Econ 1021 Chapter 4: Chapter 4

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University College - Economics
University College - Economics Econ 1021
Bandyopadhay Sudeshna

Chapter 4: Spending, Income, and GDP I. GDP Basics A. History 1. During the Great Depression (1929-33) in the US a. Factories cut production 31% b. Number of people without jobs nearly tripled by 1933 when the unemployment rate hit 25% c. Stocks lost a third of their value in 3 weeks d. All across America shantytowns named “Hoovervilles” sprang up. e. Issue of bank runs during the great depression vs. recession (have FDIC insurance today that prevents such crises) 2. Micro vs. Macro a. Microeconomics - study of production and consumption decisions of individual producers and consumers; allocation of scarce resources among industries was well established b. Macroeconomics – study of the behavior of the economy as a whole – was in a state of infancy • The study of Macroeconomics, as a separate branch of economics, was established during the Great depression • It includes the study of economic recessions and how to avoid them; long run economic growth; inflation; open economy macroeconomics, etc. 3. Why Micro principles won’t work at the macro level a. Paradox of Thrift – individually responsible thrifty behavior during hard times is bad for the overall economy • Conversely, seemingly profligate behavior leads to good times for all. b. Cash Circulation – An individual with more cash on hand is richer. But if everyone has more cash on hand, that simply raises the price level, leaving the overall purchasing power the same as before 4. Macro Data a. To understand economic developments and to give useful advice to policymakers, businesspeople and financial investors, economists need up-to-date accurate data b. Attempts at measuring the economy dates to the early 1600s in Ireland • However WWII provided the catalyst for the development of accurate economic statistics – Simon Kuznets of the US and Richard Stone of UK developed comprehensive systems for measuring a nation’s output. B. Measuring Output: GDP 1. GDP a. Gross Domestic Product (GDP) is the market value of final goods and services produced in a country during a given period of time (typically a year) b. Produced in a country = within geographic borders of a country c. GNP counts the contributions of people from countries (even if not in that respective country) d. However, profits from US companies abroad are counted in US GDP as exports 2. Real vs. Nominal GDP – see later section a. Real GDP has been rising 1947-2015 • 2007 output of the U.S. economy was more than 33 times the 1900 level. Recessions: 1929-33; 1973-’75; 1981-’82; 1990-’91; Mar–Nov 01; Dec 07- Jun 09. Expansions: 33-37; 41-’45; 61-’69; 75-’80; 82-’90; 91-2001; Nov 01 – Nov 07; July 09 till date • As has per capita real GDP b. Economic growth = slope or rate of change of per capita real GDP, % change in GDP • (GDP2-GDP1)/GDP1 X 100 c. Note: nominal GDP doesn’t show inflation, want to look at real GDP (real = nominal – effect of prices) d. GDP can change based on price and quantities C. Inequality 1. Background a. From WWII until 1970s, the income gap between the rich and poor, while significant, did not change very much. b. After the 1970s economic growth slowed and the dispersion in incomes between the rich and poor increased substantially. As of 2016, • The average annual income of the top 1% of Americans is $1,153,293. You need to make at least $389,436 to be in the top 1% income bracket. • The average annual income of everyone else (bottom 99%) is $45,567. You need to make at least $389,436 to be in the top 1% income bracket. • The top 1% takes home 20.1% of all the income in the United States. 2. Today a. Growing economic pie and expansion in the 50s-60s roughly kept proportions of land, labor, capital, operations/manufacturing the same b. Then in the 1970s, huge expansion caused the proportions to skew leading to a lack of equity because too much focus on efficiency c. Nothing in free market economics prevents such inequality disparities/gaps from forming under democracy 3. Income vs. Wealth a. Income, whatever you don’t spend you save (what you don’t consume = savings), can use to invest in assets etc. • In econ: income is a flow b. Wealth: can come from incomes you never earned and other sources • In econ: wealth is a stock of value, has a value at a point in time c. Income and relation to GDP • Must compare in terms of real values/real GDP • BLS chooses a good base year, usually a vanilla year D. Factors 1. Market Value a. GDP is a weighted average: • Market value of the final goods and services is used to add up the quantities of different goods and services into one measurement • Calculating GDP for Nation A producing three goods: X, Y and Z with prices P X PY, and PZ, respectively is: GDP = (XPX) + (YPY) + (ZP Z b. Produce G&S = firms, consume G&S = households c. GDP will be the same number if you count by amounts of monies that people have spent on G&S in economy (add expenditures = expenditure approach) or by market value sold d. For country as a whole, amount we spend = how much we earn (but trickier if you bring in foreign components) – imports = value of products made abroad (subtract contents imported and add contents exported) e. Aggregate measure of quantities produced • Weighs more expensive items more because willingness to pay is an indication of benefit derived from the good. • More expensive items are weightier in the GDP b/c their prices are their weights f. Observation about Market Value • A good or service that is not bought and sold in the market is not a part of GDP • An unpaid work of a homemaker is not counted in GDP • But paid housekeeping and paid child care services are added to GDP • Must have a price to count in GDP – counts in GDP once transaction made 2. Labor Force Participation a. The labor force participation rate (LFPR) is determined by comparing the actual labor force with the potential labor force. • The potential labor force includes persons 16 years of age and older who are non-institutionalized (i.e., not prison, mental institution, etc.) – also called the working-age population. • The actual labor force includes those employed and unemployed (i.e., actively looking for a job). b. Employment (E) vs. Unemployment (U) vs. Not in Labor Force (N) • Population – (<16 years of age) – institutionalized population = potential labor force (LF) = E + U + N • Actual LF = E + U • Ratio of Actual LF/ Potential LF = labor force participation rate c. Women's labor force participation increased since 1960 and peaked in 1999 • Measured GDP increased for two reasons: • Working women's output measured and counted • This output is a real addition to GDP • Paid workers provide previously unpaid childcare - this increase in measured GDP corrects a measurement problem • Not a net addition to goods and services produced • Measured change in GDP due to increased female LFPR probably overstates actual change • GDP has been increasing 1950s-now, but women’s labor force participation rates have been rising (some increases spurious, but GDP may overstate true increase in availability of G&S) d. Ex: WV is a very poor state, high wages (used to be very good), but main industries = steel, mining etc, manufacturing declined, lowest labor force participation rate (the lowest of all states, next state up is 10% higher!) 3. Unemployment a. Must be looking for a job and not have a job for 6 weeks to be considered unemployed b. If you are “out of the labor force” you are not included in unemployment statistics, ie students II. Measuring GDP A. Types and Inclusion of Goods 1. Some non-market goods are included a. Wages in kind (health benefits etc.) b. Agricultural output for self-consumption • If a registered farm, total production is added to GDP  even if some self- consumed c. Imputed rent from owner occupied housing; imputed values of renovations • Any renovations or changes made/paid for in that year are included, also rents are included • Rental values of owner occupied housing is included in the GDP d. Services (like checking account services) provided by financial intermediaries free or for a nominal fee are given an imputed value using differences in interest rates • Non-market G&S like bank services, added to GDP by using difference in interest rates they charge you (interest rate it receives is always higher than interest rate it pays you), shows value of service provided by bank e. Government (public) goods and services are not sold in the market but included because • These goods have value, increase overall output, quantities are known • However, prices cannot be easily established, government production is valued at cost • Overstates GDP if there is waste and inefficiency 2. Some Goods are Excluded a. Nonproduction transactions • Public transfer payments (unemployment benefits, social security, etc.) • SS taxes are paid out of paycheck (under 65), but if you receive SS payments over 65, that isn’t added to GDP b/c these are just transfer payments (across time), progressive and may receive greater than contributed, don’t reflect a current G or S being produced • Welfare, food stamps, unemployment benefits aren’t counted in GDP • Private transfer payments, such as gifts b. Capital Gains and Losses • Additional money you make + added to wealth, not a wage or salary and therefore not GDP c. Unpaid volunteer work for charities d. Illegal market activities • Illegal and not supposed to exist (not a huge US problem, some countries have problems with this and can make GPD look small without this) e. Financial Market Transactions • Financial market transactions are excluded since securities represent either ownership, such as with stocks, or they represent loans, such as bonds • Financial securities do not represent real production, but simply represent the means to finance production f. Interest paid by Government or Consumers (except mortgages because a house provides housing services) 3. Final Goods vs. Intermediat
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