer
land,and/or$60i
snotameani
ngf
ulest
imat
eofpercapi
tai
ncomei
n
Mozambi
que.Thi
sisnott
odenyt
hatahugegapexi
stsbet
weent
heaver
age
i
ncomesofver
yri
chandver
ypoorcount
ri
es,norshoul
ditl
essenourconcer
n
wi
thsuchi
nequal
it
ies.Buti
tdoesmeant
hatt
hegaponaver
agei
snotasgr
eat
ast
hest
ati
sti
cswoul
dsuggestandanumberofat
tempt
shavebeenmadet
o
comput
emor
emeani
ngf
ulcompar
isons.

Measur
ementoft
heSt
andar
dofLi
ving
Theval
ueoft
hisyear
'snat
ionali
ncomei
sausef
ulmeasur
eofhow wel
l-
offa
count
ryi
sinmat
eri
alt
erms.However
,inf
lat
ioni
ncr hemoneyval
easest ueof
nat
ionali
ncomebutdoesnotpr
ovi
deuswi
thanymor oconsume.Real
egoodst
nat
ionali
ncomei
sfoundbyappl
yingt
heequat
ion:

Realnat
ionali
ncome=Moneynat
ionali
ncome/
Ret
ailpr
icei
ndexx100.
Thest
andar
dofl
ivi
ngr
efer
stot
heamountofgoodsandser
vicesconsumedby
househol
dsi
noneyearandi
sfound

(
i)byappl
yingt
heequat
ion:

2
9
 St
andar
dofl
ivi
ng=Realnat
ionali
ncome/Popul
ati
on=nat
ionali
ncomeper
capi
ta
Ahi
ghst
andar
dofl
ivi
ngmeanshousehol
dsconsumeal
argenumberofgoods
andser
vices. Or

(
ii
)bycount
ingt
heper
cent
ageofpeopl
eowni
ngconsumerdur
abl
essuchas
car
s,t
elevi
sions,et
c.Ani
ncr
easei
nowner
shi
pindi
cat
esani
mpr
ovedst
andar
d
ofl
ivi
ng.Or

(
ii
i)bynot
inghowl
onganaver
ageper
sonhast
owor
ktoear
nenoughmoneyt
o
buycer
tai
ngoods.I
fpeopl
ehavet
owor
klesst
imet
obuygoods,
thent
her
ehas
beenani
ncr
easei
nthest
andar
dofl
ivi
ng.

I
nter
pret
ati
onoft
heSt
andar
dofLi
ving
Ani
ncr
easei
nthest
andar
dofl
ivi
ngmaynotmeanabet
terl
if
e-st
ylef
ort
he
maj
ori
tyi
f:

 Onl
yasmal
lmi
nor
it
yofweal
thypeopl
econsumet
heext
ragoods.
 I
ncr
easedout
putofcer
tai
ngoodsr
esul
tsi
nmor
enoi
se,congest
ionand
pol
lut
ion.
 Lei
sur
eti
mei
sreducedt
oachi
evet
hepr
oduct
ioni
ncr
ease.
 Ther
eisani
ncr
easei
ntheamountofst
ressandanxi
etyi
nsoci
ety.
CommonMi
sunder
standi
ng
1.Thevariousmeasur esoft henat i
onalproductgiveusat all
yoft henation’
s
i
ncomef orayear .Howevert hisdoesnotmeasur ethenat i
on’swealth.The
nati
onhasgr eatst ockofcapi talgoods.Thest ockofnat ionalcapit
alisthe
sum totalofever ythi
ngt hathasbeenpr eservedf r
om al lthathasbeen
produced t hroughoutoureconomi c history.Interesti
ngl y,perhaps the
great
estassetofmoder n economi esi st heski l
land educat ion ofthe
workforce.Thi si
scal led‘humancapi tal
’ butisnoti ncludedi nmeasur esof
netcapitalstockowi ngt odiff
icult
yofmeasur ement .
2. I
fwear
eassessi
ngsomeone’
sweal
th,
oneoft
hef
ir
stt
hingswewoul
dlook
ati
showmuchmoneyt
heyhadandwhet
hert
heyownedst
ockandshar
es.
Howevert
hesear
eexcl
udedf
rom t
hecal
cul
ati
onofnat
ionalweal
th.Why?
Theansweri
sbecausewehaveal
readycount
edt
hem i
nthef
orm ofr
eal

3
0
 weal
thsuchasbui
l
dingsandmachi
nes.Moneyandot
herf
inanci
alasset
s
ar
eonl
ycl
aimsuponweal
thandhencear
esi
mpl
ypapercer
ti
fi
cat
esof
owner
shi
p.Si
mil
arl
y,var
yingt
heamountofmoneyi
ntheeconomydoes
notdi
rect
lymakei
tanyr
icherorpoor
er.

DETERMI
NATI
ONOFEQUI
LIBRI
UM NATI
ONALI
NCOME

Equi
li
bri
um i
sthatposi
ti
oni
nwhi
cht
heopposi
ngf
orcesofchangear
ein
bal
ance.I
nat
wosect
ori
ncomeequi
li
bri
um equat
ioni
sY=C+Iwher
eC=a+
bYe.
g.50+0.
75Y

Accor
dingt
oKeynesi
ant
heor
yofi
ncomeandempl
oyment
,nat
ionali
ncome
dependsupont
heaggr
egat
eef
fect
ivedemand.I
faggr
egat
edef
fect
ivedemand
f
all
sshor
toft
heout
putatwhi
chal
lthoseabl
eandwi
ll
ingt
owor
kar
eempl
oyed,
unempl
oymenti
ntheeconomywi
llr
esul
t.Consequent
lyt
her
ewi
llbeagap
bet
weeneconomy’
sact
ualandopt
imum pot
ent
ialout
put
.Ont
hecont
rar
yift
he
aggr
egat
eef
fect
ivedemandexceedst
heeconomy’
sful
lempl
oymentout
put
i
nfl
ati
onwi
llr
esul
t.
Equi
li
bri
um aggr
egat
eincomeandout
puti
sdet
ermi
nedatt
hatpoi
ntatwhi
ch
t
otalexpendi
tur
eoraggr
egat
edemandf
unct
ionC+I+G+(
X-M)cut
sthe450
equal
it
yli
ne (
Expendi
tur
e= I
ncome)
.N.
B.Equi
li
bri
um does notmean f
ull
empl
oymentout
put
.

MULTI
PLI
ERS
Whent
her
eisani
ncr
easei
nthel
evelofi
nject
ions,
par
tofi
twi
llber
ecei
vedbya
househol
dasext
rai
ncome.Thehousehol
dswi
llpr
obabl
yactsot
hatpar
toft
his
ext
rai
ncomei
sthenspentandpar
tissaved.Thi
sext
raconsumerspendi
ng
t
hengi
vesr
iset
oaser
iesoff
urt
heri
ncomesandexpendi
tur
es.Theover
all
i
ncr
easei
nspendi
ngi
smuchhi
ghert
hant
hei
nit
iali
nject
ion.Thi
sef
fecti
s
knownast
hemul
ti
pli
eref
fect
.Thegr
eat
ert
hepr
opor
ti
onoft
heext
rai
ncome

3
1
t
hati
sspent(
theMar
ginalPr
opensi
tyt
oConsume)
,thebi
ggert
hemul
ti
pli
er
ef
fectwi
llbe.Themul
ti
pli
eri
sdef
inedast
her
ati
ooft
hechangei
nnat
ional
i
ncomet
othechangei
nexpendi
tur
ethatbr
oughti
tabout
.Thechangei
n
expendi
tur
e mi
ghtcome f
rom f
orexampl
e pr
ivat
einvest
ment(
invest
ment
mul
ti
pli
er)orgover
nmentexpendi
tur
e(gover
nmentexpendi
tur
emul
ti
pli
er)or
expor
ts(
expor
tsmul
ti
pli
er)
.Ifwel
etkbet
hemul
ti
pli
er;

I
nvest
mentMul
ti
pli
er
I
nvest
mentMul
ti
pli
erki

Tocl
ari
fyt
hei
nvest
mentmul
ti
pli
ersupposi
ngt
her
eisani
nject
ionof$120m t
o
bui
ldf
act
ori
esandot
hercapi
talgoods.Thei
mpactoft
hisi
nvest
mentwi
llbe
mor
ethant
he$120m i
nit
ial
lyi
nvest
ed.The$120m spenti
sthusi
ncomet
o
t
hosewhosuppl
iedt
heequi
pment
,resour
ceset
c.How muchoft
his$120m
whi
chhasbeenr
ecei
vedasi
ncomewi
llbespentdependsont
hekeennessof
t
her
eci
pient
stospendi
t,i
not
herwor
dst
hei
rmar
ginalpr
opensi
tyt
oconsume.
Mar
ginalPr
opensi
tyt
o consume(
MPC)woul
dthusbet
hef
ract
ion oft
he
i
ncomel
ikel
ytobespent
.Ofal
lincomeear
nedpar
twi
llbespent
,par
twi
llbe
consumed,
ie.Y=C+S
Consumpt
ion/I
ncomeear
ned=MPC=Mar
ginalPr
opensi
tyt
oConsume

AmountSavedorAmountear
nedori
ncome=MPS(
Mar
ginalPr
opensi
tyt
o
Save)andt
her
efor
eMPC+MPS=1.Assumi
ngamar
ginalpr
opensi
tyof2/
3,
t
hen$80m oft
he$120m wi
llbespenti
nthenextst
age.I
nthenextst
ageoft
he
$80m i
ncome,$53m wi
llbeconsumed.Thegr
eat
ert
heMPCt
hegr
eat
ert
he
i
ncomet
hati
sconsumedhencet
hegr
eat
ert
heamountspentatsubsequent
st
ages.Tocal
cul
atet
hemul
ti
pli
er

3
2
ki=1/
(1-
MPC)=1/
MPS.Fr
om t
heexampl
eaboveki=1/
(1-
2/3)=1/(
1/3)
=3.
Thegr
eat
ert
heMPC t
hegr
eat
ert
hemul
ti
pli
er.Thi
smeanst
hatt
het
otal
i
ncr
easei
nthenat
ionalpr
oductbr
oughtaboutbyt
hei
nvest
mentofani
nit
ial
sum of$120m i
s$360m.

Thi
sanal
ysi
sassumesawayt
axat
ionandal
sopr
icei
ncr
easesduet
ohi
gh
demandf
orgoodsandser
vices.I
mpor
tshaveal
sonotbeent
akeni
ntoaccount
.
I
nreal
it
yoncedemand i
ncr
easespr
icesmayst
abi
li
zef
orashor
twhi
lei
f
f
act
ori
eshavebeenoper
ati
ngatl
esst
hanf
ullcapaci
tybutwhent
hathappens,
i
.e.f
ullcapaci
tyi
sreachedpr
icesst
artt
ori
se.Ther
isewi
llal
sodependon
whet
hert
heeconomyi
sinwar
dlooki
ngorout
war
dlooki
ngi
nter
msofr
aw
mat
eri
ali
nput
s.I
finput
sar
eimpor
tedt
hispushesuppr
icesoft
hei
nput
sandas
ar
esul
tincr
easei
nnat
ionalout
putof$360m wi
llnotber
eal
izedbecauseoft
he
l
eakages.I
ncr
easei
n demand f
orf
ini
shed pr
oduct
sal
so causesader
ived
demandf
ormat
eri
ali
nput
shencecostoff
ini
shedgoodsandanci
ll
aryser
vices
wi
llr
ise.Ont
hewhol
ether
ewoul
dbeadecl
inei
nthequant
it
iest
hatwoul
dbe
pur
chased,
duet
oincr
easesi
npr
ices.Ant
ici
pat
edexpendi
tur
eist
husnotequal
t
oact
ualexpendi
tur
ereal
ized.Thet
axst
ruct
uremaybei
ncr
easedespeci
all
yas
t
het
axbasehasbeen wi
dened.Oncet
her
ateoft
axhasi
ncr
eased t
hen
di
sposabl
eincomedi
mini
sheshencet
hisaf
fect
stheamountofpur
chasesvi
s-à
-
vissavi
ngs.

Si
mpl
eInvest
mentMul
ti
pli
er
I
mpor
tanceoft
hemul
ti
pli
erf
oreconomi
cpol
icypur
posesst
emsf
rom t
he
assumpt
iont
hatagi
veni
nit
ialchangei
naut
onomousi
nvest
mentspendi
ng
causesamagni
fi
edchangei
ntheequi
li
bri
um i
ncomei
ntheeconomy.Mul
ti
pli
er
t
heor
yst
atest
hatt
hei
ncr
easei
ntot
ali
ncomeoccasi
onedbyanygi
veni
ncr
ease
i
naut
onomousi
nvest
ment(
orconsumpt
ion)out
layi
sacer
tai
nmul
ti
pleoft
he
or
igi
nali
ncr
easei
naut
onomousexpendi
tur
eandt
hemagni
tudeoft
hei
ncr
ease
i
ntot
ali
ncomedependsupont
heval
ueoft
heMPC.Thei
nvest
mentmul
ti
pli
erKi
andMPCar
erel
atedi
nsuchamannert
hatt
hehi
ghert
heMPCt
hehi
ghert
he

3
3
i
nvest
mentmul
ti
pli
erandvi
cever
sa.

Toder
ivewest
artwi
thY=C+I=C+ĪandC=a+bY
Subst
it
uti
ngi
ntheequi
li
bri
um equat
ion(Y=C+I)t
hisbecomes

Y=a+bY+Ī

Y(
1-b)=a+Ī

Ki=1/
MPS MPS=1–MPC
Theoper
ati
onoft
hesi
mpl
einvest
mentmul
ti
pli
eri
ntheeconomyi
sthwar
tedby
manyl
eakages.Consequent
lyt
heact
uali
ncomegener
atedconsequentupon
anygi
veni
ncr
easei
naut
onomousi
nvest
mentexpendi
tur
ewi
llbel
esst
hant
he
pr
oductoft
hei
nvest
mentmul
ti
pli
erKiandt
hegi
veni
ncr
easei
naut
onomous
i
nvest
mentΔI
.Inot
herwor
ds ΔY<ΔĪ
.Ki. Exampl
esofal
eakages
(
impor
ts)
;inf
lat
ion (
incr
eased money spendi
ng f
ail
s t
o i
ncr
ease r
eal
consumpt
ion)
;savi
ngs(
higherMPSl
ower
sthemul
ti
pli
erwhi
leal
owerMPS
r
aisest
hemul
ti
pli
er.Regr
essi
vet
axpol
icyandot
herf
iscalmeasur
esi
nvol
ving
r
edi
str
ibut
ionofi
ncomei
nfavouroft
her
ichersect
ionsoft
heeconomyal
so
r
educet
hesi
zeoft
hemul
ti
pli
erasdopayi
ngof
fdebt
s,ori
fthei
ncr
easei
s
i
nvest
edi
nsecur
it
ies.

Sof
arwef
ocusedont
hesi
mpl
einvest
mentmul
ti
pli
erwher
einvest
mentwas
t
reat
edasaut
onomous,i
.e.notr
elat
edt
oincomechanges.I
nreal
it
yincr
eases
i
nincomeal
socausesi
ncr
easesi
ninvest
ment
.Thusl
ikeconsumpt
iont
he
changesi
ninvest
menti
ntheeconomyar
einducedbychangei
nthel
evelof
i
ncome.I
nducedi
nvest
menti
sposi
ti
vel
yrel
atedt
othel
evelofi
ncomesucht
hat
ani
ncr
easei
nincomei
nducesani
ncr
easei
ninvest
mentandneti
nvest
menti
n

3
4
anygi
vent
imeper
iodwi
llbeequalt
othei
ncr
easei
naggr
egat
edemand.I
tis
t
her
efor
emor
ereal
ist
ict
otr
eatt
otali
nvest
mentasbei
ngcomposedpar
tl
yof
t
he aut
onomous i
nvest
mentand par
tl
y ofi
nduced i
nvest
ment
.Invest
ment
demandf
unct
ioni
nthef
orm I=.I
A +eYwher
eĪAi
saut
onomousi
nvest
mentand
eYi
sthei
nducedi
nvest
ment0<e<1.
Deri
vat
ion
Y=C+IandC=a+bY;andI=.I
A +eYsubst
it
uti
nggi
ves

Thi
sist
hesupermul
ti
pli
er.Thei
ncl
usi
onofi
nducedi
nvest
menti
nthemodel
r
aisest
heval
ueoft
hei
nvest
mentmul
ti
pli
er.

Par
adoxofThr
if
t
Thei
ncl
usi
onoft
hei
nducedi
nvest
menti
nthemodelshowst
hei
nter
est
ing
phenomenonoft
he“
par
adoxoft
hri
ft
”whi
chr
eveal
sthatanat
temptont
hepar
t
oft
hecommuni
tyt
osavemor
eoutofanygi
veni
ncomewi
lll
eadt
oanact
ual
decr
easei
ntheamounti
twi
llsucceedi
nsavi
ng.I
nshor
t,t
heat
temptt
osave
mor
ewi
llbesel
f-
def
eat
ing.I
nfactt
hecommuni
tymaypar
adoxi
cal
lyendup
wi
thr
educedt
otalsavi
ng.

Gover
nmentExpendi
tur
eMul
ti
pli
er
Fr
om t
hedef
ini
ti
ont
hismul
ti
pli
eri
skg

Gover
nmentexpendi
tur
ecani
nfl
uenceeconomi
cact
ivi
tyi
nacount
ry.I
tcan
i
nfl
uencenat
ionalout
putandempl
oymentl
evel
stonameaf
ew.Themul
ti
pli
er
appl
iesequal
lyt
ogover
nmentexpendi
tur
easi
tdoest
oinvest
ment
.Inasi
mpl
e
modelont
hedet
ermi
nat
ionofnat
ionali
ncomeorout
put
,aggr
egat
edemandi
s
gi
venbyt
hef
ormul
aY=C+I
+G,t
hati
saggr
egat
edemand=Y=Consumpt
ion+

3
5
I
nvest
ment+Gover
nmentExpendi
tur
e.I
fMPC=2/
3asbef
oret
hechangei
n
nat
ionalwi
llbe$360m.Thi
simpl
iest
hatani
ncr
easei
nempl
oymentf
ort
he
f
act
orsusedt
opr
oducet
hatmuchi
nout
putwi
ll
resul
t.
Knowl
edgeofgover
nmentexpendi
tur
emul
ti
pli
erwoul
dhel
pthegover
nmenti
n
deci
ding on whatexpendi
tur
elevelwoul
d be necessar
ytor
each t
he f
ull
empl
oymentl
evel
.

E=Y E=Y
AD2

C,
I
,G AD1 C,
I
,G AD1

Recessi
onarygap ∆G
Ful
lemployment Ful
l
empl
oyment

700 1000 700 1000

Nat
ionalProduct Nat
ionalPr
oduct

I
nthedi
agr
ams,assumi
ngt
hatMPC=2/
3,t
hemul
ti
pli
eri
s3ant
hepr
esent
equi
li
bri
um i
ssucht
hatt
henat
ionalpr
oduct(
aggr
egat
edemand)i
sat$700m
andt
hef
ullempl
oymentl
eveli
sat$1000m t
hent
hegover
nmentcani
ncr
ease
i
tsexpendi
tur
etowi
pet
her
ecessi
onar
ygapbyspendi
ngonl
y$100m.

Gover
nmentSpendi
ng-
Invest
mentMul
ti
pli
er
Wheni
nvest
ment(
I)var
iesasi
ncomevar
ies,t
henachangei
ngover
nment
spendi
ng l
eads t
o a modi
fi
ed mul
ti
pli
er– t
he gover
nmentspendi
ng –

i
nvest
mentmul
ti
pli
er,
kgi

wher
eMPI=mar
ginalpr
opensi
tyt
oinvestoutofi
ncome.I
fMPC=2/
3andMPI
=1/
6(MPS=1–2/
3=1/
3)

3
6
Fr
om t
hisachangei
ngover
nmentexpendi
tur
e,henceaggr
egat
edemandof
$120m l
eadst
o a magni
fi
ed changei
nincomeof$720m becauseoft
he
mul
ti
pli
erf
act
or.
∆Y=kgi∆G=6x$120=$720m.

Gover
nmentExpendi
tur
eMul
ti
pli
eri
nacl
osedeconomy,
wit
htaxes
I
fweassumeacl
osedeconomy

1. -Governmentexpendi
tur
eisexogenous
2. -Thet T)dependsont
ax( het axrat
e(t)
,whichisthefunct
ionof
i
ncome
BudgetSurplusorDefi
cit=G–T;Gi sGovernmentexpendi
tur
e;Ti
sTaxati
on
I
fG>Tt
her
ewi
ll
beabudgetdef
ici
t.
I
fG<Tt
her
ewi
llbeabudgetsur
plus.
3. where i
sdisposabl
eincome
4. Di
sposabl
eincomeequalstot
ali
ncomel
esst
axat
ion.

=
5. Investmentisexogenous(
independentofi
ncome)
Expendi
tur
e( E)=Income(Y)

Gover
nmentmul
ti
pli
er

Al
ter
nat
iveappr
oach
1.

3
7
2.
3.
4.
5.

Thehi
ghert
heMPSandt
axest
hel
owert
heamountconsumed.Thel
owert
he
MPSandt
axest
hehi
ghert
heexpendi
tur
erat
eandf
igur
e.

Gover
nmentExpendi
tur
eMul
ti
pli
eri
nanopeneconomy,
wit
htaxes

1.
2.
3.
4.
5.M=M0+M1Y
M =i
mportfunct
ion
M1=margi
nalpropensi
tytoi
mpor
t
M0=aut
onomousi mports
6.
7. export
sareexogenousbecauseimport
sdependont he
exchanger at
e.I
talsodependsont hewor l
dpri
ce.Themar gi
nalpropensi
tyto
i
mpor tdependsont heexchangerat
e. ( .Expor
tsareexogenousin
asmal lcount
rybecausetheyaredet
erminedbyothercount
ri
es.

8.

i
nject
ions=l
eakages

3
8
Gover
nmentpur
chasesofgoodsand ser
viceswhen added t
othel
evelof
pr
ivat
econsumpt
ionandbusi
nessi
nvest
mentdemandcauseani
ncr
easei
nthe
equi
li
bri
um i
ncomei
ntheeconomy.Thi
sissobecausegover
nmentpur
chases
ofgoodsand ser
vicesnotf
inanced byan i
ncr
easei
ntaxes,i
ncr
easet
he
aggr
egat
eef
fect
ivedemandandconsequent
lyi
ncr
easet
heequi
li
bri
um i
ncome
i
nthesamemanneri
nwhi
chani
ncr
easei
nconsumpt
ionand/
ori
nvest
ment
out
layr
aisest
heequi
li
bri
um i
ncome.

Taxesont
heot
herhandhavet
hesamei
mpactont
heeconomyassavi
ng.An
i
ncr
easei
ngover
nmentt
axeswi
l,cet
l eri
spar
ibus,decr
easet
heequi
li
bri
um
i
ncome.Gover
nmentpur
chasesi
nvol
vegover
nmentexpendi
tur
eongoodsand
ser
vices.Tot
algover
nmentexpendi
tur
e can be separ
ated i
nto gover
nment
pur
chasesofgoodsandser
vices(
G)andgover
nmentt
ransf
erpayment
s(R)
.
Thei
rimpactont
heeconomyi
sdi
ff
erent
.Whi
leGi
nvol
vedi
rectconsumpt
ionof
t
hepur
chasedgoodsandser
vicesbygover
nmentandt
her
efor
erai
seaggr
egat
e
demandbyt
hef
ullamountofgover
nmentexpendi
tur
e.I
nthecaseoft
ransf
er
payment
s(R)
,gover
nmentpaysmoneyt
oindi
vidual
sint
hef
orm ofol
dage
i
nsur
ance,unempl
oymentdol
e payment
s,et
c.Af
teri
ncl
udi
ng gover
nment
sect
ori
na3sect
orcl
osedeconomy,
equi
li
bri
um aggr
egat
eincomewi
llbeY=C
+I+Gwi
thnoi
ncr
easei
nthegover
nmentt
axesandaut
onomousi
nvest
ment
,
t
hegover
nmentpur
chasesmul
ti
pli
erwi
llbeequalt
othesi
mpl
einvest
ment
mul
ti
pli
er.

Der
ivat
ion.Thi
scanbeder
ivedasf
oll
ows:Y=C+I+GandC=a+bY;I=Ī
A

wher
eĪA i
s aut
onomous i
nvest
ment
.G = Go= aut
onomous gover
nment

3
9
expendi
tur
e.

Thi
sist
hemult
ipl
ieri
nt heabsenceofgover
nmentt
axesandt
ransf
erpayment
s
wit
honl
yaut
onomousi nvest
ment .

Gover
nmentt
ransf
ermul
ti
pli
er.Agover
nmentt
ransf
ermul
ti
pli
eroper
atesl
ike
t
hesi
mpl
emul
ti
pli
erexceptt
hati
tsval
uei
sgener
all
ysmal
lert
hant
heval
ueof
t
hesi
mpl
emul
ti
pli
erf
orei
thergover
nmentpur
chasesori
nvest .Nor
ment mal
ly
di
ff
erentt
ransf
erpayment
swoul
dhavedi
ff
erentmul
ti
pli
ers.Forexampl
e,t
he
t
ransf
ermul
ti
pli
erf
ori
nter
estpayment
swoul
dbesmal
lert
hant
hatf
ort
he
unempl
oymentcompensat
ionpayment
ssi
ncei
nter
estpayment
sar
emost
ly
r
ecei
vedbyhi
ghi
ncomef
ami
li
esowni
nggover
nmentbonds.Thesef
ami
li
es’
MPCi
slow whi
let
heunempl
oymentcompensat
ionpayment
sar
erecei
vedby
t
hel
owi
ncomeandpoorf
ami
li
eswhoseMPCi
sgener
all
yhi
gh.

TaxMul
ti
pli
er.Thet
axmul
ti
pli
erwoul
dbenegat
ivebecauseat
axwoul
dcause
anegat
ivechangei
nthedi
sposabl
eper
sonali
ncomeoft
hecommuni
ty.The
di
sposabl
eper
sonali
ncome

Yd=Y–T+Rwher
eRi
str
ansf
ers.(
Iti
sassumedt
hatTandRar
eaut
onomousl
y
det
ermi
ned.
)C=a+bYd andt
her
efor
eΔC=bΔYd
ΔC=bΔ(
Y–T+R)andΔC=bΔY–bΔT+bΔR)

Thei
mpactoft
axesonconsumpt
ionandt
her
efor
e,oni
ncomei
snegat
ive.
Der
ivat
ioni
sY=C+I+G

Subst
it
uti orYdgi
ngf ves

4
0
f
ort
het
ransf
ersmul
ti
pli
er.

Lumpsum t
axmul
ti
pli
er
Lumpsum t
axi
staxt
hati
saf
ixedamount
.Thel
umpsum t
axmul
ti
pli
er
ktx= - MPC/
MPS.Thi
s has a negat
ive si
gn because as t
ax i
ncr
eases
consumpt
ionf
all
s.I
fMPC=¾;MPS=¼,
thenktx=-MPC/
MPS.
=-(
3/4)
/(1/
4)=-
3.
I
fMPC=2/
3;MPS=1/
3thenktx=-MPC/
MPS=-
(2/
3)/(
1/3)
=-2.
∆Y=ktx.
∆T T=Tax.
Wi
that
axcutofsay$10m
∆Y=ktx.
∆T=-
2(-
10)=$20m.

Bal
ancedBudgetmul
ti
pli
er
Whenabudgeti
sbal
ancedG=Thence∆G=∆T.I
fbot
hGandTi
ncr
easeby
$10m,i
ncome i
ncr
eases by $10m.The mul
ti
pli
erf
ora bal
anced budget
kBB.
=1 ;
∆Y=kBB.
x∆G=1x(
$10m)=$10m t
hiswoul
dbeanexpansi
onar
ybudget
.If
t
her
eisacutofsay$10m ,∆Y=kBB.
x∆G=1x(
-10)=-
$10m andt
hisi
sa
cont
ract
ionar
ybudget
.

For
eignt
rademul
ti
pli
er.Foranopeneconomy,
incomeandout
putwi
lli
ncr
ease
f
rom oneper
iod t
othenextast
otalexpor
tsi
ncr
easeori
tst
otali
mpor
ts
decr
easebecauseasar
esul
tofbot
hthesechangest
heeconomy’
snetexpor
ts
expand.Conver
sel
y,domest
iceconomy’
sincomeandout
putwi
llf
allovert
ime

4
1
asi
tst
otalexpor
tsdecl
ineort
otali
mpor
tsr
iseasbot
hthesechangeswi
llt
end
t
ocauseaf
alli
nnetexpor
ts.Fr
om t
hisi
tfol
lowst
hatt
heef
fectofi
mpor
tsand
expor
tsoneconomy’
sequi
li
bri
um i
ncomeandout
putor
igi
nat
esf
rom t
hose
f
act
orst
hatdet
ermi
net
heeconomy’
simpor
tsandexpor
ts.

Gener
all
y,acount
ry’
stot
alexpor
tsdependont
hepr
iceofgoodsi
nthecount
ry
r
elat
ivet
othei
rpr
icesi
not
hercount
ri
es,
tar
if
fandt
radepol
ici
espr
eval
enti
nthe
count
ryandavai
labi
li
tyoff
orei
gncur
renci
esi
nthef
orei
gnexchangemar
ket
s,
i
ncomei
not
hercount
ri
es,owni
mpor
tsoft
hecount
ry,et
c.Someoft
hemor
e
i
mpor
tantf
act
orst
hatdet
ermi
neacount
ry’
sexpor
tsar
enotdi
rect
lyr
elat
edt
o
condi
ti
onswi
thi
nthatcount
ry.Consequent
ly,i
tisassumedt
hatgr
ossexpor
ts
ofacount
ryar
eaut
onomousl
ydet
ermi
ned,i
.e.expor
tsar
edet
ermi
nedbyt
he
ext
ernalf
act
ors.The vol
ume ofi
mpor
tsi
s det
ermi
ned by si
mil
arf
act
ors.
Howevermanyoft
hesef
act
orsar
einf
luencedbycondi
ti
onswi
thi
nthecount
ry.
Cet
eri
spar
ibus,acount
ry’
stot
ali
mpor
tsar
edet
ermi
nedbyt
hel
evelofnat
ional
i
ncome.I
n ot
herwor
dsassumi
ng gi
ven i
nter
nat
ionalpr
icedi
ff
erencesand
unchangi
ngt
ari
ff
,tr
adeandf
orei
gnexchanger
est
ri
cti
onsacount
ry’
simpor
ts
ar
efunct
ional
lyr
elat
edt
ohernat
ionali
ncome.

Assumi
ngal
inearr
elat
ionshi
pbet
weennat
ionali
ncomeandi
mpor
tsoft
he
f
oll
owi
ngf
orm whi
chdef
inest
hei
mpor
tfunct
ionasM =Ma+mY,wher
eMai
s
t
heaut
onomousspendi
ngoni
mpor
tsandm i
sthemar
ginalpr
opensi
tyt
o
i
mpor
t(MPM)
.

I
nthe f
oursect
oropen economy t
he equi
li
bri
um i
ncome i
s gi
ven by t
he
equat
ionY=C+I+G+(
X-M)orbyt
heequat
ionS+T+M =I+G+X.Si
nceour
consumpt
ioni
sdef
inedbyt
heequat
ionoft
heconsumpt
ionf
unct
ionC=a+b(
Y
-
T)andi
mpor
tsar
edef
inedbyt
hei
mpor
tfunct
ionequat
ionM =Ma +mY,by
subst
it
uti
ngf
ort
het
ermsCandM t
heaboveequi
li
bri
um i
ncomecanbewr
it
ten
as
Y=a+b(
Y-T)+I+G+X–(
Ma+mY)
.Thi
scanber
ewr
it
tenas

4
2
 e 1/(
Wher 1-b+m)i
sthef
orei
gnt
rademul
ti
pli
erf
ort
heeconomyi
nwhi
ch
expor
tsar
ewhol
lyaut
onomousl
ydet
ermi
nedwhi
lebot
hconsumpt
ionspendi
ng
andi
mpor
texpendi
tur
ear
eli
nearf
unct
ionsoft
hel
evelofnat
ionali
ncome.I
f
t
axesar
eassumedt
obef
unct
ional
lyr
elat
edt
othel
evelofi
ncomesot
hatt
he
t
otalt
axf
unct
i sT=d+t
oni Y,t
heequi
li
bri
um nat
ionali
ncomewoul
dthenbe

e 1/
Wher (1-
b+bt
+m)i
sthef
orei
gnt
rademul
ti
pli
erf
ort
hesyst
em i
nwhi
ch
consumpt
ion,
impor
tsandt
axesar
eal
lli
nearf
unct
ionsoft
hel
evelofdomest
ic
i
ncome.Fur
ther
mor
eifwet
reati
nvest
mentspendi
ngal
sol
inear
lyr
elat
edt
othe
l
evelofi
ncomesot
hatt
hei
nvest
mentdemandf
unct
ioncanbewr
it
tenasI=I
a

+eY,
theequat
ionf
ort
heequi
li
bri
um aggr
egat
eincomewi
llbecome

i
nwhi
chconsumpt
ion,i
nvest
ment
,impor
tsandt
axesar
eal
lli
nearf
unct
ionsof
t
hel
evelofnat
ionali
ncome.Thef
orei
gnt
rademul
ti
pli
er,al
socal
ledt
heexpor
t
mul
ti
pli
er,oper
ates i
n exact
lyt
he same manner
,as does t
he or
dinar
y
i
nvest
mentmul
ti
pli
er.Ani
ncr
easei
ncount
ry’
sexpor
tscausesani
ncr
easei
n
t
hei
ncomesoft
heexpor
ter
sandf
act
orsempl
oyedi
ntheexpor
tindust
ri
est
hat
i
ntur
nspendapar
toft
hei
rincr
easedi
ncomesondomest
icgoods.I
nshor
t,t
he
l
argert
hemar
ginalpr
opensi
ti
est
osaveandi
mpor
t,smal
lerwi
llbet
heval
ueof
t
hef
orei
gnt
rademul
ti
plerandvi
i cever
sa.

i
sthef
orei
gn t
rademul
ti
pli
erf
ort
heeconomyi
n whi
ch t
heconsumpt
ion,
i
nvest
ment
,impor
tsandt
axesar
eal
lli
nearf
unct
ionsoft
hel
evelofnat
ional
i
ncome.Al
ookatt
hemul
ti
pli
erbr
ingshomet
hef hatcet
actt eri
spar
ibust
he
val
ueoft
hef
orei
gnt
rademul
ti
pli
eri
sinver
sel
yrel
atedt
otheval
ueoft
he
mar
ginalpr
opensi
tyt
oi tm sucht
mpor gherm i
hathi sassoci
atedwi
thl
ower
f
orei
gnt
rademul
ti
plerandvi
i cever
sa.

4
3
Cr
it
ici
smsoft
heMul
ti
pli
erAnal
ysi
s
1.Si
mplemul t
ipl
iersanal
ysi
sisfaul
tybecausei
tneglect
stheroleofinduced
i
nvestmentresul
t i
ng fr
om induced consumpt
ion i
nt he det
erminati
on of
equi
li
bri
um i
ncome.

2.Mult
ipl
ieranal
ysi
sderi
vesthemul ti
pli
eront
heassumpt
ionofconst
ant
MPC.Overt heshortper
iod(shor t
-r
un)ofatr
adecycl
e,themargi
nal
pr
opensit
ytoconsumeisnotconst
ant.
3.Assumest
hatlabourandot
herf
ixedr
esour
cesar
eidl
eorunder
-ut
il
izedi
n
t
heeconomy.
4.Bott
lenecksofpar
ti
cularki
ndoflabouroratparti
cul
arplacesmaybl
ock
theexpansi
onofemploymentandoutputi
ntheeconomy.

4
4
 CHAPTERTHREE
MONEYANDBANKI
NGTHEORY

Or
igi
nsofMoney
Theear
li hodofexchangewasbar
estmet teri
nwhi
chgoodswer
eexchanged
di
rect
lyf
orot
hergoods.Pr
obl
emsar
osewhenei
thersomeonedi
dnotwant
whatwasbei
ngof
fer
edi
nexchangef
ort
heot
hergood,
ori
fnoagr
eementcoul
d
ber
eachedoverhowmuchonegoodwaswor
thi
nter
msoft
heot
her
.

Val
uabl
emet
alssuchasgol
dandsi
lverbeganact
ingasamedi
um ofexchange.
Gover
nment
sthendeci
dedt
omel
tdownt
hesemet
alsi
ntocoi
ns.

Byt
hesevent
eent
hcent
urypeopl
ewer
eleavi
nggol
dwi
tht
hel
ocalgol
dsmi
th
f
orsaf
ekeepi
ng.Recei
ptsof£1and£5wer
eissuedwhi
chcoul
dthenbe
conver
tedbacki
ntogol
datanyt
ime.Soont
heser
ecei
ptswer
erecogni
zedas
bei
ng '
as good as gol
d'and wer
ereadi
lyt
aken i
n exchange f
orgoods.
Gol
dsmi
thsbecamet
hef
ir
stspeci
ali
stbanker
sandt
hei
rrecei
ptsbegant
o
ci
rcul
ateasbanknot
es.
Onl
ythe Reser
ve Bank ofZi
mbabwe can i
ssue banknot
es i
n Zi
mbabwe.
However
,not
esar
enotusual
l
yusedt
obuyexpensi
vei
temssuchascar
s.The
buyeri
smor
eli
kel
ytowr
ieoutacheque,whi
t chi
nst
ruct
shi
sbankt
otr
ansf
er
moneyf
rom hi
saccounti
ntot
heaccountoft
hesel
ler
.Hencebankdeposi
tsact
asmoney.

Funct
ionsofMoney
Moneyi
ssomet
hingwhi
chpeopl
egener
all
yaccepti
nexchangef
oragoodora
ser
vice.Moneyper
for
msf
ourmai
nfunct
ions:

 amedi
um ofexchangef
orbuyi
nggoodsandser
vices;
 auni
tofaccountf
orpl
aci
ngaval
ueongoodsandser
vices;
 ast
oreofval
uewhensavi
ng;
 ast
andar
dfordef
err
edpaymentwhencal
cul
ati
ngl
oans.

4
5
 Pr
oper
ti
esorChar
act
eri
sti
csofMoney
Anyi
tem whi
chi
sgoi
ngt
oser
veasmoneymustbe:

 accept
abl
etopeopl
easpayment
;
 scar
ceandi
ncont
rol
ledsuppl
y
 st
abl
eandabl
etokeepi
tsval
ue
 di
visi
blewi
thoutanyl
ossofval
ue
 por
tabl
eandnott
ooheavyt
ocar
ry.

Gr
esham’sLaw-‘badmoneydr
ivesoutgoodmoney’
I
fther
earetwotypesofmoney,
andoneismorevaluabl
ethant
heot
her,
the
i
nfer
iormoneyget
sused/ci
rcul
atedandi
tdr
ivest
heval
uabl
e/super
iormoney
outofci
rcul
ati
on.Peopl
ewi
llhoar
dthegoodmoneyandspendi
t.

MONEYSUPPLY
Def
ini
ti
on
The moneysuppl
yist
het
otalamountofasset
sin ci
rcul
ati
on,whi
ch ar
e
accept
abl
einexchangef
orgoods.I
nmoder
neconomi
espeopl
eacceptei
ther
not
esandcoi
nsorani
ncr
easei
nthei
rcur
rentaccountaspayment
.Hencet
he
moneysuppl
yismadeupofcashandbankdeposi
ts.

Cr
edi
tCr
eat
ion
Somecust
omer
sleavemoneyi
nthebankear
ningi
nter
est
.A bankcanuse
hesei
t dledeposi
tst
omakel
oanst
opeopl
ewhot
henbuygoods.Shopkeeper
s
r
ecei
ve ext
ra money,whi hey r
ch t edeposi
twi
tht
he bank.Some oft
his
r
edeposi
tedmoneyi
slef
ttoear
nint
erestandcanber
e-l
ent
.Thebankhas
t
her
efor
ecr
eat
edmoney.I
fal
lcust
omer
swer
etot
ryt
ocasht
hei
rdeposi
tsat
once,t
her
ewoul
dnotbesuf
fi
cientcash.Theamountofmoneyt
hebankcan
cr
eat
ether
efor
edependsont
her
ati
oofcasht
oli
abi
li
ti
est
hatt
heyhol
d.The
hi
ghert
hiscashr
ati
othel
essmoneyt
hebankcanr
e-l
endorcr
eat
e.

Howdobankscr
eat
emoney?

4
6
 Assumeasi
ngl
ebank,
Bar
claysbank
 Mr
.Moyodeposi
ts$20000cashi
nthebank.
 Bydeposi
ti
ng$20000i
nthebank,moneychangesi
tsf
ormf
rom casht
o
deposi
t.
 Mr
s.Maphosawant
stobor
rowmoneyf
orbusi
ness.
 Bar
claysBankcanl
endbecausei
tknowsMr
.Moyowi
llnotwi
thdr
awal
l
atonce.Buti
tknowsi
tmustkeepsomecashasar
eser
vesay10%
t
her
efor
eBar
claysl
ends$18000t
oMr
s.Maphosa.
 Byl
endi
ngmoneyt
oMr
s.Maphosa,
thebanki
ncr
easesmoneysuppl
yto
$38000f
rom j
ust$20000.Thebanki
sabl
etocr
eat
emoneybecause
peopl
e have conf
idence t
hatt
he cheques si
gned by t
he bank ar
e
honour
ed.

I
fther
eser
ver
ati
oisrt
hent
hebasi
cdef
ini
ti
onofmoneymul
ti
pli
er(
m)

Thechangei
ntot
aldeposi
ts( rxDeposi
AD)=(1/ t)
Whenr=0.
1anddeposi
t=20000,
then
Thechangei
ntot
aldeposi
ts=D=

Fr
om t
hiscal
cul
ati
onchangesi
ndeposi
tscanbeashi
ghas$200000f
rom
an i
nit
ialdeposi
tof$20000.I
fther
eser
ver
ati
oincr
eases,i
tli
mit
sthe
changei
ndeposi
tsbecausemostoft
hedeposi
tsar
ekeptasr
eser
vesand
notl
ent
.
 Li
mit
stobankst
ocr
eat
emoneywi
lldependon:
 Amountofr
eser
ves(
li
qui
d)asset
s
 Reser
veassetr
ati
o
 Wi
ll
ingnessofpeopl
etobor
row
 Desi
reofpeopl
etohol
dcash.
 Whati
sregar
dedasr
eser
veassetmustbedef
inedbyl
aw.Thef
oll
owi
ng
asset
scanhoweverber
egar
dedasr
eser
veasset
s:

4
7
  Cashbal
ancewi
thcent
ralbank
 For
eignexchange
 Tr
easur
ybi
ll
s
 Gol
det
c.

Def
ini
ti
onsofmoney
1. = I
tisal
socal
ledhi
gh
power
edmoney.
2. Demanddeposi
ts not
esandcoi
nsi
nci
rcul
ati
on
wi
thpubl
ic.I
tissomet
imesr
efer
redt
oas‘
nar
rowmoney’
3. Savi
ngsdeposi
tswi
thbanks.I
tissomet
imesr
efer
redt
oas
br
oadmoney.
4. Ot
hersavi
ngsdeposi
tset
c.

Det
ermi
ningMoneySuppl
y

1.

2.

Wher
e -r
eser
ver
ati
o
-Reser
veasset
s
-Demanddeposi
ts
-Cur
rencyr
ati
o
-Not
esandcoi
nsi
nci
rcul
ati
on

i
ncount
ri
esl
ikeZi
mbabwe,
thecur
rencyr
ati
oisver
yhi
ghbecausemanypeopl
e
keepnot
esandcoi
nsathome.Thi
sisbecauset
hebanki
ngsyst
em canatt
imes
bei
nconveni
ent
.

3.

4
8
4.

Wher
e

- mi
sthemoneymul
ti
pli
erandi
sgr
eat
ert m>1)
han1(

- t
her
eser
ver
ati
ocanbesepar
atedi
ntor
equi
redr
eser
ver
ati
o and

excessr
eser
ver
ati
o

-Bankshol
dexcessr
eser
ver
ati
obecause
1.Mostbanksar
epr
udent(
prudent
ialbanks)andsensi
blet
oseewhet
her
l
endi
ngi
spr
ofi
tabl
e.
2.Li
mit
edl
iabi
li
tyofbankst
ocr
eat
e si
ncepeopl
emaynotbewi
ll
ingt
o
bor
rowduet
ohi
ghi
nter
estr
ates.

DEMANDFORMONEY

- r
efer
stot
heamountofmoneyhel
dbyt
hegener
alpubl
ici
naneconomy.

4
9
 - Themai
nreasonsf
orhol
dingmoneyar
e:
1.Tr
ansact
ionalr
eason/mot
ive
2.Specul
ati
vemot
ive
3.Pr
ecaut
ionar
ymot
ive.

MONETARYPOLI
CY

Whati
sMonet
aryPol
icy?

I
tist
heuseofmoneyori
tscost
,thei
nter
estr
atet
ofi
net
unesomeeconomi
c
var
iabl
essuchas:

 I
nfl
ati
on

 Economi
cgr
owt
h

 I
nvest
ment

 I
nter
estr
ates

 Bal
anceofpayment
s

Obj
ect
iveofmonet
arypol
icy

I
ngener
almonet
arypol
icyhast
womaj
orobj
ect
ives:

1.Tor
educei
nfl
ati
on(
stabi
li
tyobj
ect
ive)

2.Toboosteconomi
cgr
owt
h(gr
owt
hobj
ect
ive)

I
nst
rument
s/Measur
es/
tool
sofmonet
arypol
icy

 Monet
arypol
icymeasur
esar
eusedt
oincr
easeordecr
easet
he
amountofmoney,
dependi
ngont
hesi
tuat
ionpr
evai
li
ng.

 Each i
nst
rumentcan be used i
n 2ways,ei
thert
oincr
ease or
decr
easet
heamountofmoneyi
nci
rcul
ati
on

Thef
oll
owi
ngar
esomeofcommoni
nst
rument
s:

1.Bankr
ate

2.Openmar
ketoper
ati
ons

5
0
 3.Redi
scountr
ate

4.Repur
chaseAgr
eement

5.Sel
ect
ivecr
edi
tcont
rol
s

6.Mor
alSuasi
on

7.Reser
ver
equi
rement
s

Thesei
nst
rument
scanbecl
assi
fi
edi
ntot
hegener
alorquant
it
ati
vei
nst
rument
s
andt
hesel
ect
iveorqual
it
ati
vei
nst
rument
s.

Gener
alorquant
it
ati
vei
nst
rument
s

Thesei
ncl
udeopenmar
ketoper
ati
ons,changesi
nthemi
nimum l
egalcash
r
eser
ver
ati
oandchangesi
nthebankordi
scountr
ate.Thesei
nst
rument
s
i
nfl
uencet
hecr
edi
tcr
eat
ingcapaci
tyoft
hecommer
cialbanksi
ntheeconomy
byoper
ati
ngdi
rect
lyori
ndi
rect
lyont
hei
rexcesscashr
eser
ves.

Sel
ect
iveorqual
it
ati
vei
nst
rument
s

Thei
nst
rument
saf
fectt
het
ypesofcr
edi
text
endedbyt
hebanks.Theyaf
fect
t
hecomposi
ti
onr
athert
hant
hesi
zeoft
hel
oanpor
tfol
iosoft
hecommer
cial
banks. Thei
mmedi
ateobj
ectofi
mposi
ngt
hesel
ect
ivecr
edi
tcont
rol
sist
o
r
egul
atebot
htheamountandt
het
ermsonwhi
chcr
edi
tisext
endedbyt
he
banksf
orsel
ect
edpur
poses.Thesel
ect
ivecr
edi
tcont
roli
nst
rument
senabl
e
t
hecent
ralbankt
orest
ri
ctunheal
thyexpansi
onofcr
edi
tforspeci
fi
cpur
poses;
wi
thoutatt
hesamet
imeai
ri
ngcr
edi
texpansi
oni
ngener
al.

Useoft
heI
nst
rument
s/Measur
es/
Tool
s

Thei
nst
rument
sar
econt
ract
ionar
yorexpansi
onar
y,dependi
ngont
hel
iqui
dit
y
si
tuat
ion.When t
her
eist
oo much money,monet
aryt
ool
s ar
e used i
n
cont
ract
ionar
yway.Whent
her
eisl
essmoney,monet
aryt
ool
sar
eusedi
nan
expansi
onar
yway.

BankRat
e/Redi
scountRat
e
Whenbanksbor
rowf
rom t
heCent
ralBankdi
rect
ly,
theyar
echar
gedabankr
ate.

Whent
heybor
row i
ndi
rect
lyt
hrought
hedi
scounthouses,t
heyar
echar
ged

5
1
r
edi
scountr
ates.

 Thi
sist
her
ateatwhi
cht
hecent
ralbankdi
scount
sfi
rstcl
assbi
ll
s.

 I
tisabenchmar
kforcommer
cialbankl
endi
ngr
ates.

 Ani
ncr
easei
nthebankr
atei
ncr
easesl
endi
ngr
atesandr
educest
he
amountofmoney.

 A decr
easei
nthebankr
ater
educesl
endi
ngr
atesandi
ncr
easest
he
amountofmoney.

Openmar
ketoper
ati
ons

Thi
sisbuyi
ngandsel
li
ngofgover
nmentsecur
it
iese.
g.bonds(
TBs)
.When
t
her
eist
oomuchmoney,t
hegover
nmentsel
lssecur
it
ies.Thegover
nment
t
akest
hemoneyandt
hepubl
ichol
dssecur
it
ies.Tor
educemoneysuppl
y,t
he
gover
nmentsel
lsbondst
othepubl
icandpayswi
thcur
rency(
not
es+coi
nsi
n
ci
rcul
ati
on)
.Thi
sreducesmoneyavai
labl
eforspendi
ng.Thesuccessoft
he
i
nst
rumentdependson whet
hert
hepubl
icwant
sto buybondsornot
.To
per
suadepeopl
etobuybonds,
thegover
nmentr
aisesi
nter
est
.

When t
her
eisi
nadequat
e money,t
he gover
nmentbuys secur
it
ies.The
gover
nmentt
akest
hesecur
it
iesandt
hepubl
ichol
dsmoney.Moneyi
sinj
ect
ed
i
ntot
heeconomy.

Sel
ect
ivecr
edi
tcont
rol
s

When t
her
e ar
eli
qui
dit
ypr
obl
ems,t
he cent
ralbankand even banks have
pr
efer
ent
ialt
reat
mentofcl
ient
s.Cr
edi
tisal
locat
edt
osomesel
ect
edsect
ors.
Forexampl
e,cr
edi
tcanbeal
locat
edt
oexpor
torpr
oduct
ivesect
ors.Rat
ioni
ng
ofcr
edi
t-t
hisi
nvol
vesi
mposi
ngacei
li
nguponi
ts(
Cent
ralBank’
s)di
scount
sfor
anyonebankorr
eject
ingapr
opor
ti
onofeachdi
scountappl
icat
ionwhenever
t
otaldemandf
orl
oansexceedst
heamountt
hecent
ralbanki
spr
epar
edt
o
di
scountonanyoneday.

Regul
ati
onofconsumercr
edi
t

The r
egul
ati
on ofconsumercr
edi
tis empl
oyed t
oregul
atet
he t
erms and
condi
ti
onsunderwhi
chbankcr
edi
trepayabl
eini
nst
all
ment
scoul
dbeext
ended

5
2
f
orpur
chasi
ng orcar
ryi
ng t
heconsumerdur
abl
egoods.Ther
egul
ati
on of
consumercr
edi
tisqui
tei
mpor
tanti
ncombat
ingi
nfl
ati
onbyr
est
ri
cti
ngt
he
aggr
egat
econsumerdemandf
ort
hosegoodswhi
char
einshor
tsuppl
yin
i
ndust
ri
all
y devel
oped count
ri
es wher
e consumercr
edi
tisl
argel
y used t
o
f
inancedomest
icpur
chases.I
ncount
ri
eswher
ether
eisnoconsumercr
edi
t
and t
he banks do notpar
ti
cipat
einf
inanci
ng t
he pur
chase ofconsumer
dur
abl
est
oanysi
gni
fi
cantdegr
ee,t
hemet
hodcannotbeef
fect
ivei
ncur
bing
t
hei
nfl
ati
onar
ypr
essur
esi
ntheeconomy.

Mor
alSuasi
on

I
tinvol
vesdi
rectsol
ici
twi
tht
heCent
ralBank.Thecent
ralbankper
suades
f
inanci
ali
nst
it
uti
onst
obesuppor
ti
veoft
hepr
evai
li
ngmonet
arypol
icyst
ance.
Whent
her
eist
oomuchl
iqui
dit
y,i
nst
it
uti
onsar
eper
suadedt
oti
ght
ent
hei
r
cr
edi
tal
locat
ionsyst
ems.Whent
her
eisashor
tageofl
iqui
dit
y,i
nst
it
uti
onsar
e
per
suaded t
oloosen t
hei
rcr
edi
tal
locat
ion syst
ems.Thi
s measur
eis not
mandat
orybutper
suasi
veandasar
esul
titi
sdi
ff
icul
ttoi
nfl
uencet
hecur
rency
r
ati
oc/
Dandconsequent
lymoneysuppl
y.

The i
nst
rument woul
d succeed onl
y i
fthe commer
cial banks f
oll
ow
scr
upul
ousl
ythel
eader
shi
poft
hecent
ralbank.Thi
swi
llhoweverdependon
t
hest
rengt
hoft
hecent
ralbankandt
hepr
est
igeenj
oyedbyi
tamongt
he
memberbanks.I
ncount
ri
eswi
thhi
ghl
yli
qui
dmonet
arycondi
ti
onsandwher
e
t
hecent
ralbankcannotunder
take openmar
ketoper
ati
onsonamassi
vescal
e
t
ocount
eractt
hehi
ghbankl
i
qui
dit
y,i
tisadvi
sabl
efort
hecent
ralbankt
ouse
mor
alsuasi
on.

Reser
veRequi
rement
s

Whenbankdeposi
tsar
emade,par
toft
hemoneyi
skeptasbankr
eser
ves
andt
her
esti
slentoutasl
oans.Ther
eser
ver
equi
rementi
stheamountof
moneyt
hati
skeptasr
eser
ves.Theper
cent
ageofmoneykeptasr
eser
vesi
s
cal
ledt
her
eser
ver
equi
rement
srat
io.Whent
her
eist
oomuchmoney,t
he
r
eser
ver
ati
oisi
ncr
easedt
oreducecr
edi
tcr
eat
ion.Whent
her
eisashor
tage
t
her
eser
ver
ati
oisr
educedt
oincr
easecr
edi
tcr
eat
ionsoast
oincr
ease

5
3
 moneysuppl
y.Thegover
nmentcanr
egul
atet
her
equi
redr
eser
ver
ati
o .

I
ncr
easi
ngr
equi
redr
eser
ver
ati
oreducest
hel
endi
ngbase.Thei
nst
rumenti
s
notwi
thouti
tsl
imi
tat
ions:I
fthei
rcashr
eser
vesar
eswol
len,commer
cial
bankswi
llnotcar
eatal
lfort
hei
ncr
easei
nthemi
nimum l
egalcashr
eser
ves
r
ati
orequi
rementunl
esst
hei
ncr
easei
sver
yhi
gh.Theymi
ghtal
soconduct
t
hei
roper
ati
onswi
thal
owercashr
eser
vesr
ati
oift
heyar
eopt
imi
sti
cabout
t
hef
utur
e,whi
leaf
alli
nthemi
nimum l
egalr
eser
vesr
ati
omayf
ailt
oinduce
t
hem t
olendi
ndepr
essi
on.Acount
eract
ingf
orcemayar
isef
rom achange
i
nthebanki
ngpr
act
ices.I
fper
cent
agesofmi
nimum l
egalcashr
eser
ves
r
equi
redt
obekeptwi
thr
eser
vebanksdi
ff
erf
ordi
ff
erentki
ndsofdeposi
ts
hel
dbybankse.
g.wi
thami
nimum l
egalcashr
eser
vesr
ati
oof10%agai
nst
t
hedemanddeposi
tsandof3%agai
nstt
het
imedeposi
ts,
atr
ansf
erofbank
f
undsf
rom t
hef
ormert
othel
att
erwoul
denabl
ethebankst
oexpandcr
edi
t
andt
othatext
entwoul
dinducet
hem t
odi
sregar
dthecr
edi
trest
ri
cti
on
pol
icyenf
orcedbyt
hecent
ralbank.

Publ
ici
ty

Cent
ralbanksmayempl
oyt
hei
nst
rumentofpubl
ici
tyi
nor
dert
opubl
ici
set
he
economi
cfact
sint
heweekl
yst
atement
soft
hei
rasset
sandl
iabi
li
ti
es,mont
hly
bul
let
inscont
aini
ngr
evi
ewofcr
edi
tandbusi
nesscondi
ti
on,
anddet
ail
edannual
r
epor
tsst
ati
ngt
hei
roper
ati
onsandact
ivi
ti
es,t
hest
ateofaf
fai
rsoft
hemoney
mar
ketand banki
ng syst
em and gener
alr
evi
ew of t
he t
rade,i
ndust
ry,
agr
icul
tur
e,et
c.i
nthecount
ry.Byr
esor
ti
ngt
opubl
ici
ty,
thecent
ralbankenl
ist
s
publ
icopi
nioni
nfavourofi
tsmonet
arypol
icyandt
her
ebycombat
sopposi
ti
on
t
oit
spol
ici
esamongpol
it
ical
,fi
nanci
alandbusi
nessi
nter
est
s.Howevert
he
met
hodofpubl
ici
tyhast
hescopeofusef
ulappl
icat
ioni
nindust
ri
all
yadvanced
count
ri
es wher
e publ
ic opi
nion i
s enl
ight
ened.I
nthe devel
opi
ng count
ri
es
wher
epeopl
ear
emost
lyl
esseducat
edandevent
hosewhoar
eeducat
edar
e
notacquai
ntedwi
tht
het
echni
queofbanki
ngt
hemet
hodofpubl
ici
tyi
sofl
it
tl
e
usei
ncont
rol
li
ngcr
edi
t.

5
4
 CHAPTERFOUR
UNEMPLOYMENT
Whati
sunempl
oyment
?

Def
ini
ti
on

Unempl
oymenti
sthepoolofpeopl
eaboveaspeci
fi
edagewhoar
ewi
thout
wor
k,ar
ecur
rent
lyavai
l
abl
eforwor
kandar
eseeki
ngwor
kdur
ingaper
iodof
r
efer
ence.Unempl
oymentr
esul
tswhent
heavai
labl
ewor
kpl
acescannotadapt
t
othej
ob seeker
s.When t
henumberofper
sons,who of
fert
hei
rwor
king
capaci
ti
es,exceedst
henumberofavai
labl
ewor
kpl
aces,t
hisl
eadst
oal
acki
n
wor
kpl
aces.

Unempl
oymenthasbecomeaser
iouseconomi
cpr
obl
em.Maj
ori
tyofpeopl
e
canonl
ymakel
ivi
ngbywor
kingf
orot
her
s.Manymi
ll
ionsofpeopl
ear
ebot
h
abl
eandwi
ll
ingt
owor
k,butsi
mpl
ycannotf
indaj
ob.Unempl
oymenti
san
over
whel
mingconcer
nofpol
i
cymaker
sandt
hegener
alpubl
ic.Unempl
oyment
of
teni
mpl
iesawast
eofhumanr
esour
cest
hatcoul
dot
her
wisebepr
oduci
ng
goodsandser
vicest
osat
isf
ytheneedsofsoci
ety.Att
hesamet
ime,i
tcan
meanext
remeper
sonalhar
dshi
pfort
heUnempl
oyed,andt
her
efor
eiti
san
i
mpor
tantsoci
alconcer
n.Unempl
oymentr
atef
luct
uat
eswi
del
yovert
imewi
thi
n
agi
vencount
ry,
inl
inewi
tht
hebusi
nesscycl
e.Unempl
oymenti
ncr
easesdur
ing
r
ecessi
onanddecl
inesdur
ingbooms.

Measur
ementofUnempl
oyment
Whencal
cul
ati
ngt
hel
evelofunempl
oymentt
hegover
nmentonl
ycount
sthose
peopl
ewhor
egi
sterasunempl
oyedandcl
aim benef
it
.Al
argenumberofpeopl
e
seeki
ngwor
kei
therdonotr
egi
sterordonotcl
aim benef
itandar
enowexcl
uded
f
rom of
fi
cialf
igur
es.Unempl
oymentr
atei
sthenumberofunempl
oyedpeopl
e
asapr
opor
ti
onoft
hel
abourf
orce.Thel
abourf
orcei
sal
lthosewi
thwor
koral
l
t
hoseseeki
ngwor
k.

Theunempl
oymentr
atei
stheper
cent
ageoft
hel
abourf
orceof
fi
cial
lyj
obl
ess.
Ful
lempl
oymentoccur
swhent
henumberofnot
if
iedj
obvacanci
esexceedst
he
numberofr
egi
ster
edpeopl
eunempl
oyed.

Unempl
oymentTr
ends

5
5
Unempl saf
oymenti low andnotast
ock.Ther
ear
eal
waysi
nfl
owsont
othe
unempl
oymentr
egi
ster
,andt
her
ear
eout
fl
owsof
fther
egi
steraspeopl
eget
j
obsorj
oint
rai
ningschemes.

I
fal
linf
lowsr
iseandal
lout
fl
owsexceptt
rai
ningf
allt
henover
allunempl
oyment
wi
llr
ise.Youngpeopl
e,women,t
heover
-f
if
ti
esandet
hni
cmi
nor
it
iest
endt
obe
t
hehar
desthi
t.I
nnerci
ti
esandmanuf
act
uri
ngar
easal
sot
endt
ohaveabove-
aver
ageunempl
oyment
.

Nat
uralr
ateofunempl
oyment

I
tist
hatr
ate whi
ch cor
responds t
o macr
oeconomi
c equi
li
bri
um,i
n whi
ch
expect
edi
nfl
ati
oni
sequalt
oit
sact
uall
evel
.Iti
sthatr
ateofunempl
oymentt
o
whi
cht
heeconomywi
ll
ret
urnaf
teracycl
ical
,recessi
onorboom.

The nat
ural r
ate of unempl
oyment i
s somet
imes cal
led t
he “
the f
ull
empl
oyment
”rat
eofunempl
oymentconveyi
ngt
hesenset
hatunempl
oymenti
s
excessi
veonl
ywhenact
ualunempl
oymentexceedst
henat
ural
level
.

Wegener
all
yref
ert
othegapbet
weenact
ualunempl
oymentandt
henat
uralr
ate
ascycl
icalunempl
oyment
.Inot
herwor
ds,
cycl
icalunempl
oymenti
stheamount
ofunempl
oymentt
hatcan be r
educed by expansi
onar
y macr
oeconomi
c
pol
ici
eswi
thoutset
ti
ngof
fanendl
essr
isei
nther
ateofi
nfl
ati
on.

Typesofunempl
oyment

Wehavet
odi
ff
erent
iat
ebet
weenaf
ewt
ypesofunempl
oyment
:

1.Cycl
icalunempl
oyment
:ifacount
ryhasaneconomi
calboom t
henpeopl
e
have j
obs,i
fther
eis an economi
crecessi
on peopl
elose j
obs.Cycl
ical
unempl
oymenti
sunempl
oymentabovet
henat
ural
rat
e.

2.Fr
ict
ionalunempl
oyment
:Thi
sar
isesbecausepeopl
ear
eal
waysf
lowi
ngi
nto
andoutofunempl
oyment
.Newwor
ker
sar
econst
ant
lyent
eri
ngt
hel
abourf
orce,
andexi
sti
ngwor
ker
sfr
equent
lyl
eaveonej
obandl
ookf
oranot
her
.Dur
ingt
hese
t
ransi
ti
onst
heyspendt
imeont
hei
rjobsear
chese.
g.youst
opwor
kingi
n
Decemberand st
artyournew wor
kin Mar
ch,t
heseper
iod bet
ween t
hese
mont
hsi
scal
ledf
ri
cti
onalunempl
oyment

5
6
3.St
ruct
uralunempl
oyment
:St
ruct
uralunempl
oymentcanoccuri
nfact
ori
es
whent
oool
dmachi
nes,cannotpr
oduceenough,sel
llesspr
oduct
s,cannotpay
t
hei
rst
aff
,mor
eunempl
oyedpeopl
e.I
tisunempl
oymentt
hatexi
stswhent
he
economyi
soper
ati
ngatt
henat
uralr
ate.Thenat
ural
rat
eofunempl
oyment(
Un)
r
efl
ect
smanydi
ff
erentphenomenaandf
orcessuchasuni
onpower
,whi
ch
r
aisesr
ealwagesabovef
ullempl
oymentr
ealwages.

4.Hi
ddenunempl
oyment
:di
smi
ssedpeopl
edon’
taskf
oranew j
ob,t
heyal
so
don’
tregi
sterf
orunempl
oymentbenef
it
s,e.
g.womenaf
tert
hei
rmat
erni
tyl
eave
of
tenst
ayathomewi
tht
hei
rchi
ldr
en.I
tcanal
soi
ncl
udet
hedi
scour
aged,
those
nomi
nal
lyhavi
ngj
obsf
orwhi
cht
heyar
epai
dbuti
nfactdoi
ngnot
hing;and
t
hosewhocanbewi
thdr
awnf
rom r
uralar
easbecauseoft
hei
rzer
omar
ginal
pr
oduct
.

5.Seasonalunempl
oyment
:e.
g.t
our
ism-
areas,const
ruct
ion sect
or,and
agr
icul
tur
alsect
or.I
nthe r
uralar
eas orf
armi
ng ar
eas,ever
yone i
sful
ly
empl
oyeddur
ingt
her
ainseasonandhar
vest
ingper
iodsbutt
her
eaf
terdemand
f
orl
abouri
sver
ylow.Theunempl
oymenti
smost
lywher
ether
eissi
ngl
e
cr
oppi
ng

6.St
ruct
uralUnempl
oyment
.Thi
soccur
swheneconomi
creadj
ust
ment
sar
enot
f
astenoughdur
ingeconomi
cgr
owt
h,sot
hatsever
epocket
sofunempl
oyment
occuri
nar
eas,i
ndust
ri
esandoccupat
ionsi
nwhi
cht
hedemandf
orf
act
orsof
pr
oduct
ion i
sfal
li
ng f
ast
ert
han i
sthe suppl
y.Pol
ici
es t
hatdi
scour
age
movementamong r
egi
ons,i
ndust
ri
es and occupat
ions can r
aise st
ruct
ural
unempl
oyment
.

7.Technol
ogi
calUnempl
oyment
-thi
scomesaboutasar
esul
toft
echnol
ogi
cal
change.

Whyunempl
oymenti
sst
udi
ed

1.Thei
ncomeaspect
-incomecanmost
lybeear
nedi
fonei
sempl
oyed.Most
economi
esgai
nfr
om empl
oymentoft
hei
rnat
ional
s.

5
7
2.Thepr
oduct
ionaspectofempl
oyment
-concer
nisont
hel
abourut
il
isat
ion.I
f
l
abouri
sunempl
oyedt
her
eisawast
eofpr
oduct
iver
esour
ces.

3.Recogni
ti
onaspect
-thet
ypeofempl
oymentdet
ermi
nessoci
alst
atusand
sel
f-
est
eem.St
udi
esf
oundt
hatpeopl
ewhohadbeenunempl
oyedf
ort
woor
mor
eyear
shadsel
f-
est
eem.

CausesofUnempl
oyment

1.Rapi
d gr
owt
h ofl
abourf
orces due t
o hi
gh popul
ati
on gr
owt
hrat
ein
devel
opi
ngcount
ri
es.Fastgr
owt
hofl
abourf
orcepl
acesast
rai
nont
heabi
li
ty
oft
heeconomyt
ogener
atenew wor
koppor
tuni
ti
esonasuf
fi
cientscal
eto
absor
bri
singnumber
s(economi
cdual
ism andr
ural
-ur
banmi
grat
ion)
.

2.Educat
ionsyst
em al
socont
ri
but
es–t
hesi
zeoft
heeducat
edl
abourf
orcei
s
gr
owi
ngmor
erapi
dlyt
hant
heeconomycanabsor
b.

3.Shor
tageofsavi
ngandi
nvest
ment
-invest
mentperwor
keri
ndevel
opi
ng
count
ri
esi
sof
tenl
esst
hant
hati
ndevel
opedcount
ri
es.

4.I
nef
fi
cientl
andt
enur
esyst
emsi
nmanydevel
opi
ngcount
ri
escauset
hem not
t
obeabl
etout
il
iset
hei
rexpandi
ngl
abourr
esour
ces.

5.I
nappr
opr
iat
e devel
opmemntst
rat
egi
es t
hey pur
sued and t
echnol
ogi
es
adopt
ed.Theyengagedi
nimpor
tsubst
it
uti
onst
rat
egi
eshencel
imi
tedj
obs.

6.Engi
neer
ing bi
as,mi
nimum wage l
aws,gover
nmentsal
ary st
ruct
ures,
i
nfl
uenceoft
radeuni
ons,paypol
ici
esofmul
ti
nat
ionalcor
por
ati
onsal
lhel
pto
r
aiset
heur
banwageswel
labovecompet
it
ivemar
ketcl
ear
ingl
evel
s.

7.Lawsand convent
ionshol
ding down i
nter
estr
ates,t
axconcessi
onsf
or
f
orei
gni
nvest
orssi
mil
arl
yhol
dthepr
iceofcapi
talwel
lbel
ow l
evel
swhi
ch
woul
dref
lectt
hei
rscar
cit
yint
heeconomy.

Consequencesofunempl
oyment/
Cost
sofUnempl
oyment

5
8
 LostOut
put
Theoppor
tuni
tycostofeachunempl
oyedper
soni
sthei
rfor
egoneout
put
.
I
ncr
easedBenef
itPayment
s
Eachext
raper
sonwhobecomesunempl
oyedst
opspayi
ngt
ax(per
haps$4000)
andst
art
srecei
vingbenef
it(
upwar
dsof$5000)
.Thegover
nmentt
her
efor
ehas
t
orai
seaaddi
ti
onalf
undst
ofi
nanceunempl
oymentbenef
it
sforunempl
oyed.
Ast
hef
igur
efal
lst
hegover
nmentpaysoutl
essunempl
oymentbenef
it
sand
r
ecei
ves mor
eint
ax.The savi
ngs t
othe exchequerf
rom t
his wi
llbe
consi
der
abl
e.

LostTaxRevenue
Gr
owi
ng unempl
oymentmeans l
ess di
rectand i
ndi
rectt
axr
evenue.When
peopl
eloset
hei
rjobst
heywi
llst
oppayi
ngi
ncomet
ax,andt
hei
rspendi
ngwi
ll
f
allconsi
der
abl
yreduci
nggover
nmentr
ecei
ptsf
rom VATandot
heri
ndi
rect
t
axes.

HumanCost
sofUnempl
oyment
Thel
ong-
ter
m andyout
hunempl
oyedf
eeli
ncr
easi
ngl
yisol
atedandr
emoved
al
( i
enat
ed)f
rom soci
ety.Ther
ewi
llal
sobei
ncr
easedNHScost
saspeopl
e'
s
heal
thof
tensuf
fer
swhent
heyar
eunempl
oyed,andt
her
ewi
llbei
ncr
eased
cost
stosoci
etyi
nter
msofcr
ime.

I
noursoci
etywher
emoneymeanssuccesst
heunempl
oyedf
eelusel
essand
consi
dert
hemsel
vesaf
ail
ure.St
udi
eshaveshownt
hatpeopl
ewhohavebeen
unempl
oyedf
orsomet
imedevel
opal
owsel
fest
eem.
Theyar
edi
ssat
isf
iedand
depr
essedandt
hismayl
eadt
oal
cohol
ism dr
ugpr
obl
emsandhomel
essness
andevent
ocr
ime.

Especi
all
yforf
ami
li
esi
t’
sdi
ff
icul
tbecauset
heydonothaveenoughmoneyt
o
af
for
dthei
rbasi
csofl
if
e.Sobecauseoft
hatt
hatgover
nmenthast
ohel
p
f
inanci
all
y,butt
hiscauseshi
ghcost
sforwor
kingpeopl
ewhohavet
osuppor
t
t
heunempl
oyed.

Hi
ghr
iskgr
oups
Ther
ear
esomehi
gh-
ri
skgr
oups,
forexampl
eyout
hs,
womenwi
thl
it
tl
echi
ldr
en
af
tert
hei
rmat
erni
tyl
eaveorel
der
lypeopl
eaged50andover
.Lot
soft
hose
peopl
ecannotf
inda(
good)j
ob.

5
9
Youngpeopl
ear
epar
toft
hehi
gh-
ri
skgr
oupbecausei
nmostcasest
heydonot
haveanypr
act
icalexper
ienceandt
her
ear
elot
sofyoungpeopl
esear
chi
ngf
or
t
hesamef
ewj
obs.Thati
swhyt
her
eisahi
ghsel
ect
ionr
ateont
hej
obmar
ket
.
Fi
rmswantt
oempl
oyyoungpeopl
ewi
thl
otsofexper
iencewhowantt
owor
k
al
most24hour
sadayandear
njustal
it
tl
epocketmoney.

Womeni
ngener
al,butespeci
all
ywomenwi
thl
it
tl
echi
ldr
enwhowantt
owor
k
agai
naf
tert
hei
rmat
erni
tyl
eavear
eanot
herhi
gh-
ri
skgr
oup.Thei
rpr
obl
em i
s
t
hatt
hepr
obabi
li
tyoft
hei
rneedi
ngt
imeof
ftonur
sesi
ckchi
ldr
eni
sver
yhi
gh,
especi
all
yift
heyhavel
it
tl
eki
ds.Anot
herpr
obl
em i
sthatt
hosewomenhavenot
wor
kedf
ort
het
imeoft
hei
rchi
ldnur
singandt
her
emi
ghtbenew t
rends,new
devel
opment
sort
hingsl
iket
hat
.

Thel
asthi
gh-
ri
skgr
oupi
sthel
argegr
oupofover50yearol
dpeopl
e.Thei
r
pr
obl
em i
sthatt
heycostt
oomuch.I
faf
ir
m empl
oysyoungerwor
ker
stheydo
nothavet
opayasmuchast
heywoul
dforanol
derper
son.Thati
swhyt
heyar
e
f
ir
ed.Andi
tisal
mosti
mpossi
blef
ort
hosepeopl
etof
indanewwor
kpl
ace.

Sol
uti
onofunempl
oyment
Possi
blesol
uti
ons:

Ear
lyr
eti
rement

Job-
shar
ing

Newj
obs(
neweconomy)

Agener
alr
educt
ionofwor
kinghour
s

Reduct
ionofover
ti
me

I
tisver
yhar
dtof
indgoodsol
uti
onsi
nthel
ongr
un.Somei
deassuchasj
ob-
shar
ingorear
lyr
eti
rementar
eindi
scussi
on.Butmyopi
nionont
hati
sthatbot
h,
j
ob-
shar
ingandear
lyr
eti
rementar
enott
her
ightwaybecausei
fyoushar
eyour
j
obyouwon'
tear
nenoughmoneyt
oaf
for
dthebasi
csofl
if
eforyourf
ami
ly.

Ear
lyr
eti
rementsoundsni
cebuti
tmeansahugeamountofcost
sforal
lthe
ot
herwor
kingpeopl
ewhohavet
opayf
ort
hat
.Sot
hiscannotbet
her
ightway,
I
suppose.

Agoodsol
uti
onwoul
dbet
heat
tendanceoff
urt
hert
rai
ningcour
ses,sot
hat
unempl
oyedpeopl
ear
etr
ainedt
ofi
ndanewj
obandl
ear
nnewski
ll
s.Theonl
y

6
0
pr
obl
em aboutt
hatar
ethecost
s,whi
char
ever
yhi
ghandt
hequest
ioni
swhoi
s
goi
ngt
opayt
hem.

Popul
ati
oncont
rol
-ift
her
eispopul
ati
onr
est
rai
ntt
hegr
owt
hofdevel
opi
ng
count
ryl
abourf
orcewi
llbei
ncheck.

Over
hauloft
heeducat
ionsyst
emst
ochangef
rom t
hei
rpr
esentacademi
c,
el
it
ist
,whi
te-
col
larj
obor
ient
ati
ont
ovocat
ionalandt
echni
calt
rai
ningsyst
ems
t
opr
oducear
ti
sansandt
echni
cianst
hecount
ri
esdesper
atel
yneed.

Sect
oralpr
ior
it
ieswhi
ch par
ti
cul
arl
yfavourt
hedevel
opmentofsmal
l-
scal
e
agr
icul
tur
eandt
hei
nfor
malsect
or.Smal
l-
scal
eagr
icul
tur
eandt
hei
nfor
mal
sect
orar
elabouri
ntensi
ve,so t
hei
rdevel
opmentwi
llbot
h gener
ate mor
e
empl
oymentandr
aisepr
oduct
ivi
ti
esoft
hoseal
readywor
kingi
nthem.

I
ncomespol
ici
esdesi
gnedt
opr
eventf
ormalsect
or wagel
evel
sfr
om bei
ng
r
aisedbyi
nst
it
uti
onalf
act
orst
olevel
swel
labovet
het
rueeconomi
cval
ueof
unski
ll
edl
abour
.Thi
sinvol
vesat
tent
iont
othegover
nment
‘sownpaypol
ici
es,
i
tspol
ici
est
owar
dst
het
radeuni
ons,t
owar
dsmul
ti
nat
ionalf
ir
msandt
owar
ds
mi
nimum wagel
egi
slat
ion.

Rur
al devel
opment and decent
ral
isat
ion- t
his i
nvol
ves coor
dinat
ion of
pr
ogr
ammesf
ort
hei
mpr
ovementofagr
icul
tur
e,wat
er,t
ranspor
t;accesst
o
goodsandser
vicesandappr
opr
iat
elandt
enur
e-ai
mist
oreducer
ural
-ur
ban
mi
grat
ion.

I
nfor
malSect
or:
Thedevel
opmentoft
hesect
ori
sat
tr
act
ivebecausei
tdoesnot
r
equi
re compl
ex and expensi
ve i
nfr
ast
ruct
ure and has hi
gh pot
ent
ialf
or
cr
eat
ingj
obs.I
tusesmost
lyl
ocal
lypr
oducedr
esour
cesorr
awmat
eri
als.I
tcan
beamaj
orsour
ceofi
ncomegener
ati
onbot
hforr
uralandnonagr
icul
tur
al
i
nfor
malsect
ionsoft
heeconomy.I
tcr
eat
esapl
atf
ormf
ort
heexchangeof
l
ocal
ly pr
oduced goods and ser
vices.I
tpr
ovi
des st
rong base f
orl
ocal
ent
repr
eneur
s.I
tisal
soasour
ce ofgover
nmentr
evenuewhent
hesesect
ors
gr
owandbecomer
egi
ster
ed.

Pr
obl
emsoft
hei
nfor
malsect
ori
nZi
mbabwe

 Pr
ocedur
est
obef
oll
owedi
nobt
aini
ngl
icencesandpr
ojectappr
ovalar
e
di
scour
agi
ngandt
hey(
oper
ati
vesi
nthesect
or)payhi
ghr
ent
alst
olandl
ords.

6
1
 Becauseoft
hehi
ghcor
por
atet
ax,t
heywoul
drat
herr
emai
nunr
egi
ster
ed.I
f
t
heyar
etaxedt
heyf
acef
inanci
alpr
obl
emsandhencecannotpaymi
nimum
wages.

 Lack ofadequat
etr
anspor
tand i
nfr
ast
ruct
uret
ofaci
li
tat
e del
iver
y of
pr
oducet
othet
argetmar
ket
.

 Lackoft
echnol
ogi
calsuppor
tandmanager
ial
,techni
calandmar
ket
ingski
ll
s.

 Lackofpr
ojectpl
anni
ngandi
mpl
ement
ati
on.

 I
nabi
li
tyt
oobt
ainl
oanandcr
edi
tfaci
li
ti
eshenceduet
olackofcol
lat
eral
secur
it
y,90%ofmi
croent
erpr
isesar
eaut
omat
ical
lyel
imi
nat
edf
rom get
ti
ng
f
inanci
alassi
stance.

Howeveri
tmustbepoi
ntedoutt
hatt
hedevel
opmentpat
hwher
ebyt
her
eis
heavy emphasi
s on i
unf
ormal sect
or ent
erpr
ise and smal
l busi
ness
devel
opmenthasl
imi
tat
ions,
alt
houghi
tpr
ovi
desempl
oymentandi
ncome.The
di
sadvant
ageofi
nfor
malent
erpr
isei
sitdoesnotl
eadt
odevel
opmentofhi
gh
t
echnol
ogynont
radi
ti
onalexpor
t.
Itdoesnoti
nvesti
nnewt
echni
que,gener
ate
newski
ll
sanddevel
opnewpr
oduct
s.

Types,
Causes,
andRemedi
esf
orUnempl
oyment
Tabl
ebel
ow summar
isest
hemai
ncausesandr
emedi
esf
ordi
ff
erentt
ypesof
unempl
oyment
.

Theaver
agel
engt
hoft
imewor
ker
sremai
nunempl
oyedi
sacr
it
icalmeasur
eof
t
he ser
iousness oft
he unempl
oymentf
igur
es.I
fthe aver
age l
engt
h of
unempl
oymenti
sshor
tthent
heeconomywi
llbeheal
thi
erandpeopl
ewi
llnot
l
oset
hei
rski
ll
sfr
om l
ongper
iodswi
thoutwor
k.

Empl
oymentandt
rai
ningschemest
hathavebeenusedi
nthe1980sand1990s

Scheme Descr
ipt
ion
Rest
artPr
ogr
ammeI
nter
viewsandt
rai
ningf
ort
hel
ong-
ter
m unempl
oyed
Communi
ty Localpr
oject
sfort
hel
ong-
ter
m unempl
oyed
Pr
ogr
amme
New Wor
ker
sAsubsi
dyt
oempl
oyer
staki
ngonyout
hunempl
oyed
Scheme
JobSear
chSchemeRet
urnf
areandal
lowancesf
orj
obi
nter
views

6
2
Job Rel
easeOl
derwor
ker
sret
ir
eear
lywi
thanal
lowanceandar
erepl
aced
Scheme byanunempl
oyedper
son
Job Spl
it
ti
ngAsubsi
dyt
oempl
oyer
swhoencour
agej
obshar
ing
Scheme
Yout
h Tr
aini
ngTwo-
yearwor
kexper
ienceandt
rai
ningf
orschooll
eaver
s
Scheme
Job Tr
aini
ngRet
rai
ningschemef
orunempl
oyedadul
ts
Scheme
Causesandr
emedi
esofunempl
oyment

Type Descr
ipt
ion Cause Remedy
Fr
ict
ional Wor
ker
stempor
ari
lyDel
ays i
n appl
ying I
mpr
ovej
ob
bet
weenj
obs i
nter
viewi
ng and i
nfor
mat
ion,
eg
accept
ingj
obs comput
eri
sedj
ob
cent
res
St
ruct
ural Wor
ker
s have t
heDecl
ini
ngi
ndust
ri
es Subsi
dies and
wr
ong ski
ll
sint
heand t
he i
mmobi
li
tyi
mpr
ove t
he mobi
li
ty
wr
ongpl
ace ofl
abour ofl
abour
Cycl
ical Al
lfi
rmsneedf
ewerLowt
otaldemandi
nIncr
eased
wor
ker
s t
heeconomy gover
nmentspendi
ng
orl
owert
axes
Technol
ogi
cal Fi
rms r
epl
aceAut
omat
ion and Ret
rai
ning
wor
ker
s wi
thi
nfor
mat
ion
machi
nes t
echnol
ogy
I
nter
nat
ional Over
seas f
ir
ms Hi
gh-
pri
ced/
low- Tar
if
fs quot
as or
r
epl
ace UK qual
it
yUKgoods st
erl
ingdepr
eci
ati
on
pr
oducer
s
Regi
onal Hi
gh unempl
oymentLocalconcent
rat
ion Regi
onalai
d,eg
i
nonear
ea of decl
ini
ng r
elocat
iongr
ant
s
i
ndust
ri
es
Seasonal Unempl
oyment f
orSeasonal var
iat
ion Ret
rai
ning
par
toft
heyear i
ndemand
Vol
unt
ary Wor
ker
s choose t
o Mor
emoney'
ont
he Removet
hel
ow-
pai
d
r
emai
nunempl
oyed dol
e' t
han f
rom f
rom t
he l
i
abi
li
tyt
o

6
3
 wor
king payi
ncomet
ax

CHAPTERFI
VE
I
NFLATI
ON
DEFI
NITI
ONS
Ther
ear
esever
aldef
ini
ti
ons:
(
a)Thi
sisaper
sist
entr
isei
nthegener
all
evelofpr
icesoraper
sist
entf
all
int
he
pur ngpowerofmoney.Theval
chasi ueorpur
chasi
ngpowerofmoneyr
efer
sto
t
heamountofgoodsorser
vicesauni
tofmoneycanbuy.I
tshoul
dbenot
ed
t
hatt
hedef
ini
ti
oni
mpl
iest
hatani
ncr
easei
nsomepar
ti
cul
arpr
icei
snot
i
nfl
ati
onar
yifcompensat
edbyf
all
sinot
herpr
ices.
(
b)I
nfl
ati
oni
sthegener
alandpr
olongedr
isei
nthepr
icel
evel
.
(
c)I
nfl
ati
oncanal
sobedef
inedast
othecont
inuali
ncr
easei
npr
ices.
I
nfl
ati
onmeanst
heval
ueofmoneyi
sfal
li
ngbecausepr
iceskeepr
isi
ng.

MEASURESOFI
NFLATI
ON
1. Costofl
ivi
ngI
ndex(
*COLI
)-
al
socal
ledt
her
etai
lpr
icei
ndexorconsumerpr
icei
ndex.Thi
sist
hemost
f
requent
lyusedmeasur
eandi
sbasedonobser
vat
ionsofpr
icesofa‘
basket
’
ofgoodssel
ect
edasar
epr
esent
ati
veoft
hespendi
ngpat
ter
nsof
consumer
swi
thi
nsomespeci
fi
edr
angeofi
ncomes.

2. Whol
esal
epr
icei
ndex-
i
sthei
ndexwhi
chmeasur
espr
icesofcommodi
ti
escommonl
yboughtand
sol
dbywhol
esal
ers.Thi
sindexhasanadvant
ageovert
heconsumerpr
ice
i
ndexi
nthati
tgi
vesanear
li
erwar
ningofanupsur
gei
npr
icest
hanar
etai
l
i
ndex.I
ttakest
imef
orar
iset
owor
kit
swayt
hrought
otheshopsand
mar
ket
s.

6
4
3. TheGNPdef
lat
or-
Thi
sisder
ivedf
rom compar
isonsofGNPest
imat
esi
ncur
rentpr
icesandi
n
const
antpr
ices.Pr
icesofconsumergoods,
capi
talgoodset
c.ar
etakeni
nto
consi
der
ati
onwhencompi
l
ingt
his.
Cal
cul
ati
ngt
heRet
ailPr
iceI
ndex
Ther
etai
lpr
icei
ndex(
RPI
)canbeusedt
omeasur
einf
lat
ion.Ther
etai
lpr
ice
i
ndex(
RPI
)isamont
hlysur
veycar
ri
edoutbyt
hegover
nmentwhi
chmeasur
es
pr
icechanges.Thef
oll
owi
ngpr
ocedur
eisused:

 Abasketofgoodsandservi
cesconsumedbytheaveragef
ami l
yisli
sted.
Forexample,f
ood,cl
othi
ngandtranspor
tar
eincl
udedinthebasket.
 Thepr
iceofi
temsi
nthebasketi
nthebase(
fi
rst
)yeari
snot
ed.
 Eachit
em i
nt hebasketi
sgi
venanumbervalue(wei
ght
ed)toref
lectit
s
i
mport
ancetotheaveragef
ami
ly.Forexampl
e,f
oodhasahi
gherweighti
ng
t
hantr
anspor
t.
 Thepri
ceofgoodsi
nthebasketi
srecordedever
ymonthcompar
edwi
th
baseyear asapercent
age(pri
cerel
ati
ve)usi
ngtheequat
ion:

Pr
icer
elat
ive=Cur
rentpr
ice/
Basepr
icex100

 Thepr
icer
elat
iveofeachi
tem i
sthenmul
ti
pli
edbyi
tswei
ght
ing.
 ThenewRPIi
sfoundusi
ngt
heequat
ion:

RPI=Tot
alwei
ght
ingsxPr
icer
elat
ive/
Tot
alwei
ght
ings

ThevalueoftheRPIi
nthebaseyearisal
ways100.Af t
ert
welvemont hs
thepri
ceofgoodit
emsinthebasketmayhaverisenby25percentand
thatofhousi
ngby20percentwhil
ethecostoftr
ansporti
sunchanged.
TablebelowshowshowtheRPIforyeart
womi ghtthenbecalcul
ated.

TheRPI=Tot
alwei
ght
ingsxPr
icer
elat
ive/
Tot
alwei
ght
ings=12100/
100=
121
Cal
cul
ati
onoft
her
etai
lpr
icei
ndex

Basket Wei
ght
in Pr
ice Wei
ght
ings x pr
ice

6
5
 g r
elat
ive r
elat
ive
Food 60 125 7500
Housi
ng 30 120 3600
Tr
anspor
t 10 100 1000
Tot
al 100 12100

Ther
ateofi
nfl
ati
oni
stheper
cent
agechangei
ntheRPIovert
hel
astt
wel
ve
mont
hsandi
scal
cul
atedusi
ngt
heequat
ion:

Rat
eofi
nfl
ati
on=(
Cur
rentRPI-LastRPI
)/LastRPIx100

Att
hebegi
nni
ngofyeart
wot
her
ateofi
nfl
ati
oni
s:

(
121-100)
/100x100=21percent

Pr
obl
emsi
nUsi
ngt
heRet
ailPr
iceI
ndex
 TheRPIi
snar
row.
 Whi
chi
temsshoul
dbei
ncl
udedi
norexcl
udedf
rom t
hebasketofgoods?
 Di
ff
erentfamil
ieshavedif
fer
entt
ast
eshencedi
ff
erentwei
ght
ings.How
i
sanaveragefamil
yfound?
 Notal
lregi
onsi
nthecount
ryexper
iencei
dent
icalpr
icechanges.
 Forawhi
lenewpr
oduct
s(egmobi
lephones)maynotbei
ncl
udedi
nthe
i
ndex.

Advant
agesandEf
fect
sofI
nfl
ati
on
Notever
yonesuf
fer
sfr
om i
nfl
ati
on.Somepar
tsofsoci
etyact
ual
lybenef
it
:

 Thegover
nmentf
indst
hatpeopl
eear
nmor
eandsopaymor
eincomet
ax.
 Fir
msareabl
etoi
ncr
easepr
icesandpr
ofi
tsbef
oret
heypayouthi
gher
wages.
 Debtor
s(bor
rowers)gai
nbecauset
heyhaveuseofmoneynow,
wheni
ts
purchasi
ngpowerisgreat
er.
Di
sadvant
agesofI
nfl
ati
on
 Peopl
eonf
ixedi
ncomesar
eunabl
etobuysomanygoods.
 Cr
edi
tor
s(savers)l
osebecauset
hel
oanwi
llhaver
educedpur
chasi
ng
powerwheni
tisrepai
d.

6
6
 Domesti
c goods may become mor
e expensi
ve t
han f
orei
gn-
made
pr
oduct
ssothebal
anceofpayment
ssuf
fer
s.
 Industr
ialdisput
esmayoccuri fworker
sar
eunabl
eto secur
ewage
i
ncreasestorestor
ethei
rst
andar
dofl
ivi
ng.

CAUSESOFI
NFLATI
ON
Suppl
yor
ient
edExpl
anat
ions
Theseexpl
anat
ionsconcent
rat
eont
hecostpushandst
ruct
ural
istt
heor
ies.

Cost
-pushI
nfl
ati
on
CostPush Theor
y-t
his ascr
ibes i
nfl
ati
on t
oincr
eases i
n cost
,whi
ch ar
e
i
ndependentoft
hest
ateofaggr
egat
edemand.Formostmanuf
act
urer
sin
devel
opi
ngcount
ri
es,
thecostofi
mpor
tedgoodsi
scont
inuousl
yri
singbecause
ofwor
ldi
nfl
ati
on.Thi
sbot
hdi
rect
lyr
aisest
hecostofl
ivi
ngt
hroughhi
gher
pr
icesf
orf
ini
shedgoodsi
mpor
tsandi
ndi
rect
lyt
hroughmor
ecost
lyi
mpor
ted
mat
eri
alsusedbydomest
icpr
oducer
s.I
naddi
ti
on,t
radeuni
onsmayf
orce
wagesupmor
erapi
dlyt
hani
ncr
easesi
npr
oduct
ivi
ty,r
aisi
nguni
tlabourcost
s.
Ot
hergr
oupse.
gfar
mer
sor
gani
zat
ions,mayal
sobest
rongenought
opr
event
t
hei
rown posi
ti
on f
rom bei
ng er
oded,and t
he gener
all
ylow degr
ee of
compet
it
ioni
nmoder
nindust
ri
alsect
oral
lowsmanuf
act
urer
stopasscost
i
ncr
eases on t
o consumer
s per
haps addi
ng an enl
arged pr
ofi
tmar
ginf
or
t
hemsel
ves.

Cost
-pushI
nfl
ati
onoccur
swhenaf
ir
m passesonani
ncr
easei
npr
oduct
ion
cost
stot
heconsumer
.Thei
nfl
ati
onar
yef
fectofi
ncr
easedcost
scanbet
he
r
esul
tof
:

 I
ncr
easedwages,
leadi
ngt
o
1. awage-pr
icespi
ral
,whi
choccur
swhenpri
ceincr
easesspar
koffa
ser
iesofwagedemandswhichleadtof
urt
herpr
iceincr
easesandso
on;
2. a wage-
wagespir
al,whichoccurswhenonegroupofworker
s
recei
veawagei ncr
easewhichsparksof
faseri
esofwagedemands

6
7
 f
rom ot
herworkers.Wagesmayal soriseduet othetr
adeuni
ons,
whi
chmayforcethewagestori
se.Thissqueezespr
ofi
tsoff
ir
msand
t
heyrai
sepr
icetomeettar
getpr
ofi
ts.
 I
ncr
easedi
mpor
tpr
iceswhi
chcanbet
her
esul
tof
:
1. ar
isei
nwor
ldpr
icesf
ori
mpor
tedr
awmat
eri
als;
2. adepr
eci
ati
onoft
hedomest
iccur
rency.
 I
ncr
easedi
ndi
rectt
axat
ion

 I
nter
estr
ater
aisest
hecost
sofpr
oduct
ionandt
hegener
alpr
icel
evel
s.
Thecentr
albankcanr espondbyti
ghteni
ngmoneysupply,
whichinit
sel
f
rai
sesint
erestr
ates,whichincr
easescostsofpr
oduct
ionandincr
eases
pri
ces.
Pur
ecosti
nfl
ati
on-aggr
egat
edemandhel
dconst
ant
Withincr easesincost s,manufacturersshi ftsuppl
yf rom S1 t
oS2 toiS3.Thi s
i
mpl i
esl ossofout put,moreunempl oyment ,andr i
seinpr i
celevelf
rom PytoPx.
Therei s strong union resi
stance tor educti
on in wages,costpl us pricing
poli
ciesoff i
rm sell
inginoli
gopol i
sticandmonopol ist
icmar ketswherepr ices
aredeter minedbycost s,notstateofdemand.Theabi l
it
ytopassi ncreasest o
thepublicmakespr oducersl
essr esistanttowagecl aimsandot hercostraising
pressures.

S3
S2
Px S1

Py

D
Qx Qy

CostPushwi
thDemandAdj
ust
ment
s
Inthe pr
evi
ous diagram t
here was i
ncr
eased unemployment,reducti
on i
n
capaci
tyuti
li
sat
ion and t
his maynotbe inthe publ
ic’s and gover
nment’
s

6
8
i
nter
est
.Thegover
nmentwouldfi
nditsel
funderpr
essuret
oincreaseaggregat
e
demandenoughtopr
eventoutputandemploymentfrom f
all
ing(seediagram
bel
ow).

S3
Pz S2
pr
ice S1
D3
Py D2
D1
Qx
I
nthediagram,foreveryupwardmovementi nthesupplycurve,
governmentwil
l
i
nduceacompensat i
ngincreaseintotaldemand( D1 t
oD3)soast o“val
idat
e”
t
hecosti ncr
easeandpr eventoutputfrom fall
ingbelow Qx.Theef f
ectisto
i
ncreaset
her at
eofinflat
ionwithpr
icelevelgoinguptoPz.
St
ruct
ural
istTheor
yofI
nfl
ati
on
Thist heorypost ul
atest hatinfl
ati
onwi llaccompanyeconomi cdevel opment
becauseofdi sequili
bri
acr eatedbythestructuralchangest hatar enecessar yto
thedevel opmentpr ocess.Ast heeconomydevel ops,i ncomesr iseandast he
i
ncomesr i
set hecomposi ti
onofdemandchangesandsodoest hest ructureof
output.Ther ei showevernoguar anteethatthepr oducti
vest ructurewi llprove
suffi
cientlyadapt i
vet ot hechanging composi t
ion ofdemand t o avoidt he
emer genceofdi sequil
ibr
iai nproductmar kets.Demandi sgr eatert hansuppl y
i
nsomecaseswhi lesuppl yisgreaterthandemandi not hers.For ei
gnt rade
sectorwi llbeunabl etoear nenoughf orei
gnexchanget omeett hegr owing
i
mpor tneedsoft heeconomy.Thef orei
gnexchangescar ci
tieswi llalsotendt o
pushuppr ices.
Domesti
cfoodproduct
ionl
agsbehi
nddemand.Agr
icul
tur
alpr
oducti
onisoft
en
i
nel
asti
cwi t
hrespecttopr
ice.I
ncr
easeddemandwi l
lhavetoresul
tinlar
ge

6
9
priceri
sesbeforeoutputrespondsmuch.Foodpri
cesthustendtomoveahead
oft hegener
alpri
celevel.Thismayinducehi
gherpri
cesintheindust
ri
alsect
or
tooast r
adeunionsl odgewagecl ai
mst oprot
ectworkeragainsteff
ectsof
higherfoodpri
ces.
Exportearningslagbehindi
mportneedsbecauseoft heslow expansionof
world demand forprimarypr
oduct
sexported byl essdeveloped countri
es.
Art
ifi
cialbarr
ier
sofdevel
opedcount
ri
esmakemat t
ersworse.Offi
cialaidfl
ows
fal
lfarshortoffi
ll
ingt
hegapbet
weenexpor
tearningsandimpor tr
equirements.
Importpricesj oinagri
cul
turepri
cesinset t
ingtheinfl
ati
onarypacedragging
otherpri
cesupbehi ndthem.Devaluati
onofnat i
onalcur
rencyorimposit
ionof
i
mpor tcontrolsbothcausepr i
ceri
ses.Importsubst
it
uti
onstrat
egyalsocauses
i
nf l
ati
on.Ift heref
oredevelopmentswithi
nt heeconomyar ebalanced,major
disequi
li
briainpr oductmarketsandonbal anceofpayment smaybeavoi ded
thusresul
tinginmi ldi
nfl
ati
on.
Demand-
pul
lInf
lat
ion
Demand-
pul
linf
lat
ionoccur
swhent
her
eis'
toomuchmoneychasi
ngt
oof
ew
goods'
becauset
hedemandf
orcur
rentout
putexceedssuppl
y.

Demandi
nfl
ati
oni
scausedbyanexcessofaggr
egat
edemandf
orgoodsand
ser
vicesoveravai
labl
esuppl
iesatagi
venl
evelofpr
ices.Thenat
uralmar
ket
r
esponset
osuchasi
tuat
ioni
sar
isei
npr
icest
owar
dsamar
ketcl
ear
ing
equi
li
bri
um i
nwhi
choncemor
eD=S.Anew equi
li
bri
um maynotbeachi
eved
becauseofpr
opagat
ingf
orceswhi
chr
aisebot
hdemandandcost
sandt
hus
pushpr
iceseverhi
gher
.

I
nfl
ati
oni
snotani
nevi
tabl
eout
comeofani
ncr
easei
ndemand.I
tal
ldepends
ont
hepr
iceel
ast
ici
tyofsuppl
y.I
ftheel
ast
ici
tyi
slar
ge,asmal
lpr
icei
ncr
ease
maycal
lfor
thal
argei
ncr
easei
nout
putsot
hatt
hei
nfl
ati
oni
mpacti
ssl
ight
.

I
ntheshor
trun,
themai
ndet
ermi
nant
soft
hesuppl
yel
ast
ici
tywi
llbet
heext
ent
t
owhi
chsuppl
ier
sar
eoper
ati
ngbel
owpr
oduct
ivecapaci
tyandt
heavai
labi
li
ty
off
orei
gnexchange.I
fther
eismuchsur
pluscapaci
ty,
thepr
inci
palef
fectofan
i
ncr
easei
ndemandwi
l
lbet
oinducegr
eat
erout
put
,rat
hert
hant
oini
ti
atean
i
nfl
ati
onar
yspi
ral
.Si
mil
arl
y,i
fther
eissur
plusf
orei
gnexchange,t
heef
fectwi
ll
bet
oinduceal
argervol
umeofi
mpor
ts.Fort
heeconomyasawhol
e,al
arge
dangerofdemandi
nfl
ati
oni
swhent
her
eisaf
orei
gnexchangeconst
rai
ntand

7
0
t
heeconomyi
soper
ati
ng atnearf
ullcapaci
ty.Thepossi
bil
it
yofdemand
i
nfl
ati
on i
s gr
eat
ert
he near
ert
he economy i
sto bei
ng on i
ts pr
oduct
ion
possi
bil
it
yfr
ont
ier
.

Themonet
ari
stschoolofi
nfl
ati
on(
ledbyMi
lt
onFr
iedman)t
ri
est
oexpl
aint
he
or
igi
nsof demandi
nfl
ati
on.
.Theessenceoft
hemonet
ari
stposi
ti
oni
sthat
i
nfl
ati
oni
sal
waysandever
ywher
eamonet
aryphenomenon.Thegr
eat
ert
he
monet
izat
ionoft
heeconomyt
hegr
eat
ert
hei
nfl
ati
on.Peopl
ewhoseeconomi
c
l
ivesar
eent
ir
elymonet
izedwi
llbemor
est
rongl
yaf
fect
edbyi
nfl
ati
ont
han
t
hosewhost
il
lmeetmanyoft
hei
rneedsf
ort
hemsel
ves.

The consequence ofan i

ncr
easei
nthesuppl
yofmoneygr
eat
ert
han an
i
ncr
easei
nthedemandf
ormoneywi
llbear
isei
nthedemandf
orpr
oduct
sand
hencewi
llt
endt
ocausei
nfl
ati
on.Peopl
edesi
ret
heconveni
enceofhol
ding
moneybal
ancebuti
fthey6desi
ret
heywi
llspendt
hesur
plusongoodsand
ser
vices.

Assumi
ngt
hesuppl
yofmoneyi
sundert
hecont
roloft
hest
ateandt
hedemand
f
ormoneyi
saf
unct
ionoft
hel
evelofr
eali
ncome,
theext
entofmonet
izat
ionof
economi
cact
ivi
tyandt
henetut
il
it
yofhol
dingmoney,t
her
ewi
llbeani
ncr
ease
i
ndemandi
freali
ncomegoesup.Ther
ewi
llbeal
argert
ransact
ionsdemand
f
ormoney.Bar
tert
ransact
ionsorsubsi
stencepr
oduct
ionbecomemonet
ised.
Thedemandf
ormoneywi
llal
sor
isei
fint
erestr
atesonbankdeposi
tsgoupor
i
fthepeopl
eexpectsl
oweri
nfl
ati
on.NB.Monet
ari
stsar
enotcont
endi
ngt
hat
anyi
ncr
easet
hatanyi
ncr
easei
nthesuppl
yofmoneyi
sinf
lat
ionar
y.

Aneconomycani
ncr
easet
hequant
it
yofmoneywi
thouti
nfl
ati
ont
oext
entt
hat
i
tisgr
owi
ngi
nrealt
erms,t
hateconomi
cact
ivi
tyi
sbecomi
ngmonet
isedand
t
hatt
henetut
il
it
yofmoneyi
sgoi
ngup.I
npar
ti
cul
arar
api
dlydevel
opi
ng
economycanabsor
bmor
enon-
inf
lat
ionar
ymoneysuppl
yincr
easest
hana
st
agnantone.Asl
ongasmoneysuppl
yisexpandedt
omeetnon-
inf
lat
ionar
y
needs,
monet
aryst
ri
ngencymayr
etar
dthepaceofdevel
opment
.

Thef
igur
ebel
owshowsi
ncr
easeddemandandi
ncr
easedpr
icesasconsumer
s
compet
etobuyupgoodsst
il
lavai
labl
e.

7
1
A maj
orsour
ceofi
nfl
ati
onar
ypr
essur
eist
hegover
nmentwhi
chcanpr
int
obuygoods.Themonet
moneyt ari
stvi
ew ofi
nfl
ati
oncanbest
atedi
nthe
equat
ion:

MV=PT

Wher
eM =t
hemoneysuppl
y,

V=t
henumberoft
imeseachuni
tofmoneychangeshands(
thevel
oci
tyof
ci
rcul
ati
on)
,

P-t
heaver
agepr
iceofgoods,
and

T=t t
henumberofgoodsbought(ransact
ions)
.

Monet
ari
stsbel
ievet
hatt
heval
uesofVandTar
efi
xedsot
hatanyi
ncr
easei
n
t
he money suppl
y ,mustr
aise t
he l
evelofpr
ices (
P),and t
hisi
s
i
nfl
ati
onar
y.Ther
eisal
waysanassoci
atedpr
icei
ncr
easewi
thmoneysuppl
yto
bal
ancet
he2si
desoft
heequat
ion.

Remedi
esofI
nfl
ati
on
Ther
ear
emanywaysf
orbusi
nesses,
consumer
sandgover
nmentt
ohal
tor
cont
roli
nfl
ati
on.Thet
radi
ti
onalKeynesi
anappr
oachi
stocat
egor
isei
nfl
ati
onas
bei
ngei
therdemandpul
lorcostpushi
nnat
ure.

Cost
-pushRemedi
es
 I
ntr
oducepr
iceandi
ncomepol
ici
est
ofr
eepr
iceandwagei
ncr
eases.

7
2
 Thepol i
ciesmaybest atutoryorvoluntary.Ceili
ngofwagesorsal ary
i
ncr easesmaybeset .Ther emayalsobei nterfer
enceint heexchangerate
system t okeepdownpr icesofi mport
edgoods.Labourcanhel pf i
ght
i
nflation by also tr
ying toi ncr
ease productivi
ty and cooperati
ng with
managementi n control
li
ng the wage-pr i
ce spi r
al,thatis,notset t
ing
excessivewagebi ds.Busi nesscanhelpfightinfl
ati
onbyt ryi
ngtoincrease
thepr oducti
vit
yofwor kers.Thiswoul
ddecr easecost s.

 I
ndexat
ion.Thi
sconsistsofperi
odicandautomat
icrevi
sionofi
ncomes,
fi
nanci
alassetvalues,theexchangeratesandothervari
ablessoasto
compensatefort
heeffectsofi
nfl
ati
on.

 Encour
ageanappr
eci
ati
onofdomest
iccur
rency.
 Reducei
ndi
rectt
axat
ion.
Demand-
pul
lRemedi
es
Fort
heKeynesi
ans,
wher
einf
lat
ioni
sdemandpul
l,
theyadvocat
edemand
managementpol
ici
es:

 Reducegover
nmentspendi
ng(G)
.
 I
ncr
easei
ncomet
ax(
T)t
oreduceconsumerspendi
ng.
 Reducepeopl
e’sabi
li
tytobor
rowmoneybyi
ncr
easi
ngi
nter
estr
atesand
t
ighteni
ngcredi
tregul
ati
ons.
 Reducenon-essent
ialgovernmentexpendi
tur
e.(T-
G)isthebudgetdef
ici
t
whi
ch i
sf i
nanced by i ssui
ng governmentpaper(tr
easury bi
ll
s,
money)
t
her
ebycontr
ibutingt
ot henationaldebt
.AsGfall
ssowillt
hedefici
t.
 Controlthesupplyofmoney.Assumi ngadi rectrelat
ionshipbetweenthe
suppl yofmoneyandaggr egat
ei ncome(Y=f(
M) ),areductioninthemoney
suppl ycausesapr efer
ablemul t
ipli
edreduct
ioni ntheaggr egat
edemand.
Interestr ates can be rai
sed to depr
ess capitalinvestmentand cr edi
t
financialconsumerpur chase.(Thisofcoursewoul dhaveadver seeffecti
f
i
nf lat
ionisexper i
encedbeforefullempl
oymenti sreached.).
 Constr
uctionshoul
dbepost ponedinsof arasf easi
blebecauset hi
s
reducesinvest
mentinbuildi
ngs,machineryandinventor
ies.Thi
sr educes
aggregat
edemand.Pr oducti
onshoul dal
sobegear edtowardsreasonable
demandandunnecessar yst ockpi
li
ngofr aw mat
erial
sandsemi -fi
nished

7
3
 pr
oduct
sshoul
dbeavoi
ded.

However pl ausi
blet hese suggest i
ons ( or solut
ions) may be f li
msy,f or
governmentbef oreanyeconomi ci ssuecanbedeci dedthepolit
icalhalfofthe
i
ssuemustbesol ved.Thi softencausesgover nmentt oi
gnoret heeconomi c
i
ssuesort ryt o sol vei tin aroundabout ,oft
en unsuccessfulmanner .The
businesswor l
dismot ivat
edbysel finter
esthencei nthissi
tuat
ionofinflat
ion,i
t
seemsr iskytopost poneexpansi onoft heproductionfaci
li
ti
es,tokeeppr i
ces
steadyandpr ofi
tsl ow.
Theconsumeront heotherhandi sconfr
ontedbythesavingsparadox.He
knowsthatmoresavi
ngsandlessconsumptionwoul
dhelpfi
ghti
nfl
ati
on,butit
i
sinfl
ati
onit
sel
fthatispr
eventi
ngtheconsumerfr
om savi
ngmore,byinduci
ng
himtospendnowrathert
hanlater
.
Someundesi
rabl
eef
fect
sofI
nfl
ati
on
(
1)Unjust
if
iedweal
tht
ransf
ersoccurf
rom netmoneycr
edi
tor
stonetmoney
debtor
s.
(
2)Whenunionwagecont ract
sdonothavei nf
lat
ionescalat
orcl
auses,and
wor
kersnoticeanactualdecl
inei
ntheirrealwages,theymayf r
equentl
y
r
esortt
ostr
ikescr
eat
ingsocial
inst
abi
li
ty.
(
3)Assumingacount ryhasf i
xedrat
esofexchangeandi t
sdomestici
nfl
ati
on
rat
eishigherthantheinf
lati
onrat
einthecount
ri
eswithwhichi
tistr
adi
ng,it
wouldbel esscompetiti
veintheworldmarket
s.Itsexpor
tswouldbeless
anditi
mpor tsmore,l
eadingtobal
anceofpaymentspr
oblems.
(
4)Taxrevenuesofgovernmentar eautomatical
lyincr
easedbecausei nf l
ati
on
pushes i
ncome earnersinto highertax brackets(wheret ax system is
progr
essive)
.This may def eat the economic poli
cy of r eaching full
employmentbecausetot
alspendingdecreasesautomatical
ly.
(
5)Theusef
ulnessofmoneyasast or
eofvaluemayber educedandpeoplewil
l
st
arttousemoneysubst i
tut
esandwi llreducethei
rmoneybal ancesand
i
nvestmoreinreal
asset
s,l
ikehouses,
education,
automobi l
es,
etc.
(
6)Theoperat
ionofthecreditmarketforexampl
ewi
llbel
essef
fect
iveby
i
ncreasi
ngther
iskofbor
rowingandlendi
ng.
I
nfl
ati
on-
doesanyonegai
n?

7
4
1.Government -wher
et her
eisinfl
ati
on,taxresour
cewillberedi
str
ibut
edin
favourofthegovernmentbudget.I
nfl
ationbenef
it
sthebudgetbyreduci
ng
t
her ealcostofser
vici
ngoft
hedebt.
2.Far
mer
s-wher
efoodpr
oduct
ioni
srel
ati
vel
yinel
ast
icwi
thr
espectt
opr
ice.
3.Import
ers-wher
eafixedexchanger
ateismai
ntai
nedt
heycanr
aisepr
ices
onlocalsal
esofi
mportsandgetapr
emium.

I
nfl
ati
on-Thel
oser
s
1.Cr
edi
tor
s.
2.Withaf i
xedexchangerat
edomest
icpr
oducer
sofexpor
tsandofi
mpor
ts
subst
it
uteswil
lbeloser
s.
4.Consumer
soff
armer
spr
oduct
s.
5.Economi
cal
lyi
nact
ivegr
oupse.
g.housewi
ves.
6.Moder
nsect
orwagel
abourf
orce.
7.Pensi
oner
sandot
her
sonf
ixedi
ncome.

CAUSESFORANDAGAI
NSTI
NFLATI
ON
PROI
NFLATI
ONCASE
Iti
sar guedthatinfl
ati
onisnecessaryift
herei stobegr owthi ntheeconomy.
Infl
ati
on accompanies growth.Itis al
so argued t hatinfl
ation redi
stri
butes
i
ncomesi nsuchawayast orai
sesavingandi nvestmentt husaccel erati
ng
growth.Accordingtot heview,companypr ofitsandgover nmentbudgetar e
l
ikelytobenefitfrom i
nfl
ati
onatt heexpenseofconsumer sespeci all
yur ban
wagel abourforce.Companypr of
itmarginsriseandt heyoftenr ei
nvestlarge
proporti
onofincreasesinprofi
tsrat
herthanpayi ngt hem outt oshareholders.
Wor ker
sont heotherhandconsumeal mostal
lt hei
rincome.
Governmentalsogainsfrom infl
ati
on,itisar gued,becauseofinf
lat
iontaxon
moneybalance,i
.e.oneveryone.Thepubl i
chast of or
egoexpendit
ureongoods
andservi
ces.Thereduct
ioni nspendingreleasesrealresour
cesintheeconomy
whichcanthenbeusedf orinvest
ment .
Someeconomi
stsadvocat
eforgr
owt
h wi
thi
nfl
ati
on,i
nthebel
ieft
hatt
he

7
5
i
nfl
ati
onar
ytr
endwi
ll
ber
ever
sedwi
tht
ime.

ANTI
GROWTHWI
THI
NFLATI
ONARGUMENTS
Itisarguedthatinf
lat
ionpenal
izessavi
ngbecauseitreducesthepurchasi
ng
powerofi ncomesetasi de.Thereisalso ahigh pr
opensit
yt o bor
row,as
repaymentsarecheaper.
Invest
ment /
planningdecisi
onsar edi f
fi
cultunderuncertai
nty,duet oinflati
on.
Infl
ati
onmayl urefir
msi nt
ounpr oductiveinvestmentdecisi
onsbecauset hei r
accountswi l
lmostpr obablymi slead them abouttheircurrentprofitabil
ity.
Becausedepr eciat
ionofcapit
alequi pmentismai nl
ybasedonhi stor
icalcost s,
during i
nfl
ati
onar ytimes,fi
rmst end to underesti
mat ethedepr eci
ation and
overesti
mate company pr ofi
t.Many pr ofi
ts ofmanuf actur
ing and t rading
compani esintimesofr api
dinfl
ationar eoftentheresul
tofst ockappreciation
hencetheswol lenprofi
tsar
ethereforeil
lusory.
Domesti
cinf
lati
onwillr
aiset
hecostofproduci
ngexport
s.Thepr
ofi
tabi
li
tyof
expor
tsdecl
inesther
ebyundermi
ningthebalanceofpayment
sposit
ionofa
count
ry.

7
6
 CHAPTERSI
X
I
NTERNATI
ONALTRADE
I
ntr
oduct
ion
Basi
ccondi
ti
onoft
hewor
ldcommuni
tyi
soneofmut
uali
nter
dependence.Al
l
count
ri
esoft
hewor
ldr
elyf
ort
hei
rnat
ionalwel
lbei
ngoni
nter
nat
ionalt
radeand
payment
s.For
eigncur
rencyorf
orei
gnexchangei
susedf
oref
fect
ingpayment
s.
Ther
ateatwhi
chonecount
ry’
scur
rencyi
sexchangedf
oranot
her
.forexampl
e
Z$1800/1Randi
stheexchange.

ExchangeRat
es
An exchange r
atei
sthe pr
ice ofone cur
rency i
nter
ms ofanot
her
.For
Zi
mbabwe,t
hedol
larexchanger
atemeanst
henumberofpounds(
£)canone
dol
lar(
$)buy.Theexchanger
atei
sdet
ermi
nedbyt
hesuppl
yanddemandf
or
dol
lar
s)andi
s$2perpoundi
nthedi
agr
am bel
ow:

Demandf
ordol
lar
s
Br
it
ishwantt
oexchangepoundsf
ordol
lar
sfort
wor
easons:

1. TobuyZi
mbabweangoodsandser
vices;
2. Tol
endori
nvesti
nZi
mbabwe.
Thedi
agr
am aboveshowst
henumberofdol
lar
sdemandedateachandever
y
exchanger
ate.Thi
sist
heDcur
ve.

7
7
 Suppl
yofDol
lar
s
Zi
mbabweanswantt
oexchangedol
lar
sforpoundsf
ort
wor
easons:
1. t
obuyBr
it
ishgoodsandser
vices;
2. t
olendori
nvesti
nBr
it
ain.
I
nthedi
agr
am aboveSshowst
henumberofdol
lar
ssuppl
iedbyZi
mbabweat
eachexchanger
ate.

Changesi
ntheExchangeRat
e(f
lexi
bleexchanger
ate)
Af
alli
ntheval
ueoft
hedol
l depr
ar( eci
ati
on)meansonedol
larnowbuysf
ewer
pounds.Thedol
lardepr
eci
atesi
fBr
it
onsdemandf
ewerdol
lar
s(showni
nthe
di
agr
am bel
ow)ori
fZi
mbabweansof
fermor
edol
lar
s.Zi
mbabweanexpor
ts
becomecheaperandi
tsi
mpor
tsbecomedear
er.Hence,adol
lardepr
eci
ati
on
i
mpr
ovest
hebal
anceofpayment
s.

Ar
isei
ntheval
ueoft
hedol
l appr
ar( eci
ati
on)meansonedol
larnowbuysmor
e
pounds.Zi
mbabweanexpor
tsbecomedear
erandi
tsi
mpor
tsbecomecheaper
.
Henceadol
larappr
eci
ati
onwor
senst
hebal
anceofpayment
s.
Benef
it
sofTr
ade
Par
ti
cipat
ioni
nthei
nter
nat
ionaleconomycani
mpr
ovel
ivi
ngst
andar
dsandt
he
r
ateofeconomi
cdevel
opment
.Thi
sisi
n3ways:
1.Tr
adepr
ovi
descount
ri
eswi
thanescapef
rom conf
inesoft
hei
r
nat
ionaleconomi
es.I
tcr
eat
esmor
epr
ofi
tabl
einvest
mentoppor
tuni
ti
es
andt
hisl
eadst
oaccel
erat
edgr
owt
h.
2.Bygi
vingaccesst
othepr
oduct
sofot
hernat
ions,
itavoi
dst
heneedt
o
st
ri
vef
orsel
fsuf
fi
ciencywi
thi
nnat
ionalboundar
ies-t
echnol
ogy

7
8
 devel
opedel
sewher
eisavai
labl
e.
3.Capi
talf
lows,
ani
ntegr
alf
eat
ureofwor
ldt
radeandpayment
sgi
ve
devel
opi
ngcount
ri
esaccesst
othesavi
ngsofr
ichernat
ions,
toaugment
t
hei
rown.Capi
tali
sobt
ainabl
efr
om pr
ivat
esour
cesaswel
lasf
rom ‘
aid’
f
rom f
orei
gngover
nment
sandagenci
eseg.Wor
ldBank.

Reasonsf
orTr
ade
Domest
icNon-
avai
labi
li
ty
I
nter
nat
ionalt
radei
stheexchangeofgoodsandser
vicesbet
weencount
ri
es.
Ani
mpor
tist
heZi
mbabweanpur
chaseofagoodorser
vicemadeover
seas.An
expor
tist
hesal
eofaZi
mbabwean-
madegoodorser
viceover
seas.

Anat
iont
radesbecausei
tlackst
her
aw mat
eri
als,cl
imat
e,speci
ali
stl
abour
,
capi
talort
echnol
ogyneededt
omanuf
act
ureapar
ti
cul
argood.Tr
adeal
lowsa
gr
eat
ervar
iet
yofgoodsandser
vices.

Pr
inci
pleofCompar
ati
veAdvant
age
Thepr
inci
pleofcompar
ati
veadvant
agest
atest
hatcount
ri
eswi
llbenef
itby
concent
rat
ingont
hepr
oduct
ionoft
hosegoodsi
nwhi
cht
heyhavear
elat
ive
advant
age.

Fori
nst
ance,Fr
ancehast
hecl
imat
eandt
heexper
ti
set
opr
oducebet
terwi
ne
t
hanBr
azi
l.Br
azi
lisbet
terabl
etopr
oducecof
feet
hanFr
ance.Eachcount
ry
benef
it
sbyspeci
ali
singi
nthegoodi
tismostsui
tedt
omaki
ng.

Fr
ancet
hencr
eat
esasur
plusofwi
newhi
chi
tcant
radef
orsur
plusBr
azi
li
an
cof
fee.

Pr
otect
ioni
sm
Advant
agesofPr
otect
ioni
sm
Pr
otect
ioni
sm occur
s when one count
ryr
educes t
he l
evelofi
tsi
mpor
ts
becauseof
:

 I
nfanti
ndustri
es.I
fsunri
sef i
rmsproducingnew-technologygoods(eg
computers)areto sur
vive agai
nstestabl
ished f
oreign producer
sthen
temporar
ytari
ff
sorquotasmaybeneeded.

7
9
 Unfai
r competit
ion.For ei
gn f
ir
ms may receive subsi
dies or ot
her
governmentbenefi
ts.Theymaybedumping(
selli
nggoodsabr oadatbel
ow
costpri
cetocaptureamar ket)
.
 Bal
anceofpayment
s.Reduci
ngi
mpor
tsi
mpr
ovest
hebal
anceoft
rade.
 St
rat
egi
cindust
ri
es.Topr
otectt
hemanuf
act
ureofessent
ialgoods.
 Decli
ningindust
ries.Topr
otectdecl
ini
ngi
ndust
ri
esf
rom cr
eat
ingf
urt
her
st
ruct
uralunemployment.
Di
sadvant
agesofPr
otect
ioni
sm
 Prevents count
ri
es enj
oyi
ng t
he f
ull benef
it
s of i
nter
nat
ional
special
izat
ionandt
rade.
 I
nvi
tesr
etal
iat
ionf
rom f
orei
gngover
nment
s.
 Pr
otect
s inef
fi
cient home i ndustri
es f
rom f
orei
gn compet
it
ion.
Consumerspaymorefori
nfer
iorproduce.
Pr
otect
ionMet
hods
Met
hodsoft
rader
est
ri
cti
on
Tar
if
fs
Forever
yuni
tofi
mpor
tachar
gei
sputandt
hisf
ixedamountf
orever
yuni
tof
i
mpor
tist
het
ari
f.Tar
f if
fs(
impor
tdut
ies)ar
esur
char
gesont
hepr
iceofi
mpor
ts.
Thedi
agr
am bel
owusesasuppl
y-and-
demandgr
apht
oil
lust
rat
etheef
fectofa
t
ari
ff
.

8
0
Not
ethatt
het
ari
ff

 r
aisest
hepr
iceoft
hei
mpor
t;
 r
educest
hedemandf
ori
mpor
ts;
 encour
agesdemandf
orhome-
producedsubst
it
utes;
 r
aisesr
evenuef
ort
hegover
nment
.
At ar
if
fcanbespecif
icoradval
orem.Aspecifi
ctari
ffisaf i
xedamountf
or
everyamountofi
mport
s.Anadval
orem t
ari
ffi
sthechargeperval
ueofi
mport
.
Quot
as
Quot
asr
est
ri
ctt
heact
ualquant
it
yofani
mpor
tal
lowedi
ntoacount
ry.Not
ethat
aquot
a:

 r
aisest
hepr
iceofi
mpor
ts;
 r
educest
hevol
umeofi
mpor
ts;
 encour
agesdemandf
ordomest
ical
lymadesubst
it
utes.
Aquot
aisanontar
if
frest
ri
cti
on.Anotherexampl
eofanont
ari
ffr
est
ri
cti
oni
s
anembar
go.Anembargoi
sacompl et
ebanoni mpor
ts.
Ot
herPr
otect
ionTechni
ques

8
1
1.Admini
str
ati
vepracti
cescandiscr
imi
nat
eagainstimport
sthroughcustoms
del
aysorset
tingspeci
fi
cat
ionsmetbydomest
ic,butnotf
orei
gn,producer
s.
2.Exchangecontr
ols(curr
encyr
estri
cti
ons)preventdomest
icr
esi
dent
sfr
om
acqui
ringsuf
fi
cientf
orei
gncur
rencytopayforimports.
3.Pri
ortoi
mportsdeposits.Bef
oreyouimportyouaresupposedt
oputasi
de
animpor
tval
ue.Thisreducestheamountofimpor
t.
4.Techni
calspeci
fi
cat
ionsoni
mportedgoods.Thegover
nmentputst
andar
ds
onthegoodsimport
edcausi
ngr
ejecti
onofsome.

8
2
 CHAPTERSEVEN
BALANCEOFPAYMENTS
Def
ini
ti
onoft
heBal
anceofPayment
s
1.I
sasyst
emat
icr
ecor
doft
heeconomi
ctr
ansact
ionsbet
weenr
esi
dent
soft
he
expor
ti
ngcount
ryandr
esi
dent
soft
hef
orei
gncount
ri
esdur
ingacer
tai
nper
iod
oft
imeor

2.I
sthedi
ff
erencebet
weent
het
otalear
ningsonbot
hinvi
sibl
eandvi
sibl
e
i
temsandt
otalexpenses.I
nor
dert
oknowt
heposi
ti
onasr
egar
dsi
nter
nat
ional
payment
s,gover
nment compi
ler
ecor
ds of t
ransact
ions.Thi
srecor
d of
t
ransact
ionsi
sthuscal
ledt
heBal
anceofPayment
s(BOP)
.

3Thebal
anceofpayment
sisar
ecor
dofonecount
ry'
str
adedeal
ingswi
tht
he
r
estoft
hewor
ld.Anyt
ransact
ioni
nvol
vingZi
mbabweanandf
orei
gnci
ti
zensi
s
cal
cul
at ndol
edi lar
s
Deal
ingswhi
chr
esul
tinmoneyent
eri
ngt
hecount
r ecr
yar edi
t(pl
us)i
tems
whi
let
ransact
ionswhi
chl
eadt
omoneyl
eavi
ngt
hecount
r edebi
yar t(mi
nus)
i
tems.

Component
soft
heBal
anceOfPayment
s
Thebal
anceofpayment
scanbespl
itupi
ntot
hreesect
ions:

1. thecur r
entaccountwhi
chdealwi
thi
nter
nat
ionalt
radei
ngoodsand
ser
vices;
2. tr
ansact
ionsinassetsandliabi
li
ti
eswhichdeal
swi
thover
seasf
lowsof
moneyfr
om int
ernat
ionali
nvestmentsandl
oans;
3. Monetary Accountwhich deal
s wit
hfor
eign cur
rency r
eser
ves and
t
ransact
ionswit
hmulti
lat
eralbodi
es.
Cur
rentAccount
Thecur
rentaccountconsi
stsofi
nter
nat
ionaldeal
ingsi vi
ngoods( si
blet
rade)
andser
vi i
ces(nvi
sibl
etr
ade)
.Itr
ecor
dsal
ltr
ansact
ionsi
ngoodsandser
vices,
i
e.vi
sibl
esandi
nvi
sibl
es.Recei
ptofi
nter
est,pr
ofi
tsanddi
videndsonl
oans
andi
nvest
ment
sinf
orei
gncount
ri
es;ear
ningsf
rom t
our
ism andt
ranspor
tat
ion
and r
emi
tt
anceshomeofi
ncomeear
ned bynat
ional
swor
king abr
oad ar
e
i
ncl
udedi
nthi
saccountasi
nvi
sibl
es.

8
3
Exampl
eofcur
rentaccount1985

Bal
ance
Debi
ts $m Cr
edi
ts $m
£m
80 78
Vi
sibl
eimpor
ts Vi
sibl
eexpor
ts -
2068
140 072
75 I
nvi
sibl
e 80
I
nvi
sibl
eimpor
ts 5020
007 expor
ts 027

Byr
efer
ri
ngt
oabovet
abl
eyoucanseet
hati
n1985:

 Zi
mbabwebought$80140mi
ll
ionwor
thofgoodsmadeover
seas.
 Zi
mbabwesol
d$78072mi
ll
ionwor
thofgoodsover
seas.
 Thediff
erencebet
weenvisibl
eexport
sandi mport
sisknown ast
he
balanceoftr
adeorvi
sibl
ebal
ance.Theamount
edto-$2068mil
li
on.
 Zi
mbabwebought$75007mi
ll
ionwor
thoff
orei
gn-
producedser
vices.
 Zi
mbabwesol
d$80027mi
ll
ionwor
thofser
vicesover
seas.
 The dif
ference between i
nvi
sibl
e expor
ts and i
mpor
tsi
s cal
led t
he
i
nvi
sibl
ebalance.Thisamountedto$5020mi l
li
on.
Addi
ng t
he bal
ance oft
rade and bal
ance on i
nvi
sibl
es t
oget
hergi
ves t
he
bal
anceont
hecur
rentaccount
.A def
ici
tont
hecur
rentaccountmeanst
hat
mor
egoodsandser
viceshavebeeni
mpor
tedi
ntot
hecount
ryt
hanhavebeen
sol oad.Asur
dabr plusont
hecur
rentaccountmeansmor
egoodsandser
vices
havebeenexpor
tedt
hani
mpor
ted.

Tr
ansact
ionsi
nAsset
sandLi
abi
li
ti
es/Capi
talaccount
Thet
ransact
ionsi
nasset
sandl
iabi
li
ti
essect
ionoft
hebal
anceofpayment
s
showsal
lmovement
sofmoneyi
nandoutoft
hecount
ryf
ori
nvest
ment
.Thi
s
maybedi
recti
nvest
ment-i
nvest
menti
npr
oduct
ivecapaci
ty(
whenf
ir
msi
nvest
i
not
hercount
ri
est
oincr
easecapi
tali
nthesecount
ri
es)
,orpor
tfol
ioi
nvest
ment
-i
nvest
menti
nshar
es,
bondsorot
herasset
sinf
orei
gncount
ri
es.Changesi
n
asset
swi
llbeout
fl
owsf
rom Zi
mbabwe,
asZi
mbabweani
nvest
orsi
nvestmoney
over
seas.Thesef
lowswi
llbedebi
tst
otheZi
mbabwe’
sBal
anceofPayment
s.
Changesi
nli
abi
li
ti
eswi
l
lbecr
edi
tst
otheZi
mbabweanBal
anceofPayment
sas
over
seasi
nvest
orsi
nvestmoneyi
ntot
hecount
ry(
Zimbabwe)

8
4
 Monet
aryAccount
Thi
sisal
socal
ledt
heof
fi
cialf
inanci
ngaccount
.Itr
ecor
dschangesi
nthe
count
ry’
sof
fi
cialf
orei
gncur
rency/
exchanger
eser
ves(
consi
sti
ngusual
lyofa
mi
xtur
eofgol
dandf
orei
gncur
renci
es)pl
ust
ransact
ionswi
tht
heI
MFandot
her
f
inanci
ali
nst
it
uti
ons.

Bal
anceofPayment
sPr
obl
ems
Bal
anceofpayment
sdef
ici
t
Thi
sisofconcer
nespeci
all
yindevel
opi
ngcount
ri
esbecausei
taf
fect
sthe
abi
l
ityoft
hosecount
ri
est
otr
adewi
thot
hercount
ri
es.Abal
anceofpayment
s
def
ici
tisamaj
orpr
obl
em i
fiti
sper
sist
ent
.Thi
scanbet
her
esul
tofexcessi
ve
pur
chasesoff
orei
gngoodsandser
vicesorexcessi
veZi
mbabweani
nvest
ment
over
seas.Facedwi
thexi
sti
ngorpr
oject
edbal
anceofpayment
sdef
ici
tsont
he
combi
nedcur
rentandcapi
tal
account
savar
iet
yofpol
icyopt
ionsar
eavai
labl
e:

Cor
rect
ingaBal
anceofPayment
sDef
ici
t
1.Longt
erm capi
talf
rom t
her
estoft
hewor
ld.Thi
shast
hedi
sadvant
ageof
ext
ernali
ndebt
edness.

2.Usi
ngf
orei
gncur
rencyr
eser
ves-t
hisi
sashor
tter
m measur
ebecausemost
non-
oilpr
oduci
ng devel
opi
ng count
ri
es have ver
yfew mont
hs i
n whi
ch t
o
exhaustt
his.

3.At
tr
act
ingaddi
ti
onali
nfl
owsofshor
t-
ter
m capi
talbyr
aisi
ngi
nter
estr
ates.
Lackofst
abi
li
tyi
ndevel
opi
ngcount
ri
esmeanst
hatt
her
eisnoguar
ant
eef
unds
wi
ll
remai
nint
hecount
ri
es,
i.
e.t
her
eiscapi
talf
li
ght
.

4.I
mpor
tsubst
it
uti
on-t
hisi
sthel
ocalpr
oduct
ionofpr
evi
ousl
yimpor
tedgoods.
Thi
srequi
rest
hei
mpor
tat
ionofcapi
talequi
pmentandpr
otect
ionoft
hei
nfant
i
ndust
rybyi
mposi
ngt
ari
ff
sorbansoni
mpor
tedgoods.

5.Exchangecont
rol–t
hisi
sdesi
gnedt
ocont
rolf
orei
gncur
rencyr
eser
ves.The
f
orei
gncur
rencyi
srat
ionedsot
hatt
hemostpr
essi
ngneedsoft
hecount
rywi
ll
begi
ven t
op pr
ior
it
ywhen t
hef
undsar
eal
locat
ed.
,eg.capi
talgoodsand
essent
ialr
aw mat
eri
als.Measur
esal
soi
ncl
udei
mpor
tli
censi
ngaswel
las

8
5
cr
eat
ingast
atemonopol
ytaskedt
oimpor
tessent
ial
s.

6.Useofmul
ti
pleexchanger
ates-di
ff
erentr
atesf
orcur
renci
es/t
ransact
ions.
Essent
ial
ssuchasexpor
ts,t
our
ism andessent
iali
nput
sfori
ndust
rywoul
d
haveasepar
ater
ate(
s)ofexchanget
oencour
aget
hem whi
lef
ornonessent
ial
s
t
heywoul
dbedi
scr
imi
nat
ory.I
not
herwor
dst
her
eisamul
ti
-t
ier
edmar
ketf
or
f
orei
gnexchange.

7.Di
sgui
seddepr
eci
ati
on-t
hisi
sapol
icywher
ebyt
her
eisadel
iber
ateef
for
tby
gover
nmentt
o makei
mpor
tsmor
eexpensi
ve.Thi
sincl
udesr
aisi
ng i
mpor
t
dut
ies,t
axi
ngi
nvi
sibl
es,t
axi
ngr
emi
tt
ancesabr
oad,subsi
diseexpor
ts,char
ging
hi
ghf
eesonsal
esoff
orei
gncur
rency.Thi
spol
icyi
sdef
lat
ionar
yandal
sohas
l
oophol
es.

8.Deval
uat
ion-r
educi
ngt
heext
ernalval
ueofacur
rency.Thi
sincr
easest
he
vol
umeofsal
esabr
oad.

9.Pr
omot
ing t
ing expor
texpansi
on-dr
awbacks ofdut
y,expor
tincent
ive
schemes.

10.
Encour
agi
ngmor
epr
ivat
einvest
mentandseeki
ngmor
efor
eignassi
stance.
Muchoft
hef
orei
gnai
dcomesi
nthef
orm ofl
oanswhi
chhavet
oser
viced.
I
nter
esthast
obepai
dont
hel
oans.Thepr
inci
palhasal
sot
ober
epai
din
f
utur
e.

Bal
anceofPayment
sSur
plus
Thi
sisal
so acausef
orconcer
n becausei
fiti
sper
sist
ent
,par
tner
smay
r
etal
iat
ebyi
ntr
oduci
ngi
mpor
tcont
rol
set
c.Asur
plusi
mpl
iesanover
val
uat
ion
ofcur
rencyandt
hisl
eadst
oexpor
tsbecomi
ngl
esscompet
it
iveont
hewor
ld
mar
ket
.Itcoul
dal
sobei
nfl
ati
onar
ybecause,
iti
sar
guedbymonet
ari
stst
hati
t
l
eadst
o an i
ncr
easei
n moneysuppl
y.A per
sist
entsur
pluscoul
d mean a
depr
essi
onofdomest
icl
ivi
ngst
andar
ds.

Cor
rect
ingaBal
anceofPayment
sSur
plus
An unwant
ed bal
anceofpayment
ssur
pluscan bet
her
esul
tofexcessi
ve
f
orei
gni
nvest
menti
nZi
mbabwe.Thi
swi
llpl
aceaf
utur
est
rai
nont
hei
nvi
sibl
e
bal
ance.A r
educt
ioni
nint
erestr
ates(anout
fl
ow off
undsont
hecapi
tal

8
6
account
)ort
he scr
appi
ng ofpr
otect
ioni
stmeasur
es (
rest
ri
cti
ve exchange
cont
rol
s)wi
l
lcor
rectt
hesur
plus.

8
7
 CHAPTEREI
GHT
ECONOMI
CGROWTH
Def
ini
ti
on
Economi
cgr
owt
href
erst
oani
ncr
easei
nacount
ry'
sabi
li
tyt
opr
oducegoods
andser
vices.Theadvant
ageofeconomi
cgr
owt
hist
hatani
ncr
easei
nreal
nat
ionali
ncomeal
lowsmor
egoodsf
orconsumpt
ionorf
ori
nvest
ment
.

I
tisal
sodef
inedas“
alongt
ermr
isei
ncapaci
tyt
osuppl
yincr
easi
ngl
ydi
ver
se
economi
cgoodst
oit
spopul
ati
on,t
hisgr
owi
ngcapaci
tybasedonadvanci
ng
t
echnol
ogyandt
hei
nst
it
uti
onalandi
deol
ogi
caladj
ust
ment
sthati
tdemands.
”
byPr
ofessorKuznet
s.Fr
om t
hisdef
ini
ti
onadvanci
ngt
echnol
ogypr
ovi
dest
he
basi
sorpr
econdi
ti
onsf
orcont
inuouseconomi
cgr
owt
h.

Measur
ementofEconomi
cGr
owt
h

I
tcanbemeasur
edbyt
hechangei
nGDPorGNPovert
ime.I
tcanbemeasur
ed
atcur
rentpr
ices,
alsocal
lednomi
nalGDP(
GNP)
.RealGDPi
satconst
antpr
ices.
Thebesti
ndi
cat
orofgr
owt
hisr
ealGDPpercapi
ta.

Fact
orsaf
fect
ingEconomi
cgr
owt
h

1.Capi
talaccumul
ati
oni
.e.Accumul
ati
onofmachi
ner
y,equi
pment
andt
ool
set
c.Thesel
eadt
oincr
easedcapaci
tyofpl
ant
s.Capi
tal
accumul
ati
onal
soi
ncl
udesi
nvest
menti
nhumanr
esour
ces.

2.Popul
ati
onandl
abourf
orcegr
owt
h-al
argerl
abour
for
cemeans
mor
e pr
oduct
ive manpowerwhi
leal
argerover
allpopul
ati
on
i
ncr
easest
hepot
ent
ialsi
zeofdomest
icmar
ket
s.Thegr
owi
ng
suppl
ywi
l
lhaveaposi
ti
vei
mpacti
ftheeconomi
csyst
em can
absor
bandpr
oduct
ivel
yempl
oyt
heseaddedwor
ker
s.

3.Technol
ogi
calpr
ogr
ess-t
hisi
sthe mosti
mpor
tantsour
ce of
economi
cgr
owt
h.I
nit
ssi
mpl
estf
ormt
echnol
ogi
calpr
ogr
esscan
besai
dtor
esul
tfr
om new andi
mpr
ovedwaysofaccompl
ishi
ng
t
radi
ti
onalt
asks.Thepr
oduct
iver
esour
ces,i
fusedef
fi
cient
lycan
i
ncr
easeeconomi
cgr
owt
h.

4.Weat
her
.Becauseoft
hei
mpor
tanceofr
ain-
fedagr
icul
tur
eand
agr
o-i
ndust
ryi
ncer
tai
ncount
ri
essuchasZi
mbabwe,weat
heri
s

8
8
 al
soani
mpor
tantdet
ermi
nantofeconomi
cgr
owt
hint
hemedi
um
t
erm.

Devel
opi
ngCount
ri
es
Adevel
opi
ngcount
ryorl
essdevel
opedcount
ry(
LDC)i
sonet
hati
snotyetf
ull
y
i
ndust
ri
ali
sedandt
endst
ohavet
hef
oll
owi
ngf
eat
ures:

 Agr
icul
tur
eismor
eimpor
tantt
hanmanuf
act
uri
ng.
 Ther
eisl
imi
tedspeci
ali
sat
ionandexchange.
 Ther
ear
enotenoughsavi
ngst
ofi
nancei
nvest
ment
.
 Popul
ati
onisexpandi
ngtoorapidl
yforavai
labl
eresour
ces.Popul
ati
on
growthi
sequaltoormorethantherat
eofGNPgr owthinsomecountr
ies.
Therear
ehighandri
singl
evel
sofunemploymentandunderempl
oyment.
 Ther
ear el
ow i
ncomes.Int
hei
ncomedi
str
ibut
ion,t
hegapbet
weenthe
ri
chandpoori sgeneral
lygr
eat
erinl
essdevel
opedt hani
ndevel
oped
countr
ies.
 I
nadequat
ehousi
ng.
 Therearelow l
evelsofproducti
vit
y.Thi
smaybeduet otheabsenceor
severelackofcomplementaryfact
orinput
ssuchasphysi
calcapi
talandor
experi
encedmanagement .
 Ineducationther
ear
el ow l
evelsofli
teracy,si
gnifi
cantschooldr
opout
r
ates,
inadequat
eandoft
enirr
elevantcur
ricul
aandf aci
li
ti
es.
 Thereispoorhealt
h.MostLDCpeoplesuf
ferf
rom malnut
ri
ti
onandi
ll
-
healt
handhi ghinf
antmortal
it
yandhave al
owerli
feexpect
ancyt
hani
n
developedcount
ri
es(DCs)
 Alowstandardofl
ivi
ng.Al
argepor
ti
onoft
hepopul
ati
oni
sli
vingbel
ow
t
hePover
tyDatum Li
ne.
A devel
opedcount
ryi
smor
eful
lyi
ndust
ri
ali
sedandhasahi
ghst
andar
dof
l
ivi
ng.

Bar
ri
erst
oEconomi
cGr
owt
h
Acount
rycani
ncr
easepr
oduct
ioni
fiti
ncr
easest
heamountofr
esour
cesused
ormakesbet
teruseofexi
sti
ngf
act
ors.Economi
cgr
owt
hismor
edi
ff
icul
tif
:

 Acount
ryl hei
ackst nfr
ast
ruct
ure(
under
lyi
ngcapi
tal
)topr
oducegoods

8
9
 mor
eef
fi
cient
ly.Ther
ear
ethr
eet
ypesofi
nfr
ast
ruct
ure:
1. basi
cincl
udi
ngel
ect
ri
cit
y,r
oadandt
elephonenet
wor
ks;
2. soci
ali
ncl
udi
ngschool
s,hospi
tal
sandhousi
ng;
3. i
ndust
ri
ali
ncl
udi
ngf
act
ori
esandof
fi
ces.
 Acountr
ylacksthemachinesorski
ll
edl
abourneededt
omanuf
act
ure
moder
ngoodsorservi
ces.
 Acount
ryl
ackst
het
echni
calknowl
edge.
 Worker
sar
enotpr
epar
edt
oacceptspeci
ali
sat
ionandt
hedi
visi
onof
l
abour
.
 Popul
ati
ongr
owt
hist
oor
api
d.
 Acount
ryhast
ool
argeaf
orei
gndebt
.
Di
sadvant
agesofEconomi
cGr
owt
h
 I
ncr
easednoi
se,
congest
ionandpol
lut
ion.
 Townsandci
ti
esmaybecomeover
crowded.
 Ext
ra machi
nes can be pr
oduced onl
y by usi
ng r
esour
ces cur
rent
ly
i
nvol
vedi
nmakingconsumergoods.
 At
radi
ti
onalwayofl
if
emaybel
ost
.
 Peopl
emayexper
iencei
ncr
easedanxi
etyandst
ress.

ECONOMICDEVELOPMENT
“
isamul
ti
dimensi
onalpr
ocessi
nvol
vingt
her
eor
gani
zat
ionandr
eor
ient
ati
onof
t
he ent
ir
e economi
c and soci
alsyst
ems.I
n addi
ti
on t
oimpr
ovement
sin
i
ncomesandout
put
,itt
ypi
cal
l
yinvol
vesr
adi
calchangesi
ninst
it
uti
onal
,soci
al
andadmi
nist
rat
ivest
ruct
uresaswel
lasi
npopul
arat
ti
tudesandsomet
imes
evencust
omsandbel
ief
s”(
MichaelTodar
o-Economi
csf
oraDevel
opi
ngwor
ld.
)
Economi
cdevel
opmenti
sal
sodef
inedi
nter
msoft
her
educt
ionorel
imi
nat
ion
ofpover
ty,
inequal
it
yandunempl
oymentwi
thi
nthecont
extofagr
owi
ng
economy.
Devel
opmentmusthavet
heobj
ect
ivesof-
:incr
easi
ngt
heavai
labi
li
tyandwi
der
di
str
ibut
ionofbasi
c-f
ood,
shel
ter
,heal
thandpr
otect
ion;r
aisi
ngt
hel
evel
sof
l
ivi
ng(
higheri
ncomes,
higherempl
oyment
,bet
tereducat
ionandi
ncr
eased

9
0
at
tent
iont
ocul
tur
alval
ues)
.

I
ndi
cat
orsofEconomi
cDevel
opment
.
Thet
radi
ti
onalvi
ewofeconomi
cdevel
opmenti
sGNPi
sani
ndexof
devel
opment
.Anot
hercommoneconomi
cindexofdevel
opmenti
stheuseof
r
atesofgr
owt
hofpercapi
taGNP.Rapi
dindust
ri
ali
zat
ionwasvi
ewedasaway
ofhavi
ngani
ncr
easi
ngGNP,
thi
sof
tenatt
heexpenseofagr
icul
tur
eandr
ural
ar
eas–t
hesewer
etobenef
itt
hrought
he“
tri
ckl
edownef
fect
”.

Obst
acl
est
oEconomi
cDevel
opmenti
ndevel
opi
ngcount
ri
es
 Over
popul
ati
on-hi
ghpopul
ati
ongr
owt
h.
 Lowsavi
ngsr
ate-hashamper
edi
ndust
ri
aldevel
opment
.
 Li
mit
edr
angeofexpor
ts.
 Ur
bani
zat
ion-t
hiscompoundspopul
ati
onpr
obl
emst
hroughcongest
ion.
Over
crowdi
ngpr
omot
espol
lut
ion,
unempl
oyment
,di
seaseandf
ood
shor
tages.
 Lackofani
nfr
ast
ruct
ure.BecauseLDCsgener
all
ydonothave
i
nfr
ast
ruct
ures,
indust
ri
alf
ir
mswi
llnotnor
mal
lyl
ocat
epl
ant
sther
e.
Pr
oduct
smanuf
act
uredf
ormassconsumpt
ionsi
mpl
ycannotbedi
str
ibut
ed
andusedwi
thoutt
ranspor
tat
ionandcommuni
cat
ionf
aci
li
ti
es-f
ewschool
s,
r
oads,
damsandbr
idges.

Sol
uti
onsf
orEconomi
cUnder
devel
opment
 For
eignai
d
 Expor
tat
ionofamaj
orr
esour
cee.
g.oi
l.
 I
ndust
ri
ali
zat
ionandpr
otect
ivet
ari
ff
sandquot
as.
 I
ndust
ri
ali
zat
ionandt
heexpor
tofmanuf
act
uredgoods.

9
1