Forecasting by liaoqinmei

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									Lecture 3: Basics of Macroeconomics
          Dr. Rajeev Dhawan
               Director


               Given to the
            EMBA 8400 Class
          South Class Room #600
             January 18, 2008
Basics of Macroeconomics

       Chapter 23
       The Economy’s Income &
             Expenditure
 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.

 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.
   Simple Economy
Circular Flow Diagram
                                 MARKETS
                Revenue             FOR               Spending
                            GOODS AND SERVICES
               Goods            •Firms sell        Goods and
               and services     •Households buy    services
               sold                                bought




      FIRMS                                              HOUSEHOLDS
•Produce and sell                                      •Buy and consume
 goods and services                                     goods and services
•Hire and use factors                                  •Own and sell factors
 of production                                          of production




             Factors of         MARKETS            Labor, land,
             production            FOR             and capital
                          FACTORS OF PRODUCTION
        Wages, rent,            •Households sell    Income
        and profit              •Firms buy
                                                               = Flow of inputs
                                                                 and outputs
                                                               = Flow of dollars
         Definition of GDP
GDP is the market value of all final goods
 and services produced within a country in a
 given period of time.
               Definition of GDP
 “GDP is the Market Value . . .”
   – Output is valued at market prices.


 “. . . Of All Final . . .”
   – It records only the value of final goods, not intermediate
     goods (the value is counted only once).


 “. . . Goods and Services . . . “
   – It includes both tangible goods (food, clothing, cars) and
     intangible services (haircuts, housecleaning, doctor
     visits).
              Definition of GDP
 “. . . Produced . . .”
   – It includes goods and services currently produced, not
     transactions involving goods produced in the past.

 “ . . . Within a Country . . .”
   – It measures the value of production within the
     geographic confines of a country.
   –
 “. . . In a Given Period of Time.”
   – It measures the value of production that takes place
     within a specific interval of time, usually a year or a
     quarter (three months).
          Definition of GDP
What Is Not Counted in GDP?
  – GDP excludes most items that are produced and
    consumed at home and that never enter the
    marketplace.

  – It excludes items produced and sold illicitly,
    such as illegal drugs.
  GDP and Economic Well-Being
 GDP per person tells us the income and expenditure of the
  average person in the economy. Higher GDP per person
  indicates a higher standard of living.

 However…GDP is not a perfect measure of the happiness or
  quality of life.

 Some things that contribute to well-being are not included in
  GDP.
   – The value of leisure.
   – The value of a clean environment.
   – The value of almost all activity that takes place outside of
     markets, such as the value of the time parents spend with
     their children and the value of volunteer work.
Table 3 GDP and the Quality of Life
     NIPA Definition of GDP

     Y=C+I+G+NX
Y = GDP
C = Consumption
I = Investment
G = Government Purchases
NX = Net Exports = Exports-Imports
      NIPA Definition of GDP
 Consumption (C):
   – The spending by households on goods and services,
     with the exception of purchases of new housing.
 Investment (I):
   – The spending on capital equipment, inventories, and
     structures, including new housing.
 Government Purchases (G):
   – The spending on goods and services by local, state, and
     federal governments.
   – Does not include transfer payments because they are
     not made in exchange for currently produced goods or
     services.
 Net Exports (NX):
   – Exports minus imports.
GDP and Its Components
         Simple GDP Example
This simple economy has 2 people: Baker and Miller.
Baker buys flour for $350. He also uses a worker and pays
  $200 in wages. He also pays a rent of $25. He makes a
  profit as $25 on the bread he sells for $600.
The miller pays his worker $300, a rent of $25, and his
  profit is $25 on a sale of $350.
The GDP of this economy is $600!
Why? 2 sides of a coin, Income=Expenditures
Expenditures=Value of final Goods sold=600
Income=wages+Rent+profits=300+200+25+25+25+25=600
       Real vs. Nominal GDP
 Nominal GDP values the production of goods and
  services at current prices.
 Real GDP values the production of goods and
  services at constant prices.
                       Nominal GDP20XX
  Real GDP20XX                          100
                       GDP deflator20XX
•GDP Deflator deflates for Inflation!
•Inflation is rate of change of prices.
        Macro Framework
Households: Consume & Work
Firms: Production & Investment
Government: Money Supply, Taxes,
 Expenditures
Foreign Sector: Exports, Imports &
 Exchange Rate
                   Consumption Pattern
(%)
72

70

68

66

64

62

60
      1961 1966 1971 1976 1981 1986 1991 1996 2001 2006
                           GDP and Consumption
(Bil. $)
14000

12000

10000

 8000

 6000

 4000

 2000

     0
           1971     1976   1981   1986   1991   1996   2001   2006
                  Consumption     GDP
                    Investment Pattern
(%)
14

13

12

11

10

 9

 8
      1961 1966 1971 1976 1981 1986 1991 1996 2001 2006
                      Exports Share
(%)
12



10



 8



 6



 4
      1961 1966 1971 1976 1981 1986 1991 1996 2001 2006
                       Imports Share
(%)
18

16

14
12

10

 8
 6

 4

 2
      1961 1966 1971 1976 1981 1986 1991 1996 2001 2006
                       Net Exports
(%)
 2


0


-2


-4


-6


-8
     1961 1966 1971 1976 1981 1986 1991 1996 2001 2006
                    Government Share
(%)
24

23

22

21

20

19

18

17
      1961 1966 1971 1976 1981 1986 1991 1996 2001 2006
                  Federal Budget Deficit
(%)
 2



0



-2



-4



-6
     1961 1966 1971 1976 1981 1986 1991 1996 2001 2006
                Federal Budget, Trade Deficits and
                  US dollar trade-weighted exchange rate
(Bil. $)                                                          Index 2000 = 100
  200                                                                          140

                                                                                 130
     0

                                                                                 120
 -200
                                                                                 110
 -400
                                                                                 100
 -600
                                                                                 90

 -800                                                                            80

-1000                                                                            70
         1974   1978     1982    1986   1990       1994   1998   2002     2006
                Budget Deficit     Trade Deficit      U.S. Dollar Exchange Rate (R)
      GDP Components (2005)
           Government Purchases
                  19%
Investment                   Net Exports
   17%                           -6 %



             Consumption
                 70%
               Recessions
A recession is a significant decline in
 activity lasting more than a few months and
 is visible in industrial production,
 employment, real income and wholesale-
 retail sales (NBER definition). NBER uses
 monthly data.
Rule of thumb is 2 consecutive quarters of
 negative Real GDP growth or GDP decline.
      Article: Business Cycles
            BUSINESS CYCLE                                             DURATION IN MONTHS
           REFERENCE DATES
        Peak                     Trough              Contraction              Expansion               Cycle
                   Quarterly dates                        Peak                 Previous     Trough      Peak from
                 are in parentheses                        to                    trough      from       Previous
                                                         Trough                     to     Previous       Peak
                                                                               this peak    Trough
May 1937(II)               June 1938 (II)                   13                    50         63               93
February 1945(I)           October 1945 (IV)                 8                    80         88               93
November 1948(IV)          October 1949 (IV)                11                    37         48               45
July 1953(II)              May 1954 (II)                    10                    45         55               56
August 1957(III)           April 1958 (II)                   8                    39         47               49

April 1960(II)             February 1961 (I)                10                    24         34                32
December 1969(IV)          November 1970 (IV)               11                   106         117              116
November 1973(IV)          March 1975 (I)                   16                    36         52                47
January 1980(I)            July 1980 (III)                   6                    58         64                74
July 1981(III)             November 1982 (IV)               16                    12         28                18

July 1990(III)             March 1991(I)                     8                    92         100              108

March 2001 (I)             November 2001 (IV)                8                   120         128              128


                                               NBER Report Cycle Dates 2003
Mar 01’ ~ Nov 01’   9      -0.1%                       -4.0%   4.2   5.6


                        Forecast of the Nation, 2003
                       Real GDP and Business Cycles
(Bil. 2000$)
12000



10000



 8000



 6000



 4000



 2000
         1962   1966   1970   1974   1978   1982   1986   1990   1994   1998   2002   2006
                      Real GDP and Business Cycles
(Bil. 2000$)
12000


11000


10000


 9000


 8000


 7000


 6000
        1988   1990   1992   1994   1996   1998   2000   2002   2004   2006
            Industrial Production and Employment
(Index: 1997=100)                                                         (Mil.)
115                                                                        138

                                                                              136
110
                                                                              134

105                                                                           132

                                                                              130
100

                                                                              128
 95
                                                                              126

 90                                                                           124
  1998   1999       2000   2001   2002   2003    2004    2005   2006    2007
          Industrial Production          Total Payroll Em ploym ent (Right)
                                  Retail Sales
(Bil.)
340


320


300


280


260


240
         APR AUG DEC APR AUG DEC APR AUG DEC APR AUG DEC APR AUG DEC APR AUG DEC
         2001        2002        2003        2004        2005        2006
                     Real Disposable Income Growth
                      On a Percent Change from a Year Ago Basis
(%)
8

6

4

2

0

-2

-4    JUL NOV MAR JUL NOV MAR JUL NOV MAR JUL NOV MAR JUL NOV MAR JUL NOV MAR JUL NOV MAR JUL NOV
      1999    2000       2001        2002        2003         2004        2005       2006
                        Real Retail Sales Growth
                   On a Percent Change from a Year Ago Basis
(%)
8

6

4

2

0

-2

-4

-6    DEC APR AUG DEC APR AUG DEC APR AUG DEC APR AUG DEC APR AUG DEC APR AUG DEC
      2000 2001       2002        2003        2004        2005        2006
Article: NBER’s FAQs
Q: The financial press often states the definition of a recession as
   two consecutive quarters of decline in real GDP. How does that
   relate to the NBER's recession dating procedure?
    – Most of the recessions identified by our procedures consist of two
       or more quarters of declining real GDP, but not all of them
    – We consider the depth as well as the duration of the decline in
       economic activity.
    – Second, we use a broader array of indicators than just real GDP
    – Third, we use monthly indicators to arrive at a monthly chronology

Q: Could you give an example illustrating this point?
    – The two-quarter-decline rule of thumb would not have allowed the
      declaration of the recession until August 2002

Q: How does the NBER balance the differing behavior of
   employment and output?
    – There is no fixed rule for how the different indicators are weighted
Article: NBER’s FAQs
Q. You emphasize the payroll survey as a source for data on
   economy-wide employment. What about the household survey?
    – Although the household survey is a large, well-designed
      probability sample of the U.S. population, its estimates of total
      employment appear to be noisier than those from the payroll
      survey

Q. How do the movements of unemployment claims inform the
   Bureau's thinking?
    – A bulge in jobless claims would appear to forecast declining
      employment, but we do not use forecasts and the claims numbers
      have a lot of noise

Q: What about the unemployment rate?
   – Unemployment is generally a lagging indicator. Its rise from a very
     low level to date is consistent with the employment data
  Peak & Trough Announcements
The November 2001 trough was announced July 17, 2003.
The March 2001 peak was announced November 26, 2001.

The March 1991 trough was announced December 22, 1992.
    The July 1990 peak was announced April 25, 1991.

 The November 1982 trough was announced July 8, 1983.
  The July 1981 peak was announced January 6, 1982.

    The July 1980 trough was announced July 8, 1981.
   The January 1980 peak was announced June 3, 1980.
2001 Recession vs. History
         For Details Refer:
        http://www.nber.org/
Real GDP and Consumption




        FRBSF Economic Letter, June 2003
Investment and Stock Market




         FRBSF Economic Letter, June 2003
      Chapter 24
Measuring the Cost of Living
Consumer Price Index & Inflation
 Inflation refers to a situation in which the
  economy’s overall price level is rising.

 The inflation rate is the percentage change in the
  price level from the previous period.

 The Consumer Price Index (CPI) is a measure of
  the overall cost of goods and services bought by a
  typical consumer (produced by BLS).

 Inflation rate is change in CPI.
 Steps to Calculate CPI Index
 Fix the Basket: Determine what prices are most important
  to the typical consumer.
   – The Bureau of Labor Statistics (BLS) identifies a market basket of
     goods and services the typical consumer buys.
   – The BLS conducts monthly consumer surveys to set the weights
     for the prices of those goods and services.
 Find the Prices: Find the prices of each of the goods and
  services in the basket for each point in time.
 Compute the Basket's Cost: Use the data on prices to
  calculate the cost of the basket of goods and services at
  different times.
 Choose a Base Year and Compute the Index:
  Steps to Calculate CPI Index
Choose a Base Year and Compute the
 Index:
  – Designate one year as the base year, making it
    the benchmark against which other years are
    compared.
  – Compute the index by dividing the price of the
    basket in one year by the price in the base year
    and multiplying by 100.
         How the Inflation Rate Is
               Calculated
 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
Calculating the Consumer Price Index
 and the Inflation Rate: An Example
Calculating the Consumer Price Index
 and the Inflation Rate: An Example
       Another Example of CPI and
          Inflation Calculations
 Calculating the Consumer Price Index and the
  Inflation Rate:

   –   Base Year is 2002.
   –   Basket of goods in 2002 costs $1,200.
   –   The same basket in 2003 costs $1,236.
   –   CPI = ($1,236/$1,200)  100 = 103.
   –   Prices increased 3 percent between 2002 and
       2003.
 FYI: What Is in the CPI’s Basket?
                            17%
                      Transportation


                  15%
                Food and                    42%
                beverages                  Housing


Education and
                      6%
communication              6%
                                 6% 4% 4%

       Medical care
                                              Other goods
                Recreation       Apparel      and services
     The GDP Deflator vs. CPI
The BLS calculates other prices indexes:

  – The index for different regions within the
    country.

  – The producer price index, which measures the
    cost of a basket of goods and services bought by
    firms rather than consumers.
              CPI and GDP Deflator
 Percent
per Year
      15

                                CPI



     10




      5
                          GDP deflator




      0
           1965   1970   1975     1980   1985   1990   1995   2000
             Japan - GDP Growth and Deflator
                               (sm oothed)
(%)
10

 8

 6

 4

 2

 0

-2

-4
      1982   1986       1990       1994      1998   2002    2006
      Real GDP Growth     Nominal GDP Growth        GDP Deflator
              Germany - GDP Growth and Deflator
                            (sm oothed)
(%)
10

 8

 6


 4

 2

 0


-2
 1992     1994   1996     1998   2000     2002   2004   2006
        Real GDP Growth   Nominal GDP Growth     GDP Deflator
  Problems in Measuring CPI
Substitution bias
Introduction of new goods
Unmeasured quality changes
            Use of Price Indexes
 Price indexes are used to correct for the effects of inflation
  when comparing dollar figures from different times.
 Do the following to convert (inflate) Babe Ruth’s wages in
  1931 to dollars in 2005:
      Do the following to convert (inflate) Babe
       Ruth’s wages in 1931 to dollars in 2005:
                                    Price level in 2005
          Salary2005  Salary1931
                                    Price level in 1931

                                195
                     $80,000
                                15.2

                     $ 1,026,316
The Most Popular Movies of All
  Times, Inflation Adjusted
Article: Con Job Redux (PIMCO)
by: Bill Gross

   Bill claims that CPI inaccurately calculates Americans’ cost of
    living.

   Example: Say you buy 1 bag of gumdrops for $1 which has 100
    of those. Productivity makes it 110 gumdrops but for $1.10.
    Hedonic pricing says that CPI hasn’t gone up as per-capita cost
    is the same (1 cent). But you have to shelve out $1.10 to get
    the bag, which is an increase in cost of 10%. They must fork
    out an extra dime even though they’re getting more for their
    money.

   We can’t buy individual pieces of memory in a computer-we
    have to buy the entire package!
Real and Nominal Interest Rates
The nominal interest rate is the interest rate
 usually reported and not corrected for
 inflation.
  – This 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.
Real and Nominal Interest Rates
You borrow $1,000 for one year.
Nominal interest rate is 15%.
During the year inflation is 10%.
Real interest rate = Nominal interest rate – Inflation
                  = 15% - 10% = 5%
  Real and Nominal Interest Rates
Interest Rates
      (percent
      per year)
           15%

                                             Nominal interest rate

            10




             5




             0
                                             Real interest rate


             -5
               1965   1970   1975   1980   1985   1990    1995       2000   2005

								
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