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Econ 2152 Complete Notes Midterm #1.docx

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Economics 2152A/B
Desmond Mc Keon

Chapter 2 – Measurement 2/5/2013 1:26:00 PM Understand how macroeconomic variables are measured. Measuring GDP  Chief aim on national income accounting is to obtain a measure of the total quantity of goods and services produced for the market in a given country over a period of time.  Gross Domestic Product (GDP) – dollar value of final value of output produced during a given period of time within the borders of Canada.  National Income and Expenditure Accounts (NIEA) – where GDP is published on a quarterly basis.  Three approaches to measuring GDP o Product Approach o Expenditure Approach o Income Approach Intermediate Good – good that is produced then used as an input to another production process. After Tax Profits = total revenue – wages – interest – cost of intermediate inputs – taxes Product Approach  “value added approach”  The sum of value added to goods and services in production across all productive units in the economy.  To calculate: add the value of all goods produced in the economy and subtract all the intermediate goods used in production = total value added.  If we didn’t subtract intermediate goods we would be double counting. GDP = good produced – intermediate goods used in production The Expenditure Approach  Total spending on all final goods and services production in the economy. TotalExpenditure (GDP) CIGNX  C – consumption expenditure  I – investment expenditure (expenditure on goods that are produced but not consumed during the period under consideration)   G – government expenditure  NX – net exports (total exports – total imports) The Income Approach  Add up all incomes received by economic agents contributing to production.  Incomes include profits made by firms, employee compensation, corporate profits, net interest, etc. Anything coming into the company. Why do they all yield same GDP result?  because the quantity of output, or value, added in the economy is ultimately sold, thus showing up as expenditure, and what is spent on all output produced is income, in some form or other, for someone in the economy.  Let Y be GDP in economy  Y is total aggregate output and also total aggregate income. AggregateIncome AggregateExpenditure Y CIGNX * Sometimes referred to as the income-expenditure identity. The quantity on  the left side of the identity is the aggregate income and the right side is the sum of the components of aggregate expenditure.  Gross National Product (GNP)  At one time was used in Canada as the official measure of aggregate production.  However, measures the value of output produced by domestic factors of production, whether or not production takes place within or outside of Canada.  Makes big difference in Canada compared to other countries because a significant fraction of productive plant and equipment in Canada is foreign owned. What does GDP leave out?  GDP per person is invalid because does not take into account how income is distributed across the individuals in the population.  Also leaves out all non market activity.  Underground economy is not measured. Includes all unreported economic activity.  Invalid values on products. How much really worth. Components of Aggregate Expenditure  Consumption o Accounts for 55% of GDP o Is the expenditure on consumer goods and services during the current period, and the components of consumption are durable goods, semi durable goods and non durable goods.  Investment o Accounts for 20.3% of GDP o Is the expenditure on goods that are produced but not consumed during the current period. o Two typed:  Fixed – production of capital, such as plant, equipment and housing  Inventory – good hat are essentially put in storage. o Smaller than consumption because much more variable and plays a large role in the business cycle.  Net Exports o Accounts for 1.9% of GDP  Government o Accounts for 22.7% o Consists of expenditures by federal, provincial or territorial, and municipal goods and services. o Mainly of government consumption and government investment. Nominal and Real GDP and Price Indices A Price Index – a weighted average of the prices of a set of the goods and services produced in the economy over a period of time. If the price index includes prices of all goods and services, then that price index is a measure of the general price level (the average level of prices across all goods and services) Inflation Rate – rate of change in the price level from one period of time to another. >> Use to determine if the change in GDP from one period to another is real or nominal.  Nominal Change – change in GDP that occurred only because the price level changed.  Real Change – increase in the physical quantity of output. Real GDP Chain Weighted Step 1: Calculate GDP using Year 1 Prices for BOTH years a a o o GDP 1 Q 1 Q1 1 1 GDP 2 a a o o G1 GDP 2 Q 1 Q 2 1 2 GDP 1 Step 2: Calculate GDP using Year 2 prices for BOTH years  a a o o GDPP1Q P2Q 1 2 1 GDP 2   G2  a a o o GDP 1 GDPP1Q P2Q 2 2 2 Step 3: Apply to FISCHER INDEX    FV  G1xG2 Step 4: Real GDP in Year 2 = FV x Year 1 Real GDP GDP Deflator for Year 2 = NominalY2  x100 ChainWeightedY 2 *since the base is 100 in the GDP deflator answer this means there is a ___% increase in prices between the two years. *this is not a real world example. Usually targeted between 1 & 3, targeted at 2)  *basically GDP2 in using Year 2 prices divided by answer (Real GDP in Year2) Measures of the Price Level  Implicit GDP Deflator = nominal GDP/real GDP x 100 *is the price level of all new prices of domestically produced final goods in an economy. *current GDP/chain GDP  Current Year CPI = (cost of base year quantities at current prices/cost of base year quantities at base year prices) x 100 *if year 1 is the base year assume that the CPI is 100 (base year always has CPI of 100) and if the CPI is 172.1 then the percentage increase in the CPI from year 1 to year to is 72.1% *a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services Problems with measuring real GDP and the price level  The measurement of real GDP and the measurement of price level are intimately related.  Important problems: o First, If a particular measure of GDP underestimates the growth of real GDP, the rate of inflation will be overestimated. Chain fixes this problem. It assumes that when price changes buyers don’t change their buying habits which is clearly false. Therefore, goods with higher prices receive a higher weighting in the CPI than they should. Savings, Wealth and Capital  Aggregate productive capacity and how aggregate savings adds to this productive capacity.  Flows vs. Stocks o Flow – rate per unit time o Stock – the quantity in existence of some object at a point in time. o GDP, C, I, G, NX are all flows. o To help: bathtub. Water flowing into bathtub. The quantity of water coming out of the faucet per minute is a flow, whereas the quantity of water in the bathtub at any point in time is a stock. Savings – can mean very different things. Whether referring to private, government or nation as whole, etc.  Private Sector o 1) Determine what private sector has available to spend, Privade Disposal Income Y YNFPTRINTT o *Y(GDP), NFP(Net factor payments from abroad to Canadian residents, TR(transfers from the government to the private sector), INT(interest on the government debt), T(taxes).  Recall, GNP = Y + NFP. o What private sector saves is simply what it has available to spend minus what it consumes. SO… o 2) Determine Private Sector Savings Y YNFPTRINTT p d S Y C  Government Saving o What the government has available to spend is its tax revenue, T, minus TR, minus INT, and what it consumes is government expenditures, G.  g S TTRINTG *Government saving is the government surplus. SO… the government deficit is the negative of the government surplus. g D  S  (T TR  INT G)  *If we add private saving and government saving we obtain national saving. p g S S S YNFPCG  *Can also substitute Y for C+I+G+NX. Which gives you.. CA – current account surplus. S  I CA The Current Account Surplus is a measure of the balance of trade in goods with the rest of the world. Reflects the fact that any domestic savings not absorbed by domestic investment must be shipped outside the country in  the form of goods and services. National Savings represents additions to the national wealth. Accumulated in two ways:  Wealth is accumulated through investment, I, which is the addition to the nations capital stock. The stock is the amount of plants, equipment, housing, etc. that the economy has at one time.  Wealth is accumulated through current account surpluses, CA, since a current account surplus implies that Canadian residents are accumulating claims on foreigners. Labour Market Measurement  Employed – those who work part time or full time during the past week.  Unemployed – those who were not employed during the past week but actively searched for work at some point during the last 4 weeks.  Not in the labour force – those who are neither employed or unemployed.  The labour force is then equal to the employed + unemployed. Analyzing tools  Unemployment rate = number unemployed/labour force  Participation rate = labour force/total working age po  Employment/Population ratio = employment/total working age pop Labour market tightness  The unemployment rate is a useful measure of this.  It is the degree of difficulty forms face in hiring workers.  There are two ways in which the unemployment rate may mimeasure the tightness. o Discouraged workers(stopped searching for work but want to be employed), are not counted. o Does not adjust according to how hard the unemployed are searching for work. Chapter 3 – Business Cycle Measurement 2/5/2013 1:26:00 PM Business cycles are quite irregular and therefore somewhat unpredictable. Some difficulty forecasting ups and downs. Regularities in GDP Fluctuations  Primary function of business cycle is that they are fluctuations abut trend in real gross domestic product.  Peaks and troughs (+/- deviations from trend)  Turning points.  Amplitude, difference between real GDP and trend line.  Number of peaks is the frequency.  Boom large number of positive trends.  Recessions large number of negative trends.  Persistent is when it stays consistently above or below trend.  Comovement is when macroeconomic variables fluctuate together in patterns that exhibit strong regularities.  Measured in time series.  Positive vs. Negative Correlation. How they are correlated?  Procyclical – deviations from trend are positively correlated with the deviations from trend in real GDP.  Countercyclical – if its deviations from trend are negatively correlated with the deviations from trend in real GDP.  Acyclical – no correlation at all. The measure of correlation between two variables is the correlation coefficient. (Between -1 and 1) If the correlation is…  1 – perfectly positively correlated  -1 – perfectly negatively correlated  0 – uncorrelated Leading and Lagging Relationships  Leading Variable if the variable tends to aid in predicting the future path of real GDP (x is behind)  Lagging Variable if real GDP helps predict the future path of a particular variable (x is in front)  Coincident Variable neither lags or leads. Composite index of business leading indicators  Economists argue that forecasting can be done simply by exploiting past statistical relationships among macroeconomic variables to project into the future. Standard Deviation  also measures GDP Phillips Curve  The negative relationship between the rate of change in money wages and the unemployment rate.  Stable and reverse relationship.  Simply says lower the unemployment the higher the inflation and vise versa.  Inflation – level of prices in an economy. Real Wage  Purchasing power of the wage earned per hour.  Measured from the data as average money wage for all workers, divided by price level.  Average Money Wage/Prive Level Average Labour Activity  Measure of productivity.  Y/N  Where Y is the aggregate real output and N is total labour input.  For some, Y is real GDP and N is total employment. Seasonal Adjustment  In most macroeconomic time series there exists a predictable seasonal component.  I.e. GDP tends to be lower in summer months when workers are on vacation, Investment lower in winter months when building roads, bridges and other types of structures are harder to build. Chapter 4 – Consumer and Firm Behaviour 2/5/2013 1:26:00 PM The construction and analysis of a particular macroeconomic model. We focus on the behaviour of consumers and firms in a simple model environment with only one time period. One period decision making for consumers and firms will limit the kinds of macroeconomic issues we can address with the resulting model. Given that there is only one time period, consumers and firms will make static, as opposed to dynamic, decisions. Dynamic decision making involves planning over more than one period, i.e. when individuals make decisions concerning how much to spend today and how much to save for the future. The Representative Consumer  Consider the behaviour of a single representative consumer.  Act as a stand in for all of the consumers in the economy.  Show how to represent a consumers preferences over the available goods in the economy and how to represent the consumers budget constraint. The Representative Consumer’s Preferences  Suppose there are two goods that the consumer desires. o 1) Consumption good – a physical good, which we can think of as an aggregation of all consumer goods in the economy, or measured aggregate consumption. o 2) Leisure – any time not spent working. Could include recreational activities, sleep and work at home (i.e. cleaning, cooking, yard work, etc.) o Assume all consumers are equal and identical and therefore, the economy behaves as if there is only one consumer. To determine how the consumer makes choices is to show how we can capture the preferences of the consumer over leisure and consumption goods is by a Utility Function. U(C,l) Where U is the utility function, C is the quantity of consumption and L is the quantity of leisure. Refer to (C,L) – c being the particular consumption quantity and l being the particular leisure quantity as Consumption Bundle. The utility represents how a consumer ranks the particular consumption bundle. I.e. (Cl ) (C l ) 1 1 2 2 This means that the consumer values and/or gets more satisfaction from bundle 1 than 2. Note: the actual level of utility is irrelevant; all that matters for the csumer is what the level of utility is from a given consumption bundle relative to another one. Three Properties  More is always preferred to less.  The consumer likes diversity in his/her bundle. (has choices within)  Consumption and leisure are normal goods. o Normal – quantity of good
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