Stevenson/Wolfers Macroeconomics Ch. 9 & 21 Lecture Slides PDF

Chapter 9 1. GDP and the Macroeconomy Sizing Up 2. GDP Measures Total Spending, the Output, and Income Economy 3. What GDP Captures and What Using It Misses GDP 4. Real and Nominal GDP 5. Millions, Billions, and Trillions...

Chapter 9 1. GDP and the Macroeconomy Sizing Up 2. GDP Measures Total Spending, the Output, and Income Economy 3. What GDP Captures and What Using It Misses GDP 4. Real and Nominal GDP 5. Millions, Billions, and Trillions Macmillan Learning, ©2023 Chapter 9 Learn how to measure 1. GDP and the Macroeconomy the size of an economy using gross 2. GDP Measures Total Spending, domestic product: Output, and Income  Macroeconomics 3. What GDP Captures and What  The Circular Flow It Misses  Defining GDP 4. Real and Nominal GDP 5. Millions, Billions, and Trillions Macmillan Learning, ©2023  From Micro to Macro Macroeconomics builds upon microeconomics! Microeconomics focuses on Macroeconomics focuses on individuals… totals…  Your individual income.  Total income in the whole  The output your business country. produces.  Total output produced by all  Your spending, or the businesses. spending of your family, or  Total spending across all people, Do NOT think of micro and macro as two distinct halves of economics! your company. businesses, and the country’s 3 Macmillan Learning, ©2023 Key Definition (1 of 4) Diving into the Definition Interdependence in the Circular flow diagram: a macroeconomy: simple model of the economy that illustrates how households and Your household income depends businesses are linked. on how many people businesses hire… RECALL the interdependence principle from the core principle of Which depends on how much economics: output they want to produce…  Your best choice depends on Which depends on how much multiple other factors. households want to spend…  Everything is connected! Which depends on how much households earn! 4 Macmillan Learning, ©2023  © Worth Publishers The Circular Flow (1 of 3) Green arrows show the flow of real resources:  Inputs in the production process, like the labor households sell to businesses.  Outputs like the goods and services businesses sell to households. 5 Macmillan Learning, ©2023  The Circular Flow © Worth Publishers (2 of 3) Purple arrows show the flow of money :  Spending on inputs in the production process, like the wages and profits from the sale of goods and services (which translates into households’ income).  Spending on outputs like the goods and services households buy from businesses. 6 Macmillan Learning, ©2023  © Worth Publishers The Circular Flow (3 of 3) Each flow of real resources is matched by an equal and opposite flow of money. The circular flow shows: 1. The market value of total output must be equal to total spending. 2. Total spending must equal total income.  Total output, total spending, and total income are all equal. 7 Macmillan Learning, ©2023 Key Definition (2 of 4) Diving into the Gross domestic product: the Definition market value of all final goods The GDP of a country tallies and services produced within a up the value of all the goods country in a given year. and services they produce:  Key measure of economic activity.  Add up all the cereal, bananas, t-shirts, pants, In 2021, the GDP of the United movies, education housing, States was $23 trillion. cars…EVERYTHING that was produced in a given year.  We’ll focus on GDP per person Now let’s unpack the formal (GDP per capita), $69,200. definition of GDP piece by piece.  Divide $23 trillion by the 332.2 million people living in the 8 Macmillan Learning, ©2023  Gross Domestic Product (GDP) (1 of 5) Gross domestic product: the market value of all final goods and services produced within a country in a given year. “The market value…”  value each product at its market price.  You are literally adding apples and oranges (by their common unit)!  Common unit = the dollar GDP values each good according to its market price:  Example: A $1,500 couch is 100 times as valuable as a $15 9 Macmillan Learning, ©2023  Gross Domestic Product (GDP) (2 of 5) Gross domestic product: the market value of all final goods and services produced within a country in a given year. “…of all…”  include all goods and services. Includes not just what you purchase for yourself from the market, but also what the government purchases for you.  vaccines, public education, road and bridge construction, national defense, etc. Does NOT include economic activity that occurs outside of markets.  If you wash your car yourself, your labor is not included in GDP. 10 However, if you take your car to the car wash, then that service Macmillan Learning, ©2023  Gross Domestic Product (GDP) (3 of 5) Gross domestic product: the market value of all final goods and services produced within a country in a given year. “…final goods and services…”  count only final goods and services, omitting intermediate goods.  The price of a final good incorporates all the contributions of the prior stages of production.  Thus, GDP does NOT count intermediate goods: goods and services that are used as inputs in the production of other products. Car example: The new car you buy for $35,000 is considered a final product (you are the final user!). The $35,000 price includes the value of all the contributions that created that car:  Intermediate goods: the metal, wires, plastic, glass, the workers who processed and assembled those pieces, the truck driver who delivered the car to the sales lot, and the salesperson who sold the car to you. 11 Macmillan Learning, ©2023  Gross Domestic Product (GDP) (4 of 5) Gross domestic product: the market value of all final goods and services produced within a country in a given year. “…produced…”  omit resale of already-purchased goods. GDP does NOT count resale of existing finished goods.  Second-hand sales merely change ownership of goods that have already been produced and were previously counted in GDP.  Example: If you bought a used car, that purchase would not be counted in GDP. 12 Macmillan Learning, ©2023  Gross Domestic Product (GDP) (5 of 5) Gross domestic product: the market value of all final goods and services produced within a country in a given year. “…within a country…”  include all goods produced within the United States. Include everything produced in workplaces in the United States.  Even if the goods are made by foreign-owned business within the United States, and even if the goods are sold to people outside the United States.  Excludes any goods produced in other countries — even if it’s a good produced in an American-owned factory in another country. “…in a given year…”  add up the flow of output over a year. 13 Macmillan Learning, ©2023  © Worth Publishers Key take-aways: GDP and the Macroeconomy 14 Macmillan Learning, ©2023 Chapter 9 Analyze GDP as a 1. GDP and the Macroeconomy measure of total spending, output and 2. GDP Measures Total Spending, income: Output, and Income  Total spending perspective 3. What GDP Captures and What  Total output perspective It Misses  Total income perspective 4. Real and Nominal GDP 5. Millions, Billions, and Trillions Macmillan Learning, ©2023  Three Perspectives on GDP 1. Total 2. Total 3. Total Spending Measure GDP by Output Measure GDP by Income Measure GDP by adding up every adding up every adding up every dollar of dollar’s worth of dollar of income spending. output produce. earned. Highlights who’s Highlights what’s Highlights where doing the being made, and income is going, spending, and by whom. It helps and who’s what they are map the structure enjoying the fruits buying. of production. of all the economic These three measurements are all the same in theory, but they activity. get different names because real-world measurements can differ due to different sources of imperfect data. 16 Macmillan Learning, ©2023  Photo left to right: Alalal/Shutterstock; Vasily Gamayunov/Shutterstock ©Worth Publishers Perspective 1: GDP Measures Total Spending (1 of 4) GDP equals total spending on final goods… …which embodies the value created at earlier stages. Final goods GDP includes new inventories:  GDP counts goods in the year they’re made, regardless of the year in which they’re sold. 17 Macmillan Learning, ©2023  Perspective 1: GDP Measures Total Spending (2 of 4) When you track GDP by spending, you can track who is doing all the spending. Economics uses the following identity to describe each type of spending: Y GDP = C Consumpt + Investmen t I Governme nt +Net exportsG ion + NX purchases The spending summarized in this equation collectively defines all the goods and services produced in the economy. 18 Macmillan Learning, ©2023  Perspective 1: GDP Measures Total Spending (3 of 4) Y = C + I + G GD P Consumption + Investment NX Government Net exports purchases Consumption: household spending on final goods and services.  Clothes, shoes, food, gas, internet bill, haircuts, computers, cars, etc. Investment: spending on new capital assets that increase the economy’s productive capacity.  Any long-lasting good used in a business.  Research and development spending, office furniture, equipment, etc. 19  Macmillan Learning, ©2023  Perspective 1: GDP Measures Total Spending (4 of 4) Y = C + I + G + nt NX GDP Consumption Investme Governme Net exports nt purchases Government purchases: government purchases of goods and services.  Spending on schools, highways, military, vaccine research, etc.  Excludes transfer payments: payments that transfer income from one person to another.  Social security checks, or unemployment insurance checks. Net exports: spending on exports minus spending on imports.  Exports: goods or services produced domestically and purchased by foreign buyers.  Imports: goods or services produced overseas and purchased by domestic buyers.  We subtract spending on imports to offset the fact that spending on imports has already been counted in other categories. 20 Macmillan Learning, ©2023  Photo left to right: Alalal/Shutterstock; Vasily Gamayunov/Shutterstock ©Worth Publishers Perspective 2: GDP Measures Total Output The “total output” GDP perspective highlights what what is being made and by whom. Value added: the amount by which the value of an item is increased at each stage of production.  Measures your contribution toward producing that item.  = Total sales − Cost of intermediate inputs 21 Macmillan Learning, ©2023  Perspective 3: GDP Measures Total Income (1 of 2) The “total income” GDP perspective tracks whether this income is going to workers as wages or to business owners as profits. Photo left: Vasily Gamayunov/Shutterstock ©Worth Publishers  GDP is total income, which is the sum of total wages and total profits. 22 Macmillan Learning, ©2023  Perspective 3: GDP Measures Total Income (2 of 2) Labor’s share of income is declining. Macmillan Learning, ©2023  © Worth Publishers Key take-aways: GDP measures 1. GDP is total spending  This measurement is called “Gross Domestic Product”  Y = C + I + G + NX 2. GDP is total output  This measurement is called “Value Added”  Sum of value added ( = total sales − cost of intermediate inputs) 3. GDP is total income  This measurement is called “Gross Domestic Income”  Total wages + Total profits 24 Macmillan Learning, ©2023 Chapter 9 1. GDP and the Macroeconomy Assess the adequacy of GDP as a gauge of 2. GDP Measures Total Spending, economic conditions: Output, and Income  Six Limitations of 3. What GDP Captures and What GDP It Misses  GDP as a measure of living standards 4. Real and Nominal GDP 5. Millions, Billions, and Trillions Macmillan Learning, ©2023  Is GDP an adequate gauge of economic conditions? “[GDP] 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.” 26 -Former U.S. Senator Robert F. Kennedy Macmillan Learning, ©2023  Limitations of GDP (1 of 6) Recall, GDP is the market value of all goods and services. Limitations of GDP:  But our values are not the same 1. Prices are not values. as market prices. 2. Nonmarket activities — including household GDP counts your spending on a good, production — are but your benefit is often much larger excluded. if you enjoy consumer surplus. 3. The shadow economy is missing. Consider the following: 4. Environmental  Internet services like Google and degradation isn’t counted. Wikipedia are sold at a price of 5. Leisure doesn’t count. zero.  PewDiePie’s book of meme-like 6. GDP ignores distribution. wisdom for $15.99 versus a literary classic for $7.99. 27 Macmillan Learning, ©2023  Limitations of GDP (2 of 6) GDP only measures goods and services Limitations of GDP: that are sold in markets. 1. Prices are not values.  This misses a lot of productive activity! 2. Nonmarket activities — including household Examples of nonmarket activity: production — are excluded.  Doing your own laundry. 3. The shadow economy  Shopping for your own groceries. is missing.  Cooking your own meals. 4. Environmental degradation isn’t  Raising and taking care of your own counted. child (or pet!). 5. Leisure doesn’t count. If you had hired out these jobs in the 6. GDP ignores market, then that would have been distribution. counted in GDP! 28 Macmillan Learning, ©2023  Limitations of GDP (3 of 6) The shadow economy refers to the economic activity purposefully Limitations of GDP: conducted out of view of the 1. Prices are not values. government, and, thus, excluded from 2. Nonmarket activities — GDP. including household production — are  Examples: Illegal products excluded. (drugs), gambling, businesses 3. The shadow economy operating without licenses, use of is missing. cash of avoid paying taxes. 4. Environmental degradation isn’t How much larger would GDP be if it counted. counted the shadow economy? 5. Leisure doesn’t count. 6. GDP ignores distribution. 29 Macmillan Learning, ©2023  Limitations of GDP (4 of 6) GDP treats natural resources as if Limitations of GDP: they have no value until they’re 1. Prices are not values. transformed into something else. 2. Nonmarket activities — GDP ignores the costs of including household environmental degradation. production — are excluded. Examples:  If you clear-cut a forest to 3. The shadow economy is missing. make new lumber, GDP only focuses on the new lumber 4. Environmental degradation isn’t produced.  GDP focuses on the new cars counted. produced by the automobile 5. Leisure doesn’t count. industry, and ignores the 6. GDP ignores pollution emitted by the distribution. production and consumption of that good. 30 Macmillan Learning, ©2023  Limitations of GDP (5 of 6) GDP counts the benefit of work but Limitations of GDP: omits the cost of work  less 1. Prices are not values. leisure! 2. Nonmarket activities —  Working extra hours means less including household time to spend with friends or production — are family, relax, watch a movie, or excluded. take a leisurely walk. 3. The shadow economy is missing. United States versus France: 4. Environmental Work-leisure trade-off degradation isn’t The United States has a 40-hour counted. workweek, whereas France has a 5. Leisure doesn’t count. 35-hour workweek plus 6. GDP ignores distribution. substantial paid vacation time, sick leave, and paid parental 31 leave. Macmillan Learning, ©2023  Limitations of GDP (6 of 6) GDP measures the size of the economic pie, and GDP per person Limitations of GDP: measures the size of the average 1. Prices are not values. slice. 2. Nonmarket activities —  But people care about their actual including household slice! production — are excluded.  GDP does not address the distribution of income. 3. The shadow economy is missing. 4. Environmental degradation isn’t counted. 5. Leisure doesn’t count. 6. GDP ignores distribution. 32 Macmillan Learning, ©2023 33 GDP as an indicator of national well- being Macmillan Learning, ©2023  © Worth Publishers Key take-aways: What GDP captures and what it misses Limitations of GDP: 1. Prices are not values. 2. Nonmarket activities — including household production — are excluded. 3. The shadow economy is missing. 4. Environmental degradation isn’t counted. 5. Leisure doesn’t count. 6. GDP ignores distribution. …but GDP does measure the resources that a society has available to pursue what matters in life. 34 Macmillan Learning, ©2023 Chapter 9 1. GDP and the Macroeconomy Distinguish between real changes in 2. GDP Measures Total Spending, quantities, and the effect of changing Output, and Income prices. 3. What GDP Captures and What  Real and nominal GDP It Misses  How to calculate real GDP 4. Real and Nominal GDP 5. Millions, Billions, and Trillions Macmillan Learning, ©2023 Key Definition (3 of 4) Diving into the Definition Example: Last year, your local Nominal GDP: GDP grocery store sold milk for $3.40 per measured in today’s prices. gallon. This year, that same gallon of milk is priced at $4.20. Useful for…  Last year’s nominal GDP will use  Analyzing what GDP is right $3.40 per gallon.  This year’s nominal GDP will use now, based on the prices $4.20 per gallon. you face right now. Even if the grocery store sells the Not useful for… same quantity of milk, nominal GDP this year will be greater than  Comparisons of GDP over last year’s because the price of milk time. rose. 36 Macmillan Learning, ©2023 Key Definition (4 of 4) Diving into the Definition Distinguishing between price Real GDP: GDP measured in changes and quantity changes constant prices. is important:  excludes the effects of price changes.  Increases in the quantity of stuff we produced reflect a rise It’s called real GDP because it in the standard of living. measures the real change in Real GDP measurements allow production. us to isolate growth in production  focuses on changes in the that has taken place. quantity produced. Let’s work through some Useful for… calculations to fully understand nominal versus real GDP!  Comparisons of GDP over time. 37 Macmillan Learning, ©2023  You Try! Calculating nominal and real GDP (2 of 2) Quantity sold Actual price Nominal GDP Average price Real GDP 𝑃 𝑡 − 𝑃 𝑡 −1 Q P =P×Q P= P×Q 2 Last 80 shoes $30 $30 x 80 $33 $33 x 80 Year = $2,400 = $2,640 This 90 shoes $36 $36 x 90 $33 $33 x 90 Year = $3,240 = $2,970 Growth +12.5% +20% +35% +0% +12.5% rate Reflects both an increase Reflects only the in price and quantity of increase in the shoes. production of shoes. 39 Macmillan Learning, ©2023  Helpful trick for quickly jumping between real and nominal GDP For changes over short periods of time (i.e., just a few years): % Change in nominal GDP ≈ % Change in real GDP + % Change in prices or you can rearrange a bit differently to get… % Change in real GDP ≈ % Change in nominal GDP − % Change in prices Revisiting previous example: 12.5% ≈ 35% − 20% As you can see, 12.5% is not too far off from the exact result of 15%. 40 Macmillan Learning, ©2023  Concept Check: Nominal and Real GDP Last semester, you provided 50 hours of tutoring and charged $15 per hour. This semester, you provided 55 hours of tutoring and charged $18 per hour. Calculate the following: a. the growth rate of your contribution to nominal GDP. b. the growth a. Growth rate rate of of your contribution to real GDP. b. Growth rate of real GDP nominal GDP Average price: $16.50 Last semester: $15 x 50 = Last semester: $16.5 x 50 = $750 $825 This semester: $18 x 55 = This semester: $16.5 x 55 = 41 $990 $907.5 Macmillan Learning, ©2023  © Worth Publishers Key take-aways: Real and Nominal GDP Nominal GDP: adds up the market value of total production in a year using the current prices prevailing in that year. Real GDP: excludes the effects of price changes, so it isolates economic growth that’s due to changes in the quantity of output produced. Quick approximation trick: % Change in real GDP ≈ % Change in nominal GDP − % Change in prices 42 Macmillan Learning, ©2023 Chapter 9 1. GDP and the Macroeconomy Scale large numbers into something more 2. GDP Measures Total manageable. Spending, Output, and Income  Four strategies for scaling big numbers. 3. What GDP Captures and What It Misses 4. Real and Nominal GDP 5. Millions, Billions, and Trillions Macmillan Learning, ©2023 New Line/Everett © Worth Publishers Collection Holding the world ransom… for one million dollars 44 Macmillan Learning, ©2023  Strategy 1: Evaluate what it means per person Reduce the number into more human terms  what does this number mean per person? Helpful baseline numbers when applying strategy one: The world population is nearly 8 billion. The U.S. population is about 330 million. There are around 100 million households in the United States. The U.S. government spent $201 million on the The U.S. government spent $767 billion on National Endowment for the Arts in fiscal year Medicare in fiscal year 2022. 2022. Per household = $767 billion/100 million = Per household = $201 million/100 million = $7,670 $2.01 Per person = $201 million/330 million = $0.61 Per person = $767 billion/330 million = $2,324 45 Macmillan Learning, ©2023  Strategy 2: Compare big Strategy 3: Compare big numbers to the size of the numbers to their own economy. history. Scale big numbers by comparing them to the size of the total economy. Evaluate the size of a number relative to its previous values. Example: The U.S. Department of Education Example: spent $260.45 billion in fiscal year 2021. 6 million Americans were  The federal government spent unemployed in 2021. $6.8 trillion total in fiscal year In January of 2010, there were 2021. approximately 15 million  Roughly 3.8% of total federal Americans unemployed. spending went to K-12 public education.  View “6 million” in a broader context! 46 Macmillan Learning, ©2023  Strategy 4: Use the Rule of 70 to evaluate long-run growth rates Rule of 70: Divide 70 by the annual growth rate to approximately get the number of years until the original amount doubles. 70 Years it takes something to double  Annual growth rate Example: Between 1971 and 2021, real GDP per person in the United States grew at an average rate of 1.75% per year.  It would take ≈ 70/1.75 = 40 years for the average income to double.  Be careful: This rule becomes inaccurate for large growth rates. © Worth Publisher 47 Macmillan Learning, ©2023 Chapter 9 1. GDP and the Macroeconomy 1. GDP measures economic activity. 2. GDP is total spending, 2. GDP Measures Total total output, and total Spending, Output, and income. 3. GDP has limitations but Income does correlate with national well-being. 3. What GDP Captures and 4. Use real GDP! It excludes What It Misses the effects of price changes. 4. Real and Nominal GDP 5. Scale big numbers to make them more understandable. 5. Millions, Billions, and Trillions Macmillan Learning, ©2023