Unit 2: Economic Indicators and the Business Cycle

In between lines business cycle

"trend line" = "potential output" = "full-employment output" = GDP over long term Full-employment = level of GDP where unemployment = natural rate of unemployment - Diff btwn Peak & Potential Output = Positive Output Gap - Diff btwn Trough & Potential Output = Negative Output Gap

Labor-force participation rate

% of the adult population that is in the labor force

expenditure approach

(primary method for this class) 1) Consumption (C) 2) Investment (I) 3) Government Purchases (G) 4) Net Exports (NX) Y = GDP Y = C + I + G + NX

Benefits from investment from abroad

- Some benefits flow back to the foreign capital owners - Increase the economy's stock of capital = - Higher productivity and higher wages - State-of-the-art technologies developed in other countries - Especially good for poor countries that cannot generate enough saving to fund investment projects themselves (ex. World Bank helps) ~~~ foreign investment in Mexico raises the income of Mexicans (measured by GNP) by less than it raises the production in Mexico (measured by GDP).

GDP does not value

- The quality of the environment - Leisure time - Non-market activity, such as the child care a parent provides at home - An equitable distribution of income

why is housing weird

- cars can depreciate, house value fluctuates - you can renovate house to drive up market price

structural unemployment

- when less jobs than workers (usually long-term) - occurs when wage above equilibrium (happens bc:) 1) MINIMUM-WAGE LAWS - least skilled workers won't get jobs (since there's less jobs bc of higher minimum wage) - this group is small part of labor force, so min.wage can't explain most unemp. 2) UNIONS - Worker association that negotiates with employers over wages, benefits, and working conditions - use market power for higher wages -- Unions raise the wage above equilibrium = ↓ quantity labor demanded = ↑ unemp. - "insiders" remain employed = better off - "outsiders" lose job, worse 3) EFFICIENCY WAGES - Firms voluntarily pay above-equilibrium wages to boost worker productivity ~4 reasons why firms pay 1) Worker health - In less developed countries, poor nutrition is a common problem. - eat better = makes them healthier = more productive 2) Worker turnover - hiring/training new ppl is costly (gives workers incentive to stay) 3) Worker quality - attracts better job applicants, up quality of firm's workforce 4) Worker effort - (fired = not consequence bc so many jobs) not enough jobs to go around, workers have more incentive to work

frictional unemployment

- workers spend time searching for the jobs that best suit their skills and tastes (short-term for most) - job search: matching workers w/ the right jobs - sectoral shifts: Changes in the composition of demand among industries or regions (displaces workers, who must look for new job)

4 phases of Business Cycle

1) Expansion - real GDP ↑ - unemployment rate ↓ - inflation may accelerate - Early part of this phase is also called the Recovery Phase 2) Peak - real GDP @ highest - unemployment rate usually low 3) Contraction - real GDP ↓ - unemployment rate ↑ - As this continues, inflationary pressure subsides - ↑ at a slowed rate - Later part of this phase is also called the Recession Phase 4) Trough - real GDP @ lowest - if particularly deep = depression (real GDP exceptionally ↓, unemployment very ↑, point where recession becomes depression unclear!)

3 approaches for calculating GDP

1) Expenditure Approach 2) Income Approach 3) Value-Added Approach

How public policy (govt) can affect long term growth in productivity/living standards

1) Saving & investment - ↑ future productivity by investing ↑ current resources in the production of capital - Trade-off: resource scarce, making ↑ capital (savings) = making ↓ consumption goods currently - This extra saving funds the production of investment goods 3) Investment from abroad - Foreign direct investment: capital investment that is owned and operated by a foreign entity (ex. Ford factory in Mexico) - Foreign portfolio investment: investment financed w/ foreign money but operated by domestic residents (ex. US buy stock of in Mexican company, who use that to make new factory) 4) Education - investment in human capital (gap in wages btwn educated/not workers - opp cost = lost wages) - creates positive externality (effects of someone's actions on a bystander) more return for country rather than just individual - brain drain is problem for poor countries: emigration of educated ppl to rich countries (ppl can enjoy higher standard of living) 5) Health and nutrition - health care expenditure = investment in human capital (healthier workers more productive) - vicious (can be virtuous) circle in poor countries (poor bc not healthy, not healthy bc poor) 6) Property rights and political stability - Markets a great way to organize economic activity - Protect property rights (the ability of people to exercise authority over the resources they own) Prerequisite for the price system to work - courts enforce prop. rights (w/o it, contracts hard to enforce, fraud goes unpunished - firms bribe govt officials for permits) - Political instability (e.g., frequent coups): Creates uncertainty over whether property rights will be protected in the future - When ppl fear their capital may be stolen by criminals/confiscated by a corrupt government (Less investment, including from abroad, and the economy functions less efficiently) - economic stability, efficiency, healthy growth = needs law enforcement, honest govt 7) Free trade - trade makes everyone better off -- inward-oriented policies: raise living standards w/o interacting w/ other countries (ex. tariffs, limits on investment abroad) failed to create growth -- outward-oriented policies: promote integration w/world economy (ex. eliminate trade/foreign investment restrictions 8) Research and development - Tech progress: Main reason why living standards rise over the long run - Knowledge is public good - shared freely, inc productivity of many - policies to promote tech progress: Patent laws; Tax incentives/direct support for private sector R&D; Grants for basic research at universities 9) Population growth - large pop = more workers to produce more, more consumers ---pop. growth affect living standards in 3 diff ways 1) Stretching natural resources - Thomas Robert Malthus - pop growth will strain society's ability to provide for itself = mankind forever live in poverty - failed to account tech progress/productivity growth 2) Diluting capital stock - high pop. growth (higher L) - spread capital stock more thinly (lower K/L) - lower productivity/living standards - govt policy to limit pop growth (equal opp for females instead of having kids, child regulation, birth control awareness) 3) Promoting technological progress - more people = More scientists, more inventors, more engineers = More frequent discoveries - Michael Kremer: Growth rates increased as the world's population increased, More populated regions grew faster than less populated ones

Problems with the CPI

1) Substitution Bias - over time, some prices rise faster than others (consumers sub w/ goods that are cheaper) - cpi misses this bc it uses fixed basket of goods (overstates increases in cost of living) 2) Introduction of New Goods - new goods = ↑ variety, allows consumers to have goods more for their needs = $ becomes more valuable - cpi misses this bc it uses fixed basket of goods (overstates increases in cost of living) 3) Unmeasured Quality Change - improvements in quality of goods in basket = ↑ value of each $ - BLS tries to account, but misses some bc quality hard to measure - cpi overstates increases in cost of living

Income Approach

1) Total National Income (sum of wages, rent, interest, profits) 2) Sales Taxes (taxes on consumers for purchase of goods) govt's income 3) Depreciation (Cost of goods as their value is reduced) 4) Net Foreign Factor Income (Total income of citizens in foreign countries - Total income of foreigners in domestic country) GDP = Total National Income + Sales Taxes + Depreciation + Net Foreign Factor Income

2 key facts about incomes and growth around the world

1) Vast differences in living standards around the world. 2) Great variation in growth rates across countries.

REMEMBER

1) check if it's purchased/done this year 2) check if the thing is evened out by net exports, then GDP can be unchanged

How to Calculate CPI

1) fix the basket 2) find prices 3) compute basket's cost

Circular-flow diagram omits

1) govt - transfers - taxes (both take $ and push it somewhere else, DON'T COUNT) - govt purchases DO COUNT GDP 2) Financial system - take $ and push it somewhere else, DON'T COUNT 3) Foreign sector - imports/exports included in GDP

Public Policy for unemployment

1) govt employment agencies Provide information about job vacancies to speed up the matching of workers with jobs. 2) Public training programs equip workers displaced from declining industries with the skills needed in growing industries.

Contrasting CPI and GDP Deflator

1) imported consumer goods - CPI = yes - GDP Deflator = no 2) capital goods - CPI = no - GDP Deflator = yes (if made domestically) 3) The basket - CPI uses fixed basket - GDP deflator uses basket of currently produced goods & services - MATTERS IF DIFF PRICES ARE CHANGED BY DIFF AMTS ~ gdp always fluctuates more often

Consider a small economy in which consumers buy only two goods - apples and pears. In order to compute the consumer price index for this economy tor two or more consecutive ears. we assume that a) the number of apples bought by the typical consumer is equal to the number of pears bought by the typical consumer in each year. b) neither the number of apples bought by the typical consumer, nor the number of pears bought by the typical consumer, changes from year to year. c) the percentage change in the prices of apples is equal to the percentage change in the prices of pears from year to year. d) All of the above are correct.

B CPI is a fixed basket! they trace price of orange, not amount

3 groups of people

Bureau of Labor Statistics (BLS), in the U.S. Dept. of Labor - 16 yrs old+ 1) Employed: paid employees, self-employed, unpaid workers in a family business 2) Unemployed: ppl not working who have looked for work during previous 4 weeks 3) Not in the labor force: everyone else

Which of the following would not be included in Switzerland's GDP for the year 2008? a) car made in Switzerland in 2008 but sold in 2009 b) a tire made in Switzerland in 2008 and sold to a consumer through an auto shop in 2008 c) a set of screws meant for a table that was planned to be completed in Switzerland in 2008 but was not completed until 2010 d) a concert ticket that was created and sold in Switzerland in 2008 e) an audio system made and completed in Switzerland and then sold to a US citizen in New York in 2008

C

Which of the following items are used to calculate GDP? A) The purchase of glass by a car manufacturer to make cars B) The purchase of paint by a house painter C) The purchase of sweet corn by a consumer D) The payment for babysitting services done by a teen on a Friday evening E) The graduation gift received by a student from his or her family member

C ---- A/B: intermediate D: no one will track that (informal market) E: gift (not purchase)

economy's inflation rate

Compute % inc in the GDP deflator from one year to the next

CPI

Consumer Price Index measures: - overall level of prices - overall cost of goods/services bought by a typical consumer - typical consumer's cost of living - basis of COLAs (Cost of Living Adjustments) in contracts & Social Security - computed & reported every month by Bureau of Labor Statistics

Productivity and its determinants

Country's standard of living depends on its ability to produce goods and services Productivity = Y/L (output per worker) Y = real GDP = quantity of output produced L = quantity of labor - growth in productivity = growth in living standards - economy's income = economy's output DETERMINANTS 1) PHYSICAL CAPITAL per worker K/L - productivity Y/L ↑ when average worker has ↑ machines/equipment etc. K/L 2) HUMAN CAPITAL per worker H/L - productivity Y/L ↑ when average worker has ↑ education, skills, etc. H/L 3) NATURAL RESOURCES per worker N/L - productivity Y/L ↑ when more N allows a country to produce more Y 4) TECHNOLOGICAL KNOWLEDGE - society's understanding of the best ways to produce goods/services (ex. Ford assembly line, patents) allows society to get more output from resources

Cyclical unemployment

Deviation of unemployment from its natural rate - Associated with business cycles - Real Output - reduced when cyclical unemployment takes place

GDP

Gross Domestic Product total income of everyone in the economy + total expenditure on the economy's output of goods/services income = expenditure (for economy as a whole) bc one's expenditure is another's income geography not residents ~~ measures short-term economic growth - If GDP is overproducing, CPI is high in price - consumers unwilling to purchase goods - surpluses - If CPI is low in price, GDP is under producing - consumers more willing to purchase goods - shortages Best case scenario: Price Stability - average level of prices is not increasing or decreasing in real terms

GNP

Gross National Product includes all goods and services created by national residents (not geography)

Real GDP per capita

Main indicator of the average person's standard of living

nominal vs real interest rate

NOMINAL: Interest rate not corrected for inflation (dollar value) REAL: Corrected for inflation (purchasing power) Real interest rate = (nominal interest rate) - (inflation rate)

Natural rate of unemployment

Normal rate of unemployment around which the actual unemployment rate fluctuates

U-Rate Doesn't Track:

Not a perfect indicator of joblessness or the health of the labor market - excludes: - discouraged workers - not distinguish btwn full-time and part-time work (or part-time bc full-time not available) - some ppl misreport work status kinda good tho for labor market and economy

Technological knowledge vs. Human capital

TECH KNOWLEDGE society's understanding of how to produce goods and services HUMAN CAPITAL Results from the effort people expend to acquire this knowledge

Labor Force

The total # of workers = Employed + Unemployed

Unemployment insurance

UI govt program that partially protects workers' incomes when they become unemployed inc frictional unemp. - ppl respond better to incentives - UI benefits end when a worker takes a job -- workers have less incentive to search/take jobs BENEFITS - ↓ uncertainty over incomes - Gives the unemployed more time to search = better job matches, ↑ productivity

The Production Function

Y = A F(L, K, H, N) graph/equation shows relation btwn outputs & inputs F( ) = function to show how inputs combined to produce output A = level of technology - inc A = more output (Y) SCALE (increase all inputs 10% = outputs inc 10%) 1.1 Y = A F (1.1L, 1.1K, 1.1H, 1.1N) AF STAY THE SAME! if we multiply each input by 1/L: Y/L = A F(1, K/L, H/L, N/L) shows that productivity (Y/L, output per worker) depends on 1) level of tech A 2) Physical capital per worker, K/L 3) Human capital per worker, H/L 4) Natural resources per worker, N/L

Large GDP =

a country can afford - better schools - cleaner environment - health care, etc.

GDP deflator

a measure of the overall price level - change in prices

government purchases

all spending on goods and services by local, state, and federal governments G includes - employees NOT INCLUDE TRANSFER PAYMENTS - ex. social security, unemployment insurance benefits (not purchases, just taking $ one place and putting to other) counting same thing already in consumption

Consumer Price Index (CPI) measures a) Changes in the prices of all goods and services in an economy over time b) Change in the price of a select group of consumer goods and services over time

b because not all!! select consumers

graph shape - compare current and 2013 dollars

current = dollars of given year SAWTOOTH - slowly decrease value bc inflation - sharp increase bc minimum wage adjusted

GDP per capita shows

growth of living standards over time

Duration of Unemployment

most observed unemployment is long term. - small group of long-term unemployed ppl has fairly little turnover, so it accounts for most of the unemployment observed over time. this can help make better policies to help unemployed

base year

nominal GDP = real GDP

Value-Added Approach

price of output - cost of input = value added used for individual good/industry ex. tomatoes price - cost = how much value added to economy $1.10 - $0.80 = $0.30

Business Cycle

short term: defined in quarters, show ups and downs of economy bc of - real GDP (sometimes aka Aggregate Output/Real Output) - Price Stability - Employment (determined by unemployment rate of labor force) long term: economies on steady up

unemployment is short-term and long-term

short-term

The circular-flow diagram

simple depiction of the macroeconomy shows GDP as: EXPENDITURE - spending - factor payments (payments to factors of production, ex. wages, rent) INCOME - revenue - income

net exports

spending on domestically produced goods by foreigners (exports) minus spending on foreign goods by domestic residents (imports) NX = exports - imports exports: foreign spending on the economy's goods and services Imports: are the portions of C, I, and G that are spent on goods and services produced abroad - not counted in GDP

Gross Domestic Product is...

the market value of all final goods & services produced within a country in a given period of time 1) market value - all goods measured in same units $ - things that don't have market value are excluded (ex. clean air, housework u do for urself) 2) all - GDP includes what is made/sold legally - NOT INCLUDE stuff sold illegally, items made/had @ home 3) final - final good: meant for end user (GDP ONLY COUNTS THIS, already embody value of intermediate goods) - intermediate good: used as components in production of other goods 4) goods & services - tangible goods & intangible services (ex. dry cleaning, concerts, phone service) 5) produced - currently produced (not made in past) 6) within a country - value of production within country's borders (done by own citizens/foreigners located there) - imports dont count, exports do! 7) given period of time - usually 1 yr / quarter (3mon)

capital stock

the plant, equipment, and other assets that help with production.

real GDP

the production of goods and services valued at constant prices value of goods while adjusting for inflation

nominal GDP

the production of goods and services valued at current prices value of goods without adjusting for inflation

Types of unemployment

there's always unemp! 1) FRICTIONAL UNEMP. 2) STRUCTURAL UNEMP.

consumption

total spending by households on goods & services C includes - rent payments (RESIDENTIAL) - homeowners - imputed rental value of house NOT INCLUDE mortgage payments & purchases of new housing

investment

total spending on goods that will be used in the future to produce more goods I includes - business capital (business structures, equipement, intellectual property products) - residential capital (landlord's apartment building; a homeowner's personal residence - inventory accumulations (goods produced but not yet sold) NO FINANCIAL CAPITAL (ex. investing in stocks) ** INCLUDES initial purchase of a house, landlord's purchase of making apartments?

Dollar figures from different times

turn nominal into real

Unemployment rate

u-rate: % of the labor force that is unemployed

long-run equilibrium

when the real GDP equals the potential GDP (on business cycle graph)

Demand-Pull Inflation

↑ demand for goods/services - bc right shift in demand (supply & demand curve) - ex. exiting lockdown, panics

Cost-Push Inflation

↓ supply of goods/services - bc left shift in supply (supply & demand curve) - ex. input price ↑, logistical issues