Macroeconomics Notes #2

Chapter 8 - Gross Domestic Product (GDP) ________________________________________________________ Definitions ● Microeconomics ○ The study of how households and firms make choices, how they interact in markets, and how the government attempts to influence their choices ● Macroeconomics ○ The study of the economy as a whole, including topics such as inflation, unemployment, and economic growth ● Gross Domestic Product (GDP) ○ The market value of all final goods and services produced in a country during a period of time, typically one year ● Final good or service ○ A good or service purchased by a final user ● Intermediate good or service ○ A good or service that is an input into another good or service, such as a tire on a car ● Consumption ○ Is spending by households on goods and services, not including spending on new houses (which are included as investments) ● Services ○ Medical care, education, and haircuts ● Nondurable goods ○ Such as food and clothing ● Durable goods ○ Such as cars and furniture ● Investment ○ Is spending by firms on new factories, office buildings, and additions to investments, plus spending by households and firms on new houses ● Government Purchases ○ Are spending by federal, state, and local governments on goods and services, such as teachers’ salaries, highways, and aircraft carriers ○ This does not include transfer payments, since those do not result in immediate gains ● Net Exports ○ Are the value of exports minus the value of imports ○ This difference might be positive or negative; in recent years, this has been negative in the US ○ Since we want to count domestic production, we add up the value of goods and services sold to foreigners and subtract the value of the goods and services sold to Americans by foreigners ● Underground Economy ○ Buying and selling of goods and services that is concealed from the government to avoid taxes or regulations or because the goods and services are illegal ● Nominal GDP ○ The final values of final goods and services evaluated at the current year prices ● Real GDP ○ Value of final goods and services evaluated at base-year prices ● Price Level ○ A measure of the average prices of goods and services in the economy - often measured by either the Consumer Price Index of the GDP deflator ● GDP deflator ○ A measure of the price level, calculated by dividing nominal GDP by real GDP and multiplying by 100 ● Gross National Product (GNP) ○ Gross national product is the value of final goods and services produced by residents of the UW ● National Income ○ Calculated as GDP minus the consumption of fixed capital ● Personal Income ○ Income received by households ● Disposable Personal Income ○ Is equal to personal income minus personal tax payments How to measure GDP (3 ways) ○ 1st ■ The value of total production in the economy = the value of total income, since payments that firms receive are used to pay factors of production ■ Firms use factors of production (labor, capital, natural resources and entrepreneurship) to produce goods and services ■ Households supply factors of production , in exchange for income: wages, interests, profits, and rents ■ We can measure GDP as the sum of this income ○ 2nd ■ Value added method for calculating GDP ■ Uses the values of different products while the product is created ■ The most inaccurate way to measure GDP, not used often ○ 3rd ■ Domestic firms sell goods and services to three groups: domestic households, the government and foregin firms and households ■ Therefore, we can measure GDP by (1) expenditures by domestic households, (2) expenditures by the government and (3) exports to goreign firms and households, (4) minus the value of imported goods that these actors consume (plus what firms do not sell - the change in inventories and investments by firms and households) Measuring GDP by summing expenditures in the economy ● To measure GDP, the BEA in the Department of Commerce measures four major categories of expenditures: ○ Personal consumption expenditures or consumption (C) ○ Gross private domestic investment, or investment (I) ○ Government consumption and investment or government purchases (G) ○ Net exports of goods and services or net exports (NX) ■ GDP can be expressed as the sum of these: ● Y = C + I + G + NX ○ Y = GDP ○ C = personal consumption ○ I = investment ○ G = government purchases ○ NX = net exports Example of an Underground Economy ● Produces more than 80% of the world’s cocaine supply ● The cultivation, production, and trafficking of cocaine in Columbia employs about 200,000 people and generates annual revenues at 2.2 billion dollars with is 3% of Columbia’s GDP GDP as a measure for well-being? ● Shortcomings of real GDP per capita as a measure of well-being: ○ (1) the value of leisure is not included in the GDP ○ (2) GDP is not adjusted for pollution or other negative effects or production ○ (3) GDP is not adjusted for changes in crime and social problems ○ (4) GDP measures the size of the pie but not how the pie is distributed Nominal v. Real GDP ● Nominal GDP → the final value of goods produced (value = quantity x price) ● We are mainly interested in GDP as a measure or production (i.e. quantity) need to separate the price changes from quantity changes ADD IN OTHER NOTES ABOUT THE SLIDES NOT DISCUSSED ON GDP Chapter 9- Unemployment __________________________________________________________________________ Definitions ● Unemployment rate ○ The percentage of the labor force that is unemployed ○ This is a key indicator of the state of the economy ● Unemployment ○ The number of people unemployment ● Labor Force ○ The sum of employed and unemployed workers in the economy ● Discouraged workers ○ They have actively look for a job the past twelve months but not looked for a job during the last four weeks because they think there are no jobs available for them ● Three Types of Unemployment: ○ Frictional Unemployment ■ Short-term that arises from the process of matching workers with jobs ○ Structural Unemployment ■ Arising from a persistent mismatch between the skills and attributes of workers and the requirements of jobs - may take time to correct (e.g. going back to school) ○ Cyclical Unemployment ■ Unemployment caused by a business cycle recession ● Natural rate of unemployment ○ The normal rate of unemployment, consisting of friction unemployment rate and the structural unemployment rate Formula for the Unemployment Rate This statistic measures the percent of those in the labor force who are unemployed Formula for the Labor Force participation rate This statistic measures the percentage of the working-age population in the labor force Labor Force Participation Rate of Women/Men What determines Natural Unemployment Rates ● Unemployment insure and other payments ○ Potential incentives to stay unemployed ● Minimum wage laws ○ Less attractive to hire ● Labor unions ○ Less attractive to hire ● Efficiency wages ○ Believed to motivate workers Chapter 9 - Inflation ______________________________________________________________________________ ___ Definitions ● Inflation rate ○ The percentage increase in the price level from one year to the next ● Price level ○ A measure of the average prices of goods and services in the economy ● Consumer Price Index ○ A measure of the average change over time in the prices a typical middle class family of four pays for the goods and services they purchase ○ Based off of the basket of goods that the household buys ● Producer Price Index ○ An average of the prices received by producers of goods and services at all stages of the production process ● Inflation ○ An increase in the price level ● Deflation ○ A decline in the price level ● Disinflation ○ A decline in the inflation rate ● Hyperinflation ○ An out of control inflationary spiral Four Biases that make changes in the CPI ● Substitution bias ○ Making the assumption that the same consumption exists as the base year, the idea that we respond to prices and when they rise we find substitutes or stop using the product ● Increase in quality bias ○ Rapid increases in fields like technology, the products are a higher quantity and the CPI does not account for that ● New Product bias ○ New products that didn’t exist in the base year won’t be accounted for, like cell phones ● Outlet Bias ○ We buy more and more online which means that price inconsistencies can exist between local stores and online outlets ● Interest Rate ○ Cost of borrowing, expressed as a percentage of the amount borrowed ● Nominal Interest Rate ○ The stated interest rate on a loan ● Real Interest Rate ○ Is equal to the nominal interest rate - inflation rate ■ The real interest rate is a better measure of the cost of borrowing than is the nominal interest rate Calculating the Consumer Price Index Calculating Real Average Hourly Earnings Chapter 11 - Economic Growth and the Business Cycle___________________________________________ Definitions ● Business cycle ○ Altering periods of economic expansion and economic recession ● Real GDP per capita ○ A measure of the standard of living ● Potential GDP ○ The level of real GDP attained when all firms are producing at capacity ● “At capacity” ○ Normal working hours, normal workforce ● Growth in potential GDP ○ (long term sustainable growth) in the US is estimated to around 3.3% ● Financial system ○ The system of financial markets and financial intermediaries ● Personal savings rate ○ Personal savings as a percentage of disposable income ● Market for loanable funds ○ The interaction of borrowers and lenders that determines the market interest rate and the quantity of loanable funds exchanged ● Recession ○ A significant decline in activity spread across the economy, lasting more than a few months, visible in the economy What explains long-run economics growth? ● Two leading growth contributors: ○ Increase in physical capital per hour worked and human capital ○ Technological change ■ An increase in the output a firm can produce, using a given quantity of inputs Calculating Growth Rates ● (real GDP 2015 - real GDP 2014) / real GDP 2014 x 100 ● How long will it take for real GDP per capita to double ○ Use the rule of 70 to get an approximation: ○ Real GDP per year grows by 5%, the number of years = 70/5 = 14 years Savings = Investment The Market for Loanable Funds The Business Cycle ● Usually illustrated by fluctuations in real GDP ● Consists of two phases: ○ Expansion phase of the business cycle: production, employment and income increase, ending with a business cycle peak ○ Recession phase of the cycle: production, employment, and income decrease, endings with a business cycle trough Who benefits from Recessions? ● Relatively speaking: those who sell necessary consumption (e.g. food industry) ○ In particular: cheap food is in demand ● Those who are successful at taking advantage of cheaper labor and investments, to position themselves for the coming expansion phase Typical Pattern from Expansion to Recession ● At the end of an expansion: ○ Inflation is high, debts are high, interest rates are rising, wages are rising faster than prices ● The recession begins with falls in firm investments and household purchases of new homes and durables, firms will start laying off workers due to lower sales ● Rising unemployment and falling profits means less income, which further reduces spending, falling inflation due to a lower demand ● Turning point: ○ Declines in spending means, reduced by their debt, interest rates decline, further boosting spending ● The next expansion begins: ○ Firms begin to increase investments and households will start investing in new homes and spending, inflation picks up Chapter 12 - Long Run Economic Growth__________________________________________________________ Definitions ● Economic growth model ○ A model that explains growth rates in real GDP per capita over the long run ● Growth depends on labor productivity ○ The quantity of goods and services that can be produced by a worker in one unit of work/worker ● Human Capital ○ The accumulated knowledge and skills that workers acquire from education and training or from their life experiences ● Per-worker production function ○ The relationship between real GDP per hour worked and capital per hour worked, holding the level of technology constant ● Solow’s economic growth model ○ Explains increases in real GDP per capita over time as resulting from two factors: ■ The quantity of physical capital available to workers and technological change ● Catch-up ○ The prediction that the level of GDP per capita in poor countries will grow faster than in wealthy countries ● Hinders to economic growth in low income nations ○ Property Rights ■ The rights individuals or firms have to the exclusive use of their property, including the right to buy or sell it ○ Rule of Law ■ The ability of a government to enforce the laws of the nation, with respect to protecting private property and enforcing contracts ○ Wars and Revolutions ■ Wars have made it impossible for countries like Syria and the DRC to accumulate capital or adopt new technologies ○ Poor Public Education and Health ■ Many low-income nations have weak public school systems, so many workers are unable to read and write ■ People who are sick work less and are less productive when they do work ○ Low rates of Savings and Investment ■ The low savings rates in low-income countries can contribute vicious to a cycle of poverty ○ Chapter 12 - Long Run Economic Growth _________________________________________________________ (ADD IN NOTES FROM CLASS MISSED ON TUESDAY!!) Chapter 13 - Aggregate Expenditure________________________________________________________________ (ADD IN NOTES FROM CLASS MISSED ON TUESDAY!!) Chapter 14 - Aggregate Demand and Supply ______________________________________________________ Definitions ● Aggregate demand curve ○ Shows the relationship between the price level and the quantity of real GDP demanded by households, firms, and the government ● Short-run aggregate supply curve ○ A curve that shows the relationship in the short run between the price level and the quantity of real GDP supplied by firms ● Long-run aggregate supply curve ○ A curve that shows the relationship in the long run between the price level and the quantity of real GDP If the Price level changes what happens to aggregate expenditures ● If the price level increases: AE will decrease because C, NX and I decrease due to the following: ○ The real value of household wealth decreases therefore C increase ○ US products become relatively more expensive than foreign products, therefore NX decreases ○ The interest rate increases, it becomes more expensive to borrow, investment decreases ■ If the price level falls, we will have the reverse effects, i.e. AE increases, due to increases in C,NX, and I Why is the Aggregate demand curve downward sloping? Variables that shift the Aggregate Demand curve ● Changes in government policy ○ More money into infrastructure would create an increase ○ Decrease income taxes would create an increase ● Changes in the expectations of households and firms ○ If you’re expecting that we are heading to a recession would cause a decline ● Changes in foreign variables The short run aggregate supply curve Variables that shift the short run aggregate supply curve Macroeconomic Equilibrium in the Long Run and the Short Run Macroeconomic Equilibrium in a Recession - At point B, the price level is lower than expected so firms and workers will adjust therefore SRAS from Sras1 to Sras2 —> the new equilibrium is point C Net outcome: real GDP is the same but the price level is lower Macroeconomic Equilibrium in an Expansion - - (1) An increase in investment shifts aggregate demand from AD1 to AD2, the price level went up and actual real GDP is higher than the potential real GDP (unemployment is lower than the natural unemployment rate) (2) firms and workers agree on higher wages which leads to production costs increasing so the short run aggregate supply will shift from SRAS1 to SRAS2 Supply Shock - - (1) oil prices rise so production costs go up so the SRAS shifts from SRAS1 to SRAS2, the price level will rise, real GDP will decrease and is now lower than potential real GDP (this is stagflation) - Stagflation exists when the real GDP is lower than potential real GDP, and unemployment is low while inflation still exists (2) we have high unemployment which leads to workers will accept lower wages which means production costs with go down and shift the SRAS from SRAS2 to SRAS1