Econ 112 Notes PDF

Measures in Price Level GDP Consists of Consumption, Expenditure, Investment Spending and Net Exports via the equation C + G + I + (X-M) GDP per capita income (Welfare) Measured by dividing GDP by the number of citizens, has limitations as it is possible for metrics to be skewed. GNP GDP + NFIA Net...

Measures in Price Level GDP Consists of Consumption, Expenditure, Investment Spending and Net Exports via the equation C + G + I + (X-M) GDP per capita income (Welfare) Measured by dividing GDP by the number of citizens, has limitations as it is possible for metrics to be skewed. GNP GDP + NFIA Net Domestic Product (NDP) GDP - Depreciation. Ideally the best because it includes the actual cost of economic activity. Very difficult to measure as we cannot place a currency to qualitative factors (Ex. The cost of an OFW not raising their children) Nominal vs Real GDP Nominal is what is on paper. Real is based on previous years. To solve for Real GDP it is the Nominal GDP divided by the GDP deflator. Price Index Measures the general price level at a certain period. a. GDP Deflator = Nominal/Real Inflation: π𝑡 = 𝐺𝐷𝑃𝑑𝑡 − 𝐺𝐷𝑃𝑡−1 𝐺𝐷𝑃𝑡−1 π𝑡 = [(𝐺𝐷𝑃𝑑𝑡 / 𝐺𝐷𝑃𝑑𝑡−1) − 1] 𝑥 100 Consumer Price Index (CPI) Measures the cost of living of a fixed basket of goods and services representative of consumer purchases. Non-Weighted: (Previous/Current) Weighted: (Non-weighted x Weight) CPI is indicative of those that are typical of FIlipinos to purchase vs all. This is useful for understanding welfare as these are the necessary commodities to live. GDP Deflator is variable in nature. On one hand, CPI fluctuates as can be tied to imports which can fluctuate as a result. GDP Deflator is slower to change. CPI will be used for Macro, GDP Deflator will be used for international. Limitations of CPI: Selection of goods for what is typical is subjective, differences in income distribution, changes in consumption patterns because what is relevant in consumption changes, and changes in quality over time. Producer Price Index Used to forecast or acts as an indicator for what might happen to the CPI later on. It is the average change in selling prices of domestic producers over time. Macro Identities Expenditure Approach Expenditure ≡ Consumption, Government Expenditure, Investment Spending (Gross Capital Formation, Maintenance Costs, etc.) and Net Exports via the equation E ≡ C + G + I + (X-M) “I” is 𝐾𝑡+1 − 𝐾𝑡 or 𝐾𝑡+1 − 𝐾𝑡 + 𝑑𝐾𝑡 Income Approach Income ≡ Consumption, Taxation, Savings Y≡C+S+T Y-T=C+S (Y - T) - S = C *(Y - T) refers to disposable income. 1. Simple Economy (No Govt. Autarky.) E≡C+I Y≡C+S At equilibrium in a simple economy without government, your investment spendings are also your savings. Think about what you do with extra crops. You would plant them since they are surplus and that will act as an investment later. 2. Simple Economy (Govt. Autarky.) E≡C+I+G Y≡C+S+T G-T=S-I At equilibrium in a simple economy with government, your Government Spending less Tax (Government Budget Deficit) is equal to your Savings less Investment (Crowding Out). The role of the private sector in the economy is diminished. If G-T is positive, that means your government spent more than it collected, if it is negative, it saved more than it spent. The private sector can use what the government saved. S-I refers to the crowding out effect. You would like the private sector to spend more than the government as they are usually more efficient. Crowding out usually results in higher taxes, interest rates, and increased government spending. The government competes in the loanable funds market. 3. Open Economy w/ Govt. E ≡ C + I + G + (X - M) Y≡C+S+T At equilibrium, G - T = (S - I) + (M - X) Where the government budget deficit is equal to the crowding out and trade deficit. Assuming that what the private sector saves is what they invest (S = I) the budget deficit usually results in a trade deficit leading to a twin deficit as that means we are importing more. If the government collects 100B PHP and spends 75B PHP, that means there is an excess of 25B PHP. If the government saves it outside the country, a foreign body purchases the peso, that means they will buy something from the PH, we now have a trade surplus. Solow Model (1950’s) Y = AF (K,N) *where A is technology, K is your capital, and N is your labor and 𝑌𝐴 , 𝑌𝐾 , 𝑌𝑁 > 0 and 𝑌𝐾𝐾 and 𝑌𝑁𝑁 < 0 If you have been given a laptop, your productivity increases but if you were given another laptop, your productivity/output won’t increase by a significant amount. General Cobb-Douglas θ if there are more laborers who have to share the same machine, the per capita output decreases. Formal argument for population management. 1−θ Y = A𝐾 𝑁 *Such that 0 Capital > Population. Population makes the economy grow by increasing activity fbut not the per capita income. Convergence Process of one economy catching up with others. So we say: θ 1−θ Y = A𝐾 𝑁 𝑌 𝑁 𝐾 θ = A( 𝑁 ) θ y = A𝑘 *where y is per capita income and k is the capital labor ratio. It would grow in a concave manner due to the law of diminishing marginal productivity. (Capital labor refers to the proportion of capital to labor) For example, the Philippines and the US. The Philippines has a lower capital labor ratio so less per capita income compared to the US who has the exact opposite. That said, if you were to increase the capital labor of both, the Philippines would see a greater rate of change compared to the US. There is an inherent force that will cause the two economies to eventually converge. So why have we not converged with the US? We are assuming that all economies have the same level of technology and efficiency. *Where the growth of per capita income (dy/y) is the growth in technology (dA/A) and the share of capital (θ) times the growth rate of capital labor ratio (dk/k) If you want to raise the standard of living in terms of per capita income is technology while growth in capital can improve but not the most. 𝑑𝐴 𝐴 = 𝑑𝑦 𝑦 − θ 𝑑𝑘 𝑘 We now have a mathematical answer, not an economic answer. Technology is whatever is left over from the things we can’t explain anymore. The Solow model argues technology is the most important but we don’t know what it is exactly. Making it hard to manipulate or adjust. Neoclassical Model “Monetarist.” If resources are allowed to be fully employed, economies can correct themselves. Technology raises your ceiling per capita income even with the same capital labor ratio. If you increase the investment in the PH and the US given this new graph, the returns will basically be the same so the two will never converge. Residual 𝑑𝑌 𝑌 − 𝑑𝑌 𝑌 𝑑𝑁 𝑁 𝑑𝑌 𝑌 𝑑𝑌 𝑌 𝑑𝐴 𝑑𝐾 𝑑𝑁 + θ 𝐾 + (1 − θ) 𝑁 𝐴 𝑑𝐴 𝑑𝐾 𝑑𝑁 = 𝐴 + θ 𝐾 + (1 − θ) 𝑁 𝑑𝑁 𝑑𝐴 𝑑𝐾 𝑑𝑁 − 𝑁 = 𝐴 + θ 𝐾 − θ 𝑁 𝑑𝑁 𝑑𝐴 𝑑𝐾 𝑑𝑁 − 𝑁 = 𝐴 + θ( 𝐾 − 𝑁 ) = 𝑑𝑦 𝑦 = 𝑑𝐴 𝐴 + θ 𝑑𝑘 𝑘 − 𝑑𝑁 𝑁 k is endogenized - it develops (something) internally, especially a parameter within an economic model. y = Af(k) f’(x) >0 f’’(x) < 0 Three assumptions: 1. Savings rate is constant 2. n = 𝑑𝑁 𝑁 = Population Growth Rate is constant So 𝐾 𝑁 → 𝐾 𝑁+𝑛𝑁. If the population grows by 1.9%, capital has to grow by 1.9% per year. So laborers are equipped with the same number of tools. 3. S = Depreciation is constant 𝐾 𝑁. There is a natural decrease in the capital labor ratio and therefore you need to invest to maintain the capital Therefore for the second and third assumption you would need (N + S)*K to keep the capital labor ratio constant - the breakeven investment. When: S/N = (m+d)*k/N ; k is constant We are maintaining our capital, maintaining the capital labor ratio. This is the steady state. S/N > (m+d)*k/N ; k is increasing We save more than we need, resulting in a surplus. Leading to a higher capital labor ratio. S/N < (m+d)*K/N ; k is decreasing Here we are unable to maintain our machinery. This leads to a lower capital labor ratio. When you have natural disasters or terrorism, infrastructure and capital get destroyed. Lower things to maintain, it will return to the (k/N)*or the steady state. *Refer to the linear curve in graph above for the breakeven investment. When you have unconditional foreign aid, due to the law of diminishing marginal productivity wrought by the maintenance of the capital, you will return to the steady state. Steady State There is no way to change the steady state with capital - you will have to employ other factors like population control. In the poorest region of the country, they cannot save. No savings, no investment. No investment, no income. No income, no savings. It’s a loop, a vicious cycle or perpetual shit. That is the origin point in the graph. https://sites.middlebury.edu/econ0428/neocl assical-growth-model/ This is where external help comes from. It’s not private investment that will help. It’s missionary work of the government. A minor irrigation project results in a small increase in savings, investment, and income. A small maintenance. The capital labor ratio increases slowly and eventually it will start to make a dent. That is how regions in extreme poverty eventually get out of the shithole. GDP Growth or ∆𝑌/𝑌 is always growing by small n - growing at the population growth rate. Balanced Growth Path 𝑑𝑁 𝑁 = 𝑑𝐾 𝐾 = 𝑑𝑌 𝑌 =𝑛 At steady state, we say that k (capital labor ratio) is constant, K/N is constant. If the population is growing by “n” therefore the aggregate capital is also growing by “n”. What affects the economy is population growth. 2% more population means 2% more capital means 2% growth in the entire economy. If we change capital labor ratio only we go back to (k/N)*. So how do we change (k/N)*? In order to increase the savings rate however is tricky. Many of these evidences are: 1. Correlation, not causality. Maybe the reason people are able to save is because they have higher income. They have higher income because they can save. 2. Time - Generational Wealth The period between 0 and 1 is roughly 25 years. A generation. If you have nothing at the start, you can only save very little, little return. With GW behind you, you can save so much and have a huge return in the next generation. 3. Golden Rule of Accumulation. The slope of the breakeven investment is exactly the same as the slope of the production function. Find the point where the slopes are the same using derivatives. We would want a bigger proportion of income saved. You would have excess savings, more investment, capital labor ratio increases - moving the equilibrium capital labor ratio to the right and up. Increasing savings rate increases income, but that’s not the end. Income allows you to consume. Savings does not infinitely increase welfare. Consumption = y - sy. The end goal is to consume so savings is probably not worth it… The graph shows that at lower rates of population growth, the long run standard of living will be higher That said, negative population growth will cause GDP to decrease. Making an “L” shaped function. Effect of n Let’s see what happens when you control the population. Malthusian The slope gets flatter, you have a higher capital labor ratio permanently, higher per capita income permanently, more welfare.