Chapters 6&7 Introduction to Macroeconomics McGraw-Hill/Irwin v

Chapters 6&7

Introduction to Macroeconomics

McGraw-Hill/Irwin v

Economic Performance?

• How much “stuff” did our economy produce this year?– How do you add electricity+grapes+doctor’s

visits+toothpaste+shoelaces+movies+….?



visits+toothpaste+shoelaces+movies+….?– What do they all have in common?



visits+toothpaste+shoelaces+movies+….?– What do they all have in common?– They can be bought/sold for $



visits+toothpaste+shoelaces+movies+….?– What do they all have in common?– They can be bought/sold for $

• So GDP=$PxQ of all final goods and services produced within the borders of an economy during a given year.

GDP=∑(PxQ)We want to measure REAL changes in the

output (Q) of goods and services.

• $1x 100 cokes/year=$100

$100

• $1x 200 cokes/year=$200– $100 $200 correctly represents a 100%

increase in coke production and sales

BUT, what if the price of coke went up from $1$2?

Then, $2 x 100 cokes =$200: no real increase in coke production (Q)

GDP=∑(PxQ)

• Real GDP–Corrects for price changes

• Nominal GDP–Uses current prices

• Unemployment

• Inflation –Increase in overall level of prices

6-7

Business Cycle

GDP= Employment?

(PxQ) Unemployment?

$ Inflation?

TIME (years)

Performance and Policy

• Can governments:–Promote economic growth?

–Reduce severity of recession?

• Is monetary or fiscal policy more effective at mitigating recession?

• Is there a tradeoff between inflation and unemployment?

6-9

Economic Performance

• Output growth +3.1% per year 1995-2005

• Unemployment rate 4.6% in 2007

• Inflation rate 2.7% in 2007

6-10

Economic Performance

• Output growth +3.1% per year 1995-2005

• Unemployment rate 4.6% in 2007

• Inflation rate 2.7% in 2007

6-11

2008GDP - 1%

2008GDP - 1%

Unemployment rate now =

Unemployment rate now =

Inflation rate now = ? %Inflation rate now = ? %

Economic Growth

• Standard of living measured by output per person (per capita)

• No growth in economic living standards prior to Industrial Revolution

• Modern economic growth–Output per person rises

–Not experienced by all countries 6-12

Savings and Investment

• Saving–Tradeoff current for future

consumption

• Investment–Financial investment

–Economic investment

• Banks and financial institutions6-13

Expectations

• The future is uncertain

• Expectations affect investment

• Shocks –What happens is not what you

expected

• Demand shocks

• Supply shocks6-14

Shocks• Demand shocks and flexible prices

–Price falls if demand low–Sales unchanged

• Demand shocks and sticky prices–Maintain inventory–Sales change–Business cycles-especially

unemployment

6-15

Demand Shocks

Cars per week

Pri

ce

DM

DL

DH

900

$40,000

$37,000

$35,000

Flexible Prices

6-16

Demand Shocks

Cars per week

DMDL

DH

700 900 1150

$37,000

Fixed Prices

Pri

ce

6-17

Sticky Prices

• Many prices sticky in short run–Consumers prefer stable prices

–Firms want to avoid price wars

• All prices flexible in long run–Firms adjust to unexpected, but

permanent changes in demand

6-18

Measuring Domestic Output and National Income

Chapter 7

McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter Objectives

• Define and measure GDP• GDP and income relationships• The GDP price index• Nominal GDP vs. real GDP• Limitations of the GDP measure

7-20

• Bureau of Economic Analysis compiles National Income and Product Accounts (GDP, NDP, NI,PI, DI)–Assess health of economy–Track long run course–Formulate policy

National Income Accounting

7-21

Gross Domestic Product

• Measure of aggregate output (Q)

• Monetary measure ($) = PxQ

• Avoid multiple counting–Market value final goods

–Ignore intermediate goods

–Count value added

7-22


• Exclude financial transactions–Public transfer payments–Private transfer payments–Stock (and bond) market

transactions–Excludes illegal activities

• Second hand sales–Sell used car to a friend–Garage/yard sales 7-23

GDP: Value Added Concept• $0 Iron ore


• $1,000 Mine ore


• $1,000 Mine ore

• $5,000 Ship to Steel Mill


• $1,000 Mine ore


• $10,000 Make Steel


• $1,000 Mine ore



• $15,000 Ship to Detroit


• $1,000 Mine ore




• $20,000 Make Car


• $1,000 Mine ore




• $20,000 Make Car

• $25,000 Sell/Ship Car to Dealer


• $1,000 Mine ore




• $20,000 Make Car


What is added to the GDP ?

What is added to the GDP ?


• $1,000 Mine ore




• $20,000 Make Car


• $30,000 Consumer purchases Car

What is added to the

GDP ?

What is added to the

GDP ?

Two Approaches to GDP

• Income approach–Count income derived from

production–Wages, rental income, interest

income, profit• Expenditure approach

–Count sum of money spent buying the final goods

–Who buys the goods?7-33

Circular Flow

ResourceMarket

ProductMarket

Businesses Households

Both Flows Are Equal

GDP

GDP

= =

+Consumption by

Households

Investment byBusinesses

GovernmentPurchases

ExpendituresBy Foreigners

+

+

+++

Wages

Rents

Interest

Profits

StatisticalAdjustments

+

Two Approaches to GDP

7-35

ExpenditureExpenditure IncomeIncome

Expenditures Approach

GDP=C + Ig + G + Xn

(X-M)

Expenditure Approach

• Personal consumption expenditures (C)–Durable consumer goods–Nondurable consumer goods–Consumer expenditures for

services–Domestic plus foreign produced

(within the borders of the USA)7-37


• Gross private domestic investment (I)–Machinery, equipment, and tools–All construction–Changes in inventories

• Creation of new capital asset• Noninvestment transactions (don’t

include transfer of stocks, bonds, etc.)7-38


January 1 Year’s GDP December 31

Consumption& Government

Spending

Depreciation

NetInvestment

GrossInvestment

Stock ofCapital

Increase

Stock ofCapital

Gross InvestmentDepreciation (consumption of fixed capital)

Net Investment-=

7-39

Yellow Bike Investment?

2010100

Yellow Bikes

2010100

Yellow Bikes


2010100

Yellow Bikes

2010100

Yellow Bikes

201150 Yellow

Bikes

201150 Yellow

Bikes

100

Yellow Bikes

100

Yellow Bikes

Gross Investment =50

Bikes


Bikes

20112011


2010100

Yellow Bikes

2010100

Yellow Bikes

201150 Yellow

Bikes

201150 Yellow

Bikes

100

Yellow Bikes

100

Yellow Bikes

20 Bikes “Wear out”



Bikes


Bikes

20112011


2010100

Yellow Bikes

2010100

Yellow Bikes

201150 Yellow

Bikes

201150 Yellow

Bikes

100

Yellow Bikes

100

Yellow Bikes




Bikes


Bikes

Net Investment= 30 bikes

Net Investment= 30 bikes

100 Yellow Bikes

100 Yellow Bikes

130 Total Bikes

130 Total Bikes

20112011


• Government purchases (G) Expenditures for goods and services Expenditures for social capital Excludes transfer payments

• Net exports (Xn)= exports - imports

Add exported goods ($’s spent in US) Subtract imported goods($’s spent

outside US)

• GDP = C+Ig+G+Xn7-44

Compensation

Rents

Interest

Proprietor’s Income

Corporate Profits

Taxes on Production and

Imports

National Income

Net Foreign Factor Income (-)

Statistical Discrepancy (+)

Consumption of Fixed

Capital (+)


$ 7874

65

603

1043

1627

1009

$12,221

96

29

1687

$ 13,841

Personal Consumption (C)

Gross Private Domestic

Investment (Ig)

Government Purchases (G)

Net Exports (Xn)


in Billions ReceiptsExpenditures Approach

AllocationsIncome Approach

$ 9734

2125

2690

-708

$ 13,841

U.S. Economy 2007

7-45

Comparative GDP

Source: World Bank

Selected Nations GDPs, 2007

United StatesJapan

GermanyChina

United KingdomFrance

ItalyCanada

SpainBrazil

RussiaIndia

South KoreaMexico

Australia

0 1 2 3 4 5 6 7 8 9 10 12 13GDP in Trillions of Dollars

7-46

China is now

#2

China is now

#2

Components of National Income

• Compensation of employees• Rents• Interest• Proprietor’s income• Corporate profits

– Corporate income taxes– Dividends– Undistributed corporate profits

–Taxes on production and imports7-47

Income Approach

• From national income to GDP– Net foreign factor income– Statistical discrepancy– Consumption of fixed capital

• Other national accounts– Net domestic product (NDP)– National income (NI)– Personal income (PI)– Disposable income (DI)– DI = C + S 7-48

U.S. Income Relationships 2007

Gross Domestic Product (GDP)Less: Consumption of Fixed CapitalEquals: Net Domestic Product (NDP)Less: Statistical DiscrepancyPlus: Net Foreign Factor IncomeEquals: National Income (NI)Less: Taxes on Production and ImportsLess: Social Security ContributionsLess: Corporate Income TaxesLess: Undistributed Corporate ProfitsPlus: Transfer PaymentsEquals: Personal Income (PI)Less: Personal TaxesEquals: Disposable Income (DI)

$ 13,8411687

$ 12,1542996

$ 12,2211009

979467344

2237$ 11,659

1482$ 10,177

7-49

For Homework Problem #8 p. 143

GDP= C + Ig + G + (X-M)-depreciation

NDP= C + In + G + Xn-statistical discrepancy

+ net foreign factor income

NI=(comp. to employees)+(rent)+(interest)+(profit)+

(proprietor's income)+(taxes on production & imports)

+transfer payments

-social security taxes

-undistributed corporate profits

-corporate income taxes

-taxes on production and imports

PI= C + S + Tx-Tx

DI= C + S

GDP= C + Ig + G + (X-M) = TOTAL PROD.-depreciation

NDP= C + In + G + Xn = NET PRODUCTION-statistical discrepancy

+ net foreign factor income

NI=(comp. to employees)+(rent)+(interest)+(profit)+

(proprietor's income)+(taxes on production & imports) = INCOME EARNED

+transfer payments

-social security taxes

-undistributed corporate profits

-corporate income taxes

-taxes on production and imports

PI= C + S + Tx = INCOME RECEIVED-Tx

DI= C + S = INCOME AVAILABLE

Nominal vs. Real GDP

• GDP is a dollar measure of production

• Using dollar values creates problems

• Nominal GDP =∑ Pi X Qi–Use prevailing prices

• Real GDP–Reflect changes in prices–Use base year price 7-53

GDP=∑(PxQ)We want to measure REAL changes in the

output (Q) of goods and services.

• $1x 100 cokes/year=$100

$100

• $1x 200 cokes/year=$200– $100 $200 correctly represents a 100%

increase in coke production and sales

BUT, what if the price of coke went up from $1$2?

Then, $2 x 100 cokes =$200: no real increase in coke production (Q)

GDP Price Index

• Use price index to determine real GDP

PriceIndexIn GivenYear

= x100Price of Market Basket

In Specific Year

Price of Same BasketIn Base Year

RealGDP =

Nominal GDP

Price Index (in hundredths)

7-55

“Basket”

“Basket”= typical goods and services purchased or produced in a year (apples, gasoline, clothes, electricity, rent, books, toothpaste, bagels, …)

• 1st: determine the price index for each year (every year has its own price index).

• 2nd: Divide the Nominal GDP for a year by that years price index to determine Real GDP

Prices in 1967= $100 (of a specified

“basket” of goods

& services).

Prices in 1987= $300 for same

“basket”

Prices in 2010=$600 for same

“basket” of goods

and services

Price index= Pg/Pb

Let 1967=base year

P index 1967= Pg/Pb= $100/$100=1 or 100% (it is common to “drop the % sign) = 100

P index in 1987

P index in 2010

Price index= Pg/Pb

Let 1967=base year

P index 1967= Pg/Pb= $100/$100=1 or 100%

P index in 1987= $300/$100=3 or 300%

P index in 2010=

Price index= Pg/Pb

Let 1967=base year

P index 1967= Pg/Pb= $100/$100=1 or 100%

P index in 1987= $300/$100=3 or 300%

P index in 2010= $600/$100=6 or 600%

Nominal GDP 1967= $3,000

(current)

Nominal GDP 1987= $9,000

(Current)

Nominal GDP in 2010=$24,000

(Current)

What is the REAL GDP in each year?

Real GDP= Nominal GDPt/PRICE

INDEXt

For 1967 $3,000/1=$3,000

For 1987 $9,000/3=

For 2010 $24,000/6


INDEXt

For 1967 $3,000/1=$3,000

For 1987 $9,000/3= $3000

For 2010 $24,000/6


INDEXt

For 1967 $3,000/1=$3,000

For 1987 $9,000/3= $3000

For 2010 $24,000/6=$4,000

Year Nominal GDP RealGDP

1995 7,414.7 9,093.7

1996 7,838.5 9,433.9

1997 8,332.4 9,854.3

1998 8,793.5 10,283.5

1999 9,353.5 10,779.8

2000 9,951.5 11,226.0

2001 10,286.2 11,347.2

2002 10,642.3 11,553.0

2003 11,142.1 11,840.7

2004 11,867.8 12,263.8

Base year 2005 12,638.4 12,638.4

2006 13,398.9 12,976.2

2007 14,077.6 13,254.1

2008 14,441.4 13,312.2

2009 14,258.2 12,990.3

In Millions $

Actual BEA Data

Actual BEA Data

Shortcomings of GDP

• Nonmarket activities• Leisure• Improved product quality• The underground economy• GDP and the environment• Composition and distribution of the

output• Noneconomic sources of well-being

7-67

Underground Economy

Source: Open Assessment, E-Journal

As a percentage of GDP, Selected Nations, 2007

MexicoSouth Korea

IndiaItaly

SpainChina

SwedenGermany

FranceUnited Kingdom

JapanSwitzerland

United States

0 5 10 15 20 25 30 Percentage of GDP

7-68

Sources of BEA Data

• Consumption– Census Bureau’s Retail Trade Survey– Census Bureau’s Survey of Manufacturers– Census Bureau’s Service Survey

• Investment– All Consumption data sources– Census Bureau’s Housing Starts Survey and

Housing Sales Survey– Retail Trade Survey– Wholesale Trade Survey– Survey of Manufacturing

7-69

• Government Purchases– Office of Personnel Management

– Construction Surveys

– Census Bureau’s Survey of Government Finance

• Net Exports– U.S. Customs Service

– BEA Surveys and Analysis

Sources of BEA Data

7-70

Key Terms

• national income accounting

• gross domestic product• intermediate goods• final goods• multiple counting• value added• expenditures approach• income approach• personal consumption

expenditures• gross and net private

domestic investment

• government purchases

• net exports • taxes on production

and imports• national income• consumption of fixed

capital• net domestic product • personal income • disposable income• nominal GDP• real GDP• price index

7-71

Next Chapter Preview…

Economic Growth

7-72

Documents

Chapters 6&7 Introduction to Macroeconomics McGraw-Hill/Irwin v