Macroeconomic Issues

AMBA Managerial Economics

Macroeconomics I

Recent Hot Macroeconomic Issues

Sovereign Bond Crisis in Europe Recession and QE policy in America Inflation and Soft Landing in China Taiwan’s No Pay Holiday Nightmare Earthquake and Long-Term Recession

in Japan

Major Macroeconomic Concerns

National Income: Low Economic Growth Rate

Employment Opportunity: High Unemployment Rate

Cost of Living: High Inflation Rate Trade Surplus: Low Exchange

Rate(Depreciation) Direct Investment: High Interest Rate

How to Measure National Income?

Gross Domestic Product (GDP) Gross National Product (GNP) GDP (Purchasing Power Parity)

Economy’s Income and Expenditure

When judging whether the economy is doing well or poorly, it is natural to look at the total income that everyone in the economy is earning.

For an economy as a whole, income must equal expenditure because: Every transaction has a buyer and a seller. Every dollar of spending by some buyer is a

dollar of income for some seller.

Spending

Goods andservicesbought

Revenue

Goodsand servicessold

Labor, land,and capital

Income

= Flow of inputs and outputs

= Flow of dollars

Factors ofproduction

Wages, rent,and profit

FIRMS•Produce and sellgoods and services

•Hire and use factorsof production

•Buy and consumegoods and services

•Own and sell factorsof production

HOUSEHOLDS

•Households sell•Firms buy

MARKETSFOR

FACTORS OF PRODUCTION

•Firms sell•Households buy

MARKETSFOR

GOODS AND SERVICES

Copyright © 2004 South-Western

Gross Domestic Product

Gross domestic product (GDP) is a measure of the income and expenditures of an economy.

It is the total “Market value” of “all final” “goods and services” “produced” “within a country” in a “given period of time”.

Components of GDP

GDP includes all items produced in the economy and sold legally in markets.

What Is Not Counted in GDP? GDP excludes most items that are

produced and consumed at home and that never enter the marketplace.

It excludes items produced and sold illicitly, such as illegal drugs.

Formula of GDP

GDP (Y) is the sum of the following: Consumption (C) Investment (I) Government Purchases (G) Net Exports (NX)

Y = C + I + G + NX

Components: C and I

Consumption (C): The spending by households on goods

and services, with the exception of purchases of new housing.

Investment (I): The spending on capital equipment,

inventories, and structures, including new housing.

Components: G and NX

Government Purchases (G): The spending on goods and services by local,

state, and federal governments. Does not include transfer payments because

they are not made in exchange for currently produced goods or services.

Net Exports (NX): Exports minus imports.

Nominal Versus Real GDP

Nominal GDP values the production of goods and services at current prices.

Real GDP values the production of goods and services at constant prices.

GDP deflator

An accurate view of the economy requires adjusting nominal to real GDP by using the GDP deflator.

The GDP deflator is a measure of the price level calculated as the ratio of nominal GDP to real GDP times 100.

It tells us the rise in nominal GDP that is attributable to a rise in prices rather than a rise in the quantities produced.

The GDP Deflator

Converting Nominal GDP to Real GDP Nominal GDP is converted to real GDP

as follows:

R eal G D PN o m in a l G D P

G D P d efla to r2 0 X X2 0 X X

2 0 X X

1 0 0

GDP and Economic Well-Being

GDP is the best single measure of the economic well-being of a society.

GDP per person tells us the income and expenditure of the average person in the economy.

Higher GDP per person indicates a higher standard of living.

GDP is not a perfect measure of the happiness or quality of life, however.

GDP and Economic Well-Being

Some things that contribute to well-being are not included in GDP. The value of leisure. The value of a clean environment. The value of almost all activity that takes

place outside of markets, such as the value of the time parents spend with their children and the value of volunteer work.

GDP(PPP)

Gross Domestic Product (GDP) at Purchasing Power Parity (PPP)

Gross National Product

GNP is the total income earned by a nation’s permanent residents. It differs from GDP by including income that citizens earn abroad and excluding income that foreigners earn here.

Green GDP

Green GDP is an index of economic growth with the environmental consequences of that growth factored in.

Green GDP=Traditional GDP- environmental/ecological costs

GDP Per Capita Ranking

http://en.wikipedia.org/wiki/List_of_countries_by_GDP_%28nominal%29_per_capita

http://en.wikipedia.org/wiki/List_of_countries_by_GDP_(PPP)_per_capita

Consumer Price Index

The consumer price index (CPI) is a measure of the overall cost of the goods and services bought by a typical consumer.

It is used to monitor changes in the cost of living over time.

When the CPI rises, the typical family has to spend more dollars to maintain the same standard of living.

Calculating CPI: steps

Fix the Basket Find the Prices Compute the Basket’s Cost Choose a Base Year and Compute the Choose a Base Year and Compute the

IndexIndex

Calculating Inflation Rate

Compute the inflation rate: The inflation rate is the percentage change in the price index from the preceding period.

In fla tio n R a te in Y ear 2 =C P I in Y ea r 2 - C P I in Y ea r 1

C P I in Y ea r 1 1 0 0

GDP deflator and CPI

Economists and policymakers monitor both the GDP deflator and the consumer price index to gauge how quickly prices are rising.

There are two important differences between the indexes that can cause them to diverge.

The GDP deflator reflects the prices of all goods and services produced domestically, whereas...

…the consumer price index reflects the prices of all goods and services bought by consumers.

GDP deflator and CPI

The consumer price index compares the price of a fixed basket of goods and services to the price of the basket in the base year

…whereas the GDP deflator compares the price of currently produced goods and services to the price of the same goods and services in the base year.

Correcting Economic Variables for Effects of Inflation

Price indexes are used to correct for the effects of inflation when comparing dollar figures from different times.

Example

S ala ry S a la ryP rice lev e l in 2 0 0 1

P rice lev e l in 1 9 3 12 0 0 1 1 9 3 1

$ 8 0 ,.

$ 9 3 1,

0 0 01 7 7

1 5 2

5 7 9

Indexation

When some dollar amount is automatically corrected for inflation by law or contract, the amount is said to be indexed for inflation.

Business Cycle I

The term business cycle or economic cycle refers to the fluctuations of economic activity (business fluctuations) around its long-term growth trend.

Business Cycle II

The cycle involves shifts over time between periods of relatively rapid growth of output (recovery and prosperity), and periods of relative stagnation or decline (contraction or recession).

Business Cycle III

These fluctuations are often measured using the real GDP. Despite being termed cycles, these fluctuations in economic growth and decline do not follow a purely mechanical or predictable periodic pattern.

Types of Business Cycle

A number of types of business cycles, in the traditional sense of a fluctuation within a regular period have been proposed. The main types of business cycles enumerated by Joseph Schumpeter.

Juglar Cycle

In 1860, French economist Clement Juglar identified the presence of 8 to 11 year cycles. In Business Cycles, Schumpeter suggested this cycle be named after Juglar. These cycles are made up of four stages, each linked to the variation in prices, production and interest rates.

Four stages

expansion = increase in production and prices , and low interests rates.

crisis = stock exchanges crash and bankruptcies of several companies occur.

recession = decrease in price and in output, high interests rates.

recovery= stocks recover thanks to the fall in prices and incomes.

Recession

A recession is a contraction phase of the business cycle, or "a period of reduced economic activity.

Recession and Depression

The U.S. based NBER defines a recession more specifically as "a significant decline in economic activity spread across the economy, lasting more than a few months. A sustained recession may become a depression.

Attributes of Recession

A recession has many attributes that can occur simultaneously and can include declines in coincident measures of overall economic activity such as employment, investment, and corporate profits.

Causes of Recession

Recessions are the result of falling demand and may be associated with falling prices (deflation), or sharply rising prices (inflation) or a combination of rising prices and stagnant economic growth (stagflation). A severe or prolonged recession is referred to as an economic depression.

Possible Predictors of Recession

A significant stock market drop has often preceded the beginning of a recession.

The three-month change in the unemployment rate.

Index of Leading Indicators

Index of Leading Indicators

The Index of Leading Indicators is an economic index intended to estimate future economic activity. The index is calculated based on ten key variables that have historically turned downward before a recession and upward before an expansion.

Recession’s Warning System

The index of leading indicators can provide an early warning system so that policymakers can shift toward macroeconomic stimulus when the index fails.

Ten key variables

Average number of initial applications for unemployment insurance

Number of manufacturers' new orders for consumer goods and materials

Speed of delivery of new merchandise to vendors from suppliers Amount of new orders for capital goods unrelated to defense Amount of new building permits for residential buildings The S&P 500 stock index Inflation-adjusted money supply (M2) Spread between long and short interest rates Consumer sentiment Average weekly hours worked by manufacturing workers

Monitoring Indicators

Red Light: Very hot Yellow Red light: hot Green light: stable Yellow blue light: cool/poor Blue light: very cool/poor