Midterm 1- all notes
Midterm 1- all notes Econ3020
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Date Created: 10/05/15
CHAPTER 1 SECTION 1 3 main ways to measure GDP Production expenditure and income Production The market value of all nal goods and services newly produced over a xed period of time 0 Market value The price that goods and services sell for 0 Issues 0 Nonmarket goods and services family run business with employed children 0 Black market underground economy 0 Bartering 0 Solution imputed values gvt estimate 0 Final the end product sold to the consumer 0 Do not count intermediate goods goods added to make nal goods 0 Capital goods a machine that creates nal goods is sustainable but it is only counted when the machine is purchased 0 Inventory investment changes in levels of inventory in set amount of time is counted in GDP Newly produced must be new and sold only one time o e If you buy a used car the price of the car does not go into GDP but the price for the services of the salesman etc does 0 Fixed period of time GDP is a ow not a stock 0 Flow over a period of time 0 Stock is a set time Expenditure The total spending on nancial goods and services currently produced in an economy 0 C Households o 70 of the GDP 0 Durable goods goods that last more than 3 years 0 Non durable goods goods that don t last long 0 Services 0 l Business investment 0 Most unpredictable and volatile aspect o Fixed investment structure capital goods 0 Inventory investment can be negative 0 Residential investment purchases of homes 0 G Government spending 0 Federal ie Military CHAPTER 1 0 State and local greater than federal XN net exports 0 Exports 0 Imports Income National income depreciationGNP l GNP net factor income GDP 0 National income 0 Compensation for employees wages salaries bene ts 0 Other income self employed royalties 0 Corporate profits income for businesses after taxes Depreciation o The wear and tear of equipment 0 Have to add it because it is subtracted when measuring national income 0 Gross national product 0 Similar to GDP but includes production abroad 0 Net factor income 0 Amount of money that US companies make abroad amount of money that foreign companies make in the US Section 2 Nominal vs Real GDP Nominal uses current prices and doesn t account for in ation Real uses base year with xed prices only to be used Ex 1 Country X produces apples and oranges The price of apples in 2005 was 50 and the price of oranges was 200 In 2012 1 billion apples were sold and 1 billion oranges were sold A Calculate real GDP for 2012 with a base year of 2005 price apples 2005 x quantity sold apples 2012price oranges 2005 x quantity sold 2012 5 x 1 billion 2 x 1 billion 25 billion So real GDP in 2012 utilizing prices in 2005 is 25 billion CHAPTER 1 B Calculate real GDP for 2013 with a base year of 2005 if 2 billion apples were sold and 15 billion oranges were sold 5 X 2 billion 2 X 15 billion 4 billion So Real GDP in 2013 utilizing 2005 prices is 4 billion Section 3 In a on Increasing price levels over time 3 Methods to measure price levels 1 GDP De ator le The nominal GDP in 2012 is 15 billion and the real GDP is 12 billion Calculate the GDP de ator for 2012 with a base year of 2005 Price level 100 x 15 billion 12 billion 125 So from 2005 to 2012 there was a 25 rise in price level 2 Personal Consumption Expenditure PCE De ator a Only looks at household consumption doesn t account for business or gvt 3 Consumer Price Index CPI The bureau of statistics takes surveys from urban consumers to see what goods they buy most often They then take this data and create a basket of goods that most people consume They then study the price levels and consumption of these basket goods le In 2012 people consumed 2 apples and 10 gallons of gas monthly Calculate CPI for 2012 with a base year of 2005 CPI 10 x price of gas in 2012 2x price of apples in 2012 10 x price of gas in 2005 2 x price of apples in 2005 CHAPTER 1 CPI is very important because it is used to set taxes determine transfers and set wages Controversies 1 Does not account for substitutes a If a price of a good in the basket goes up people will move towards a sub 2 Does not account for rise in quality a If the quality of a good rises the price will go up 3 Does not account for increasing consumer choice a People don t need to buy as many cars now because they can buy bigger ones F e The price level in 2014 is 102 The price level in 2015 is 103 Calculate in ation 103102102 1102 Other method of calculation e Nominal GDP Price level x Real GDP change nominal GDP change price level change real GDP Growth rate nominal GDP in ation growth rate real GDP Section 4 Unemployment Rate The percentage of civilian population who wants to work but cannot nd work Bureau of labor and statistics publishes the employment situation monthly with 2 surveys Household survey calculates 60000 homes 0 Establishment survey calculates 150000 businesses 0 Differing results Household survey counts people not jobs someone holding two jobs will be counted once in household and twice in establishment CHAPTER 1 Household counts self employed as a job and establishment doesn t Establishment is more extensive than household Types of civilians 1 Employed someone who has worked 1 hour in the past week 2 Unemployed someone who hasn t worked in the past week but has looked for work in the past 4 weeks 3 Not in labor force someone who hasn t worked or looked for work in 4 weeks a Discouraged workers b Voluntary leavers of the labor force Labor force employed unemployed Issues 1 Leaves out underemployed and discouraged workers lt underestimates the actual rate of unemployment Solution 1 The U6 method of measuring which includes marginally attached workers and part time workers with the unemployed in the numerator as well as marginally attached in the denominator Why this is important Different countries may have similar unemployment rates However if only half of a country s civilians are permitted to join the labor force then the unemployment rate misrepresents the number of employed persons For example women may not join the labor force in the Middle East but they are adult civilians Section 5 Interest Rates The price for lending money or the cost of borrowing money Real interest rate adjusted for in ation our focus Exante real interest rates real interest rate adjusted for expected changes in prices 0 The most commonly used form CHAPTER 1 Expost real interest rate real interest rate adjusted for actual changes in price level Fisher Equation He or He 0 i nominal interest rate 0 r real interest rate can be less than zero 0 e expected average in ation 0 Nominal can be high and real can be low in cases of hypedn a on ie 2 year loan He averages 6 between the 2 years and nominal interest rate is 4 2 4 6 negative interest rates are good for the borrower because he owes less so The returned amount has 2 less purchasing power of the money that was lent Productivity Why are some countries richer than others Factors of production 0 Labor number of hours it takes one person to produce a given level of output 0 Assumes quantity of hours worked is constant 0 Capital All structures equipment transportation used to produce goods 0 Measured in constant prices 0 L quantity of labor 0 K all capital used 0 K and L are xed and being used to their full extent Production function CobbDouglas production function Y F K L AIC L 1 o A Total factor productivity 0 x percent of national income 1 Developed countries can produce more with same amount of K and L because of A 2 The share of K in national income is stable Kw I CHAPTER 1 b Because US capital is 30 and labor is 70 of economy A Solow residual how well does a country use K amp L Y K3 L7 De ning Income Per Capita Y AK393L397 Ak393 k 3 Y L L L k L xk y per capita income Example Country k k3 A y A k3 Income per capita USA 1 1 1 1 Japan 114 104 69 71 So 0 Japan has 14 more capital per worked than the US 0 More access to technology or software 0 Therefore 0 4 higher income per capita if we were equally productive But 0 Japan is 31 less productive than the US 0 So 0 They have 71 as much income per worker than the US Cobb Douglas Production Function 1 Display constant returns to scale a If you increase input by an amount output will increase by same amount 2 Diminishing marginal product a Each additional factor of production contributes less and less to total production i Productivity increases at decreasing rate b One of the factors of production must remained x See graphs on notes to calculate slope through graph Be able to calculate with derivatives i Labor is equal to 100 and productivity is equal to 2 ii Y 2 31007 simplify iii Y 5 K393 Take the derivative iv 3 x 5 7 bring the negative exponent down 3x5 K 7 an v Multiply and divide by Y CHAPTER 1 3x5Y vi sim lif 5K3XK7 p y 3y V K Productivity shocks K and L don t change but A does Can be positive or negative 1 Technological shocks new inventions positive 2 Environmental shocks natural disasters negative 3 Energy shocks increase energy prices negative a Less limitations on energy increase Negative shocks a output decreases b marginal productivity decreases c production function shifts downward Positive shocks a output increases b marginal productivity increases c production function shifts upward Determining Factor prices wage rate price at which one rents machinery 1 Assume perfect competition 0 We can do this because while income has risen in the US over the past 6 decades shares of the income have remained 7030 a Firms don t in uence prices b Firms are price takers use set wages c Labor unions don t in uence wages d Work in long run all people are employed and all factors utilized 2 What is economic pro t Pro t revenue costs rental wage Revenue PYF K L Capital rental RK Labor wage WL Nominal pro t PYF K L RK WL l PYFlng RK WL N 39 orFKL gK hUgtU I 0 6 real rental price Nominal rental price Price level or 39W w real wage rate NomInal wage rate Prlce level or CHAPTER 1 HFKL rc wL q 3 Determining how much to purchase hire When the wage is equal to the marginal product of labor or capital Graphically o The slope of the marginal product increases then decreases 0 We want to hirerent at the time where it is at its peak 0 At this point the slope is zero Calculate derivative and set slope zero 0 Derivative o D H DL DYDL w Or 0 MPL W O o MPL W 0 When marginal productivity equals the wage o SAME FOR CAPITAL BUT WITH rc instead of wage 4 Deriving a market for factors of production The price is set because of perfect competition Supply is vertical because in the long run all fo the capital and labor is used Up 7 so quot quot 39 Egng r w Java gi39 V vww 39 W 7 wwmwm r 7 0 ways V V W e QAL JRWK m Qquot E Vii germav ad i a g N oDL Kim 0 Excess supply will lead to lower wages or rental costs pushing to equilibrium 0 Excess demand will lead to higher rental prices or wages pushing to equilibrium 5 How do we distribute income 0 real labor income I o MPL w to maximize pro ts I MPL I o MPL 7yL equation for marginal product labor in US CHAPTER 1 0 7yL 70 of national income goes towards labor 0 real capita income rc I 0 rc MPK to maximize pro ts I MPK o MPK 3yK equation for marginal product capital in US 0 31 39 30 of national income goes towards labor 0 National income rea labor income rea capita income 0 labor income share wLy 7yy 7 0 Capital income share rc Ky 3yy 3 o This makes sense because capital is 30 of national income and labor is 70 TEST LIKE QUESTION 1 Period Growth rate of real Growth rate labor wages productivity 19591973 23 29 19731995 7 14 19952009 16 31 Explain why the growth rate of labor happens Real wages are equal to marginal productivity of labor when maximizing pro t Therefore as growth rate labor productivity goes up or down real wages will do the same 2 The US has an oil crisis During this time real wages and stock market decHne Explain these events LOOK AT GRAPHS IN NOTES Real wages As prices for oil goes up this produces a negative productivity shock The production function decreases so the marginal productivity of labor will decrease as well This will result in the demand for labor to decrease As demand for labor decreases so do real wages Stock Market Similarly as the production function decreases due to higher oil prices the marginal productivity of capital will decrease This decreases the demand for CHAPTER 1 capital and therefore the price of shares in a company will decrease All of the reduced prices of shares result in a decline in the stock market Savings and Investment Background When we discuss a country we focus on the GDP However this does not show enough For example if you have a person with a huge amount of student debt but is earning a salary they will add positively to the GDP On the other hand you have an unemployed person whose parents developed a large savings account for them they do not account for GDP Based on GDP alone the person with debt looks better However they are not actually better off 0 US private savings 10 and US budget public savings have been declining for a long time 0 There s a direct connection between savings and wealth 0 Income savings investment l wealth Private Savings SPZ disposable income Yd Consumption c o Yd GDP y net taxes T o Yd YT I Sp PrivatesavingsrateZSpYd Amount of disposable income is put in savings Government Savings Sg Net taxes T government expenditures I ngT G o G consumption expenditures short term investments long term 0 G CGIG lssue it is too hard to classify government spending as long term or short term so we combine them as one G 0 When government spending is greater than taxes we run a deficit National Savings 5 S Sg P 0 National savings rate How government tries to increase savings 1 Tax consumption if we tax what you spend you will spend less a lssue this only happens on a state wide level so other country s quotvalue addedquot tax is more bene cial i Value added tax we tax the money created when we take the difference of the price the producer sells for and the cost it takes him to produce CHAPTER 1 2 1974 Individual Retirement Account IRA incometax free savings on retirement The taxless investment encourages people to use it a Issue if people are going to save their money they re probably rich and don t need this taxbreak 3 2003 Capital gains tax lowered if we reduce this investment on things like housing will go up a Capital gains if someone buy something for 50 then sells it for 100 they are taxed on the 50 gain i Issue the only people able to make gains are rich or large banks 4 Balance the budget to x de cit we need to either raise taxes or cut spending a Issue democrats won t cut spending and republicans won t raise taxes How will savings be utilized SY C G YCGNX 0 Uses of savings identity ldentity both sides of equation must be equal 0 Net capital out ow identity 0 Sl net capital out ow o NX trade balance Uses of savings identity S l NX How savings are allocated 1 Investment 2 Net exports if we have extra savings we will obtain foreign assets o If we save in these two ways wealth will rise Net Capital Out ow Identity S l NX If S is greater than I we will use the savings to buy foreign assets money will ow out of the US 0 Net capital out ow o lfl is greater than S we have to borrow money from other countries to fun excess investment 0 Net capital in ow Trade balance o If exports are greater than imports trade surplus o If imports are greater than exports trade de cit Savings towards foreign assets Net foreign assets foreign assets owned by US residents US assets owned by foreigners Foreign assets stocks bonds factories plants etc CHAPTER 1 0 Excess savings foreign assets l rise in net foreign assets l rise in wealth Opposite for investment greater than savings decrease in wealth What else leads to wealth in a nation The US has been in trade de cit and has very little savings How are they still wealthy Valuation of assets assets worth uctuates and falls over time o e In 2008 savings began to rise but at the same time the value of the stock market and the housing bubble burst and we had a de cit In this case the devaluation of assets had a greater impact on wealth than savings did Practice Test Question Q Until the mid 19705 the US was a net creditor for the world held the most foreign assets Now the US is one of the biggest net debtors Explain this phenomenon A Prior to the 19705 the US had a massive trade surplus so we owned foreign assets as a result Since then the US has run a trade de cit meaning we have capital in ow to fund our investments causing great debt Relationship between savings and investment In closed economy small open economy and large open economy 1Closed economy Assume o No exports or imports 0 Work in the long run 0 Prices are exible 0 Level of production comes from how much factors of production is available Goods market equilibrium Savings investment 0 Y C l G o Y G Cl savings Y G C Real interest rate determines how we save and how we invest S Y C G l o Cquot Autonomous spending regardless of other variables 0 C Y T r Spending based on disposable income Y T amp real interest rate Direct relationship between disposable income and spending CHAPTER 1 Indirect relationship between real interest rate and spending 0 G G o T T We cannot determine scal policy so we keep it constant 0 Y I F 612 There is a xed level of K and L FOP This countries production is based on how much K and L they have S i c Ci Tr c39 o Exogenous variables shift savings curve Y C T G o Endogenous variables movement along savings curve r Investment and real interest rates e o A rm wants to expand but it does not have the money to do so It will borrow the money to nance his investments If the real interest rate is low he will borrow more 0 I r Th lnestment Curve Real interest rates 0 Change in real interest rate leads to movement along the savings or investment curves Savings hifters 1 Consumption CHAPTER 1 o If consumption goes up less money is being saved and real interest rates rise oCTSirT C o If people consume less they save more and real interest rates go down oCiSTriB 2 Taxes 0 If taxes are higher disposable income falls so consumption falls and savings rise oTTYdiCiST B o If taxes are lower disposable income rises so consumption rises and savings falls oTiYdTCTSiC 3 Government Spending Has same impact as consumption spending 0 If the government spends more private savings falls quotCrowding outquot o G T S i o If the government spends less private savings rises o G i S T Practice prob assume increase in government budget 0 So taxes T or spending i Savings T real interest rate i The in uence of taxes on national savings 0 National savings private savings government savings 59 T G Sp Y T C 0 Assume Taxes are raised 0 An increase tax causes Private savings to nearly stay the same It also makes consumption spending go down This nearly balances out the equation because T is getting bigger while C is getting smaller 0 An increase in taxes causes government savings to go up 0 So Raised taxes leads to raised national savings Investment Shifters I i Anything that would change autonomous investment will shift investment curve Businesses become more optimistic o Investments increase real interest rate increase S and I increase Businesses become more pessimistic 0 Investment decrease real interest rate decrease S and l decrease CHAPTER 1 Business regulation increase fees and taxes 0 Investment decreases real interest rate decrease S and decrease Reduced business regulation 0 Investment increases real interest rate increases S and I increase
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