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University of Ottawa
Claude Théorêt

ECO1102 B don't email he probably won't answer. ask him after class or ask a TA or office hours (TBD) Evaluation Midterms : 3 x 15% M/C only Assignment: 10% released during reading week. Final: 45% all topics, M/c only sample exam questions with answers will be provided online along with several past-year examinations hopefully with answers (hopefully with correct ones) - never trust answers or information Chapter 1 LO 1. Learn that economics is about allocation of scarce resources 2. Examine some of the tradeoffs that people face 3. Learn the meaning of opportunity costs 4. See how to use marginal reasoning when making decisions 5. Discuss how incentives affect people's behavior 6. Consider why trade among people or nations can be good for everyone 7. Discuss why markets are a good, but not perfect, way to allocate resources 8. Learn what determines some trends in the overall economy Ten Principles of Economics Economy - Greek word for "one who manages a household" Households & economies 1. who will work? 2. What goods and how many of them should be produced? 3. what resources should be used in production? 4. at what price should the goods be sold Economics - science of efficiency. we have to make choices.  the study of how society manages it's scarce resources  the management of society's resources is important because resources are scarce Scarcity  Society o has limited resources o cannot produce all the goods and services people wish to have Ten Principles of Economics How people make decisions (microeconomics) our focus is almost exclusively on efficiency 1. People face tradeoffs  there is no such thing as a free lunch  to get something, we usually have to give up something else  guns v. butter  food v. clothing  leisure time v. work  efficiency v. equity  Efficiency: society gets the most that it can from its scarce resources you have a certain quantity of resources (which are used to produce goods and services)  Equity: the benefit of those resources are distributed fairly among the members of society  resources: labour, land, capital --> these are known as passive resources, they are not decision makers as such. a. labour - passive b. land - passive c. capital - passive i. physical capital (machinery ii. human capital (knowledge ) d. entrepreneurial spirit - what decides what will be produced &how - not passive  making decisions requires trading off one goal against another  some people are better at some things than other things. Given that we can't do everything we want we have to decide what is best for us- what will maximize our economic wellbeing. 2. the cost of something is what you give up to get it  Decisions require comparing costs and benefits of alternatives  whether to go to college or to work  whether to study or go out on a date  whether to go to class or sleep in  opportunity cost of an item  what you give up to obtain that item, what you forego in order to obtain this item or do this thing. which one is the most satisfying alternative? the best alternative to what you did, what you gave up, for instance, is the cost of being here this morning, that cost is the opportunity cost.  we are talking about economic cost not accounting cost. 3. rational people think at the margin  marginal changes  small, incremental adjustments to an existing plan of action  people make decisions by comparing costs and benefits at the margin  when you have to decide on the best option, you have to do a cost benefit analysis. what is the incremental benefit of doing this, and what is the cost of not doing that. you only change your life marginally/ incrementally etc. 4. people respond to incentives  marginal changes in costs or benefits motivate people to respond  the decision to choose one alternative over another occurs when that alternative's marginal benefits exceed its marginal costs!  you have to look at both prices and cost to get to the best idea. 5. trade can make everyone better off  people gain from their ability to trade with one another  competition results in gains from trading  trade allows people to specialize in what they do best  we cannot excel at everything. some people (individually, collectively) are better at some things than us. this is how you become better off by trading with somebody else, but all of these trades must be voluntary. you cannot have coerced trade here. when all trade is voluntary, in most cases it is a win-win situation. it does not mean that the gains are split 50-50, but everybody wins. If trade is not voluntary, then it is a loser-winner situation. in other words your wellbeing will decrease. we can all do this, because if you trade with people, people will specialize, and you will see that some people can do a far better job at doing certain things than others can. (adam smith). at the end of the day, specialization (focus on a narrow portion of a product) will increase efficiency. this will generage large wellbeing in the economy. trade is good as long as it is voluntary! 6. markets are usually a good way to organize economic activity you do not have enough resources to do / produce everything. markets (supply & demand / buyers & sellers) markets are there to optimize the allocation of ressources, to get the biggest bang for your buck. for instance if your car breaks down, or if you want to build a house, you can do it yourself, but it will cost you a lot of time to learn how to do it, and time is money. A specialist (builder, car repairman) can do it much more efficiently.  market economy  an economy that allocates resources through the decentralized decisions of many firms and households as they interact in markets for goods and services  markets are not truly efficient. either because of asymetric information or because of market structure etc.  the real focus is that you have specialists in a market economy, who will take less time (and therefore more efficient)  households  decide what to buy and who to work for  households supply labour and buy goods and services  decisionmaker  firms  decide who to hire and what to produce  decisionmaker  produce goods and services that households purchase. produced on the basis of labour provided by households  these markets are based on two decision makers (households & firms)  other decision makers in a modern economy:  gov't - buys and makes decisions  foreign sector - a lot of canadian goods are exported - buys goods and services and supplies us with capital.  Adam smith made the observation that households and firms interacting in markets act as if guided by an "invisible hand"  because households and firms look at prices when deciding what to buy and sell, they unknowingly take into account the social costs of their actions  as a result, prices guide decision makers to reach outcomes that tend to maximize the welfare of society as a whole 7. governments can sometimes improve economic outcomes  market failure  occurs when the market fails to allocate resources efficiently  may be caused by  an externality, which is the impact of one person or firm's actions on the well-being of a bystander  market power, which is the ability of a single person or firm to unduly influence market prices  when the market fails (breaks down) governments can intervene to promote efficiency and equity  market inefficiency:  market structure: monopoly etc  corruption  natural disaster  taxes = disentives. as taxes rise, the tax burden increases, because leisure becomes less costly.  external affects / externalities: the environment/pollution - ie green tax  when you buy insurance, you have more information on your driving habits than the insurer, so this is known as asymetry Trends and forces that affect how the economy as a whole works (macroeconomics) 8. the standard of living depends on a country's production - ch5  standard of living  may be measured by comparing  personal incomes  the total market value of a nation's production  almost all variation in living standards are explained by differences in countries' productivities  productivity is the amount of goods and services produced from each hour of a worker's time  GDP.  the more a country produces, the higher a standard of living.  the more money a country prints, the more inflation rises 9. prices rise when the government prints too much money  inflation is an increase in the overall level of prices in the economy  the rate of interest is just the price of money. when the supply of money increases, the price of money decreases, money is not worth as much!  one cause of inflation is the growth in the quantity of money  when the government creates large quantities of money, the value of the money falls 10. society faces a short-run tradeoff between inflation and unemployment  the Phillips Curve illustrates the tradeoff between inflation and unemployment  Inflation   Unemployment  it's a short-run tradeoff if the average price of goods & services decreases, we have deflation. (neverhappens) unemployment is when people who are willing and able to work but cannot. the important thing to remember is that there is a tradeoff btn inflation and unemployment. If the inflation rate increases, the rate of unemployment decreases. ie before an election, unemployment is more visible. gov'ts may want to ddecreasse unemployment because it is more visible, and it will be at the cost of inflation (prices), which is more subtle. Summary 1. When individuals make decisions, they face tradeoffs among alternative goals 2. the cost of any action is measured in terms of foregone opportunities 3. rational people make decisions by comparing marginal costs and marginal benefits 4. people change their behavior in response to the incentives they face 5. trade can be mutually beneficial 6. markets are usually a good way of coordinating trade among people 7. governments can potentially improve market outcomes if there is some market failure or if the market outcome is inequitable 8. productivity is the ultimate source of living standards 9. money growth is the ultimate source of inflation 10. society faces a short-run tradeoff between inflation & unemployment Chapter 2 Thinking Like an Economist Economists as Scientists 1. Make positive statements  describe the world as it is (not as it ought to be)  statements can be confirmed or refuted 2. Employ the scientific method to develop and to test theories above how the world works Economists as Policy Advisors  Make normative statements  prescribe how the world should (ought to) be  these statements cannot be confirmed or refuted  governments employ many economists for policy advice  finance canada, to help design tax policy  HRDC to help formulate labour-market policies  environment canada to help design environmental regulations Positive & Normative Statements Which statements are positive? Normative? a. prices rise when the gov't increases the quantity of money positive b. the gov't should print less money normative c. a tax cut is needed to stimulate the economy normative d. an increase in the price of gas will cause an increase in consumer demand for video rentals positive Why economists Disagree  Economists may  disagree about the validity of alternative positive theories about the world  have different values --> different normative views about what policy should try to accomplish  income distribution, minimum wages, income tax rates  yet, there are many propositions about which most economists agree Assumptions & Models Assumptions  simplify the complex world to make it easier to understand  yield useful insights about the more complicated real world  example: when studying international trade, we might assume the world consists of two countried and two goods  economist use models to study economic issues  a model is a simplified representation of a more complicated reality  ie: a road map, human anatomy, model airplane the circular flow diagram: our first model  a visual model of the economy  shows how dollars flow through markets among households and firms  includes two types of economic decision-makers  households  firms  includes two markets  goods and services  factors of production  used to produce goods & services  labour  land  capital  physical - buildings & machines  human - knowledge  entrepreneurial spirit Model 1: The circular-flow diagram  Households:  own the factors of production that they sell/rent them to firms for income  buy and consume goods & services  Firms:  buy/hire factors of production to produce good & services  sell goods & services Model 2: the Production Possibilities Frontier (PPF)  Shows the combinations of two goods the economy can possibly produce given the available factors of production and the available production technology  example:  two goods: computers and wheat  one resource: labour (measured in hours)  economy has 50 000 labour hours per month available for production  producing one computer requires 100 hours of labour  producing one ton of wheat requires 10 hours of labour Labour hours Production Computers wheat Computers Wheat A 50000 0 500 0 B 40000 10000 400 1000 C 25000 25000 250 2500 D 10000 10000 100 4000 E 0 50000 0 5000  PPF: what we know thus far  points on the PPF (like A-E)  possible  efficient in production: all resources are fully utilized  points under PPF (like F)  possible  not efficient (some resources underutilizied) eg, workers unemployed, factories idel  points above PPF (like G)  not possible (not feasible)  Opportunity cost  what must be given up to obtain something  moving along a PPF involves shifting resources (e.g. labour) from production of one good to another  society faces a tradeoff: getting more of one good requires sacrificing some of the other  the slope of the PPF tells you the opportunity cost of one good in terms of the other.  the slope of a line equals the "rise over the run" - the amount the line rises when you move to the right by one unit. Here , the opportunity cost of a computer is 10 tons of wheat  in which country is the opportunity cost of cloth lower? England, because the slope is not as steep  Economic Growth & the PPF  with additional resources or an improvement in technology, the economy can produce more computer, more wheat or any other combination of wheat and computers  the shape of the PPF  the PPF could be a straight line, or bow-shaped  depends on what happens to opportunity cost as the economy shifts resources from one industry to another  if the opportunity cost remains constant, the PPF is a straight line (in the previous example, cost of a computer was always 10 tons of wheat  if the opportunity cost of a good rises as the economy produces more of the good, which is more likely the case, then the PPF is bow-shaped  as the economy shifts resources from beer to mountain bikes  PPF becomes steeper  The opportunity cost of an extra mountain bike increases  At point A, most workers are producing beer, even those who are better suited to building mountain bikes. So, we do not have to sacrifice much beer to get more bikes  At point B, most workers are producing bikes. The few left in the beer industry are the best brewers. Producing more bikes would require shifting some of the best brewers away from beer production, which would result in a big drop in beer output but little gain in the production of bikes  So, PPF is bow-shaped (ie concave) when different workers have different skills, which results in different opportunity costs of producing one good in terms of the other  The PPF would also be bow-shaped when there is some other resources, or mix of resources with varying opportunity costs. Eg, different types of land suited for different uses. PPF: Summary - The PPF shows all combinations of two goods that an economy can possibly produce, given its resources and technology - The PPF illustrates the concepts of tradeoff and opportunity costs, efficiency and inefficiency, unemployment and economic growth The concavity of the PPF illustrates increasing opportunity cost Microeconomics & Macroeconomics Microeconomics: the study of how households and firms make decisions and how they interact in markets Macroeconomics: the study of economy-wide phenomena, including inflation, unemployment, and economic growth These two branches of economics are closely intertwined, yet distinct: they address different questions Your turn: a) What characteristics of a country’s production possibility frontier (PPF) reflects the opportunity cost of producing larger quantities of a good or services? The slope of the PPF reflects the opp cost b) If country A’s PPF is completely outside (to the right of) country B’s PF, can the two countries still benefit from trade? Explain. c) Specialization and trade allow countries to produce quantities of goods and service beyond their respecitive PPFs? d) Specialization and trade allow countries to consume quantities of goods & services beyond their respective PPFs? e) The final terms of trade between two countries must fall within the opportunity costs of the goods or services traded? Sept 10, 2013 Chapter 5 Measuring a nation's income Macroeconomic Policy Challenges - goals, may of which conflict 1. Low unemployment (unemployment rate) - as low as possible but cannot be 0. if Unemployment goes up inflation will go down. impossible to satisfy all of them at one time 2. Strong economic growth (GDP per capita) - want it to grow over the years at a reasonable rate, which requires sacrifices, cannot simply focus on GDP. rapid increase in GDP means prices will increase (impact on inflation). GDP is affected by local and international forces (if the boarders are open ie Canada & the US) 3. stable economic cycle (mitigate GDP fluctuations)we want to minimize fluctuations in GDP b/c fluctuations in GDP make decision-making difficult 4. stable prices of goods & services (inflation) we want inflation to be small because it has a subtle, nasty way of redistributing income. 5. Reduce budgetary deficits é balance gov’t budgets (fiscal revenues and expenditures) - balanced 6. balance trade & capital flows a. exports X and imports M - we want balance between X and M. If you have a fluctuating exchange rate it will affect Potential & Current GDP Canada's GDP is based on using all resourcing and using them efficiently. the Economy would like to be at position "Potential GDP" We have a 7.1% unemployment rate now, which means a lot of ppl who would like to work cannot find work, and ppl who are working are not doing so in their most productive way. Instead of being dead on the GDP line the economy will stray. If the economy is to the left of the "potential gdp" (A) then resources are not being used, and you have a deflationary gap If the economy has a GDP greater than it's potential (B), it is producing more than what it's ressources should allow for (short-term phenonemon) it is short-lived and it means that people are working more (ie overtime) and you have an inflationary gap; the role of the bank of canada & the gov't is to bring the economy towards it's potential. There are policies intended to bring the economy back:  monetary policy (bank of canada changing the supply of income)  fiscal policy (gov't changing the level of expenditures or changing taxes - ie chaning gov't expenditures and revenues) where is the economy now? Measur GDP Measuring a Nation’s Income Macroeconomics answers the following types of questions 1. why is average income high in some countries and low in others? 2. Why do prices rise rapidly during some time periods and are more stable during others? 3. Why do production and employment expand in some years and contract in others? An economy's income & expenditure  when judging whether the economy is doing well or poorly, it is naturalto look at the total income in the economy o total income is equal to wages and salaries in our circular-flow model (ie labour income  the is the task of gross domestic product (GDP) Income Approach or Expenditure approach either approach will give you the same answer a lot easier to sum the expenditures GDP measures two things at once: 1. the total income of everyone in the economy 2. the total expenditure on the economy’s output of goods & services for an economy as a whole, income must equal expenditure because: - every transaction has a buyer and a seller - every dollar spent by a buyer is a dollar of income rec’d by a seller GDP  a measure of the economy's income and expenditure  the total market value (at current prices) of all final goods (as opposed to intermediate goods) and services produced within a country in a given period of time - the focus is on goods that are ready for consumption or investment, that is a final good.  the equality of income and expenditure can be illustrated with the circular-flow diagram Model: a simplification of the real world, we only use the variables that are of interst to us and assume the others are constant (drop them) Major Sectors (decision-makers) of an economy  Firms / businesses  hire and use resources (eg labour, land, human capital, physical, entrepreneurial spirit)  produce and sell goods and services  produce g&s by buying/renting resources to increase our economic well-being  Households  own and supply resources to firms  buy and consume goods and services  Gov'n  also buy G&S and use resources  Foreigners in this model we pretend there is no gov't or foreign sector, and we have only two markets: market for factors of production / resources (labour) firm is buyer and household is seller other market is for goods & sellers, where firm is the seller and household is the purchaser the green and red line enables us to measure GDP. Green: income flow. Firms hire resources, have to pay them, so wages/rent/profit flows to markets for factors of production, and houselholds get income, they spend it and it flows back to the market for goods & services and eventually back to the firm and so on. this is a model! all income is spent, there is no savings in this model, which is known as a leackage of income, but that would still come back to the stream in what is known as an investment. (you can measure GDP by summing up all the wages, rent profit or you can measure all the spending)-? GDP the market value of all final goods & services produced within a country in in a given period of time. final good: if they are not final goods, then they are intermediate goods and would be excluded. anything illegal is excluded from GDP it has to be a buyer and a seller in a market setup. has to be market price = current price there has to be a market for the thing. If you do some housecleaning, that would not be part of GDP - NO. but if you hired a molly maid then that would be included in GDP. within the boarders of a country = geographic given period of time - ie a quarter, a year etc. GDP is the market value...  valued at market prices  final goods remember that intermediate goods are excluded form GDP  produced  includes g&S currently produced, not produced in the past  within a country  measures the value of production within the geographic confines of a country  in a given period of time  meausre the value of production that takes place within a specifi interval of time, usually a year or quarter  includes all items sold legally in markets  exclusions  items produced and consume at home that never enter the marketplace (eg garden vegetables)  goods sold illicitly  it your neighbor & you trade services (you are a plumger he is an electrician) - this is tax evasion, should be but isn't included in GDP **be able to distinguish for GDP and GNP** GDP & GNP (domestic vs national) - Canadian GDP: the total market value of all final goods and services produced within Canada by Canadians and non-canadians in a given period of time - Canadian GNP: the total market value of all final goods & services produced by Canadians throughout the world in a given period of time your turn in a simple circular-flow diagara, how are total income an dtotal expenditure interrelated a. they are seldom equal because of the dynamic changes that occur in an economy: iyou can calculate GDP on the income or expenditure side of the house b. they are equal only when all goods and services produced are sold c. they are always equal because every transaction has a buyer and a seller d. they are always equal because of accounting rules Which of the following is not included in the GDP? a. unpaid cleaning and maintenance of houses b. services such as those provided by lawers and hairstylists c. final goods that are produced but not sold by the end of the year - stock or inventory is included in GDP in the year it is produced d. production of foreign citizens living in canada - included in GDP, but not included in GNP which of the following non-market goods or serivces is included as an estimate in canadian GDP? a. value of unpaid housework b. value of vegetables that ppl grow in gardens - c. estimated rental value of owner-occupied homes - if you rent, it is included in GDP. because of the significance of this value, the statistical agency estimated the rent of owner-occupied homes. d. est value of illegal drugs How are intermediate goods accounted for when calculating GDP? a. the value of all intermediate goods is included in GDP b. the value of intermediate goods is included in GDP only if they were produced in the previous year c. the value of intermidate goods is included in GDP only of the yare purchased by firms rather than housholds d. the value of intermidate goods is not included in GDP unless they are part of inventory iti s the value of the bread that is important, not the value of the products that make up the bread, but if you have excess flour at the end of the year, that is included inventory and included in GDP George buys a house and lives in a newly ontrcuted home he paid 100,000 for in 2010. he sells in 2011 for 225 000. how is GDP impacted by the sale in 2011? a. the 2011 sale increases 2011 gdp by 225000 and does nothing to 2010 gdp b. the 2011 sale increases 20111 gdp by 225 and does ntthing to 2010 c. 2011 sale does not increase 2011 gdp and does nothing to 2010 it was nothing to 2011 because it was built in 2010 so that is the only year it affects gdp in. d. the 2011 sale increases 2011 by 22f and 2010 is revised upward by 25 however, if he used a realtor, the commission paid to the realtor in 2011 would be included in GDP but the value of the house would still not be included in GDP because it was not build in that year. Measures of Income: GDP and GNP Canadian GDP  Canadian GDP: the total market value of all final goods and services produced within Canada by Canadians and non-canadians in a given period of time  Canadian GNP: the total market value of all final goods & services produced by Canadians throughout the world in a given period of time  Canadian GDP 1987-2002    y Nirvana's GDP and GNP 1. Nirvanaès GDP 2012 is 800B 2. the income of Nirvanians working abroad in 2012 is 10B 3. the income of foreign workers in Nirvana in 2012 = 25 GNP = 800B + 10B - 25B = 785B a canadian company owns a fast food restaurant in romania. is the value of goods and services it produces included in canada or romania's GDP? a. in both Romania and canadian GDP b. d c. the right answer is C would be included in romanian GDP but not GNP. would be included in canadian GNP but not Canadian GDP Corporate (business) profits Before Taxes  Business Taxes: first clam in income is taxes to the gov't. the rest of the money can be spent it two ways:  Dividends to shareholders (retained earnings)  undistributed profits Calculating GDP: Income Method Wages & Salaries + Corp profits before taxes + interest and div income (bond and equity) +net agricultural income (because of the importance of agriculture in canada) + net income of unincorporated non-farm businesses (those that are not incorporated) = net income at factor prices (not GDP) + indirect taxes - subsidies (taxes less subsidies) ( indirect taxes are taxes on things other than income, HST for instance) (subsidies are transfer payments by gov't to corporations) = Net Domestic Product (NDP) + Depreciation of physical Capital (D) the gov't calls it CCA - loss of value of physical assets = Gross Domestic Product (GDP)  for our purposes we are only concened with Corp income tax, undistribut corp profits and gov't transfer payments  why do you subtract corporate income taxes? Because it is paid to the gov't not to individuals, this is part of GDP  undistributed corporate profits (retained earnings) - what the company does not pay out to shareholders or the gov't but it is part of GDP so we must factor it out  gov't transfer payments to persons  Personal income taxes (leakage)  Personal Disposable income: people either spend their money in Consumption (C) or they save it (S) what does personal income include and exclude? a. it includes RE, corp income taxes and social insurance contributions, and excludes interest and transfer pmts rec'd by households from gov't b. it excludes REnorp income taxes, social incsurance contributions, and interest, and includes transfer mayment rec'd by households from gov't c. excludes RE, corp income taxes, and Social insurance contributions, and includes interst income and transfer payment rec'd by households from the gov't d. includes EE corp income taxes, social insurance contributions and interst, and excludes transfer pmts rec'd by households from the gov't Retained earnings Is excluded Interest income is Included End of Sept 10 Class th September 13 Class More income measures on the exam, he will probably ask us to calculate disposable income using some previous method/income measure GDP - depreciation of capital goods = Net Domestic Product - (Indirect taxes less subsidies) = Net Income at Factor Prices - Corporate income taxes - Undistributed Corporate Profits (to shareholders) + Gov't transfer payments to persons = Personal income - Personal Income taxes = Personal Disposable Income --> Consumption(C) + Savings (S) Depr = decrease in value of physical (not financial) assets), whether you use them or not Factors = resources. Indirect tax = tax on expenditure, not on income, like HST Undistributed corp profits (Retained earnings) Transfer payments are added because they are just a redeistribution of purchaseing power from the gov’t to persons  Calculating GDP: Expenditure Method Investments (I) = capital expenditures – must include depreciation – there are two types of I – Gross (befpre depr) and net (after depr) Ig= IN+Dep - Personal (residential construction) - business (equipment of all kinds) - gov’t (roads, hospitals, schools etc Add Exports (X) and subtracts Imports (M) – if the borders are open - if you import goods that means that people are When we talk about investment in this call, we are not talking about financial investments. New housing is included in I. Residential construction is a physical investment. If you buy a new house that would be included in Investments. If you rented an apt, that would be included under Consumption.. NX = Net Exports (Imports minus Exports) Q: A German citizen buys an automobile produced in Canada by a Japanese company, what happens as a result? A: C: Canadian NX and GDP increase, Japanese GNP increases, German NX decreases and German GDP and GNP are unaffected Canadian GDP: 1987-2002 – This is REAL GDP (not nominal or actual GDP) Potential GDP what a country should produce given it’s resources and given their productivity. Peak: we are above potential because resources are being used more than expected (overtime) Irregular cycles Peak: For this period of time, our output exceeded our potential. What would this do to unemployment? – It would decrease? To price – would increase. Trough: unemployment will rise and inflation will drop. The important part is that our GDP over time has been increasing. What could cause actual GDP to increase from one year to the next 1. price of goods & services increases 2. increase in the quantity of goods & services produced  Tradeoff though we are going to remove the price affect from the actual GDP actual GPD is a function of the …. real GDP focuses exclusively on a change of volume (remove the price affect) A Bakery’s Value Added Bakery sells 400 loaves of bread weekly at 1.50$ each. What is the weekly income? What is its value added? Here, a loaf of bread is a final good. Output is a loaf of bread. What amount is included in GDP? 600$ for GDP we are only concerned with the price of the final unit, so 400x1.5$ The 550$ here is the value of the intermediate steps. And the difference is the profit, and the profit is included in GDP Value Added 3. Wheat growers sell crop to miller for 100$ 4. Miller sells flour to bakery for 200$ 5. Loblaws sells bread to customers for $300 6. The economic value of the break sold by loblaws is? Economic Growth - Always irregular - Every business cycle has o Two phases  Recession: a period during which real GDP decreases for at least 2 successive quarters  Expansion: a period during which real GDP increases o Two turning points  Peak  Trough In order to compare two countries, you would compare real GDP and you would divide it by the size of the population. WE can see that GDP is rising, but is it rising faster than the population? Benefits and Costs of Economic Growth Benefits of long-term economic growth - Expanded consumption possibilities, including more health care for the poor and elderly, more research on cancer and AIDS, more space exploration, better roads, more and better housing, and a cleaner environment - If GDP per capital is rising at a good clip, then all of us will have more: better healthcare etc. we all have better/ more of everything we want, cleaner environment, better houses etc. Costs of economic growth - Forgone consumption in the present, more rapid depletion of nonrenewable natural resources, and more frequent job changes - If we want growth to be fast in the future, today we need to not consume as much. If all the Canadian resources are used in the production of beer & pretzels, then we are not adding to our stock of capital (machinery, capital etc) so next year we would only be able to produce, at best, the same amount, but probably the cost will be that we will only be able to produce less because we used all our resources this year. Components of GDP GDP (Y) is the sum of the following: 1. Consumption expenditures (C) 2. Investment expenditures (I) 3. Gov’t expenditures (G) 4. Net exports (NX) = Exports (X) – Imports (M) = (X-M) Consumption (C) - Spending by households on goods & services, with the exception of purchases of new housing - Current consumption expenditures on goods & Services. Includes durable and non-durable goods - if I purchase a new car for pleasure (not business) it would be in C. - A television set that I buy – C - Anything you purchase for your own use (not for generating income) is in C - (If a company buys a new delivery van, that would be included in I because it is a business and the van is for generating income) Investment (I) - Spending on capital equipment, inventories, and structures, including new housing - Gross investment = net investment + depreciation - Mostly Capital /physical assets. The life of the investment spreads over several years, more than just the year in which the asset was purchased. - Gov’t construction of hospitals, roads, business investments of all kinds: machiner, equipment etc - Change in the value of inventory is included - Gov’t expenditures on capital - Household expenditure on new housing - Gross investment (includes depreciation)= (net investment + depr) Government Purchases (G) - Spending on goods & services by local, state, and federal gov’ts o Excludes transfer pmts b/c they are not made in exchange for currently produced goods or services Net Exports (NX) Exports (x) minus imports (M) In economics there are two types of variables : stock and flow - Stock variable: measured at a point in time (like a picture) - Flow variable: measured over a period of time – most variables in macro Savings (S) - Income remaining after consumption expenditures (flow variable) - What you don’t consume of your income over a period of time (flow) Wealth - Saving accumulated over time (stock variable) - Market value of your assets at a point in time (stock) - How much are you worth net of liabilities/debt - Net worth investment (I) - Purchases of productive capital (buildings, plant, machinery and equipment) (flow variables) - Also measured over time - Very close cousin to savings - This is what generates a capital stock (Physical) Capital Stock - Total physical capital at a point in time - Like wealth: stock variable: measured at a point in time Other Measures of Income 1.Net domestic product (NDP) = GDP minus depreciation 2.National income at factor cost = NDP minus indirect (sales) taxes plus subsidies 3.Personal income (PI) = inceom rec’d by households and non-corporate busineses 4.Disposable income = personal income less personal taxes Also: GNP as opposed to GDP Question: What is the GNP for this economy? A: GDP: 200 Income earned by citizens abroad: 15 income forigners earned here: 25 GNP = 200 + 15 – 25 = 90 Q: what is the NDP? A: GDP: 200 Depr: 7 NDP = 200-7 = 193 How do you go from GDP to NDP - subtract depreciation GDP less depr = NDP Q: what is national income? (income of all resources / all factors of production) A: you have NDP – what do you have to subtract and add? NDP – (indirect taxes + subsidy) = 193-12+4 = 185 Q: personal income: = National income – corporate earnings -… check Real & Nominal GDP - If total spending rises from one year to the next, one of two things must be true 1. The economy is producing a larger output of goods & services 2. Goods & services are sold at higher prices - Economists want to measure the quantity of goods & services produced - Nominal (Actual) GDP values the production of goods & services at current (year) prices - Real GDP values the production of goods & services at constant (reference or base-year) prices - Remove the price effect - Nominal GDP is simply the product of quantities x prices of that year - Real gdp is the product of quantities produced in any year but you use base year prices instead of current year (prices of a reference year) GDP Deflator - If we want to remove the price effect we need a deflator. - The deflator is simply the ratio of the two GDPs x 100 - A measure of the price level calculated as the ratio of nominal GDP to real GDP times 100 o = 100 (nominal GDP ÷ real GDP) - It tells us the rise in nominal GDP that is attributable to a rise in prices rather than a rise in the quantities produced - GDP deflator is our way of measuring the impact of prices on GDP. What do you use in your daily life? Consumer price index. End of class Sept 13 Converting Nominal GDP to real GDP - Nominal GDP is converted to real GDP as follows - All the 20xx must be the same. IE the GDP deflator for 2012, the nominal for 2012 and the real for 2012. You cannot mix years and you need to calculate the GDP deflator for the specific year - Be able to calculate Real & Nominal GDP as well as the deflator for quizzes/exams For Real GDP, quantities do not change. What does change is the price – they use the base year price. In the base year, Real GDP = Nominal GDP For the base year, GDP deflator is always 100(??) The rate of inflation does not change even if you change the base year. What is the rate of inflation between 01 and 02 based on these numbers? ((171-100)/100)x100 = ((end yr – starting year)/ starting year GDP deflator) x 100 = inflation rate Inflation rate: Calculate the rate of inflation between 02-03 – (240-171)/171 x 100 = GDP and economic Well-Being Our goal is to calculate well-being of a country based on GDP. Is it a good measure of economic well-being? Not perfect but the best we have. - GDP is the best single measure of the economic well-being of a society - GDP per person tells us the income and expenditure of the average person in the economy - A higher GDP per person indicates a higher standard of living - GDP is not a perfect measure of the happiness of quality of life - Examples of contributions to well-being excluded from GDP 1. The value of leisure 2. The value of a clean environment 3. The value of almost all activities that occur outside markets a. The value of time parents spend with their children b. The value of volunteer work 4. When there is a natural disaster and people come to do rebuilding (like in Haiti) then GDP will rise b/c of a bad thing. the higher the life expectancy and adult literacy, the higher the number, the higher the perceived well-being. Chapter 5 Summary Because every transaction has a buyer and a seller, the total expenditure in the economy must equal the total income in the economy GDP measures - An economy’s total expenditure on newly produced goods & services - The total income earned from the production of these goods & services GDP is - The market value of all final goods & services produced within a country in a given period of time - Divided among four components of expenditure: consumption, investment, gov’t purchases & net exports Nominal GDP uses current prices to value the economy’s production Real GDP uses constant base-year prices to value the economy’s production of goods & services The GDP deflator – calculated from the ratio of nominal to real GDP – measures the level of prices in the economy GDP is a good measure of economic well-being because ppl prefer higher to lower incomes It is not a perfect measure of well-being because some things, such as leisure time and clean environment ,aren’t measured by GDP (chapter 5 questions at end of chapter 5 slides) Chapter 6 – Measuring the cost of living Learning Objectives 1. Learn how the CPI is constructued 2. Consider why the CPI is an imperfect measure of the cost of living 3. Compare the CPI and the GDP deflator as measures of the overall price level 4. See how to use a price index to compare dollar figures from different times 5. Learn the distinction between real and nominal interest rates To which expenditure component (C; I; G; X or M) do the following items belong a) Purchase of sports cars – Consumption b) Purchase of automobiles by firms – Investment because it is for a company c) Purchase of new machinery by CDN owned steel companies in Canada - Investment d) Purchase of new mach by CDN owned steel companies in the US – not part of GDP. Would be part of GNP e) Purch of new mach by US owned steel companies in Canada – GDP – Investment f) Increases in business inventories – if the company produces something that remains unsold at the end of the year, it is included in GDP because it was production during the year. It would be a part of Investment g) Purchases of second hand cars by a cab company – not included because it is second-hand h) Purchases of CND-produced beaver tails by Chinese firms – X – exports Look at slides for Excel GDP Calculations – chapter 6 slides beginning and end Slide 11: For GDP it is gross investment that you use. You would use Net investment to calculate Net domestic product. Measuring the Cost of Living - Inflation refers to a situation in which the economy’s overall price level is rising - The inflation rate is the percentage change in the price level from the (or a ) previous product - The CPI is a common measure of the price level - Canadian Inflation has been o Similar to that in other industrial countries o Lower than that in developing countries - Inflation – prices increasing - Deflation – prices decreasing - Stagflation: prices are increasing, and GDP is decreasing (as in early 80’s) – means the unemployment rate is increasing because GDP is decreasing, and Unemployment is decreasing because prices are increasing(check??)g – double whammy Causes of Inflation - Money supply: more money chasing the same quantity of goods: prices increase o Growth in the money supply (currency and bank deposits) exceeds the growth of goods & services - Exchange rates: as the exchange rate decreases, we stop shopping in the states. o Value of one currency in terms of another currency; changes may affect the cost of purchasing goods & services from other countries - Cost-push inflation: increases in production costs (wages)  higher prices o Increase in prices because increase in wages - Demand-pull inflation: demand for g&s grows faster than their production. Like a public auction – many ppl bidding on the same things Why bother with inflation? Subtle way of redistributing wealth - Repercussions on the purchasing power of money o Purchasing power (or value) of money declines if prices increase and cash flows (including weekly wages) are not fully responsive (do not grow at the same rate as prices( o Future dollars are less valuable than today or present dollars  100$ today will have a purchasing power of  90.91 in 1 year if prices increase by 10 per cent during the year or  62.10 in 5 years - Investors are not satisfied with keeping pace with inflation - A successful investment must result in a new gain in buying power over time (ie must exceed inflation( o Buyers of corporate bonds (for example) or investors in a business (such as a restaurant) must account for the impact of price changes in their decision-making - Two rates of resturn are important in an investment decision: o Total or combined rate = real rate + rate of inflation o Real (inflation-free rate) - Of course, an investor should not forget the impact of income taxes on the return on investment  must determine his/her rate of return after adjusting for price changes AND after accounting for income taxes - If you earn 5% on your money (50$ on 1000$) then you pay taxes on your interest, so say 5$ x 50%. Then you end up with only 2.50. Then if inflation is more than 2.5% you are losing money. Is Inflation Problematic? - Yes. Unpredictable changes in the inflation rate redistribute income (and wealth) in arbitrary ways between o Employers and workers o Lenders and borrowers - A high inflation rate is problematic because it diverts resources from productive activities to the unproductive activity of forecasting inflation o An engineer allocates much of her time to forecasting inflation instead of producing the G&S to meet the needs of society Calculating the CPI Both CPI and GDP calculate inflation - Find the prices o Of each of the g&s in the basket for each point in time - Compute the basket’s cost o Use the data on prices to calculate the cost of the basket of g&S at different times GDP and CPI are similar in that they both calculate inflation, only GDP uses a very big basket and CPI a much smaller one The GDP deflator would give a very similar number CPI is 100 for the base year just like for GDP. For CPI the nominator does not change (here 8$) because the basket does not change from year to year as it does in GDP. .you can use the CPI to calculate the rate of inflation: Your turn Wheat production Honey production Price of a bushel of Price of a barrel of wheat honey 2011 200 90 5 60 2012 210 80 7 65 Computer nominal GDP for each year. GDP in 2011 = 200(5)+90(60)=6400 GDP in 2012 =210(7)+____ = 6610 Compute real GDP each year using 2011 as the base year Real GDP in 20ll = 6400 (same as nominal b/c this is the base year) Real GDP in 2012 = 210(5)+80(60) = 5850 Nominal Real 2011 6400 6400 2012 6610 5850 GDP deflator GDO Deflator for 2011 = 100 (base year) GDP deflator for For 2012 = 100 (6610/5850) = 11
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