-Sessions 8-9_macroecon Intro & National Income

8/12/2019 -Sessions 8-9_macroecon Intro & National Income

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2010 Worth Publishers, all rights reserved 2010 Worth Publishers, all rights reserved

The Science of MacroeconomicsThe Science of Macroeconomics

the meaning and measurement of themost important macroeconomicstatistics:

Gross Domestic Product (GDP)

The Consumer Price Index (CPI)

The Unemployment Rate

Introduction to Macroeconomicsmicroeconomics Examines the functioningof individual industries and the behavior ofindividual decision-making unitsfirms &households.

macroeconomics Deals with the economyas a whole. Macroeconomics focuses on thedeterminants of total national income, dealswith aggregates such as aggregateconsumption & investment, and looks at theoverall level of prices instead of individualprices.

aggregate behavior The behavior ofall households and firms together.

Three of the major concerns ofmacroeconomics are

Output growth

Unemployment

Inflation and deflation

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Households Firms

Goods

Labor

Expenditure ($)

Income ($)

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The CircularFlowDiagram:with govt &

rest of theworld


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The Components of the Macroeconomy:The Three Market Arenas

(1) Goods-and-Services MarketFirms supply to the goods-and-services

market; households, the government, &firms demand from this market

(2) Labor Market

in this market, households supplylabor and firms & the governmentdemand labor.

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(3) Money Market

Households supply funds to this marketin the expectation of earning income inthe form of dividends on stocks &interest on bonds

Firms, the government, & the rest of theworld also engage in borrowing &lendingwhich is coordinated by financialinstitutions

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Two definitions:

Total expenditure on domestically-producedfinal goods and services.

Total income earned by domestically-locatedfactors of production.

Expenditure equals income becauseevery peso spent by a buyer

becomes income to the seller.

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One caveat:

Measurement of income and expenditure isimperfect.

Difference in GDP and Gross Domestic Income(GDI) is called the Statistical Discrepancy.

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Value added :The value of output minusthe value of the intermediate goodsused to produce that output

! "

#$ % & 'A farmer grows a bushel of wheatand sells it to a miller for $1.00.

The miller turns the wheat into flourand sells it to a baker for $3.00.

The baker uses the flour to make a loaf ofbread and sells it to an engineer for $6.00.

The engineer eats the bread.

Compute value added at each stageof production and GDP


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% ( & (

GDP = value of final goods produced= sum of value added at all stages

of production.The value of the f inal goods already includes thevalue of the intermediate goods,so including intermediate and final goods in GDPwould be double-counting.

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#

consumption,

investment,

government spending,net exports, )

An important identity:

* + + + )

aggregateexpenditure

value oftotal output

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, -

durable goods last a long timee.g., cars, homeappliancesnondurable goods last a short timee.g., food, clothingservices work done forconsumerse.g., dry cleaning,air travel

definition: The value of allgoods & services bought byhouseholds. Includes:

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!./. ( 0112

42.6

20.8

7.2

70.5%

6,069.6

2,965.1

1,023.2

$ 10,057.9

Services

Nondurables

Durables

Consumption

% of GDP $ billions

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& , -

Spending on goods bought for future use(i.e. , capital goods)

Includes:Business fixed investment Spending on plant & equipmentResidential fixed investment Spending by consumers & landlords onhousing unitsInventory investment The change in the value of all firms inventories

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!./. & ( 0112

0.3

3.4

10.9

14.0%

47.0

487.7

1,552.8

$1,993.5

Inventory

Residential

Business fixed

Investment

% of GDP $ billions


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& & .

Note: Investment is spending on new capital.

Example (assumes no depreciation) :

1/1/2009:economy has $500b worth of capital

during 2009:investment = $60b

1/1/2010:economy will have $560b worth of capital

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/ 3 & .

A flow is a quantity measured per unit of time.E.g ., U.S. investment was $2.5 trillion during 2009.

Flow Stock A stock is aquantity measuredat a point in time.

E.g .,The U.S. capital stockwas $26 trillion onJanuary 1, 2009.

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/ 3 & . '

the govt budget deficitthe govt debt

# of new collegegraduates this year

# of people with collegedegrees

a personsannual saving

a persons wealth

flow stock

! "

/ 3 4

the balance on your credit card statement

how much you study economics outside of class

the size of your compact disc collection

the inflation rate

the unemployment rate

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& % , -

G includes all government spending on goodsand services.

G excludes transfer payments(e.g., unemployment insurancepayments), because they do not representspending on goods and services.

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!./. & / %( 0112

- Federal

20.2%$2,882.4Govt spending

- State & local

Defense

7.5

12.7

5.2

2.4

1,071.9

1,810.4

734.9

337.0Non-defense

% of GDP$ billions


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) * ) 5 6def: the value of total exports (EX) minus the valueof total imports (IM)

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7 ' 88 4

Suppose a firm:

produces $10 million worth of final goods

only sells $9 million worth

Does this violate theexpenditure = output identity?

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$ *

Unsold output goes into inventory,& is counted as inventory investmentwhether or not the inventory buildup wasintentional.

In effect, we are assuming thatfirms purchase their unsold output.

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7 &

We have now seen that GDP measures:

total income

total output

total expenditure

the sum of value-added at all stagesin the production of final goods

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& . Gross National Product (GNP):Total income earned by the nations factors ofproduction, regardless of where located

Gross Domestic Product (GDP):Total income earned by domestically-locatedfactors of production, regardless of nationality

GNP GDP = factor payments from abroadminus factor payments to abroad

Examples of factor payments:wages, profits, rent, interest & dividends onassets

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In our country,which would you

want to be bigger,GDP or GNP?

Why?


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& . ( 011:

GNP and GDP in millions of current U.S. dollars

Country GNP GDP GNP GDP(% of GDP)

Philippines $157,087 $144,062 9.0%

Japan $4,530,191 $4,384,255 3.3%

China $3,229,841 $3,205,507 0.8%

United States $13,827,201 $13,751,400 0.6%

Canada $1,318,304 $1,329,885 0.9%

South Africa $274,141 $283,007 3.1%

New Zealand $125,936 $135,667 7.2%

Peru $98,625 $107,297 8.1%

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6 #

National Income = GNP - Depreciation

National Income = Compensation of

Employees + Proprietors Income + RentalIncome + Corporate Profits + Net Interest +Indirect Business Taxes

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# !/

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6 #

Personal Income = National Income - IndirectBusiness Taxes - Corporate Profits - SocialInsurance Contributions - Net Interest +Dividends + Government Transfers toIndividuals + Personal Interest Income

Disposable Personal Income = PersonalIncome - Personal Tax and Nontax Payments

Disposable Personal Income is whathouseholds & noncorporate businesses have

to spend (or save).

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" & .

GDP is the value of all final goods and servicesproduced.

nominal GDP measures these values usingcurrent prices.

real GDP measure these values using constantprices.

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" # #

Changes in nominal GDP can be due to:changes in prices.changes in quantities of output produced.

Changes in real GDP can only be due tochanges in quantities,

**One way to construct real GDP is by usingconstant base-year prices.


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" & .

= 1

= 1

! "

" ;

Compute nominal GDP in each year.

Compute real GDP in each year using 2006 asthe base year.

2006 2007 2008

P Q P Q P Q

good A P30 900 P31 1,000 P36 1,050

good B P100 192 P102 200 P100 205

!./. " (1'011=

Nominal GDP

Real GDP (in 2000 dollars)

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#

Inflation rate : the percentage increase in theoverall level of prices

One measure of the price level: GDP deflator

Definition:

! "

# #

Use your previous answers to computethe GDP deflator in each year.Use GDP deflator to compute the inflation ratefrom 2006 to 2007, and from 2007 to 2008.

Nom. GDP Real GDP GDPdeflator

Inflationrate

2006 $46,200 $46,200 n.a.

2007 51,400 50,000

2008 58,300 52,000

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! % #

Example with 3 goods

For good i = 1, 2, 3

P it = the market price of goodi

in month t

Q it = the quantity of good i produced in month t

NGDP t = Nominal GDP in month t

RGDP t = Real GDP in month t


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! % #

The GDP deflator is a weighted average of prices.

The weight on each price reflectsthat goods relative importance in GDP.

Note that the weights change over time.

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3 #3 % % %

EX: If your hourly wage rises 5%and you work 7% more hours,then your wage income risesapproximately 12%.

1. For any variables X and Y ,

percentage change in ( X *Y )

= percentage change in X + percentage change in Y

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3 #3 % % %

EX: GDP deflator = NGDP/RGDP.

If NGDP rises 9% and RGDP rises 4%,then the inflation rate is approximately 5%.

2. percentage change in ( X / Y )= percentage change in X

- percentage change in Y

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6 %

1

1

1

= 1

1= 1

1 + = 1

= 1

47

6 %

A problem arises when using fixedbase-year weights: Growth will vary

depending on base year chosen.Rapidly growing sectors with decliningrelative prices will be weighted toomuch as base year becomes furtherand further in the past. Opposite forslowly growing sectors.

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$ " 4

Rule of Thumb: Two quarters of decline in Real GDP

National Bureau of Economic Research uses more nuanced

approach:Monthly Indicators rather than Quarterly.

A significant decline in activity spread across theeconomy, lasting more than a few months, visible inindustrial production, employment, real income, andwholesale-retail trade.


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49Source: Department of Labor, Bureau of Labor Statistics. 50Source: Department of Commerce, Bureau of Economic Analysis.

51Source: Board of Governors of the Federal Reserve. 52Source: Department of Commerce, Bureau of the Census and Bureau of Economic Analysis.

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, -

A measure of the overall level of prices

Published by the Bureau of Labor Statistics

(BLS)Uses:

tracks changes in the typical householdscost of living

adjusts many contracts for inflation (COLAs)

allows comparisons of dollar amounts over time

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? @A/

1. Survey consumers to determine composition ofthe typical consumers basket of goods

2. Every month, collect data on prices of all itemsin the basket; compute cost of basket

3. CPI in any month equals


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! "

Basket: 20 pizzas, 10 compact discs

prices:pizza CDs

2002 $10 $152003 $11 $152004 $12 $162005 $13 $15

For each year, computethe cost of the basketthe CPI (use 2002 asthe base year)the inflation rate fromthe preceding year

# B CD 3 E

15.1%

42.4%

3.8%

17.4%

6.2%5.6% 3.0%

3.1%

3.5%

Food and bev.

HousingApparelTransportationMedical careRecreationEducationCommunicationOther goods and services

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! %

Example with 3 goods

For good i = 1, 2, 3

C i = the amount of good i in the CPIs basket

P it = the price of good i in month t

E t = the cost of the CPI basket in month t

Eb = the cost of the basket in the base period

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! %

The CPI is a weighted average of prices.

The weight on each price reflectsthat goods relative importance in the CPIs basket.

Note that the weights remain fixed over time.

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! %

CPI =E

t

EB

= 1

= 1

= 1

= 1

60

! %

CPI =E

t

EB

= 1

=

= 1

where the weights aregiven by:


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! %

The CPI is a weighted average of prices relativeto their value in the base period.

The weight on each price relative reflectsthat goods relative importance in the CPIs

basket.

Note that the weights remain fixed over time.

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$ $ & #Substitution bias :The CPI uses fixed weights, so it cannot reflectconsumers ability to substitute toward goodswhose relative prices have fallen.Introduction of new goods :The introduction of new goods makes consumersbetter off and, in effect, increases the real value ofthe dollar. But it does not reduce theCPI, because the CPI uses fixed weights.Unmeasured changes in quality :Quality improvements increase the value of thedollar, but are often not fully measured.

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8 # B D

In 1995, a Senate-appointed panel of expertsestimated that the CPI overstates inflation byabout 1.1% per year.

So the BLS made adjustments to reduce thebias.

Now, the CPIs bias is probably under 1% peryear.

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9

1. If your grandmother receives Social Security,how is she affected by the CPIs bias?

2. Where does the government get the money to payCOLAs to Social Security recipients?

3. If you pay income and Social Security taxes,how does the CPIs bias affect you?

4. Is the government giving your grandmothertoo much of a COLA?

5. How does your grandmothers basket differ fromthe CPIs? Does this affect your answer to Q4?

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& . #Prices of capital goods:

included in GDP deflator (if produceddomestically)

excluded from CPIPrices of imported consumer goods:

included in CPIexcluded from GDP deflator

The basket of goods:CPI: fixedGDP deflator: changes every year

# # !./.

P e r c e n

t a g e c h a n g e

f r o m

1 2 m o n

t h s e a r l

i e r

CPI

GDP deflator


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% #

employedworking at a paid job

unemployednot employed but looking for a joblabor forcethe amount of labor available for producinggoods and services; all employed plusunemployed persons

not in the labor forcenot employed, not looking for work

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? / & $ D #

unemployment ratepercentage of the labor force that is unemployed

(there are alternative measures of theunemployment rate)

labor force participation ratethe fraction of the adult populationthat participates in the labor force

! "

% D

U.S. adult population by group, May 2009

Number employed = 140.57 millionNumber unemployed = 14.51 millionAdult population = 235.45 million

Use the above data to calculatethe labor forcethe number of people not in the labor forcethe labor force participation rate

the unemployment rate

! "

% % D

Supposepopulation increases by 1%labor force increases by 3%number of unemployed persons increases by 2%

Compute the percentage changes in the labor forceparticipation and unemployment rates.

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D / & $

The BLS obtains a second measure ofemployment by surveying businesses,asking how many workers are on their payrolls.

Neither measure is perfect, and theyoccasionally diverge due to:

treatment of self-employed personsnew firms not counted in establishment surveytechnical issues involving population inferencesfrom sample data

# $ %

P e r c e n

t a g e c

h a n g e

f r o m

1 2 m o n

t h s e a r l

i e r


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Gross Domestic Product (GDP) measures bothtotal income and total expenditure on theeconomys output of goods & services.

Nominal GDP values output at current prices;real GDP values output at constant prices.Changes in output affect both measures,but changes in prices only affect nominal GDP.

GDP is the sum ofconsumption, investment, governmentpurchases, and net exports.

The overall level of prices can be measuredby either:

the Consumer Price Index (CPI),the price of a fixed basket of goods purchasedby the typical consumer, orthe GDP deflator,the ratio of nominal to real GDP

The unemployment rate is the fraction of thelabor force that is not employed.

Documents

-Sessions 8-9_macroecon Intro & National Income