eco 509 pp2 gdp and components revised
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Accounting for the economy Economists must have a system of
accounts that summarize economic
activity across the economy This data base is called The National
Income and Product Accounts
Issued quarterly, though the data areannualized
Sitting atop the NIPA is Gross DomesticProduct
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Gross Domestic Product is our broadest
measure of production
GDP: the dollar market value of all finalgoods, services and structures produced
by labor and property located in theUnited States in one year
Note that GDP is a flow concept, as areall parts of the NIPAs because we aremeasuring activity over time; in thiscase one year (or in some cases, onequarter)
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Key observations about the
nature of GDP GDP is measured in dollars, or dinars, or
euros, not physical units of weight or size
GDP is limited to market activities, and toprices as actually paid in the market
We must avoid double counting production,so we limit GDP to final goods and services
Most Important: GDP is a measure of currentproduction
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GDP can be computed three ways The sum of all expenditures in the economy:
consumption, investment, government, net
exports The sum of income payments and costs
incurred in production in the economy:purchasing power of households and the
financial status of businesses The sum of gross value added (gross output
less intermediate purchases) across all privateindustries and government
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Reporting of GDP The expenditures approach is most reliable,
and is used by most all analysts worldwide
GDP is computed and reported by theDepartment of Commerce, Bureau ofEconomic Analysis (www.bea.gov)
In Bahrain it is done by the CentralInformatics Organization(http://www.cio.gov.bh/cio_eng/SubDetailed.aspx?subcatid=233 )
http://www.bea.gov/http://www.cio.gov.bh/cio_eng/SubDetailed.aspx?subcatid=233http://www.cio.gov.bh/cio_eng/SubDetailed.aspx?subcatid=233http://www.cio.gov.bh/cio_eng/SubDetailed.aspx?subcatid=233http://www.cio.gov.bh/cio_eng/SubDetailed.aspx?subcatid=233http://www.bea.gov/ -
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Three ways to report GDP Reporting styles vary across countries, and can lead
to confusion if you are not careful
1.
Growth from one quarter to the next, called quarterover quarter (Q/Q)
2. Growth over the past 12 months, comparing GDP in2009Q2 to 2008Q2, called year over year (Y/Y)
3.
Seasonally adjusted annual rate (s.a.a.r.),annualizes quarter over quarter data by assuminggrowth continues for one year at the Q/Q rate; USdata reported as s.a.a.r.
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How s.a.a.r works GDP is computed in one quarter, and then
compared to GDP the quarter before,
resulting in a rate of change This Q/Q rate is then annualized essentially
by multiplying Q/Q rate by 4
So, if the change from Q1 to Q2 is 1.0%,then the s.a.a.r. is roughly 4.0%, which is thenumber that will be reported by the BEA
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Adjusting GDP for changes in
prices GDP is computed first using current prices
and quantities, called current dollar GDP (e.g.$14.867 trillion current dollars in 2011Q1)
Cannot compare current dollar GDP from yearto year due to possible changes in the valueof the dollar within the country (inflation ordeflation)
GDP adjusted for changes in prices is calledreal GDP (e.g. $13.227 trillion chained 2005dollars in 2011Q1)
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Adjusting GDP results in an overall
measure of inflation Price changes are removed using a
price index; a different index is used for
each category of good because inflationrates vary by sector
The overall index for inflation economy-wide is called the chain-weighted index
Once price effects are removed we cancompare values for RGDP over time
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What is a good number for
GDP growth? To decide if GDP is growing as it should
we must establish some standard
Can use history as a standard: theaverage reported growth rate of GDPover several decades can serve as abenchmark (3.32% per year since 1946for US, 5.4% for Bahrain since 1989)
Or we can establish some measure ofpotential (not computed by BEA)
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Potential GDP is our best
benchmark for assessing growth Potential GDP is the sum of labor force
growth, productivity growth, and the
change in the number of hours worked Potential GDP is different for every
country, and for the same country at
different times because thedeterminants of potential change overtime
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The Growth Cycle The Growth Cycle, defined as fluctuations in
the rate of growth of RGDP around its long-
run trend growth rate
The gap between actual growth and potentialgrowth can tells us much about production,and it can be a signal about other facets ofthe economy
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Setting the Growth Cycle
benchmark The Growth Cycle is segmented by how
actual RGDP growth compares to the
benchmark growth rate The preferred benchmark is potential
RGDP
Many economists put potential currentlyat 2.25 - 2.5%, with labor growing alittle less than 1% and productivitygrowing around 1.25-1.5%
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The Growth Cycle graph
0
Growth Rateof Real GDP
Time
Potential GDP
Growth Expansion:
Actual Growth > Potential
Growth Recession:0 < Actual Growth < Potential
Recession:Actual Growth < 0
Potential Growth:Growth of Productivity
+Growth of Labor Force
+
Change in Hours Worked
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A three-part interpretation When assessing the implications of a single
observation we must evaluate three facets:
Where exactly are we, above or belowpotential?
Where have we been over the past four to sixquarters?
What are the values of other importantvariables such as unemployment andinflation?
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Segments of the Growth Cycle:
growth expansion The area on the Growth Cycle graph where
actual growth is greater than potential
Can involve a rise in inflationary pressures, afall in unemployment, and often a rise ininterest rates
Interest rates will not be raised in a growthexpansion directly after a recession, whenunemployment is still well above its naturalrate
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Segments of the Growth Cycle:
growth recession Involves a weak but growing economy where
actual growth is lower than potential, but
greater than zero Growth is too slow to create enough new jobs
to accommodate new labor-market entrants,so unemployment usually rises
Usually inflationary pressures fall, as willinterest rates if the Fed fears a recession willsoon follow
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Segments of the Growth Cycle:
recession The area of the Growth Cycle graph
where the growth rate of RGDP falls
below zero (Note: RGDP in dollar termsis falling as well)
Results in falling inflationary pressures,rising unemployment, and a fall ininterest rates as the Fed attempts tostimulate spending
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Coming in for a landing The Fed responds to a prolonged growth expansion
by raising interest rates to stave off inflation, butwhere do we end up when the economy ultimately
slows?
A soft landing occurs when we achieve our goal,which is actual growth equal to potential
A hard landing occurs when we end up in a growth
recession
A crash landing occurs when the result is a recession
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The components of GDP: why
they matter Provides information on what parts of
the economy are weak or strong; can
guide analysts and policy makers Comparing actual GDP to the sum of
planned spending by the four
components allows us to determine thefuture direction of the economy
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The concept of equilibrium In macroeconomics, equilibrium exists
when the planned spending of all
economic agents (households, firms,government, and foreigners) match theactual output of the economy, RGDP
Requires we specify what constitutesplanned spending, and then compare itto actual RGDP
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Why equilibrium matters Equilibrium is the only level of RGDP (Y) that
can exist with no tendency for change
Levels ofY that are not equilibriums will notlast, and actual Y will drift towards a stableequilibrium level, which we called Ye
In short, once Ye
is known and compared toactual Y, we can forecast the next move in Y
Plans reality always results in change
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Equilibrium condition specified If equilibrium means reality equals planned
spending, then we must define both
Reality will be measured by RGDP, Y Plans will be measured by aggregate planned
expenditures of all four agents:
AEp = C + I + G + NXSo, equilibrium will require that
Y = AEp = C + I +G + NX
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Violation of the equilibrium
condition How will we know if plans and reality do not match?
Lets call this error unplanned investment, Iu
It shows up in unwanted accumulation ofinventories:
1. If(Y- AEp)>0, then spending was less than firmsexpected and produced for, and inventories rise;Iu>0
2. If(Y- AEp)
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The components of GDP:
Consumption Consumption is spending done by households
on goods and services
Officially called Personal ConsumptionExpenditures
Comprised of: services, non-durables, anddurables (lasting 3 years or more)
Services and non-durables are stable Spending on durables can be highly unstable,
and is of utmost importance to analysts
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Modeling consumption Households receive income, and two things
are done with the money: some is spent, andsome is saved: y = C + S
The amount spent is called Consumption, andit is a positive function ofy:
C= f (y) ; dC/dy > 0
Then we can run the function in a linearform, and the consumption function is:
C = a + by
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Components of the
consumption function The component arepresents the amount of
spending dependent on factors other than
income It is called autonomous consumption, which is
spending independent of income
The bis the slope of the consumption function,and is equal to dC/dy; the name ofbis themarginal propensity to consume, or MPC
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The consumption function
C = a + by
C = y
a
C
y0
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Income not spent is called saving Since y = C+S, and C = a + by, then
the saving function is
S = -a + (1-b)y The (1-b)is the marginal propensity to
save
Saving is found graphically as thevertical gap between the consumptionfunction and the C=yline
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Finding saving
C = a + by
C = y
a
C
y0
y2 y0 y1
S < 0
S > 0
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Saving on the graphAt any given y, ifC>y, then the
household is drawing funds from its
savings accounts to spend more than itmakes - called dissaving
At any given y, ifC
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The components of GDP:
Investment Consists of spending done by firms on final
goods Officially known as Gross Private Domestic
Investment Divided into three components: residential
construction, non-residential construction,and changes in inventory
All three components can be unstable,especially inventories, thus investment iswatched by analysts constantly
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The plans of firms: investment Investment divided into two parts: planned
and unplanned
Planned Investment is spending by firms, andit depends on the cost of funds and theprofitability of the capital; at any point in timeit is independent of income but dependent on
interest rates Unplanned are unwanted additions to
inventories
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Where does the money for
investment come from? Saving involves households setting
aside for the future, foregoing
spending now so that they may spendin the future
Investment is exactly the samebehavior, just done by firms
For investment to occur, householdsmust save, and I = S
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The components of GDP:
Government Involves government purchase of goods
and services only, not all government
expenditures Excludes transfer payments because
they do not involve current production
Has a stabilizing effect on the economydue to size and constancy over time
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The plans of the government
sector Government spending depends on a budget,
and at any one time it is a fixed amount,
independent of GDP, which we will call G Need taxes to pay for the G, and the most
simple way is to pay a lump sum, which willcan call T; All taxes will be paid by the
households, so now we have a newconsumption function:
C = a + b (y-T)
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Deficits and the debt A fiscal deficit occurs when, in one fiscal year,
a government spends more in total (including
transfer payments) than it receives in taxrevenue
If total spending is less than total taxrevenues, then the government has a fiscal
surplus The running total of unpaid deficits is called
the national debt
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The components of GDP: Net
Exports Calculated as dollar value of exports minus
dollar value of imports
NX can be either positive (a trade surplus) ornegative (a trade deficit)
Is a relatively small net number in total GDPin most countries, so it has not historically
been the source of business cycles or inflation
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The foreign sector is part of
total spending plans We cannot ignore this sector because
several sectors of the economy are
absolutely dependent on the foreignproducers and buyers, e.g. automobiles,electronics, machinery, apparel
Generally speaking, imports arecorrelated with the growth rate of GDP:when GDP growth rises, imports rise
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