Macroeconomics General Concepts & Topics PDF

Macroeconomics General Concepts & Topics MEASURING A NATION’S INCOME 0  What is Macroeconomics? Macroeconomics is a branch of economics that studies the behavior of an overall economy, which encompasses markets, businesses, consumers, and governments. Macroeconomi...

Macroeconomics General Concepts & Topics MEASURING A NATION’S INCOME 0  What is Macroeconomics? Macroeconomics is a branch of economics that studies the behavior of an overall economy, which encompasses markets, businesses, consumers, and governments. Macroeconomics examines economy-wide phenomena such as inflation, price levels, rate of economic growth, national income, gross domestic product (GDP), and changes in unemployment. MEASURING A NATION’S INCOME 1  Income and Expenditure § Gross Domestic Product (GDP) measures total income of everyone in the economy. § GDP also measures total expenditure on the economy’s output of g&s. For the economy as a whole, income equals expenditure because every dollar a buyer spends is a dollar of income for the seller. MEASURING A NATION’S INCOME 2  The Circular-Flow Diagram § a simple depiction of the macroeconomy § illustrates GDP as spending, revenue, factor payments, and income § Preliminaries: § Factors of production are inputs like labor, land, capital, and natural resources. § Factor payments are payments to the factors of production (e.g., wages, rent). MEASURING A NATION’S INCOME 3 The Circular-Flow Diagram Households: § own the factors of production, sell/rent them to firms for income § buy and consume goods & services Firms Households Firms: § buy/hire factors of production, use them to produce goods and services § sell goods & services MEASURING A NATION’S INCOME 4 The Circular-Flow Diagram Revenue (=GDP) Spending (=GDP) Markets for G&S Goods & G&S sold Services bought Firms Households Factors of Labor, land, production Markets for capital Factors of Wages, rent, Production Income (=GDP) profit (=GDP) MEASURING A NATION’S INCOME 5  What This Diagram Omits § The government § collects taxes, buys g&s § The financial system § matches savers’ supply of funds with borrowers’ demand for loans § The foreign sector § trades g&s, financial assets, and currencies with the country’s residents MEASURING A NATION’S INCOME 6 Gross Domestic Product (GDP) Is… …the market value of all final goods & services produced within a country in a given period of time. Goods are valued at their market prices, so: § All goods measured in the same units (e.g., dollars in the U.S.) § Things that don’t have a market value are excluded, e.g., housework you do for yourself. MEASURING A NATION’S INCOME 7 Gross Domestic Product (GDP) Is… …the market value of all final goods & services produced within a country in a given period of time. Final goods: intended for the end user Intermediate goods: used as components or ingredients in the production of other goods GDP only includes final goods – they already embody the value of the intermediate goods used in their production. MEASURING A NATION’S INCOME 8 Gross Domestic Product (GDP) Is… …the market value of all final goods & services produced within a country in a given period of time. GDP includes tangible goods (like DVDs, mountain bikes, beer) and intangible services (dry cleaning, concerts, cell phone service). MEASURING A NATION’S INCOME 9 Gross Domestic Product (GDP) Is… …the market value of all final goods & services produced within a country in a given period of time. GDP includes currently produced goods, not goods produced in the past. MEASURING A NATION’S INCOME 10 Gross Domestic Product (GDP) Is… …the market value of all final goods & services produced within a country in a given period of time. GDP measures the value of production that occurs within a country’s borders, whether done by its own citizens or by foreigners located there. MEASURING A NATION’S INCOME 11 Gross Domestic Product (GDP) Is… …the market value of all final goods & services produced within a country in a given period of time. Usually a year or a quarter (3 months) MEASURING A NATION’S INCOME 12  The Components of GDP § Recall: GDP is total spending. § Four components: § Consumption (C) § Investment (I) § Government Purchases (G) § Net Exports (NX) § These components add up to GDP (denoted Y): Y = C + I + G + NX MEASURING A NATION’S INCOME 13  Consumption (C) § is total spending by households on g&s. § Note on housing costs: § For renters, consumption includes rent payments. § For homeowners, consumption includes the imputed rental value of the house, but not the purchase price or mortgage payments. MEASURING A NATION’S INCOME 14  Investment (I) § is total spending on goods that will be used in the future to produce more goods. § includes spending on § capital equipment (e.g., machines, tools) § structures (factories, office buildings, houses) § inventories (goods produced but not yet sold) Note: “Investment” does not mean the purchase of financial assets like stocks and bonds. MEASURING A NATION’S INCOME 15  Government Purchases (G) § is all spending on the g&s purchased by govt at the federal, state, and local levels. § G excludes transfer payments, such as Social Security or unemployment insurance benefits. They are not purchases of g&s. MEASURING A NATION’S INCOME 16  Net Exports (NX) § NX = exports – imports § Exports represent foreign spending on the economy’s g&s. § Imports are the portions of C, I, and G that are spent on g&s produced abroad. § Adding up all the components of GDP gives: Y = C + I + G + NX MEASURING A NATION’S INCOME 17  GDP and Its Components, 2007 billions % of GDP per capita Y 13,841 100.0 45,825 C 9,734 70.3 32,228 I 2,125 15.4 7,037 G 2,690 19.4 8,905 NX –708 –5.1 –2,344 MEASURING A NATION’S INCOME 18  GDP and Its Components billions % of GDP per capita Y 2,509 C 2,234 I 345 G 235 NX (305) Compute GDP/capita (at 118Million population) and Percentage of GDP 19 GDP and its components In each of the following cases, determine how much GDP and each of its components is affected (if at all). A. Debbie spends $200 to buy her husband dinner at the finest restaurant in Boston. B. Sarah spends $1800 on a new laptop to use in her publishing business. The laptop was built in China. C. Jane spends $1200 on a computer to use in her editing business. She got last year’s model on sale for a great price from a local manufacturer. D. General Motors builds $500 million worth of cars, but consumers only buy $470 million worth of them. Answers A. Debbie spends $200 to buy her husband dinner at the finest restaurant in Boston. Consumption and GDP rise by $200. B. Sarah spends $1800 on a new laptop to use in her publishing business. The laptop was built in China. Investment rises by $1800, net exports fall by $1800, GDP is unchanged. 21 Answers C. Jane spends $1200 on a computer to use in her editing business. She got last year’s model on sale for a great price from a local manufacturer. Current GDP and investment do not change, because the computer was built last year. D. General Motors builds $500 million worth of cars, but consumers only buy $470 million of them. Consumption rises by $470 million, inventory investment rises by $30 million, and GDP rises by $500 million. 22  Real versus Nominal GDP § Inflation can distort economic variables like GDP, so we have two versions of GDP: One is corrected for inflation, the other is not. § Nominal GDP values output using current prices. It is not corrected for inflation. § Real GDP values output using the prices of a base year. Real GDP is corrected for inflation. MEASURING A NATION’S INCOME 23 EXAMPLE: Pizza Latte year P Q P Q 2005 $10 400 $2.00 1000 2006 $11 500 $2.50 1100 2007 $12 600 $3.00 1200 Compute nominal GDP in each year: Increase: 2005: $10 x 400 + $2 x 1000 = $6,000 37.5% 2006: $11 x 500 + $2.50 x 1100 = $8,250 30.9% 2007: $12 x 600 + $3 x 1200 = $10,800 MEASURING A NATION’S INCOME 24 EXAMPLE: Pizza Latte year P Q P Q 2005 $10 400 $2.00 1000 2006 $11 500 $2.50 1100 2007 $12 600 $3.00 1200 Compute real GDP in each year, using 2005 as the base year: Increase: 2005: $10 x 400 + $2 x 1000 = $6,000 20.0% 2006: $10 x 500 + $2 x 1100 = $7,200 16.7% 2007: $10 x 600 + $2 x 1200 = $8,400 MEASURING A NATION’S INCOME 25 EXAMPLE: Nominal Real year GDP GDP 2005 $6000 $6000 2006 $8250 $7200 2007 $10,800 $8400 In each year, § nominal GDP is measured using the (then) current prices. § real GDP is measured using constant prices from the base year (2005 in this example). MEASURING A NATION’S INCOME 26 EXAMPLE: Nominal Real year GDP GDP 2005 $6000 $6000 37.5% 20.0% 2006 $8250 $7200 30.9% 16.7% 2007 $10,800 $8400 § The change in nominal GDP reflects both prices and quantities. § The change in real GDP is the amount that GDP would change if prices were constant (i.e., if zero inflation). Hence, real GDP is corrected for inflation. MEASURING A NATION’S INCOME 27  Nominal and Real GDP in the U.S., 1965-2007 Billions $12,000 $10,000 Real GDP $8,000 (base year $6,000 2000) $4,000 Nominal $2,000 GDP $0 1965 1970 1975 1980 1985 1990 1995 2000 2005 28  The GDP Deflator § The GDP deflator is a measure of the overall level of prices. § Definition: nominal GDP GDP deflator = 100 x real GDP § One way to measure the economy’s inflation rate is to compute the percentage increase in the GDP deflator from one year to the next. MEASURING A NATION’S INCOME 29 EXAMPLE: Nominal Real GDP year GDP GDP Deflator 2005 $6000 $6000 100.0 14.6% 2006 $8250 $7200 114.6 2007 $10,800 $8400 12.2% 128.6 Compute the GDP deflator in each year: 2005: 100 x (6000/6000) = 100.0 2006: 100 x (8250/7200) = 114.6 2007: 100 x (10,800/8400) = 128.6 MEASURING A NATION’S INCOME 30 Computing GDP 2007 (base yr) 2008 2009 P Q P Q P Q Good A $30 900 $31 1,000 $36 1050 Good B $100 192 $102 200 $100 205 Use the above data to solve these problems: A. Compute nominal GDP in 2007. B. Compute real GDP in 2008. C. Compute the GDP deflator in 2009. 31 Answers 2007 (base yr) 2008 2009 P Q P Q P Q Good A $30 900 $31 1,000 $36 1050 Good B $100 192 $102 200 $100 205 A. Compute nominal GDP in 2007. $30 x 900 + $100 x 192 = $46,200 B. Compute real GDP in 2008. $30 x 1000 + $100 x 200 = $50,000 32 Answers 2007 (base yr) 2008 2009 P Q P Q P Q Good A $30 900 $31 1,000 $36 1050 Good B $100 192 $102 200 $100 205 C. Compute the GDP deflator in 2009. Nom GDP = $36 x 1050 + $100 x 205 = $58,300 Real GDP = $30 x 1050 + $100 x 205 = $52,000 GDP deflator = 100 x (Nom GDP)/(Real GDP) = 100 x ($58,300)/($52,000) = 112.1 33  GDP and Economic Well-Being § Real GDP per capita is the main indicator of the average person’s standard of living. § But GDP is not a perfect measure of well-being. § Robert Kennedy issued a very eloquent yet harsh criticism of GDP: MEASURING A NATION’S INCOME 34 Gross Domestic Product… “… does not allow for the health of our children, the quality of their education, or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages, the intelligence of our public debate or the integrity of our public officials. It measures neither our courage, nor our wisdom, nor our devotion to our country. It measures everything, in short, except that which makes life worthwhile, and it can tell us everything about America except why we are proud that we are Americans.” - Senator Robert Kennedy, 1968 35  GDP Does Not Value: § the quality of the environment § leisure time § non-market activity, such as the child care a parent provides his or her child at home § an equitable distribution of income MEASURING A NATION’S INCOME 36  Then Why Do We Care About GDP? § Having a large GDP enables a country to afford better schools, a cleaner environment, health care, etc. § Many indicators of the quality of life are positively correlated with GDP. MEASURING A NATION’S INCOME 37