Macroeconomics Section 3.1 & 3.2

What is the difference between Macroeconomics and Microeconomics?

List some key terms you’ve heard that refer to Macroeconomics:

- - - -

3.1 Measuring national income * Circular flow of income * Methods of measurement - income, expenditure and output * Distinction between

• gross and net• national and domestic• nominal and real• 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

Unit 3: MacroeconomicsUnit Overview

PowerPoint Made by Jason Welker

Micro concept >>>>>> Macro equivalentMarketDemandSupplyPriceQuantityDecrease 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?

Blog post: "Trying to see the forest through the trees"

MacroeconomicsThe circular flow of income – Micro version

Households Firms

Product market

Resource market

Government

Factors of productin

Income

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.

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

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 population, 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

Macroeconomics Section 3.1 & 3.2

Of the following things, what would be included in Peru’s GDP?

- Building of roads- Buying a used book off of Amazon.com- Social security payment to the elderly- A mother at home raising her children- Cutting down trees to make paper- Rebuilding after an earthquake- Cleaning up an oil spill- Buying pizza at Papa John’s- Hiring an empleada- Ocean pollution caused by building a new Malecon

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.

MacroeconomicsMeasuring national income

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.

MacroeconomicsMeasuring national income

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.

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).

MacroeconomicsMeasuring national income

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 GDPPrice index (in hundredths)

MacroeconomicsMeasuring national income

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

Example:

Price index=Ppizza 2008 = $10Ppizza 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?

Macroeconomics Section 3.1 & 3.2

• Nominal GDP for Peru was $139 billion last year. However, the price index or CPI was 118.

• What is the Real GDP? • What is Per Capita GDP if Peru has a population of 29 million people?

• IMPORTANT: Don’t sign up for HOW TO SAVE THE WORLD

Macroeconomics Section 3.1 & 3.2

• What are the three/four macroeconomic policy objectives?• What is the difference between stock and flow?• Describe the sources of leakages and injections in the circular

flow model.• What are the three methods for measuring GDP?• What is the difference between gross national income and net

national income?• What is the difference between gross national income and

gross domestic income?• What is the difference between national income at factor cost

and national income at market prices?

Macroeconomics Section 3.1 & 3.2

• What is the difference between nominal national income and real national income?

• What is the difference between total and per capita, in regards to national income figures?

• Describe how gross domestic product is calculated using the expenditure method.

• Describe how gross domestic product is calculated using the income method.

• Describe how gross domestic product is calculated using the output method.

• What is the difference between real gross domestic product and nominal gross domestic product?

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 - 305b

305bSwitzerland's GDP growth rate = .013 X 100 = 1.3%

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%

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

GDP: How is it measured? Two methods are used for measuring GDPExpenditures approach: Measures all the spending on final goods and services that has taken 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.

MacroeconomicsMeasuring national income

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)

MacroeconomicsMeasuring national income

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

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

Discussion Questions:

MacroeconomicsMeasuring Economic Goals