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Econ 1010 Midterm notes.docx

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York University
ECON 1010
Xueda Song

Chapter 5 Measuring a Nation's Income • Experience will be shaped by prevailing economic conditions • People prefer to enter the work force in a year of economic expansion Microeconomic The study of how individual households and firms make decisions and how they interact with one another in markets Macroeconomics The study of the economy as a whole Goal: to explain the economics changes that affect many household firms , and market simultaneously It measures: • Total income of everyone in the economy - GDP • Rate at which average prices are rising - inflation • Percentage of the labour force that is out of work - unemployment • Total spending at store - retail sales • Imbalance of trade between the US and the rest of the work - trade deficit Economy: collection of many households and many firms interacting in many markets GDP: measures the total income of a nation • Most closely watched economic statistic because it is through to be the best single measure of a society's economic well being The Economy's Income and Expenditure • People with high incomes enjoy higher standards of living • When judging whether the economy is doing poorly or well --> look at the gross domestic product (total income of everyone in the economy) GDP Measures two things: • Total income of everyone in the economy • Total expenditure on the economy's output of goods and services • For an economy as a whole: income must equal expenditure o This is true because every transaction has a buyer and seller o Every dollar of spending is a dollar of income for someone else •GDP equals total amount spend by households in the market for goods and service •GDP also equals the total wages, rent, and profit paid by firms in the market for the factors of production •Diagram: o Households buy goods and services from firms --> expenditures flow through the markets for goods and services o Money to pay wages, rent, profit --> income flows through the markets for the factors of production o Money constantly flows from households to firms and then back to households •GDP measures the flow of money o Computed by: • Adding total expenditure by households • Adding up total income paid by firms Measurement of Gross Domestic Product Definition: market value of all final goods and services produced with a country in a country in a given period of time Breakdown Market value: GDP adds together different kinds of products into a single measure of the value of economic activity •Uses market prices to do this •Market price = how much people are willing to pay for those goods Of all: GDP includes all items produced in the economy and sold legally in markets •Includes market value of the housing services (from economy's stock of housing) o Government includes this owner-occupied housing in GDP by estimating rental value o Based on the assumption that owner is renting for himseld • Excludes illicit drugs and homegrown stuff "Final": • Intermediate good: one good is used to produce a god which is the final good • GDP include ONLY the value of final goods o Adding value of intermediate goods doubles the counting o Exception: intermediate good is produced and is added to a firm's inventory of goods for use/sale at a late date o Using the good --> reduced GDP "Good and Services": GDP includes tangible goods and intangible resources "produced": GDP includes goods and services currently produced • Doesn't include transaction involving items produced in the past • In example selling used cars doesn't add to the GDP "Within a Country" • GDP measure the value of production within a geographic confines of a country • Items are included in a nation's GDP if they are produced domestically, regardless of the nationality of the producer "In a Given Period of Time" • GDP measure value of production within a specific interval of time o Usually a year/quarter o When displayed in quarters it is usually displayer at annual rate (GDP for 3 months x 4) o Government presents data with seasonal adjustment • Government statisticians adjust quarterly data to take out the seasonal cycle • The two ways of adding up GDP gives almost the same answer o Almost the same because there are differences in the two calculations of GDP called statistical discrepancy The Components of GDP Formula: • GDP = Consumption + Investment + Government purchases + Net Exports • Y = C + I + G + NX o This equation is an identity o Identity: an equation that must be true because of how the variables in the equation are defined Breakdown Consumption: spending by households on goods and services • Exception of purchasing new houses • Goods=tangible , services = intangible (education included) Investment: purchase of goods that will be used in the future to produce more goods and services • Includes: inventory, capital goods, and new housing • Goods added to inventory are part of that period's production Government Purchases: spending on goods and services by local, state, and federal government • Included salaries of government workers and expenditure on public works • Transfer payment: example - paying a Social Security benefit to a person who is elderly or an unemployment insurance benefit o No made in exchange for a currently produced good/service o Alter household income, but they do not reflect the economy's production o Are like negative taxes Net Exports • Equal the foreign purchases of domestically produced goods (exports) minus the domestic purchases of foreign goods (imports) • Domestic purchases of foreign goods (imports) increases net exports • Meaning of "net": imports are subtracted from exports • Next exports include goods and services produced abroad (with a minus sign) because these goods and services are included in consumption, investment, and government purchases • Buying a good or service from aboard reduces net exports, but also raises consumption o Therefore, it doesn't affect GDP Real Vs Nominal GDP • If total spending rises in the next year: o Economy is producing a larger output of goods and services o Goods and services are being sold at high prices • Economists wants to measure the total quantity of goods and services the economy is producing that is not affected by changes in the prices of those goods and services • Real GDP: determines the value of goods and services produced this year given the prices in a specified year in the past o Uses current production and past prices o Shows how economy's overall production of goods and services changes over time • Nominal GDP: the value of the production of goods and services valued at current prices • To obtain a measure of the amount produced that is not affected by changes in price, we use real GDP o Definition: Production of goods and services values at constant prices How to calculate Real GDP • Designating one year as a base year • Use the prices in the base year to compute the value of goods and services in all the years o These prices provide the basis for comparing quantities in different years o For the base year -- real GDP always equals nominal GDP Summary • Use Nominal GDP uses current prices to place a value on the economy's production of goods and services • Real GDP uses constant base-year prices to place a vale on the economy's production of goods and services • Real GDP is not affected by the changes in prices o Changes in real GDP reflect only changes in the amounts being produced • Real GDP is a measure of the economy's productions of goods and services o Determines how well the overall economy is performing o Also reflects the economy's ability to satisfy people's needs and wants o Real GDP is better than nominal GDP o Economists refer to real GDP when talking about the economy's GDP o Growth in economy is measured as the percentage change in real GDP from one period to another The GDP Deflator • Holding prices constant at base year levels, real GDP reflects only the quantities produced • GDP Deflator: reflects the prices of goods and services, but not the quantities produced • Formula: o GDP Deflator = Nominal GDP/Real GDP X 100 • GDP Deflator from the base year has to equal 100 because Nominal GDP has to equal real GDP in the base year o Measure the current level of prices relative to the level of prices in the base year o Scenarios: • Quantities rise, prices same --> nominal and real GDP rise together --> GDP Deflator is constant • Prices Rise, Quantities stay the same --> nominal GDP rise, real GDP stays the same --> GDP Deflator rises o GDP reflects change in prices, not quantity • Inflation: economy's overall price level is rising o Inflation rate: percentage change in some measure of the price level from one period to another • Formula: Inflation rate in year 2 = (GDP Deflator in Year 2 - GDP Deflator in year 1)/(GDP Deflator in year 1) X 100 • GDP deflator is used to monitor • the average level of prices in the economy Case Study # 1 - Notes • GDP growth enable economic prosperity • Recessions cause a halt in the upward trend of real GDP o Rule of thumb: two consecutive quarters of falling real GDP o Recessions are associated: • Lower income • Rising unemployment • Falling profits, etc. • Macroeconomics is aimed at explaining the long-run growth and short-run fluctuations in real GDP Case Study # 2 - Notes • GDP is a long list of indicators of well being •Higher value of the index = average person in that jurisdiction enjoyed a higher level of well being Case Study #3 - Notes GNP: measures the value of all income earned by Canadian regardless of if it is earned in Canada or other countries GDP: measure the value of all income earned in Canada, regardless of the nationality of the person earning the income GDP - GNP = measure of the difference between the value of output produced by foreigners in Canada and the value of output produced by Canadians in foreign countries •Difference grows as foreigners purchase more of Canada's productivity capacity and as Canadians purchase less of the productive capacity of other countries •Growth indicates that foreigners were purchasing more of Canada's productive capacities o Controls were imposed of foreign ownership o Foreign Investment Review Act: designed to monitor and regulate the purchase of Canada's productive capacities by foreigners •For Graphs: o Height of bar shows the difference between GDP and GNP (measured as a percentage of GDP) o Line above 0 line means foreigners have owned more of Canada's productive capacities than Canadians have owned productive capacities of other countries •Gap between GDP and GNP indicates that Canada is an attractive place to produce goods/services GDP and Economic Well Being •Senator Robert Kennedy claimed that GDP doesn't include things like health of children, strength of marriage, etc. •GDP doesn't reflect the harm that it factory production inflicts on the environment •GDP does not directly measure those things that make life worthwhile, but it does measure our ability to obtain the inputs into a worthwhile life •GDP excludes almost all activity that takes place outside the markets o In example leisure which offsets a higher GDP •Omits value of goods and services produced at home •GDP omits two things: leisure and quality of the environment o GDP will rise and pollutions will also rise (GDP doesn't reflect that) •GDP doesn't say anything about the distribution of income Case Study #4 - Notes •One way to gauge usefulness of GDP as a measure of economic well being is to examine the international data •Higher GDP = higher quality of life o In rich countries people live longer and have high literacy rates Conclusion •The first step to developing the science of macroeconomics is quantifying the behavior of the economy with statistics such as GDP Chapter 6 The Consumer Price Index • Used to monitor changes in the cost of living over time • As consumer price index rises --> typical family spends more to maintain the same standard of living o Inflation: situation in which the economy's overall price level is rising o Inflation rate: percentage change in the price level from the previous period • Consumer Price Index (CPI): measure of the overall cost of the goods and services bought by a typical consumer How to Calculate the Consumer Price Index • Statistics Canada uses data on the prices of over 600 different goods and services to calculate price index and inflation rate • Steps: o Step 1: Determine the Basket • Determine which prices are most important to the typical consumer  Whichever good is purchased more o Step 2: Find the Price • find the prices of each of the good and services in the basket for each point in time o Step 3: Compute the basket's cost • Use the data on prices to calculate the cost of basket of goods and services at different times  Only the prices change • This isolates the effect of price changes only from the effects of changing quantity o Step 4: Choose a base year and compute the index • Designate one year as the base year  Benchmark for comparison with other year  Choice of base year doesn’t matter because index is used to measure changes in cost of living • After base year is chosen, calculate the index by:   A value of 250 = price level is 250% percent of the price level in the base year o Step 5: Compute the Inflation Rate • Inflation rate: percentage change in the price index from the preceding period o With these steps, Statistics Canada is able to determine the cost of living for the typical consumer o Statistics Canada also calculate core inflation • Core Inflation: excludes the most volatile components from the CPI basket of goods and services  Useful in predicting the underlying trend of change in the consumer price index Problems in Measuring the Cost of Living •Goal of CPI is to measure changes in the cost of living o Determines how much incomes must rise to maintain a constant standard of living • Problems: o Problem 1: Commodity Substitution Bias • Prices do not change proportionately from one year to the next • Consumers buy more of goods whose prices have dropped • Consumers substitute towards goods that become relatively inexpensive  Price index assumes a fixed basket of goods and thus ignore customer substitution • This results in the overstatement of the increase in the cost of living from one year to the next o Problem 2: Introduction of New Goods • New good = more variety  Variety makes each dollar more valuable --> consumer need fewer dollars to maintain any given standard of living  In example a gift card to a store with a large variety  As new goods are introduced, consumers have more choices and each dollar is worth more • CPI doesn't reflect the increase in the value of the dollar that arises from the introduction of new goods • In example, the introduction of the VCR reduced the cost of living (not reflected by the index) o Problem 3: Unmeasured Quality change • As quality increase --> value of dollar rises • As quality decreases --> value of dollar drops  Even if price is the same  Stats Canada tries to compute the price of a basket of goods of constant quality • Sometimes difficult because it is hard to me
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