Macro Midterm 1

GDP in 2016

$18.6 trillion - $57, 500 per person

consumption good

A Consumption good is any good purchased for consumption and not later used for the production of another good .

Aggregate Labor Supply

Macroeconomic determinants of labor supply -Size of the working age population • Domestic birthrate • Immigration and emigration • Ages when people enter and retire from the workforce -Share of working-age population willing to work • LFPR

Adjusting Wages for Inflation

Real Wage is the purchasing power of the workers' nominal wages. • Real wage for year X = nominal (dollar) wage in year X divided by the CPI for year X • Real wages (of US Production workers - non supervisory) were marginally higher in 1970 than in 2007.

Cyclical Unemployment

The extra unemployment that occurs during periods of recession -Although relatively short-lived, they are associated with significant declines in real GDP and can be associated with significant economic costs -results when the overall demand for goods and services in an economy cannot support full employment. It occurs during periods of slow economic growth or during periods of economic contraction.

Explaining labor market trends

The problem in the U.S. is - Stagnant real wages post 1973, and, - Increasing wage inequality • We will see how demand, supply and equilibrium in the labor market can help us explain the trends in real wages, employment, and wage inequality for the US

GDP Expenditures Equation

Y = C + I + G + NX

four groups of final users

1. household: consume 2. firms: investment 3. governments: government purchases 4. private sector: buys nations exports

Diminishing Returns

Diminishing returns to capital occurs when an addition of capital with other inputs held constant increases output by less than the previous increment of capital - Assumption: all inputs except capital are held constant - Result: output increases at a decreasing rate •When a firm has many machines, the most productive uses have already been filled - The increment in capital will necessarily be assigned to a less productive use than the previous increment - Principle of Increasing Opportunity Cost - Low Hanging Fruit Principle

Economic Investment

Economic investments (are added to GDP) -These are the production of capital goods used to produce other goods • This value is based on the purchase price of the capital goods, not on stock value

incomes of capital and labor

GDP also = capital income + labor income capital income: is made up of payments to owners of physical capital (such as factories, machines, and office buildings) and intangible capital (such as copyrights and patents). The components of capital income include items such as profits earned by business owners, the rents paid to owners of land or buildings, interest received by bondholders, and the royalties received by the holders of copyrights or patents. labor income: comprises wages, salaries, and the incomes of self employed

GDP Deflator

The GDP deflator for year 2017 is: • If the Real GDP is expressed say in 1982 dollars, then the GDP deflator for the year 1982 will be 100. • The three price measures have significant differences - CPI includes imports and sales/excise taxes, PPI does not. - The GDP deflator will include defense equipment; the other two will not. • Despite the differences, the CPI, PPI and GDP deflator often move closely together although the PPI shows greater variability compared to the other two.

Minimum Wage?

The Minimum Wage was not indexed to inflation when introduced in 1950. What would the minimum wage have been today had it been indexed? - Real Minimum Wage in 1950 = $0.75/0.241 = $3.11 in 1982-84 dollars -To maintain a real value of $3.11, current (average CPI 2018) Minimum Wage should be raised to $3.11 2.51 = approx. $7.80 - The current Fed Min Wage is $7.25

U.S. Real GDP per Person and Average Labor Productivity, 1960- 2016

Why is the Real GDP per Worker graph above the Real GDP per Person graph? -Because, the population is larger than the number of workers.

net exports

exports minus imports Net exports equal exports minus imports -Exports are goods and services produced domestically and sold abroad • Exports reduce the amount available to the domestic economy - Imports are purchases in the US of goods and services produced abroad • Imports can be consumption, investment, or government spending • Imports increase the amount available to the domestic economy

Structural unemployment

is long-term, chronic unemployment in an otherwise well-functioning economy -Lack of skills, language barriers, or discrimination -Structural shifts in production create a long-term mismatch between workers and market needs -Barriers to employment such as ■ Minimum wages ■ Unions ■ Unemployment Insurance - High economic, psychological, and social costs - Example: U.S. steel, manufacturing

Duration of unemployment

longer unemployment the worse the costs

nominal interest rate (or market interest rate)

the annual percentage increase in the nominal value of a financial asset

real interest rate

the annual percentage increase in the purchasing power of a financial asset; the real interest rate on any asset equals the nominal interest rate on that asset minus the inflation rate -real rate of return

duration

the lengths of an unemployment spell -rises during recessions, reflecting the greater difficulty of finding work during those periods

Marginally Attached Workers

would like to have a job but they have not looked for work in the past four weeks -Counted as out of the labor force -Willing and ready to work -Could be counted as unemployed but they are not

income inequality

• From WWII until 1970s, the income gap between the rich and poor, while significant, did not change very much. • After the 1970s economic growth slowed and the dispersion in incomes between the rich and poor increased substantially. As of 2016, - The average annual income of the top 1% of Americans is $1,153,293. You need to make at least $389,436 to be in the top 1% income bracket. - The average annual income of everyone else (bottom 99%) is $45,567. - The top 1% takes home 20.1% of all the income in the United States.

The cost of unemployment

1. economic: -output lost, incomes fall and skills may deteriorate, liable to stop paying taxes, eligible for benefits (cost to all tax-payers) 2. psychological: -mostly felt by unemployed workers and their families: loss of self esteem, depression, suicide, loss of control, 3. social costs: -result of psychological and economic effects: increase in crime, domestic violence, alcoholism, drug abuse, and other social problems-- leads to more public resources being spent (more police or social services)

Shifts in Labor Supply

A shift in labor supply is caused by any change in the number of workers willing to work at each wage -Increase in the working-age population • Baby Boom • Higher net immigration • Increasing age at retirement - Increase in the share of working-age population willing to work •Women's participation in the labor force has increased in the last 50 years - It has fallen some since 2000

Final Vs. Intermediate: Treatment of the Government Sector

All Government spending is valued arbitrarily as there are no markets for government services. • So they are all valued at Cost. • For simplicity all government expenditure is considered to be on final goods and services although some are really on intermediate goods and services.

Is the CPI a Cost of Living Index?

Although flawed, it is the best approximation that we have. •A true cost-of-living index should measure changes over time, in the amount that consumers need to spend to reach a certain utility level (i.e., a level of well being) or standard of living. However, a person's well being or standard of living is often determined by non-market factors like political stability, human rights, environmental factors, social, cultural and religious freedoms, etc. - all of which affect consumers' well-being but are not recorded in the CPI.

Expected and Actual Real Interest Rates

At the time of purchasing the asset with a fixed nominal interest rate, the future inflation rate and therefore the future real interest rates are unknown. •We make calculations about the expected real interest rates based on current information. The concept of Real Interest rates explains why unexpected inflation benefits borrowers and hurts lenders - For a given nominal interest rate, the higher the inflation rate, the lower the real interest rate, which is good for borrowers • High expected inflation may not hurt lenders if they can adjust the nominal interest rates appropriately • Inflation-Protected Bonds pay a fixed real interest rate . People who buy these bonds receive a nominal interest rate equal to the fixed real interest rate plus the actual inflation rate. •Owners of Inflation-Protected Bonds suffer no loss in real wealth even if inflation is unexpectedly high.

Chain Weighting

Bureau of Economic Analysis (BEA) calculates GDP -Real GDP uses a chain weighting approach •Less sensitive to the choice of the base year •Uses Geometric average (GA of X1, X2, ..., Xn, is the nth root of X1*X2*X3* ... *Xn) Suppose the first ratio equals 1.06 and the second ratio is 1.03. •The chain-weighted ratio of real GDP between 2008 and 2007 is √1.06 * √1.03 = 1.0449 = A 4.49% rise •The simple arithmetic average would be (1.06+1.03)/2 = 1.045 = A 4.5% rise

quality of life

GDP does not account for intangibles. People value - Low crime rates - Low traffic congestion - High quality and quantity of civic organizations - Existence of open space - Sense of community • These have value but are not added to GDP • Real GDP overstates the true well-being What makes a particular town or city an attractive place to live? Some desirable features you might think of are reflected in GDP: spacious, well-constructed homes, good restaurants and stores; a variety of entertainment; and high-quality medical services. However, other indicators of the good life are not sold in markets and so may be omitted from GDP. Examples include a low crime rate, minimal traffic congestion, active civic organizations, and open space. Thus, citizens of a rural community may oppose the construction of a new shopping center because they believe it may have a negative effect on the quality of life—even though the new shopping center may increase local GDP.

understanding growth

GDP per capita increases when -Output per worker (Y / N) increases OR -The share of the population employed (N / POP) increases •Between 1960 and 2016, -Real GDP per capita increased by 200% - Real GDP per worker (average labor productivity) grew by 133% - The share of the population employed increased from 36% to 47% Share of population employed (N/POP) rose from 36% to 47% of the entire population. Why? -increase in labor force participation of women - the share of working age population (age 16 -65) in total population rose (coming of age of baby boomers and immigration). •Rise in N/POP is expected to slow down. Why? -female LFPR has stabilized and is falling -baby boomers began retiring around 2001 - LFPR of young adults is also falling

Frictional Unemployment

The short-term unemployment associated with the process of matching workers with jobs. -These are short-term - May lead to a better match between the worker and job -May increase efficiency and is necessary in a dynamic economy - Low economic costs -It is sometimes called search unemployment and can be based on the circumstances of the individual. It is time spent between jobs when a worker is searching for a job or transferring from one job to another

Summary observations for counteracting relative price changes and inflation

To counteract relative price changes, government policy should try to make appropriate changes in the market for that specific good or service. -To counteract inflation, the government must use economy-wide monetary and/or fiscal policy to bring about changes to the overall economy.

Big Mac Index

Tool for calculating purchasing power parity that compares prices of a Big Mac throughout the world. • The Big Mac index was invented by The Economist in 1986 as a lighthearted guide to whether currencies are at their "correct" level. • The concept of a "Correct" level based on the theory of purchasing-power parity (PPP), is the notion that in the long run exchange rates should move towards the rate that would equalize the prices of an identical basket of goods and services (in this case, a burger) in any two countries. • For example, the average price of a Big Mac in America in January 2018 was $5.28; in China it was $3.17 at market exchange rates • So the Big Mac index says that the Yuan (RMB; renmibi) was undervalued by 40% = [(3.17 - 5.28)/5.28].

Real GDP

a measure of GDP in which the quantities produced are valued at the prices in a base year rather than at current prices; real GDP measures the actual physical volume of production Real GDP values output in the current year using the prices from the base year -The base year is a reference year that changes infrequently -Real GDP measures the physical volume of production

price index

a measure of the average price of a given class of goods or services relative to the price of the same goods or services in a base year

price level

a measure of the overall level of prices at a particular point in time as measured by a price index such as the CPI -recall: inflation rate is the percentage change in the price level from year to year

deflation

a situation in which the prices of most goods and services are falling over time so that inflation is negative -1930s was last time USA experienced significant deflation

involuntary part-time workers

are people who say they would like to work full-time but are able to find only part-time work. Because they do have jobs, involuntary part-time workers are counted as employed rather than unemployed. These workers are sometimes referred to as underemployed or part-time workers for economic reasons. Some economists have suggested that these workers should be counted as partially unemployed

nominal quantity

is measured in terms of its current dollar value. a quantity that is measured in terms of its current dollar value -can use CPI to adjust for real terms

rate of inflation

is the annual percentage rate of change in the average price level, measured, for example by the annual percentage rate of change in the CPI (or the PPI or the GDP deflator). -CPI is a measure of the average level of prices in the base year while inflation is a measure of how fast the average price is changing over time -annual percent rate of change in the price level as measure for example by the CPI Example: 2016 CPI 1.25 and in 2017 1.27 -Inflation is percent increase in the price level or the increase in price level (0.02) divided by the initial price level (1.25) which is 1.6 percent "In general, unexpectedly high inflation rates help borrowers at the expense of lenders because borrowers are able to repay their loans in less-valuable dollars."

government purchases

purchases by federal, state, and local governments of final goods and services; government purchases do not include transfer payments, which are payments made by the government in return for which no current goods or services are received, nor do they include interest paid on the government debt -like fighter planes and teaching in public schools

labor force

the total number of employed and unemployed people in the economy

long-term unemployment

those looking for work 27 weeks or longer? -6 months or longer -highest costs for individuals and society have been out of work for 6 months or longer; specific BLS definition: 27 weeks or longer

Gross Domestic Product (GDP)

" the market value of the final goods and services produced in a country during a given period " -link between high output associated with high living standard -some public goods (ie. education, highways, military) supplied by government measured by cost (salaries, textbooks): adds to GDP even if poorly spent by government. GDP is a weighted average: -Market value of the final goods and services is used to add up the quantities of different goods and services into one measurement -Calculating GDP for Nation A producing three goods: X, Y and Z with prices PX, PY, and PZ, respectively is • GDP =(X PX) + (Y PY) + (Z PZ) Spending, Income and GDP GDP is an aggregate measure of quantities produced •More expensive items receive a higher weighting -Rationale - willingness to pay is an indication of benefit received from the good

Why is redistribution bad for economy?

"Although redistributions caused by inflation do not directly destroy wealth, but only transfer it from one group to another, they are still bad for the economy. Our economic system is based on incentives. For it to work well, people must know that if they work hard, save some of their income, and make wise financial investments, they will be rewarded in the long run with greater real wealth and a better standard of living. Some observers have compared a high-inflation economy to a casino, in which wealth is distributed largely by luck—that is, by random fluctuations in the inflation rate. In the long run, a "casino economy" is likely to perform poorly, as its unpredictability discourages people from working and saving. A high-inflation economy encourages people to use up resources in trying to anticipate inflation and protect themselves against it."

Financial investment

(are not added to GDP) -Purchases of stocks, bonds, and other financial assets - These purchases generally transfer ownership of a portion of the firm's existing capital stock - Does not correspond to any increase in physical capital or production capacity, in most cases •New stock issues can be an exception

Impediments to Full Employment

- Here are some structural features of the market that lead to long-term and/or chronic unemployment •Minimum Wage Laws •Labor Unions •Unemployment Insurance •Other Govt. Regulations like Health and Safety regulations Many of these impediments can explain the differences in the employment rate between the USA and Western Europe •European labor markets are highly regulated -High minimum wage -Very generous unemployment benefits -More powerful unions • This, combined with globalization and skill-biased technological change, has reduced employment in Europe - Many workers aren't worth employing because their VMP are less than the high wages implied by these regulations

environmental quality and resource depletion

-China large increase in real GDP, but also suffered severe decline in water and air quality -decrease not in GDP -exploitation of finite resources also tends be overlooked in GDP, oil sold goes into GDP but not the fact there is less oil in the world -tried to incorporate but have to place a dollar value on intangible Suppose a factory is built in your town -People are employed and output is produced •Productive activity is included in GDP •Suppose further that the factory creates pollution -Your city hires a company to restore the environment to its initial condition -Clean-up activities are included in GDP •At best, it gets environment back to its starting point, not better •Real GDP overstates the true well-being No adjustment is made for the decline in resource availability due to mining or any other form of harvesting - One more barrel of oil on the market means one less barrel for future use •Environmental quality and preventing resource depletion are difficult to value - They have value and that value is omitted from GDP • Real GDP overstates the true well-being

Why do fewer children complete high school in poor countries

-Opportunity cost higher, better used in agriculture or other source of labor -cost of books and supplies

unemployment

-another way to help asses economic activity -when low jobs are secure and easy to find also usually associated with improving wages and working conditions as employers compete for workers

GDP is related to economic wellbeing

-can't only look at GDP but GDP per person does tend to be positively correlated with things people value like a high standard of living, better health and life expectancies, and better education Clearly, GDP omits and undervalues some goods and services •However, GDP per capita is positively associated with several measures of well-being -Material standard of living: more goods and services -Health and life expectancy •Residents of industrialized countries fare better than residents of developing countries in a range of health measures -Education •Literacy and school enrollment rates are higher in high-income countries

How far do economists go wrong by leaving nonmarket economic activities out of GDP?

-depends on type of economy being studied. Although nonmarket economic activities exist in all economies, they are particularly important in poor economies. -example: in rural villages of developing countries, people commonly trade services with each other or cooperate on various tasks without exchanging any money. Families in these communities also tend to be relatively self-sufficient, growing their own food and providing many of their own basic services. Because such nonmarket economic activities are not counted in official statistics, GDP data may substantially understate the true amount of economic activity in the poorest countries. -Similarly the underground economy, which includes transactions that are never reported to government officials and data collectors -encompasses both legal and illegal activities, from informal babysitting jobs to organized crime. -example: people pay temporary or part-time workers like housecleaners and painters in cash, which allows these workers to avoid paying taxes on their income. --Economists who have tried to estimate the value of such services by studying how much cash the public holds have concluded that these sorts of transactions make up an important share of overall economic activity, even in advanced industrial economies."

Problems with CPI: Two Reasons Why the CPI May Overstate the Inflation Rate?

-does not adjust for quality improvement (quality adjustment bias)- can underestimate true improvement in living standards- try hard to avoid but may be getting worse There was no internet and no cell phones in 1982. Innovations widen consumer choices thereby making a given amount of money worth more. -Innovation essentially mimics a fall in consumer prices. -substitution bias: calculated by fixed baskets or services; does not allow for the possibility that consumers will switch from more expensive (prices rising) to less expensive (stable or falling)- overestimate cost of living: may switch from coffee to tea without being worse off Example: Car pooling or driving more efficient cars when gas prices rise. Don't know how much either overstates

Short term unemployment

-often end in them finding stable jobs -do not usually have high costs -some do withdraw from labor force or in a short term or temporary job

domestic part of GDP

-only production that takes place within the country's borders is counted. -For example, the GDP of the United States includes the market value of all cars produced within U.S. borders, even if they are made in foreign-owned plants. -However, cars produced in Mexico by a U.S.-based company like General Motors are not counted. -What about cars that are produced in the United States from parts that are produced in Mexico? The value-added method introduced earlier could again be used to suggest an answer. - we can use this method to divide the value of a product that was produced in part in two different countries into its contribution to each country's GDP. Example: suppose ABC Grain Company produces the grain in Mexico. General Flour buys $0.50 worth of grain from ABC in Mexico, imports it to the United States, and uses it to produce $1.20 worth of flour (in the U.S.). Finally, Hot'n'Fresh Baking buys $1.20 worth of flour from General Flour and uses it to produce $2.00 worth of bread (in the U.S.). Using the value-added method, Table 5.1 suggests that the total value of the bread, $2.00, is divided across the two countries' national accounts: $0.50 is included in Mexico's GDP (the value of the grain produced in Mexico), and $1.50 is included in the United States' GDP (the value added in the U.S.)."

chronically unemployed

-unemployment broken up by brief period of employment or withdrawals from labor force -similar costs to long-term unemployed

How has GDP been affected by women joining the workforce?

1) Services produce has increased GDP 2) Paid workers took over previously unpaid work "The first of these two changes represents a genuine increase in economic activity, but the second reflects a transfer of existing economic activities from the unpaid sector to the market sector (moreover, it is possible that this transfer lowered the quality of these activities). Overall, then, the increase in measured GDP associated with increased participation in the labor force by women probably overstates the actual increase in economic activity." Women's labor force participation increased since 1960 and peaked in 1999 •Measured GDP increased for two reasons: -Working women's output was measured and counted •This output is a real addition to GDP -Paid workers now provided previously unpaid childcare -this increase in measured GDP simply corrects a measurement problem • This is not a net addition to goods and services produced • Measured increase in GDP due to increased female LFPR probably overstates actual change

2 ways to measure GDP

1. adding up the market values of all the final goods and services that are produced domestically 2. adding up the total amount spent by each of the four groups (household, firms, governments, private sector) on final goods and services and subtracting spending on imported goods and services

capital good

A capital good is any good that helps to increase future production . - They are different from financial capital, which refers to funds companies use to grow their businesses .tool, equipment, or other manufactured good used to produce other goods and services; a factor of production a long-lived good that is used in the production of other goods and services -houses and apartments -not used up during production process -newly produced capital goods classified as final Capital Goods may be potentially difficult to classify as intermediate or final: •A capital good is a long-lived good used in the production of other goods and services - Houses, apartments, hotels, etc -Stoves in restaurants and cooking schools, but not homes -Delivery vehicles and taxis •Capital Goods are -not final goods as they are inputs in the production of final goods -not intermediate goods as they are not immediately used up during the production of other goods •Solution? -Newly produced capital goods are classified as final goods & added to GDP as Investment . •Money is NOT a capital good. Money is a means of payment and a unit of account - it is neither a good nor a service.

out of the labor force

A person is considered to be out of the labor force if they did not work in the past week and did not look for work in the past four weeks. Not employed or unemployed (in the sense of looking to work without being able to find it). This includes full-time students, unpaid homemakers, retirees, and people unable to work due to disabilities.

Slowdown in Productivity Growth After 2000

Although technological progress continued after 2000, productivity growth slowed to - 1.5% from 2000 - 2007, and, to - 1% from 2007 - 2016. • Economists don't yet fully understand all the reasons. • Contributory factors include - Dot com collapse of 2000 and the recession of 2001 - 2007-09 recession - Global financial crisis leading to tighter credit conditions • Optimists argue - Advances in mobile computing, biotechnology, communications and other ICT fields will elevate productivity levels to the late 1990s levels

True Costs of Inflation: Distortions of the Tax System

Capital depreciation allowances are not indexed •They are designed to encourage purchase of capital goods -Allows firms to deduct a portion of the purchase price as a business expense • Say a machine costs $1,000 and has a life of 10 yrs. -Capital depreciation allowance of 10% = $100 per year -$100 in year 1 is worth more than $100 in year 10 because of inflation; so the investment doesn't look as lucrative •In times of high inflation, investment in plant and equipment decreases The US tax code is complex containing hundreds of provisions and taxes that are not indexed •These taxes can seriously distort the incentives for people to work, save, and invest -Lower savings and investment means lower economic growth - a real cost of inflation •Distorted economic incentives lead to lower economic efficiency - a real cost of inflation.

Can we compare CPIs across areas?

Comparisons between area CPIs cannot tell you which area is more expensive (because the standard basket composition varies significantly across areas). • The following illustration shows that Area B has higher prices than Area A, but the price change in Area A has been greater than in Area B. So CPI can only tell you how prices have changed within an area; it does not allow for comparisons across areas.

Inflation and interest example

Consider two countries Alpha and Beta. • Alpha's currency is alphan and inflation is expected to remain at zero •Bank deposits pay 2% nominal annual interest rate in Alpha •Beta's currency is betan and inflation is expected to remain at 10% • Bank deposits pay 10% nominal annual interest rate in Beta • Which country's citizens have the better deal?

Great Depression

During the Great Depression (1929-33) in the US -Factories cut production 31% - Number of people without jobs nearly tripled by 1933 when the unemployment rate hit 25% -Stocks lost a third of their value in 3 weeks -All across America shantytowns named "Hoovervilles" sprang up. •President Herbert Hoover (1929-33) and his economic advisors were clueless about how to help. He lost to Franklin D. Roosevelt in 1933 (4 terms, 1933-45). President's Hoover's cluelessness was understandable. •Microeconomics - study of production and consumption decisions of individual producers and consumers and allocation of scarce resources among industries, was well established. •Macroeconomics - study of the behavior of the economy as a whole - was in a state of infancy. • The study of Macroeconomics, as a separate branch of economics, was established during the Great depression. • Macroeconomics is the study of the performance of national economies and the policies governments use to try to improve that performance.

Inflation and Interest Rates

Economists refer to the annual percentage increase in the purchasing power of a financial asset as the Real Interest Rate (r) •Nominal Interest Rate (I) is the annual percentage increase in the nominal value of a financial asset • r = I- pi, where pi is the rate of inflation. • There is a close positive relationship between inflation rates and nominal interest rates.

A Note on VMP (L) vs MRP (L)

Equilibrium amount of labor employment by firms: • Set W = MRP (L) • Where MRP(L) is the additional revenue that one extra unit of labor earns for the firm. •MRPL = MR x MPL •VMPL = P x MPL •Under perfect competition P=MR. Therefore MRPL= VMPL

CPI: 1 fix the basket

FOOD AND BEVERAGES (breakfast cereal, milk, coffee, chicken, wine, full service meals, snacks) •HOUSING (rent of primary residence, owners' equivalent rent, fuel oil, bedroom furniture) •APPAREL (men's shirts and sweaters, women's dresses, jewelry) •TRANSPORTATION (new vehicles, airline fares, gasoline, motor vehicle insurance) •MEDICAL CARE (prescription drugs and medical supplies, physicians' services, eyeglasses and eye care, hospital services) •RECREATION (televisions, toys, pets and pet products, sports equipment, admissions); •EDUCATION AND COMMUNICATION (college tuition, postage, telephone services, computer software and accessories); •OTHER GOODS AND SERVICES (tobacco and smoking products, haircuts and other personal services, funeral expenses). Also included: Government-charged user fees, such as water and sewerage charges, auto registration fees, vehicle tolls, auto insurance; sales and excise taxes. •Not included: -Income and Social Security taxes as they are not directly associated with the purchase of consumer goods and services; -Purchase of stocks, bonds, real estate, and life insurance. These items relate to savings and not to consumption expenditures.

Shifts in the Demand Curve

Factors that Increase Demand for Labor -A rise in the relative price of the company's output. • An increase in market demand for the good - A rise in the labor productivity •Greater quantity of non-labor inputs • Organizational change •Better technology • Training and education

Poverty and Economic Inequality

GDP does not capture the effects of income inequality - Most would prefer living in a relatively equal society compared to one with a few wealthy and many poor • U.S. uses an absolute standard of poverty and we are certainly becoming less poor over time. -In 2017, a family of four was poor if their income was less than $24,600 • However inequality is increasing in the US and it matters -If you have an old beat up car but you are the only one with a car, you may consider yourself privileged. - On the other hand, you would be less satisfied if everyone else had a luxury car. -GDP conveys no information about who gets to enjoy those goods and services. -Two countries may have identical GDPs but differ radically in the distribution of economic welfare across the population. -Example, that in one country—call it Equalia—most people have a comfortable middle-class existence; both extreme poverty and extreme wealth are rare. But in another country, Inequalia—which has the same real GDP as Equalia—a few wealthy families control the economy, and the majority of the population lives in poverty. -While most people would say that Equalia has a better economic situation overall, that judgment would not be reflected in the GDPs of the two countries, which are the same. In the United States, absolute poverty has been declining -Today, many families whose income is below today's official "poverty line" (in 2016, $24,560 for a family of four) own a television, a car, and in some cases their own home. -Some economists have argued that people who are considered poor today live as well as many middle-class people did in the 1950s. But, though absolute poverty seems to be decreasing in the United States, inequality of income has generally been rising. -The CEO of a large U.S. corporation may earn hundreds of times what the typical worker in the same firm receives. Psychologists tell us that people's economic satisfaction depends not only on their absolute economic position—the quantity and quality of food, clothing, and shelter they have—but also on what they have compared to what others have. -Example: you own an old, beat-up car but are the only person in your neighborhood to have a car, you may feel privileged. But if everyone else in the neighborhood owns a luxury car, you are likely to be less satisfied. To the extent that such comparisons affect people's well-being, inequality matters as well as absolute poverty. -Again, because GDP focuses on total production rather than on the distribution of output, it does not capture the effects of inequality. "

non market economic activity

GDP omits services that are not traded in markets -Household production -Volunteer services •Valuing these services would be difficult •Nonmarket activities are important in poor countries -Self-sufficient households and bartered goods and services • Real GDP will understate true economic well-being. -Not all economically important activities are bought and sold in markets; with a few exceptions, such as government services, nonmarket economic activities are omitted from GDP. -example: parenting and child care services and unpaid housekeeping services; volunteer services, such as the volunteer fire and rescue squads -not unimportant. Problem is there are no market prices and quantities for unpaid services, estimating their market values is very difficult. Nonproduction transactions - public transfer payments (unemployment benefits, social security, etc.) -private transfer payments, such as gifts •Capital Gains and Losses •Unpaid volunteer work for charities •Illegal market activities •Financial Market Transactions -Financial market transactions are excluded since securities represent either ownership, such as with stocks, or they represent loans, such as with bonds. •Financial securities do not represent real production, but simply represent the means to finance production. •Interest paid by Government or Consumers (except mortgages because a house provides housing services).

Government Expenditure

Government Expenditures: are final goods and services bought by federal, state, and local governments ■ Fighter jets ■ Teaching ■Office Supplies •Government expenditure excludes transfer payments or the interest paid on government debt . -Transfer payments are made by government but the government receives no current goods or services ■ Social Security ■ Food Stamps - Spending on new goods and services by transfer payment recipients, however, is included in GDP Government expenditure does not include the interest paid on government debt . • Interest paid on government bonds is NOT counted as part of GDP. The argument is that the interest on a govt. loan is not usually used for purchasing capital equipment, and therefore is not connected to production; whereas net business interest paid is typically for a loan used to purchase capital equipment and is counted as part of GDP since it is related to production.

GNP

Gross national product - GNP - is the total factor income that is earned by the citizens of a country. •What are the factors of production that earn factor incomes? -Land -Labor -Capital -Entrepreneurship •How do the factors of production earn factor incomes? -Land is paid Rents -Labor is paid Wages and Salaries -Capital is paid Interest - Entrepreneurs are paid Profits Gross national product - GNP - is the total factor income that is earned by the citizens of a country. •Includes factor incomes earned abroad by Americans -Profits from IBM's European operations accruing to American shareholders and wages of Americans working abroad •Excludes factor incomes earned by foreigners -Dividends (profits) paid to foreign holders of US stocks and wages of foreign workers who temporarily work in the US • In 2017, US GNP was about 0.75% larger than GDP because of overseas profits of US companies. • For smaller countries GNP and GDP can diverge significantly.

Banana Computer Example

Hire an extra worker if and only if the VMP exceeds the wage paid •If wage is $60,000, BCC will hire 3 workers -At $50,000, BCC hires 5 workers • The lower the wage, the more workers employed

Malthus

Historically, land was important. In the 19th C countries that were rich, typically had abundant supply of rich farmland and mineral deposits -Canada, US, Australia and Argentina. • English economist Thomas Malthus in his 1798 book, "An Essay on the Principle of Population", predicted that in the long run a great majority of people were destined to live on the edge of starvation. • The MALTHUSIAN argument: Land is finite. Rising world population will reduce land per capita and hence labor productivity. Physical capital and technological improvements will not raise productivity fast enough. Only starvation will raise death rates high enough to prevent rapid population growth from outstripping productivity growth. Was he right? In the past - yes. -Many historians believe that Malthusian prediction of falling and stagnant productivity was valid for much of human history - until as recently as 1820. •Population pressure was responsible for stagnant productivity growth until the 18th C. Since then, especially 19th C and beyond, other changes - advances in technology, increases in human and physical capital have been crucial in preventing population growth from outstripping productivity growth. • In the US farmers are less than 1% of the workforce and yet they produce enough for us and for export.

True Costs of Inflation: Shoe Leather Costs

Holding cash is convenient because it lubricates economic transactions. If there is no inflation, cash holds its value over time. •Inflation reduces purchasing power and raises the cost of holding cash to consumers and businesses •However, from society's point of view the above is not a true cost of inflation. Why? - Currency is a debt owed by the government to the currency holder. When currency loses value, losses to the holder of currency are offset by corresponding gains to the government - there are no wasted resources. The Real costs of inflation arise from actions taken to "economize" on cash holdings: -More frequent and smaller withdrawals cost consumers and businesses time with OC - a real cost of inflation -Banks process more transactions, increasing costs - another real cost of inflation - Costs of managing cash holding are called "shoe leather" costs, referring to the cost of frequent trips to the bank Except for economies with significantly high levels of inflation, shoe leather costs are not considered to be significant. •During the German Hyperinflation of 1921-23, merchants employed runners to carry their cash to the banks several times a day. •During Brazil's hyperinflation in the early 1990s, the Brazilian banking sector accounted for 15% of GDP - more than twice the size of the US banking sector as a share of GDP. • In the mid 1980s, Israel experienced a "clean" inflation (i.e., not accompanied by war or political instability). Shoe leather costs were commonly incurred.

consumption expenditure (consumption)

Household spending on goods and services, such as food, clothing, and entertainment is called Consumption Expenditure, or simply Consumption •Three categories of consumption expenditure are -Consumer durables are long-lived consumer goods ■ Cars ■ Furniture ■Appliances -Consumer non-durable goods are shorter-lived goods ■ Clothing ■ Food ■ Bedding -Services are the largest component of consumer spending ■ Education ■ Taxi rides ■ Haircuts spending by households on goods and services such as food, clothing, and entertainment Subdivided: 1. Consumer durables are long-lived consumer goods such as cars and furniture. Note that new houses are not treated as consumer durables but as part of investment 2. Consumer nondurables are shorter-lived goods like food and clothing. 3. Services, a large component of consumer spending, include everything from haircuts and taxi rides to legal, financial, and educational services.

Consumer Price Index (CPI)

How do we measure the Aggregate Price level and its rate of change, namely inflation/deflation? -By calculating a measure called the Consumer Price Index (CPI). • The CPI for any period, measures the cost of a typical consumer's consumption bundle - standard basket of goods and services - in that period relative to the cost of the same basket of goods and services in some pre-determined year, called the base year. for any period, a measure of the cost in that period of a standard basket of goods and services relative to the cost of the same basket of goods and services in a fixed year, called the base year -CPI: for any period measures the cost in that period of a standard set, or basket, of goods and services relative to the cost of the same basket of goods and services in a fixed year, called the base year -base year CPI is also 1.00 since in that year the numerator and denominator are the same -CPI for given period (such as a month or year) measures the cost of living in that period relative to what it was in the base year -the BLS multiplies nu 100 to get rid of the decimal point -does not measure the price of a specific good or service- no unit of measurement (dollars cancel out) rather it a index and only has value in relation to another year The CPI reflects spending patterns for each of two population groups - all urban consumers (CPI-U) and separately for all urban wage earners and clerical workers (CPI-W). •The all urban consumer group represents about 87% of the total U.S. population and includes the expenditures of almost all residents of urban or metropolitan areas, including professionals, self-employed, poor, unemployed, retired, and urban wage earners and clerical workers (32% of the total US population). • Not included in the CPI are the spending patterns of people living in rural nonmetropolitan areas, farm families, people in the Armed Forces, and those in institutions, such as prisons and mental hospitals.

Price of Output Increases BCC

If w=$60,000, BCC will now hire 7 workers •When price of the product the worker produces increases, demand for labor shifts to the right -There is a separate demand for labor curve for each possible output price •An increase in the price of workers' output increases the demand for labor

Trend 3: Inequality

Increased wage inequality in U.S in recent decades -A growing gap in real wages between skilled and unskilled workers is of particular concern •Real Wages of the least-skilled, least-educated workers have fallen since early 1970s -By as much as 25 to 30% by some estimates •Best-educated, highest-skilled workers' real wages have increased continuously • Today, income with a master's degree is - Three times the income of a high school graduate - Four times the income of a worker who did not graduate from high school Economists and policy makers worry that the US is increasingly characterized by a two-tier labor market: -Plenty of good, well paying jobs for the highly educated and highly skilled -Lack of opportunities for those without schooling or skills • Outside the US, particularly in Western Europe, the trend towards wage inequality has been much less pronounced. •However, we will see that employment trends in Western Europe have been much worse than that of the US. Trend 3: Increased Wage Inequality in the US • Why has the gap between the wages of skilled and unskilled workers widened in recent years? -Globalization -Skill-biased technological change Globalization results in an expansion of many markets to worldwide supply - Increasing ease of goods and services crossing national borders • Benefit of globalization is increased specialization and efficiency -Principle of Comparative Advantage •Globalization also means that some goods produced domestically are no longer competitive -Some domestic sectors shrink When wages in import competing industries fall and wages in exporting industries rise, wage inequality increases - Low-skill industries in the U.S. face the toughest international competition -Political resistance to free trade grows • Worker mobility is the movement of workers between jobs, firms, and industries - Market incentives will move workers out of textiles and into software, to an extent - Transition aid by government can assist workers to make the change Technological change can be a source of increasing wage inequality -Occurs if technical change favors higher-skilled or better- educated workers •Innovation often renders old skills less valuable -Online banking and bank clerks • Skill-biased technological change affects the marginal products of higher skilled workers differently from those of lower-skilled workers -Recent changes favor higher skilled workers -Automobile production lines increasingly use labor replacing robots - You need workers who can program the robots, not workers who can run the line

simple interest

Interest earned only on the original principal amount invested •Simple Interest: • How much would an initial Investment (N) of $10 in year 1800 @ 4% simple interest be worth in year 2005? •N = P(1+rt) •In 2005, N = $10 (1+ (0.04 x 205)) = $92.00

Structural Barriers to Employment: labor unions

Labor union benefits Reduced worker exploitation -Support progressive labor legislation - Increase productivity - Promote democracy in the workplace Labor union costs Introduces inefficiency into competitive markets - May keep companies from competing globally -Increase labor supply in non-union sector -Decreases wages for non-union workers

Natural Resources: Determinant of Average Labor Productivity

Land and Other Natural Resources - Ceteris Paribus, an abundance of valuable natural resources (fertile land, rich mineral resources, etc) increases the productivity of workers and hence per capita real GDP. -Examples - Middle east countries and oil deposits. •But "other things" are not equal. In the modern world, natural resources is not a very important factor in determining labor productivity - Nigeria is poor although it has significant oil deposits. - South Korea is rich although it is poor in natural resources.

True Costs of Inflation: Menu Costs

Menu Costs are the resource or real costs of changing listed prices. • During times of high inflation, like shoe leather costs, menu costs can be significant. • During the Brazilian inflation of the 1990s supermarket workers reportedly spent half their time replacing old price stickers with new ones. •In the mid 1980s the Israeli real estate markets quoted prices in US dollars although the transaction would be done in Israeli shekels.

Structural Barriers to Employment: Minimum wage

Minimum Wage Laws •Setting a minimum wage (W min) above equilibrium (W) creates (NB- Naartjie ) unemployment •Workers who find a minimum-wage job get a higher wage •Others are unemployed

leisure time

Most Americans (and most people in other industrialized countries as well) work many fewer hours than their great-grandparents did 100 years ago. Early in the twentieth century, some industrial workers—steelworkers, for example—worked as many as 12 hours a day, 7 days a week. Today, the 40-hour workweek is typical. Also, Americans tend to start working later in life (after college or graduate school), and, in many cases, they are able to retire earlier. The increased leisure time available to workers in the United States and other industrialized countries—which allows them to pursue many worthwhile activities, including being with family and friends, participating in sports and hobbies, and pursuing cultural and educational activities—is a major benefit of living in a wealthy society. These extra hours of leisure are not priced in markets, however, and therefore are not reflected in GDP. Amount of leisure time has increased in the past 100 years [Fair Labor Standards Act of 1938] -Work weeks are shorter -People enter the labor force at an older age -People retire earlier •Leisure produces no goods for market -GDP places a value of zero on all leisure time -Opportunity cost of an hour of leisure is your hourly wage - Omission of the value of leisure time makes GDP seem smaller -Therefore Real GDP understates the true extent of well being .

Availability of goods and services

Obviously, citizens of a country with a high GDP are likely to possess more and better goods and services (after all, that is what GDP measures). On average, people in high-GDP countries enjoy larger, better-constructed, and more comfortable homes; higher-quality food and clothing; a greater variety of entertainment and cultural opportunities; better access to transportation and travel; better communications and sanitation; and other advantages. While social commentators may question the value of Page 125 material consumption—and we agree that riches do not necessarily bring happiness or peace of mind—the majority of people in the world place great importance on achieving material prosperity. Throughout history people have made tremendous sacrifices and taken great risks to secure a higher standard of living for themselves and their families. In fact, to a great extent the United States was built by people who were willing to leave their native lands, often at great personal hardship, in hopes of bettering their economic condition.

Physical Capital and Average Labor Productivity

Physical Capital - Worker productivity depends not only on their skills (human capital) but also on the tools/machines (physical capital) they work with. - An excellent surgeon needs his equipment to perform surgery Marginal product of the third machine is zero because there are only two workers. •Can you see Diminishing Marginal Productivity of capital? Ceteris Paribus, a greater quantity of physical capital per worker raises average/marginal labor productivity -We say, labor and capital are complements in production • However, physical capital is subject to diminishing returns - If labor and other inputs are held constant, then the greater the amount of physical capital already in use, the less an additional unit of capital will add to productivity.

True Costs of Inflation: Noise in the Price System

Prices transmit information about - The cost of production, and, -The value buyers place on an additional unit •Inflation creates static in the communication - Buyers and sellers can't easily tell whether •The relative price of this good is increasing, or, •Inflation is increasing the price of this good and those of all others as well -Deciding on these issues requires market participants to gather information - at a cost -Response to changing prices is tentative and slow

GDP and the Meaning of Life

Rich is better. However money is neither necessary (Brazil, Costa Rica) nor sufficient (Hong Kong, Kuwait, etc.). Money matters less as you get richer •Robert Kennedy in 1968: •"[GDP] does not allow for the health of our children, the quality of their education, or the joy of their play. It does not include the beauty of our poetry..., the intelligence of our public debate or the integrity of our public officials. It measures neither our courage, nor our wisdom, nor our devotion to our country. It measures everything, in short, except that which makes life worthwhile, and it can tell us everything about America except why we are proud that we are Americans."

Solution to inequality: Stop Globalization and technological Advancement?

Should we try to slow technological change and / or ban globalization (trade) to reduce wage inequality? - Remember the Luddites? The Luddites were a group of English textile workers and weavers in the 19th century (under the leadership of Nedludd) who destroyed weaving machinery as a form of protest. •Improving worker mobility and providing transition aid is a better bet.

Real GDP per Person, 1870-2010 (in 1990 Intl Dollars) chart

Small differences in growth rates matter •Brazil and Japan were similarly placed in 1870. •However, over the period 1870 - 2010, Japan had the highest growth rate of 2.5% and Brazil's was 1.6% •This 0.9% differential was enough to make Japan's real per capita GDP be more than 3 times as large as Brazil's in 2010.

True Costs of Inflation: Interference With Long Run Planning

Some decisions have a long time horizon - Erratic inflation increases risk and makes long term planning difficult • Retirement planning requires an estimated cost for your desired life-style - Save too little and you live less well in the future -Save too much and you live less well now •Given the costs of inflation, most economists agree that low and stable inflation promotes a healthy economy

Non market good included in GDP

Some non-market items are included: • wages in kind (health benefits etc.) • agricultural output for self-consumption • imputed rent from owner occupied housing; imputed values of renovations • Services (like checking account services) provided by financial intermediaries free or for a nominal fee are given an imputed value using differences in interest rates Government (public) goods and services are not sold in the market but included because -These goods have value -Increase overall output - Quantities are known -However, prices cannot be easily established •So, Government production is valued at cost -Overstates GDP if there is waste and inefficiency

True Costs of Inflation: Distortions in the Tax System

Some taxes are not indexed to inflation, leading to Bracket Creep -Bracket creep occurs when a household is moved into a higher tax bracket due to increases in nominal but not real income • Higher tax brackets have a higher percentage tax rate • Income taxes are indexed - Suppose the tax rate on $50,000 is 30% and that on $60,000 is 40%, in 2000 - CPI is 1 for 2000, 1.25 for 2005 - Without indexing, a person with a nominal income of $60,500 would be taxed at 40% in 2005. With indexing, , incomes up to $62,500 will still be taxed at 30% in 2005.

investment expenditure or investment

Spending by firms on final goods and services (primarily capital goods) and by households on housing, is called Investment expenditure, or simply, Investment • Categories of Investment expenditures: •Business fixed investment is purchases of new capital goods ■ Plant/Factories ■ Property ■ Equipment • Residential investment is construction of new homes and apartment buildings • Inventory investment is the change in unsold goods to the company's inventory = End of year inventory minus beginning of year inventory -These goods are produced but not yet sold -This entry can be positive or negative spending by firms on final goods and services, primarily capital goods and housing 1. Business fixed investment is the purchase by firms of new capital goods such as machinery, factories, and office buildings. (Remember that for the purposes of calculating GDP, long-lived capital goods are treated as final goods rather than as intermediate goods.) Firms buy capital goods to increase their capacity to produce. 2. Residential investment is construction of new homes and apartment buildings. For GDP accounting purposes, residential investment is treated as an investment by the business sector, which then sells the homes to households. Page 115 Inventory investment is the addition of unsold goods to company inventories. In other words, the goods that a firm produces but doesn't sell during the current period are treated, for accounting purposes, as if the firm had bought those goods from itself. (This convention guarantees that production equals expenditure.) 3. Inventory investment can be positive or negative, depending on whether the value of inventories on hand rises or falls over the course of the year. In 2009, for example, inventories fell, and the inventory investment component contributed a negative value to GDP. People often refer to purchases of financial assets, such as stocks or bonds, as "investments." That use of the term is different from the definition we give here. A person who buys a share of a company's stock acquires partial ownership of the existing physical and financial assets controlled by the company. A stock purchase does not usually correspond to the creation of new physical capital, however, and so is not investment in the sense we are using the term in this chapter. We will generally refer to purchases of financial assets, such as stocks and bonds, as "financial investments," to distinguish them from a firm's investment in new capital goods, such as factories and machines."

The Labor Market

Supply and demand analysis can be used to find the price of labor (real wages) and the quantity (employment) -Analysis will consider the number of workers employed, not work-hours per year •Labor market is an input market -Firms buy labor to produce goods and services • Macroeconomics looks at aggregate levels of employment and real wages - Microeconomics looks at wage determination for a category of workers, or in a particular firm or industry.

Median Weekly Real Earnings of Wage and Salalry Workers, 16 yrs and Older

The "Median" earnings level is the level where 50% of employees earn less and 50% earn more •It's what the "middle" person earns • Mean Earnings are typically higher than Median Earnings in the US (look up BLS data) • Stagnant median earnings but rising average (mean) earnings is indicative of rising inequality

international dollar

The Geary-Khamis dollar, more commonly known as the International Dollar is a hypothetical unit of currency that has the same purchasing power parity (PPP) that the US dollar had in the United States at a given point in time •It was proposed by Roy C. Geary in 1958 and developed by Salem Hanna Khamis between 1970 and 1972. • An international dollar would buy in the cited country a comparable amount of goods and services a U.S. dollar would buy in the United mStates.

Income and Poverty in the US

The Median Household Income (for all households, Census Bureau) for 2016 was $59,149 •The Mean Income (for all households, Census Bureau) was $83,143 •The Median Household Income for household with one person for 2016 was $30,367 and the mean was $43,567 •The 2015 poverty threshold for one person was $12,082 and $24,257 for a household with 4 people. •The nation's official poverty rate in 2016 was 12.7% and 40.6 million people were "poor"

Role of Government in Determining Labor Productivity

The Role of Government in Fostering Productivity - Establish well-defined property rights •Who owns what and how they can profit from them •Reliable recourse through unbiased courts - Maintain political stability - Promote free and open exchange of ideas (which includes, freedom of the press) - Help in building infrastructure

Real GDP per Person, 1870-2010 (in International Dollars per person) graph

The US was already a relatively wealthy industrialized country in 1870 •US real per capita GDP grew 12 times between 1870 and 2010. • In Japan, real per capita GDP in 2010 was almost 30 times its 1870 level •There was a significant growth spurt post 1950 especially in Japan, and, post 1980 in China and India. • China and India have grown faster since 1990 than in the earlier periods. • Caution: Older data are not as reliable and are not strictly comparable to newer data

Wages and Demand for Labor

The demand for labor depends upon: -The productivity of workers, and, -The price of the output the worker produces • Firms hire labor until the MB of the last unit of labor is equated to its MC. • Value of Marginal Product (VMP) is extra revenue that an added worker earns for a firm. It is the firm's MB from hiring a worker • Wage is the firm's MC from hiring a worker. So firms hire labor until the VMP is equal to the wage rate. •The VMP graph is the firm's labor demand curve. It depends upon: -The productivity of workers, and, -The price of the output the worker produces • Increase in worker's productivity increases labor demand • Increase in the price of output, increases labor demand. • The VMP (labor demand) graph is downward sloping because of Diminishing Returns to Labor (diminishing marginal product of labor) - Assumes non-labor inputs are held constant - Adding one worker increases output but by less than the previous worker added • Value of Marginal Product (VMP) = P x MPL

Trend 4: Job growth

The number of people with jobs has grown in the past 50 years. •The rate of job growth has slowed recently. •In 1970, about 57% of people over 16 had jobs; by 2000 this was 64%; 60% in 2017 •Between 1989-2000 US economy created 35 million new jobs •Between 1980-2000, number of jobs grew by 36%, while the over-16 population grew by only 25% • The pace of new job creation has slowed since, falling below the over-16 population growth rate

Rule of 72

The number of years it takes for a certain amount to double in value is equal to 72 divided by its annual rate of interest. How long does it take for per capita real GDP to double itself? •where n = number of years it takes for the variable to double itself. Some economists use 69, 69.3 or 70; works for small and moderate growth rates that are positive. •US took 70/1.8 = 38.9 years to double per capita real GDP. Example: FV = PV (1+r) t • Where FV = is the accumulated value of an initial sum (PV) after t years r % rate of interest. •Doubling implies FV = 2PV. •So 2 = (1+r)t Taking natural logs on both sides we get: ln2 = t ln(1+r) •Assuming r is small, ln(1+r) by Taylor's expansion is approximately equal to r and ln2 is 0.693. •So t is approximately equal to = 69.3/r% •Why 72? Because it has more factors.

aggregate price level

The overall level of prices in an economy is called the Aggregate Price Level . • An increase in the aggregate price level = inflation • A decrease in the aggregate price level = deflation • In the short run - movements in APL are closely related to the overall movements of the economy - up or down - called Business Cycles . • In the long run - the APL is mainly determined by changes in Money Supply - inflation occurs because... - there is too much money chasing too few goods!

relative price

The price of a specific good or service in comparison to the prices of other goods and services. "For example, if the price of oil were to rise by 10 percent while the prices of other goods and services were rising on average by 3 percent, the relative price of oil would increase. But if oil prices rise by 3 percent while other prices rise by 10 percent, the relative price of oil would decrease. That is, oil would become cheaper relative to other goods and services, even though it has not become cheaper in absolute terms." people get confused with inflation which is an increase in overall price level and relative price A change in relative prices may not imply inflation. •A high inflation may not affect relative prices.

Trend 2: Slowdown

The rate of real wage growth has stagnated since 1973 - Fastest growth was during the 1960s and early 1970s • Data on growth in Real annual Earnings: - 1960 - 1973 2.5% per year •But a slowdown followed -1973 - 1995 0.9% per year •Resurgence after 1996 despite 2001 recession -1996 - 2007 1.8% per year • Slowdown after 2007 again - 2007 - 2016 0.7% per year • For the entire post 1973 period - 1973 - 2016 1.1% per year US Wage Growth Stagnated Since 1970 But Employment Growth has been rapid Stagnated growth in real wages could be either due to -Slower growth in demand for labor, or -Faster growth in the supply of labor . • Productivity growth and real wages have moved together Productivity based explanations are incomplete . Given supply, a productivity slowdown explains the slower growth of real wages but not the increase in employment. • New jobs were created and filled between 1973 - 1990 at record rates • Must be explained by a simultaneous increase in the supply, explained by - Increased participation by women - Baby Boom - High rates of immigration • Looking forward -Labor supply growth will slow, helping real wages -Partly depends on whether productivity growth continues to decline

working age population

The total number of people aged 16 years and over (out of the labor force, unemployed, or employed)

The Expenditure Method for Measuring GDP

There are 4 groups that buy final goods and services: - Households, Firms, Government and Foreign buyers - Total Expenditure = C + I + G + (X-M) = Total Market Value of goods and services = GDP - Where, C = Consumption; I = Investment; G = Government Expenditures; X = Exports; M = Imports

The True Cost of Hyperinflation

Three economists (Stanley Fischer, Ratna Sahay, and Carlos Vegh) examined 133 market economies from 1960 - 96. They found •45 episodes of high inflation (100% +) in 25 countries - Real GDP/person fell by an average of 1.6%/yr - Real consumption/ person fell by an average of 1.3%/yr -Real investment/person fell by an average of 3.3%/yr - During low inflation years these countries enjoyed positive growth in these variables.

CPI: 2 find the prices

To find out the price of each item, BLS data collectors called economic assistants (EA) visit or call thousands of retail stores, service establishments, rental units, and doctors' offices, all over the US and record the prices of about 80,000 items each month, representing a scientifically selected sample of the prices paid by consumers for goods and services purchased. • If an item is available, the EA records its price. If the item is no longer available, or if there have been changes in the quality or quantity (for example, packaged spinach sold as a 10 oz bag instead of what was previously a 12 oz bag) of the good or service since the last time prices were collected, the EA selects the new item or records the quality change in the current item. Next, BLS commodity specialists (who have detailed knowledge of the particular goods/services priced) check the data for accuracy/consistency and make any necessary corrections or adjustments based on changes in size, quantity and even features or quality of a product. Thus, commodity specialists try to prevent changes in the quality of items from affecting the CPI's measurement of price change.

Technology: The Most Important Determinant of Average Labor Productivity

Today, most economists would probably agree that technological advancement is the single most important source of productivity improvement. -A new technology will expand the productivity in other sectors - introduction of railroad increased productivity of all its clients as well. -Refrigerated transportation increased productivity of farmers by opening up national and international markets. US labor productivity grew 2.8% from 1947 - 1973 - Slowed to 1.4% per year from 1973 - 1995 -Resurgence to 2.4% per year between 1995 - 2000 • Growth since 1995 is largely attributed to new information and communications technologies (ICT) making workers more productive - Growth seen in industries that produce these technologies and in industries that use them - Slower growth in sectors that do not use much information and communications technologies The slow growth from 1973-95 still remains a mystery. -The first micro-processor was developed in 1971 but it took more than 25 years for that invention to become standard equipment in the business world - fax machines, desktop and laptop computers, cell phones, email, etc. •So why didn't information technology raise productivity earlier? -Economic development does not automatically follow from breakthroughs in basic science. It takes time for new inventions to become commercially viable. It was only when the multistoried tightly packed factory layout was transformed to a single-storied layout that the full impact of the new technology (light bulb) found its expression in higher productivity - the assembly line (1913). •New technology does not yield benefits if it is used in old ways.

Trend 1: Real Wage Growth

Trend 1: large increases in real wages of industrialized countries in the 20th C, especially before 1970. - Happened because demand for labor increased due to improvements in productivity -Both real wages and employment increased • productivity increased because of - Technological progress - Increases in capital

Producer Price Index (PPI)

Two other prices measures that are widely used to calculate economy-wide price changes are: • the Producer Price Index (PPI), and, • the GDP deflator . • The PPI is a Wholesale Price Index and measures the cost of a typical basket of goods and services purchased by producers - raw materials such as steel, electricity, coal, etc. Because commodity producers are quick to change prices in the face of changing supply and demand conditions and because these price changes ultimately get reflected as higher consumer prices, economists often regard trends in the PPI as an early signal predicting changes in the retail price of manufactured goods.

U1 - U6 Unemployment Rates

U1 = Percentage of labor force unemployed 15 weeks or longer • U2 = Percentage of labor force who lost jobs or completed temporary work •U3 = Percentage of labor force who did not work in the last week but have looked for work in the last four weeks (this is the officially reported unemployment rate) U4 = take U3 and add "discouraged workers to the numerator and denominator. •U4 = ( Unemployed+ Discouraged) / (Labor Force + Discouraged) •Discouraged workers (CPS. Def) -Persons not in the labor force who want and are available for work and who have looked for work sometime in the past 12 months (or since the end of their last job if they held one within the past 12 months), but who are not currently not looking because they believe there are no jobs available or there are none for which they would qualify . - CPS: Current population Survey maintained by BLS The BLS officially designates someone as a marginally-attached worker if they are not working and are not actively seeking employment because: - they believe their efforts would be futile - discouraged workers - other reasons - These two categories together are called marginally-attached workers. • Persons marginally attached to the labor force are those who currently are neither working nor looking for work but indicate that they want and are available for a job and have looked for work sometime in the past 12 months. • Discouraged workers are a subset of Marginally attached workers who have given a job-market related reason for not currently looking for work. • U5 = (Unemployed + All Marginally Attached) / (Labor Force + All Marginally Attached) U6 = Total unemployed (from U3), plus all persons marginally attached to the labor force, plus total employed part time for economic reasons, as a percent of the civilian labor force plus all persons marginally attached to the labor force •U6 = (Unemployed + Marginally Attached + Involuntary Part-Time workers)/ (Labor Force + Marginally Attached). •BLS calls this group "Persons employed part time for economic reasons". Economists call them "Underemployed". -They are those who want and are available for full-time work but have had to settle for a part-time schedule.

GDP Ignores Underground Economy

Underground economy is all unreported transactions, both legal and illegal • Casual labor is often paid in cash - Failure to report transaction reduces taxes - Includes baby sitters, lawn care, home repair, etc. • Some underground activity is illegal -A service of value is provided -Drug dealers, bookies (illegal bets), fences (dealing in stolen goods), prostitution, etc. •Estimates suggest the underground economy is large regardless of national income level •Real GDP will understate true economic well-being .

Structural Barriers to Employment: unemployment benefits

Unemployment insurance is a government transfer to unemployed workers -Helps to reduce the costs of unemployment -May give the unemployed an incentive to search longer and less intensely •To work efficiently, unemployment benefits should be -For a limited time - Less than the income received when working Other Government Regulations: Health and safety regulations can reduce the demand for labor by -Increasing employer costs -Reducing productivity •The reduction in demand will increase unemployment and lower wages

Current Unemployment Situation

Unemployment rate is declining. •But average duration of unemployment is still high by historical standards. - Changing demographics and high unemployment benefits does not fully explain the higher long term unemployed numbers. -We have seen a tough recovery since the last Great recession. We are doing well in terms of number of jobs being created but many of these jobs fail to provide a living wage for workers.

True Costs of Inflation: Unexpected Redistribution of Wealth

Unexpected inflation redistributes wealth • Unexpectedly high inflation hurts workers with non- indexed contracts and benefits employers -Fixed salaries lose purchasing power •Unexpectedly high inflation benefits borrowers at the expense of lenders - Borrowers repay with dollars worth less than anticipated •Although redistribution by itself does not destroy wealth, unexpected inflation confuses incentives. - A high inflation economy is like a "casino economy ".

Nominal GDP versus Real GDP

Usually, nominal and real GDP increase each year •But can nominal GDP rise and real GDP go down? - yes; happens during recessions, especially stagflations; -happened in the US during the 1990-91 recession • Fewer goods and services produced AND •Prices increase faster than output decreases •Can nominal GDP in any "year n" be smaller than real GDP in that same "year n"? - Yes, if the prices in the current year are less than those of the base year - Usually true for years before the base year • Can Real GDP rise while nominal GDP is falling? - Although rare, it can happen if prices fall faster than increase in output (as happened in Japan during several recessionary years in the 1990s)

production within a year

Value must be produced in the year considered -A 20-year old house is sold in 2018 for $500,000 •Commission is 6% = $30,000 •Value added is $30,000 •House was not produced in 2018; just the sale service by the real estate agency was. •Amount included in 2018 GDP = $30,000

average labor productivity and per capita real GDP

We know that economic growth rates are measured by annual percentage change in Per capital Real GDP. Y=Real GDP; N=employed; POP = Total population Per capita real GDP is (Y/POP) is the product of average labor productivity (Y/N) and share of population that is employed (N/POP);

Are There Limits to Growth?

We live in a finite world with finite resources - does that limit economic growth? Can growth be sustained? Depletion of natural resources Environmental damage and global warming Limits to growth, assumes economic growth will take the form of what we have now. Limits to growth, overlooks that growth expands society's capacity to safeguard the environment. Limits to growth, underestimates the power of markets to deal with scarcity Why is the air quality so poor in New Delhi or Beijing? -Middle income economies are the worst affected by the costs of growth - they are well placed to grow rapidly but not rich enough to afford to be "clean"

Trend 5: High European Unemployment

Western Europe has suffered higher unemployment than the USA •Unemployment in France from 1990-2001 was 10.9% vs. 5.5% in the USA • In 2017, 4.4% in USA vs. 9.8% in France •Similar problems in many other Western European countries

domestic product

What do we mean by "domestic product"? - Domestic - production that takes place within a country's border -Nationality of the owners or company is irrelevant. • Cars produced in the U.S. by foreign owned companies are counted. • Car produced in Mexico by U.S. owned companies are not counted.

Is Economic Growth Costless?

What is the cost of Economic Growth? •It is the cost of creating new capital. -Implies giving up current consumption -Implies saving more. - Reduced leisure time, worker's safety, and health (US in 1800s and early 1900s) - The cost of R & D - The cost of education and training (human capital)

Income Approach to GDP

When a good is sold, its proceeds are distributed to workers or business owners •GDP = labor income + capital income •Labor income is wages, salaries, benefits, and incomes of the self-employed -About ¾ of GDP •Capital income pays for physical capital and intangibles -Measured before taxes •Profits for business owners •Rent for land •Interest for bond holders •Royalties

Purchasing Power Parity (PPP)

When comparing GDP numbers across nations, we would need to convert them to the same currecncy. - Method 1: Use official exchange rates - Method 2: Use Purchasing Power Parity (PPP) exchange rates - the rate at which the currency of one country would have to be converted into that of another countryto buy the same market basket of goods and servicesin each country. 2nd part of example • If you had to exchange dollars for pounds at the PPP rate, you would pay • 2.89 x 1.7059 = $4.93 for a burger in London. • At the official exchange rate you can buy more for a $1 in London than what the PPP would have allowed you to. So the dollar holds more value because you can buy more (at the official exchange rate) than what you truly should have been able to. • So the official exchange rate overvalues the dollar and undervalues the pound.

Communism and Economic Growth

Why did communism fail? Because of its poor economic record. The Soviet Union had enough Human capital; Physical capital; Natural resources and Technology. Yet, output per person in the Soviet Union at the time of its decline in 1991 was probably less than one-seventh the U.S. level • What communism did not offer: Private property rights; Free markets; Modern legal framework. • No incentives for enterprise

LFPR by Age: 1948-to date

Why is the LFPR among younger adults falling? -Younger adults are staying in school longer -There has been a decline in demand for unskilled workers •Share of the employed in the population is likely to continue its downward trend. •Improving living standards by increasing the share of the population with jobs is an uncertain prospect at best. • So hopes are on average labor productivity (Y/N)

U.S. Population Employed and Labor Force Participation Rate, 1960-2016 27

Why is the LFPR graph above the Share of population with jobs graph? -Because the numerator in LFPR is larger and the denominator is smaller (it is just the adult non-institutional population).

How do we count haircuts in gdp?

Your barber charges $10 for a haircut. In turn, the barber pays his assistant $2 per haircut in return for sharpening the scissors, sweeping the floor, and other chores. For each haircut given, what is the total contribution of the barber and his assistant, taken together, to GDP? The answer to this problem is $10, the price, or market value, of the haircut. The haircut is counted in GDP because it is the final service, the one that actually has value to the final user. The services provided by the assistant have value only because they contribute to the production of the haircut; thus they are not counted in GDP.

Nominal GDP

a measure of GDP in which the quantities produced are valued at current-year prices; nominal GDP measures the current dollar value of production Nominal GDP values output in the current year using prices from the current year -Nominal GDP is the current dollar value of production

unemployment spell

a period during which an individual is continuously unemployed -ends when finds a job or leaves labor force

unemployed

a person is employed if he or she did not work in the preceding week but made some effort to find work (ex: interviewed) in the past four weeks -often understated because discouraged and involuntary part time workers not counted

employed

a person is employed if he or she worked full time or part time (even a few hours) during the past week or is on vacation or sick leave from a regular job

Hyperinflation

a situation in which the inflation rate is extremely high -no specific number but definitely 500-1000% per year -USA never had a period of hyperinflation but during Civil War prices in confederacy rose 92x -hyperinflation has worse costs -usually do not last longer than a few years Hyperinflation is an extremely high inflation rate. •How high? Runaway inflation like 500% or 1000% or more is surely hyperinflation - Germany in 1923 - 102,000,000 % - Hungary in 1945 - 3.8 x 1027% -Israel in 1985 - 400 % -Nicaragua in 1988 - 33,000 % -Brazilin 1994 - 2075.8 % -Zimbabwe in May 2009 (official) - 1,694,000 % - Venezuela -282,973% in 2018

discouraged workers

are people who say they would like to have a job but have not made an effort to find one in the past four weeks. Often, discouraged workers tell the survey takers that they have not searched for work because they have tried without success in the past or because they are convinced that labor market conditions are such that they will not be able to find a job. Because they have not sought work in the past four weeks, discouraged workers are counted as being out of the labor force rather than unemployed. Some observers have suggested that treating discouraged workers as unemployed would provide a more accurate picture of the labor market.

inflation-protected bonds

bonds that pay a nominal interest rate each year equal to a fixed real rate plus the actual rate of inflation during that year

exports

domestically produced goods and services sold in other countries

Value Added

for any firm, the market value of its product or service minus the cost of inputs purchased from other firms Recall the bread example: Suppose that the grain and flour were produced in late 2017, but the bread was produced in 2018. •Should we add $2 to the GDP of 2017 or 2018 or both? • Solution? Value Added Method •.Value added for any firm is the market value of its product or service minus the cost of inputs purchased from other firms Value added is the market value of the product minus the cost of inputs purchased from other firms -Count value added in the year it is produced -Hot'n'Fresh buys flour and other inputs to make bread that sells for $2.00

final goods and services

goods or services consumed by the ultimate user; because they are the end products of the production process, they are counted as part of GDP -ie bread Final goods are consumed by the ultimate user -End products of production -Included in GDP • Intermediate goods are used up in the production of final goods -Not included in GDP •Avoids double counting •A barber charges $10 for a haircut. He hires an assistant who provides services such as shampooing and sweeping - Barber's assistant is paid $2 for his services -Haircut's contribution to GDP is $10 Example of Final and Intermediate Goods - Bread - final good; Wheat and flour - intermediate goods •Milling Co. (produces flour) pays $0.50 for wheat •Bakery (produces bread) pays $1.20 for flour •Bakery sells bread for $2.00 •Contribution to GDP = $2.00 The same good may be intermediate or final - Farmer B produces $100 worth of milk of which he sells $40 worth to his neighbor and uses the rest to feed his pigs, which he eventually sells to Farmer A for $120 • GDP = $40 + $120 = $160 Spending, Income and GDP

intermediate goods and services

goods or services used up in the production of final goods and services and therefore not counted as part of GDP

real quantity

is measured in physical terms - in terms of goods and services. a quantity that is measured in physical terms - for example, in terms of quantities of goods and services -divide nominal quantity by a price index for the period

Reservation wage

is the lowest wage a worker would accept for a given job -Opportunity cost of working is the value of pleasure you would've got from your lost leisure activity -Work compensates you for lost leisure • If working conditions are unpleasant or dangerous, a premium for that would be included in the wage - compensating wage differential -Cost - Benefit Principle at work

Inflation

is the rate of change in the average price level over time, measured, for example by the rate of change in the CPI over time.

unemployment rate

number of unemployed people divided by the labor force (E+UE)

imports

purchases by domestic buyers of goods and services that were produced abroad. Since imports are included in consumption, investment, and government purchases but do not represent spending on domestic production, they must be subtracted. Imports are subtracted fringe exports to find the net amount of spending on domestically produced goods and services. A shorthand way of adding exports and subtracting imports is to add exports, which equals exports minus imports

real GDP and economic well-being

real GDP does not equal economic well-being -many things that contribute to economic wellbeing are not priced and sold in markets -maximizing GDP should not be priority of law makers Examples: 1. leisure time 2. non market economic activity 3. environmental quality and resource depletion 4. quality of life 5. poverty and economic inequality

participation rate

the percentage of the working-age population in the labor force (that is, the percentage that is either employed or looking for work) -divide labor force (E+UE) by the working age population (16+)

Indexing

the practice of increasing a nominal quantity each period by an amount equal to the percentage increase in a specified price index. Indexing prevents the purchasing power of the nominal quantity from being eroded by inflation the practice of increasing a nominal quantity each period by an amount equal to the percentage increase in a specified price index like the CPI - done to prevent erosion of the purchasing power of the nominal quantity - Social security payments are indexed! The minimum wage is not. -convert real to nominal -done for social security

deflating the nominal quantity

the process of dividing a nominal quantity by a price index (such as the CPI) to express the quantity in real terms -not deflation

market value

the selling prices of goods and services in the open market -use market value because sellers and buyers agree on it -price pay represents economic benefit they anticipate getting from it • Observation about Market Value -A good or service that is not bought and sold in the market is not a part of GDP -An unpaid work of a homemaker is not counted in GDP -But paid housekeeping and paid child care services are added to GDP

Macroeconomics

the study of economy-wide phenomena, including inflation, unemployment, and economic growth Can Macroeconomics be understood by simply adding up the answers to corresponding Microeconomic problems? •No. •Examples: -Paradox of Thrift - individually responsible thrifty behavior during hard times is bad for the overall economy. Conversely, seemingly profligate behavior leads to good times for all. -Cash Circulation - An individual with more cash on hand is richer. But if everyone has more cash on hand, that simply raises the price level, leaving the overall purchasing power the same as before. To understand economic developments and to give useful advice to policymakers, businesspeople and financial investors, economists need up-to-date accurate data. •Attempts at measuring the economy dates back to the mid 1600s when Sir William Petty conducted detailed survey of land and wealth in Ireland. • However WWII provided the catalyst for the development of accurate economic statistics - Simon Kuznets of the US and Richard Stone of UK developed comprehensive systems for measuring a nation's output.

fisher effect

the tendency for nominal interest rates to be high when inflation is high and low when inflation is low Fisher-Effect (Irving Fisher) - The tendency for nominal interest rates to be high when inflation is high and low when inflation is low. - Happens because borrowers and lenders want a given real interest rate on their loans. Therefore they raise the nominal interest rate appropriately if inflation is expected to be high. - However, if actual inflation ends up being greater than expected inflation, actual real interest rates will be lower than expected real interest rates. Borrowers will gain, lenders will lose from this unexpected redistribution of wealth.

average labor productivity

total output divided by the quantity of labor employed in its production High labor productivity is not determined only by the willingness of the population to work hard. U.S. average labor productivity is -24 times that of Indonesia -53 times that of Bangladesh •Six factors determine average labor productivity 1.Human capital 2. Physical capital 3. Land and other natural resources 4. Technology 5. Entrepreneurship and management 6. Political and legal environment .

How Can We Promote Economic Growth?

• Government support of education and training programs - US Govt. support for public education extends from kindergarten through to institutions of higher learning - Head Start program for pre-school children - Job training and retraining programs • Government should subsidize education because it has positive externalities - A democracy works better with educated voters -Progressive taxes can capture some of the higher income - Increases the chances of technological innovations Policies that promote saving and investment -Individual Retirement Account (IRA), Investment tax credit •Policies that provide and maintain basic infrastructure - the public capital that promotes private economic activities •Policies that support research and development - National Science Foundation; the Global Positioning System (GPS) was developed originally for the military •Free, fair and stable legal and political framework Promoting Economic Growth in Developing Countries? Prescription for more human and physical capital is broadly correct -Appropriate technology and education •Most countries need institutions to support growth - Corruption creates uncertainty about property rights and drains financial resources out of the country -Regulation discourages entrepreneurship -Taxes discourage risk-taking -Markets do not function efficiently -Lack of political stability discourages foreign investment

Entrepreneurship, Management and Productivity

• The productivity of workers depends on the people who decide what to produce and how to produce it --the entrepreneurs -Henry Ford and mass production -Bill Gates and standardized graphical user interface operating system -Larry Page and Sergey Brin and Google's search - Steve Jobs, Steve Wozniak, Ronald Wayne and Apple •Factors influencing entrepreneurship - Taxation, Regulation, Social Customs • Management: - Influences productivity by implementing more efficient methods of production. Scientific advances alone do not ensure technological change and growth

What is 1982-84=100?

• Most of the current CPI data from BLS is calculated with a base year of 1982-84. • BLS sets an average index level, representing the average price level, for the 36-month period covering the years 1982, 1983, and 1984, equal to 100. • BLS then measures changes in particular year prices in relation to that base of 100. •An index of 110, for example, means there has been a 10% increase in price since the base year period. • An index of 90 implies a 10% decrease in price since the base year period.

compund interest

•Concept of Compound Interest -The payment of interest is not just on the original deposit but also on all previously accumulated interest -Economic growth rates are similar to compound interest rates. -Government policies that affect the long- term growth rate even by a small amount will have a major economic impact. Compound Interest: • How much would an initial Investment (N) of $10 in year 1800 @ 4% compound interest be worth in year 2005? • N=P(1+r)t • In 1801, N = $10.40 = $10 x (1.04) • In 1802, N = $10.40 x (1.04) = $10 x (1.04)2 = $10.82 In 1802, N = $10.40 x (1.04) = $10 x (1.04) 2 =$10.82 In 2005, N = $10 x (1.04) 205 = $31,033.77 @ 6% compound interest? N = $10 x (1.06) 205 = $1,540,644.29

Human Capital and Average Labor Productivity

•Human Capital - The talents, education, training, and skills of workers raise productivity •Human capital is a the result of a combination of factors such as education, training, experience, intelligence, trustworthiness, initiative, motivation, etc. Japan was practically destroyed after WWII. •The occupying US forces restructured the Japanese school system and encouraged all citizens to obtain a good education. •Even more than Germany, Japan emphasized on-the-job- training. With lifetime employment, employers invested heavily in worker training. • By 1980, Japanese manufactured goods were among the best in the world and its labor force, among the most skilled. •East Germany did not have the same experience although levels of human capital were comparable to that of West. Germany.