Principles of Economics Session 10. Topics To Be Covered  Macroeconomics vs. Microeconomics  History of Macroeconomics  Major Concerns of Macroeconomics.

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  • Slide 1
  • Principles of Economics Session 10
  • Slide 2
  • Topics To Be Covered Macroeconomics vs. Microeconomics History of Macroeconomics Major Concerns of Macroeconomics Objectives of Macroeconomics Instruments of Macroeconomics Markets and Players of Macroeconomics
  • Slide 3
  • Topics To Be Covered Definition of Gross Domestic Product Measurement of GDP GDP, GNP, NNP, NI, PI, and DPI Price Indexes AS, AD, and Macroeconomic Equilibrium
  • Slide 4
  • Macroeconomics vs. Microeconomics Microeconomics is the study of how individual households and firms make decisions and how they interact with one another in markets. Macroeconomics is the study of the economy as a whole. Its goal is to explain the economic changes that affect many households, firms, and markets at once.
  • Slide 5
  • History of Macroeconomics The Great Depression was a period of severe economic contraction and high unemployment that began in 1929 and continued throughout the 1930s.
  • Slide 6
  • History of Macroeconomics Classical economists applied microeconomic models, or market clearing models, to economy-wide problems. The failure of simple classical models to explain the prolonged existence of high unemployment during the Great Depression provided the impetus for the development of macroeconomics.
  • Slide 7
  • History of Macroeconomics In 1936, John Maynard Keynes published The General Theory of Employment, Interest, and Money. Keynes believed governments could intervene in the economy and affect the level of output and employment. Fine-tuning was the phrase used to refer to the government s role in regulating inflation and unemployment.
  • Slide 8
  • History of Macroeconomics The use of Keynesian policy to fine-tune the economy in the 1960s, led to disillusionment in the 1970s and early 1980s. Stagflation occurs when the overall price level rises rapidly (inflation) during periods of recession or high and persistent unemployment (stagnation).
  • Slide 9
  • Major Concerns of Macroeconomics Macroeconomics answers questions like: Why do production expand in some years and contract in others? Why do prices rise rapidly in some time periods while they are more stable in others? Why are some people unable to have the opportunity to work although they do want to work?
  • Slide 10
  • Major Concerns of Macroeconomics Output (GDP change) Price level (Inflation) Employment (Unemployment)
  • Slide 11
  • Objectives of Macroeconomics Output growth Stable prices High employment
  • Slide 12
  • Instruments of Macroeconomics Macroeconomic tools mainly consist of fiscal policy and monetary policy. Fiscal policy refers to government policies concerning taxes and expenditures. Monetary policy consists of tools used by the central bank to control the money supply.
  • Slide 13
  • Markets and Players of Macroeconomy
  • Slide 14
  • Goods and Service Market Financial Market Labor Market
  • Slide 15
  • Markets and Players of Macroeconomy Households and the government purchase goods and services from firms in the goods- and services market, and firms supply to the goods and services market. In the labor market, firms and government purchase labor from households.
  • Slide 16
  • Markets and Players of Macroeconomy The financial market consists of money market, capital market, and foreign exchange market in the open economy. In the money market, the government (central bank) supplies money and households and firms demand money for transaction and speculation.
  • Slide 17
  • Markets and Players of Macroeconomy In the capital market, households purchase stocks and bonds from firms. In the foreign exchange market, those who want to invest in foreign countries exchange domestic currency for foreign currencies, while those foreigners who want to invest in this country supply foreign currencies and demand domestic currencies.
  • Slide 18
  • Gross Domestic Product GDP is the market value of all final goods and services produced within a country in a given period of time.
  • Slide 19
  • Gross Domestic Product GDP is the best single measure of the economic well-being of a society. GDP per person tells us the income and expenditure of the average person in the economy. Higher GDP per person indicates a higher standard of living.
  • Slide 20
  • Gross Domestic Product CountryRealGDP per Person (1997) Life Expectancy Adult Literacy United States$29,01077 years99% Japan24,0708099 Germany21,2607799 Mexico8,3707290 Brazil6,4806784 Russia4,3706799 Indonesia3,4906585 China3,1307083 India1,6706353 Pakistan1,5606441 Bangladesh1,0505839 Nigeria9205059
  • Slide 21
  • Gross Domestic Product It is estimated that: China's GDP will surpass that of France in 2005 China is expected to become the world's third economic power in 2020 China is likely to outstrip Japan in 2050 to become the worlds second largest economic power.
  • Slide 22
  • Gross Domestic Product The 16th CPC Party Congress established the objective to double the 2000 GDP by 2010, and further by 2020 quadruple its 2000 GDP. To attain the goal, what should be the annual GDP growth of China?
  • Slide 23
  • Gross Domestic Product A rough solution to such issue can be resorted to the rule of 70. According to the rule of 70, if some variable grows at a rate of x percent per year, then that variable doubles in approximately 70/x years. For example, $5,000 invested at 7 percent interest per year, will approximately double in size in 10 years.
  • Slide 24
  • The Measurement of GDP Output is valued at market prices. It records only the value of final goods, not intermediate goods (the value is counted only once). It includes both tangible goods (food, clothing, cars) and intangible services (haircuts, housecleaning, doctor visits).
  • Slide 25
  • The Measurement of GDP It includes goods and services currently produced, not transactions involving goods produced in the past. It measures the value of production within the geographic confines of a country. It measures the value of production that takes place within a specific interval of time, usually a year or a quarter (three months).
  • Slide 26
  • The Measurement of GDP The term final goods and services refers to goods and services produced for final use. Intermediate goods are goods produced by one firm for use in further processing by another firm.
  • Slide 27
  • The Measurement of GDP Aggregate Output (GDP) = Aggregate Income Aggregate Output (GDP) =Aggregate Expenditure Aggregate Expenditure = Aggregate Income
  • Slide 28
  • GDP can be computed in two ways: The expenditure approach (product approach) A method of computing GDP that measures the amount spent on all final goods during a given period. The income approach (cost approach) A method of computing GDP that measures the income wages, rents, interest, and profits received by all factors of production in producing final goods. The Measurement of GDP
  • Slide 29
  • The Expenditure Approach C = Consumption I = Investment G = Government Purchases NX = Net Exports Y= C + I + G + NX NX = Export - Import
  • Slide 30
  • The Expenditure Approach Consumption (C) : u Durable goods (cars, televisions, etc.) u Non-durable goods u Services Investment (I) : u Houses purchased by households u Plant and equipment purchased by firms u Inventory changes
  • Slide 31
  • The Expenditure Approach Government Purchases (G) : u The spending on goods and services by local, state, and federal governments. u Does NOT include transfer payments because they are not made in exchange for currently produced goods or services. Net Exports (NX) : u Exports minus imports.
  • Slide 32
  • The Income Approach Components of the income approach: Wages, salaries, and supplements Net interest Rental income of persons Income of unincorporated enterprises Corporate profits before taxes Indirect taxes Depreciation
  • Slide 33
  • The Income Approach In calculating GDP, we can either sum up the value added at each stage of production, or we can take the value of sales of final goods and services. We do not use the value of total sales in an economy to measure how much output has been produced. If we do, we are committing the fault of double counting.
  • Slide 34
  • The Income Approach One practical income approach to avoid the problem of double counting is to use the value added method. Value added is the difference between the value of goods as they leave a stage of production and the cost of the goods as they entered that stage.
  • Slide 35
  • The Income Approach STAGE OF PRODUCTION VALUE OF SALES VALUE ADDED (1)Cotton$50$ (2)Yarn6515 (3)Cloth8015 (4)Coat10020 (5)Retail sale12020 Total value added $120
  • Slide 36
  • GDP and Its Components (1998)
  • Slide 37
  • Slide 38
  • Consumption 68 %
  • Slide 39
  • Investment 16% GDP and Its Components (1998) Consumption 68 %
  • Slide 40
  • Consumption 68 % Government Purchases 18% GDP and Its Components (1998) Investment 16%
  • Slide 41
  • Net Exports -2 % GDP and Its Components (1998) Consumption 68 % Investment 16% Government Purchases 18%
  • Slide 42
  • Inappropriateness of GDP GDP excludes most items that are produced and consumed at home and that never enter the marketplace. It excludes value of leisure and clean environment. It excludes items produced and sold illicitly, such as illegal drugs.
  • Slide 43
  • Other Measures of Income Gross National Product (GNP) Net National Product (NNP) National Income (NI) Personal Income (PI) Disposable Personal Income (DPI)
  • Slide 44
  • Gross National Product Gross national product (GNP) is the total income earned by a nations permanent residents (called nationals). It differs from GDP by including income that our citizens earn abroad and excluding income that foreigners earn here.
  • Slide 45
  • Net National Product Net National Product (NNP) is the total income of the nations residents (GNP) minus losses from depreciation. Depreciation is the wear and tear on the economys stock of equipment and structures. NNP=GNP Depreciation
  • Slide 46
  • National Income National Income is the total income earned by a nations residents in the production of goods and services. It differs from NNP by excluding indirect business taxes (such as sales taxes). NI=NNP Indirect Taxes
  • Slide 47
  • Personal Income Personal income is the income that households and noncorporate businesses receive. Unlike NI, it excludes retained earnings, which is income that corporations have earned but have not paid out to their owners. In addition, it includes households interest income and government transfers. PI=NI Retained Earnings+Interest Income + Government Transfers
  • Slide 48
  • Disposable Personal Income Disposable personal income is the income that household and noncorporate businesses have left after satisfying all their obligations to the government. It equals personal income minus personal taxes and certain nontax payments. DPI=PI (Personal Taxes + Nontax Payments)
  • Slide 49
  • GNP, NNP, NI, PI, and DPI NNP=GNP Depreciation NI=NNP Indirect Taxes PI=NI Retained Earnings+Interest Income + Government Transfers DPI=PI (Personal Taxes + Nontax Payments)
  • Slide 50
  • Price Level and Price Indexes The price level can be expressed in terms of price indexes. If the economys overall price level is rising, we call such situation inflation. If the overall price level is decreasing, we call such situation deflation. Common price indexes include the consumer price index (CPI), GDP deflator, and producer price index (PPI).
  • Slide 51
  • The Consumer Price Index The consumer price index (CPI) is a measure of the overall cost of the goods and services bought by a typical consumer. It is used to monitor changes in the cost of living over time.
  • Slide 52
  • The Consumer Price Index Steps to determine the CPI and the inflation rate: Fix the basket Find the prices Compute the baskets cost Choose a base year Compute the index Compute the inflation rate
  • Slide 53
  • The Consumer Price Index Fix the Basket: Determine what prices are most important to the typical consumer. u The Bureau of Labor Statistics (BLS) identifies a market basket of goods and services the typical consumer buys. u The BLS conducts monthly consumer surveys to set the weights for the prices of those goods and services.
  • Slide 54
  • Housing Food/Beverages Transportation Medical Care Apparel Recreation Other Education and communication Whats in the CPIs Basket? 40% 16% 17% 6% 5% 6% 5% 5%
  • Slide 55
  • The Consumer Price Index Find the Prices: Find the prices of each of the goods and services in the basket for each point in time. Compute the Baskets Cost: Use the data on prices to calculate the cost of the basket of goods and services at different times.
  • Slide 56
  • The Consumer Price Index Choose a Base Year and Compute the Index: u Designate one year as the base year, making it the benchmark against which other years are compared. u Compute the index by dividing the price of the basket in one year by the price in the base year and multiplying by 100.
  • Slide 57
  • The Consumer Price Index Compute the inflation rate: The inflation rate is the percentage change in the price index from the preceding period.
  • Slide 58
  • The Consumer Price Index: An Example Step 1:Survey Consumers to Determine a Fixed Basket of Goods
  • Slide 59
  • The Consumer Price Index: An Example Step 2: Find the Price of Each Good in Each Year
  • Slide 60
  • The Consumer Price Index: An Example Step 3: Compute the Cost of the Basket of Goods in Each Year
  • Slide 61
  • The Consumer Price Index: An Example Step 4: Choose One Year as the Base Year (2001) and Compute the Consumer Price Index in Each Year
  • Slide 62
  • The Consumer Price Index: An Example Step 5: Use the Consumer Price Index to Compute the Inflation Rate from Previous Year
  • Slide 63
  • The Consumer Price Index: Another Example Base Year is 1998. Basket of goods in 1998 costs $1,200. The same basket in 2000 costs $1,236. CPI = ($1,236/$1,200) X 100 = 103. Price...

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