The Global Economy

Chris EdmondNYU Stern

Spring 2007

1

Today

• Housekeeping

– assessment– class sessions– course materials– problem set #1

• Brief course overview

• First topic: macroeconomic measurement

2

This course

• Twelve 3-hour sessions (including this one)

– introduction and macroeconomic measurement (1 session)– long-run economic growth (2)– international trade (1)– midterm review and exam (1)– labor markets (1)– business cycles (1)– inflation and monetary policy (2)– taxation and fiscal policy (1)– exchange rates and international capital flows (1)– final exam review and exam (1)

3

Assessment

• Grade based on

– four problem sets, 25%– optional midterm exam, 25% or nothing– final exam, 50% or 75%

• Practice exams will be distributed in advance

• Review sessions will be scheduled in advance

• Read syllabus for fine print

4

Class sessions

• I want them to be interactive and interesting

• I expect you to help make them that way

• I expect you to be here and be prepared

• Professionalism matters

– come on time– don’t use cell phone, check email, browse web– show courtesy to classmates and their comments

• Bring articles from the Economist, Financial Times, etc

5

Course materials

• Notes

– custom-designed for you

• Slides

– posted before class

• Videos

– available after class

• Getting help

– me: cedmond@stern.nyu.eduTuesdays 4:30-6:00pm, by appointment, or anytime you find me

– Gary: gc793@stern.nyu.edu

6

Problem set #1

• Posted on Blackboard

• It’s hard. . .

– don’t panic!– work in groups– stop by if you have questions– get started asap

7

Me

• Grew up in Australia

• PhD in Economics, UCLA, 2004

• Before that, research department of Reserve Bank of Australia

• Third year at Stern

8

Other questions?

9

Over the next few weeks

• Economic growth

• International trade

• Labor markets

10

Growth

Cross-country comparisons of GDP

0

5000

10000

15000

20000

25000

30000

35000

40000

1950 1954 1958 1962 1966 1970 1974 1978 1982 1986 1990 1994 1998 2002

USA

FRA

CHN

IND

KOR

ARG

IRL

JPN

real GDP per person, 2000 dollars (at ‘PPP’)

11

Trade

Value of services o!-shored

Rank Country Business Services Rank CountryComputer and

Information Services

1 United States 40,929 1 Germany 6,124

2 Germany 39,113 2 United Kingdom 2,602

3 Japan 24,714 3 Japan 2,148

4 Netherlands 21,038 4 Netherlands 1,586

5 Italy 20,370 5 Spain 1,572

6 France 19,111 6 United States 1,547

9 United Kingdom 16,184 9 France 1,150

11 India 11,817 10 China 1,133

18 China 7,957 14 Russia 592

20 Russia 4,583

Millions of US dollars

12

Labor markets

Job creation and job destruction rates

6.0

6.5

7.0

7.5

8.0

8.5

9.0

1993 1995 1997 1999 2001 2003 2005

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

job creation

job destruction

percent per quarter

13

Later in the semester

• Business cycle fluctuations

– booms and recessions– implications for goods and asset markets

• Monetary policy

– fed e!orts to control inflation (and unemployment?)

• Fiscal policy

– taxes– debts and deficits

• Exchange rates and international capital flows

14

Next

• Macroecononomic measurement

– dry, but foundation for all that follows

15

Macroeconomic measurement

• Gross domestic product (GDP):

– how it’s measured– how it relates to national income, expenditure– accounting identities– cross-country comparisons, etc

• Changes in prices vs. changes in quantities

– inflation– quality change and intangibles

16

GDP: Gross domestic product

• Product

– total value of production in economy– value = price ! quantity– economy could be country, state, etc

• Domestic

– domestic product, produced by inputs inside economy– national product, produced by inputs owned by economy– for US, di!erences between GDP and GNP is small

• Gross

– net domestic product NDP = GDP " depreciation– economic depreciation di"cult to measure

17

GDP: Gross domestic product

• In US:

– system of National Income and Product Accounts– produced by Dept. of Commerce’s Bureau of Economic Analysis

• Similar agencies in all other industrialized countries

• Key principle: value added

– want to avoid ‘double counting’

18

Value added, not sales

A firm that makes PCs with labor and computer parts

Sales revenue 40m

Expenses 26m

Wages 20m

Cost of computer parts 6m

Net income 14m

• Firm has sales of $40m

– but $6m of computer parts were produced elsewhere– this firm added $34m value to the parts– total GDP = sum of all value added in economy– value chain typically involves many firms

19

Value added = sum of income

A firm that makes PCs with labor and computer parts

Sales revenue 40m

Expenses 26m

Wages 20m

Cost of computer parts 6m

Net income 14m

• Value added $34m, divides into

– payments to labor, $20m wages– payments to capital, $14m income to owners

• What does this accounting look like for the whole economy?

20

National income

United States, 2004, billions of dollars

Compensation of employees 6,693.4

Proprietor’s income 889.6

Corporate profits 976.6

Rental income 134.2

Net interest income 630.9

Taxes and miscellaneous 897.4

Depreciation 1,435.3

Value added 11,657.5

Source: Department of Commerce, BEA.

21

Income shares

0.00

10.00

20.00

30.00

40.00

50.00

60.00

70.00

1929 1934 1939 1944 1949 1954 1959 1964 1969 1974 1979 1984 1989 1994 1999 2004

compensation

corporate profits+ rental income+ net interest income+ taxes+ depreciation

proprietor’s income

percentage share of GDP

Source: Department of Commerce, BEA.

22

Income shares

0.00

10.00

20.00

30.00

40.00

50.00

60.00

70.00

80.00

90.00

100.00

1929 1934 1939 1944 1949 1954 1959 1964 1969 1974 1979 1984 1989 1994 1999 2004

capital income

labor income = compensation +0.66 proprietor’s income

Source: Department of Commerce, BEA.

23

Income and expenditure

• Can break GDP into sources of income

GDP = Y = wL + rK

where

– labor income is wage rate w times labor L

– capital income is rental rate r times capital K

• Can also break GDP into uses of expenditure

GDP = Y = C + I + G + NX

where

– C is private consumption– I is private investment– G is government consumption– NX is net exports

24

National expenditure

United States, 2004, billions of dollars

Consumption 8,214.3

Investment 1,928.1

Government 2,215.9

Net exports -624.0

Value added 11,734.3

• Follow the ‘goods and services’:

– consumption of durables, non-durables, and services– investment is purchases of buildings and machines, inventories– government does not include transfers, interest payments, etc

25

Expenditure shares

-10.00

0.00

10.00

20.00

30.00

40.00

50.00

60.00

70.00

80.00

90.00

1929 1934 1939 1944 1949 1954 1959 1964 1969 1974 1979 1984 1989 1994 1999 2004

C/Y

I/Y

percentage share of GDP

Source: Department of Commerce, BEA.

26

Expenditure shares

-10.00

0.00

10.00

20.00

30.00

40.00

50.00

60.00

70.00

80.00

90.00

1929 1934 1939 1944 1949 1954 1959 1964 1969 1974 1979 1984 1989 1994 1999 2004

C/Y

I/Y

G/Y

percentage share of GDP

Source: Department of Commerce, BEA.

27

Cross-country comparisons

• Often want to compare GDP across countries

• Several di"culties:

– size, typically use GDP per capita numbers– exchange rates, need to convert to some common unit– others?

28

GDP per capita across countries

0.000

20.000

40.000

60.000

80.000

100.000

120.000

140.000

160.000

180.000

GDP per capita as percentage of US

Source: United Nations.

29

GDP is not a measure of well-being

• If I have to repair store after robbery, that expenditure is in GDP

• If I have a heart attack and need an operation, that expenditure isin GDP too

• GDP typically increases during wars

• GDP only measures production, not ends to which that productionis used

• But GDP highly correlated with other measures of well-being

– life expectancy– literacy

30

GDP and life-expectancy

20

30

40

50

60

70

80

90

0 10000 20000 30000 40000 50000 60000 70000

GDP per capita vs. life expectancy at birth

years

US dollars

Source: United Nations.

31

GDP and ‘human development’

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1

0 10000 20000 30000 40000 50000 60000 70000

GDP per capita vs. the UN’s ‘human development index’

US dollars

Source: United Nations.

32

Prices and quantities

• GDP measures value of output at market prices

value = price! quantity

• But often want to know volume (or quantity) of output

– easy if there’s one good, just ÷ by price– hard if there’s many goods, need price and quantity indices– no unique way to calculate price index

# fixed weight methods: e.g., GDP deflator# fixed basket methods: e.g., consumer price index (CPI)

• Real GDP is nominal GDP ÷ price index, a measure of quantity of output

• Inflation is growth rate of price index

33

Prices and quantities

Two prices, two quantities

Fish Chips

Date Price Quantity Price Quantity

2005 0.50 10 0.25 10

2006 0.75 12 0.50 8

• What is real GDP growth?

• What is the inflation rate?

34

GDP deflator

Fixed weight method: The GDP deflator, base 2005 prices

Date Nominal GDP Real GDP Price deflator

2005 0.50*10+0.25*10

2006 0.75*12+0.50*8

Growth rate

prices

quantities

35

GDP deflator

Fixed weight method: The GDP deflator, base 2005 prices

Date Nominal GDP Real GDP Price deflator

2005 7.50 7.50 1.000

2006 13.00 8.00 1.625

Growth rate 73.3% 6.7% 62.5%

36

Consumer price index

Fixed basket method: The CPI

Date 2005 basket 2006 basket

2005

2006

Growth rate

0.50*10+0.25*10

37

Consumer price index

Fixed basket method: The CPI

Date 2005 basket 2006 basket

2005 7.50 8.00

2006 12.50 13.00

Growth rate 66.7% 62.5%

38

Price levels

0.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

0.80

0.90

1.00

1929 1934 1939 1944 1949 1954 1959 1964 1969 1974 1979 1984 1989 1994 1999 2004

fixed basket CPIfixed weight GDP deflator

$1 today was how many cents?

Source: BEA and BLS.

39

Inflation, growth in price level

-15.00

-10.00

-5.00

0.00

5.00

10.00

15.00

1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000

fixed weight GDP deflator

annual inflation in percentage points

Source: BEA and BLS.

40

Many other measurement issues

• Quality change:

– computers in the 1990s

• Intangibles:

– GDP only measures production that shows up as a measured transaction– firms may have value not reflected in transactions– how should we take this into account?

41

What have we learned today?

• GDP

– total value added in economy– total income in economy– total expenditure in economy

• Accounting

GDP = Y = wL + rK

GDP = Y = C + I + G + NX

• Need to keep changes in prices distinct from changes in quantities

42