Econ 1012 2 Week of In Class and Textbook Notes
Econ 1012 2 Week of In Class and Textbook Notes Econ 1012
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This 11 page Class Notes was uploaded by Caroline Jok on Thursday January 21, 2016. The Class Notes belongs to Econ 1012 at George Washington University taught by Dr. John Volpe in Spring 2016. Since its upload, it has received 95 views. For similar materials see Principles of Economics II in Economcs at George Washington University.
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Date Created: 01/21/16
WEEK 2 Introduction to Macroeconomics Dr. John Vol Caroline E. Jok The George Washington University Class 3 ~ Notes: Ch. 6 Continued What's in a Firm's Financial Statements? • Income Statement: o How well/poorly a company is doing o Summary of the firm's revenues, costs, and profit over a period of time (12 month fiscal year) o Gross Profit = Money made (revenue) - Cost of goods sold • Accountants: pay attention to explicit costs • Economists: pay attention to both explicit and implicit (money you aren't earning, opportunity costs etc…) costs • Balance Sheet o Financial statement that sums up a firm's financial position on a particular day, usually the end of a quarter or year o Summarizes the liabilities (RH side) (anything owed by a person/firm) • Accounts payable • preferred dividends o And assets (LH side) (listed quickness of which these assets can be put into cash ) • Cash • Cash receivable • Inventories • Assets: (ex: Treasury Bills, stocks, bonds, etc.) o Net worth: amount of assets - amount of liabilities • Cash Flow o Cash companies earn from a variety of things that they do (income, investments in other corporations etc.) o Keep accurate track of how much cash they have available (not assets) o Can go into bankruptcy if you are asset rich but cash poor Accounting Profit o Profit on the income statement = net income o Calculated: revenue - operating expenses - taxes o Accounting profit = Revenue - explicit cost (involve actually spending money: operating+taxes) Financial Crisis • 2007 -09 • Heart: mortgage-backed securities o Much like bonds, securities were incorrectly perceived to be low -risk • Prices fell in housing markets, Underlying mortgages went into default, Value of securities plunge • Mortgage-backed securities were popular with investors, including large investment banks and insurance companies o Suffered heavy losses, several needed federal government aid to sta y open • Wall Street Reform and Consumer Protection Act 2010 to reform financial regulation o Aka: Dodd-Frank Act o Created Consumer Financial Protection Bureau (protect consumers in their borrowing and investing activities) o Est. Financial Stability Oversight Co uncil (identify and act on risks in the financial system) o Overall effect on likelihood of future financial crisis, unknown • Themes of why the crisis occurred o Thought that having more people owning homes would be good (why? Because it would promote creation/sustaining of families) • 90's it wasn't easy to get a loan --> Prime Loans • 2000's: Sub Prime Loans --> loans to individuals who aren't qualified to have loans (aka: no documentation loan) § The banks/companies making the loans then bundled them into one secur ity and sold it to (pension funds, money market funds etc.) § Companies start declaring bankruptcies (they were carrying premiums w/ no money) § Bail outs: too big to fail § Collateralized Debt Obligations o We just needed people who were paying attention to wha t they were regulating Class 4 ~ Notes Chapter 8 Present value and Future value • The distinction between compounding and discounting • Future value = Present Value multiplied by [(1+ rate of interest) raised by time] • Present value = Future value divided by [(1 + Rate) raised by time] Determining what the price of a stock should sell for (Ch. 6 appendix) • Preferred stock = Dividend / (rate of return) = what it should sell for • Common Stock = Dividend / (rate of return% - increase in dividend%) = what you should pay for the stock o May pay a constant dividend, a dividend that varies, or a dividend that increases each year o The riskier the security, the higher the dividend you need in order to purchase the security o Just because an investment will pay a lot of money doesn't mean you should go for it (depends on the risk) o No risk, no reward o The riskier the investment, the more that you want to demand in return Measuring total Production: Gross Domestic Product • The most common measure used by economist o f overall economic activity in an economy • Market value of all final goods and services produced in a country during a period of time (one year) • Gross = including investment that is new and also investment replacing already existing investment • Domestic = only for goods in the united states • Product = goods and services • Economy o The output of the economy and the input of the economy are theoretically two sides of the same coin • Denoted by (Y) o Y = C + I + G + NX • NX = (X-M) o C = Consumption durable - goods that last a long time • • nondurable goods - goods that are used quickly services - things people provide for other people • o I = investment • Personal • Businesses • Inventory investment o G = Government spending o NX - Net Exports (what doesn't really effect the United States) • Exports - imports • Gross Domestic vs. Gross national o For Ireland it'd be a big deal (tariffs/movement of products etc. affects it) o GDP = consumption + investment + (government spending) + (exports − imports). GNP = GDP + NR (N et income inflow from assets abroad or Net Income Receipts) - NP (Net payment outflow to foreign assets). o Irish GDP is high, GNP is low • Let's get the government to spend more o Social security, welfare, etc. = transfer payments / redistribution of income o Workers, planes, tanks etc. o How much? • If aggregate demand is weak, the economy turns down • Consumption is extremely important. o If they aren't buying, businesses aren't making investments. • Lift demand: Deficit spending / spend money you don't have o ** People get nervous, so they pay off their debt, and save their money o Theoretically a good idea o Spend money you don't have now, stimulate aggregate demand, more people get higher, government collects more taxes, and use that money to pay off the debt • Doesn't work because there's always a constituency with their hand in the governments pocket - the money goes somewhere else • Underground economy = Savings o People working off of the books (that aren't getting taxed) Reading Notes ~ Chapter 8 GDP: Measuring Total Production and Income Microeconomics: the study of house -holds and firms make choices, how they interact in markets, and how the government attempts to influence their choice Macroeconomics: the study of the economy as a whole, including topics such as inflation, unemployment and economic growth • Business cycle: alternating periods of economic expansion and economic recession o Expansion: period of a business cycle during which total production and total employment are increasing o Recession: the period of business cycle during which total production and total employment are decreasing • Economic growth: ability of an economy to produce increasing quantities of goods and services • What determines the total level of employment • Why some economies are more successful than others at maintaining high levels of employment • Inflation rate: the percentage increase in the price level from one year to the next • Provides information that consumers and firms need in order to understand current economic conditions and help predict future conditions 8.1 Gross Domestic Product Measures Total Production Measuring total production: Gross Domestic Product • Gross Domestic Product: market value of all final goods/services produced in a country during a period of time (year) o Bureau of Economic Analysis compiles data GDP is Measured using Market Valu es, Not Quantities • Macroeconomics - measures production in quantity terms (the number of…) • Macroeconomics - measures production in value (the worth in dollar terms) GDP Includes Only the Market Value of Final Goods • Final good/service: purchased by a final user, is not included in the production of any other good/service • Intermediate good/service: an input into another good or service such as a tire on a tuck • Double counting: value of good counted once when it is sold and a second time when it is sold with the product in which it is installed GDP Includes Only Current Production Only production during the indicated time period • Production, Income, the circular flow diagram • When we measure value of total production in the economy by calculating GDP, we simultaneously measure the value of total income • If we add up the value of every good/service sold in the economy, we must get a totla that is exactly equal to the value of all the income in the economy • Circular flow diagram o Firms sell goods/services to • Domestic households • Foreign firms/households • Governments o Exports: domestically produced goods/services to foreign markets o Factors of production: labor, capital, natural resources, entrepreneurship o Households supply factors of production to firms in excha nge for income o Income: • Wages • Interest • Rent • Profit • Transfer payments: payments by the government to households for which the government does not receive a new good or service in return • GDP can be measured by calculating the total value of expenditures on final goods and services or by calculating the value of total income Components of GDP • Four categories of expenditure: consumption, investment, government purchases, net exports Personal Consumption Expenditur es • Consumption: spending by households on goods/services not including spending on new houses • Durable goods: automobiles, furniture… • Nondurable goods: food, clothing… Gross Private domestic Investment • Investment: Spending by firms on new factories, office buildings, machinery and additions to inventories, plus spending by households and firms on new firms o Business fixed investment: spending by firms on new factories/office buildings/machinery o Residential investment: spending by households and firms on new single-family and multi- unit houses o Changes in business inventories • Inventories: goods that have been produced but not yet sold Government Consumption and Gross Investment: Government Purchases: • Government purchases: Spending by federal, state, and local governments on goods and services Net Exports of Goods and Services • Net exports: exports minus imports • Exports: goods/services produced in the united states and purchased by foreign firms/households/governments • Imports: goods/services produced in foreign countries and purchased by U.S. Firms/households, and governments An Equation for GDP and Some actual Values: • Equation: Y = C+I+G+NX o Y = GDP o C = Consumption o I = investment o G = Government purchases o NX = net exports • Consumer spending on services is greater than the sum of spending on durable/nondurable good • U.S. trends: away from production of goods and towards the production of services o Population : older and wealthier • Business fixed investment is the largest component of investment • Purchases made by state and local government are greater than purchases made by the federal government • Imports are greater than exports, net exports are negative Measuring GDP using the Value -Added Method • Value added: market value a firm adds to a product • The price of a shirt on L.L. Bean's Website is exactly equal to the sum of the value added by each firm involved in the production of the shirt. • Calculate the GDP by adding up the market value of every final good/service produced during a particular period 8.2 Does GDP Measure What We Want It to Measure? • When BEA calculates GDP it doesn't include production of the home and production in the underground economy Household Production • Household production: goods and services people produce for themselves The Underground Economy • Underground Economy: Buying and selling of goods/services that is concealed from the government to avoid taxes or regulations or because the goods/services are illegal • Is not counting underground economy a shortcoming of GDP? Most would say no • GDP is also used to measure how production of goods/services grows over long periods of time o Omitting household production and underground economy is more important Why do many developing countries have such large underground econom ies? • Developing countries have larger underground economies o Informal sector • Entrepreneurs who start firms in the informal sector, may be afraid the government could someday close/confiscate their firms o Entrepreneurs limit their investments in these firms • Workers have less machinery/equipment § Produce fewer goods/services § Entrepreneurs in the informal sector also have to pay the costs of avoiding government authorities § Bribes to government officials to remain in business o Informal sector is large in some developing economies because taxes are high and government regulations are extensive o Taxes in developing countries are so high because these countries are attempting to pay for government sectors that are as large relative to their economies as the go vernment sectors of industrial economies Shortcomings of GDP as a Measure of Well -Being • The main purpose of GDP is to measure a country's total production • Also used as a measure of well -being • GDP per person = GDP per capita o Imply: the higher GDP per capita countries are better off The value of Leisure is not included in GDP • if an economic consultant retires, GDP will decline even though the consultant may value increased leisure more than the income he/she was earning o Well being has increased but GDP ha s decreased GDP is not adjusted for pollution or other negative effects of production • When a dry cleaner cleans and presses clothes, the value of this service is included in GDP, however if the chemicals pollute the air or water, GDP is not adjusted to com pensate for the costs of the pollution • Increasing GDP often leads countries to devote more resources to pollution reduction • Developing countries often have higher levels of pollution than high=income countries because the lower GDPs of the developing countries make them more reluctant to sped resources on pollution reduction GDP is not adjusted for Changes in Crime and Other social Problems • Increase in crime reduces well-being cut may increase GDP if it leads to greater spending on police, security guards and alarm systems Did World War II Bring Prosperity? • With the end of the war, true prosperity returned to the U.S. economy 8.3 Real GDP versus Nominal GDP • Because GDP is measured in value terms, we have to be careful about interpreting changes over time Calculating Real GDP • Nominal GDP: the value of final goods/services evaluated at current -year prices • Real GDP: The value of final goods/services evaluated at base -year prices • When keeping prices constant, we know that changes in Real GDP represent changes in the quantity of goods/services produced in the economy • Drawback to calculating real GDP using base -year prices: overtime, prices may change relative to each other • Using chain-weighted prices: o Starting with the base year, the BEA takes an average of pr ices in that year and the prices in the following year o Then uses this average to calculate real GDP in the year following (2 years after the base year) • Holding prices constant means that the purchasing power of a dollar remains the same from one year to the next Comparing Real GDP and Nominal GDP • Real GDP holds prices constant o Better measure than nominal GDP of changes in the production of goods/services • Growth in economy is almost always measured as growth in real GDP • Real GDP as being measured in "base -year dollars" The GDP deflator Price level: a measure of the average prices of goods/services in the economy • • One of the goals of economic policy is to maintain a stable price level • GDP deflator: measure of the price level, calculated by dividing nominal GDP by real GDP and multiplying by 100 • What would happen if prices of goods/services rose while production remained the same (nominal GDP would increase, real GDP would remain constant, so the GDP deflator would increase) • What would happen if the prices of goods and services rose while production remained the same - in that case, nominal GDP would increase but GDP would remain constant so the GDP deflator would increase o Reality: both prices/production usually inc rease each year, but the more prices increase relative to the increase in production the more nominal GDP increases relative to real GDP, and the higher the value for the GDP deflator o Increases in the GDP deflator allow economists and policy makers to trac k increase in price level over time 8.4 Other Measures of Total Production and total income • National income accounting: refers to the methods the BEA uses to track total production and total income in the economy • National Income and Product Accounts: stati stics tables containing this information Gross National Product • Gross National Product: value of final goods and services produced by residents of the united States even if the production takes place outside the United States • U.S. Firms have facilities in foreign countries and foreign firms have facilities in the United States • Many countries other than the U.S., a significant percentage of domestic production takes place in foreign-owned facilities: GDP is much larger than GNP and is more accurate measure of the level of production within the country's borders National Income • Depreciation: value of worn -out machinery, equipment and buildings • Consumption of fixed capital: depreciation in NIPA tables • GDP - depreciation = national income • Stressed: value of total production is equal to the value of total income o If value of total production = GDP o Value of total income = national income o National income will always be smaller than GDP by an amount equal to depreciation o Difference between the value of GDP and value of national income does not matter for macroeconomic issues Personal Income • Personal income: received by households • Personal income = subtract the earnings that corporations retain rather than pay to shareholde rs in the form of dividends • Also add in transfer payments Disposable Personal Income • Disposable personal income = personal income - personal tax payments such as federal personal income tax The Division of Income • GDP is the sum of income payments to hous eholds is sometimes called gross domestic income • Wages: all compensation received by employees including fringe benefits (health insurance) • Interest: net interest received by households or the difference between the interest received on savings accounts/government bonds and other investments and the interest paid on car loans, home mortgages and other debts • Rent: rent received by households • Profits: profits of sole proprietorships and corporation
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