Chapter 6
Growth Rate=
(present year real GDP - past year real GDP) / past year real GDP × 100
The Great Depression
80 years ago, during the Great Depression, President Franklin D. Roosevelt and his economic advisers knew things were bad—but how could they express and measure just how bad it was? An economist named Simon Kuznets, who later won the Nobel Prize for his work, came up with a way to track what the entire economy is producing. The result—gross domestic product (GDP)—remains our basic measure of macroeconomic activity.
GDP Deflator
= (Nominal GDP / Real GDP) * 100
Net export
= export - import
unsold inventory and counted as a part of investment and current GDP
A good produced in the current time period but put into a firm's inventory instead of being sold Is considered
recession
A significant decline in real GDP is called a
Recession and Depression
A significant decline in real GDP is called a recession. An especially lengthy and deep recession is called a depression. The severe drop in GDP that occurred during the Great Depression of the 1930s is clearly visible in the figure, as is the Great Recession of 2008-2009.
depression
An especially lengthy and deep recession is called a
Comparing the Real and Nominal GDP
Comparing real GDP and nominal GDP for 2005, you see they are the same. This is no accident. It is because 2005 has been chosen as the "base year" in this example. Since the price index in the base year always has a value of 100 (by definition), nominal and real GDP are always the same in the base year. As long as inflation is positive, meaning prices increase on average from year to year, real GDP should be less than nominal GDP in any year after the base year. The reason for this should be clear: The value of nominal GDP is "inflated" by inflation. Similarly, as long as inflation is positive, real GDP should be greater than nominal GDP in any year before the base year. For the same reason, real GDP should be greater than nominal GDP in any year before the base year, as long as inflation is positive.
GDP =
Consumption + Investment + Government + Trade balance GDP = C + I + G + (X - M) where C is consumption, I is investment, G is government spending, X is export and M is import. (X-M), trade balance, is also refered to as net export (NE).
Figure 6.4: Components of GDP on the Demand Side
Consumption is about two-thirds of GDP, but it moves relatively little over time. Business investment hovers around 15% of GDP, but it increases and declines more than consumption. Government spending on goods and services is around 20% of GDP. Exports are added to total demand for goods and services, while imports are subtracted from total demand. If exports exceed imports, as in most of the 1960s and 1970s in the U.S. economy, a trade surplus exists. If imports exceed exports, as in recent years, then a trade deficit exists. (Source: http://bea.gov/iTable/iTable.cfm?ReqID=9&step=1)
GDP Consumption
Consumption makes up over half of the demand side components of the GDP. Consumption expenditure by households is the largest component of GDP, accounting for about two-thirds of the GDP in any year. This tells us that consumers' spending decisions are a major driver of the economy. However, consumer spending is a gentle elephant: when viewed over time, it does not jump around too much.
GDP Measured by Components of Demand
Demand in the economy could be divided into four main parts: consumer spending (consumption), business spending (investment), government spending on goods and services, and spending on net exports. Based on these four components of demand, GDP can be measured as: GDP = Consumption + Investment + Government + Trade balance GDP = C + I + G + (X - M) where C is consumption, I is investment, G is government spending, X is export and M is import. (X-M), trade balance, is also refered to as net export (NE).
Measuring GDP: Income and Expenditure approach
Each of the market transactions that enter into GDP must involve both a buyer and a seller. The GDP of an economy can be measured either by the total dollar value of what is purchased in the economy, or by the total dollar value of what is produced. We can calculate the total amount of expenditures or total amount of incomes in a country to calculate GDP.
Macroeconomic Goals
Economic growth ultimately determines the prevailing standard of living in a country. Economic growth is measured by the percentage change in real (inflation-adjusted) gross domestic product (measured by real GDP). A growth rate of more than 3% is considered good. Unemployment, as measured by the unemployment rate, is the percentage of people in the labor force who do not have a job. When people lack jobs, the economy is wasting a precious resource-labor, and the result is lower goods and services produced. While measured unemployment is unlikely to ever be zero, a measured unemployment rate of 5% or less is considered low (good). Inflation is a sustained increase in the overall level of prices, and is measured by the consumer price index. If many people face a situation where the prices that they pay for food, shelter, and healthcare are rising much faster than the wages they receive for their labor, there will be widespread unhappiness as their standard of living declines. For that reason, low inflation—an inflation rate of 1-2%—is a major goal.
Final and intermediate goods
Final goods are goods at the furthest stage of production at the end of a year. Intermediate goods are goods that go into the production of other goods. To avoid the mistake of double counting, in which output is counted more than once as it travels through the stages of production, government statisticians count just the value of final goods and services in the chain of production that are sold for consumption, investment, government, and trade purposes. Intermediate goods are excluded from GDP calculations.
Have a market value Be a final good or service Be produced within a given country Be produced within a certain time frame
For a good or service to be counted in a given year's gross domestic product (GDP), what four following criteria must be met?
GDP
GDP = C + I + G + (X - M)
GDP alternate solution
GDP Per capita x Population
Gross national product (GNP)
GDP plus what is produced by domestic businesses and labor abroad, and minus any payments sent home to other countries by foreign labor and businesses located in the United States.
If we are considering just the US how are GDP and GNP related
GDP= GNP- (output of U.S. citizens living abroad) + (output of foreign nationals living in the U.S)
How GDP is measured by the government
Government economists at the Bureau of Economic Analysis (BEA), within the U.S. Department of Commerce, piece together estimates of GDP from a variety of sources. All of these bits and pieces of information arrive in different forms, at different time intervals. The BEA melds them together to produce estimates of GDP on a quarterly basis (every three months). These numbers are then "annualized" by adding them up for a year. For more details on how this is done see "How do statisticians measure GDP?" in the textbook.
Government expenditure
Government expenditure in the United States is about 20% of GDP, and includes spending by all three levels of government: federal, state, and local. The only part of government spending counted in demand is government purchases of goods or services produced in the economy. Examples include the government buying a new fighter jet for the Air Force (federal government spending), building a new highway (state government spending), or a new school (local government spending). A significant portion of government budgets are transfer payments, like unemployment benefits, veteran's benefits, and Social Security payments to retirees. These payments are excluded from GDP because the government does not receive a new good or service in return or exchange. Instead they are transfers of income from taxpayers to others.
Gross national product (GNP)
Gross national product (GNP) is GDP plus what is produced by domestic businesses and labor abroad, and minus any payments sent home to other countries by foreign labor and businesses located in the United States. In other words, GNP is based more on the production of citizens and firms of a country, wherever they are located, and GDP is based on what happens within the geographic boundaries of a certain country. For the US, the gap between GDP and GNP is relatively small; in recent years, about 0.2%. For small nations, which may have a substantial share of their population working abroad and sending money back home, the difference can be substantial.
trade surplus
If a country's exports are larger than its imports, then a country is said to have a
trade deficit
If a country's imports are larger than its exports, then a country is said to have a
fallacy of composition
If you believe that "something that is true form micro/individual point of view is also necessarily true for the economy as a whole", you are committing what economist refer to as the
What is meant by "investment" or "business spending"?
In calculating GDP, investment does not refer to the purchase of stocks and bonds or the trading of financial assets. It refers to the purchase of new capital goods, that is, new commercial real estate (such as buildings, factories, and stores) and equipment, residential housing construction, and (change in) inventories. Inventories that are produced this year are included in this year's GDP—even if they have not yet sold. From the accountant's perspective, it is as if the firm invested in its own inventories. Business investment in 2014 was almost $3 trillion.
GDP is Rough, but Useful
In general, no single number can capture all the elements of a term as broad as "standard of living." Nonetheless, GDP per capita is a reasonable, rough-and-ready measure of the standard of living. In most countries, a significantly higher GDP per capita occurs hand in hand with other improvements in everyday life along many dimensions, like education, health, and environmental protection.
Macroeconomic Frameworks
In macroeconomics, we use the theories of aggregate demand (AD) and aggregate supply (AS). We presents two perspectives on macroeconomics: the Neoclassical perspective and the Keynesian perspective, each of which has its own version of AD and AS.
Does a Rise in GDP Overstate or Understate the Rise in the Standard of Living?
In some ways, the rise in GDP understates the actual rise in the standard of living. The typical workweek for a U.S. worker has fallen over the last century from about 60 hours per week to less than 40 hours per week. Life expectancy and health have risen dramatically, and so has the average level of education. Since 1970, the air and water in the U.S. have generally been getting cleaner. New technologies have been developed for entertainment, travel, information, and health. A much wider variety of basic products like food and clothing is available today than several decades ago. On the other side, rates of crime, levels of traffic congestion, and inequality of incomes are higher in the U.S. now than they were in the 1960s. Moreover, a substantial number of services that used to be provided, primarily by women, in the non-market economy are now part of the market economy that is counted by GDP. By ignoring these factors, GDP would tend to overstate the true rise in the standard of living.
Services
In thinking about what is produced in the economy, many non-economists immediately focus on solid, long-lasting goods, like cars and computers. By far the largest part of GDP is services. Moreover, services have been a growing share of GDP over time. A detailed breakdown of the leading service industries would include healthcare, education, and legal and financial services. The most common jobs in a modern economy involve a worker looking at pieces of paper or a computer screen; meeting with co-workers, customers, or suppliers; or making phone calls.
Investment
Investment expenditure refers to purchases of physical plant and equipment, primarily by businesses plus the changes in inventories. Investment demand is far smaller than consumption demand, typically accounting for only about 15-18% of GDP, but it is very important for the economy because this is where jobs are created. However, it fluctuates more noticeably than consumption. Business investment is volatile; new technology or a new product can spur business investment, but then confidence can drop and business investment can pull back sharply.
Comparing GDP among Countries
It is common to use GDP as a measure of economic welfare or standard of living in a nation. When comparing the GDP of different nations for this purpose, two issues immediately arise. First, the GDP of a country is measured in its own currency: the United States uses the U.S. dollar; most countries of Western Europe, the euro; Japan, the yen; and so on. Thus, comparing GDP between two countries requires converting to a common currency. A second issue is that countries have very different numbers of people. For instance, the United States has a much larger economy than Canada, but it also has roughly nine times as many people as Canada. So, if we are trying to compare standards of living across countries, we need to divide GDP by population.
Fallacy Of Composition.. more info
It is not unusual that what results at the macro level is different from the sum of the microeconomic parts. Indeed, what seems sensible from a microeconomic point of view can have unexpected or counterproductive results at the macroeconomic level. For example while it might be a good idea for one individual to save more and spend less, at macroeconomic level, spending less by everybody in an economy could potentially lead to a recession.
macroeconomics
Macroeconomics focuses on the economy as a whole (or on whole economies as they interact). Macroeconomics involves adding up the economic activity of all households and all businesses in all markets to get the overall demand and supply in the economy.
Macroeconomic Tools
National governments have two tools for influencing the macroeconomy. Monetary policy, which involves managing the money supply and interest rates. Fiscal policy, which involves changes in government spending/purchases and taxes.
Net national product (NNP)
Net national product (NNP) is calculated by taking GNP and then subtracting the value of how much physical capital is worn out, or reduced in value because of aging, over the course of a year. The process by which capital ages and loses value is called depreciation. The NNP can be further subdivided into national income, which includes all income to businesses and individuals, and personal income, which includes only income to people.
Real GDP =
Nominal GDP / Price Index(GDP Deflator)*100
Other Components of GDP on the Production Side
Other than services, within the overall category of goods, long-lasting durable goods like cars and refrigerators are about the same share of the economy as short-lived nondurable goods like food and clothing. The category of structures includes everything from homes, to office buildings, shopping malls, and factories. Inventories is a small category that refers to the goods that have been produced by one business but have not yet been sold to consumers, and are still sitting in warehouses and on shelves. The amount of inventories sitting on shelves tends to decline if business is better than expected, or to rise if business is worse than expected.
Growth rate
Percentage change in Real GDP is called growth rate. What was the rate of growth of real GDP from 1960 to 2010? Growth Rate= (2010 real GDP - 1960 real GDP) / 1960 real GDP × 100 Growth Rate (between years 1960-2010) = ( (13,598.5 - 2,859.5) / 2,859.5 ) × 100 = 376% In other words, the U.S. economy has increased real production of goods and services by nearly a factor of four (3.76) since 1960. Of course, that understates the material improvement since it fails to capture improvements in the quality of products and the invention of new products. Since Real GDP = Price × Quantity, one % change in real GDP = % change in price + % change in quantity OR % change in quantity = % change in real GDP - % change in price Therefore, the growth rate of real GDP (% change in quantity) equals the growth rate in nominal GDP (% change in value) minus the inflation rate (% change in price). Note that using this equation provides an approximation for small changes in the levels.
Nominal GDP
Price Index × Real GDP / 100
Problems associated with Resession
Real GDP is important because it is highly correlated with other measures of economic activity, like employment and unemployment. When real GDP rises, so does employment. The most significant human problem associated with recessions (and their larger, uglier cousins, depressions) is that a slowdown in production means that firms need to lay off or fire some of the workers they have. Losing a job imposes painful financial and personal costs on workers, and often on their extended families as well. Even those who keep their jobs are likely to find that wage raises are scanty at best—or they may even be asked to take pay cuts.
Figure 6.6 Types of Production
Services are the largest single component of total supply, representing over half of GDP. Nondurable goods used to be larger than durable goods, but in recent years, nondurable goods have been dropping closer to durable goods, which is about 20% of GDP. Structures hover around 10% of GDP. The change in inventories, the final component of aggregate supply, is not shown here; it is typically less than 1% of GDP
Figure 6.5 Percentage of Components of GDP on the Production Side
Services make up almost half of the production side components of GDP in the United States.
Table 6.2 Components of U.S. GDP on the Production Side, 2014
Since every market transaction must have both a buyer and a seller, GDP must be the same whether measured by what is demanded or by what is produced:
The Problem of Double Counting
Statisticians who calculate GDP must avoid the mistake of double counting, in which output is counted more than once as it travels through the stages of production. For example, imagine what would happen if government statisticians first counted the value of tires produced by a tire manufacturer, and then counted the value of a new truck sold by an automaker that contains those tires. In this example, the value of the tires would have been counted twice-because the price of the truck includes the value of the tires. To Avoid double counting, GDP is defined as the current value of all final goods and services produced in a nation in a year.
Final goods
are goods at the furthest stage of production at the end of a year.
GDP per capita
The U.S. economy has the largest GDP in the world, by a considerable amount. The United States is also a populous country; in fact, it is the third largest country by population in the world, although well behind China and India. So is the U.S. economy larger than other countries just because the United States has more people than most other countries, or because the U.S. economy is actually larger on a per-person basis? This question can be answered by calculating a country's GDP per capita; that is, the GDP divided by the population. GDP per capita = GDP / population
BASE YEAR
The base year is the year whose prices are used to compute the real statistic. When we calculate real GDP, for example, we take the quantities of goods and services produced in each year (for example, 1960 or 1973) and multiply them by their prices in the base year (in this case, 2005), so we get a measure of GDP that uses prices that do not change from year to year. That is why real GDP is labeled "Constant Dollars" or "2005 Dollars," which means that real GDP is constructed using prices that existed in 2005. The price index in the base year is always 100
trade balance
The gap between exports and imports is called the
peak
The highest point of the economy, before the recession begins, is called the
Business Cycle, Peak, trough
The highest point of the economy, before the recession begins, is called the peak; conversely, the lowest point of a recession, before a recovery begins, is called the trough. Thus, a recession lasts from peak to trough, and an economic upswing runs from trough to peak. The movement of the economy from peak to trough and trough to peak is called the business cycle. The National Bureau of Economic Research (NBER), is the official tracker of business cycles for the U.S. economy. The effects of a severe recession often linger on after the official ending date assigned by the NBER.
How Well GDP Measures the Well-Being of Society
The level of GDP per capita clearly captures some of what we mean by the phrase "standard of living." Standard of living includes all elements that affect people's well-being, whether they are bought and sold in the market or not. Most of the migration in the world, for example, involves people who are moving from countries with relatively low GDP per capita to countries with relatively high GDP per capita.
business cycle
The movement of the economy from peak to trough and trough to peak is called the
Real VS nominal values
The nominal value of any economic statistic means the statistic is measured in terms of actual prices that exist at the time. The real value refers to the same statistic after it has been adjusted for inflation. Generally, it is the real value that is more important. For example, for calculating Real GDP given a price index that is normalized to 100 in the base year we could use the following formula: Real GDP = (Nominal GDP / Price Index) * 100 Real value of variable Y = (Nominal value of variable Y / appropriate Price Index) * 100 If one compared nominal GDP in 1960 to nominal GDP in 2010, it might appear that national output had risen by a factor of twenty-seven over this time (that is, GDP of $14,958 billion in 2010 divided by GDP of $543 billion in 1960). This conclusion would be highly misleading. Recall that nominal GDP is defined as the quantity of every good or service produced multiplied by the price at which it was sold, summed up for all goods and services. In order to see how much production has actually increased, we need to extract the effects of higher prices on nominal GDP. This can be easily done, using the GDP deflator. GDP deflator is a price index measuring the average prices of all goods and services included in the economy. GDP Deflator = (Nominal GDP / Real GDP) * 100 Nominal GDP values have risen exponentially from 1960 through 2010, by a factor of twenty-seven over this time, according to the BEA. But this does not mean that the production in US has increased twenty-seven times. To see how much production has increased one needs to calculate and compare Real GDP during this time period.
depreciation
The process by which capital ages and loses value is called
Figure 6.9 U.S. Nominal and Real GDP, 1960-2012
The red line measures U.S. GDP in nominal dollars. The black line measures U.S. GDP in real dollars, where all dollar values have been converted to 2005 dollars. Since real GDP is expressed in 2005 dollars, the two lines cross in 2005. However, real GDP will appear higher than nominal GDP in the years before 2005, because dollars were worth less in 2005 than in previous years. Conversely, real GDP will appear lower in the years after 2005, because dollars were worth more in 2005 than in later years.
gross domestic product (GDP) (info)
The size of a nation's overall economy is typically measured by its gross domestic product (GDP), which is the value of all final goods and services produced within a country in a given year. The measurement of GDP involves counting up the production of millions of different goods and services—smart phones, cars, music downloads, computers, steel, bananas, college educations, and all other new goods and services produced in the current year—and summing them into a total dollar value. To do that, take the quantity of everything produced, multiply it by the price at which each product sold, and add up the total. In 2014, the U.S. GDP totaled $17.4 trillion, calculated by the Bureau of Economic Analysis, the largest GDP in the world.
Converting Currencies with Exchange Rates
To compare the GDP of countries with different currencies, it is necessary to convert to a "common denominator" using an exchange rate, which is the value of one currency in terms of another currency. Two types of exchange rates can be used for this purpose, market exchange rates and purchasing power parity (PPP) equivalent exchange rates. Market exchange rates vary on a day-to-day basis depending on supply and demand in foreign exchange markets. PPP-equivalent exchange rates provide a longer run measure of the exchange rate and are typically used for cross country comparisons of GDP (see chapter 16)
Intermediate goods
are goods that go into the production of other goods.
Calculation of real GDP revisited
Value = Price × Quantity, or Nominal GDP = Price Index × Real GDP, so Real GDP = Nominal GDP / Price Index A price index (like GDP deflator) is a two-digit decimal number like 1.00 or 0.85 or 1.25. Because some people have trouble working with decimals, when the price index is published, it has traditionally been multiplied by 100 to get integer numbers like 100, 85, or 125. Hence, Real GDP = Nominal GDP / (Price Index / 100) , or Real GDP = (Nominal GDP / Price Index) * 100 In 1960, nominal GDP was $543.3 billion and the price index (GDP deflator) was 19. Real GDP = Nominal GDP / (Price Index / 100) = $543.3 billion / (19 / 100) = $2,859.5 billion Note that you get exactly the same answer using the following formula: Real GDP = (Nominal GDP / Price Index) * 100 = ($543.3 billion / 19) * 100 = $2,859.5 billion
Economic Growth Low unemployment Low inflation
What are the goals of macroeconomics
Monetary Policy Fiscal Policy
What are the policy tools of macroeconomics
The followings are examples of issues in macroeconomics:
What causes recessions? What makes unemployment stay high when recessions are supposed to be over? Why do some countries grow faster than others? Why do some countries have higher standards of living than others? Why and how price levels are changing over time and at different locations.
Consumption Business investment government Spending on goods and services net exports
What is Counted in GDP:
What is included and what is not included in the GDP
What is Counted in GDP: Consumption Business investment government Spending on goods and services net exports What is not included in GDP: intermediate goods Transfer payments and non-market activities Used goods illegal goods The sales of used goods are not included because they were produced in a previous year and are part of that year's GDP. The entire underground economy of services paid "under the table" and illegal sales should be counted, but is not, because it is impossible to track these sales. In a recent study, the underground economy in the United States was estimated to be 6.6% of GDP, or close to $2 trillion dollars in 2013 alone. Transfer payments, such as payment by the government to individuals, are not included, because they do not represent production. Also, production of some goods—such as home production as when you make your breakfast—is not counted because these goods are not sold in the marketplace.
: intermediate goods Transfer payments and non-market activities Used goods illegal goods
What is not included in GDP
Aggregate demand/Aggregate supply Keynesian Model neoclassical Model
What is the framework of macroeconomics
Net Export (X-M)
When thinking about the demand for domestically produced goods in a global economy, it is important to count spending on exports—domestically produced goods that are sold abroad. By the same token, we must also subtract spending on imports—goods produced in other countries that are purchased by residents of this country. The net export component of GDP is equal to the dollar value of exports (X) minus the dollar value of imports (M), (X - M). The gap between exports and imports is called the trade balance. If a country's exports are larger than its imports, then a country is said to have a trade surplus. If a country's imports are larger than its exports, then a country is said to have a trade deficit.
Limitations of GDP as a Measure of the Standard of Living ***
While GDP includes spending on recreation and travel, it does not cover leisure time. While GDP includes what is spent on environmental protection, healthcare, and education, it does not include actual levels of environmental cleanliness, health, and learning. While GDP includes production that is exchanged in the market, it does not cover production that is not exchanged in the market. GDP has nothing to say about the level of inequality in society. GDP also has nothing in particular to say about the amount of variety available. GDP has nothing much to say about what technology and products are available. It is not clear that a rise in GDP is even a good thing. If a city is wrecked by a hurricane, and then experiences a surge of rebuilding construction activity, could we claim that the hurricane was economically beneficial? If people are led by a rising fear of crime, to pay for installation of bars and burglar alarms on all their windows, is this increase in GDP has made them better off? Similarly, some people would argue that sales of certain goods, like pornography or extremely violent movies, do not represent a gain to society's standard of living.
Depreciation must have been greater than investment making net investment negative
Your econ Professor asks you to explain to class the implications of a decline in Mexico's capital stock from 525 billion in 2007 to 490 billion in 2008 despite positive investment all else equal you respond that
how to calculate the balance of trade
exports-inports
inventory
good that has been produced but not yet been sold
1) GDP does not account for how people distribute their time between work and leisure. 2) GDP doesn't account for changes in environmental quality. 3) GDP does not measure production that occurs outside of the market economy.
in what way does GDP not give an accurate representation of standard of living?
double counting
in which output is counted more than once as it travels through the stages of production.
Standard of living
includes all elements that affect people's well-being, whether they are bought and sold in the market or not.
GDP deflator
is a price index measuring the average prices of all goods and services included in the economy.
GDP per capita
is a reasonable, rough-and-ready measure of the standard of living. GDP / Population
Government expenditure
is about 20% of GDP, and includes spending by all three levels of government: federal, state, and local.
Net national product (NNP)
is calculated by taking GNP and then subtracting the value of how much physical capital is worn out, or reduced in value because of aging, over the course of a year.
durable good
long lasting good like a car or a refrigerator
final good and service
output used directly for consumption, investment government and trade purposes; contrast with intermediate good
service
product which is intangible such as entertainment healthcare or education
Investment
refers to purchases of physical plant and equipment, primarily by businesses plus the changes in inventories
real value
refers to the same statistic after it has been adjusted for inflation.
nondurable good
short lived good like food and clothing
structure
the building used as residence factory office building retail store or for other purposes
trough
the lowest point of a recession, before a recovery begins, is called the
The nominal value
the statistic is measured in terms of actual prices that exist at the time.
gross domestic product (GDP
the value of all final goods and services produced within a country in a given year.
base year
the year whose prices are used to compute the real statistic.
measure unemployment rate
unemployed/labor force
Spending goods to be used in future production
what does the investment componet of GDP measure?
Consumption
what makes up over half of the demand side components of the GDP and is the largest component of GDP
national income
which includes all income to businesses and individuals,
personal income
which includes only income to people.
exchange rate
which is the value of one currency in terms of another currency
