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Macro Economics, Week7 Notes

by: Johanna Glaser

Macro Economics, Week7 Notes ECON 2220-004

Marketplace > University of Nebraska at Omaha > ECON 2220-004 > Macro Economics Week7 Notes
Johanna Glaser
GPA 3.717

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Continuation of Chapter 10 along with Chapters 11 &12.
Principles of Economics-Macro
R. Metz
Class Notes
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This 6 page Class Notes was uploaded by Johanna Glaser on Thursday October 6, 2016. The Class Notes belongs to ECON 2220-004 at University of Nebraska at Omaha taught by R. Metz in Fall 2016. Since its upload, it has received 3 views.

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Date Created: 10/06/16
Week 7 Real vs Nominal GDP  Inflation can distort economic variables like GDP, so we have 2 versions of GDP  Nominal GDP- o The production of goods and services valued at current prices  Real GDP- o The production of goods and services valued at constant prices  In each year, o Nominal GDP is measured using the (then) current prices o Real GDP is measured using constant prices from base year o The change in nominal GDP reflects both prices and quantities The GDP Deflator  The GDP deflator is a measure of the overall level of prices o Definition: a measure of the price level calculated as the ratio of nominal GDP to real GDP times 100  GDP deflator= 100 x (nominal GDP/real GDP)  Inflation o Economy’s overall price level is rising  Inflation Rate o Percentage change in some measure of the price level from 1 period to the next o Inflation in yr 2= GDP deflator in year 2 – GDP deflator in year 1 x 100 GDP deflator in year 1 Real GDP over recent history  The GDP data o Real GDP grows over time o Growth- average 3% per yr singe 1965 o Growth is not steady  GDP growth interrupted by recession  Recession o 2 consecutive quarters of falling GDP o Real GDP declines o Lower income o Rising unemployment o Falling profits o Increased bankruptcies GDP  GDP- “the best single measure of the economic well-being of a society” o Economy’s total income o Economy’s total expenditure o Larger GDP  Good life, better healthcare  Better educational systems  Higher standard of living  Why do we care about GDP? o Having a large GDO enables a country to afford better schools, a cleaner environment, health care, etc.  GDP- not a perfect measure of well-being o Doesn’t include  Leisure  Quality of the environment  Improvements in product quality  Underground economy  Nonmarket transactions  Work done in the home  Babysitters  Second hand sales  Financial transactions  Public transfer payments  Private transfer transactions  Stock market transaction  Secondhand sales  France’s “Happiness Quotient” Summary  GDP measures a country’s total income and expenditure  The 4 spending components of GDP include: consumption, investment, govt purchases, and net exports  People face tradeoffs  The cost of any action is measured in terms of foregone opportunities  People respond to incentives Chapter 11: Measuring the Cost of Living The consumer price index  Consumer Price Index (CPI) o Measure of the overall level of prices o Measure of the overall cost of goods and services  Bought by a typical consumer o Bureau of Labor Statistics Calculating CPI  Fix the basket o Which prices are most important to the typical consumer o Different weight  Find the prices o At each point in time  Compute the baskets cost o Same basket of goods o Isolate the effects of price changes  Chose a base yr and compute the CPI o Base yr= benchmark  Price of basket of goods and series in current year  Divided by price of basket in base year  Times 100  Compute the Inflation Rate o Use consumer price index to calculate the inflation rate o Inflation rate is year 2 =  CPI in yr 2 – CPI in yr 1/ CPI in yr 1 x 100 The Consumer Price Index  Inflation rate o Percentage change in the price index  From the preceding period  Producer Price Index (PPI) o Measure of the cost of a basket of goods and services bought by firms o Changes in PPI are often thought to be useful in predicting changed in CPI  CPI Basket o Set prices o Housing is the biggest 41%  Problems in measuring the cost of living o Substitution bias  Prices do not change proportionately  Consumers substitute toward goods that have become relatively less expensive o Introduction of new goods  More variety of goods o Unmeasured quality change  Changes in quality  Thus, the CPI overstates increases in the cost of living GDP deflator versus CPI  GDP deflator o Ratio of nominal GDP to real GDP o Reflects prices of all goods and services produced domestically o Compares the price of currently produced goods and services  To the price of the same goods and services in the base yr  Tends to understate inflation  CPI o reflects prices of goods and services bought by consumers o Compares price of a fixed basket in the base yr o Tends to overstate inflation Correcting Economic Variables  Dollar figures from different times ' Price Leveltoday Amount∈today sdollars=Amount∈yrT dollars× PriceLevel∈yr T= Target yr  Indexation o Automatic correction by law or contract o Of a dollar amount o For the effect of inflation o COLA  Cost of Living Allowance Real and Nominal Interest Rates  Nominal Interest Rate o Interest rate as usually reported o Without a correction for the effects of inflation o Always exceeds the real interest rate o U.S. economy has experienced rising consumer prices every year  Real Interest Rate o Interest rate corrected for the effects of inflation =Nominal Interest Rate- Inflation Rate  Inflation is variable o Real and nominal interest rates do not always move together  Periods of deflation o Real interest rate exceeds the nominal interest rate Summary  The CPI is a measure of the cost of living. The CPI tracks the cost of the typical consumer’s “basket” of goods and services  The CPI is used to make Cost of Living Adjustments and to correct economic variables for the effects of inflation  The real interest rate is corrected for inflation and is computed by subtracting the inflation rate from the nominal interest rate Chapter 12: Production and Growth Economic Growth  Real GDP per person o Living standard o Vary widely from country to country  Growth Rate o How rapidly real GDP per person grew in the typical yr Productivity  Productivity o Quantity of goods and services o Produced form each unit of labor input  Why productivity is so important o Key determinant of living standards o Growth in productivity is the key determinant of growth in living standards  Determinant of productivity o Physical capital (K)- equipment structures used to produce goods and services o Human Capital (H)- knowledge “brains”, experience o Natural Resources(N)- land, rivers, mineral deposits  Input into the production of goods and services that are provided by nature o Technological Knowledge(A)  Society’s understanding of the best ways to produce goods and services The Production Function  The production function is a graph or equation showing the relation between output and inputs: Y=AF(L,K,H,N) o F= a function that shows how the inputs are combined to produce output o A= a variable that reflects the available production technology o As technology improves, A rises, so the economy produces more output from any given combination of inputs Are natural resources a limit to growth?  Argument o Natural Resources- will eventually limit how much the world’s economies can grow  Fixed supply of nonrenewable natural resources- will run out  Stop economic growth  Force living standards to fall  Technological progress o Often yields ways to avoid these limits  Improved use of natural resources over time  Recycling  New materials  Prices of natural resources o Scarcity- reflected in market prices o Natural resource prices  Substantial short-run fluctuations  Stable or falling- over long spans of time o Rationing function of prices… “the competing forces of supply and demand to establish a price producers and buyers can agree upon and leave the no shortage or surplus” –Adam Smith o Our ability to conserve these resources Saving and Investment  Raise future productivity o Invest more current resources in the production of capital o Trade-off Diminishing Returns  Higher savings rate o Fewer resources-used to make consumption goods o More resources- to make capital goods o Capital stock increases o Capital/Labor Ratio Increase o Rising productivity o More rapid growth in GDP  Diminishing returns o Benefits from an extra unit of an input o Declines as the quantity of the input increases  In the long run, higher savings rate o Higher level of productivity o Higher level of income o Not higher growth in productivity and income  Catch-up Effect o Countries that start off poor o Tend to grow more rapidly than countries that start off rich – look at China  Poor countries o Low productivity o Even small amounts of capital investment  Increase workers’ productivity sustainability o Tend to grow faster than rich countries  Rich countries o High productivity o Additional capital investment  Small effect on productivity


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