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This 15 page Class Notes was uploaded by Jessica Zuritis on Friday September 30, 2016. The Class Notes belongs to ECO181 at University at Buffalo taught by Dr. Monica Cherry in Summer 2016. Since its upload, it has received 8 views. For similar materials see Intro to Macroeconomics in Macro Economics at University at Buffalo.
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Date Created: 09/30/16
Chapter 5– Measuring the Economy’s Performance - GDP (Gross domestic product) measures the level of economic activity. - GDP/population (GDP per capita) measures standard of living - % change in GDP measures Economic Growth and short run fluctuations ^ during recession GDP is falling GDP measures two important economic values Since every dollar a buyer spends is a dollar of income for the seller this implies that: Total spending Total income earned by households on = by households Goods and Services The value of the goods and services produced is called GDP, Thus GDP measures both 1. Spending on goods 2. Income earned by and services resources used to produce goods Gross Domestic Product (GDP) is the market value of all final goods and services produced domestically in a given period (quarterly or annually). 1) Goods are valued at their market prices, so that all goods are measured in the same units ($ or whatever currency). Problem is that things that don’t have a market value are excluded from GDP. This includes: _________________ - Goods and services that are produced ate home rather than in the market and - Goods and services that are sold under the table (unreported, illegal activity or avoiding taxes). - Bartered goods 2 - Final goods: intended for the final user Intermediate goods: used as ingredients in the production of other goods GDP only includes goods – they already embody the value of the intermediate goods used in their production. (counting intermediate goods results in double couting) Example: Flour purchased by baker is not included because it’s an intermediate good. Flour bought by mom to make cookies is included. 3.) Produced – only includes new goods.- Excludes used goods. Even if they are not sold still counts, all goods produced 4.) Domestically (Within a Country)- regardless of who produces the good - Excludes goods produced abroad (imports) even if produced by a domestic produce. Important questions to ask are: 1. Does this activity generate new economic activity in the domestic economy? (Are domestic resources being used?) 2.Has it already been counted? (Intermediate goods) 3.Can it be measured? ( ie: Does it have a market price?) In Class Example: Say whether or not the following transactions would be counted in 2015 GDP. 1.McDonalds buys buns for their Big Macs. No intermediate 2. You hire a maid to clean your house. Yes 3.You mow your own lawn. No (none market activity) 4.You buy a new BMW that was built in Ohio. Yes 5.You buy an IBM computer that was made in China. No (import) 6.You buy a 2012 Subaru Tribeca for $20,000. No, (used 2012) 7.You buy stock issued by Google. No (saving money not spending, no good or service is received in return) Summary: Goods Excluded From GDP 1. Non-market (under the table or household production) 2. Intermediate 3. Used 4. Imports 5. Financial Transactions How is GDP measured? GDP measures both: spending on final goods and services and income earned by resources. I. Expenditure Method of Computing GDP GDP is measured by adding up all of the spending by all sectors of the economy. Four Sectors Spending 1. Households (own resources) consumption 2. Firms (produce goods/services) investment 3. Government government 4. International net exports(NX) = Exports (X) – Imports (M) These spending levels all add up to GDP (denoted Y) Y (GDP) = C + I + G + X + NX X-M= NX Consumption, C: Spending by households on goods and services: - Non-Durable goods (less than 3 years) - Durable goods - Services Exception: purchases of new homes (included in investment). - Rent is included in consumption (housing service) along with estimated cost of living in own home Investment – I – total spending on goods that will be used in the future to produce other goods. 1. Non-fixed capital (machinery, software, desks, cars, phones) 2. Fixed capital - Commercial (factories, stores, warehouses) - Residential (Homes, apartments, condos) 3. Inventory produced but not yet sold Government Purchases(G) – Spending on the goods and services provided by the government at the federal, state, and local level such as spending on defense, roads, education, police, etc. - This will exclude spending by the government on transfer payments such as unemployment security, unemployment, food stamps because the government is not receiving a good or service in return. Net Exports (NX) = Exports (X) – Imports (M): where exports represent goods produced domestically and sold to foreign residents while imports are the portions of C, I, and G that are spent on Goods and Services produced abroad. Adding up all the components of GDP gives: GDP = C + I + G + NX The largest component of GDP has always been consumption The most volatile component of GDP is investment and has recently made up a smaller part of GDP. In Class Example: Determine how much GDP and what components are affected (if at all). A. Cassandra buys her boyfriend dinner at Applebees for $60. C and GDP increase by $60 B.Susie spends $1200 on a new I-Pad that she is going to use in her catering business. It was made in China. I increases by $1,200, M increases by $1,200, NX goes down $1,200 GDP stays the same C.Jake spends $500 on a computer for his own use. He got a deal because it was last year’s model. C increases by $500, I decreases by $500, GDP stays the same D. General Motors builds $500 million in cars but only sells $470 million. C increases by $470 million, I increases by $30 million, GDP increases by $500 million a.) I and GDP increases b.) No effect on GDP c.)No effect on GDP d.) X and GDP Increase e.) C M increase, NX decrease, No effect on GDP f.) I and GDP increases GDP is defined as the market value of final G & S produced. If GDP increases by 5% does this mean that output increases by 5%? Not necessarily, depends on what happens to prices Nominal vs. Real GDP Nominal GDP: Measures current output in terms of the current prices at which goods are sold; expressed in current dollars, also called current $ GDP Nominal GDP = summation of (current output (Q) X price) - Nominal GDP can increase if either price increases or output increases. Real GDP - Measures current output valued at base year prices; Base year is chosen arbitrarily (given in problem). Real GDP = Summation of (current output (Qcurrent) X Price in Base year (Pbase) Real GDP will only change when output (Q) changes. Thus real GDP is a better measure of changing economic activity. In the base year Nominal GDP equals Real GDP What is the base year in the above table? 2005 since real = nominal in 2005. In class Example (use 2013 as the base year) Q Gas P gas Q pizza Ppizza Q soda Psoda 2013 1000 3.75 10000 2.00 5000 1.50 2014 1200 2.75 11000 2.50 4900 2.00 2015 1300 2.25 12000 3.00 5200 2.50 Nominal GDP 2013= (3.75 X 1,000) + (2.00 X 10,000) + (1.50 X 5,000) = 31,250 Nominal GDP 2014 = (2.75 X 1,200) = (2.50 X 11,000) + (2.00 X 4,900) = 40,600 Nominal GDP 2015 = (2.25 X 1,300) + (3.00 X 12,000) + (2.50 X 5,200) = 51,925 Increase 2013 – 2014 = ( (51,925 – 40,600) / 40,600 ) X 100 = 27.9% Increase 2014- 2015 % increase = (new – old/old) X 100 Real GDP 2013: Real GDP 2014: (3.75 X 1,200) + (2 X 4,00) + (1.5 X 4,900) = Real GDP 2015: (3.75 X 1300) + (2 X 12,000) + (1.50 X 5,2000) = 36,675 Increase 2013: (2014 33,850 – 31,250)/ 31,250 = 8.2% Increase 2014:2015 (36,675 – 33,850) / 33,850 = 8.35 % Important notes from looking at graph 1. Nominal GDP usually grows faster than Real GDP due to rising prices (inflation). 2.Nominal GDP=Real GDP in 2005 since it uses 2005 prices to value output (2005 is base year). 3.Real GDP > Nominal GDP before 2005. 4.Real GDP < Nominal GDP after 2005 5.During times of deflation (falling prices), Nominal GDP grows slower than real GDP. Can we use the information on Nominal and Real GDP to get information about inflation? Inflation = % Change in Price index (measures the average price of goods in the economy) Price Index- (cost of “basket” of goods today/cost of basket of goods in base year) X 100 GDP Deflator = one type of price index - (nominal GDP/real GDP) X 100 - Basket is all goods and services produced domestically - Always 100 in base year Nominal Real GDP Year GDP GDP Deflator 2013 $31,250 $31,25 100 0 $33,850 2014 $40,600 (40600/33850) X 100= 119.9 $36,675 2015 $51,925 (51,925/36,675) X100 = 141.6 Inflation rate 2013-14 = (119.9-100/100) X100 = 19.9% 18.1%tion rate 2014-15 = (141.6-119.9/119.9) X 100 = DO AT HOME ANSWERS ON NOTES In class Example: Suppose that the economy of Oz produces gold and slippers. In year 1 they produce 10 gold and 20 slippers with a price of $1,000 for gold and $100 for slippers. In the following year, gold production increases to 11 while prices fall to 900. On the other hand slipper production rises to 30 and prices are $200. Use year 1 as the base year to compute the following: Nominal GDP year 1= Nominal GDP year 2= Real GDP year 1= Real GDP year 2= GDP Deflator= GDP Deflator= GDP as a measure of Economic well- being. Higher GDP means higher production of goods and services - and higher income earned. This may imply that an economy has more money to spend on education, health care, research, infrastructure, and other things that improve quality of life. GDP is usually positively related with other measure of Quality of life.. such as life expectancy, literacy rates, internet access. For low levels of income, there is a strong relationship between GDP and life expectancy. At higher levels of income, relationship is not as strong. GDP is an imperfect measure of well- being… Limitations (or flaws): It ignores things like: 1. The quality of the environment. 2.Distribution of Income Thus GDP may overstate well-being 3.Leisure time has increased. 4.Home production. But GDP may also understate well- being GDP is the “best” measure of economic prosperity but is not a perfect measure!!!
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