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Economics

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Macroeconomic Data
Gross Domestic Product (GDP) Consumer Price Index (CPI) Unemployment rate

Gross Domestic Product: Expenditure and Income
Two definitions:
Total expenditure in goods and services produced in a country Total income earned by productive factors in a country

Expenditure equals income, since each dollar/euro spent by a consumer, is also the income of a producer

Circular flow in the Economy
Income Labor

Households

Firms

Goods/Services

Expenditure

Value Added
Value added of a firm is

- The value of its good/service
Minus - The value of the intermediate goods used to produce that good/service

Exercise:
A farmer grows a bushel of wheat and sells it to a miller for $1.00. The miller turns the wheat into flour and then sells the flour to a baker for $3.00. The baker uses the flour to make bread and sells the bread to an engineer for $6.00. The engineer eats the bread. What is the value added by each person? What is GDP?

Solution
1. Farmer’s value added: 1,00 € 2. Miller’s VA: 2,00 € 3. Baker’s VA: 3,00 €. 4. GDP = 1 + 2 + 3 = 6 (sum of incomes) 5. GDP = Price of Bread!

Final Goods, Value Added and GDP
GDP = the total value of final goods and services produced. GDP = the total value added of all firms in the economy. The value of intermediate goods is already included as part of the market price of the final goods in which they are used. To add the intermediate goods to the final goods would be double counting.

The Components of Expenditure
Consumption (C) Investment (I) Government purchases (G) Net exports (NX)

Consumption (C) def: the value of all goods and services bought by households. Includes:

• durable goods: last a long time ex: cars, home appliances • non-durable goods: last a short time ex: food, clothing • services: work done for consumers ex: dry cleaning, air travel.

Investment (I) def1: spending on [the factor of production] capital. def2: spending on goods bought for future use.

Includes: business fixed investment spending on plant and equipment that firms will use to produce other goods & services residential fixed investment spending on housing units by consumers and landlords inventory investment the change in the value of all firms’ inventories

Investment vs. Capital
Note: Investment is spending on new capital

Example (assumes no depreciation):

1/1/2006: economy has $500b worth of capital during 2006: investment = $60b 1/1/2007: economy will have $560b worth of capital

Stocks y flows
Flow
A stock is a quantity measured at a given point in time. A flow is a quantity measured per unit of time.

Stock

GDP: Flow Variable Capital: Stock Variable

Stock vs. Flows: More Examples

stock a person’s wealth # of people with college degrees the govt. debt

flow a person’s saving # of new college graduates the govt. budget deficit

Government spending (G)

G includes all government spending on goods and services. G excludes transfer payments (e.g. unemployment insurance payments), because they do not represent spending on goods and services.

An important identity

Y = C + I + G + XN
GDP Aggregate Expenditure

GNP vs. GDP
Gross National Product (GNP): total income earned by the nation’s factors of production, regardless of where located

Gross Domestic Product (GDP): total income earned by domestically-located factors of production, regardless of nationality. (GNP – GDP) = (factor payments from abroad) – (factor payments to abroad)

GNP vs. GDP (Spain)
(GNP – GDP) = factor payments from abroad minus

factor payments to the rest of the world

(GNP – GDP) as a percentage of GDP for selected countries, 1997.

Real vs. Nominal GDP
GDP is the value of all final goods and services produced. Nominal GDP measures these values using current prices. Real GDP measure these values using the prices of a base year.

Practice problem, first part
2006 P good A good B $30 $100 Q 900 192 P $31 $102 2007 Q 1.000 200 P $36 $100 2008 Q 1.050 205

What is nominal GDP each year? How do we calculate real GDP using 2006 as a base year?

Answers
Nominal GDP: multiply Ps & Qs from same year 2006: $46.200 = $30 × 900 + $100 × 192 2007: $51.400 2008: $58.300 Real GDP: multiply each year’s Qs by 2006 Ps 2006: $46.200 2007: $50.000 2008: $52.000 = $30 × 1050 + $100 × 205

Real GDP controls for inflation

Changes in nominal GDP can be due to: changes in prices changes in quantities of output produced Changes in real GDP can only be due to changes in quantities, because real GDP is constructed using constant base-year prices.

GDP Deflator
The inflation rate is the percentage increase in the overall level of prices. One measure of the price level is the GDP Deflator, defined as

Nominal GDP GDP deflator = 100 × Real GDP

Practice problem, 2nd part: calculate inflation using GDP deflator
Nominal GDP 2006 2007 2008 $46.200 51.400 58.300 Real GDP $46.200 50.000 52.000 GDP deflator Inflation rate n.d.

Practice problem: answer
Nominal GDP 2006 2007 2008 $46.200 51.400 58.300 Real GDP $46.200 50.000 52.000 GDP deflator 100,0 102,8 112,1 Inflation rate n.d. 2,8% 9,1%

Understanding the GDP deflator
Example with 3 goods
For good i = 1, 2, 3 Pit = the market price of good i in month t Qit = the quantity of good i produced in month t NGDPt = Nominal GDP in month t RGDPt = Real GDP in month t

Understanding the GDP deflator
NGDPt P1t Q1t + P2t Q2t + P3t Q3t GDP deflatort = = RGDPt RGDPt

 Q1t =  RGDPt

  Q2t   Q3t   P1t +   P2t +   P3t   RGDPt   RGDPt 

The GDP deflator is a weighted average of prices. The weight on each price reflects that good’s relative importance in GDP. Note that the weights change over time.

Working with percentage changes
USEFUL TRICK #1
For any variables X and Y,

the percentage change in (X × Y ) ≈ the percentage change in X + the percentage change in Y

EX: If your hourly wage rises 5% and you work 7% more hours, then your wage income rises approximately 12%.

Working with percentage changes
USEFUL TRICK #2 the percentage change in (X/Y ) ≈ the percentage change in X − the percentage change in Y
EX: GDP deflator = 100 × NGDP/RGDP.

If NGDP rises 9% and RGDP rises 4%, then the inflation rate is approximately 5%.

Consumer Price Index (CPI)
A measure of the overall level of prices Published by the Bureau of Labor Statistics (BLS) Used to track changes in the typical household’s cost of living adjust many contracts for inflation (i.e. “COLAs”) allow comparisons of dollar figures from different years

How the BLS constructs the CPI
1. Survey consumers to determine composition of the

typical consumer’s “basket” of goods.
2. Every month, collect data on prices of all items in the

basket; compute cost of basket
3. CPI in any month equals

Cost of basket in that month 100 × Cost of basket in base period

Exercise: Calculate CPI
The basket consists of 20 pizzas and 10 CDs.

Prices: 2002 2003 2004 2005 pizza $10 $11 $12 $13 CDs $15 $15 $16 $15

Calculate for every year: The cost of the basket CPI (use 2002 as a base year) The inflation rate with respect to previous year

Answers
Cost of basket 2002 2003 2004 2005 $350 370 400 410 100,0 105,7 114,3 117,1 n.d. 5,7% 8,1% 2,5% CPI Inflation

The composition of the CPI’s “basket”
Food and bev. Housing Apparel Transportation Medical care Recreation Education Communication
40.0% 16.2% 4.5% 17.6% 5.8% 5.9% 2.8% 2.5% 4.8%

Other goods and services

Understanding the CPI
Example with 3 goods
For good i = 1, 2, 3 Ci = the amount of good i in the CPI’s basket Pit = the price of good i in month t Et = the cost of the CPI basket in month t Eb = cost of the basket in the base period

Understanding the CPI
Et P1t C1 + P2t C2 + P3t C3 CPI in month t = = Eb Eb

 C1   C2   C3  =   P1t +   P2t +   P3t  Eb   Eb   Eb 
The CPI is a weighted average of prices. The weight on each price reflects that good’s relative importance in the CPI’s basket. Note that the weights remain fixed over time.

Reasons why the CPI may overstate inflation
Substitution bias: The CPI uses fixed weights, so it cannot reflect consumers’ ability to substitute toward goods whose relative prices have fallen. Introduction of new goods: The introduction of new goods makes consumers better off and, in effect, increases the real value of the dollar. But it does not reduce the CPI, because the CPI uses fixed weights. Unmeasured changes in quality: Quality improvements increase the value of the dollar, but are often not fully measured.

CPI vs. GDP deflator prices of capital goods • included in GDP deflator (if produced domestically) • excluded from CPI prices of imported consumer goods • included in CPI • excluded from GDP deflator the basket of goods • CPI: fixed • GDP deflator: changes every year

Measuring Unemployment: Categories of the population employed working at a paid job unemployed not employed but looking for a job labor force the amount of labor available for producing goods and services; all employed plus unemployed persons not in the labor force not employed, not looking for work.

Two important labor force concepts unemployment rate percentage of the labor force that is unemployed labor force participation rate the fraction of the adult population that ‘participates’ in the labor force

Exercise: Calculate the

statistics of the labor force
Adult Population in US. June 2006 Number of employed = 144,4 millones Number of unemployed = 7,0 millones Adult population = 228,8 millones

Use this data to calculate: Labor fource Persons not in labor force Labor-force participation rate Unemployment rate

Answers : given: E = 144,4, U = 7,0, POP = 228,8 Labor force L = E +U = 144,4 + 7 = 151,4 Persons not in labor force NILF = POP – L = 228,8 – 151,4 = 77,4 Unemployment rate U/L x 100% = (7/151,4) x 100% = 4,6% Labor-force participation rate L/POP x 100% = (151,4/228,8) x 100% = 66,2%

Compute percentage changes in labor force statistics
Suppose the population increases by 1% the labor force increases by 3% the number of unemployed persons increases by 2% Compute the percentage changes in the labor force participation rate: 2% the unemployment rate: −1%…...

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