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Macroeconomics tries to understand the economy to achieve three basic goals 1) Rapid Economic Growth Economic growth is the ability of an economy to produce increasing quantities of goods and services 2) High Employment High employment is important, both because it helps us achieve our full productive potential, and because it affects the distribution of economic well-being among our citizens. 3) Stable Prices (or low inflation rates) Inflation rate is the percenage increase in a price level from one period (usally measured annually) to the next. Low inflation rates are important because coping with inflation uses up resources that could otherwise be used to produce goods and services. Inflation imposes costs on society and keeping the rate of inflation low helps to reduce these costs. The Macroeconomic Approach Aggregation is the process of combining different things into a single category The next two chapters examine three of the most important economic aggregates: output (chapter 7), employment (chapter 8), and the price level (chapter 8). First though we will introduce the Business cycle and call our measure of aggreate output Gross Domestic Product (GDP), which we will defined later. 1999Q1 - 2002Q4 Real GDP RGDP 9600 9500 9400 9300 9200 9100 9000 8900 8800 8700 1999Q1 1999Q2 1999Q3 1999Q4 2000Q1 2000Q2 2000Q3 2000Q4 2001Q1 2001Q2 2001Q3 2001Q4 2002Q1 2002Q2 2002Q3 2002Q4 1 Business cycles and economic fluctuations Real GDP Peak Trough Expansion Recession Expansion Time The Business Cycle An Expansion is a period of increasing real GDP A Peak is the point at which real GDP reaches its highest level during an expansion. A Trough is the point at which real GDP reaches its lowest level during a recession. A Recession is the period of a business cycle during which total production and total employment are decreasing. A recession is generally considered to be a period when real GDP falls for 6 or more consecutive months. (This is only a ―rule of thumb‖) A recession is also considered to exist during periods of abnormally low real GDP that are considered to be significant in terms of depth, breadth, and duration. For the U.S. the determination of an ―official‖ recession is made by the National Bureau of Economic Research. Depression is a severe recession Other terms associated with the business cycle A Countercyclical variable is a variable that falls when real GDP rises. An example is unemployment. 2 A Pro-cyclical variable is a variable that rises when real GDP rises. Examples are investment spending and employment. Chapter 7: GDP: Measuring Total Production and Income Using the production possibility frontier we were able to conceptually answer questions of how much an economy could produce. But we need to move beyond the abstract to find a variable that we can use to measure the value of actual output aggregated over the economy. How might this be useful to you in your personal life? Production, Income, and the Circular Flow Diagram Gross Domestic Product (GDP) is the total market value of final goods and services produced within an economy in a given year. Calculation: Sum of all final goods and services produced in a given year multiplied by their respective prices 3 For example suppose the economy produced the following with the listed prices- desks apples coats Price $ 100 $1 $50 Qty 10 1000 50 GDP = $4500 About the definition of GDP Only final goods are used to eliminate double counting of intermediate goods For example suppose we are trying to calculate the value of products sold and we have a loaf of bread to count. Look at the below costs and price data for the loaf of bread that is made with flour (we will assume no other ingredients). Goods bought Product Produced Sold for Farmer ----------- Wheat (1b) $.20 Miller 1b wheat Flour 1lbs $.50 Baker 1lbs flour bread $.90 Kroger bread service $1.10 What should be counted in GDP? Intermediate goods are goods used up in producing final goods. Final goods are goods sold to its final user. A good must be produced and not just represent a claim on ownership, such as stocks and bonds. Only goods and services produced for the market place are included. A time period is specified—in a given year. Thus, GDP is a flow variable GDP measures only final goods and services produced within a nation’s borders The expenditure Approach to Calculate Gross Domestic Product (GDP) GDP = C + I + G + (X – M) Personal Consumption ( C ): Purchases buy households of: Durable goods: goods that lasts for long period of time. However, it does not include new homes Non-durable goods: goods that lasts for short periods of time Services 4 Gross Private Domestic Investment (I) Purchases by business of On new plants and equipment Newly produced housing (Spending by consumers on new houses) Inventory investment Note: Depreciation is the wear and tear of capital as it is used in production Gross investment = net investment + Depreciation Government (G): or ―GOVERNMENT PURCHASES‖ Government Consumption Expenditures Government Gross Investment Government purchases do not include transfer payments. Transfer payments are payments by the government to individuals for which the government does not receive a good or service in return Net Exports: Exports (X) – Imports (M) Net exports > 0 is a trade surplus Net exports < 0 is a trade deficit For example, use the data below to calculate the Nominal GDP via the Expenditure method. U.S. 2006 Third Quarter National Accounts in Current $ (billions) $$$$$ $$$$$ Personal consumption (C) 9346.7 Durable goods 1075.5 Nondurable goods 2747.7 Services 5523.5 Gross private domestic Investment (I) 2235.5 Fixed investment 2171.4 Nonresidential (Business) 1420.8 Residential 750.5 Change in private Inventories 64.2 5 Net exports (NX) -801.7 Exports 1488.3 Goods 1055.8 Services 432.5 Imports 2290.1 Goods 1938.8 Services 351.3 Government Purchases (G) 2542.1 Federal 927.2 Consumption expenditures 809.1 Gross investment 118.1 State and local 1614.9 Consumption expenditures 1300.0 Gross investment 315.0 Gross Domestic Product (GDP) 9346.7+2235.5+2542.1-801.7=13322.6 The table shows several interesting points: G is 19%, I is 17%, C is 70%, and NX is -6% of GDP Consumer spending on services is greater than the sum of spending on durable and nondurable goods. Business fixed investment is the largest component of investment. Purchases by state and local governments are greater than purchases by the federal government. Imports are greater than exports, so net exports are negative. Value Added Approach to Calculate GDP is measuring GDP by summing the market value added to a product or service by all firms in the economy. Value added is the revenue a firm receives minus the cost of the intermediate goods and services it buys. For example in our earlier example of the loaf of bread we had the following— Intermediate good Product Produced Sold for Farmer --------------- Wheat (1b) $.20 Miller 1B wheat Flour 1lbs $.50 Baker 1lbs flour bread $.90 Marsh bread service $1.10 6 Calculate the value added for each stage of production and the total value added. Cost of Intermediate goods Revenue Value added From sale Farmer $0 .20 .20 Miller $.20 .5-.2 .3 Baker $.50 .9-.5 .4 Marsh $.90 1.10-.9 .2 Total---------------------------------- $1.10 The Factor Payments Approach to calculating GDP is measuring GDP by summing the factor payment made by all firms in the economy. Factor payments are payments to the owners of resources that are used in production. Remember from our circular flow diagram that production = income therefore; GDP = wages and salaries + interest + rent + profit Real versus Nominal GDP Nominal variables are measured with out adjustment for the change in the value of currency over time. Real variables are measured with an adjustment for the change in the value of currency over time Inflation and the measurement of Real GDP Price level is a measure of the average prices of goods and services in the economy. GDP deflator is a price index calculated by dividing nominal GDP by real GDP, and multiplying by 100. This produces an index that measures how the prices of goods included in GDP change over time. The GDP deflator uses a base year’s prices to calculate the real value of the goods. Calculation of a single base year GDP deflator index Suppose we have the following and we want 2000 to be the base year. 2000 apples coats Price $1 $100 Qty 1000 50 7 2007 apples coats Price $2 $120 Qty 1200 100 NGDP2007 = 2400 + 12000 = 14400 RGDP2007 = 1200 + 10000 = 11200 GDP deflator for 2007 = (NGDP2007 / RGDP2007) * 100 From the above we see that RGDP = (NGDP/GDPdef) * 100 A Chained index is a method for calculating changes in prices that includes an average of price changes using base years from neighboring years. This is the primary way Commerce Department now reports price indexes. U. S. system of national accounts provides us with data for calculating GDP and other variables. Some other commonly used measured derived from the national accounts are: Gross National Product (GNP) is the market value of all final goods and services produced by a nation’s residents, no matter where they are located. GNP = GDP + net income earned abroad Net National Product (NNP) = GNP – depreciation National income = NNP - indirect business taxes National income equal the sum of the below general categories Compensation to employees (wages plus benefits) Corporate profits Rental income Proprietor’s income (income of unincorporated businesses) Net interest (interest payments received by households from business and from abroad) Personal Income (PI) is income including transfers received by households. PI = National income + Transfer payments + personal interest income ─ Corporate Retained profits – Social Security taxes 8 Disposable Income (DI) is personal income after income taxes. DI= Personal Income – Personal income Taxes Account Relationships 2006:Q3 Gross domestic product (GDP) 13322.6 + Income receipts from abroad 682.3 - Income payments abroad 665.7 Gross national product (GNP) 13339.2 - depreciation 1582 Net National Product (NNP) 11757.2 - indirect business taxes and Retained corporate profits 3151.3 - Soc. Ins Tax 948.9 - statistical discrepancy -5.3 + Transfers 1618.6 + Personal interest 1683.6 Personal Income (PI) 10964.5 -income taxes 1366.2 Disposable Income DI) 9598.3 Problems with GDP as a Measure of Value of Output or Well-being It ignores non-market transactions. GDP ignores leisure time It ignores the underground economy. Distribution and Quality of Products It ignores changes in the environment. or other negative effects of production GDP is not adjusted for changes in crime and other social problems GDP is used to guide the economy in the short run and in the long run to give us an idea of the growth of the economy. It is not used as a measure of well-being However, per capita real GDP is used as a rough estimate of average economic well-being for macroeconomic models. 9
"Production Income and Gross Domestic Product"