ECONOMICS CHAPTERS 7-11

MEASURING TOTAL PRODUCTION GDP! The gross domestic product measure total production

Definition> the market value of all final goods and services produced in a country during a

period of time, typically one year.

GDP includes only the market value of finals good, like final good or service and intermediate

good or service (such as a tire on a truck)

GDP only includes production that takes place during the indicated time period

It is not sufficient to measure progress though

Components of GDP Personal consumption expenditures or consumption (spending by households on goods and

services, not including spending on new houses.)

Gross private Domestic investments or investment ( spending by firms on new factories, office

buildings, machinery, and additions to inventories and spending by households on new houses.

Government consumption and Gross investment or government purchases ( spending by

federal, state, and local government on goods and services.

Net Exports of Goods and Services or Net exports ( export minus imports.)

Equation for GDP and Some Actual Values Y= C+I+G+NX

Measuring GDP with the value added method whch means the market value a firm adds to a

product.

FIRM VALUE OF PRODUCT VALUE ADDED

Cotton Farmer Value of raw cotton = $ Value added by cotton farmer = 1

Textile Mill Value of raw cotton woven into cotton fabric = $3

Value added by cotton textile mill = ($3 – $1) = 2

Shirt Company Value of cotton fabric made into a shirt = $15

Value added by shirt manufacturer = ($15 –$3) = 12

L.L. Bean Value of shirt for sale on L.L. Bean’s Web site = $35

Value added by L.L. Bean = ($35 – $15) = 20

Total Value Added

= $35

Does GDP Measure What We Want it to measure? GDP doesn’t measure HOUSEHOLD PRODUCTION AND UNDERGROUND ECONOMY.

Household production refers to goods and services people produce for themselves.

Underground eonomy is the buying and selling of goods and services that is concealed from the

government to avoid taxes or regulations or because the goods and services are illegal

Value of leisure is not included

Not adjusted for pollution or other negative effects of production

Not adjusted for changes in crime and other social problems

{ measures everything in shorts, except that which makes life worthwhile)

Other measures of total production and total income Gross National product (GNP)

NET NATIONAL PRODUCT (NNP)

Measuring economic growth by real GDP REAL GDP VERSUS NOMINAL GDP

REAL GDP, the value of final goods and services evaluated at base year prices.

NOMINAL GDP, The value of final goods and services evaluated at current year prices.

Real GDP versus Nominal GDP THE GDP DEFLATOR

PRICE LEVEL> a measure of the average prices of goods and services in the economy

GDP deflator> A measure of the price level, calculated by dividing nominal GDP by real GDP and

multypling by 100.

Measuring inflation, the CPI and the inflation rate PRICE LEVEL, a measure of the average prices of goods and services in the economy.

INFLATION RATE> the percentage increase in the price level from one year to the next.

The consumer price index> CPI Weights… other goods and services, apparel, education and

communication, recreation, medical care, food and beverages, Transportation and Housing.

Is the CPI Accurate? There are four biases that make changes in the CPI overstate the true

inflation rate> substitution bias, increase in quality bas, new produt bias, outlet bias.

Causes of inflation PUSH AND PULL

Real versus Nominal interest Rates The real interest rate is equal to the nominal interest rate minus the inflation rate.

The real interest rate provides better measure of the true cost of borrowing and the true return

on lending than does the nominal interest rate.

The inflation rate is measured by the percentage change in the CPI from the same quarter

during the previous year.

Does inflation impose costs on the Economy? Inflation affects the distribution of income

Problem with anticipated inflation> menu costs, the costs to firms of changing prices.

The problem with unanticipated inflation> even when inflation is perfectly anticipated ,

however, some individuals will experience a cost.

Measuring the unemployment rate and the labor force participation rate The unemployment rate measures the percentage of the labor force that is unemployed.

The labor force participation rate, measures the percentage of the working age population

in the labor force.

INTERNATIONAL COMPARISONS

FLUCTUATIONS IN UNEMPLOYMENT

TYPES OF UNEMPLOYMENT Frictional unemployment and job search> short term unemployment that arises from the

process of matching workers with jobs.

Structural unemployment> unemployment arising from a persistent mismatch between the

skills and charactersitics of workers and the requierements of jobs.

Cyclical unemployment> unemployment caused by a business cycle recession.

Institutional factors and the unemployment rate Unemployment insurance and other payments to the unemployed

Minimum wage laws

Labor unions

Efficiency wages

The sources of short run economic growth Aggreagate expenditure> the total amount of spending in the economy, the sum of

consumption planned investment, government purchases and net exports.

The sources of long run economic growth

The sources of economic growth When labor productivity grows, real GDP per person grows, so the growth in labor productivity

is the basis of rising living standards.

The growth of labor productivity depends on three things<

Saving and investment in physical capital

Expansion of human capital

Discovery of new technologies.

The market for loanable funds Demand and supply in the loanable funds market

What determines how fast economies grow? Which is more important for economic growth, more capital or technological change?

Technological change helps economies avoid diminishing returns to capital.

The per worker production function> the relationship between real GDP per hour worked and

capital per hour worked, holding the level of technology constant.

The per workers production function, diminishing returns>

Technologial change> the key to sustaining economic growth

New Growth theory> a model of long/run economic growth which emphasizes that

technological change is influenced by economic incentives and so is determined by the working

of the market system.

Government policy> can help increase the accumulation of knowledge capital in three ways

Protecting intellectual property with patents and copyrights, *the exclusive right to a product

for a period of 20 years from the date the product is invented.

Subsidizing research and development

Subsidizing education.

WHY isn’t the whole world rich?? Catch up. The prediction that the level of GDP per capita or income per capita in poor countrie

will grow faster than in rich countries.

Why don’t more low income countries experience rapid growth?

Failure to enforce the rule of law

Propery rights> the rights individuals or firms have to the exclusive use of their property,

including the right to buy or sell it.

Rule of law> the ability of a government to enforce the laws of the country, particulary with

respect to protecting private property and enforcing contracts.

Wars and revolutions> wars have made it impossible for countries such as Afghanistan, Angola,

Ethiopia, The Central African Republic and the Congo to accumulate capital or adopt new

technologies.

Poor Public Education and Health> Many low income countries have weak public school

systems, so many workers are unable to read and write., people who are sick work less and are

less productive when they do work.

Low Rates of saving and investment> the low savings rates in developing countries contribute to

a vicious cycle of poverty.

The benefits of globalization

Foreign direct investment (FDI) the purchase or building by a corporation of a facility in a foreign

country.

Foreign portfolio investment> the purchase by an indifividual or a firm of stock or bonds ssued

in another country.

Globalization> the process of countries becoming more open to foreign trade investment.

Growth Policies We have seen that even small differences in growth rates compounded over the years can lead

to major differences in standards of living. Therefore, there is potentially a very high payoff to

government policies that increase growth rates.

Enhancing property rights and the rule of law

Improving health and education

Policies with respect to technology

Policies with respect to saving and investment

Is economic growth good or bad?

The sources of short run economic growth Aggregate expenditure> the total amount of spending in the economy, the sum of consumption

planned investment, government, purchases and net exports.

In the short run GDP is determined by aggregate expenditure.

Aggregate expenditure model> a macroeconomic model that focuses on the relathionshp

between total spending and real gdp, assuming that the price level is constant.

AE = C + I + G + NX

Macroeconomic equilibrium> aggregate expenditure = GDP

Determining the Level of Aggregate Expenditure in the Economy Consumption< the following are the five most important variable that determines the level of

consumption

Current disposable income

Household wealth

Expected future income

The price level

The interest rate

The consumption function> The relationship between consumption spending and disposable

income.

Marginal propensity to consume (MPC) the slope of the consumption function. The amount by

which consumption spending changes when disposable income changes.

Planned investment> the four most important variables that determine the level of investment

are

Expectations of future profitability

The interest rate

Taxes

Cash flow

Net exports> the following are the three most important variables that determine the level of

net exports

The price level in the united states relative to the price levels in other countries

The growth rate of GDP in the united states relative to the growth rates of GDP in other

countries

The exchange rate between the dollar and other currencies.

GRAPHING Macroeconomic equilibrium

The multiplier Effect Autonomous expenditure> an expenditure that does not depend on the level of GDP

Multiplier> the increase in equilibrium real GDP divided by the increase in autonomous

expenditure.

Multiplier effect> the process by which an increase in autonomous expenditure leads to a larger

increase in real GDP.

Summarizing the multiplier effect>

The multiplier effect occurs both when autonomous expenditure increases and when it

decreases.

The larger the MPC, the larger the value of the multiplier

The formula for the multiplier * IS oversimplified because it ignores some real world

complications, such as the effect that an increasing GDP can have on imports, inflation and

interest rates.,* 1/(1 − MPC),

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