Transcript Accounting an Economy - Wake Forest University

Accounting an Economy
Variables of Interest in
Macroeconomics
Value of Output
• Gross Domestic Product- the value of all finished
goods or services produced in the borders of an
economy in a calendar year.
• Doesn’t count intermediate goods or goods
produced by citizens living abroad.
• Example: Automobile is finished product. Steel,
glass, wiring, etc… not counted individually.
Value of Output in US
• US GDP in 2010 will be about $14.5 trillion.
That’s a big number!
Historic GDP
• US Economy has been a thoroughbred since
WWII.
• Average annual growth has been 3.3% since
1950.
Historic GDP
• Not every year sees equal increases in GDP.
Why does this happen?
• Expansions occur. GDP > potential GDP
• Recessions occur. GDP < potential GDP
• http://www.tradingeconomics.com/Economic
s/GDP-Growth.aspx?Symbol=USD
Measuring Prices
• Inflation- the rate at which prices change
• Consumer Price Index (CPI)
• Base year is chosen and given a base value of
100. Allows for easy point of comparison.
Measuring Prices
• CPI Example- Assume 2000 is the base year.
So, the CPI for 2000 = 100.
• If the CPI in 2001 is 103, then prices rose 3% in
a year.
• If the CPI in 2005 was 110, then prices rose
10% in five years.
Measuring Prices
• Inflation is important because it must be easily
estimable in order for credit markets to
function and for currency to be used.
• In US, the Federal Reserve System acts as an
inflation watchdog. Many other countries
have central banks that serve a similar
purpose.
Historic Inflation
• http://www.inflationdata.com/inflation/inflati
on_rate/historicalinflation.aspx
• Generally prices in the US change about 1.5%
to 3% every year.
Interest Rates
• Interest rates are the shadow price of capital.
• If technologically innovative products are
available, then businesses will be willing to
enter into loan agreements with higher
interest rates because businesses’ productivity
levels will increase with capital expansion.
Interest Rates
• Interest rates are tied closely to inflation
because creditors and debtors must be able to
make an accurate estimate of expected
inflation in order to know the real interest
rate.
• Fisher Equation:
Nominal Interest Rate =
Expected Real Interest Rate + Expected Inflation
Interest Rates
• Example:
Assume that nominal interest rates are 5%.
If Amanda wants to enter into a one-year credit
agreement in which she is loaned $1000, then
she needs to know what inflation will be in
order to understand how much she’ll have to
pay back in real terms.
Interest Rates
• Because she is loaned $1000 at nominal
interest rate of 5%, she’ll have to pay back the
principal, $1000, and interest, $50.
• If she expects inflation to be 3%, which is $30,
then she’ll have to pay 2%, or $20, of real
interest.
(5% = 2% + 3%)
Interest Rates
• If inflation is unexpectedly high, then the
creditor gets the short end of the deal
because the real interest she collects is less
than what she thought it to be.
• (Above example with 4% actual inflation…)
Historic Interest Rates
• http://www.federalreserve.gov/releases/h15/
data.htm
• Absolutely critical that inflation be somewhat
predictable. If not, then credit markets cannot
operate effectively, and long term growth will
suffer.
Long Run Growth
• Democracy, Property Rights, and Legal
Systems
• Monetary Policy
• Fiscal Policy