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    CH

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    2008 Pearson Education Macroeconomics, 5/e Olivier Blanchard

    A Tour of theBook

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    The problems with GDP definition

    Consider the following examples

    A person spends $100 for a doctor visit.

    You spend a day as a volunteer teaching childrenmandarin.

    China's central finance would arrange RMB70 billionthis year for the post-earthquake reconstruction.

    U.S has spent more $ 600 billion in Iraq War. It's likespending $121,000 per person ($484,000 per family of

    4) in the US. The Iraq war has already cost the lives ofnearly 4,000 U.S. troops. But this is counted as a part ofGDP!!!

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    Short Summary of GDP

    GDP is a basic measure of a country'seconomic performance and is the

    market value of all final goods and

    services made within the borders of an

    economy in a year . It is a fundamentalmeasurement of production and is very

    often positively correlated with the

    standard of living.

    GDP can be defined in three ways (totalproduction, total expenditure, totalincome), all of which are conceptually

    identical.

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    Short Summary of GDP

    But GDP as an indicator of economic health also has the followinglimitations:

    Wealth distribution GDP does not take disparity in incomesbetween the rich and poor into account.

    Non-market transactions GDP excludes activities that arenot provided through the market, such as household productionand volunteer or unpaid services.

    Underground economy Official GDP estimates may not takeinto account the underground economy What is being produced GDP counts work that produces nonet change or that results from repairing harm. For example,rebuilding after a natural disaster or war may boost GDP.

    Externalities GDP ignores externalities or economic badssuch as damage to the environment. GDP does not deduct badsor accounting for the negative effects of higher production,such as more pollution.

    Sustainability of growth GDP does not measure thesustainability of growth.

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    The Other Major

    Macroeconomic Variables

    GDP is obviously the most importantmacroeconomic variable. But two other variablestell us about other important aspects of how aneconomic is performing:

    Inflation

    Unemployment

    2-2

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    Nominal and Real GDP

    Nominal GDP is the sum of the quantitiesof final goods produced times their currentprice.

    Nominal GDP increases over time because:

    The production of most goods increasesover time.

    The prices of most goods also increaseover time.

    Real GDP is constructed as the sum of thequantities of final goods times constant(rather than current) prices.

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    Nominal and Real GDP

    To construct real GDP, multiply the number ofcars in each year by a common price.

    Suppose we use the price of the car in 2000as the common price. This approach gives us,in effect, real GDP in 2000 dollars.

    Year Quantityof Cars

    Price

    of cars

    Nominal GDP Real GDP

    (in 2000 dollars)

    1999 10 $20,000 $200,000 $240,000

    2000 12 $24,000 $288,000 $288,000

    2001 13 $26,000 $338,000 $312,000

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    Nominal and Real GDP

    Nominal GDP is also called dollar GDPorGDP in current dollars.

    Real GDP is also called GDP in terms ofgoods, GDP in constant dollars, GDPadjusted for inflation.

    GDP will refer to real GDP, and Ytwill

    denote real GDP in year t.

    Nominal GDP will be denoted by a dollarsign in front of it: $Yt.

    Real GDP, Technological Progress,and the Price of ComputersHedonic pricing puts an implicit price on each of a

    goods characteristics.

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    Nominal and Real GDP

    From 1960 to 2003, nominal

    GDP increased by a factor of21. Real GDP increased by afactor of 4.

    Nominaland RealGDP U.S. GDP Since1960

    Figure 1 - 2

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    Nominal and Real GDP

    Real GDP per capita is the ratio of real GDP tothe population of the country.

    GDP growth equals:

    1

    1)(

    t

    tt

    YYY

    Periods of positive GDP growth are calledexpansions.

    Periods of negative GDP growth are calledrecessions.

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    Nominal and Real GDP

    Figure 2-2

    Growth Rate of U.S.

    GDP Since 1960

    Since 1960, theU.S. economy hasgone through aseries ofexpansionsinterrupted byshort recessions.

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    The GDP Deflator

    The GDP deflatoris what is called an indexnumberset equal to 100 in the base year.

    The rate of change in the GDP deflator equalsthe rate of inflation:

    PY

    Ytt

    t

    = =

    n o m i n a l G DP

    r e a l G D P

    t

    t

    $

    ( )P P

    Pt t

    t

    1

    1

    Nominal GDP is equal to the GDP deflator timesNominal GDP is equal to the GDP deflator timesreal GDP:real GDP:

    $ Y P Yt t t

    =

    The GDP deflatorin year t, Pt, is defined as the

    ratio of nominal GDP to real GDP in yeart:

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    The Inflation Rate

    Inflation is a sustained rise in the general levelof pricesthe price level.

    The inflation rate is the rate at which the pricelevel increases. (Conversely, deflation is asustained decline in the price level. Itcorresponds to a negative inflation rate).Deflation is rare, but it does happen. Japan has

    experienced deflation since the late 1990s.

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    Example

    The country of Myrule has produced the following quantityof oranges and potatoes, with the price of each listed indollar terms.

    Year

    1 2

    Quantity Price Quantity Price

    Oranges 8,000 $4 10,000 $3

    Potatoes 6,000 $8 5,000 $14

    (a)Using Year 1 as the base year, what is the growth rateof real GDP from Year 1 to Year 2?

    (b)Based on the GDP deflator, what is the inflation ratefrom Year 1 to Year 2?

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    Answer :

    (a) Real GDP for Year 1 = Year 1 quantities at Year 1 prices= (8000 x $4) + (6000 x $8) = $80,000.

    Real GDP for Year 2 = Year 2 quantities at Year 1 prices =(10,000 x $4) + (5000 x $8) = $80,000.

    Growth rate of real GDP = 0%

    (b) Nominal GDP for Year 1 = Year 1 quantities at Year 1 prices =(8000 x $4) + (6000 x $8) = $80,000.

    Nominal GDP for Year 2 = Year 2 quantities at Year 2 prices =

    (10,000 x $3) + (5000 x $14) = $100,000.GDP deflator = nominal GDP/real GDP

    GDP deflator in Year 1 = $80,000/$80,000 = 1.

    GDP deflator in Year 2 = $100,000/$80,000 = 1.25.

    Inflation rate = [(1.25/1) - 1] x 100% = 25%.

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    The Consumer Price Index

    The GDP deflator measures the average price ofoutput, while the consumer price index, or CPI,measures the average price of consumption, orequivalently, the cost of living.

    The CPI gives the cost in dollars of a specific listof goods and services over time, which attemptsto represent the consumption basketof a typical

    urban consumer.

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    The Consumer Price Index

    The set of goods produced in the economy is notthe same as the set of goods purchased byconsumers for two reasons: Some of the goods are sold to firms, the

    government, or to foreigners. Some of the goods are not produced

    domestically but are imported from abroad.

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    The Consumer Price Index

    Inflation Rate, Usingthe CPI and the GDPDeflator since 1960

    Figure 2-4

    The inflation

    rates, computedusing either theCPI or the GDPdeflator, arelargely similar.

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    The Consumer Price Index

    Figure 2-4 yields two conclusions:

    The CPI and the GDP deflator move togethermost of the time. In most years, the twoinflation rates differ by less than 1%.

    There are clear exceptions, however. In both1974 and in the late 1970s, the increase inthe CPI was significantly larger than theincrease in the GDP deflator.

    Wh D E i t C

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    Why Do Economists Care

    About Inflation?

    Economists care about inflation for two reasons:

    During periods of inflation, not all prices andwages rise proportionately, inflation affectsincome distribution.

    Inflation leads to other distortions.

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    The Unemployment Rate

    The Current Population Survey (CPS)is usedto compute the unemployment rate.

    Only those looking for work are counted asunemployed. Those not working and not lookingfor work are not in the labor force.

    People without jobs who give up looking for workare known as discouraged workers.

    Participation rate = l a b o r f o r cep o p u l a t i o no f w o r k i ng a g e

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    The Unemployment Rate

    labor force = employment + unemployment L = N + U

    Unemployment rate:LUu =

    u 2 0 0 38 8

    1 3 77 8 8 6 0 %= + =.

    . . .

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    The Unemployment Rate

    Since 1960, the U.S.unemployment ratehas fluctuatedbetween 3 and 10%,going down duringexpansions, andgoing up during

    recessions.

    U.S. UnemploymentRate Since 1960.

    Figure 2-3

    Why Do Economists Care

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    Why Do Economists Care

    About Unemployment?

    Economists care about unemployment for

    two reasons:

    Because of its direct effects on the welfare of theunemployed.

    Because it signals that the economy may not be usingsome of its resources efficiently.

    Did Spain Really Have a 24%Unemployment Rate in 1994?The underground economyis not measured in

    official statistics.

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    A Tour of the Book

    The book is organized into three parts:

    A core which has three parts the short run,the medium run, and the long run.

    Three extensions which explore the role ofexpectations, closed economies, andexpansion and recessions.

    A deeper look at the role of microeconomic

    policy.

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    A Tour of the Book

    Figure 2-5

    The Organization of

    the Book

    2-4

    The Short Run

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    The Short Run,

    the Medium Run, the Long Run

    Output is determined by:

    demand in the short run, say, a few years,

    the level of technology, the capital stock, and the

    labor force in the medium run, say, a decade orso,

    factors such as education, research, saving, andthe quality of government in the long run, say, ahalf century or more.

    2-3