achievement standard 3.4
DESCRIPTION
Achievement Standard 3.4. Describe aggregate economic activity. Aggregate?. The amount or total formed from separate units. Aggregate refers to a total, everything added up. Aggregate = Total The economy can be viewed as a series of aggregates, flowing together to make a working whole. - PowerPoint PPT PresentationTRANSCRIPT
Achievement Standard 3.4
Describe aggregate economic activity.
Aggregate?
The amount or total formed from separate units. Aggregate refers to a total, everything added up.
Aggregate = Total
The economy can be viewed as a series of aggregates, flowing together to make a working whole
The Circular Flow Model
Shows the economic transactions that occur between households, firms and other sectors in the economy.
Money flows- We will only focus money flows as it is simpler than trying to account for the physical flows.
The Circular Flow of Income and Spending
The simplest form of circular flow
HouseholdsProducers
Incomes $ rent wages interest profit
$ Consumption
Goods and Services
Factors of production
Introduction of the Financial Sector
a
b
d
c
Households Producers
Financial Institutions
C (Payments for goods and services)
Y (Income)
S (savings)
I (Investment)
An Open Economy
a
b
c
d
f
g
HouseholdsProducers
Financial Institutions
Overseas Sector
C (consumption)
Y (Income)
S (Savings)
I (Investment)
X (Export receipts)
M (Import payments)
Role of the Government
a
b
c
d
f
g
HouseholdsProducers
Financial Institutions
Overseas Sector
C (consumption)
Y (Income)
S (Savings)
I (Investment)
X (Export receipts)
M (Import payments)
Government
a b
c
tr (transfers)
T (taxes)
G (Government Spending)
The Circular Flow Model
a
b
c
d
e
f
h g
i
C (consumption)
HouseholdsProducer
Financial Institutions
Overseas Sector
Y (Income)
S (Savings)
I (Investment)
X (Export receipts)
M (Import payments)
T (taxes)
tr (transfers)
G (Government Spending)
Government
The Circular Flow model Y= Incomes including rent wages interest and profit C= Consumption spending- the payment for goods and
services S= Savings – income not spent on consumption this is a
withdrawal from the economy I= Investment spending-purchase of capital goods. This is
an injection into the economy X= Export receipts- Money received for exports sold M= Import payments- Payments made for imports
purchased G= Government Spending- on collective goods T= Taxes the government collects from households and
firms. These are used to fund G and Tr. Tr= Transfer money from one group to another, because of
this transfer payments are not true expenditure.
Page 138
Questions 1-3
The Circular Flow Model
a
b
c
d
e
f
h g
i
C (consumption)
HouseholdsProducer
Financial Institutions
Overseas Sector
Y (Income)
S (Savings)
I (Investment)
X (Export receipts)
M (Import payments)
T (taxes)
tr (transfers)
G (Government Spending)
Government
Calculating National Output
What is national output? National Output =Total quantity of goods and services
demanded in an economy in a year.
Y= National outputY = C +I +∆R
Where ∆R is changes in stocksStocks are caused from unplanned investment where there
is a build up of inventories/ stocks ready for sale. Negative unplanned investment also occurs however when there is a rundown of stocks.
Calculating National Output
The value of incomes always equals the value of what is produced
National Output= C +I+ ∆RNational Income=C +S
Where national incomes is the total incomes resulting from the production of goods and services in an economy in a year.
Because outcome equals income, it follows that
C+S=C+I+ ∆RS=I + ∆R
Calculating national Output using the Circular flow model. Output Y = C + I + ∆R + G + (X-M) Income Y= C + S +T
Output = Income I + ∆R + G +X = S + T + M(Injections= Withdrawals)
For the economy to be in equilibrium planned injections must equal planned withdrawals. (∆R=0)
Calculating national Output using the Circular flow model. Changes in any of the flows in the circular flow
diagram will result in the changes in national income.
E.g What do you think would happen if people saved more?
C would decrease and this would result in a reduction in national income
Aggregate Demand
What does aggregate mean? Aggregate refers to a total, everything added up.
Aggregate demand is the total demand in the economy. AD shows how many goods and services will be demanded in an economy given the general price level and the level of income.
Aggregate demand is equivalent to national output What are the components of national output? Output Y = C + I + ∆R + G + (X-M)
AD=C+I +G + (X-M)
Components of Aggregate demand
AD=C+I +G + (X-M)
C= ConsumptionTotal demand for all final goods and services. This is shown by the household sector through its spending
$ Consumption
Households
Household Consumption Expenditure 1995-2000
Food and beverages
Clothing and footwear Housing Transport Other G&S
$ Million
1995 8922 2486 11083 7934 5499
1996 9306 2523 11243 8699 5941
1997 9428 2639 11395 9389 6080
1998 9595 2696 11548 8974 6317
1999 9714 2758 11701 9429 6459
2000 10164 2934 11879 9966 6806
1. In 2000, Real GDP was $102445million. What proportion of the 2000 GDP was made up of household consumption?
2. Which item of expenditure accounted for the largest proportion of household consumption spending over the period 1995-2000?
3. Why is savings not on the table?
AD=C+I +G + (X-M)
I=Investment = Expenditure by businesses as they demand investment/capital goods.
Investment is exogenous. It is not influenced by the level of income but by
other elements in the circular flow model. Three main reasons why firms invest?• Expect high demand in the future• Existing capital has depreciated and needs replacing• Changes in government policies make it favourable to invest. The main determinant of the level of investment
is the market interest rate
Gross Capital Fixed Formation
Expenditure of producers on investment on new plant and machinery
New capital spending by the govt e.g. motorways, roading
Investment spending by households on housing.
Capital Goods- 2002 calendar year $ (million)
01000200030004000500060007000
Machinery and plant Transportequipment
Total
Capital goods
$(m
illio
n) Exports
Imports
1. What are capital goods?
2. Using the information above, analyse the links between, imports and investment.
3. Why do you think this link exists?
4. Why do you think Investment is important for economic growth?
AD=C+I +G + (X-M)
G= Government spending as it demands goods and services. Also exogenous (not dependent on level of national income)The government decides on what it is going to spend the money on then goes about raising the money necessary.
Major items of expenditure in NZ are • Health • Education• Welfare
AD=C+I +G + (X-M)
(X-M)= Net exports We use net exports as we are interested in
what NZ economy produces. M>X (X-M)? + or – This is a withdrawal from the circular flow M<X (X-M)? + or - This is an injection from the circular flow.
Gross Domestic Product (GDP)
GDP= the money value of final goods and services produced in an economy in a year.
Three ways to measure GDP • Production• Income• Expenditure
Why do you think we would want to measure GDP?
GDP An economies standard of living is measured by
the number of goods and services that it has available to use and enjoy.
An economies growth can be measured by the increase in the number of goods and services it makes
Why do you think investment and savings are so important in an economies growth?
Measuring GDP The Expenditure Approach- by adding up selling prices
of all goods and services bought in the economy then making allowances for goods and services bought overseas.
Formula= C + I + ∆R + G + (X-M)
Consumption excludes buying new houses- this is investment
Investment includes govt investment (Roading)• Change in inventories are included as these represent goods
available for sale and represent an increase in investment spending
• A decrease in stocks will reduce GDP because they represent expenditure on goods that were produced in the previous year.
Measuring GDP
The income approach- by adding up incomes generated in the production process.
Income includes wages, salaries (Compensation to employees) profits, dividends, rents, interest (Gross operating surplus)
Then make final adjustments to account for govt intervention. (Add taxes on production e.g. GST and imports e.g. tariffs then takeaway subsidies)
Y= C+ S + T
The production approach- measures the value added by producers, by deducting the value of goods and services used up in the production from the total value of goods and services produced.
To calculate find the value that each sector/producer adds to the value of the product during the production process.
A problem that can occur with this approach is that of double counting.
We will focus on the other two approaches
Measuring GDP
Find GDP for the following data using the income and expenditure approaches
Grower Miller Baker
Wages 30 45 75
Intermediate goods
- 30 75
Sales price
30 75 150
Values of output at each stage of Bread production
• The expenditure approach= value of the final product = $150 million
Wheat Grower Miller Baker
Wages 30 45 75
Intermediate goods
- 30 75
Sales price 30 75 150
•The incomes approach totals wages at each stage of production= 30+45+75=$150million
NSNA The New Zealand System of National Accounts
(NZSNA) provides an international standard of measure of GDP that enables international comparisons
Sometimes there will be a statistical discrepancy in the NSNA this is
Basically it is used to make Income and Expenditure approaches balance
Statistical discrepancy = Income Approach GDP – Expenditure Approach GDP
NZSNA Terminology
Table 6.2
Consumption
Investment
Government Spending
Net Exports
Final private expenditure
Gross fixed capital formation
Government final expenditure
Exports of goods and services – Imports of goods and services.
NZSNA Terminology
Table 6.2
Wages and salaries
Gross Profits
Depreciation
Net Indirect Taxes
Compensation of Employees
Operating Surplus
Consumption of fixed capital
Indirect taxes minussubsidies.
Important things to remember when calculating GDP Include only G&S produced in NZ economy
Include G&S produced only within that time period. (inventories included in time period they were made not when they were sold)
Avoid double counting (second hand goods not counted)
Questions What is GDP? What is the formula for calculating expenditure on GDP? Draw the simple circular flow diagram With reference to the model explain three ways GDP can be
measured Calculate GDP from the data below using the Income and
Expenditure methods
Item $m Item $mExports of G$S 4000 Indirect taxes 1000Compensation employees 10000 Imports of G&S 4000Gross fixed capital formation 2500 Subsidies 800Private spending 12000 Increase in stocks 200
Gross Operating surplus 7500
Government spending 3000
Nominal GDP VS Real GDPQuantity of Pizzas
Price of pizzas
Quantity of pies
Price of pies
2000 10 $10 15 $5
2004 20 $12 30 $6
Imagine the economy only produces pizzas and pies.
Calculate GDP in year as the market value of production
GDP 2000=(10pizzasX$10/pizza) +(15piesX$5/pie)=$175
GDP 2004=(20pizzasX$12/pizza) + (30piesX$6/pie)=$420
Looking at these two GDPs what would you conclude?BUT
Looking closely you can see the quantities produced of pizzas and pies in 2004 are twice that produced in 2000
If eco activity exactly doubled why do the calculated values of GDP show a greater increase?
Prices as well as quantities rose!
Nominal and Real GDP Notes Nominal GDP= the actual dollar value of all
goods and services produced in a year
Inflation =
These values cannot be meaningfully compared from year to year
Increase’s in the price level
Consumer Price Index (CPI) Measures the price level of a ‘basket’ goods and services
purchased by the average NZ household
The data on prices comes from household surveys conducted by Statistics New Zealand
CPI is then released quarterly
Used as a general measure of inflation
Indicates the effect of price changes on the purchasing power of households
To calculate and index =Expenditure Now Expenditure Base Year
Consumer Price IndexYear CPI % price
level change
2002 1000
2003 1222
2004 1300
2005 2300
22.2%
30%
130%
Measures rate of change in price level from the base year (2002).
Rate of change between 2003 and 2004 is
1300 – 1222 * 100 12226.4%
Change in CPI
An increase in the CPI is called inflation. The price level increases. The purchasing power of money decreases.
A decrease in the CPI is called deflation.
Disinflation refers to a decrease in the inflation rate. The CPI is increasing at a decreasing rate.
Real Values
Calculated using constant prices. –prices used for one year is used to calculate values for all years
Are inflation adjusted. Can be meaningfully compared from year to
year Real Income= Nominal Value X 1000
CPI
Real GDP and Nominal GDP
Nominal GDP= the actual dollar value of all goods and services produced in a year
Real GDP= is nominal GDP adjusted for inflation. This measure allows for comparison of changes in the value
of national output without price changes distorting the data.
Real GDP In order to calculate RGDP the effect of price
increases need to be removed.
We will use the CPI index to do this: both the base year value (1000) and the value for the year we are calculating the RGDP for.
The part of the equation in which this is taken into account is the GDP deflator: (taking inflation out of GDP value)
CPIbase
CPIyear1
Real GDP equation
RGDP = GDPyear1 × CPIbase (GDP deflator)
CPIyear1
NOTE: Year 1 refers to the year you are calculating the RGDP for.
Real GDPQuantity of Pizzas
Price of pizzas
Quantity of pies
Price of pies
2000 10 $10 15 $5
2004 20 $12 30 $6
Using the data in the table above and assume year 2000 is the base year find real GDP fro years 2000 and 2004
How much did real output grow between 2000 and 2004
Year 2000 real GDP=(10pizzasX$10/pizza) +(15piesX$5/pie)=$175
Year 2004 real GDP=(year 2004 quantity pizza's X year 2000 pizza prices) + (Year 2004 quantity pies X year 2000 pie prices)
= (20X$10) + (30X$5)
=$350
By using real GDP we have eliminated the effects of price changes and obtained a reasonable measure of actual change in physical production
Measuring the rate of Economic Growth
Rate of growth= GDP 2nd year-GDP 1st year x 100
GDP 1ST year
Rate of inflation= CPI 2ND year - CPI 1ST year x 100
CPI 1ST year
Calculating the rate of inflation
Limitations to GDP In groups give an opinion into how well GDP is as
a measure of the standard of living.
Think about Unpaid work? Non-market activities? If it is not sold it
is not counted Merit and demerit goods The distribution of wealth.
Standard of living - the degree to which people have access to goods and services that make their lives easier, healthier, safer and more enjoyable
Limitations to GDP as a measure of Standard of Living
Non market activity GDP excludes
Voluntary Labour Cash transactions, barter Illegal transactions
Relative Merits of production There is no distinction in GDP whether goods being produced are
merit goods or demerit goods e.g. a dollar spend on cigarettes has the same weight as a dollar spent on education
Distribution of Income GDP is a total. Does not tell us how this total is distributed
e.g. a country may have high GDP but there also may be large numbers of people living in poverty.
GDP per capita
Use GDP per capita (per head of population).
GDP per capita = GDP
Total Population
Shows how much of the economies total production each person would receive if it was divided equally
The Business (Trade Cycle
Over time fluctuations in economic activity occur.
The trade cycle shows us how fluctuations in the levels of output, employment, income and trade affect the level of real GDP.
A Typical Trade Cycle
Time
Real
GDP
Boom
Peak
Recession
Trough/Depression
Recovery
Trade Cycles Boom
Rising interest rates High eco activity “Full” employment Great optimism Businesses operating at capacity
Peak (Turning point) Eventually rate of growth must slow down. Even if economy is still
growing t is now doing so at a decreasing rate
Recession Rising unemployment and business failures Savings may increase as people fear unemployment Business activity slows down
Trade Cycle Depression (Trough)
Unemployment stabilised Low level eco activity Excess capacity Interest rates low Low consumption , low saving
Eventually some major piece of capital equipment will need replacing- injection of investment lead to recovery
Recovery Rise in real GDP slow at first, speeds up Rehiring of workers as demand increases Unemployment falls Consumption increases
Ryan’s Thinker Keys
The Variations Key
How many other ways can you think of that may be used as a measure of standard of living if GDP was not used?
National Income statistics for New Landzia 2050
National income statistics for Ecotopia 2050
Exports of G$S 51 Exports of G$S 51
Compensation employees
75 Change in inventories
7
Gross fixed capital formation
43 Gross fixed capital formation
43
Final consumption expenditure: private
57 Final consumption expenditure: private
57
Final consumption expenditure: government
36 Final consumption expenditure: government
36
Subsidies 8 Imports of goods and services
54
Gross operating surplus
76 Statistical Discrepancy
3
Indirect taxes 30 Taxes on production and imports
30
SLO: Describe, Explain and anaylse
Aggregate demand The AD curve, reasons for its slope Factors that move AD
Aggregate Demand and Aggregate Supply The AD/AS model is used to demonstrate equilibrium
national income
Actual level of national income may be above or below the AD/AS equilibrium but economic forces will act on national income and force it to equilibrium.
AD/AS can help explain inflation and unemployment and shows us the impact of Government policies Exchange rate Other influences
Aggregate Demand
AD= is national output and represents total demand in the economy
AD= C + I + G + (X-M) + ∆ R
Look at your circular flow diagram which half does AD relate to?
The AD curve shows us the quantity of output demanded at each price level.
Aggregate Demand Curve
Real GDP (Y)
Price Level
AD
AD curve bows towards the origin
AD should not be confused with market demand curve for a commodity
The axes are different and reasons for AD curves shape very different.
Reasons for downward sloping of AD curve An increase in the price level
Means all goods and services are more expensive. Less can be bough with a given quaintly of income C
Leads to an increase in the rate of interest. Costs of borrowing increases C I AD
Exports now relatively more expensive, means decrease in demand for exports, (X-M) low
Shifts along the AD curve
Change in price level causesMovement along the AD curve
AD
PL1
PL
YY1
Shifts of the AD curve Change in any variable in the AD equation
(AD=C+ I+ G+ (X-M)) will move the AD curve itself.
Shift to the right
C G X
Shift to the Left
C G X
Aggregate Supply Shows the quantity of national output that all
producers are willing to supply at each price level.
Micro- Price increases quantity supplied increases- Upwards sloping supply curve
Macro- Upwards sloping also. But it is relatively flat at low levels and gets steeper as it approaches capacity
Price Level
Real GDP (Y)
ASAggregate Supply Curve
Shifts in AS curve
Y Y1
PL1
PL
A change in the price level will cause a movement along the supply curve.
AS
Pric
e Le
vel
Real Income (Y) ,output, employment Good X
Goo
d Y
A
A
B
B
Yf
C
C
Aggregate Supply CurveEconomies Production Possibilities Curve
1. At very low levels of output there is excess capacity (idle factories, machinery and unemployed workers). Shown by point A, we are well inside our PPC curve. Production could be increased with very little cost, meaning prices don’t need to increase as much
2. As production increases diminishing returns sets in. Output will only rise at a higher price level shown by upwards sloping of the curve, point B
3. At greater levels of output, businesses are being pushed to their maximum and production becomes inefficient. Overtime will be paid as there are less people to be employed as we move towards Yf. The economy is operating on its PPC. The economy can operate at point C only in the short run.
Shifts of the AS curveShift to the
right:Wages
Imported raw
materials
Productivity
Shift to the leftWages
Imported raw materials
Productivity
Shifts of the AS curve Any shifts of the AS curve is caused by changes to:Wage rates
Increases in wages would increase the costs of production.
Imported Factor Costs Are a cost of production. E.G. If cost of Oil increases then
cost of production increases.
Changes in Productivity Can be due to improved technology or processes. This
reduces costs of production and more can be produced at the existing price.
Long Run AS curve
SRAS
The SRAS can operate at a level above full capacity for limited periods of time.
This will lead to increased competition for scarce resources as producers attempt to increase output.
This then causes resource costs to increase (e.g. higher wages) and will Shifts SRAS to the left back to Yf.
The Long-run AS curve is at full employment level.
LRAS
YYf
Price level
Work Books page 151
Questions 1-2
Questions to think about
Which two categories in the National Accounts make up the investment flow on the circular flow income model?
Briefly explain the difference between these two categories
Underlying causes of changes in AD
We know that AD=C+I+G+(X-M) If either of these components increase AD also
increases, but what will cause either of these components to increase?
Group 1 – Consumption spending will increase if? Group 2- Investment spending will increase if? Group 3 – Government spending will increase if? Group 4 – Expenditure on net exports will increase if?
Report back to the class on your findings in 10mins.
Equilibrium
YfYe
PLe
Full employment (economic potential)
Occurs where AD=AS and the price level PLe.
This level also indicates the level of employment.
Equilibrium represents where the economy will tend to move towards. Once we are at this equilibrium the economy will stay here unless AD or AS moves
This means that if there is unemployment at the equilibrium level, it is likely to be chronic and will not go away by itself. Unless AD or As alters, the unemployment level will stay the same.
Equilibrium AD/AS
Changes to Equilibrium A change in either aggregate demand or aggregate supply results in a change in the equilibrium price level and a change in the level of national income, output and employment.
Y
Price Level
An increase in AS•A decrease in the price level
•An increase in real income, output and employment
AS’
PL
PL’
Ye Ye’
AS’’
Ye’’
PL ‘’
A decrease in AS
An increase in the price level
A decrease in real income, output and employment levels
Changes in AD and AS
What will happen if there is an increase in AD?
Increase in price level Increase in real income, output and employment What will happen if there is a decrease in AD? A decrease in price level A decrease in real income, output and
employment.
Disequilibrium
Real Income (Y) ,
output, employment
Pric
e Le
vel
PLe
Ye
If AD>AS
If AD<AS
Lead to an unplanned build up of stock. Producers will cut back on production. Workers will be laid off causing income to fall. This leads to prices falling
Lead to an unplanned rundown of stocks. Producers will respond by increasing output but may also have to pay for more resources. Goods become scarce which causes price to increase.
Equilibrium AD/AS
YfYe Y
Pl
Price Level
Actual GDP
PL2
Actual GDP is below full employment level of GDP.
There is excess production because of a lack of demand.
AD is at a point where a price level of PL1 is needed to increase demand.
BUT
AS is operating at PL2
What will be the result?
Stocks will build up
Businesses will lay off workers
National output will fall and unemployment will rise
PL1
Page 153 question 3-4
AD/AS analysis of Fiscal and Monetary Policy. Full employment is where the economy is
operating on the PPC and all existing productive capacity is used.
Often this is not the same as Ye
Deflationary Gap
Real GDP
Price Level
YfY
Unemployment
Deflationary GapPL
AD and AS meet at a level of Real GDP that is below economic capacity. Therefore we have unemployment.
Unemployment is shown by Y being less than Yf
This level of unemployment is also called the deflationary gap.
(As prices will have to fall to reach full employment)
In conditions like this the characteristics of a recession can be seen! (also called a recessionary gap)
We are operating well within the PPC.
How would the government intervene to try and close this gap?
Why is a Recessionary (Defaltionary) gap unfavourable?
Equilibrium income is below full employment level of income resulting in Unemployment Idle Factories
This is a concern to the government because, even though the economy is in equilibrium there is under-utilised resources in the economy i.e. unemployed workers
Expansionary Fiscal Policy The government can run an expansionary
fiscal policy by increasing government spending and reducing taxes.
This will result in a budget deficit or a reduction in the surplus.
Tax Cuts A reduction in income taxes increases
consumers disposable income, leading
to an increase in consumption spending
(C)
A reduction in company taxes enable companies to distribute more after tax income to shareholders in the
form of dividend increasing income (Y) To increase investment spending (I)
An increase in C and I lead to AD increasing
Price Level
YfY
Deflationary Gap
PL
Expansionary Fiscal Gap
Lower tax rates or increase in govt spending to increase aggregate demand.
This is called operating a budget deficit
How this deficit is funded will depend on how much the AD moves.
If the govt borrows from the banks or the public (non monetised). There will be a greater transaction demand for money which will push the interest rate up. This will then decrease I and C causing AD to move back but not as much as the initial shift left.
Inflationary Gap
YeYf
PL
Ye is now greater than Yf
The economy is trying to achieve a level of real GDP that is beyond its capacity.
AD>AS This gap is called an output gap.
Inflationary Gap
How would the government intervene to try and close this gap?
Why is a Inflationary gap unfavourable? National income is temporarily at an over-
full level of income, and there is full employment and inflationary pressure.
This is a concern to the government because there will be pressure for resource costs to rise leading to inflation.
Contractionary Fiscal Policy The government will run a contractionary fiscal policy
by increasing taxes or reducing spending in key areas such as health, education and cutting benefits.
This will result in a budget surplus or a reduction in the deficit.
Increases in Tax leads to less disposable income meaning less consumption.
Lower Government spending and lower consumption will cause the AD curve to move to the left.
PL
Inflationary Gap
Contractionary fiscal policy would mean running a budget surplus (This is done through reducing government spending or increasing tax)
AD would be reduced through less consumer spending and/or less govt spending
Conctractionary Fiscal Policy
Fiscal Policy Refers to the governments revenue and expenditure
decisions. These decisions are shown in the Budget. The Budget sets out the sources of govt revenue and the
areas of expenditure.
The Impact of Fiscal Policy
The govt raises most of its revenue as taxation from individuals and firms
Raising revenue through collection of taxes is a withdrawal from the economy. T disposable incomes and after tax incomes of
businesses C I
So an increase in the tax rate to increase govt revenue will have a negative effect on economic activityT increases disposable incomes and after tax incomes of businesses C I
Impact of Fiscal Policy
However, Govt spending has a considerable impact on the economy.
Govt spending is an injection into the economy. G increases the incomes of individuals and
businesses. C I
G decreases the incomes of individuals and businesses C I
How is your Thinking Shaping Up?Copy one shape into your books and answer the questions.
What is squaring your thinking?
What d
o you ag
ree with?
What is the most important thing you have learnt?W
hat is at the top of your head?
Wha
t is
goin
g ar
ound
you
r hea
d? W
hat are your questions?
How do you feel about your learning? J.Wilson & K Murdoch 2006,
How to succeed with thinking, Curriculum Corporation
These are answers and your job is to think of a question for each one
Government revenue and expenditure decisions
Expansionary fiscal gap
Wages increase, cost of imported raw materials increase, productivity decreases
At very low levels of output there is excess capacity
Will move the AD curve to the right
The government raises most of its revenue through taxation.
LI- Understand the role of the RBNZ and its implementation
of Monetary Policy.
Define money supply and explain how financial
institutions can affect this.
Reserve Bank of New Zealand
The RBNZ has five roles It implements Monetary policy aimed at price
stability.To issue currency It acts as the Governments Banker It is the Central Bank. It is the banker for
banks and hold their settlement cash. Banks can only be called registered banks if they
hold settlement cash with the RBNZ It supervises the banking system
What is Money?
http://www.youtube.com/watch?v=DjTs-rjVkB8&feature=related
http://www.dailymotion.com/video/x871et_real-world-economics-barter-bank-no_school
Barter Banknotes and Beyond1. What was the problem with barter?
1. Double coincidence of wants
2. What characteristics does money need to have?1. Long Lasting2. Easily divisible3. Reasonably scarce4. Easy to store
3. What other items have been used as money in the past?1. Salt 2. Cloth3. Shells4. Tabacco
4. What was an early problem with money? Burglars
What were the first banks called? GoldSmiths
Name major functions of banks Look after customers money (Savings) Lending money to customers
If all depositors wanted their money back from the bank at once what would happen?
The bank would go bankrupt Why would people be no better off if the nation’s money
supply increased? If the money supply doubles, the prices will double (inflation) we
would be no better off What causes the money supply to change?
Banks increasing net lending Government spending increases Spending > Taxation ----- Money supply will increase
Money Supply
The official money supply has three measures
1. M1-Notes and coins in circulation plus other funds that are immediately accessible by deposit holders without making a trip to the bank
2. M2=M1 + other on call funds at registered banks and non-bank financial institutions (e.g. savings, eftpos)
3. M3=M2+ term deposits at registered banks and non-bank financial institutions
Financial Institutions and Money Supply
What determines the amount of money in the economy?
If the nations money supply consisted entirely of currency the answer would be simple: The supply of money would just be equal to the value of the currency created and circulated by the government.
However, in modern economies money supply consists not only just currency but also deposits balances held at private banks
Example- Gorgonzola land Originally no commercial banking system Barter becomes a problem- Govt directs central
bank to put into circulation $1million.
Printed and distributed to the public Money supply =$1million But notes may be lost or stolen- public unhappy
Example- Gorgonzola land In response some people set up a system of commercial banks
At first- banks only storage vaults People need to withdraw $ - physically withdraw $
or write a cheque gives banks permission to transfer $
Suppose all $1million is deposited as people prefer bank deposits to cash
Example- Gorgonzola landBalance sheet of Gorgonzolan Commercial Banks
Assets Liabilities
Currency $1’000’000 Deposits $1’000’000
Cash held by banks are called bank reserves. In this example banks reserves for all the banks equal 1000000. Banks hold reserves to meet their depositors demands for cash withdrawals.
In this situation 100% reserve banking.
Bank reserves are held in vaults rather than circulated among the public and thus are not counted as part of the money supply.
But bank deposit balances are counted as money.
Money supply= $1million
Example- Gorgonzola land Commerical banks decide they only need to keep
reserves equal to 10% of deposits. The remaining 90% can be lent out to borrowers to earn interest.
Balance sheet of Gorgonzolan Commercial Banks
Assets Liabilities
Currency=reserves
100’000 Deposits 1’000’000
Loans 900’000
Notice $900,000 have flown out of the banking system into the hands of the public. We assume citizens prefer bank deposits to cash ao will redeposit the $900’000
Example- Gorgonzola land
Balance sheet of Gorgonzolan Commercial Banks
Assets Liabilities
Currency= reserves
1’000’000 Deposits 1’900’000
Loans 900’000
Money supply now equals $1’900’000!
The existence of the commercial banking system has permitted the creation of new money
Example- Gorgonzola land Bankers see they are keeping to many reserves With deposits of $1’900’000 and a 10% reserve
deposit ratio, banks need only $190’000 in reserves. $810’000 too much.
Banks lend out an extra $810’000 These are eventually redeposited into banks
Balance sheet of Gorgonzolan Commercial Banks
Assets Liabilities
Currency= reserves
1’000’000 Deposits 2’710’000
Loans 1’710’000
Example- Gorgonzola land Money supply=2’710’000 The process of expansion of loans and deposits
will only end when reserves equal 10% of bank deposits.
Balance sheet of Gorgonzolan Commercial Banks
Assets Liabilities
Currency= reserves
1’000’000 Deposits 10’000’000
Loans 9’000’000
Money supply= 10’000’000
Money supply
Desired reserve-deposit ratio= Bank reserve
Bank deposit
Bank deposits = Bank reserves
Desired reserve-deposit ratio
Bank reserves = $1’000’000
Reserve deposit ratio =0.10
Bank deposits = 10’000’000
Money Supply with both currency and Deposits
• Assumed money is held in the form of deposits• Citizen decide to hold 500’000 in the form of currency and to deposit the rest
into banks • Banks keep reserves equal to 10% of deposits
• Money supply= sum of currency in the hands of the public and the bank deposits.
• Currency =500’000• Remaining 500’000 available as bank reserves• 500’000/0.10=5’000’000
• Total money supply= $5’500’000
Money Supply=Currency held by public + Bank reservesDesired reserve-deposit ratio
Questions Money Aggregates
Transaction account balances 65
NZD funding 20
Currency in circulation 10
Other on call funds 140
1. From the above calculate M1, M2 and M3.
2. Place the following in order in terms of liquidity-from the most liquid to the least liquid. Term deposit, Cash, Transaction account balance, On call account balance.
3. Calculate the change in the money supply in each of the following cases.
a) A new deposit of 20000 and a reserve ratio of 25%
b) A new deposit of $40000 and a reserve ratio of 10%
c) New deposits exceed withdrawals by $100000 and the reserve ratio is 20%
Questions Fiscal Policy revision
Price Level
YfY
PL
Y
1. What is the name of the gap shown in the graph?
2. What characteristics are shown in this graph for you to recognise that it is the gap you identified above?
3. The government decides that it will implement fiscal policy to try and close this gap. What type of fiscal policy will the government use? Fully explain the effects this policy will have on the economy.
Page 170
An increase in Money Supply (Primary Expansion)
The reserves of the banking system increase and the money supply increases when Deposits from the public exceed withdrawals The govt repays its debt The RBNZ engages in Open Market Operations
purchasing of stock
The reserves of the banking system decrease and the money supply decreases whenOpposite of above occurs
Secondary Expansion
When a primary expansion occurs banks are holding more reserves than prudence requires.
They are then able to extend lending which is a secondary expansion in credit.
This lending goes into transaction accounts and because these form a high proportion of M1 the money supply is increased.
Demand for money
The demand for money has two parts
1. Transaction demand (For money to make purchases) . The more purchases that takes place the higher the transaction
demand for money (seen periods high eco activity)
2. Asset demand (Demand on assets used to be sold later or for precautionary reasons) Higher dependent on the interest rate. The higher the interest rate
the lower the asset demand for money
Money demand and Money Supply
MD
MS
r
Quantity
Interest rate
Why do you think MS is a vertical line?
The RBNZ controls the supply of money and is fixed at any point in time. (Market forces have no effect)
The NZ Financial System
Government Banks with
Reserve Bank of New Zealand (RBNZ)
The Public Banks with
Registered banks:
e.g. ANZ, BNZ. National Bank etc
Non-Bank deposit-taking institutions
e.g. saving institutions, finance companies
Maintaining Price Stability • The Reserve Bank ensures that money retains its buying
power. – It is responsible for maintaining price stability i.e. guarding
against inflation or deflation in order to protect the value of people’s incomes and savings.
Inflation = an increase in the general level of prices over a period of time.
Inflation = Change CPI x 100
Original CPI
e.g. Year CPI
2006 985
2007 1010
Inflation = 1010 – 985 x 1000
985
= 2.54%
Inflation, Disinflation and Deflation• Inflation = increase in general price level
• Disinflation = rate of inflation is decreasing
• Deflation = decrease in average price level
+ve
-ve
% c
hang
e in
pric
e le
vel
A
B
C
D
Years
Text Book Activity C3.6
Page 325 10mins
Why do we need stable prices?• Key reason is to keep export prices competitive. • Rising prices make NZ exports more expensive compared
with competing products
Low inflation also means Businesses can plan for the future People are encouraged to save rather than borrow Firms more likely to invest in new production Wages and prices are consistent
Policy Targets Agreement
• The Reserve Bank’s responsibilities are set out in the Policy Targets Agreement: a contract between the Minister of Finance and the Governor of the RBNZ
Policy Targets Agreement: required to keep inflation between 1% and 3% in the medium term.
Monetary Policy • Monetary Policy – Changing interest rates or the
money supply to influence the level of economic activity.
Monetary Policy
• Official Cash Rate (OCR) – Interest rate set by the Reserve bank to implement monetary policy, so as to maintain price stability
The Reserve Bank in NZ now directly influences interest rates using the OCR.
By setting the OCR the RBNZ is able to substantially influence short term interest rates.
Short term interest rates have a big impact on
the overall level of economic activity in the
country and therefore on inflation.
Influence on Interest rates by OCR
• The reserve bank pays financial institutions 0.25% below the OCR for money deposited in the Reserve Bank settlement accounts
• The reserve bank charges interest at 0.25% above the OCR for overnight cash to banks.
• The Reserve Bank also sets no limit on the amount of cash it will take in or let out.
OCR
• The Reserve Bank reviews the OCR eight times a year.
• Only in exceptional circumstances would the Reserve Bank make unscheduled adjustments to the OCR.
• The OCR is much more simpler and easier understood than earlier systems.
Effects of the OCR
Reserve Bank increases OCR from 2.5% to 3%
Financial Institutions pay 3.25% on loans, up from 2.75%
Financial Institutions get 2.75% on settlement accounts up from 2.25%
Various Financial Institutions will then increase their own interest rates to consumers and producers.
Consumption rate falls as consumers will begin to save more.
Investment will fall as producers pay more interest on loans
Aggregate demand for goods and services in the economy falls
The Inflation Rate will fall
Monetary Polices
• Loose Monetary Policy – Lowering the OCR to stimulate the economy
and encourage economic growth
• Tight Monetary Policy– Increasing the OCR to dampen economic
activity
Open Market Operations (OMO) • The buying and selling of government securities (bonds) in
the open market in order to expand or contract the amount of money in the banking system.
Purchases by the government of government bonds owned by banks inject money into the banking system and stimulate growth
Sales of government bonds by the government withdraw money from the banking system and contract the economy.
Sell stock to reduce money supply and buy back stock to increase money supplyhttp://www.nzdmo.govt.nz/securities/govtbonds
Moral Suasion
• The Reserve Bank lets the market know about what its expectations are for the future.
• This then lets markets predict as to what the RBNZ might do in the future and thus people will change behaviours to favour themselves in the future.
• The RBNZ Monetary Policy Statements are one example of how the RBNZ tells the financial markets (banks etc) about its actions.
Building a Cycle way the Length of NZ to Beat the Recession (2009 external examination)
A national cycle way funded by Central Government at an estimated costs of $50 million and built throughout the country, would have a multiplied impact on local economies. For example, the 152km Central Otago Rail Trail attracted 12000 riders last year and a survey of local businesses estimated that 90 full-time staff and 240 part-time staff are currently employed in jobs as a result of the Rail Trail.
(a) Predict the effects of the government spending $50million to build a national cycle way by ticking the appropriate box in each of the columns in Table 2 below
Aggregate Demand
Aggregate Supply
Price Level Real GDP
b) What type of policy that this government spending on a national cycle way would best represent?
Increase Increase
Decrease
Increase Increase
No Change No Change
Expansionary Fiscal Policy
c) Based on your predictions in the table above explain the initial impact the government spending would have on the level of unemployment
As government spending increases on a cycle way, workers will be demanded to build the cycle way and thus more and more people will be employed. There will also be flow on jobs being created from the building of the cycle way, as there is likely to be an increased demand for local businesses products. Therefore with the creation of jobs due to the development of a cycle way the initial level of unemployment in the new Zealand economy will decrease.
c) Based on your predictions in the table above explain the initial impact the government spending would have on the level of unemployment
The Money Market and Interest Rates The RBNZ influences interest rates through OCR Interest rates have a large impact on economic activity and inflationary pressure The demand for money is created by those wanting to make transactions or to
hold it as an asset
Quantity of Money
Interest
rate
MD1
MS1
An increase in GDP or eco activity
-Results from an increase in any component of AD
-Results in increased production and sales therefore transactions
-Increase in transactions means an increase in demand for money
-Increase in interest rates
r1
MD2
r2
Interest Rate Changes An increase in the interest rate will
Decrease household consumption spending as consumer confidence falls and they now prefer to save rather than spend.
Household income may also fall as eco activity slows
A decrease in business investment spending as business confidence falls. Sales and revenue may also fall as eco activity
slows
An increase in the exchange rate which will reduce net exports. Export volumes and receipts decrease while
import volumes and payment may increase.
All of these changes will cause the AD to fall and thus inflation will fall.
The Money Market and the OCR
Quantity of Money
Interest rate
MD
MS1
r1
An increase in the OCR
( Tight Monetary Policy)
r2
Interest rates rise from r1 to r2
ms2
AD
As I and C falland net exports fall. Causing a decrease in AD
ASAS moves out as the appreciated exchange rate causes a fall in imported materials costs
Money supply decreased, Price level falls inflationary pressure is reduced.
YY’
PL
PL’
A rise in the OCR
Increased retail interest rates
Credit more expensive
Existing borrowers face increased costs
Lower demand for credit
Increased demand for the NZD
Adverse effects on net exports
Appreciation of the exchange rate
Downward pressure on AD curve
Less new
Investment
spending
Less new
Borrowing for
consumption
Holders of existing mortgages have less disposable income leading to lower consumption spending of more elastic G&S
Downward pressure on the AD curve
Higher costs on existing borrowing for investment
Increased costs of production
AS moves to the left
Reduction in Real GDP
Rising unemployment
A rise in the OCR
Increased retail interest rates
Credit more expensive
Existing borrowers face increased costs
Lower demand for credit
Increased demand for the NZD
Adverse effects on net exports
Appreciation of the exchange rate
Downward pressure on AD curve
Less new
Investment
spending
Less new
Borrowing for
consumption
Holders of existing mortgages have less disposable income leading to lower consumption spending of more elastic G&S
Downward pressure on the AD curve
Higher costs on existing borrowing for investment
Increased costs of production
AS moves to the left
Reduction in Real GDP
Rising unemployment
Monetary Policy and the Inflationary Gap
YeYf
PL
Inflationary Gap
Economic activity is too high and unsustainable.
There is pressure on price levels.
Tight Monetary Policy will be used.
Increase OCR
Interest rates increase
Reduces lending and increases saving
I and C decrease
AD falls
Inflation is reduced
Monetary Policy and the Deflationary Gap
Real Income, Output Employment
Pric
e Le
vel
AD
AS
PLe
Ye Yf
There is under-utilsed productive capacity in the economy and therefore unemployment
Loose Monetary Policy will be used
OCR reduced
Reduces interest rates
Reduces saving and increases lending
Increase in C and I
AD increases
Inflation increases
Ad’
Pe’
Official Cash Rate (OCR) decisions and current rate
Change in OCR OCR rate 29 July 2010 +0.25 3.00 10 June 2010 +0.25 2.75 29 April 2010 No change 2.50 11 March 2010 No change 2.50 28 January 2010 No change 2.50 10 December 2009 No change 2.50 29 October 2009 No change 2.50 10 September 2009 No change 2.50 30 July 2009 No change 2.50 11 June 2009 No change 2.50 30 April 2009 -0.50 2.50 12 March 2009 -0.50 3.00 29 January 2009 -1.50 3.50
List of Registered Banks in NZ as at 4 May 2010 Name of registered bank Registration Date Name of credit rating agency and rating
ANZ National Bank Limited1 April 1987 AA AA-Aa2 ASB Bank Limited 11 May 1989 AA -Aa2 Australia and New Zealand Banking Group Limited (B)5 January 2009 AA AA-Aa1 Bank of Baroda (New Zealand) Limited1 September 2009 -BBB— Bank of New Zealand1 April 1987 AA-Aa2 Citibank N A (B)22 July 1987 A+A+A1 Commonwealth Bank of Australia (B)23 June 2000 AAAAAa1 Deutsche Bank A G (B)8 November 1996 A+AA-Aa3 JPMorgan Chase Bank NA (B)1 October 2007 AA-AA-Aa1 Kiwibank Limited29 November 2001 AA--- Kookmin Bank (B)14 July 1997 A-A1 Rabobank Nederland (B)1 April 1996 AAAAA+Aaa Rabobank New Zealand Limited 7 July 1999 AAA— Southland Building Society7 October 2008 -BBB- The Bank of Tokyo-Mitsubishi UFJ (B)1 March 2004 A+AAa2 The Hongkong and Shanghai Banking Corporation (B)22 July 1987 AAAAAa1 TSB Bank Limited 8 June 1989 BBB+-- Westpac Banking Corporation (B)1 April 1987 AAAAAa 1Westpac New Zealand Limited31 October 2006 AAAAAa2
Exercises page 170
Questions 1-4
What type of gap would you expect the economy to be in by looking at the above picture?
What tools are there available for the government to try and close this gap?.
Economic Problem Solving Sheets
Balance of Payments
Where New Zealand's international transactions are summarised
International transactions include the value of Inflows and outflows of moneyFinancial assets and liabilities
Balance of Payments
Financial AccountCapital Account
Current Account
Current Account
Balance on goods
Balance On services Balance
on income
Balance on current ‘transfers
Value of exported goods minus value imported goods
Usually positive
Includes all tangible items that can be seen, moved or stored
Value exported services minus value of imported services
e.g. Transport, insurance, education etc.
Tourists from overseas who spend money in NZ contribute to our exports of services
Value of investment income received from investments overseas minus investment income paid to foreign investors
e.g. Interest on savings loans and dividends on shares
Value of transfers received by NZlanders minus value of transfers paid to others overseas.
e.g. Money transfers from Govt aid, gifts etc
FORMULA TO CALCULATE CURRENT ACCOUNTBALANCE
BoG=Xg-Mg BoS= Xs-Ms BoII= net investment income BoCT= net transfers CAB=BoG + BoS + BoII + BoCT
Current account balance 1999-2006
Positive balances indicate a surplus, negative balances are in deficit
-The goods balance has gone from a surplus of $2.1 billion in 2001 to a deficit of $4.2 billion in 2006
-- Mainly driven from rising imports
-- Service balance went from deficit to small surplus
-- Investment income deficit increased to over 11billion in 2006
-- result of increasing income earned by foreign investors (high foreign investment)
Item Year 1 Year 2 Year 3 Year 4 Year 5
Xg 32 33 32 35 36
Mg 28 29 33 36 38
Xs 18 20 25 29 30
Ms 23 24 24 26 26
Investment income
-3 -4 -7 -8 -10
Net transfers 2 1.5 2 2.5 1
1. Calculate the current account balances for Ecotania
2. Describe how these events will affect the CA balance
(a) Air NZ buys another plane from the US
(b) There is an economic downturn in NZ’s main export markets
(c) Profits of foreign-owned companies in NZ increase
(d) NZlanders donate large sums to help with disaster relief overseas
Ecotonia’s current account statistics, years 1 to 5
Capital Account
Balance of Transfers made by immigrants
e.g. Aid moneyRelatively small impact on the
Overall BOP
Think of capital in an accounting sense of transfers of money
Financial Account
Capital InflowsAssets brought in NZ by
overseas investors (Foreign investment)
-NZ borrowing overseas
Capital OutflowsAssets brought overseas
by NZ investors ( NZ Investment Abroad)
-Debt repayment
Capital Inflows- Capital Outflows
If NZ sells more assets to foreigners than it buys from foreigners, there will then be a financial account surplus.
Is set out using these categories Direct investment
Investments that make up over 10% of the equity in a company
Portfolio investment Includes investments that make up under 10% of the equity
in a company Other capital investment
All other investment flows (including those from govt) Reserve assets
Financial Account
Current Account Balance Is consistently in deficit.
NZ has experienced current account deficits since the 1970s. Due to too much domestic demand, a lack of domestic savings and
an over-valued exchange rate
This deficit has to be paid for in some way, from overseas borrowing, foreign investment or assets sales
Which account do all these components appear in?
Financial Account Balance Is consistently in surplus – Generally considered undesirable as
these are liabilities that have to be paid in the future.
Thus the current account balance will be the opposite of the financial account balance.
Balance of Payments
2005 2006 2007 2008(1) 2009(1)
Current Account
Export receipts 31,114 31,581 35,636 38,720 44,259
Import receipts 33,343 35,685 38,464 40,515 45,594
Merchandise BALANCE (2,228) (4,104) (2,828) (1,796) (1,337)
Services BALANCE 1,200 522 433 184 (1,119)
Investment income BALANCE (9,384) (11,065) (11,906) (13,343) (13,035)
Transfers BALANCE 293 144 774 828 919
Current account BALANCE (10,120) (14,504) (13,527) (14,128) (14,568)
Deficit as % OF GDP (6.7) (9.0) (8.0) (7.8) (7.9)
Financial Account (net)
Foreign investment in NZ 13,870 10,421 23,370 26,795 (8,853)
NZ investment abroad 3,222 (3,790) 11,120 12,500 (16,122)
Reserves (914) 4,850 6,744 5,763 (9,947)
Financial account BALANCE 10,648 14,211 12,250 14,295 7,269
Capital Account
BALANCE OF Capital Account 108 (326) (457) (773) (579
New Zealand’s Balance of Payments 2005-2009 dollars amounts in millions) Year ended 31 March
Work book page 177 Question 1-4
Trade Accounts
Statistics NZ has upgraded the way it calculates and presents trade statistics to bring NZ statistics into line with IMF guidelines.
NZ stats can be meaningfully compared with those of other countries.
The Foreign Exchange Market
Foreign currency is required for international trade. e.g. Before NZ importers can buy a shipment of Japanese cars, they
must first buy Japanese yen.
Forces of demand and supply will interact to establish the equilibrium quantity and price. Those who create supply in one foreign exchange market create demand in another. e.g. a NZlander travelling to Australia supplies $NZ to the foreign
exchange market and demands $AU.
The price is referred to as the exchange rate
The exchange rate is referred to as how much of another currency $1 NZ buys
Foreign Exchange Market
Demand for $NZ foreign exchange is mainly created by
Exporters Foreign tourists Foreign investors
Supply of $NZ foreign exchange is mainly created by Importers NZ tourist travelling aboard NZ investors investing internationally.
Exchange rates
Supply ($NZ)
Demand ($NZ)
Q1
0.72 USD or 62.41JPY or 0.77 AUD
Price of each NZD in terms of overseas currency
Quantity of
NZ dollars
If people from overseas wish to buy our exports or deposit money in our banks, they must first buy our dollars to do this.
The price of the Australian dollar September 2010
Q1
Demand
(AUS $)
Supply
(AUS $)
Price in NZD
Quantity of Australian dollars
$1.29
The price of one Australian dollar is $1.29 NZ.
What would the price of one NZ dollar cost in Australian currency?
1AUS = 1.29 NZ
1.29 = 1.29
0.77AUS= 1NZD
If a NZ importer wished to import a shipment worth $100’000 AUS what would it cost them in NZD?
100000X 1.29
= $129’000 NZ
Supply and Demand of NZD
The Supply curve of NZD is influenced by Demand for imports (price of imports, incomes etc) Investment by NZlanders overseas Tourism by NZlandes overseas Repayment of overseas debts Investment earnings by foreign owned businesses in
NZ Business and consumer confidence
Supply and Demand of NZD
Demand of NZD is influenced byDemand for NZ exports (price of exports,
incomes etc)Foreign investment in NZ
Influenced by OCR and interest ratesOverseas borrowing Overseas earning of NZ owned assetsOverseas confidence in NZ ecnomy
Trade Weighted Index (TWI) Measures the overall changes in the
exchange rate, of our major trading partners.
It shows if the NZ $ has appreciated or depreciated overall against our trading partners. Our dollar could appreciate against some but depreciate against others.
Appreciation- when the value of $NZ INCREASES against another currency Could be due to an increase in demand or a reduction in the supply caused by things like high interest rates, increased demand for NZ exports, low inflation.
Depreciation- when value of $NZ DECREASES against another currency. Could be due to a decrease in demand or an increase in supply. Caused by things like, low interest rates, high inflation.
Impacts on Imports and Exports Appreciation
This impacts on exports by making them more expensive (to foreigners) causing exports to reduce
This impacts on imports by making them relatively more cheaper, as the $NZ now buys more, imports increase
Negative effect on BOP (X-M) as BOP surplus’s are reduced but BOP deficits will increase.
Deprecation This impacts on exports by making them cheaper in other
currencies- exports will increase This impacts on imports by making them more expensive thus
imports will decrease. Positive effect on BOP (X-M)
What would happen if tourist numbers to NZ decreased?
Q $NZ
S $NZSupply ($NZ)
Demand ($NZ)
Q
P
1. Show the effects on the graph. Will the exchange rate appreciate or depreciate?
Explain why falling tourist numbers cause this effect?
What effect will this have on the
Balance of goods
Current Account
Aggregate demand
Other Factors effecting Imports and Exports Demand for exports will depend on
Price of the product Income levels of the countries we export to Tastes and preferences for our product The price of substitutes and compliments Access to foreign markets (Trade barriers prevent
access) Trade agreements free up access.
Demand for imports will depend on The price Income levels in NZ The price of substitutes and compliments.
Terms of Trade
Terms of = Total Exports Price Index x 1000 Trade Total Imports Price Index
Is an index of export and import prices
• Show what a given amount of exports can purchase in the way of imports
•The higher the index the more competitive our exports are
•If the terms of trade rise (favourable increase) a given amount of exports can now purchase a greater amount of imports than before.
Average for USA UK Aust. Japan Euro TWI TWI
period ended Base June Monthly
Mid-rates all quoted to NZ$1 1979 = 100 % change
Aug 2009 0.6754 0.4082 0.8089 64.14 0.4736 62.9 3.7
Sep 2009 0.7024 0.4304 0.8166 64.29 0.4827 64.3 2.3
Oct 2009 0.7383 0.4566 0.8157 66.58 0.4986 66.5 3.4
Nov 2009 0.7309 0.4400 0.7943 65.26 0.4901 65.2 -1.9
Dec 2009 0.7162 0.4407 0.7929 64.15 0.4902 64.7 -0.9
Jan 2010 0.7277 0.4500 0.7959 66.38 0.5092 66.1 2.3
Feb 2010 0.6974 0.4455 0.7868 62.93 0.5094 64.6 -2.3
Mar 2010 0.7032 0.4670 0.7712 63.66 0.5178 65.1 0.8
Apr 2010 0.7124 0.4644 0.7685 66.52 0.5304 66.1 1.6
May 2010 0.6992 0.4761 0.8019 64.36 0.5557 67.0 1.3
Jun 2010 0.6928 0.4696 0.8105 62.96 0.5665 67.1 0.1
Jul 2010 0.7111 0.4657 0.8134 62.31 0.5572 67.2 0.2
Aug 2010 0.7154 0.4566 0.7944 61.17 0.5541 66.6 -0.9
The Fluctuating value of NZD using TWI Base June 1979 = 100
60.061.062.063.064.065.066.067.068.0
Aug-09
Sep-09
Oct-09
Nov-09
Dec-09
Jan-10
Feb-10
Mar-10
Apr-10
May-10
Jun-10
Jul-10
Aug-10
Year
Ind
ex