ap/ib economics unit 3.1-3.2: macroeconomics indicators...

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3.1 Measuring national income * Circular flow of income * Methods of measurement - income, expenditure and output * Distinction between o gross and net o national and domestic o nominal and real o total and per capita

3.2 Introduction to development * Definitions of economic growth and economic development * Differences in the definitions of the two concepts * Gross Domestic Product (GDP) vs. Gross National Product (GNP) as measures of growth * Limitations of using GDP as a measure to compare welfare between countries * Allowance for differences in purchasing power when comparing welfare between countries * Alternative methods of measurement * Problems of measuring development

3.3 Macroeconomic models * Aggregate demand - components * Aggregate supply o short-run o long-run (Keynesian vs. neo-classical approach) o Full employment level of national income o Equilibrium level of national income o Inflationary gap o Deflationary gap o Diagram illustrating trade/business cycle

MacroeconomicsUnit Overview

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3.4 Demand-side and supply-side policies * Shifts in the AD curve / demand-side policies o fiscal policy o interest rates as a tool of monetary policy * Shifts in the AS curve / supply-side policies * Strengths and weaknesses of these policiesHigher level only: * Multiplier o calculation of multiplier * Accelerator * "Crowding out"

3.5 Unemployment and inflation Unemployment * Full employment and underemployment * Unemployment rate * Costs of unemployment * Types of unemployment o structural o frictional o seasonal o cyclical/demand-deficient o real wage * Measures to deal with unemployment Inflation * Definitions of inflation and deflation * Costs of inflation and deflation * Causes of inflation o cost push o demand pull o excess monetary growth

Higher level only: * Methods of measuring inflation * Problems of the methods of measuring inflation * Phillips curve o short-run o long-run * Natural rate of unemployment (NRU) * Non-Accelerating Inflation Rate of Unemployment (NAIRU)

3.6 Distribution of income * Direct taxation * Indirect taxation * Progressive taxation * Proportional taxation * Regressive taxation * Transfer payments

Higher level only: * Laffer curve * Lorenz curve and Gini coefficient

MacroeconomicsUnit Overview

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Micro concept >>>>>> Macro equivalent

MarketDemandSupplyPriceQuantityDecrease in demandIncrease in demandDecrease in supplyIncreaese in supplyExcise (indirect) taxSubsidy

National EconomyAggregate DemandAggregate SupplyPrice levelNational Output/Income (GDP)Recession and unemploymentInflationSupply shock, stagflationEconomic growthIncome (direct) taxGovernment spending

MacroeconomicsMicro vs. Macro

Intro to Macroeconomics: What is Macroeconomics?

Welker’s Wikinomics Blog »Macroeconomics - Trying to see the forest through the trees

http://welkerswikinomics.com/blog/2008/01/21/trying-to-see-the-forest-through-the-trees-welcome-to-macroeconomics/

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Households Firms

Product market

Resource market

Government

Factors of productin

Income: W I R P

Goods/Services

Expenditures / revenue

Taxes TaxesGoods/services Goods/services

Leakages: Savings and purchase of imports

Injections: Investment and purchase of exports

MacroeconomicsThe circular flow of income - macro version

Revisiting the circular flow: The macro circular flow model includes household saving and firm investment, government taxation and spending on G&S, and foreigners who buy exports and sell imports.

Leakages: The money that leaves the circular flow because it is not being spent on domestic G&S.Injections: Spending that enters the circular flow from external sources i.e. foreign investors and consumers.

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In Microeconomics, the objectives are: • firms aim to maximize profits• consumers aim to maximize utility • efficient resource allocation in competitive markets• the correction of market failure through government intervention

These can be thought of the goals of microeconomics

In Macroeconomics, the objectives are:

Full - employment: Does NOT mean every single person has a job. Means that most people who want to work are working. Some unemploymenet will exist in a healthy economy.

Stable prices: This refers not to the prices of individual products, but to the price level in the economy as a whole. A rise in the overall price level is called inflation, a fall is called deflation.

Economic growth: The most talked about macroeconomic goal, growth occurs when the total amount of goods and services an economy produces increases from year to year.

1)

2)

3)

4) Income distribution: A nation's income should be somewhat equally distributed between the upper and lower "classes" in society. Some tax systems are designed to achieve more equitable income distribution.

MacroeconomicsThe Macroeconomic Objectives

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Gross Domestic Product: GDP is the monetary measure of the total market value of all final goods and services produced within a country in one year.

Why is GDP important?>>It tells us something about the relative size of different countries' economies>>It is a monetary measure, so it tells us how much income a country earns in a year (assuming everything that is produced is sold).>>When we divide GDP by the populuation, we get GDP per capita, which tells us how many goods and services the average person consumes in a country.>>When real GDP grows more than the population, that tells us that people on average, have more stuff than they did before.>>If you believe that having more stuff makes people better off, then GDP per capita tells us how well off people in society are.

IMPLICATIONS: GDP is the most important macroeconomic measurement!

Can be thought of as: national income or national output or national expenditures

GDP=W+R+I+P GDP=primary output + secondary output + tertiery output

GDP=C+I+G+(X-M)

MacroeconomicsMeasuring national income

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What's included and not included in GDP?

GDP includes:• GDP includes only final products and services• GDP is the value of what has been produced within the borders of a nation over one year, not what was actually sold.


GDP Excludes "nonproduction transactions":• Purely financial transactions are excluded.>>Public transfer payments, like social security or cash welfare benefits.>>Private transfer payments, like student allowances or alimony payments.>>The sale of stocks and bonds represent a transfer of existing assets (However, the brokers’ fees are included for services rendered.)• Secondhand sales: If I buy a used car in 2008, that sale does not count towards 2008's GDP, because the car was not made in 2008! The price of the car was originally included in the year's GDP when it was produced.

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Gross National Product: the total income that is earned by a country's factors of production regardless of where the assets are located.

GNP = GDP + net property income from abroad

The value of the cars made in a Honda factory in the US count towards Japan's GNP and America's GDP. Bank of America's operations in Japan count towards US GNP and Japan's GDP.

Nominal GDP and real GDP:

Nominal GDP measures the money value of a nation's output. To measure the REAL value of the nation's output, the value of money must be taken into account. Inflation erodes the value of money and therefore the nation's output.

REAL GDP = Nominal GDP adjusted for inflation.

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How do we determine Real GDP? We will assume that we live in an economy that produces only one thing, Pizza..

1. Find Nominal GDP for each year2. Determine a price index for each year (using the price index formula), 3. Adjust the nominal GDP figures by dividing by the price index (in hundredths).


What is a price index?A price index is a measure of the price of a specified collection of goods and services called a, “market basket” in a given year as compared to the price of an identical basket of goods and

services in a reference year.

Price index for a given year =

Price of a "market basket" of goods in a specific year

Price of same "basket" in the base year

X 100

Real GDP = Nominal GDP

Price index (in hundredths)

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2008: 10 pizza's @ $10/pizza. Nominal GDP = $1002009: 12 pizza's @ $12/pizza. Nominal GDP = $144

Example:

Price index=P

pizza 2008 = $10

Ppizza

2009 = $12=1.2 x 100 = 120

Nominal GDP in 2009 = 12 x $12 = $144

Real GDP in 2009 = $1441.2

= $120

Conclusions: Because the price of pizza's increased by 20% (inflation rate was 20%), the nominal GDP growth of 44% was over-stated. After adjusting for inflation, the nations' growth rate is only 20%

What is the REAL GDP in 2009?

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GDP: How is it measured? Two methods are used for measuring GDP

Expenditures approach: Measures all the spending on final goods and services that has take place during a year. This includes:

Personal Consumption (C): the purchase by households of all goods and services• Including non-durables: bread, milk, toothpaste, t-shirts, socks, toys, etc...• and durables: TVs, computers, cars, refrigerators, etc... • and services: dentist visits, haircuts, taxi rides, accountants, lawyers, etc...

Gross Private Domestic Investment- (Ig)• All final purchases of machinery, equipment, and tools by businesses.• All construction (including residential).• Changes in business inventory.>>If total output exceeds current sales, inventories build up.>>If businesses are able to sell more than they currently produce, this entry will be a negative number.


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Government Purchases (of consumption goods and capital goods) - (G)• Includes spending by all levels of government (federal, state and local).• Includes all direct purchases of resources (labor in particular).• This entry excludes transfer payments since these outlays do not reflect current production.

Components of GDP, continued...

Net Exports- (Xn)• All spending on goods produced in the U.S. must be included in GDP, whether the purchase is made here or abroad.• Often goods purchased and measured in the U.S. are produced elsewhere (Imports).• Therefore, net exports, (Xn) is the difference: (exports - imports) and can be either a positive or negative number depending on which is the larger amount.

Summary: GDP = C + I + G + Xn (X-M)


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MacroeconomicsUnemployment

Four broad Macroeconomic Goals:

1) Full-employment (low unemployment)2) Price level stability (low inflation)3) Economic growth (increase in real GDP year on year)4) Income distribution

Measuring unemployment: The unemployment rate is the number of people who are unemployed (actively seeking employment but unable to find work) expressed as a percentage of the total labor force.

Labor force: "the economically active population", usually between the ages of 16-64

Part-time workers are counted as “employed.”

“Discouraged workers” who want a job, but are not actively seeking one, are not counted as being in the labor force, so they are not part of unemployment statistic.

This means that most country's unemployment data is skewed, i.e. it may underestimate the number of people who are truly unemployed.

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Types of unemployment:

Frictional unemployment consists of those searching for jobs or waiting to take jobs soon; it is regarded as somewhat desirable, because it indicates that there is mobility as people change or seek jobs.

Structural unemployment: due to changes in the structure of demand for labor; e.g., when certain skills become obsolete or geographic distribution of jobs changes; examples, Glass blowers were replaced by bottle-making machines., Oil-field workers were displaced when oil demand fell in 1980s, Airline mergers displaced many airline workers in 1980s.,Foreign competition has led to downsizing in U.S. industry and loss of jobs.

Cyclical unemployment is caused by the recession phase of the business cycle, which is sometimes called deficient demand unemployment


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Definition of “Full Employment”: Full employment does not mean zero unemployment. but is equal to the total of frictional and structural unemployment

When the economy is at full-employment, the natural rate of unemployment or NRU prevails in the economy. With some unemployment, the economy still has room to grow in the short-run, as there are some workers available for firms to hire if they wish to expand output.

The NRU is achieved when labor markets are in balance• At this point the economy's potential output is being achieved. • The natural rate of unemployment is not fixed, but depends on the demographic makeup of the labor force and the laws and customs of the nations. Historically, Western European nations have a higher NRU than the USand East Asian economies

WHY? • Better "social safety net" in Western Europe means that when workers are unemployed, they receive more government support and benefits. • The incentive is not as strong in such economies to seek employment than in countries with few social safety nets. • In the US, unemployment benefits expire after only 3 months of collecting them. The incentive, therefore, is to find work as quickly as possible in the US, whereas in France unemployment benefits can be collected for much longer.


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Economic cost of unemployment:• GDP gap and Okun’s Law: GDP gap is the difference between potential and actual GDP. >>Economist Okun quantified relationship between unemployment and GDP as follows:

For every 1 percent of unemployment above the natural rate, a 2 percent GDP gap occurs. This has become known as “Okun’s law.”

• Unequal burdens of unemployment exist. Examples:>>Rates are lower for white-collar workers than blue-collar, >>teenagers have the highest rates, >>blacks have higher rates than whites, >>less educated workers, on average, have higher unemployment rates than workers with more education.

• Non-economic costs include loss of self-respect and social and political unrest.


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MacroeconomicsInflation

Measuring Inflation: Inflation is defined as a persistent increase in the average price level in the economy, usually measured through the calculation of a consumer price index (CPI)

This year’s CPI - last year’s CPI

Last year’s CPI= X 100Rate of inflation

Example: Assume our economy produces only pizzas. Therefore, the "basket of goods" our CPI will use consists of one pizza. In a real economy the basket of goods would be made up of hundreds of consumer products from utilities to automobiles to petrol to shoes and electronics.

2008: Ppizza

= $102009: P

pizza = $12 Rate of inflation =

12-10

10X 100 = 20%

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“the Rule of 70”: 70 / inflation rate = # years for the price level to double)

• Single digit inflation is called moderate inflation. • Rapid inflation of double digits is called galloping inflation • Extremely high inflation exceeding 50% per month, is called hyperinflation.

Deflation: A persistent fall in the average level of prices in the economy. Deflation sounds like a good thing at first because it means the real values of people's incomes are rising. However, deflation leads to a disincentive for firms to increase production, meaning they will cut back output, lay off workers, leading to a recession and rising unemployment.


Degrees of inflation: Not all inflation is bad. Some inflation is considered an indication of a healthily growing economy. However, high inflation is clearly undesirable as it erodes the value of people's incomes and the nation's output.

Interpretation: In a country experiencing 5% inflation, the price level will double in only 14 years. If inflation reaches 10%, prices will double in only 7 years.

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Causes and theories of inflation:• Demand-pull inflation: an excess of total spending beyond the economy’s capacity to produce. When resources are already fully employed, firms cannot respond to increases in demand. “Too much spending chasing too few goods.”

• Cost-push or supply-side inflation: Prices rise because of rise in per-unit production costs (Unit cost = total input cost/units of output).

>>Wage-push can occur as result of union strength. And Supply shocks may occur with unexpected increases in the price of raw materials. >>Cost push; experience has shown that rising prices and unemployment can exist together, it is called stagflation

Complexities: It is difficult to distinguish between demand-pull and cost-push causes of inflation, although cost-push will die out in a recession if spending does not also rise.


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The Redistributive effects of inflation:Who is hurt?1. Fixed-income groups will be hurt because their real income suffers. Their nominal income does not rise with prices.2. Savers will be hurt by unanticipated inflation, because interest rate returns may not cover the cost of inflation.3. Creditors: Unanticipated inflation hurts creditors.

Who benefits?Debtors (borrowers) Interest payments may be less than the inflation rate

Is there any “cushioning” for inflation built into the economy?• If inflation is anticipated, the effects of inflation may be less severe, >>since wage and pension contracts may have inflation clauses built in>>interest rates will be high enough to cover the cost of inflation to savers Ex; “Inflation premium” is amount that interest rate is raised to cover effects of anticipated inflation. >>“Real interest rate” is defined as nominal rate minus inflation premium.

The Output Effects of Inflation• Cost-push inflation, where resource prices rise unexpectedly, could cause both output and employment to decline. Real income falls. Real income is nominal income /price index• Mild inflation (<3%) has uncertain effects. It may be a healthy by-product of a prosperous economy, or it may have an undesirable impact on real income.• Danger of creeping inflation turning into hyperinflation, which can cause speculation, reckless spending, and more inflation


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MacroeconomicsEconomic Growth

Measuring economic growth: Economic growth is achieved when there is an increase in a nation's real income and output in a given year.

GDP Growth rate = Real GDP in year 2 - Real GDP in year 1

Real GDP in year 1X 100

Example:Switzerland's real GDP in 2008: $309 billionSwitzerland's real GDP in 2007: $305 billion

309b - 303b

305b

Switzerland's GDP growth rate

= .019 X 100 = 1.9%

Per-capita economic growth: If population grows faster than GDP, then the average person may be worse off even with real economic growth.

Example: If real GDP increases by 3% while population increases by 2%, then real GDP per capita has only increased by 1%

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Switzerland

Consu

mer

goods

Capital goods

A

Deflationary gap: when the economy is producing below full-employment. Low aggregate demand and high unemployment puts downward pressure on prices

BFull-employment output: The economy is producing just inside its PPC, the NRU prevailes

CInflationary gap: The economy is producing beyond full-employment at less than NRU. Competition for workers puts upward pressure on prices.

D

Economic growth: A point beyond the nation's PPC represents what could be attained through economic growth

MacroeconomicsMeasuring Economic Goals

PPC analysis of Macroeconomic goals: The simple production possibilities curve can be used to illustrate three of the economic goals

Practice Measuring Macroeconomic Goals: NCEE activity 11

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Country 1st 20% 2nd 20% 3rd 20% 4th 20% 5th 20% Gini indexAustralia 5.9 12 17.2 23.6 41.3 35.2Brazil 2.4 5.9 10.4 18.1 63.2 59.3Croatia 8.3 12.8 16.8 22.6 39.6 29Hungary 9.5 13.9 17.6 22.4 36.5 26.9Sierra Leone1.1 2.0 9.8 23.7 63.4 62.9

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0 20 40 60 80 100% of total population

Lorenz Curve

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• Organizes a country's households into the richest 20% down to the poorest 20%

• Determines what percentage of national income is received by each group.

• Graphs the data with % of total income on the Y-axis, % of total population on the X-axis

MacroeconomicsIncome Distribution

Measuring Income distribution: the Lorenz Curve. The Lorenz curve is a graphical representation of the income distribution of a country.

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Lorenz Curve relatively equal income distribution

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Lorenz Curve relatively unequal income distribution

MacroeconomicsIncome Distribution

Practice with the Lorenz Curve: In the graphs below, illustrate the Lorenz curves for a country with relatively equal income distribution and one for a country with relatively unequal income distribution

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Shortcomings of GDP: GDP is reasonable and useful in measuring how well or poorly the economy is performing but it has some shortcomings:

• certain important work is left out of accounting (homemakers, labor of carpenters who make own homes because GDP measures only the MARKET VALUE of output. GDP therefore is understated.

• Our accounting system does not take reflect that we work less hours than in past years (1900 avg was 53 hours) and that we have more leisure time

• Does not reflect improved product quality

• Does not include the underground economy

• GDP does not put a market value/cost on the environment. Higher GDP may be accompanied by negative externalities, which are NOT subtracted from GDP.

• GDP does not tell us if the best combo of G and S are produced, weighs G and S equally, a rifle and encyclopedias are assigned equal weight.

• Nor does it measure how GDP is distributed in among the population

• GDP does not measure the total well being, happiness, a reduction of crime or better relationships with society, with other countries, etc...

MacroeconomicsEvaluating GDP

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1) How can only half the people in a country be working, and the unemployment rate be only 5%? Explain.

2) How can you get paid 5% more this year than last year, but actually experience a fall in real wages? Explain.

3) When the economy is at full-employment, the unemployment rate is ZERO. True or false, explain.

4) Because policymakers understand so much about macroeconomics, modern economies will always experience economic growth. True or false, explain.

Discussion Questions:

MacroeconomicsMeasuring Economic Goals

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Leve

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Time

Boom

Recession

Trough

Recession

Expan

sion

Expan

sion

Trough

Boom

Boomthe Business CycleFour phases of the business cycle are

identified over a several-year period:1.A boom is when business activity reaches a temporary maximum with full employment and near-capacity output.2.A recession is a decline in total output, income, employment, and trade lasting six months or more.3.The trough is the bottom of the recession period.4.Recovery is when output and employment are expanding toward full-employment level.

Theories about causation:• Major innovations may trigger new investment and/or consumption spending.• Changes in productivity may be a related cause.• Most agree that the level of aggregate spending is important, especially changes on capital goods and consumer durables.• Cyclical fluctuations: Durable goods output is more unstable than non-durables and services because spending on latter usually can not be postponed.

Macroeconomicsthe Business Cycle

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ap/ib economics unit 3.1-3.2: macroeconomics indicators...

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