Macroeconomics

Boom v Slump, Growth Recession

BOOM is when the GDP is above the trend. SLUMP is when the GDP is below the trend. A growth recession is where there is a fall in the inflation of the GDP % below the trend, but is still expanding.

Calculating GDP (Income Approach)

Labour income + Capital income + Net Indirect Taxes (GST)

Labour Alone (Production Function)

Labour productivity: output per hour of work Material living standards over the trend improve only with greater productivity Productivity is not raised by employing more workers or by more hours per worker! Output per worker-hour depends on the amount of available capital (K) and know-how, i.e., technology (Te) Consider a simple economy in which changes in production relies on changes in the amount of labour available for use. Real GDP depends on only labour - the amount of output in the economy described by the production function Y5F(L), where Y is real GDP and L is labour input. (Real GDP is a function, F, of labour.) Land (its fertility and the climate), capital and technology are held constant, and only the amount of labour used in production is varied. The model shows that in such an economy output per worker reaches a limit. Consider the production of grapes on a small vineyard. The only input that can be varied is the number of workers (L). More workers can cultivate and harvest more grapes. In Figure 4.2, the vertical axis shows output and the horizontal axis shows labour input. The curve shows that more labour can produce more output. The curve is a graphical plot of the production function: Y5F(L). Let a similar shaped production function hold true for the entire economy.

The Effect of Research & Development

Research and development (R&D) the activities designed to further scientific knowledge and develop new products Today, countries with a high standard of material living spend huge quantities of resources on research and development (R&D). Some of the research supports pure science, but much is for applied research in engineering and medical technology. The government provides most of its R&D funds through research grants and contracts to private firms and universities via the Australian Research Council and other public bodies.

Investment vs Consumption (Economic Growth)

Resources can be devoted to consumption (making and eating food) or investment (improving the technology or human capital that makes the food). If resources for a given year are devoted more to Consumption, then the PPC would shift further outwards in the given year than if resources were devoted to investment. However, the more resources devoted to investment one year could lead to a greater shift to the PPC in the years to come.

Government Expenditure (G)

Spending by federal, State/ government total amount of investment, replacing worn-out capital The capital stock, before and after net investment Left: Add net investment - new construction (less depreciated buildings) each year, for many years. Right: The result is a larger capital stock - the buildings in Sydney today. expenditure (G) spending Territory and local governments on goods and services. Examples of government expenditure include spending on defence, health care (surgery in a public hospital) and road building. Government Expenditure on Centre-link is not included in GDP. It is a transfer of wealth.

Forecasting Potential GDP Growth

Suppose potential GDP is forecast to grow at 2.5 per cent per year over the next few years. Plausible assumptions underlying this forecast are summarised in Figure 4.11. The 2.5 per cent potential GDP growth rate is based on a growth rate of aggregate hours of 1.2 per cent per year and a productivity growth rate of 1.3 per cent per year. The growth rate of potential GDP is, therefore, the sum of the growth rate of aggregate hours of work plus the productivity growth rate.

Steps to Technological Change

Technological change has three steps: • 1. an invention is the discovery of new knowledge or a new principle such as electricity • 2. an innovation, in which the new knowledge is applied in a new product such as the electric generator and light bulb • 3. a diffusion of the innovation throughout the economy - a process involving marketing, learning and imitating, which spreads the innovation to new uses (for example, the use of the electric light to facilitate night shifts in factories).

Diminishing Returns to Labour

The slope of the curve shown in Figure 4.2 indicates diminishing returns to labour: the greater the number of workers used in producing output, the lower the additional output from each additional worker. Increasing employment from one to two workers raises production more than does increasing employment from 101 to 102 workers. A second worker could usefully inspect the vines for insects while the first worker harvested grapes. With 100 workers already employed, it gets harder for each extra worker to share in the use of a limited amount of land and capital. As total production rises, the extra (marginal) product of each extra (marginal) worker sooner or later falls. In this simple agricultural economy, there are diminishing returns to labour. There is also a point where extra workers would eat more than they produce. There even is some point where overcrowding means that an extra worker would hinder production.

Unemployment Types

Unemployment = cyclical component + natural component FRICTIONAL: Process of matching workers with jobs. Unemployment: short-term unemployment arising from normal turnover and job search in the labour market - On average some people are always frictionally unemployed - 'Between jobs' or entering the labour market, or re-entering STRUCTURAL: Mismatch of Jobs and worker skillets. Unemployment: longer-term unemployment due to structural problems such as poor skills or longer-term changes in demand or insufficient work incentives in specific industries. There is always structural change in a dynamic economy - Mismatch of what skills employers want and what skills workers have - Mismatch of where the jobs are and where workers live - There's some scope to improve on current market outcomes E.g., re-location assistance and re-training to increase flexibility and adaptability CYCLICAL: Unemployment that follows the business cycle. Unemployment is a change in total unemployment caused by a change in total demand (or spending) Suppose u* = 5% and current u = 7%. The cyclical component is ... 2% Suppose u* = 5% and current u = 4%. The cyclical component is ... -1%

Labour Income

Wages, salaries and supplements (or fringe benefits) paid to workers as labour income, signifying that it is payment to people for their labour.

Types of Technological Changes 1. Labour-saving technological change 2. Capital-saving technological change

1. Fewer workers are needed for the same amount of output - For example, some Australian mining companies use gigantic driverless trucks. Higher wages may sometimes encourage investment in means of production that use less labour. 2. Less capital is required for the same amount of output. - Owning a smartphone means that people don't need a separate camera, video recorder and player, calculator, laptop and more.

4. International Comparison

1. GDP per country needs to be compared in the same currency. This means having to convert the currencies with exchange rates. Exchange rates are changing daily and so a longer-term rate called the Purchasing Power Parity (PPP) is generally used. eg. Step 1. Determine the exchange rate for the specified year. In 2013, the exchange rate was 2.230 reals = $1. (These numbers are realistic, but rounded off to simplify the calculations.) Step 2. Convert Brazil's GDP into U.S. dollars: 2. GDP needs to be calculated per capita for comparison as the populations of countries differ. This is done by: GDP per capita = GDP/population

Shortcomings of GDP

1. Revisions to GDP 2. Omissions to GDP 3. Quality of Life 4. Difficulty comparing international GDP

Technology Definitions 1. Technological Process 2. Embodied Technology 3. Disembodied Technology

1. Technological Progress: an improvement in technology over time 2. Embodied Technology: technology in a physical form 3. Disembodied Technology: how existing resources are used or arranged. - Technology also includes how firms organise the inputs required for production. Improvements purely in organisation are examples of disembodied technologies. Raised productivity levels are likely to be a result of: • streamlined flows of information • a workforce aligned with management goals and appropriately incentivised • fewer levels of reporting hierarchy

Business/Economic Cycle

A business cycle is growth and decline of real GDP over time observed against the trend.

What is Net Investment?

A large portion of investment each year by businesses is the replacement of broken or depreciating assets such as machinery. When a machine wears out, companies must replace these machines by buying new ones. The total expenditure of this is the "Gross Investment". (I) The "Net Investment" is the Gross Investment - The Value of the items being replaced due to breaking or being worn out (Depreciation) Net Investment = Gross Investment - Depreciation When calculating GDP, Gross Investment is used. Net Investment is used when calculating Net Domestic Product.

Market System

A market system is the network of buyers, sellers and other actors that come together to trade in a given product or service. The participants in a market system include: Direct market players - producers, buyers and consumers who drive economic activity in the market. Suppliers of supporting goods and services such as finance, equipment and business consulting Entities that influence the business environment such as regulatory agencies, infrastructure providers and business associations

Malthusian equilibrium

A theory which suggests that population will rise until it hits equilibrium. If the population becomes too high for the food being harvested (laws of diminishing returns to labour) people will have less food than needed to survive and starve. This is illustrated in Figure 4.3. Suppose subsistence is 50 units of food per equilibrium person (shown by a dashed line from the origin with a slope of 50). There is only one point on the production function where output per person equals 50. If it takes 50 units of output per worker to survive, then there is a point along the production function where 100 workers require exactly 5000 units of output. Aside from brief periods of prosperity, most people were doomed to struggle at the brink of starvation. This can be negated if technological advances outpace population growth.

Depreciation effect on K

After a while K stays constant. This is because of depreciation. K is calculated using Net-Investment which is Gross Investment in Capital - Depreciation. For example, if one Bullsozer was made and replaced after 10 year, Gross Investment would be 2 bulldozers, but Net Investment would stay at 1 Bulldozer. 10 years later when a new bulldozer replaces the older one, Gross Investment would become 3, but Net Investment would stay at one. However, in this 3rd decade, if the company made 2 bulldozers, their Gross Investment would be 4 and their Net Investment 2.

Growth Accounting Formula

An equation showing how to measure the respective contributions to increases in labour productivity of extra capital per worker and improvements in technology.

High vs Low Inflation on Long-Term Economic Growth

An examination of trend inflation and economic growth in a number of countries indicates that inflation (above about 5 per cent) is negatively correlated with long-term economic growth. It may be that inflation raises uncertainty and, therefore, reduces incentives to invest in capital or improve technology. Inflation is rarely evenly spread, with the price of everything rising by the same percentage. The average increase in the price level may be 10 per cent, but some inputs and outputs rise by around 5 per cent and others by around 15 per cent. Business calculations of expected benefits and costs become difficult and riskier. The resulting lower investment and lower embodied technological growth reduces trend economic growth.

Gross National Income

Another way of measuring a countries economy. Gross national income (GNI) is defined as the sum of value added by all producers who are residents in a nation, plus any product taxes (minus subsidies) not included in output, plus income received from abroad such as employee compensation and property income.

Diminishing Returns to Capital

As more capital is added, there is less ability further to increase output per worker. A carpenter with a hammer is more productive, but a second and a third hammer are likely to be less and less useful. When everybody who can use a tool has as many as are worth the cost, the process of accumulating capital fizzes out. Output per worker plateaus. Growth of productivity stops.

Learning Curve (Learning by doing)

Because specialisation permits workers to repeat the same task many times, their productivity increases - 'practice makes perfect'. Each time the task is repeated, the worker the division of production into various parts in which different groups of workers specialise becomes more proficient, a phenomenon economists call learning by doing. Learning is a type of disembodied technological progress.

Calculating GDP (Production Approach)

Calculating the value added in production of Goods and Services (G&S)

1. Revisions to GDP

Data for GDP comes in slowly in reports and so the GDP calculations may not be up to date. In business or government, faults in GDP data, which become apparent only when the data are revised, can lead to mistaken decisions.

Expansion v Recession, Peak v Trough

EXPANSION is a positive trend along the scale - when the % rate of growth is INCREASING. DEPRESSION is a negative trend along the scale - when the % rate of growth is DECREASING. PEAK is the highest point before a depression. TROUGH is the lowest point before an expansion.

What causes rise of real GDP in the Long-run?

Eventually, growth in output per hour of work stops. Living standards will rise over time and level out. Labour and capital alone, therefore, cannot explain the phenomenal growth in real GDP that occurred; higher output levels per person and per hour of work are instead explained by continuing advances in technology. For ever-rising trend productivity, we require technology to keep improving.

Market Systems (Free v Interventionist)

Free markets can spontaneously coordinate activity system-wide and observably promote prosperity. Thus, FREE MARKET economics has merit in the LONGER TERM; esp. with market-friendly interventions and institutions. But markets can spontaneously malfunction system-wide and spread mal-coordination. Thus, INTERVENTIONIST economics has merit in the SHORTER TERM.

3. Quality of Life

GDP cannot measure the: - Happiness and well-being of people - Quality of life - Environmental Quality

Nominal GDP v Real GDP

Gross Domestic Product is the value of all goods and services produced by an economy over a period of time. GDP includes all private and public consumption, government outlays, investments, private inventories, paid-in construction costs and the foreign balance of trade (exports are added, imports are subtracted). The General Price level (P): The average price of total output (and its growth rate, inflation): Constant Price/Inflation-Corrected Price level: The average price of total output for the 'Base-Year'. Nominal GDP = Quantity of Total Output @ The General Price level Real GDP = Quantity of Total Output @ Inflation-Corrected Price Level For example: In the year 2000, GDP was $100 when the average price of an item was $1. This price and year is the 'Base Year'. When measuring 'Real GDP', inflation and deflation in prices (P) are ignored. In 2005, the average price went up to $1.20 but the quantity of total product was the same as 2000. Thus, with respect to the price inflation, Nominal GDP rose to $120 even though the quantity did not change. Real GDP, however, strips out the significance of prices (P). Real GDP in 2005 is calculated by using the same 'Base-Year' price as in 2000, which was $1. Therefore, as the quantity of output stayed the same, and the price inflation wasn't factored in, the GDP equals $100.

Shortcomings of GDP

Household activities: Cleaning, cooking, etc Voluntary Work Underground Economy

Human Capital

Increases in education and training can raise workers' productivity and are a source of a situation in which workers become more proficient by doing a particular task many times technological change. This training is termed human capital by economists, and is similar to physical capital such as factories and equipment.

Net Indirect Taxes

Indirect Taxes are the taxes that the government obtains through means of GST. When calculating GDP using the income approach, we must calculate NET Indirect Tax, which is: Total Indirect Tax - Subsidies

Transforming Inputs and Know-How into Outputs

Inputs are Labour and Capital. Labour is Population and is assumed to grow slowly. Capital include machinery, structures, land and is also assumed to grow slowly. Know-How is the advancement of technology and is assumed to grow steadily also. The steady growth of Inputs and Know-How grows production capacity over the trend. Thus, in the Long-run, we follow a trend. However, in the Short-run, UTILISATION of existing capacity can be highly unstable. This causes output fluctuation around the trend which is seen in the Expansions and Recessions of a cycle.

Technological Process

Invention: the origination of new knowledge and ideas - knowledge production Innovation: the adoption and deployment of ideas within a real world context - knowledge application Diffusion: the spread and retention of this applied knowledge and its replication, adaptation, refinement and absorption into rules and routines

Non-Excludeability

Meaning that the inventor of the technology cannot exclude other people from its use without enforceable legal rights. The legal system and the enforcement of intellectual property laws in part determine the degree of non-excludability. Intellectual property laws cover trademarks, copyrights and patents. T

2. Omissions to GDP

Most of the production omitted from GDP either does not occur in a formal market or is difficult for the government statisticians to measure. These include: Unpaid work, Leisure activities, Underground Economy, Quality Improvements of Goods and Services.

Shifting the PPC outwards faster (Long-Term)

Moving from A to B at step 1 involves lower material living standards (less consumption per person), which may impose hardship on much of the population (as occurred in Stalin's Russia). But the higher investment share results in a more rapid outward shift of the PPC. [It is possible to be more humane to the population by gradually moving vertically from A to C. This is done by by moving vertically onto higher PPCs as they gradually shift up. The share of C would gradually decline -the ray from the point between A and B and the origin would gradually rise- but the absolute size of consumption would be constant. This would be slower process but would involve less transitional hardship.]

Market Systems (Ideology v Science)

Policy need not be ruled by ideology; reason, discussion and wisdom are viable, but these methods differ from those at the heart of practising pure science (understood as the application of particular techniques of enquiry and testing, methods that include controlled experiments, modelling etc.). Science may be used to inform policy-making.

Positive v Normative Statements

Positive: ordinary observation, theories of causality, maths, measurement using instruments, evidence and scientific tests Normative: ethics, philosophy, religion, appeals to life experience and wisdom, illumination via art and literature ... Positive economic statements do not have to be correct, but they must be able to be tested and proved or disproved. Normative economic statements are opinion based, so they cannot be proved or disproved.

PPC

Production Possibilities Curve The production possibility frontier (PPF) is a curve depicting all maximum output possibilities for two goods, given a set of inputs consisting of resources and other factors. The PPF assumes that all inputs are used efficiently. A-F are possible, given existing laws, tax incentives, attitudes, organisations etc... (These are included in 'technology, very broadly defined.) Institutions include minimum wage laws, unions, Occupational Health and Safety, certification standards, hire & fire laws, tax incentives... Labour's availability for production refers to skill sets, location, willingness to work etc. We don't know about preferences ($ values of A-F), so we can't really say where the 'best point is: in practice it's unlikely to be at A or F, but certainly not D (just because it 'sticks out the most'). Q is possible in the Short-Run by overworking workers. This is inefficient as it will over tire workers creating a recession in the Lon-run.

Capital Income

Profits, rental payments and interest payments as capital income. Profits include the profits of large companies such as Coles and Woolworths, and also the income of small businesses and farms.

Recovery

RECOVERY is the time after a trough in which an expansion of GDP is occurring but is still in a slump below the trend.

Rule of 72

The 'Rule of 72' is a simplified way to determine how long an investment will take to double, given a fixed annual rate of interest. By dividing 72 by the annual rate of return, investors can get a rough estimate of how many years it will take for the initial investment to duplicate itself. eg. If growth is 9% per year, 72/9 = 8. Growth will double every 8 years.

Unemployment (Measurements)

The Labour Force = The employed + The unemployed The % rate of unemployment is [Number unemployed/Labour Force] x 100 Employed = working > 1hr a week. Unemployed = working < 1 hr in a week and actively looking for work (within the last 4 weeks) and is ready to get started (within a week if an offer is made Underemployed (Still Employed) = Anyone working 1 or more hours per week who wishes to work more hours.

Shifts in the PPC

The PPC can be shifted inwards or outwards depending on Technological advancements, changes in resources, human capital, labour, etc. Shifting the PPC outwards shows a growth in real GDP while shifting it inwards shows a decrease.

The Effect of Investment in Human Capital

The decision to invest in human capital is influenced by considerations similar to those motivating investment in physical capital: the cost of the investment versus the expected return. Investing in higher education may require debt-financing if the investment is not funded by the government or if education is provided only by the private sector. In Australia, schemes such as the Higher Education Loan Program (HELP) provide fee subsidies and loans to university students and may encourage investment in higher education more than relying on market forces.

Net Exports (NX)

The difference between exports and net exports (NX) the value imports.

Division of Labour

The division of production into various parts in which different groups of workers specialise

What is Consumption? (C)

The first category, consumption (C), includes purchases of final goods and services by individuals or households. In the Australian national accounts, this item is called household expenditure, or private final consumption expenditure.

Natural Rate of Unemployment

The natural rate of unemployment (u*) occurs when there is neither a slump nor a boom and real GDP is equal to potential GDP(i.e. the economy is on its PPC) This is also where Real GDP = Potential GDP. Thus, the Natural Rate of Unemployment and the PPC/Economic/Business Cycle follow the same trend. Boom : Y>Ystar, u<ustar, Cyclical Unemployment is less than 0 (UC<0) Slump: Y<Ystar, u>ustar, Cyclical Unemployment is greater than 0 (UC>0)

New Growth Theory

The new growth theory is an economic growth theory that posits humans' desires and unlimited wants foster ever-increasing productivity and economic growth. The new growth theory argues that real GDP per person will perpetually increase because of people's pursuit of profits. Growth in Solow's model (Ch.4) is self-limiting because of diminishing returns to physical capital accumulation But ongoing (cumulative, compound) growth is possible... Investment in 'knowledge capital' [know-how] does not have diminishing returns and may even have... increasing returns, implying accelerating growth and... ... divergence if new ideas cannot be transferred to poor countries

Types of Investment (I)

When a cafe buys a new microwave oven, it is part of investment. (If a household bought an identical item, the purchase would be regarded as consumption. Residential: The purchase of dwellings (that is, new houses and apartment buildings). purchases of new houses and apartments Although many of these purchases are made by households rather than firms, they are included in investment because they produce services over a long period of time. Business Fixed: Investment by businesses in physical capital, such as factories and equipment. Inventory: Inventory investment is defined as the change in inventory (or stock), which is the goods on store shelves, on showroom floors or in warehouses that have not yet been sold or assembled into a final form for sale - for example, cars in the yard of a car dealership are part of the dealership's inventory. NOTE: To a macroeconomist, Investment means the purchase of new factories, machinery, houses or inventories. These raise potential output in the future. Investment IS NOT 'investing' money into eg. stocks. That is a transfer of wealth. NOT included in GDP.

Labour plus Capital (Production Function)

When capital is included, the production function becomes Y5F(L, K), where K stands for capital. Output can be increased by using more capital, even when labour is held constant. Consider the vineyard example again. A wheelbarrow or a ladder helps workers harvest the grapes. By increasing the amount of capital in the economy, more real GDP can be produced with the same number of workers. Initially, the analysis ignores the need to allocate resources for the maintenance of capital or to offset depreciation. In reality, net investment needs to rise to raise the stock of capital. Figure 4.4 illustrates how more capital raises output.

Purchasing power Parity

When comparing the GDP of different countries, we must give adjust wealth for exchange rate, but also purchasing power. The purchasing power of local currency equivalent of a US dollar is much less in Australia than in Indonesia. Statisticians and econometricians estimate GDP at purchasing power parity (PPP), for example, by converting each country's GDP into US dollars that have the same purchasing power in that country as they would have in the United States. Indonesia's economy is measured as more than double the size of Australia's when adjustment is made for Australia's high relative cost of living. I

Non-Rivalry

When viewed as a producible commodity, technology (know-how) is characterised by: non-rivalry, meaning that the use of the technology does not diminish the stock available to be used.

Double Counting

While the production approach is the sum of value of all new goods and services produced, we must be careful not to double count. GDP only looks at the final value of a product. As seen in the example, Coffee beans are sold for a price, used in a coffee and sold for another price. The final consumption price of the Coffee is your GDP. Do not double count the beans by counting the beans sold at the start and the coffee made using those beans. Just use the FINAL sale price of Goods and Services to calculate GDP.

Algebraic Layout for Spending Approach

Y = GDP C = Consumption I = Investments G = Government Expenditure NX = Net Exports AE = Aggregate Expenditure Y = C + I + G + NX = AE

Calculating GDP (Spending Approach)

Y = consumption + investment + government expenditure + net (exports - imports) Consumption = G&S bought by households, Investment = G&S bought by firms, Government Expenditure = G&S bought by Government

Labour and Capital with Technology (Production Function)

Y=F(L, K, Te) Y = Real GDP F = Function of Real GDP L = Labour K = Capital Te = Technology This function identifies labour, capital and technology as inputs to production.