economics 200 basic economic issueschrystie/econ200/lecture 8.pdf•inflation can distort economic...

ECONOMICS 200

BASIC ECONOMIC ISSUES

January 3, 2011

What is Macroeconomics?

• Provides a top-down view of the economy

• Four main goals include:

▫ Economic Growth

▫ Low unemployment

▫ Low inflation

▫ Sustainable trade deficit

What is Macroeconomics?

• It is not just a bigger version of microeconomics.

• Microeconomics discuss what happens in the individual markets but not about overall problem of the economy.

• Individual’s rational behavior in a group sometimes leads to unexpected outcome at the macroeconomic level.

Gross Domestic Product

• Gross domestic product (GDP) is the standard measure for the size of nation’s macroeconomy.

• Definition: GDP is the total value of final goods and services produced in a year.

http://earth.google.com/kmlpreview/

How to Measure GDP?

• Measure by

1) value of what is produced▫ Durable goods

▫ Nondurable goods

▫ Services

▫ Structures

2) value of what is demanded▫ Consumption

▫ Investment

▫ Trade

Value of Produced = Value of Demanded

Spending

Goods and

services

bought

Revenue

Goods

and services

sold

Labor

Income

= Flow of inputs

and outputs= Flow of dollars

Wages, rent,

and profit

FIRMS

•Produce and sell

goods and services

•Hire and use factors

of production

•Buy and consume

goods and services

•Own and sell factors

of production

HOUSEHOLDS

•Households sell

•Firms buy

MARKETS

FOR

•Firms sell

•Households buy

MARKETS

FOR

GOODS AND SERVICES

Labor

Labor

GDP Measure by Total Production

In trillions of dollars Share of total GDP

Durable goods $1.7 trillion 14.5%

Nondurable goods $2.1 trillion 17.9%

Services $6.7 trillion 57.3%

Structures $1.2 trillion 10.3%

TOTAL GDP $11.7 trillion 100%

Source: U.S. Bureau of Economic Analysis

Measured GDP by What is Produced (2004 data)

GDP Measure by Total Demand

In trillions of dollars Share of total GDP

Consumption (C) $8.2 trillion 70.1%

Investment (I) $1.9 trillion 16.2%

Government (G) $2.2 trillion 18.8%

Export (X) $1.2 trillion 10.2%

Import (M) $1.8 trillion 15.4%

TOTAL GDP $11.7 trillion 100%

Source: U.S. Bureau of Economic Analysis

Measured GDP by What is demanded (2004 data)

GDP Composition by Total Demand

Consumption, 70.10%

Investment, 16.20%

Government, 18.80%

Export, 10.20%

Import, 15.40%

Measuring GDP

• GDP = C + I + G + X – M

• Who measures it?

▫ Bureau of Economic Analysis (BEA)

Components of Gross Domestic Product

• Consumption: Spending by households on goods and services with the exception of purchases of new housing.

• Investment: Spending on capital equipment, inventories, and structures, including household purchases of new housing.

Components of Gross Domestic Product

• Government Purchases: Spending by local, state, and federal governments.

▫ Salaries

▫ Public works

▫ Not including transfer payments: payments not in exchange for a currently produced good or service.

• Net Exports: Equals foreign purchases of domestically produced goods (exports) minus the domestic purchases of foreign goods (imports).

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.

B. Sarah spends $1800 on a new laptop to use in her publishing business. The laptop was built in China.

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.

D. General Motors builds $500 million worth of cars, but consumers only buy $470 million of them.

Per Capita GDP

• It is a simple, rough way of comparing standards of living across times and places.

• China: GDP- 5 trillion (2009), PCGDP- $4,283

• Belgium: GDP – 0.5 trillion, PCGDP- $43,430

Population

GDP

2010 Per Capita GDP

Nominal vs. Real 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.

• Real GDP is a measure of the economy’s production of goods and services.

Example of Nominal vs. Real GDP

Pizza Latte

year P Q P Q

2007 $10 400 $2.00 1000

2008 $11 500 $2.50 1100

2009 $12 600 $3.00 1200

Compute nominal GDP in each year:

2007:

2008:

2009:

Increase:


Pizza Latte

year P Q P Q

2007 $10 400 $2.00 1000

2008 $11 500 $2.50 1100

2009 $12 600 $3.00 1200

Compute real GDP in each year, using 2007 as the base year

2007:

2008:

2009

Increase:

$10 $2.00


year

Nominal

GDP

Real

GDP

2007

2008

2009

In each year,

• nominal GDP is measured using the (then) current prices.

• real GDP is measured using constant prices from the base year (2007 in this example).

Nominal and Real GDP in the U.S.

bil

lio

ns

Limits with GDP

• Things that is not bought and sold

▫ Health

▫ Environment

▫ Crime

▫ Home production

▫ Leisure

• Change of ownership

▫ Stock

▫ Used cars

Is GDP an Important Tool?

• Does matter

• Long term upward trend

• GDP in ‘07 ~4x GDP in ‘64

• Recessions (2 consecutive quarters of falling GDP)

0

2000

4000

6000

8000

10000

12000

14000

192

9

193

2

193

5

193

8

194

1

194

4

194

7

195

0

195

3

195

6

195

9

196

2

196

5

196

8

197

1

197

4

197

7

198

0

198

3

198

6

198

9

199

2

199

5

199

8

20

01

20

04

20

07

bil

lio

ns

of

Do

lla

r (

20

05

)

Real Gross Domestic Product

GDP Growth 1923 - 2009

GDP and Life Expectancy in 12 countries

GDP and Internet Usage in 12 countries

GDP and Living Standards

A typical family with all their possessions in the U.K., an advanced economy

GDP per capita: $35,580


A typical family with all their possessions in Mexico, a middle income country



A typical family with all their possessions in Mali, a poor country


Unit 20: Economic Growth

• Question:

Would you prefer to be a rich person in 1925,with access only to the technologies and lifestyleavailable in 1925, or to be a person with anaverage standard of living today, with access toall the modern technologies?

20101925

Economic Growth

• Definition: The increase of per capita gross domestic product or other measure of aggregate income. It is often measured as the rate of change in real GDP

Economic Growth

• The economic growth compounds over time, small differences in annual growth rate work out to enormous difference over a generation or two.

• PV(1+g)t =FV

PV: present value of the economy

g: percentage growth rate

t: number of years the growth occurs

FV: future size of the economy

Example of Compounded Growth

• GDP starts at 100

• Given growth rate g and time t, the future size of the economy F can be calculated as:

100(1+g)t=F

Annual growth rateof per capita GDP

10years

25years

40years

1% 110 128 149

3% 134 209 326

5% 163 339 704

8% 216 685 2172

Implication of Compounded Growth

Rate• Countries that start out at lower levels of

productivity may be able to take advantage of a period of catch-up growth.

• Catch-up effect: the property whereby countries that start off poor tend to grow more rapidly than countries that start off rich.

The Variety of Growth ExperiencesGDP per capita, 2005

Growth rate, 1960-2005

China $6,572 5.8%Singapore 29,921 5.4%Japan 30,821 3.8%Spain 26,125 3.2%India 3,486 2.7%Israel 25,670 2.7%United States 41,854 2.2%Canada 32,886 2.1%Colombia 7,769 1.8%New Zealand 22,511 1.4%Philippines 4,920 1.4%Argentina 14,421 1.0%Saudi Arabia 14,729 0.8%Rwanda 1,333 0.3%Haiti 1,836 –1.2%

The Variety of Growth Experiences

-15.00

-10.00

-5.00

0.00

5.00

10.00

15.00

20.00

25.00

197

0

197

2

197

4

197

6

197

8

198

0

198

2

198

4

198

6

198

8

199

0

199

2

199

4

199

6

199

8

20

00

20

02

20

04

20

06

20

08

20

10

United States

-15.00

-10.00

-5.00

0.00

5.00

10.00

15.00

20.00

25.00

197

0

197

2

197

4

197

6

197

8

198

0

198

2

198

4

198

6

198

8

199

0

199

2

199

4

199

6

199

8

20

00

20

02

20

04

20

06

20

08

20

10

China

-15.00

-10.00

-5.00

0.00

5.00

10.00

15.00

20.00

25.00

197

0

197

2

197

4

197

6

197

8

198

0

198

2

198

4

198

6

198

8

199

0

199

2

199

4

199

6

199

8

20

00

20

02

20

04

20

06

20

08

20

10

Saudi Arabia

-15.00

-10.00

-5.00

0.00

5.00

10.00

15.00

20.00

25.00

197

0

197

2

197

4

197

6

197

8

198

0

198

2

198

4

198

6

198

8

199

0

199

2

199

4

199

6

199

8

20

00

20

02

20

04

20

06

20

08

20

10

India

Differences in Growth Rate

Since growth rates vary, the country rankings can change over time:

▫ Poor countries are not necessarily doomed to

poverty forever – e.g., Singapore, incomes were

low in 1960 and are higher than U.S. now (‘09).

▫ Rich countries can’t take their status for

granted: They may be overtaken by poorer but

faster-growing countries.

Difference in Growth Rate

• If the nation falls far behind in per capita GDP, it can take many decades to catch up.

• In the long run, internally generated growth is by far the single most important factor in a nation’s standard of living, far outstripping the impact of redistribution from those with high incomes to those with low incomes.

Example of Catching-up Growth

Question in Growth Rate Variation

• Why are some countries richer than others?

• Why do some countries grow quickly while others seem stuck in a poverty trap?

• What policies may help raise growth rates and long-run living standards?

Sources of Economic Growth

• Productivity

▫ Measured as the amount of goods and services a worker produces in each hour of work.

• Determinant of productivity

▫ Physical capital

▫ Human capital

▫ Natural resources

▫ Technology

Why is Productivity Important?

• When a nation’s workers are very productive, real GDP is large and incomes are high.

• When productivity grows rapidly, so do living standards.

• What, then, determines productivity and its growth rate?

Factors of Productivity

• Physical capital

▫ Any manufacturing assets such as equipment and structures that are used to produce goods and services.

• Examples:

▫ Tools

▫ Machinery

▫ Building


• Human capital

▫ The knowledge, competence, personal attributes that workers acquire through education, training and experience.

• Example:

▫ Human capital flight (brain drain)- large-scale emigration of individuals with technical skills or knowledge. Thus increased in human capital in the rich country.


• Natural resources

▫ The inputs into the production of goods and services that are provided by nature.

• Examples:

▫ Land

▫ River

▫ Mineral deposits


• Technology

▫ Includes all methods of reorganizing and changing production, as well as new ways of applying scientific discoveries to production

Example of Productivity: U.S.

Public Policy to Encourage Growth

• Saving and Investment

• Education

• Health and Nutrition

• Property Rights

• Political Stability

• Free Trade

• Research and Development

Summary of Economic Growth

• How much economic growth differs around the world.

• Productivity is the key determinant of a country’s standard of living.

• The factors that determine a country’s productivity.

• How a country’s policies influence its productivity growth

Unit 21: Unemployment

• What is unemployment?

▫ Persons are classified as unemployed if they do not have a job, have actively looked for work in the prior 4 weeks, and are currently available for work.

Current Population Survey

• Official unemployment rate is based on a government survey.

• Employed:▫ Full-time and part-time workers, business owners,

unpaid job in a family business

• Unemployed:▫ Not employee, available for work and tried to find

employment during the previous 4 weeks

• Out of labor force:▫ Don’t’ have to work and not looking for work

Definition of Labor Force

• People 16 years old or older who are employee or actively looking for work.

Labor force = Number of employed + Number of unemployed

Calculating Unemployment Rate

• Unemployment rate is the percentage of labor force that is unemployed.

Unemployment rate =Number unemployed

Labor force100

Breakdown of Population in 2009

Calculating the Labor-force

Participation rate• The labor-force participation rate measures the

percentage of the total adult population that is in the labor force:

Labor force participation rate

Labor force

Adult population 100

U.S. Labor-force Participation Rate

Why is unemployment bad?

• A question only an economist can ask.

• Unemployment harms the individuals who are unemployed.

• Unemployment also reduces the size of the economy.

▫ Economy loses potential output of the unemployed workers.

▫ Increases government spending on welfare and social services.

Why is there Unemployment?

• At equilibrium, quantity supplied equals quantity demanded.

• The only way that someone can be willing to supply labor at the market wage but not find a willing employer is if the wage stuck above the equilibrium level.

Why is there Unemployment?

• Why is the wage stuck above the equilibrium level?

▫ Minimum wage

▫ Explicit or implicit labor contract

▫ Labor union

▫ Efficiency wage

Above-equilibrium wages paid by firms in order to increase worker productivity.

Categories of Unemployment

• Unemployment can be divided into two broad categories

▫ The natural rate of unemployment

▫ Cyclical unemployment

Natural Rate of Unemployment

• Definition: The level of unemployment generated by the institutional structure in an economy that encourage hiring and firing and affect the incentive to work.

• Example:

▫ Rules preventing businesses from forming or expanding in certain areas

▫ Tax on employment

▫ Rules prohibiting layoffs

▫ Generous welfare or unemployment benefit

Factors of Natural Rate of Unemployment

• Frictional Unemployment:

▫ Unemployment that results because it takes time for workers to search for the jobs that best suit their tastes and skills.

• Structural Unemployment:

▫ Unemployment that results because the number of jobs available in some labor markets is insufficient to provide a job for everyone who wants one.

Policy Implication for Natural Rate of

Unemployment• Frictional Unemployment

▫ Government-run employment agencies give out information on job vacancies

▫ Public training programs to ease the transition of workers from declining to growing industries

• Both

▫ Think of ways to provide the desired social protections but to retain incentive to work and hire.

Cyclical Unemployment

• Results from recessions when many businesses all at once don’t see enough demand for their services to justify hiring.

Policy Implication

• Cyclical unemployment:

▫ Pump up demand with temporary spending in creases or tax cuts or with reductions in interest rates.

U.S. Unemployment Rate Trend

Natural rate of

unemployment

Unemployment rate

Unemployment Rate in Selected

Countries

Comparison of the Unemployment

Rates• Since 1980s, U.S. had relatively low

unemployment compared to Europe but also relatively low wage growth. (Tradeoff!)

• Greater supply of labor (low unemployment) leads to a lower price (lower wages).

• Wages are based on productivity of workers. Best long term policy for high wages is to improve productivity.

Unemployment Rate by Education

Attainment

U.S. Unemployment Rate (2008) by

County

economics 200 basic economic issueschrystie/econ200/lecture 8.pdf•inflation can distort economic...

Documents