Transcript GDP

Welcome to Macroeconomics!
Everyone is concerned about macroeconomics
lately. Why?
Because the state of the
macroeconomy affects everyone in
many ways.
Recently, there is much discussion of
recessions-- periods in which real GDP falls mildly-and depressions, when GDP falls more severely.
Macroeconomists are also concerned with issues
such as inflation, unemployment, monetary and fiscal
policy.
What should we know?
The Data for Macroeconomic
Income and expense
The Real Economy in the Long Run
Growth, saving and investment, financial
system and unemployment
Money and Prices in the Long Run
Monetary system
Macroeconomics of Open Economies
Short-run economics Fluctuations
Part I. Data for Macroeconomics
Income & Expense (Chapter 23 & 24)
Income, Expenditure
And the Circular Flow
There are 2 ways
of viewing GDP
Total income of everyone in the economy
Total expenditure on the economy’s
output of goods and services
Data for Macroeconomics
For an economy as a
whole, income must
equal expenditure
because:
Every transaction has a
buyer and a seller.
Every dollar of spending
by some buyer is a dollar
of income for some seller.
MARKETS
Spending
FOR
GOODS AND SERVICES
•Firms sell
Goods and
Goods
and services •Households buy services
Revenue
sold
FIRMS
•Produce and sell
goods and services
•Hire and use factors
of production
bought
HOUSEHOLDS
•Buy and consume
goods and services
•Own and sell factors
of production
Labor, land,
MARKETS
and capital
FOR
FACTORS OF PRODUCTION
•Households sell Income
Wages, rent,
•Firms buy
and profit
= Flow of inputs
and outputs
= Flow of dollars
Factors of
production
GDP
Gross domestic product (GDP) is a
measure of the income and expenditures
of an economy.
It is the total market value of all final
goods and services produced within a
country in a given period of time.
GDP is the most widely reported measure
of a nation’s economic performance
Y = C + I + G + NX
Total demand
for domestic
output (GDP)
is composed
of
Investment
spending by
businesses and
households
Government
Consumption
spending by purchases of goods
and services
households
Net exports
or net foreign
demand
This is the called the national income accounts identity.
To compute the total value of different goods and services, the
national income accounts use market prices.
Thus, if
$0.50
$0.50
$0.50 $0.50
$1.00
$1.00
$1.00
GDP = (Price of apples  Quantity of apples)
+ (Price of oranges  Quantity of oranges)
= ($0.50  4) + ($1.00  3)
GDP = $5.00
•The value of final goods and services measured at
current prices is called nominal GDP. It can change
over time either because there is a change in the
quantity of goods and services or a change in the prices
of those goods and services.
Hence, nominal GDP Y = P  Q, where P is the price
level and Q is real output
Real GDP is the value of goods and services measured
using a constant set of prices.
Let’s see how real GDP is computed in our apple
and orange economy.
For example, if we wanted to compare output in 2002 and
output in 2003, we would obtain base-year prices, such as
2002 prices.
Real GDP in 2002 would be:
(2002 Price of Apples  2002 Quantity of Apples) +
(2002 Price of Oranges  2002 Quantity of Oranges).
Real GDP in 2003 would be:
(2002 Price of Apples  2003 Quantity of Apples) +
(2002 Price of Oranges  2003 Quantity of Oranges).
Real GDP in 2004 would be:
(2002 Price of Apples  2004 Quantity of Apples) +
(2002 Price of Oranges  2004 Quantity of Oranges).
GDP Deflator = Nominal GDP
Real GDP
Nominal GDP measures the current dollar value of the
output of the economy.
Real GDP measures output valued at constant prices.
The GDP deflator measures the price of output relative
to its price in the base year. It reflects what’s happening
to the overall level of prices in the economy.
Summary of GDP
GDP is a good measure of economic wellbeing because people prefer higher to
lower incomes.
It is not a perfect measure of well-being
because some things, such as leisure time
and a clean environment, aren’t measured
by GDP.
Measuring cost of living
Turning dollar figures into meaningful
measures of purchasing power
Consumer Price Index (CPI) can be used
CPI is used to monitor changes in the cost of
living over time
CPI rises  typical family has to spend more
money to maintain same standard of living
CPI has strong relationship with inflation
The Consumer Price Index (CPI) turns
the prices of many goods and services
into a single index measuring the overall
level of prices.
Let’s see how the CPI would be computed in our
apple and orange economy.
For example, suppose that the typical consumer buys 5 apples
and 2 oranges every month. Then the basket of goods
consists of 5 apples and 2 oranges, and the CPI is:
CPI= ( 5  Current Price of Apples) + (2  Current Price of Oranges)
( 5  2002 Price of Apples) + (2  2002 Price of Oranges)
In this CPI calculation, 2002 is the base year. The index tells
how much it costs to buy 5 apples and 2 oranges in the current
year relative to how much it cost to buy the same basket of
fruit in 2002.
The Inflation Rate
The Inflation Rate
The inflation rate is calculated as follows:
CPI in Year 2 - CPI in Year 1
Inflation Rate in Year 2 =
 100
CPI in Year 1
GDP Deflator VS Consumer Price Index
The GDP deflator reflects the prices of all
goods and services produced
domestically, whereas...
…the consumer price index reflects the
prices of all goods and services bought by
consumers.
GDP Deflator VS Consumer Price Index
The consumer price index compares the
price of a fixed basket of goods and
services to the price of the basket in the
base year (only occasionally does the BLS
change the basket)...
…whereas the GDP deflator compares the
price of currently produced goods and
services to the price of the same goods
and services in the base year.
CPI
The consumer price index is imperfect:
substitution bias
the introduction of new goods
unmeasured changes in quality.
Because of measurement problems, the
CPI overstates annual inflation by about 1
percentage point.
Correcting Economic Variables for
the Effects of Inflation
Price indexes are used to correct for the
effects of inflation when comparing dollar
figures from different times.
Carabao “Made in Thailand” sold about 1.5 million cassettes in
1985. How much did the band earn if we convert into 2003? :
Suppose each cassette the band received 20 baht, thus, 1.5
times 20 = 30 million baht. This can convert to value in 2003 by
= 30,000,000 * (Price level 2003/Price level 1985)
= 30,000,000 * (106.1/54.1)
= 58,835,489 baht
Correcting Economic Variables for the
Effects of Inflation
Indexation
When some dollar amount is automatically
corrected for inflation by law or contract, the
amount is said to be indexed for inflation.
Interest rate
The nominal interest rate is the interest rate
usually reported and not corrected for inflation.
It is the interest rate that a bank pays.
The real interest rate is the nominal interest rate
that is corrected for the effects of inflation.
Part II. Real Economy in the Long Run
Production and Growth
Saving, Investment, and Financial System
Unemployment and its Natural Rate
Production and Growth
Economic growth is determined by
productivity
Productivity refers to the amount of goods
and services that a worker can produce
from each hour of work.
The inputs used to produce goods and
services are called the factors of production.
The factors of production directly determine
productivity.
How Productivity Is Determined
Physical Capital
Human Capital
Natural Resource
Technological Knowledge
ECONOMIC GROWTH AND PUBLIC
POLICY
Government Policies That Raise
Productivity and Living Standards
Encourage saving and investment.
Encourage investment from abroad
Encourage education and training.
Establish secure property rights and maintain
political stability.
Promote free trade.
Promote research and development.
The Importance of Saving and
Investment
One way to raise future productivity is to
invest more current resources in the
production of capital.
Diminishing Returns and the Catch-Up
Effect
As the stock of capital rises, the extra
output produced from an additional unit of
capital falls; this property is called
diminishing returns.
Because of diminishing returns, an
increase in the saving rate leads to higher
growth only for a while.
Diminishing Returns and the Catch-Up
Effect
The catch-up effect refers to the property
whereby countries that start off poor tend
to grow more rapidly than countries that
start off rich.
ECONOMIC GROWTH AND PUBLIC
POLICY
Government Policies That Raise
Productivity and Living Standards
Encourage saving and investment.
Encourage investment from abroad
Encourage education and training.
Establish secure property rights and maintain
political stability.
Promote free trade.
Promote research and development.
Saving and investment are key
ingredients to long-run economic growth
Save large portion of GDP  more resources
are available for investment in capital 
higher capital raises a country’s productivity
and living standard
The Financial System
The financial system consists of the group
of institutions in the economy that help to
match one person’s saving with another
person’s investment.
FINANCIAL INSTITUTIONS
The financial system is made up of
financial institutions that coordinate the
actions of savers and borrowers.
Financial markets are the institutions
through which savers can directly provide
funds to borrowers.
Financial intermediaries are financial
institutions through which savers can
indirectly provide funds to borrowers.
FINANCIAL INSTITUTIONS
Financial Markets
Stock Market
Bond Market
Financial Intermediaries
Banks
Mutual Funds
Financial Markets
The Bond Market
A bond is a certificate of indebtedness that
specifies obligations of the borrower to
IOU
the holder of the bond.
Characteristics of a Bond
Term: The length of time until the bond matures.
Credit Risk: The probability that the borrower will
fail to pay some of the interest or principal.
Tax Treatment: The way in which the tax laws
treat the interest on the bond.
Municipal bonds are federal tax exempted.
Financial Markets
The Stock Market
Stock represents a claim to partial ownership
in a firm and is therefore, a claim to the profits
that the firm makes.
Bond & Stock
Bond
Bond holder is a
creditor of the
corporation
Bondholders get only
the interest on their
bonds.
Stock
Owner of share = part
owner
If company is very
profitable 
stockholders enjoy
benefits of these
profits
Compared to bonds, stocks offer both higher risk and
potentially higher returns.
Financial Intermediaries
Banks
take deposits from people who want to save
and use the deposits to make loans to people
who want to borrow.
pay depositors interest on their deposits and
charge borrowers slightly higher interest on
their loans.
Financial Intermediaries
Mutual Funds
A mutual fund is an institution that sells
shares to the public and uses the proceeds to
buy a portfolio, of various types of stocks,
bonds, or both.
They allow people with small amounts of money to
easily diversify.
SAVING AND INVESTMENT IN THE
NATIONAL INCOME ACCOUNTS
Recall that GDP is both total income in an
economy and total expenditure on the
economy’s output of goods and services:
Y = C + I + G + NX
Some Important Identities
Assume a closed economy – one that
does not engage in international trade:
Y = C + I + G + NX
Y=C+I+G
GDP is the sum of consumption,
investment, and government purchases
Some Important Identities
To find out national saving, subtract C and
G from both sides of the equation:
Y- C - G = C + I + G – C – G
Y – C – G =I
The left side of the equation is the total
income in the economy after paying for
consumption and government purchases
and is called national saving, or just saving
(S).
Some Important Identities
Substituting S for Y - C - G, the equation
can be written as:
S=I
Some Important Identities
National saving, or saving, is equal to:
S=I
S=Y–C–G
T denote the amount of taxes minus the
amount it pays back to households in form
of Social security or welfare
S = (Y – T – C) + (T – G)
Some Important Identities
S = (Y – T – C) + (T – G)
The two T’s in this equation cancel each other
National saving are separated into two parts
Private saving is the amount of income that
households have left after paying their taxes and
paying for their consumption.
Private saving = (Y – T – C)
Public saving is the amount of tax revenue that the
government has left after paying for its spending.
Public saving = (T – G)
The Meaning of Saving and Investment
Surplus and Deficit
If T > G, the government runs a budget
surplus
The surplus of T - G represents public saving.
If G > T, the government runs a budget deficit
THE MARKET FOR LOANABLE FUNDS
Loanable funds refers to all income that
people have chosen to save and lend out,
rather than use for their own consumption.
The market for loanable funds is the
market in which those who want to save
supply funds and those who want to
borrow to invest demand funds.
Supply and Demand for Loanable
Funds
The supply of loanable funds comes from
people who have extra income they want
to save and lend out.
The demand for loanable funds comes
from households and firms that wish to
borrow to make investments.
Supply and Demand for Loanable
Funds
The interest rate is the price of the loan.
It represents the amount that borrowers
pay for loans and the amount that lenders
receive on their saving.
The interest rate in the market for
loanable funds is the real interest rate.
Supply and Demand for Loanable
Funds
Financial markets work much like other
markets in the economy.
The equilibrium of the supply and demand for
loanable funds determines the real interest
rate.
Figure 1 The Market for Loanable Funds
Interest
Rate
Supply
5%
Demand
0
$1,200
Loanable Funds
(in billions of dollars)
Copyright©2004 South-Western
Supply and Demand for Loanable
Funds
Government Policies That Affect Saving
and Investment
Taxes and saving
Taxes and investment
Government budget deficits
Policy 1: Saving Incentives
Taxes on interest income substantially
reduce the future payoff from current
saving and, as a result, reduce the
incentive to save.
Policy 1: Saving Incentives
A tax decrease increases the incentive for
households to save at any given interest
rate.
The supply of loanable funds curve shifts to
the right.
The equilibrium interest rate decreases.
The quantity demanded for loanable funds
increases.
Figure 2 An Increase in the Supply of Loanable Funds
Interest
Rate
Supply, S1
S2
1. Tax incentives for
saving increase the
supply of loanable
funds . . .
5%
4%
2. . . . which
reduces the
equilibrium
interest rate . . .
Demand
0
$1,200
$1,600
Loanable Funds
(in billions of dollars)
3. . . . and raises the equilibrium
quantity of loanable funds.
Copyright©2004 South-Western
Policy 1: Saving Incentives
If a change in tax law encourages greater
saving, the result will be lower interest
rates and greater investment.
Policy 2: Investment Incentives
An investment tax credit increases the
incentive to borrow.
Increases the demand for loanable funds.
Shifts the demand curve to the right.
Results in a higher interest rate and a greater
quantity saved.
Policy 2: Investment Incentives
If a change in tax laws encourages
greater investment, the result will be
higher interest rates and greater saving.
Figure 3 An Increase in the Demand for Loanable Funds
Interest
Rate
Supply
1. An investment
tax credit
increases the
demand for
loanable funds . . .
6%
5%
2. . . . which
raises the
equilibrium
interest rate . . .
0
D2
Demand, D1
$1,200
$1,400
Loanable Funds
(in billions of dollars)
3. . . . and raises the equilibrium
quantity of loanable funds.
Copyright©2004 South-Western
Policy 3: Government Budget Deficits
and Surpluses
When the government spends more than
it receives in tax revenues, the short fall is
called the budget deficit.
The accumulation of past budget deficits
is called the government debt.
Policy 3: Government Budget Deficits
and Surpluses
Government borrowing to finance its
budget deficit reduces the supply of
loanable funds available to finance
investment by households and firms.
This fall in investment is referred to as
crowding out.
The deficit borrowing crowds out private
borrowers who are trying to finance
investments.
Policy 3: Government Budget Deficits
and Surpluses
A budget deficit decreases the supply of
loanable funds.
Shifts the supply curve to the left.
Increases the equilibrium interest rate.
Reduces the equilibrium quantity of loanable
funds.
Figure 4: The Effect of a Government Budget Deficit
Interest
Rate
S2
Supply, S1
1. A budget deficit
decreases the
supply of loanable
funds . . .
6%
5%
2. . . . which
raises the
equilibrium
interest rate . . .
Demand
0
$800
$1,200
Loanable Funds
(in billions of dollars)
3. . . . and reduces the equilibrium
quantity of loanable funds.
Copyright©2004 South-Western
Policy 3: Government Budget Deficits
and Surpluses
When government reduces national
saving by running a deficit, the interest
rate rises and investment falls.
A budget surplus increases the supply of
loanable funds, reduces the interest rate,
and stimulates investment.
IDENTIFYING UNEMPLOYMENT
Categories of Unemployment
The problem of unemployment is usually divided into
two categories.
The long-run problem and the short-run problem:
The natural rate of unemployment
unemployment that does not go away on its own even in the
long run.
It is the amount of unemployment that the economy normally
experiences.
The cyclical rate of unemployment
year-to-year fluctuations in unemployment around its natural
rate.
It is associated with short-term ups and downs of the business
cycle.
Figure 2 Unemployment Rate Since 1960
Percent of
Labor Force
10
Unemployment rate
8
6
Natural rate of
unemployment
4
2
0
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
Copyright©2003 Southwestern/Thomson Learning
IDENTIFYING UNEMPLOYMENT
Describing Unemployment
Three Basic Questions:
How does government measure the economy’s
rate of unemployment?
What problems arise in interpreting the
unemployment data?
How long are the unemployed typically without
work?
How Is Unemployment Measured?
Based on the answers to the survey
questions, the BLS places each adult into
one of three categories:
Employed
Unemployed
Not in the labor force
How Is Unemployment Measured?
Labor Force
The labor force is the total number of
workers, including both the employed and the
unemployed.
Figure 1 The Breakdown of the Population in
2001
Employed
(135.1 million)
Labor Force
(141.8 million)
Adult
Population
(211.9 million)
Unemployed (6.7 million)
Not in labor force
(70.1 million)
Copyright©2003 Southwestern/Thomson Learning
How Is Unemployment Measured?
The unemployment rate is calculated as
the percentage of the labor force that is
unemployed.
Number unemployed
Unemployment rate =
 100
Labor force
How Is Unemployment Measured?
The labor-force participation rate is the
percentage of the adult population that is
in the labor force.
Labor force participation rate
Labor force

 100
Adult population
Why Are There Always Some People
Unemployed?
In an ideal labor market, wages would
adjust to balance the supply and demand
for labor, ensuring that all workers would
be fully employed.
In reality there are always some workers
without jobs, even when the whole
economy is doing well.
Why???
Why Are There Always Some People
Unemployed?
Frictional unemployment 
unemployment that results from the time
that it takes to match workers with jobs.
Job search
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.
Minimum-Wage laws, Unions, Theory of
efficiency wages
1.) JOB SEARCH
Job search
the process by which workers find
appropriate jobs given their tastes and skills.
results from the fact that it takes time for
qualified individuals to be matched with
appropriate jobs.
Public Policy and Job Search
Government programs can affect the time
it takes unemployed workers to find new
jobs.
These programs include the following:
Government-run employment agencies
Public training programs
Unemployment insurance
2.) MINIMUM-WAGE LAWS
When the minimum wage is set above the
level that balances supply and demand, it
creates unemployment.
Figure 4 Unemployment from a Wage Above
the Equilibrium Level
Wage
Labor
supply
Surplus of labor =
Unemployment
Minimum
wage
WE
Labor
demand
0
LD
LE
LS
Quantity of
Labor
Copyright©2003 Southwestern/Thomson Learning
3. ) UNIONS AND COLLECTIVE
BARGAINING
A union is a worker association that
bargains with employers over wages and
working conditions.
The process by which unions and firms
agree on the terms of employment is
called collective bargaining.
4.) THE THEORY OF EFFICIENCY
WAGES
Efficiency wages are above-equilibrium
wages paid by firms in order to increase
worker productivity.
The theory of efficiency wages states that
firms operate more efficiently if wages are
above the equilibrium level.
Wages above the equilibrium
Minimum-wage laws
and unions
Prevent firms from
lowering wages in the
presence of a surplus
of workers
Efficiency-wage
theory
Firms prefer to keep
wages above the
equilibrium level
Unemployment is the result of wages above the level
that balances the quantity of labor supplied and the
quantity of labor demanded.