eco answers
answer 1
The limitations of GDP
- The exclusion of non-market transactions
- The failure to account for or represent the degree of income inequality in society
- The failure to indicate whether the nation’s rate of growth is sustainable or not
- The failure to account for the costs imposed on human health and the environment of negative externalities arising from the production or consumption of the nation’s output
- Treating the replacement of depreciated capital the same as the creation of new capital
- The Human Development Index (HDI)
- The Genuine Progress Indicator (GPI)
- The Happy Planet Index (HPI)
answers 2
CIRCULAR FLOW IN A THREE-SECTOR ECONOMY
Circular flow of income in a three-sector economy, consists of households, firms and government sector. Government plays a very important role in the economic development of a country. It acts as both consumer and a firm. As a consumer, it spends on consumption of goods and services produced by the firms. As a producer, it produces goods and services for the economy.
In addition to flows of circular flow in two-sector economy with financial market, the introduction of Government leads to following flows:
• Between Households and Government: Money flows from government to household in the form of: (i)Transfer payments like scholarships, old age pension, etc.; and (ii)Factor payments for hiring factor services of households. Money flows back to the government from households in the form of direct taxes like income tax, interest tax, etc.
• Between Firms and Government: Money flows from firms in the form of direct taxes and indirect taxes. Money flows to the firms from government, when the latter grants subsidies and makes payment to the former for purchase of goods and services produced by the firms.
A part of the income earned by government is also saved and deposited in the financial market. Government also borrows money from the financial market to meet its expenditure.
It follows from above that the inclusion of the Government sector significantly affects the overall economic situation. Total expenditure flow in the economy is now the sum of consumption expenditure (denoted by C), investment expenditure (I) and Government expenditure (denoted by G) Thus
Total expenditure (E) = C + I + G …..(i)
Total income (K) received is allocated to consumption (C), savings (S) and taxes (T). Thus
Y = C + S + T … (ii)
Since expenditure) made must be equal to the income received (Y), from equations (i) and (ii) above we have
C + I + G = C + S + T … (iii)
Since C occurs on both sides of the equation (iii) and will therefore be cancelled out, we have
I + G = S + T …(iv)
By rearranging we obtain
G – T = S – I … (v)
Equation (v) is very significant as it depicts what would be the consequences if government budget is not balanced, that is, if Government expenditure (G) is greater than the tax revenue (7), that is, G >T, the government will have a deficit budget. To finance the deficit budget, the Government will borrow from the financial market.
For this purpose, then private investment by business firms must be less than the savings of the households. Thus Government borrowing reduces private investment in the economy. In other words, Government borrowing crowds out private investment.
ROLE OF GOVERNMENT SECTOR IN AN ECONOMY
Government Sector performs the following activities in the economy:
a) Government collects taxes from households and firms.
b) Government makes transfer payments to the households and provides subsidies to the firms. c) Government makes the payment for purchase of goods and services from the firms. d) Government saves and borrows money with the help of financial market.
CIRCULAR FLOW IN A FOUR-SECTOR ECONOMY
Circulation of income in four-sector economy consists of households, firms, government and foreign sector. The various money flows in each sector are:
• Household Sector: Households provide factor services to firms, government and foreign sector. In return, it receives factor payments. Household also receive transfer payments from the government and the foreign sector. Household spend their income on: (i)Payment for goods and services purchased from firms; (ii)Tax payments to government; (iii) Payments for imports.
• Firms: Firms receive revenue from households, government and foreign sector for sale of their goods and services. Firms also receive subsidies from the government. Firm makes payments for: (i)Factor services to households; (ii)Taxes to the government; (iii)Imports to the foreign sector.
• Government: Government receives revenue from firms, households and the foreign sector for sale of goods and services, taxes, fees, etc. Government makes factor payments to households and also spends money on transfer payments and subsidies.
• Foreign Sector: Foreign sector receives revenue from firms, households and government for export of goods and services. It makes payments for import of goods and services from firms and the government. It also makes payment for the factor services to the households.
They savings of households, firms and the government sector get accumulated in the financial market. Financial market invests money by lending out money to households, firms and the government. The inflows of money in the financial market are equal to the outflows of money. It makes the circular flow of income complete and continuous.
From the circular flows that occur in the open economy the national income must be measured by aggregate expenditure that includes net exports, that is, X-M where X represents exports and M represents imports. Imports must be subtracted from the total expenditure on foreign produced goods and services to get the value of net exports. Thus, in the open economy
National Income = C + I + G + NX
where NX represents net exports, X-M.
Since national income can be either consumed, saved or paid as taxes to the Government we have
C + I + G + NX = C + S + T
The Definition of Money
Money is any object that is generally accepted as payment for goods and services and the repayment of debt.
Money is any object that is generally accepted as payment for goods and services and repayment of debts in a given socioeconomic context or country. Money comes in three forms: commodity money, fiat money, and fiduciary money.
Many items have been historically used as commodity money, including naturally scarce precious metals, conch shells, barley beads, and other things that were considered to have value. The value of commodity money comes from the commodity out of which it is made. The commodity itself constitutes the money, and the money is the commodity.Fiat money is money whose value is not derived from any intrinsic value or guarantee that it can be converted into a valuable commodity (such as gold). Instead, it has value only by government order (fiat). Usually, the government declares the fiat currency to be legal tender, making it unlawful to not accept the fiat currency as a means of repayment for all debts. Paper money is an example of fiat money.
Fiduciary money includes demand deposits (such as checking accounts) of banks. Fiduciary money is accepted on the basis of the trust its issuer (the bank) commands.
Most modern monetary systems are based on fiat money. However, for most of history, almost all money was commodity money, such as gold and silver coins.
Functions of Money
Money has three primary functions. It is a medium of exchange, a unit of account, and a store of value:
- Medium of Exchange: When money is used to intermediate the exchange of goods and services, it is performing a function as a medium of exchange.
- Unit of Account: It is a standard numerical unit of measurement of market value of goods, services, and other transactions. It is a standard of relative worth and deferred payment, and as such is a necessary prerequisite for the formulation of commercial agreements that involve debt. To function as a unit of account, money must be divisible into smaller units without loss of value, fungible (one unit or piece must be perceived as equivalent to any other), and a specific weight or size to be verifiably countable.
- Store of Value: To act as a store of value, money must be reliably saved, stored, and retrieved. It must be predictably usable as a medium of exchange when it is retrieved. Additionally, the value of money must remain stable over time.
Economists sometimes note additional functions of money, such as that of a standard of deferred payment and that of a measure of value. A “standard of deferred payment” is an acceptable way to settle a debt–a unit in which debts are denominated. The status of money as legal tender means that money can be used for the discharge of debts. Money can also act a as a standard measure and common denomination of trade. It is thus a basis for quoting and bargaining prices. Its most important usage is as a method for comparing the values of dissimilar objects.
answer 4
The quantity theory of money (QTM) also assumes that the quantity of money in an economy has a large influence on its level of economic activity. So, a change in the money supply results in either a change in the price levels or a change in the supply of goods and services, or both. In addition, the theory assumes that changes in the money supply are the primary reason for changes in spending.
One implication of these assumptions is that the value of money is determined by the amount of money available in an economy. An increase in the money supply results in a decrease in the value of money because an increase in the money supply also causes the rate of inflation to increase. As inflation rises, purchasing power decreases. Purchasing power is the value of a currency expressed in terms of the amount of goods or services that one unit of currency can buy. When the purchasing power of a unit of currency decreases, it requires more units of currency to buy the same quantity of goods or services.
Throughout the 1970s and 1980s, the quantity theory of money became more relevant as a result of the rise of monetarism. In monetary economics, the chief method of achieving economic stability is through controlling the supply of money. According to monetarism and monetary theory, changes in the money supply are the main forces underpinning all economic activity, so governments should implement policies that influence the money supply as a way of fostering economic growth. Because of its emphasis on the quantity of money determining the value of money, the quantity theory of money is central to the concept of monetarism
Calculating QTM
The quantity theory of money proposes that the exchange value of money is determined like any other good, with supply and demand. The basic equation for the quantity theory is called The Fisher Equation because it was developed by American economist Irving Fisher. In it's simplest form, it looks like this:
Some variants of the quantity theory propose that inflation and deflation occur proportionately to increases or decreases in the supply of money. Empirical evidence has not demonstrated this, and most economists do not hold this view.
- New money has to actually circulate in the economy to cause inflation.
- Inflation is relative—not absolute.
In other words, prices tend to be higher than they otherwise would have been if more dollar bills are involved in economic transactions.