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Econ 2 Week 2 Notes

by: James Judelson

Econ 2 Week 2 Notes ECON 2

James Judelson

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Econ 2 with Rojas second week of notes.
Principles of Economics
Class Notes
Economics, Econ, ECON 2, Rojas, UCLA, week 2
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This 25 page Class Notes was uploaded by James Judelson on Tuesday April 12, 2016. The Class Notes belongs to ECON 2 at University of California - Los Angeles taught by Rojas in Fall 2015. Since its upload, it has received 13 views. For similar materials see Principles of Economics in Economcs at University of California - Los Angeles.


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Date Created: 04/12/16
Week 1 Lecture 1: ● Sign up for MindTap ● 2 attempts for homework ● Chapter 23 ○ What is Gross Domestic Product (GDP)? ○ How is GDP related to a nation’s total income and spending? ■ How to calculate income? ● Income for an entire country ○ Add-up everyone in the country’s income ■ Issue s ● S ome may not be reported ● N ot reported correctly ○ Look up spending habits ○ What are the components of GDP? ○ How is GDP corrected for inflation? ■ Overall price level increases (inflation) ● Short-term (ST) and long- term (LT) effects ○ Unemployment (LT) ○ Supply begins to increase ○ Wages ■ If wage increases match inflation, then there will be no change in spending habit ■ If prices increase by 5% but wages stays flat, then spending decreases ■ Have to make sure to account for that increase ○ Does GDP measure Society's well being? ■ GDP a very good measure of what's happening ○ Microeconomics ■ The study of how individual households and firms make decisions, interact with one another in markets ○ Macroeconomics ■ The study of the economy as a whole ○ Gross Domestic Product (GDP) ■ Measures total income of everyone in the economy ■ Also measures total expenditure of the economy's output of goods and services ■ For the economy as a whole, income equals expenditure because every dollar a buyer spends is a dollar of income for the seller ○ Circular-flow diagram ■ Looks at the inputs (factors of production) and outputs (factor payments) and sees who's doing what ■ Looks at households/firms ● Households ○ own the factors of production, sell/rent them to firms for income ○ buy and consume goods & services ● Firms ○ buy/hire factors of production, use them to produce goods and services ○ sell goods & services ■ Households provide the labor/land/capital ● There is a market for these because the firms will hire us ● As such we are providing the factors of production for these firms ■ The firms in return for our labor will provide wages ● This income now goes back to the households ● Another market ○ For the goods and services that we enjoy ■ General description of how an economy works ■ Problems ● Diagram omits stuff (over simplified) ○ The government ■ collec ts taxes, buys goods and services. ■ Taxes ● H ow much are you getting taxed for factors of productions ● I f taxes get too heavy it will become detrimental ○ W on't want to work if being taxed hard ● T axes are important ○ D epends on relative necessities ● W ill have effect on buyers and sellers ○ The financial system ■ Bank s ■ How to finance things like homes/cars ● L oans ■ There has to be a match between needs and what they can provide ■ Some one has to do the due diligence (a system) that can best allocate these resources ■ Credi t cards ■ Look at demanders of money and savers of the money ● N o one person saying who gets this and that ● D epends on characteristics ● N eed this financial system ■ How did firms in the first place get money that they needed ● L oans to build infrastructure ● N ow can hire and begin making profits ■ What if not enough money in the economy as a whole to match financial needs ● B orrow money (foreign) ■ matc hes savers’ supply of funds with borrowers’ demand for loans. ○ The foreign sector ■ Impor tant for course ■ Trade s goods and services, financial assets, and currencies with the country’s residents. ○ GDP ■ the market value of all final goods & services produced within a country in a given period of time ● Value at those market prices and at the same time ● Goods are valued at their market prices ○ All goods are measured in the same units (money/currency) ○ Prices can change over time ■ Inflati on ○ Things that do not have a market value are excluded ■ Such as housework ■ the market value of all final goods & services produced within a country in a given period of time. ● Final goods: Intended for the end user. ● When calculating value of the economy ○ Look at the whole car and not all the parts individually ○ Other factors go into car ■ Labor ■ Costs of production ○ Final cost reflects all of these values combined ■ This is what goes into GDP budget ● Intermediate goods: Used as components or ingredients in the production of other goods. ■ GDP only includes final goods—they already embody the value of the intermediate goods used in their production ● The market value of all final goods & services produced within a country in a given period of time. ● GDP includes tangible goods ( DVDs, mountain bikes, beer) and intangible services (dry cleaning, concerts, cell phone service) ○ Services ■ Defini te price tags on these that can be included ■ Shoul d therefore be added into the GDP mix ■ the market value of all final goods & services produced within a country in a given period of time. ● GDP includes currently produced goods, not goods produced in the past. ○ For annual GDP, only examines stuff produced in that year ○ Would not count fall quarter stuff into winter quarter’s GDP ● Ex. Laptop was produced in both 2014-2015 ○ By the definition of final goods, would only count when it is finalized ○ Therefore part of the 2015 GDP ● Ex. Model from 2015 but not sold till 2016 ○ Technically part of 2015 therefore since that’s when it was done ○ Using car for business or personal ■ What is purpose of the good? ■ the market value of all final goods & services produced within a country in a given period of time. ● GDP measures the value of production that occurs within a country’s borders, whether done by its own citizens or by foreigners located there ● Not stuff produced abroad by US companies ○ Will be further examines later in the course ● BUT, foreign companies that produce in the US will be included ● Could potentially have parts that were made somewhere else (china) but if sold in the US then would be part of US GDP ● Imports ○ Made in foreign country but sold here ○ Will look at effects of imports later on ○ Will be many dynamics on GDP with regards to imports/exports ■ the market value of all final goods & services produced within a country in a given period of time. ● Usually a year or a quarter (3 months) ● GDP would be huge if a period of time was not taken into account ■ Components of GDP ● GDP is total spending ● Four components: ○ Consumption © ■ Purch ases ■ Boug ht final goods ■ Total spending by households on goods and services ■ Note on Housing costs ● F or renters ○ C onsumption includes rent payments ● F or homeowners ○ c onsumption includes the imputed rental value of the house, but not the purchase price or mortgage payments ● I f buy a house that was built years ago ○ U se rent of the home for that year ● H ome prices traditionally go up ○ B ecause of inflation ○ B y actually using imputed value for rent ■ C apturing the value of inflation ■ R eflects whats happening ■ T his applies across the board ■ USE CURRENT PRICES ○ Investment (I) ■ Is total spending on goods that will be used in the future to produce more goods ● P urchase of equipment makes it into the GDP bucket ■ Inclu des spending on ● c apital equipment (e.g., machines, tools) ○ L aptop (for website design business) ○ C an apply to anything ● s tructures (factories, office buildings, houses) ○ F or building a business ○ C an apply to any industry ● i nventories (goods produced but not yet sold) ■ Note: “Investment” does not mean the purchase of financial assets like stocks and bonds ○ Government Purchases (G) ■ Every thing that the government is spending money on ● m ilitary/healthcare/etc. ■ Is all spending on the goods and services purchased by the government at the federal, state, and local levels. ■ Exclu des transfer payments, such as social Security or unemployment insurance benefits. ● T hey are not purchases of goods and services. ● T hese do not make it into the government’s spending ○ G oes under consumption bucket ○ S ince if you are receiving this benefit you are also spending ○ I mportant for midterm ■ W hich bucket ○ Net Exports (NX) ■ NX = exports – imports ■ Expor ts represent foreign spending on the economy’s goods and services ● T he more exports than more spending by foreign powers on our goods/services ■ Impor ts are the portions of C, I, and G that are spent on goods and services produced abroad ■ Differ ence between what were exporting and importing ■ Can be used to characterize the health of the economy ● V ery large negative can bring GDP down a lot ○ W ould therefore correlate with a lower standard of living ■ If positive ● E xporting more than importing ● C ontribute positively to GDP ■ If negative ● E xporting less than importing ● D ecrease GDP ● These components add up to GDP (denoted Y) ○ Y = C + I + G + NX ○ If we have high GDP ■ Assoc iates with a high standard of living ○ Look at GDP trajectory over time ■ Are we growing or shrinking ○ Ex. US Week 1 Lecture 2: ● Often times consumer confidence/spending is a good barometer of what is going on with GDP ○ If we’re spending a lot ■ Increase of income/wages ■ Maybe subsidies ■ Availability of credit ● Government policies ● If credit is available and interest rates are kept low ○ Good for spending ● Examples of GDP and its components ○ Determine how much GDP and each of its components is affected (if at all) ■ Debbie spends $300 to buy her husband dinner at the finest restaurant in Boston. ● GDP increases $300 ● Consumption up $300 ■ Sarah spends $1200 on a new laptop to use in her publishing business. The laptop was built in China. ● GDP is unchanged ● Investment up $1200 ● Net Exports down $1200 ■ Jane spends $800 on a computer to use in her editing business. She got last year’s model on sale for a great price from a local manufacturer. ● GDP is unchanged ● Computer was built last year therefore does not affect current GDP ○ GDP only takes into account current period ■ General Motors builds $500 million worth of cars, but consumers only buy $470 million worth of them. ● GDP increases $500 million ● Consumption up $470 million ● Investment (inventory) up $30 million ● Nominal vs. real GDP ○ Inflation can distort economic variables like GDP, so we have two versions of GDP: ○ Nominal GDP ■ values output using current prices ■ not corrected for inflation ■ The estimate just using the current prices ● Not a fair comparison ○ If 2015 GDP = $100 ○ If 2013 GDP = $90 ○ Nominal GDP sees large increase but did not take into account inflation ○ Real GDP ■ values output using the prices of a base year ■ is corrected for inflation ■ Creates a fair comparison by converting everything to a common year ● Using inflation rates ● Put all GDP’s into a certain year’s dollars ○ Example: ■ Nominal GDP ● ■ Real GDP ● ● Prices for all years set to the base year (2011) ● Better to use this (real) comparison ○ Accounting for inflation ○ Shows increase in GDP without inflation ○ Using nominal and real GDP to gauge inflation rate ■ ● Curves cross in 2009 because it is the base year ● Real GDP is higher than the nominal before 2009 because 2009 prices not taken into account in nominal ● Real GDP is lower than the nominal after 2009 because 2009 prices taken into account ● GDP deflator ○ The GDP deflator is a measure of the overall level of prices ○ Definition ■ GDP deflator = 100 x (nominal GDP/real GDP) ● ■ One way to measure the economy’s inflation rate is to compute the percentage increase in the GDP deflator from one year to the next ○ GDP deflator change from one year to the next shows the change in price/cost of goods ■ Is GDP deflator gives 114.6 ● Price of a burger from the first year to the next will rise by 14.6% ■ Measuring relative to base year ● Example ○ Computing GDP ○ ○ Use the above data to solve these problems: ■ Compute nominal GDP in 2011 ● $30 x 900 + $100 x 192 = $46,200 ■ Compute real GDP in 2012 ● $30 x 1000 + $100 x 200 = $50,000 ■ Compute the GDP deflator in 2013 ● Nom GDP = $36 x 1050 + $100 x 205 = $58,300 ● Real GDP = $30 x 1050 + $100 x 205 = $52,000 ● GDP deflator = 100 x (Nom GDP)/(Real GDP) ○ = 100 x ($58,300)/($52,000) = 112.1 ● GDP Issues ○ Real GDP per capita is the main indicator of the average person’s standard of living ○ GDP is not a perfect measure of well-being ○ GDP ■ Even though it is trying to measure the overall well-being of society if fails to take into account a lot of other factors that contribute towards the well-being of society ■ It IS, however, a good place to start ○ GDP does not value ■ The quality of the environment ■ Leisure time ● Health ● Mental/physical well-being ■ Non-market activity ● Child care a parent provides at home vs. at a daycare ■ An equitable distribution of wealth ○ Why do we care about GDP ■ Having a large GDP enables a country to afford better schools, a cleaner environment, health care, etc. ■ Many indicators of the quality of life are positively correlated with GDP ● GDP and life expectancy ○ ○ Line connecting dots is generally increasing ■ Seem s to have positive slope ■ As real GDP per person increases, we see increase in life expectancy ● GDP and average schooling ○ ○ Line slopes up as well ■ Educ ation leads to better quality of life ■ More efficiency ■ Etc. ● GDP and water quality ○ ○ Line slopes up as well ■ GDP may have its flaws ● But countries with higher GDP have better quality of life ● Measuring the Cost of Living (Chapter 24) ○ Consumer Price Index (CPI) ■ Measures the typical consumer’s cost of living ● What are we (consumers) spending money on ● Identifies set of items that most people would agree on ○ Food ○ Transportation ○ Rent ■ CPI is the basis of cost of living adjustments (COLAs) in many contracts and in Social Security ● Increases of salary ○ Contracts should meet the cost of living in the future ○ Use CPI to anticipate what will happen to the overall price level ○ Instead of saying ‘we will increase salary by $2000, say “we will increase salary by .5% above the inflation rate ■ How is CPI calculated ● Traditionally calculated monthly ● Fix the “basket.” ○ The Bureau of Labor Statistics (BLS) surveys consumers to determine what is in the typical consumer’s “shopping basket.” ○ What is being consumed ■ Food, healthcare, housing, transport, etc. ○ Current consumption is different than past ■ differ ent/new products ■ Prefer ences change ● c igarettes ● Find the prices. ○ The BLS collects data on the prices of all the goods in the basket. ■ Meth od of getting prices ● V ery inefficient/antiquated ● c alls/visits to stores ● Compute the basket’s cost. ○ Use the prices to compute the total cost of the basket ○ Must take into account the consumption ■ Some of these are going to be larger numbers ● C ertain goods are consumed more ● 2 0% to rent, 10% to food, etc. ■ Find generalized spending habits ● Choose a base year and compute the index ○ The CPI in any year equals: ■ ● Compute the inflation rate ○ The percentage change in the CPI from the preceding period ■ Week 2 Lecture 1: ■ Problems with the CPI (Look at examples in powerpoint) ● Over time, some prices rise faster than others ○ Consumers substitute toward goods that become relatively cheaper, mitigating the effects of price increases ○ The CPI misses this substitution because it uses a fixed basket of goods ○ Thus, the CPI overstates increases in the cost of living ● The introduction of new goods increases variety, allows consumers to find products that more closely meet their needs ○ Products that are introduced into the market ■ Espec ially ones that make life better for us ● I phones ● F acebook ● I ntroduction of email ● U ber ● I s it adding value to the existing dollars that I have or is it diminishing the value ○ P rior to product release look at dollars ○ N ow product is introduced ○ A re remaining dollars more or less valuable ■ M ORE VALUABLE ■ When new goods are introduced to the market that make things easier, they increase the value of dollars ○ In effect, dollars become more valuable ○ The CPI misses this effect because it uses a fixed basket of goods ■ The increase in efficiency brought on by new goods is not accounted for ● T his is a reduction in personal costs ● B ut CPI does not take this reduction into account ○ Thus, the CPI overstates increases in the cost of living ■ The value added in the reduction of costs not taken into account ■ Only looks at the cost of buying uber ● D oes not look at time saved getting uber vs. taxi ● D oes not see increases in efficiency ● Improvements in the quality of goods in the basket increase the value of each dollar ○ Not just the introduction of a new good, but the increase in efficiency/quality of an existing good ■ Fuel efficiency in cars ■ Comp uters (power, memory) ○ The BLS tries to account for quality changes but probably misses some, as quality is hard to measure ○ Thus, the CPI overstates increases in the cost of living ● Each of these problems causes the CPI to overstate cost of living increases ○ At least it overstates in all cases ■ Since we know this, we can try and mitigate the overestimate ○ The BLS has made technical adjustments, but the CPI probably still overstates inflation by about 0.5 percent per year ○ This is important because Social Security payments and many contracts have COLAs tied to the CPI ● ○ If measuring inflation ■ The fact that they’re so close is really good ● S ince they are very different metrics ○ Analyzing the departures ■ Mark et crashes ■ High inflation ■ Wars ■ Drasti c change in political powers ● 1 980s ● R eaganomics ○ As a whole they seem to trace out each other ■ There fore both can be used to look at the economy ● CPI vs GDP Deflator ○ Imported consumer goods ■ Included in CPI ■ Excluded from GDP Deflator ○ Capital goods: ■ excluded from CPI ● Everyday people not buying them ○ Like airplanes ■ In GDP but cannot be in CPI ■ included in GDP deflator (if produced domestically) ● Included in investment, not consumption ○ The basket ■ CPI uses fixed basket ■ GDP deflator uses basket of currently produced goods & services ■ This matters if different prices are changing by different amounts ● Even though the different goods make it in the different baskets, they tell a similar story (graph above) ○ In each scenario, determine the effects on the CPI and the GDP deflator ■ Starbucks raises the price of Frappuccinos ● The CPI and GDP deflator both rise ■ Caterpillar raises the price of the industrial tractors it manufactures at its Illinois factory (Classic exam question) ● The GDP deflator rises, not the CPI ■ Armani raises the price of the Italian jeans it sells in the U.S. ● The CPI rises, the GDP deflator does not ○ Not a domestic product ● Correcting variables for inflation ○ Comparing dollar figures from different times ○ ■ Researchers, business analysts, and policymakers often use this technique to convert a time series of current-dollar (nominal) figures into constant- dollar (real) figures ● They can then see how a variable has changed over time after correcting for inflation ○ Minimum wage ■ LEFT SIDE: Dollars Per Hour ● Current dollars stepped ○ Takes time for increases to happen ● 2013 dollars ○ Ability to purchase is decreasing ■ Since 1960 dollars had more purchasing power ● If data went to 2016 ○ Orange curve would drop below brown ○ (LOOK AT POWERPOINT EXAMPLES) ■ ○ A dollar amount is indexed for inflation if it is automatically corrected for inflation by law or in a contract ■ Indexing ● A fancy word meaning to correct for inflation ■ For example, the increase in the CPI automatically determines ● the COLA in many multi-year labor contracts ● adjustments in Social Security payments and federal income tax brackets ○ Real vs. Nominal interest rates ■ The nominal interest rate: ● the interest rate not corrected for inflation ● the rate of growth in the dollar value of a deposit or debt ■ The real interest rate: ● corrected for inflation ● the rate of growth in the purchasing power of a deposit or debt ● Real interest rate = (nominal interest rate) – (inflation rate) Week 3 Lecture 1:


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