Economics: Income & Expenditure

Economics

• Microeconomics studies how households and firms make decisions and interact in markets
• Macroeconomics examines economy-wide phenomena, including inflation, unemployment, and economic growth

The Economy's Income & Expenditure

• Gross Domestic Product (GDP) measures total income and expenditure of an economy
• For an economy as a whole, income must equal expenditure

Circular-Flow Diagram

• This illustrates the flow of money and goods in an economy
• It assumes:
  • Markets exist for both goods/services and factors of production
  • Households spend all income buying goods/services
  • Households own factors of production and sell/rent them to firms for income
  • Firms buy/hire factors of production to produce goods/services
  • Firms pay wages, rent, and profit to resource owners
• The diagram simplifies by excluding the government, the financial system, and the foreign sector

Measurement of GDP

• Gross Domestic Product (GDP) represents the market value of all final goods and services produced within a country in a given period of time
• Market prices reflect the value of goods
• GDP includes legally sold items but excludes illicitly produced or consumed items
• Final goods are intended for the end user, while intermediate goods are used in production
• The value of intermediate goods is already included in final goods prices
• GDP accounts for tangible goods and intangible services
• Goods and services must be currently produced to be counted
• GDP considers goods and services produced domestically, regardless of producer nationality
• GDP is measured within a specific time frame, such as a year or quarter

Components of GDP

• The GDP identity states: Y = C + I + G + NX
  • Y = GDP
  • C = consumption
  • I = investment
  • G = government purchases
  • NX = net exports
• Consumption (C) is household spending on goods and services
  • Goods are further divided into durable and non-durable
  • Services include intangibles like education
  • New housing purchases form an exception
    • Rent payments are consumption for renters
    • Imputed rental value is consumption for homeowners
• Investment (I) is the purchase of capital goods for future production
  • Business capital includes structures, equipment, and intellectual property
  • Residential capital includes landlord's apartments and personal residences
  • Inventory accumulation counts goods produced but unsold
• Government purchases (G), officially known as government consumption expenditure and gross investment, include spending on goods/services by local, state, and federal entities
  • Transfer payments like social security are excluded
• Net Exports (NX) equals exports minus imports
  • Exports represent foreign spending on domestic goods.
  • Imports are the portion of C, I, and G spent on foreign goods

Real versus Nominal GDP

• Total spending can rise due to larger output or higher prices
• Nominal GDP values production at current prices.
• Real GDP values production at constant prices, using a base year
• Real GDP is not affected by price changes
• For the base year, nominal and real GDP are equal

The GDP Deflator

• The GDP deflator is calculated as (Nominal GDP / Real GDP) x 100
• It equals 100 in the base year.
• The deflator is used to measure current price levels relative to the base year
• It can deflate nominal GDP by removing inflation
• Inflation is the overall rise in the economy’s price level
• The inflation rate calculates the percentage change in a price level measure

GDP Data

• Real GDP generally grows over time
  • US real GDP has grown at 3% per year since 1965
• Growth is not steady and suffers recessionary interruptions
• Recession refers to two consecutive quarters of falling GDP
  • Real GDP, income, and profits decline
  • Unemployment and bankruptcies increase

GDP as the Measure of Well-Being

• GDP measures the economic prosperity of a society
• Real GDP per capita is the main indicator of average living standards
• Larger GDP leads to better healthcare and education
• GDP measures ability to obtain elements of a worthwhile existence
• GDP is not perfect because it excludes:
  • Leisure
  • Value of activity outside markets
  • Environmental quality
  • Distribution of income

Chapter 24 – Measuring the Cost of Living

• The Consumer Price Index (CPI) measures the prices of goods bought by a typical consumer
• The Bureau of Labor Statistics computes and reports CPI monthly

Calculating CPI

• Fix the basket by determining the most important prices, weighted appropriately for a typical consumer
• Find the prices of goods in basket at each point in time
• Compute the basket’s cost while keeping the basket of goods the same
• Choose a base year and compute the CPI - CPI = (Price of basket in current year / Price of basket in base year) x 100
• Compute the inflation rate

Consumer Price Index

• The Inflation Rate is the percentage change in the price index from the previous period
• Core CPI measures consumer goods and services excluding food and energy
• The Producer Price Index (PPI) measures the cost of a basket of goods and services bought by firms and can predict changes in the CPI

Problems in Measuring the Cost of Living

• Substitution bias occurs because consumers substitute relatively cheaper goods
• Introduction of new goods increases variety and makes dollars more valuable
• Unmeasured quality changes mean that dollars become more valuable

GDP Deflator vs. CPI

• The GDP deflator measures the ratio of nominal to real GDP and reflects the prices of domestically produced goods and services
• Compares the same goods and services in the current year with base year
• The CPI reflects the price of goods and services bought by consumers
• Compares a fixed basket of goods and services to the cost of the basket in the base year
• Dollar figures from different times require inflation correction

Correcting Economic Variables

• Amount in today’s dollars = Amount in year T dollars x (Price level today / Price level in year T)
• A price index such as the CPI, measures the price level and indexes to correct for inflation

Indexation

• Indexation provides the automatic correction of a dollar amount to account for inflation, adjusting for a dollar amount
• COLA: Cost-of-living allowance is the effects of inflation

Real and Nominal Interest Rates

• The nominal interest rate refers to the rate usually reported, which is reported without correcting for the effects of inflation
• Real interest rate is corrected for the effects of inflation and is equal to the nominal interest rate - inflation rate

Chapter 25 – Production and Growth

• Real GDP per person gauges living standards and differs across countries
• The the growth rate indicated how rapidly real GDP per person grows in a typical year
• Countries are ranked by income changes substantially over time due to differences in growth rates, which means countries are not are necessarily destined to a path
• Poor countries are not necessarily doomed to poverty forever, e.g. Japan
• Rich countries can't take their status for granted

Productivity

• Productivity (Y/L) represents the quantity of goods and services from each unit of labor input
• Productivity is key to living standards and determinant for living standards
• An economy’s income is the economy’s output

Determinants of Productivity

• Physical Capital (K) consists of equipment and structures used to produce goods and services, where is a increase if K/L capital in worker
• Human Capital (H) consists of knowledge/skills workers acquire through education/experience
• Natural Resources (N) consist of inputs into production provided by nature
• Technological Knowledge "A" is society's understanding of the best ways to produce goods and services

Production Function

• Y = A x F(L, K, H, N) is a graph/equation showing relation between outputs and inputs
• F() is a function that shows how inputs combine to produce output
• “A” is the level of technology which gives more output (Y) to be produced from any given combination of inputs
• Constant returns to scale describes when changing all inputs by the same percentage causes output to change in that same percentage
• If each input multiplies each input by 1/L, then the output is multiplied by 1/L, productivity (Y/L worker), physical capital per worker (k/l), human capital per worker, and natural resources per worker

Saving and investment

• Investment in capital raises future productivity
• More current resources for production of capital have a trade-off with the need that consumption goods and services devote fewer resources

Diminishing Returns

• A higher savings rate means fewer resources are make consumption goods for more rapid growth in GDP
• Diminishing returns reflects when extra unit of an input declines input increases
• In the long run, a higher savings rate not higher economic productivity
• The catch-up effect is when countries off poor tend to grow rapidly countries off rich
• Poor countries have low productivity

Investment From Abroad

• For countries looking to invest, can be made abroad
• Foreign Direct Investment (FDI) refers capital investment w/foreign-owned/operated
• Foreign Portfolio Investment (FPI) funds in foreign Money w/domestic operators
• Benefits from investment increases economy’s stock of capital, higher productivity/wages, and current technology
• The World Bank encourages capital to poor countries from advanced countries via loans
• The World Bank and the International Monetary Fund set up in order to promotes economic prosperity around the world
  • After World War II, economic distress could lead to conflict

Education

• Education is an investment in human capital
• there is opportunity costs to wages loss
• Conveys positive externalities
• Public educations subsidizes human cap investment but poor countries have brain drain problems

Health and Nutrition

• Human capital is education towards high work productivity
• It is important to invest to increase productivity
• Virtuous cycle results when health, leads to economic to health and is improved from better nutrition

Property Rights and Political Stability

• To promote economic growth, property rights must be protected, where people ability resource
• Courts facilitate property rights the stability of market
• Lack of property rights causes high corruption and discourages saving/abroad investment
• Political Instability is a threat that discourages new businesses so foreigners become less incentivized

Free Trade

• Inward Policies limit outside interaction like using tariffs (with bad growth effects) or promoting external like open countries
• Trading can be determined by government policy and is easier to trad for geography

Research and Development

• Knowledge is a public good, with federal aid which includes farming, breaks and patents

Population Growth

• A larger population means to producing and consuming goods
• Malthus theorized ability provision self
• Higher and smaller share and can promote technological

Chapter 26 – Saving, Investment, and the Financial System

• The financial system is a group of institutions help match one person's saving with another person's investment. it moves the economy’s scarce resources from savers to borrowers

Financial Markets and Intermediaries

• In Financial markets- savers can directly provide funds to borrowers In bond Market: Bond is a certificate a type of IOU=I owe)
• Loans have dates of maturity and paid periodically until amount borrowed Finical markets are Sale of bonds to raise money and is used by large corporations, the federal government or state and local government.
• Bonds differentiate according to Characteristics/Time
• Municipal bonds do not owners are not required federal and low interest rates.

Stock Market

• Stock in claims that can have to profits higher higher returns
• Markets is when stick prices are influential from influence them
• Stock indexes can increase

Financial Intermediaries

• Financial intermediaries in banks and mutual funds help savers to indirectly provide funds to burrowers.
• Banks charge interest and provides a exchange

Mutual funds

• A mutual Funds institution sells where proceeds buy a stocks
• Provides diversification and money

National Income Accoutns

• National income accounts have rules of national income and identities
• Gross Domestic is equation Expenditure Y=C+I+G+Nx

Savings

• Savings is a closed economy which where

Saving and Investing

• Account identity
• One loan
• Markets from loan funds are where saves and borrwiings at inters rate

Supply and Demand for Loanable Funds

A supply where of loanable is what A Price = interest rate

Effects Governemnt Polices on Saving

• Saving affect affects where shifts right to low rate but quantities with greater
• Tax increase decrease

Chapter 28 – Unemployment

• Labor workforce where full-
• Full time or vacations

Labor Force Stats

• Number force
• Rates of workforce
• Frictional
• Insurance

The Job Process

• Governmens

Unions

• Are a force for labor
• But raise benefits