Macro Economics, Week7 Notes
Macro Economics, Week7 Notes ECON 2220-004
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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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