Economics chapters 7 to 11


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Economics chapters 7 to 11

  1. 1. ECONOMICS CHAPTERS 7-11 MEASURING TOTAL PRODUCTION GDP! The gross domestic product measure total production Definition> the market value of all final goods and services produced in a country during a period of time, typically one year. GDP includes only the market value of finals good, like final good or service and intermediate good or service (such as a tire on a truck) GDP only includes production that takes place during the indicated time period It is not sufficient to measure progress though Components of GDP Personal consumption expenditures or consumption (spending by households on goods and services, not including spending on new houses.) Gross private Domestic investments or investment ( spending by firms on new factories, office buildings, machinery, and additions to inventories and spending by households on new houses. Government consumption and Gross investment or government purchases ( spending by federal, state, and local government on goods and services. Net Exports of Goods and Services or Net exports ( export minus imports.) Equation for GDP and Some Actual Values Y= C+I+G+NX Measuring GDP with the value added method whch means the market value a firm adds to a product. FIRM VALUE OF PRODUCT VALUE ADDED Cotton Farmer Value of raw cotton = $ Value added by cotton farmer Value of raw cotton woven into cotton fabric = $3 Value added by cotton textile mill = ($3 – $1) Value of cotton fabric made into a shirt = $15 Value added by shirt manufacturer = ($15 –$3) Value of shirt for sale on L.L. Bean’s Web site = $35 Value added by L.L. Bean = ($35 – $15) Textile Mill Shirt Company L.L. Bean Total Value Added
  2. 2. Does GDP Measure What We Want it to measure? GDP doesn’t measure HOUSEHOLD PRODUCTION AND UNDERGROUND ECONOMY. Household production refers to goods and services people produce for themselves. Underground eonomy is the buying and selling of goods and services that is concealed from the government to avoid taxes or regulations or because the goods and services are illegal Value of leisure is not included Not adjusted for pollution or other negative effects of production Not adjusted for changes in crime and other social problems { measures everything in shorts, except that which makes life worthwhile) Other measures of total production and total income Gross National product (GNP) NET NATIONAL PRODUCT (NNP) Measuring economic growth by real GDP REAL GDP VERSUS NOMINAL GDP REAL GDP, the value of final goods and services evaluated at base year prices. NOMINAL GDP, The value of final goods and services evaluated at current year prices. Real GDP versus Nominal GDP THE GDP DEFLATOR PRICE LEVEL> a measure of the average prices of goods and services in the economy GDP deflator> A measure of the price level, calculated by dividing nominal GDP by real GDP and multypling by 100. Measuring inflation, the CPI and the inflation rate PRICE LEVEL, a measure of the average prices of goods and services in the economy. INFLATION RATE> the percentage increase in the price level from one year to the next. The consumer price index> CPI Weights… other goods and services, apparel, education and communication, recreation, medical care, food and beverages, Transportation and Housing. Is the CPI Accurate? There are four biases that make changes in the CPI overstate the true inflation rate> substitution bias, increase in quality bas, new produt bias, outlet bias. Causes of inflation PUSH AND PULL Real versus Nominal interest Rates The real interest rate is equal to the nominal interest rate minus the inflation rate. The real interest rate provides better measure of the true cost of borrowing and the true return on lending than does the nominal interest rate.
  3. 3. The inflation rate is measured by the percentage change in the CPI from the same quarter during the previous year. Does inflation impose costs on the Economy? Inflation affects the distribution of income Problem with anticipated inflation> menu costs, the costs to firms of changing prices. The problem with unanticipated inflation> even when inflation is perfectly anticipated , however, some individuals will experience a cost. Measuring the unemployment rate and the labor force participation rate The unemployment rate measures the percentage of the labor force that is unemployed. The labor force participation rate, measures the percentage of the working age population in the labor force. INTERNATIONAL COMPARISONS FLUCTUATIONS IN UNEMPLOYMENT TYPES OF UNEMPLOYMENT Frictional unemployment and job search> short term unemployment that arises from the process of matching workers with jobs. Structural unemployment> unemployment arising from a persistent mismatch between the skills and charactersitics of workers and the requierements of jobs. Cyclical unemployment> unemployment caused by a business cycle recession. Institutional factors and the unemployment rate Unemployment insurance and other payments to the unemployed Minimum wage laws Labor unions Efficiency wages The sources of short run economic growth Aggreagate expenditure> the total amount of spending in the economy, the sum of consumption planned investment, government purchases and net exports.
  4. 4. The sources of long run economic growth The sources of economic growth When labor productivity grows, real GDP per person grows, so the growth in labor productivity is the basis of rising living standards. The growth of labor productivity depends on three things< Saving and investment in physical capital Expansion of human capital Discovery of new technologies. The market for loanable funds Demand and supply in the loanable funds market
  5. 5. What determines how fast economies grow? Which is more important for economic growth, more capital or technological change? Technological change helps economies avoid diminishing returns to capital. The per worker production function> the relationship between real GDP per hour worked and capital per hour worked, holding the level of technology constant. The per workers production function, diminishing returns>
  6. 6. Technologial change> the key to sustaining economic growth New Growth theory> a model of long/run economic growth which emphasizes that technological change is influenced by economic incentives and so is determined by the working of the market system. Government policy> can help increase the accumulation of knowledge capital in three ways
  7. 7. Protecting intellectual property with patents and copyrights, *the exclusive right to a product for a period of 20 years from the date the product is invented. Subsidizing research and development Subsidizing education. WHY isn’t the whole world rich?? Catch up. The prediction that the level of GDP per capita or income per capita in poor countrie will grow faster than in rich countries.
  8. 8. Why don’t more low income countries experience rapid growth? Failure to enforce the rule of law Propery rights> the rights individuals or firms have to the exclusive use of their property, including the right to buy or sell it. Rule of law> the ability of a government to enforce the laws of the country, particulary with respect to protecting private property and enforcing contracts.
  9. 9. Wars and revolutions> wars have made it impossible for countries such as Afghanistan, Angola, Ethiopia, The Central African Republic and the Congo to accumulate capital or adopt new technologies. Poor Public Education and Health> Many low income countries have weak public school systems, so many workers are unable to read and write., people who are sick work less and are less productive when they do work.
  10. 10. Low Rates of saving and investment> the low savings rates in developing countries contribute to a vicious cycle of poverty. The benefits of globalization Foreign direct investment (FDI) the purchase or building by a corporation of a facility in a foreign country. Foreign portfolio investment> the purchase by an indifividual or a firm of stock or bonds ssued in another country. Globalization> the process of countries becoming more open to foreign trade investment. Growth Policies We have seen that even small differences in growth rates compounded over the years can lead to major differences in standards of living. Therefore, there is potentially a very high payoff to government policies that increase growth rates. Enhancing property rights and the rule of law Improving health and education Policies with respect to technology Policies with respect to saving and investment Is economic growth good or bad? The sources of short run economic growth Aggregate expenditure> the total amount of spending in the economy, the sum of consumption planned investment, government, purchases and net exports. In the short run GDP is determined by aggregate expenditure.
  11. 11. Aggregate expenditure model> a macroeconomic model that focuses on the relathionshp between total spending and real gdp, assuming that the price level is constant. AE = C + I + G + NX Macroeconomic equilibrium> aggregate expenditure = GDP Determining the Level of Aggregate Expenditure in the Economy Consumption< the following are the five most important variable that determines the level of consumption Current disposable income Household wealth Expected future income The price level The interest rate The consumption function> The relationship between consumption spending and disposable income. Marginal propensity to consume (MPC) the slope of the consumption function. The amount by which consumption spending changes when disposable income changes. Planned investment> the four most important variables that determine the level of investment are Expectations of future profitability The interest rate Taxes Cash flow
  12. 12. Net exports> the following are the three most important variables that determine the level of net exports The price level in the united states relative to the price levels in other countries The growth rate of GDP in the united states relative to the growth rates of GDP in other countries The exchange rate between the dollar and other currencies. GRAPHING Macroeconomic equilibrium The multiplier Effect Autonomous expenditure> an expenditure that does not depend on the level of GDP Multiplier> the increase in equilibrium real GDP divided by the increase in autonomous expenditure. Multiplier effect> the process by which an increase in autonomous expenditure leads to a larger increase in real GDP.
  13. 13. Summarizing the multiplier effect> The multiplier effect occurs both when autonomous expenditure increases and when it decreases. The larger the MPC, the larger the value of the multiplier The formula for the multiplier * IS oversimplified because it ignores some real world complications, such as the effect that an increasing GDP can have on imports, inflation and ,* 1/(1 − MPC), interest rates. THE END…