Topic 2: MacroeconomicsGDPUnemploymentInflation

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Gross Domestic Product (GDP)Gross Domestic Product (GDP) is the value of all

goods and services produced in an economy during a given period of time. i.e., what is earned by people working in the US.

Gross National Product (GNP) is the value of all goods and services produced by a country’s citizens during a given period of time. i.e., what Americans earn supplying labor in the US and elsewhere.

Gross means it doesn’t account for wearing out (e.g., how many cars die each year?). Net accounts for wearing out.

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What we care about, what we observe

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Most policy makers are more concerned with National Income (Y) or NDP, rather than GDP

GDP is easier to measure

We will refer to any these items as “output”, and treat them as approximate equals

Guidelines for calculating GDP

1. It must go through the market place. Otherwise, ignore it. e.g., the neighborhood babysitter.

2. Should involve the 3 factors of production that year. Ignore payments towards future production, or things produced last year.

3. Don’t include transfers in ownership without production, or pure paper money transfers. i.e., buying stock doesn’t county, unless there are broker fees. Buying a used car from my brother doesn’t count either.

4. Nothing illegal. Limo driver or mafia wheel man?

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Ways to measure GDPOption 1: Count only final sales. (If all

transactions happen in the same year.)

Option 2: Count value added (sales - inputs).

VA = final sales - intermediate goodsGDP = ΣVA

DON’T double count. Avoid counting Value Added and Final Sales.

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GDP ExampleIn an economy, there are three producers:

a grape farm, a winery, and a liquor store. All production goes towards the production of wine.

Buys input at

Sells output at

VA

Vineyard 0 $75k

Winery $75k $200k

Liquor store

$200k $300k

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GDP ExampleIn an economy, there are three producers:

a grape farm, a winery, and a liquor store. All production goes towards the production of wine.

Buys input at

Sells output at

VA

Vineyard 0 $75k

Winery $75k $200k

Liquor store

$200k $300k

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GDP Example

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If a thief steals $10k in wine from the liquor store…

If the store owner drinks $10k in wine himself…

If the vineyard produced the grapes and sold them to the winery in 2007, but the winery and liquor store didn’t do anything themselves until 2008…

If the liquor store only sells $150k worth of wine in 2007, then sells the other $150k worth of wine in 2008…

Liquor Store Value Added

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The liquor store bought inputs for $200K, sold outputs for $300K, and added value of $100K.

What did the liquor store produce?

Is value added equal to profit?

GDP in the long-run

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Graphing economic growthWhy do we care about the downturns and

upswings?

Two main macroeconomic dangers?

Economic Growth

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Economic Growth = Sustained rise in real GDP per capita

Causes:Increased workforce participationIncrease output per worker hour

Better quality (education & skills) of the work forceMore capital Better capital (improved technology)Declining share in agriculture (can work year round)

Economic Growth

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Representing economic growth on the PPF

Graph: GDP per capital over time

Unemployment

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Who’s considered unemployed? Ask three questions:

Unemployment

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The labor market in a recession Demand for workers decreases Wages are slow to respond (“Sticky” wages)

Why might wages be sticky?

3 types of unemployment

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1. Structural – comes from the rigidity of the labor market

2. Frictional – the natural flow of people between jobs or careers, or transition into the workforce

3. Cyclical – unemployment resulting from economic downturns

Natural Rate of Unemployment = Structural + Frictional

Types of unemployment

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A mother returns to work after raising her children?

Graduate from college and must find a job?

Unemployment caused by a minimum wage law?

Unemployment resulting from lack of information about available jobs? (i.e., bad matching)

You move to NYC then start looking for a job?

Types of unemployment

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Real estate brokerage lays off some of its agents?

A steel plant lays off some of its works after the government eliminates steel tariffs

GM lays off workers due to poor economic conditions?

GM lays off workers due to changing production technology?

Inflation

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Inflation = “An increase in the overall price level”

Usually measured by the consumer price index (CPI)

CPI = A price index computed each month by the Bureau of Labor Statistics using a pre-defined “market basket” purchased monthly by the typical urban consumer.

CPI Example – 3 good basket

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Good CPI Amount

Price 1998

Price 1999

Expend. 1998

Expend. 1999

Gasoline

100 gal $1.40/gal $1.60/gal

Bread 150 loaves

$1.30/loaf

$1.20/loaf

Milk 300 quarts

$0.75/qrt $0.77/qrt

Total:Inflation between 1998 and 1999 =

“Price of basket in 1999” / “Price of basket in 1998”

CPI Example – 3 good basket

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Good CPI Amount

Price 1998

Price 1999

Expend. 1998

Expend. 1999

Gasoline

100 gal $1.40/gal $1.60/gal

Bread 150 loaves

$1.30/loaf

$1.20/loaf

Milk 300 quarts

$0.75/qrt $0.77/qrt

Total:Inflation between 1998 and 1999 =

“Price of basket in 1999” / “Price of basket in 1998” - 1

CPI Example – 3 good basket

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Good CPI Amount

Price 1998

Price 1999

Expend. 1998

Expend. 1999

Gasoline

100 gal $1.40/gal $1.60/gal

Bread 150 loaves

$1.30/loaf

$1.20/loaf

Milk 300 quarts

$0.75/qrt $0.77/qrt

Total:If 1998 is the “base year” for the CPI (i.e., the CPI in 1998 = 100), then what is the CPI for 1999?

CPI Example – 3 good basket

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Good CPI Amount

Price 1998

Price 1999

Expend. 1998

Expend. 1999

Gasoline

100 gal $1.40/gal $1.60/gal

Bread 150 loaves

$1.30/loaf

$1.20/loaf

Milk 300 quarts

$0.75/qrt $0.77/qrt

Total:If 1998 is the “base year” for the CPI (i.e., the CPI in 1998 = 100), then what is the CPI for 1999?

CPI = “current year price” / “base year price” x 100 =______

CPI Example 2

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Suppose thatThe CPI in 1980 equals 82.4The CPI in 1990 equals 130.7Inflation between 1990 and 2000 was

31.75%

Questions:What was inflation between 1980 and 1990?What is the CPI in 2000?What was inflation between 1980 and 2000?

Inflation

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Types of Inflation:Demand-Pull Inflation (increase in demand

drives up prices)Cost-Pull Inflation (wage price spiral)Supply-shocks (oil price driven)

Why does it matter?