EC 309 PDF

1/8/25 Chapter 1 Gross Domestic Product (GDP) = how much $ worth and goods and services we produce; aggregate output Nominal GDP = face value of output ○ current $ GDP ○ use current prices in calculation Real GDP = Nominal GDP corrected for inflation ○ Constant $ GDP - use base period prices in calculation 1/13/25 Nominal GDP is current prices Real GDP ○ Base price x current quantities P = price index = the price level = average cost of goods and services PPI = Producer Price Index CPI = Consumer Price Index ○ MBt/MBb = Pt/100 MB = Market Basket; t = period t; b = base period In the base period => Pt = 100 ○ MBt/MBb x 100 = Pt = CPI Use base period quantities in CPI calculation Rate of inflation = new CPI - base period price {100}/100 x 100 Deflating: ○ Nominal variable/real variable = Pt/100 ○ Nominal variable x 100 = real variable x Pt ○ Nominal variable/Real variable x 100 = Pt Personal Consumption Expenditure Deflator (preferred by federal reserve) ○ Variable = C (Consumer spending) ○ Nominal C x 100 = Real C x Pt ○ Nominal C/Real C x 100 = Pt = PCE Deflator 1/15/25 Chapter 2 Why CPI might overstate inflation ○ Substitution bias ○ Introduction of new goodsUnmeasured changes in quality CPI vs GDP Deflator ○ Prices of capital goods Included in GDP Deflator (if produced domestically) Excluded from CPI ○ Prices of imported consumer goods Included in CPI Excluded from GDP Deflator ○ The basket of goods CPI: fixed GDP Deflator: changed every year ○ ***GDP Deflator deals with things made in America*** ○ ***capital goods - goods used to make other goods*** Personal Consumption Expenditures (PCE) Deflator ○ Another measure of the price level, ratio of nominal to real consumer spending Mix of CPI and GDP Deflator ○ How PCE is like CPI: Only includes consumer spending Includes imported consumer goods ○ How PCE is like GDP Deflator: The “basket” changes over time ○ Federal Reserve prefers PCE PCE has the positive attributes of CPI and GDP Deflator Core inflation ○ Another measure of inflation that excludes food and energy ○ Good and energy prices have volatile in the short run ○ Sometimes viewed as a better gauge of underlying inflation trends ○ There exists both Core CPI and Core PCE Chapter 3 Long-run output (income) Determination & Distribution Y = F (K, L) at A Y = Real GDP K = economic capital (machinery, factory, office buildings, etc.) L = labor (# workers and/or # working hours) A = production technology ***Note: 𝑋 = fixed*** In the long run: ○ Y = 𝑌 = F (𝐾, 𝐿,) at 𝐴 ○ Y = 𝑌 = full employment GDP, potential GDP, or natural level of output In the long run: ○ Need to ↑L or ↑K or ↑A ↑Y in the long run L, K, and A = supply-side factors Spending = demand-side factor Long-run output is directly affected by supply-side factors (L, K, A) Supply-side economics ○ Increase incentive = ↑L or ↑K or ↑A (raise Y in long-term) 1/17/25 Determination of price (cost) of L & K Use classical model/neo-classical model ○ Classical = market-clearing model — price determined by supply-demand ○ Neo-classical = emphasizes marginal analysis Classical model ○ Firm’s profits = π = P * F(K, L) - W * L (cost of labor) - R * K (cost of capital) P = constant = determined by the big market For output — Y = F(K, L) W = nominal wage of labor = $ / hr R = nominal rental price/cost of capital To maximize π L* = optimal labor ○ At how many hours worked are profits maximized? ○ Δπ/ΔL = 0 ○ P * ΔF (L, K)/ΔL - W = 0 Note: ΔF(K, L)/ΔL = MPL = Marginal Product of Labor ○ P * MPL - W = 0 — P * MPL = W — MPL = W/P (real wage) K* = optimal capital ○ R/P = Real Rental Price of capital ○ R/P = MPK = ΔF(K, L)/ΔK MPK = Marginal Product of Capital ○ W/P = unit output/per L — purchasing power Cobb-Douglas Production Function Y = A Ka L1-a ○ *with constant factor share of income ○ a = capital share of income ○ 1-a = Labor share of income W/P = MPL = ΔF/ΔL ○ = (1-a) A Ka L-a ○ W/P = (1-a) Y/L ○ Note: Y/L = Average Product of Labor R/P = MPK = ΔF/ΔK ○ a A Ka-1 L1-a ○ a * A Ka/K * L1-a ○ R/P = a*Y/K 1/22/25 Law of Diminishing Marginal Returns Suppose ↑L (keep k = 𝐾) ⇒ ↓MPL ⇔ ↓W/P ↑L ⇒ ↑MPK ⇔ ↑R/P ↑ 𝐾 ⇒ ↓ 𝑀𝑃𝐾 ⇔ ↓ 𝑅/𝑃 ○ (keep L = 𝐿) ↑ 𝐾 ⇒ ↑ 𝑀𝑃𝐿 ⇔ ↑ 𝑊/𝑃 ↑ 𝐴 ⇒ ↑ 𝑀𝑃𝐿 ⇔ ↑ 𝑊/𝑃 ↑ 𝐴 ⇒ ↑ 𝑀𝑃𝐾 ⇔ ↑ 𝑅/𝑃 Example: W = $18/hr ○ P = $3/unit ○ R = $60/per K ○ Current MPL = 4 unit output/1 more hour ○ Current MPK = 22 unit output/1 more K ○ To max Π: Statement: ↑ 𝐿 𝑎𝑛𝑑 ↓ 𝐾 in order to max. Π Under max Π: W/P = MPL ⇒ W/P = 18/3 = 6 unit output/per L R/P = MPK ⇒ 60/3 = 20 unit output/per K ○ Current MPL = 4 vs MPL = 6 under max Π ○ Need to ↓ 𝐿 ⇒ ↑ 𝑀𝑃𝐿 so MPL rises from 4 to 6 ○ Current MPK = 22 vs MPK = 20 under max Π ○ Need to ↑ 𝐾 ⇒ ↓ 𝑀𝑃𝐾 to reduce MPK from 22 to 20 (R/P * K) / Y = a If K = 𝐾, L = 𝐿, A= 𝐴, ⇒ 𝑌 = 𝑌 = potential GDP 1/24/25 Chapter 1 Slides Endogenous versus Exogenous Variables The values of endogenous variables are determined in the model ○ Solved by a model The values of exogenous variables are determined outside the model: the model takes their values and behaviors as given ○ NOT solved by a model Chapter 2 Slides Expenditure Compnonets of GDP (Y) Consumption, C Investment, I Government spending, G Next exports, NX (exports - imports) Important identity ○ Y C + I + G + NX Consumption (C) The value of all goods and services bought by households Durable goods ○ Last a long time ○ Ex. cars, home appliances Nondurable goods ○ Last a short time ○ Ex. food, clothing Services Investment Spending (I) Spending on capital, a physical asset used in future production Includes: ○ Business fixed investment – Spending on plant and equipment Firms purchase (economic) capital (K) ○ Residential fixed investment – Spending by consumers and landlords on housing units New house is included ○ Inventory investment – The change in value of all firms’ inventories Ex. in 2023; $10,000 worth of cars produced and sold $10,000 counted in 2023 GDP Recorded as investment (I) under inventory investment Suppose $10,000 worth of cars sold in 2024 Not counted in 2024 GDP Consumer spending (C) increases by $10,000 Inventory Investment decreases by $10,000 Government Spending (G) G includes all government spending on goods and services ○ National defense ○ Purchases of trains and installation of subway rail ○ Services provided by a Park Ranger to visitors of a national park G excludes transfer payments ○ (ex. Unemployment insurance payments) because they do not represent spending on goods and services Net Exports NX = exports - imports ○ Exports: the value of goods and services (g&s) sold to other countries ○ Imports: the value of g&s purchased from other countries Hence, NX equals net spending from abroad on our g&s Notice: The trade deficit (NX < 0) does not reduce GDP 1/27/25 Value Added Value added is the value of output minus the value of the intermediate goods used to produce that output ○ It represents the increase in the value of a product or service at each stage of the production process ○ It measures the contribution of a specific economic activity or sector to the overall economy Intermediate goods are goods purchased for resale or for use in producing another good Final Goods, Value Added, and GDP GDP = value of final goods produced ○ = sum of value added at all stages of production The value of the final goods already includes the value of the intermediate goods, so including intermediate and final goods in GDP would be double counting GNP vs GDP Gross National Product (GNP) ○ Total income earned by the nation’s factors of production, regardless of where located ○ Total value of goods and services sold by residents of a country, regardless of location ○ Nationality counts Gross Domestic Product (GDP) ○ Total income earned by domestically located factors of production, regardless of nationality ○ Location counts Examples of factor payments: wages, profits, rent, interest and dividends on assets

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