Measuring the Economy

When looking at the elements of macroeconomics, demand and supply, we must consider aggregate demand and aggregate supply – the overall level of demand in an economy. Gross Domestic Product (GDP) has long been used as the definitive measure of the economy. However, it is important to distinguish between real and nominal measurements carefully, take account of population changes, and remember that GDP is not a comprehensive measure of everything contributing to economic welfare or growth. When we seek to understand how to measure the economy and its many macroeconomic elements, we need to understand better what GDP does and does not measure.

Welcome to Topic 8: Measuring the Economy. In this topic, you will learn about:

• Measurements of the economy
• Economic indicators
• Leading and lagging economic indicators
• Effects of movement in economic indicators.

These relate to the Subject Learning Outcomes:

1. Interpret economic models, diagrams and tables to describe the economic situations.
2. Explain how government policy influences microeconomic choices and macroeconomic outcomes.
3. Analyse the economy as a whole using macroeconomic models.

Welcome to your pre-seminar learning tasks for this week. Please ensure you complete these prior to attending your scheduled seminar with your lecturer.

Click on each of the following headings to read more about what is required for each of your pre-seminar learning tasks.

Measurements of the economy

Before we delve into the measurements of the economy, let us look at the following figure, which provides an overview of the circular flow.

Many North American texts/sources refer to Gross Domestic Product (GDP) and Gross National Product (GNP). GDP measures the output produced by factors of production located in the domestic economy. GNP measures the total income earned by domestic citizens, including offshore production locations. Therefore, GNP = GDP + net income from abroad.

GDP is our primary focus in this topic. In later topics, we will look at international economics and how it connects with GNP and other international concepts (Worldometer 2021).

If we observe the significant impact of the global COVID-19, Australia’s GDP has made a profound fluctuation. In 2019, the GDP went from 1.95 % to −2.44 % in 2020 and is forecast to rise to 4.54 % in 2021. From these statistics, you can see the impact the COVID-19 pandemic has had and the changes in macroeconomic factors (O’Neill 2021).

The importance of timing

Throughout our consideration of measuring the economy and assessing the economy’s current conditions, timing is everything!

We must consider taking a short- or long-term view of the various economic indicators. We must also consider established economic measures that, by definition, most often have a time frame built in. For example, while you can measure your wages every fortnight as an employee, we consider a monthly measure of wages growth as an economic indicator. From the whole economy perspective, a recession requires two (2) consecutive quarters of negative GDP growth to be recorded as a recession. The Recession of the 1990s lasted 12 months (Reserve Bank of Australia 2021). Whereas, if we think back to microeconomic demand and conditions, we note that supply and demand often change by the hour, even by the minute, so timing is critical.

The business cycle

Although the business cycle shows straight lines for demand and supply, the actual economy is far more up and down in the short run. Effectively, the economy is often overextended or outperforming at times, and at other times there is underutilisation, and the economy has spare capacity.

The many economic indicators beyond GDP help inform our understanding of the status of the economy. For example, if the economy is in an upswing or downturn, this impacts many businesses, government and financial decisions. So, the more accurate the assessment of where the economy is at, as can be measured, the better.

As we progress, we will learn about lead indicators and lagging indicators. It is crucial to appreciate that it is not unusual for government and institutions such as the stock market or central bank to overestimate or underestimate how far or how fast an economy is moving. So, the measurement tools are most often considered in combination to form a better analytical picture. The following figure illustrates the business cycle and potential gap.

Economic indicators

The business cycle figure shows the gap between actual and potential GDP. While GDP is widely accepted as the best measure of the economy, there are several other economic indicators that government, financial regulators, and industry all look to when considering the economic conditions now and the months and years ahead (Reserve Bank of Australia 2021).

Various economic indicators can be categorised into leading indicators or lagging indicators. To put it simply, that means they are good predictors of what other economic changes are underway and will be apparent in the future. They confirm data that has already passed in time but not previously collated, recorded, or confirmed as being the official statistics of that period. GDP is a lag indicator itself.

We look to understand macroeconomics through the GDP focus and become better informed through a broader range of economic indicators leading and lagging that highlight specific parts of the economy. For example, it is not unheard of for parts of the economy to be surging with growth and other parts to be contracting with slow demand.

In seeking to understand better and estimate if the economy is tracking above potential GDP or below potential GDP in the short run, we consider additional economic indicators.

Leading economic indicators

Let us take a look at the leading economic indicators.

The stock market

The stock market is considered one of the most substantial leading economic indicators. The stock market dynamics are based on the future expectations of the hundreds of companies listed on the stock exchange. The yet-to-be-achieved growth of these stock market companies is factored into the prevailing share prices and trades. So, a declining share market is due to the buyers of shares expecting the company's value to fall, this feeding into reduced aggregate demand.

Inventory levels

When looking at inventory levels, a common situation is seasonal retail sales. In this case, before December, businesses purposely stock up on inventory to prepare for increased consumption in the coming month. If consumer activity increases as expected, businesses with high inventory can meet the demand and increase their profit. Both driving the growth of the economy.

However, high stock inventories, particularly slow stick turnover, can reflect that company supplies exceed the current demand. Slow inventory turnover costs companies money, and it indicates that retail sales and consumer confidence are both down, which further suggests that the economy is contracting. As soon as people are nervous about their job prospects or wider economic circumstances, including inflation and interest rates, then discretionary or ‘wants’-based spending slows dramatically. In the early stages of the global COVID-19 pandemic, we saw that many significant purchases were put on hold until confidence in the economy returned. As a result, in 2020, Australia slipped into its first recession in almost 30 years (Reserve Bank of Australia 2021).

New building approvals

Building permits offer foresight into future real estate supply levels. A high volume indicates the construction industry will be active, which forecasts more jobs and an increase in GDP. But just like with inventory levels, if more houses are built than consumers are willing to buy, it softens prices and impacts the builders’ profits. So, when housing prices are likely to decline, the entire real estate market devalues, not just ‘new’ homes.

A rare event occurred in housing in Australia 1999-2000. The introduction of the 10 % GST was legislated to commence from July 1, 2000. People shopping for new houses knew this was coming, and speculation and fear of a price rise of 10% on new homes took hold. As a result, a massive spike in new home approvals occurred leading up to July 2000, which dragged demand forward. The problem then came with delays in completing that extra level of demand in construction over many months and insufficient capacity in the economy (particularly skilled labour and building materials production).

The market also stalled as many people took some time to adjust to the new tax system. New home approvals after July 2000 fell to low levels, which slowed aggregate demand significantly.

The Sydney Olympic Games of September-October 2000 in Australia were widely credited with being the economic stimulus that rebalanced demand and growth in the economy. The subsequent growth in international tourism and the services sector offset the concurrent decline in building approvals to sustain overall economic demand (Madden & Crowe 2014). It is important to understand that the available capacity in the economy to support the growth in tourism and services was in very different parts of the economy to the areas that were driven by the earlier new housing approvals and construction-related parts of the economy.

Lagging economic indicators

Now that we have looked at leading economic indicators, we will look at lagging economic indicators.

Changes in GDP

Remember, the GDP formula includes C + G – private consumption (C) plus government (G). So, it is essential to dig deeper and see if the investment driving growth in GDP is coming from the private sector or from the government. If entirely from the private sector, that would indicate high business confidence in growth. However, if the majority is from government investment, this may indicate a slow economy where the government sets stimulus policies to revive the economy. So effectively, the government alone is propping up the economy, which will be discussed further in the following two topics.

Unemployment rate

The unemployment rate measures the number of people looking for work as a percentage of the total labour force. Some unemployment rates can be expected even in a healthy economy, in low single-digit percentage figures from 3 % to 5 % This means 90-95 % of people in the labour market who are ready and available for work can gain employment (Australian Bureau of Statistics 2021).

However, when unemployment rates are high, consumers have less money to spend, negatively affecting retail sales, new housing, the stock market, and the service industries. The government may also be required to spend more on employment assistance programs, such as unemployment benefits. In a slow economy, the government may also adopt policies of direct incentives to employers to encourage taking on new employees. This is almost always at the labour market's entry-level, which is the lowest level of wages.

Income and wages

Generally, in an efficient economy, there is growth and wages are generally increasing as people work more and earn more in supplying labour to meet demand. However, when incomes decline, it is a sign that employers are either cutting pay rates, laying workers off or reducing their hours.

Welcome to your seminar for this topic. Your lecturer will start a video stream during your scheduled class time. You can access your scheduled class by clicking on ‘Live Sessions’ found within your navigation bar and locating the relevant day/class or by clicking on the following link and then clicking ‘Join’ to enter the class.

Click here to access your seminar.

The learning tasks are listed below. These will be completed during the seminar with your lecturer. Should you be unable to attend, you will be able to watch the recording, which can be found via the following link or by navigating to the class through ‘Live Sessions’ via your navigation bar.

Click here to access the recording. (Please note: this will be available shortly after the live session has ended.)

In-seminar learning tasks

The in-seminar learning tasks identified below will be completed during the scheduled seminar. Your lecturer will guide you through these tasks. Click on each of the following headings to read more about the requirements for each of your in-seminar learning tasks.

Welcome to your post-seminar learning tasks for this week. Please ensure you complete these after attending your scheduled seminar with your lecturer. Your lecturer will advise you if any of these are to be completed during your consultation session. Click on each of the following headings to read more about the requirements for each of your post-seminar learning tasks.

Each week you will have a consultation session, which will be facilitated by your lecturer. You can join in and work with your peers on activities relating to this subject. These session times and activities will be communicated to you by your lecturer each week. Your lecturer will start a video stream during your scheduled class time. You can access your scheduled class by clicking on ‘Live Sessions’ found within your navigation bar and locating the relevant day/class or by clicking on the following link and then clicking 'Join' to enter the class.

Click here to access your consultation session.

Should you be unable to attend, you will be able to watch the recording, which can be found via the following link or by navigating to the class through ‘Live Sessions’ via your navigation bar.

Click here to access the recording. (Please note: this will be available shortly after the live session has ended.)

• Chapter 1 & 3 - Heijdra, BJ 2009, Foundations of modern macroeconomics, 2nd edn., Oxford University Press.
• Chapter 6: Greenlaw, SA & Shapiro, D 2011, Principles of macroeconomics, OpenStax
• Reserve Bank of Australia 2021, Economic indicators snapshot, Reserve Bank of Australia.

References

• Australian Bureau of Statistics 2021, Online report of the national economic indicators, Australian Bureau of Statistics, https://www.abs.gov.au/statistics/economy/national-accounts/australian-national-accounts-national-income-expenditure-and-product/latest-release
• Dwyer, J & Leong, K 2001, Changes in the determinants of inflation in Australia, Reserve Bank of Australia, https://www.rba.gov.au/publications/rdp/2001/pdf/rdp2001-02.pdf
• Freebairn, J 1998, Microeconomics of the Australian labour market, Reserve Bank of Australia, https://www.rba.gov.au/publications/confs/1998/pdf/freebairn.pdf
• Garton, Pl 2008, The resources boom and the two speed economy, Domestic Economy Division: the Australian Treasury, https://treasury.gov.au/sites/default/files/2019-03/02_Resources_boom.pdf
• Kawi, I 2020, Australia’s first recession in decades signals tougher times to come, The New York Times, The New York Times, https://www.nytimes.com/2020/09/02/business/australia-recession.html
• Madden, J & Crowe, M 2014, Economic impact of the Sydney Olympic games, European Regional Science Association, ERSA conference papers, https://www.researchgate.net/publication/23732594_Economic_Impact_of_the_Sydney_Olympic_Games
• Milligan, B 2015,  How can inflation be good for you?, BBC News, https://www.bbc.com/news/business-30778491
• O’Neil, A 2021,  Australia: Real gross domestic product (GDP) growth rate from 2016 to 2026*, Statista, https://www.statista.com/statistics/263602/gross-domestic-product-gdp-growth-rate-in-australia/
• Oner, C n.d.  Inflation: Price on the Rise, International Monetary Fund, https://www.imf.org/external/pubs/ft/fandd/basics/30-inflation.htm
• Reserve Bank of Australia 2021, Recession, Reserve Bank of Australia, https://www.rba.gov.au/education/resources/explainers/recession.html
• worldometer 2021, What is GDP, worldometer, https://www.worldometers.info/gdp/what-is-gdp/