Macro Quiz #2

Describe Produced (GDP definition)

(Currently). John bought a 2010 Ford in 2014. Not increase 2014, not affect 2010 GDP either. Car produced already counted in 2010. A 2014 Ford sold in 2015, counts as 2014 GDP, inventory investment.

Problems of CPI

(measured of cost of living-CPI) CPI assumes a fixed basket of goods. EX substitutes - coke/pepsi find cheaper/ on sale items (-CPI doesn't account for this) 1. Substitution bias -CPI doesn't allow consumers to substitute toward cheaper goods. 2. Unmeasured quality change 3. Ignore the introduction of new goods. -CPI is not a perfect measure of the cost of living. It OVERESTIMATES the living cost.

Correcting Economic Variables for the effects of inflation 2. Interest Rate

-(EX: student loans, mortgages, car loans, corporate bonds, ect.) - deposit = $1000 - annual interest rate = 10% - a year later balance: $1100 - ar you $100 richer?? -DVDs today price = $10 -your deposit = $1000/$100 = 100 DVDs -one year later DVD price is still $10 your account balance = $1100/100 = 110 DVDs your interest rate (110-100) = 10% (measured as the increase in DVDs) one year from today dvd price= $11 your account balance $1100/11 = 100 DVDs 0% return your interest rate (measured as the increase in DVDs) (100-100)/100 = 0 DVD price increased by (11-10)/10 = 10%

CPI or GDP deflator?

-CPI can over estimate -price of tractors: GDP deflator goes up and no change in CPI -Armani raises CPI and GPD doesn't change when the Italian company changes the price in the US by a higher price.

IS A GDP A GOOD MEASURE OF ECONOMIC WELL-BEING?

-GDP DOES NOT MEASURE: housework, leisure time, pollution, income distribution (income gap occurs), education quality, underground economy, and health care. -GDP is not a perfect measure our ability to obtain these items.

Another difference between GDP deflator and CPI

-GDP deflator: currently produced goods and services DIFFERENT over time -CPI: a FIXED basket

GDP deflator vs CPI

-both measure change in price - GDP deflator = [ (nominal GDP) / (real GDP) ] x 100 [ (P2014Q2014) / (PbaseyearQ2014) ] x 100 -CPI= [ (P2014 BASKET) / (Pbase year Basket) ] x 100 -deflator: all goods and services (domestically- gov't too) -CPI: all goods and services only purchased by consumers -GDP deflator: prices of all goods and services PRODUCED DOMESTICALLY -CPI: prices of all goods and services BOUGH BY CONSUMERS -CPI: measures inflation/ cost of living BETTER (BUT NOTE:) GDP deflator - not all people need it CPI - more common GDP deflator- helicopter CPI - wine

How to calculate CPI?

1. Fix the Basket: Consumer expenditure survey (EX) 7000 families 60,000 quarterly interviews 28,000 weekly diaries. - which prices are most important? - once the basket of goods and services is selected, it is fixed** - want some basket 2. Choose a Base Year and Compute the Index: CPI = [ (Cost of the basket in current year) / (Cost of the basket in the base year) ] x 100 - current base year period: 1982 - 1984 - CPI is always 100 in the base year (EX) hot dogs and hamburgers (on blackboard) 3. Inflation Rate - the percentage change in the consumer prove index from the preceding period. Inflation Rate = [ (CPI this year - CPI last year) / (CPI last year) ] x 100 -Inflation rate is usually measured over a one year period

2. Below are some data from the land of milk and honey. a. Compute nominal GDP, real GDP, and the GDP deflator for each year, using 2016 as the base year. b. Compute the percentage change in nominal GDP, real GDP, and the GDP deflator in 2017 and 2018 from the preceding year. For each year, identify the variable that does not change. Explain why your answer makes sense. c. Did economic well-being increase more in 2017 or 2018? Explain.

1. Nominal GDP2016 = 1*100+2*50 = $200 Nominal GDP2017 = 1*200+2*100 = $400 Nominal GDP2018 = 2*200+4*100 = $800 Real GDP2016 = 1*100+2*50 = $200 Real GDP2017 = 1*200+2*100 = $400 Real GDP2018 = 1*200+2*100 = $400 GDP deflator2016 = 200/200 *100 = 100 GDP deflator2017 = 400/400 *100 = 100 GDP deflator2018 = 800/400 *100 = 200 Percentage change in nominal GDP2017 = (400-200)/200 * 100 = 100% Percentage change in nominal GDP2018 = (800-400)/400 * 100 = 100% Percentage change in real GDP2017 = (400-200)/200 * 100 = 100% Percentage change in real GDP2018 = (400-400)/400 * 100 = 0% Percentage change in GDP Deflator2017 = (100-100)/100 * 100 = 0% Percentage change in GDP Deflator2018 = (200-100)/100 * 100 = 100% Economic well-being rose more in 2017 than in 2018, since real GDP rose in 2017 but not in 2018. In 2017, real GDP rose but prices did not. In 2018, real GDP did not rise but prices did.

GDP measures

1. total output of goods and services 2. total income of everyone in the economy 3. total expenditure on the economy's output of goods and services. -it is a measure of a society's economic well-being -It's the most closely watched economic status -For an economy has a whole, income must be equal expenditure.

Correcting Economic Variables for the effects of inflation 1. INCOME

1931: CPI = 15.2 salary = $75,000 (HOOVER) 2012: CPI = 229.5 salary = $400,000 (OBAMA) 229.5 /15.2 = 15.1 times (Cost of Living) 400,000/ 75,000 = 5.33 times (salary) -hoover had higher purchasing power. -amount so Obama obtains obtains same: 75,000 x 15.1 = $1,132,500 ~projected 2012 salary for the same living standard as in 1931

Measure of Cost of Living 1. Consumer Price Index

CPI - a measure of the overall cost of the goods and services bought by a typical consumer. (The Bureau of Labor Stats) What's in the CPI Basket? 41% housing

Describe All (GDP definition)

Comprehensive. Does not include the trading/ value of illegal drugs

Describe Market Value (GDP definition)

Convert all kinds into one number. Exclude: housework, vegetables in backyard.

3 of three measures of GDP 3. The GDP deflator

GDP deflator = [ (nominal GDP) / (real GDP) ] x 100 EX: GDP delator 2014 = [ (PA2014 QA2014 + PB2014 QB2014) (PA2009 QA2014 + PB2009 QB2014) ] x 100 -measures inflation -measure of "relative price" -GDP deflator for the base year is always 100 -GDP deflator measures the current level of prices relative to the level of prices in the base year. -GDP 2009 = 100 -GDP 2014 = 120 -2014 prices were higher than base year prices by 20%

A farmer grows wheat, which she sells to a miller for $100. The miller turns the wheat into flour, which she sells to a baker for $150. The baker turns the wheat into bread, which she sells to consumers for $180. Consumers eat the bread. a. What is GDP in this economy? Explain. b. Value added is defined as the value of a producer's output minus the value of the intermediate goods that the producer buys to make the output. Assuming there are no intermediate goods beyond those described above, calculate the value added of each of the three producers. c. What is total value added of the three producers in this economy? How does it compare to the economy's GDP? Does this example suggest another way of calculating GDP?

GDP is the market value of the final good sold, $180. Value added for the farmer: $100. Value added for the miller: $150 - $100 = $50. Value added for the baker: $180 - $150 = $30. Together, the value added for the three producers is $100 + $50 + $30 = $180. This is the value of GDP. This example suggests that GDP could be calculated as the sum of the value added by all producers.

(National Income Account Identity) Net Exports

NX= Exports - Imports Y= C+ I+ G+ EX - IM NX>0 -- EX>IM -- TRADE SURPLUS (EX CHINA) NX<0 -- EX<IM -- TRADE DEFICIT (EX USA) NX=0 -- EX=IM -- BALANCED TRADE

Describe Final (GDP definition)

Price of whole items. ice cream cone is $3 and sugar used $.50, GDP increases by 3 or 3.50? 3. Excludes intermediate goods.

(National Income Account Identity) Investment

Purchase of CAPITAL gods. That will be used in the future to produce more goods and services. 1. Business investment: capital equipment and structures 2. Inventory investment: produced but not sold yet. 3. Residential investment: -this investment is different from the personal investment such as buying stocks and bonds. **

Describe Within a country (GDP definition)

Regardless of the nationality of the producer. Honda builds a factory in the U.S. - U.S. GDP goes up. Walmart opens a store in China - China GDP goes up.

GDP was first developed by_________ for a US Congress report in 1934

Simon Kuznets

(National Income Account Identity) Government Purchases

Spending on goods and services by state, local, and federal governments. -National defense, roads, schools, exclude social security and other welfare programs. -transfer payments** do not reflect the economy's production.

2 of three measures of GDP 2. Real GDP

The production of goods and services valued at CONSTANT prices. to calculate real GDP: choose a year as a base year (2009), then use base year prices. (EX): REAL GDP2009 = PA2009 QA2009 + PB2009 QB2009 REAL GDP2013 = PA2009 QA2013 + PB2009 QB2013 base year of number and nominal number = same (in this case 2009)

1 of three measures of GDP 1. Nominal GDP

The production of goods and services valued at CURRENT prices. (EX): Nominal GDP2013 = PA2013 QA2013 + PB2013 QB2013 For different years: change 2013 to 2014 both prices and quantities vary, reflect changes in market value

GDP formula

Y = C + I +G + NX (Y= GDP, C= Consumption, I= investment, (G) Government purchases, and Net Exports (NX)

What adds to 2012 GDP? What does not? Why? Indicate the component of GDP when appropriate. All transactions take place in 2012. a. Andy sells one share of stock ($200) to Mary. b. You borrowed $50 from your roommate. c. You hire someone to clean your house. d. Ashley sells a car that she bought in 2004 to William for $5,000. e. Gambling becomes legal. f. 20 TVs were manufactured in 2012 and remained in inventory. g. An Irish marketing consultant works in Boston and earns $60,000. h. You received an unemployment paycheck of $2000.

a. No. (Stocks are financial assets. No more goods or services are produced.) b. No. (No change in total national income. The money flows from your roommate to you.) c. Yes. (consumption, cleaning service) d. No. (It is a transaction of used goods, not produced in 2012) e. Yes. (This makes the dealers income, induced spending in casinos like food legal. The amount of money that people win or lose does not affect GDP.) f. Yes. Inventory investment. g. Yes. (Location matters, not nationality.) h. No. (transfer payment)

A small nation of ten people idolizes the TV show The Voice. All they produce and consume are karaoke machines and CDs, in the following amounts: a. Using a method similar to the CPI, compute the percentage change in the overall price level. Use 2017 as the base year and fix the basket at 1 karaoke machine and 3 CDs. b. Using a method similar to the GDP deflator, compute the percentage change in the overall price level. Also use 2017 as the base year. c. Is the inflation rate in 2018 the same using the two methods? Explain why or why not.

a. The cost of the market basket in 2017 is (1 × $40) + (3 × $10) = $70. The cost of the market basket in 2018 is (1 × $60) + (3 × $12) = $96. Using 2017 as the base year, we can compute the CPI in each year: 2017: $70/$70 × 100 = 100 2018: $96/$70 × 100 = 137.14 We can use the CPI to compute the inflation rate for 2018: (137.14 - 100)/100 × 100 = 37.14% b. Nominal GDP for 2017 = (10 × $40) + (30 × $10) = $400 + $300 = $700. Nominal GDP for 2018 = (12 × $60) + (50 × $12) = $720 + $600 = $1,320. Real GDP for 2017 = (10 × $40) + (30 × $10) = $400 + $300 = $700. Real GDP for 2018 = (12 × $40) + (50 × $10) = $480 + $500 = $980. The GDP deflator for 2017 = ($700/$700) × 100 = 100. The GDP deflator for 2018 = ($1,320/$980) × 100 = 134.69. The rate of inflation for 2018 = (134.69 - 100)/100 × 100 = 34.69%. c. No, it is not the same. CPI is based on a fixed basket purchased by consumers while the GDP deflator is based on all domestically produced goods.

Suppose that a borrower and a lender agree on the nominal interest rate to be paid on a loan. Then inflation turns out to be higher than they both expected. a. Is the real interest rate on this loan higher or lower than expected? b. Does the lender gain or lose from this unexpectedly high inflation? Does the borrower gain or lose? c. Inflation during the 1970s was much higher than most people had expected when the decade began. How did this affect homeowners who obtained fixed-rate mortgages during the 1960s? How did it affect the banks that lent the money?

a. When inflation is higher than was expected, the real interest rate is lower than expected. b. Because the real interest rate is lower than was expected, the lender loses and the borrower gains. The borrower is repaying the loan with dollars that are worth less than was expected. c. Homeowners (borrowers) in the 1970s who had fixed-rate mortgages from the 1960s benefited from the unexpected inflation, while the banks (lenders) that made the mortgage loans were harmed.

A dozen eggs cost $0.88 in January 1980 and $2.11 in January 2015. The average wage for production workers was $7.58 per hour in January 1980 and $19.64 in January 2015. a. By what percentage did the price of eggs rise? b. By what percentage did the wage rise? c. In each year, how many minutes did a worker have to work to earn enough to buy a dozen eggs? d. Did workers' purchasing power in terms of eggs rise or fall?

a. price of egg: (2.11-0.88)/0.88 *100 = 140% b. wage: (19.64-7.58)/7.58 * 100 = 159% c. 1980: $0.88 / ($7.58/60) = 6.97 minutes 2015: $2.11 / ($19.64/60) = 6.45 minutes d. Workers' purchasing power rose in 2015 (wage increased more, work fewer minutes to buy a dozen eggs).

NOMINAL vs REAL GDP

for the base year, real GDP always equals nominal GDP Real GDP is a better gauge of economic well-being prices are held constant, real GDP reflects changes in quantities (production) only.

Inflation turns out to be lowered than expected lenders helped and borrowers hurt

lenders are given more and borrowers are hurt.

REAL INTEREST RATE (r)

nominal interest rate (i) - inflation rate (pie) SO r=i-pie -can real interest rate be negative? YES WHEN i<pie

Describe In a given period of time (GDP definition)

quarterly, annually

(National Income Account Identity) Consumption

spending by households on goods and services. Purchases of new housing are excluded. -residential investment.

(GDP definition)

the market value of all final goods and services produced within a country in a given period of time