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Economics (157)
ECON 0110 (84)
Lecture

Section 2 Notes.doc

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Department
Economics
Course
ECON 0110
Professor
K E N K E L
Semester
Spring

Description
SECTION 2: MAJOR GOALS OF MACROECONOMICS GOAL 1 PROMOTE ECONOMIC GROWTH Increase output of goods and services Boost output per capita. HOW DO WE MEASURE TOTAL OUTPUT? NOMINAL GROSS DOMESTIC PRODUCT (GDP) The dollar value of final output of goods and services produced in the United States. 1. IF OUTPUT INCREASED 10%: This is economic growth 2. IF PRICES INCREASED 10%: This is not economic growth This is inflation CALCULATION OF A GROWTH RATE: Growth rate = (New – Old)/Old x 100% Example: New value = 2,200 Old value = 2,000 Growth rate = (2200 – 2000)/2000 x 100% = .10 x 100% = 10% NOMINAL GDP: Value of output calculated using prices that existed during the year when the goods and services were produced Value of output in 2005 using 2005 prices CREATION OF A CONSUMER PRICE INDEX To create a price index, we first choose some year to be the base year, say, Year 0. Next we choose a representative set of quantities of items Q0that are purchased by consumers. Next we determine how much those quantities cost using the prices that existed during various years. That is, we calculate, say, 0 0 , 1 0,P2Q 0 etc. PRICE INDEX The index for Year n is equal to: (PnQ 0P 0 0 x 100 Example: Suppose an economy produced the following quantities of items and sold them at the following prices during years 0, 1, and 2. Item P 0 Q 0 P 1 Q 1 P 2 Q 2 Shirts 30 10 35 12 37 14 Shoes 24 15 25 16 28 19 Coats 17 21 20 25 23 26 We obtain: P Q = 30x10 + 24x15 + 17 x 21 = 300 + 360 + 357 = 1,017 0 0 This tells us that the base year quantities had a value of 1,017 if sold during year 0. P1Q 0 35x10 + 25x15 + 20 x 21 = 350 + 375 + 420 = 1,145 This tells us that the base year quantities had a value of 1,017 if sold during year 1. P2Q 0 37x10 + 28x15 + 23 x 21 = 370 + 420 + 483 = 1,273 This tells us that the base year quantities had a value of 1,273 if sold during year 2. We have held the items in the market basket constant and we have changed the prices from year to year. We obtain the following values for the price index Year 0: (P Q / P Q ) x 100 = (1017/1017) x 100 = 100 0 0 0 0 Year 1: (P Q / P Q ) x 100 = (1145/1017) x 100 = 112.59 1 0 0 0 Year 2: (P Q 2 0 Q )0x0100 = (1273/1017) x 100 = 125.17 Interpretation of the price index: Items which cost 100 during Year 0 cost 112.59 during Year 1 and 125.17 during Year 2. Thus, the cost of the items has increased and we have had inflation. Prices are 12.59% higher during Year 1 than during Year 0. Prices are 25.17% higher during Year 2 than during Year 0. Inflation rate between Year 1 and Year 2 During Year 1 the price index had a value of 112.59. During Year 2 the price index had a value of 125.17. The inflation rate is the rate of growth in prices. We obtain: Inflation rate = [(125.17 – 112.59)/112.59] x 100% = 11.55% Suppose the base year was 1983. Thus the price index in 1983 would be 100. Assume prices during 2005 are 75% higher than during 1983 Then the PRICE INDEX for 2005 would be 175 REAL GDP: Value of output during any year calculated using prices that existed in some base year CALCULATION OF REAL GDP GIVEN A SET OF PRICES AND QUANTITIES Suppose we are given a set of prices and a set of quantities sold during various years. To calculate REAL GDP, we pick a base year and use the prices during that year to determine the value of output during any year using the base year prices. As a result, the value of output during any year is not affected by changes in prices. EXAMPLE: Suppose an economy produced the following quantities of items and sold them at the following prices during years 0, 1, and 2. Let us use Year 0 as the base year. Thus, we calculate the value of output each year based on the Year 0 prices. Item P0 Q 0 P 1 Q 1 P2 Q2 Shirts 30 10 35 12 37 14 Shoes 24 15 25 16 28 19 Coats 17 21 20 25 23 26 We obtain the following values for REAL GDP: Year 0: P0Q 0 30x10 + 24x15 + 17 x 21 = 300 + 360 + 357 = 1,017 Year 1: P0Q 1 30x12 + 24x16 + 17 x 25 = 360 + 384 + 425 = 1,169 Year 2: P0Q 2 30x14 + 24x19 + 17 x 26 = 420 + 456 + 442 = 1,318 We obtain the following values for NOMINAL GDP: Year 0: P0Q 0 30x10 + 24x15 + 17 x 21 = 300 + 360 + 357 = 1,017 Year 1: P1Q 1 35x12 + 25x16 + 20 x 25 = 420 + 400 + 500 = 1,320 Year 2: P2Q 2 37x14 + 28x19 + 23 x 26 = 518 + 532 + 598 = 1,648 1. Nominal GDP increased each year. This is because BOTH quantities increased AND prices increased each year. 2. Real GDP increased each year. This is because quantities increased. We have held prices constant, so none of the increase is caused by price increases. Growth rate of NOMINAL GDP between Year 1 and Year 2 [(1648 – 1320)/1320] x 100% = 24.85% Growth rate of REAL GDP between Year 1 and Year 2 [(1318 – 1169)/1169] x 100% = 12.75% CALCULATION OF REAL GDP GIVEN A PRICE INDEX Suppose we have data showing nominal GDP for each year and we have a price index using, say, 1983 as the base year. Real GDP for, say, Year 1993 is calculated by valuing the things produced during 1993 using 1983 (base year) prices. FORMULA FOR REAL GDP during Year i: Real GDP = iNominal GDP/Price iidex) x 100 i CA
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