Transcript Measurement of Output, Employment & Prices

A Review of the Basics
1
Learning Objectives
1. Understand the concept of the National
Income Identities
2. Understand the definition of Unemployment
3. Understand the definition of a price index
4. Understand the concept of Economic
equilibrium and how it is influenced by
expectations
2
1. NIE Identities
• Review GDP defn in Mankiw 2.1
• Before we get into models of economic
behaviour we need to look some definitions
and some issues in measurement
• Measurement economic quantities may seem
boring…
– But it can give crucial insight even without a
model of behaviour
– Example: the current crisis
3
NIE Identity
• We measure macroeconomic activity primarily by looking at annual
(or quarterly) flows of Output (O), Income (Y) and Expenditure (E).
• These are different ways of measuring the same thing, so they sum to
identical totals
– Basic Identity:
YO E
• Think of why this is the case
– Income and Product are identical: Product is Value-Added in Production, i.e sales
minus purchases from other firms, which = payment of incomes to Factors (Wages,
Interest…)
– Expenditure equals Income, because any production not sold is counted as
Inventory Investment, and is thus part of Expenditure (the firm purchases its own
output from itself)
• Note this is an identity not an equilibrium condition
– An identity holds for all values
– An eqm condition holds only for some values i.e. in eqm
– Distinction important later
4
NIE: GDP vs GNP
• Open economy: GNP v GDP
– GNP  GDP + NFIA
– (NFIA is net factor inc from R.O.W., i.e. inflows minus
outflows)
– GNY  GNP + EUtrasfers – EUtaxes
– GNDY  GNP + NTA (NTA is all net Transfers from R.O.W. incl
EU)
– GDP + NFIA + NTA  GNDY
– Note: Irish GNP was approx 85% of GDP (2007)
– For many other countries the distinction is not relevant
– Can lead to lots of debate of which is best measure in
Ireland
5
NIE: SAVINGS & INVESTMENT IDENTITY
• The Income Identity
– YC+S+T
– Accounting rule: Income is either spent, saved or taxed
• The Expenditure Identity
– E= C + I + G + NX
– Accounting rule: add up the components of expenditure
• Combine the two
– C + I + G + NX  C + S + T
• Thus:
– or:
(G – T)  (S – I) – NX
(G – T) + NX  (S – I) etc.
• clearly, adding in net foreign factor and transfer income, including them in
the totals for T and S etc as appropriate, and changing signs we get:
• (T - G) + (S - I)  NX  BOP Current A/C
• Note: the 2 left hand expressions are National Savings
6
NIE: SAVINGS & INVESTMENT IDENTITY
• This is often known as the twin deficits identity
• Even though it doesn’t involve any model or description of economic
behaviour it can be informative
• Implication: a current account surplus can only occur if there is an excess
of national savings
• Application 1: The US
– The US has trade deficit (esp with China)
– This is inescapable given it has insufficient savings
– China surplus equates to surplus Chinese savings
• Application 2: Ireland’s Bubble
– We had a bubble (high investment)
– Insufficient savings
– So high current account deficit
7
Savings
35.00%
30.00%
Personal
25.00%
Corporate
Gov
20.00%
Inv
CA
15.00%
10.00%
5.00%
0.00%
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
-5.00%
-10.00%
8
2. Unemployment
•
•
•
•
•
•
See Mankiw 2.3
The labour force (L) = employed (E) + unemployed (U)
The unemployment rate u% = U/L or U/(E + U)
Letting the population of Labour-force Age = P, we also have:
The Labour force participation rate: LFPR% = L/P
Measuring Employment and Unemployment
– Surveys: household QNHS in Ireland, quarterly household survey (CPS
in USA); business surveys for employment.
– Administrative: “Live Register” (Ireland); related to benefit claimants
9
Unemployment
• The precise details of how surveys and other measures are
constructed will differ from country to country. Survey
methods are generally more comparable.
• Key Issue: have to “want” to work to be unemployed as
distinct from not working
• Surveys try to capture this: “active search”
– Issue of how active
– Discouraged worker effects
• There is a difference between what economists’ defn of U and
rest of society
• Claimant counts do not – may include people NILF
10
3. Prices
• Mankiw 2.2
• Some components of GDP have well-known measures of
inflation: the CPI for household consumption
• For a more comprehensive measure the implicit price deflator
for GDP is used: this relates to all items in the GDP
• A price index is a weighted average measure of price changes
• Two questions arise: (i) what is included (ii) what kind of
weighting system to use
– For Consumption the Irish CPI includes a measure of housing costs, the
Eurozone HIPC does not (why?)
• Generally if an index uses base-year weights (Laspeyre), the
resulting inflation is higher than if current year weights are
used (Paasche)
– CPI is Laspeyre
11
Laspeyre vs Pasche
• A Laspeyre index of prices uses the quantities prevailing in some base (e.g.
survey) year to weight prices. The index takes the form:
• (p1q0 / p0q0)x100
• Note: base-year quantities (q0) are used to compare prices in the two
years (p1 and p0 )
• A Paasche index of prices uses the quantities prevailing in the terminal
year to weight prices. The index takes the form:
• (p1q1/ p0q1)x100
• Note: current-year quantities (q1) are used to compare prices in the two
years (p1 and p0)
• As relatively cheaper are substituted for dearer goods, the Laspeyre index
of prices has an upward substitution bias.
• So CPI inflation is biased upwards
12
4. Equilibrium
• Key concept in economics
– illustrate with the simplest possible macro model
– Mankiw 11
• Equilibrium is a point of balance or stability
– Specifically in economics it is a point where economic agents’
plans are mutually consistent and therefore are realised
• Disequilibrium
–
–
–
–
–
–
plans are inconsistent
then someone’s plans are not realised
Somebody is disappointed
Behaviour will change
The economy will change
so not stable or balanced
13
MACROECONOMIC EQUILIBRIUM
• First, Output (which equals Income) is a function of inputs: for simplicity,
Capital (K) and Labour (L)
Y = f(K, L)
– This is the amount firms plan to spend
• There will also be Aggregate Demand or Planned Expenditure (PE)
– the amount of Expenditure which agents plan to make
– Agents: Households, firms, the Government and foreigners
• In equilibrium plans are consistent
Y = PE
• Later we will see that sometimes Output or Income do not equal planned
expenditure: this corresponds to a disequilibrium
• The general idea is that in equilibrium the forces acting on some variable
(Y) are balanced and hence Y will not change.
14
Planned Expenditure
• Conventionally we look at separate components of aggregate (planned)
expenditure: C, I, G, NX. This is because they behave differently.
• Crucially C (Consumption) depends partly on Income: so part of
Expenditure depends on Income: hence the term Induced (Consumption)
Expenditure
• Other components of Expenditure are Autonomous: this should be
understood as depending on something other than Income.
• We have
–
–
–
–
an Autonomous component of Consumption (Ca)
Investment (I)
Government purchases (G)
Foreign demand (NX)
15
Consumption Function
• An equation that describes consumption plans
• Very Generally, Consumption depends on Disposable Income (Y minus net
taxes, T).
• More specifically: C = Ca + c(Y – T)
– the “Autonomous” and “Induced” elements are on the right-hand side.
– For simplicity Mankiw leaves out Ca
• The coefficient c (The Marginal Propensity to Consume) is > 0 and < 1,
implying that for any given increase or decrease in disposable income C
will change in the same direction, but by a lesser amount.
• i.e.
0 < dC/d(Y – T) = c < 1
• This is a model of consumption insofar as it is a simplified representation
of how people make their consumption plans
– It doesn’t say that plans will be successful
– It is very simple (even simplistic): no interest rates, future income, life cycle
16
THE CONSUMPTION FUNCTION (2)
• Note: Ca is “Autonomous” consumption; C/Y (APC) falls as Y increases; c
(MPC) is < APC.
C
45 (C = Y)
Ca + c(Y – T)
Ca
0
Slope = c
(Y-T )
17
Equilibrium
• As always equilibrium is where plans are consistent
• Specifically in this case planned production is equal to planed demand
Y = PE,
• Sub in equation for planned expenditure (“Aggregate Demand”)
PE = C + I + G + NX
• To get
Y = C + I + G + NX
• Sub in consumption function
• To get:
Y = Ca + cY – cT + Ip + G + NX
• Note
– cY is the one part of Expenditure which depends on Income
– The other components (Ca –cT + I + G + NX) may be termed autonomous planned
spending, in that they do not depend in Income (at least for now…)
• Alternatively we might term them the Endogenous and Exogenous
components of planned spending.
18
Eqm. Vs Idenitity
• We have an accounting identity:
Y = C + I + G + NX
• This different from the equilibrium condition
• The equilibrium condition describes planned magnitudes
– These plans may or may not be realised
• The identity describes what actually happens
– This may or may not have been what was planned
• Thus the equilibrium condition is true only for certain values of the
variables
• The identity is true always
– Best thought of as an account rule
19
DISEQUILIBRIUM
• To illustrate the concept of equilibrium consider a numerical example
– Suppose we have Ca = 50, c = 0.8, T = 150, I = 40, G = 150, NX = 60
• Suppose we have Y = 600
• Is Income at equilibrium?
• Calculate Planned expenditure (Aggregate Demand)
– PE = Ca + c(Y – T) + I + G + NX
– = 50 + 0.8(450) + 40 + 150 + 60
–
300 + 360 = 660
• So Planned Production (Y) < Planned Expenditure (PE)
– Somebody’s plans will not be realised
– Production is not sufficient to meet demand
20
Disequilibrium
• Plans must be updated
–
–
–
–
How?
We will assume that production will be increased to meet demand
Note we assume prices don’t change
Will provide empirical evidence later
• Note this is a key assumption
– We will spend much of the course looking at how plans are
updated
– This will depend on expectations and timeframe (LO 3)
– In this simple model we assumes that plans cannot be
updated by changing prices
– This turns out to be valid in the short term but not in the
long term
21
EQUILIBRIUM
•
•
•
•
What is Equilibrium Y in this case?
We could try by trial and error
Or we could solve the equations
By definition equilibrium is where planned production equals planned
expenditure:
Y = PE
Y = Ca + c(Y – T) + I + G + NX
Y – cY = Ca – cT + I + G + NX
Y(1-c) = Ca – cT + I + G + NX
Y(1 – c) = PA
• Where PA = Autonomous planned spending = Ca – cT + I + G + NX
• Plug in numbers
–
Y = PA/(1 –c) = (50-120+40+150+60)/(0.2) = 180/0.2 = 900
• One can re-check by plugging in all the components of PE when Y = 900
and getting PE = 900, i.e. equilibrium
22
EQUILIBRIUM
• This can all be illustrated graphically
• When PE > Y, Y < Ye hence Y rises: similarly when PE < Y…..
Ep
45 (PE = Y)
PE = PA + c(Y – T)
Ap
0
Ye
Y
23
Comment
• The process is self sustaining
– If we are not at equilibrium there is an automatic adjustment process that will bring us
into equilibrium
– If this were not the case no point in studying eqm
• If not at eqm we are heading there
• We assume for the moment that the adjustment process works by
producers changing out put to meet demand
• We also assume that prices don't change
– Seems counter intuitive
– This model effectively assumes that prices are fixed
• We will
– provide empirical evidence alter that this is approximately true in the short run
– and spend much of the rest of the course discussing when and how it isnt true
24
A CHANGE IN AGGREGATE SPENDING (1)
• Suppose Ip and therefore PA fall by 40, Ye1 falls to Ye2 by a multiple of 40
(Ye > PA)
Ep
45 (PE = Y)
PE1 = PA1 + c(Y – T)
PE2 = PA2 + c(Y – T)
PA1
PA2
0
Ye2
Ye1
Y
25
A CHANGE IN AGGREGATE SPENDING (2)
•
•
•
•
•
•
•
•
•
•
•
•
•
Initial Equilibrium is: Y1 = PA1 + c(Y1 – T)
Following Shock to PA: Y2 = PA2 + c(Y2 – T)
Subtracting:
Y2 – Y1 = PA2 – PA1 + c(Y2 – Y1)
i.e.
Y = PA + c Y
so
Y(1 – c) = PA
And thus:
Y/PA = 1/(1 – c) or 1/s
So if c = 0.8, s = 0.2, multiplier = 5: etc….
Intuitively: an increase in PA (say G) is spent: it becomes income to someone
who re-spends c times the increase, etc…
Y = G(1 + c + c2 + c3 + ….. + cn)
 cY = G(c  c2  c3 + ….. + cn+1) then adding
And Y(1  c) =G(1)
(the other terms cancel)
So
Y/G = 1/(1-c)
You should have seen this before . If note review it in your fits year book or in
Mankiw
26
CHANGES IN SAVINGS, TAXES
• In the previous example, an increase in G of 100 produced an increase of
500 in Y.
• As T is given this means that (Y – T) increased by 500, and C increased by
c.Y so savings increased by s.Y = 100
• Financing the increased G by selling Bonds to Savers??
• Now what happens if T were reduced by 100 instead of increasing G?
• Initial Equilibrium is: Y1 = PA + c(Y1 – T1)
• Following cut in T:
Y2 = PA + c(Y2 – T2)
• i.e.
Y = c.Y – c.T
• So
Y(1 – c) = – c.T
• 
Y/ T = – c/(1 – c)
• Thus if c = 0.2, –c/(1 – c) = – 0.8/0.2 = – 4.
• Note sign, magnitude (intuition of this)
27
Conclusions
1. Understand the concept of the National Income
Identities
– Accounting rule so true by definition for all values
2. Understand the definition of Unemployment
–
NILF vs U
3. Understand the definition of a price index
– CPI inflation biased upwards
4. Understand the concept of Economic equilibrium and
how it is influenced by expectations
–
–
Plans are consistent
What adjusts when plans are not consistent?
28
What’s Next?
• We will spend the rest of the course expanding
on L.O. 4
– We will add more detailed accounts of how plans are
formed
– Progressively more complicated models
– We will also carefully consider what adjusts when
plans are inconsistent
• Next topic provides more detail on how
consumption and investment plans are made
specifically we take into account interest rates.
29