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Introduction and measuring nations income

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  • Why do economists disagree even over positive theories?
    Economics is a social science, like psychology, anthropology, and political science. It is concerned with reaching generalizations about human behavior. Human behavior is more variable and often difficult to predict. But, probably more important, humans too often can’t explain their true motivations. Economics assumes people are rational self-interest maximizers. All that we can really claim is that people act as if they are rational.
    Social scientists don’t have laboratories to conduct controlled repeatable experiments to test theories like physical scientists. We can’t manipulate the economy simply to test our theories
  • Suggestion: Show these questions, and give your students 1-3 minutes to formulate their answers. When you are ready to discuss the answers, go to the next slide….
  • Suggestion (continued from previous slide): Show part A (but not the answer) and ask for someone to volunteer his or her response. Then show the answer to part A. Repeat for parts B, C, and D. (The answers to parts C and D appear on the following slide.)
    After showing the answer to part A, ask your students whether the answer would be different if Debbie were a government employee. The correct answer is NO. Government employees engage in consumption, just like everyone else.
  • Regarding part C:
    Jane’s purchase causes investment (for her own business) to increase by $1200. However, the computer is sold out of inventory, so inventory investment falls by $1200. The two transactions cancel each other, leaving aggregate investment and GDP unchanged.
    Regarding part D:
    This problem illustrates why expenditure always equals output, even when firms don’t sell everything they produce due to lackluster demand. The point here is that unsold output is counted in inventory investment, even when that “investment” was unintentional.
  • This example is similar to that in the text, but using different goods and different numerical values.
    Suggestion: Ask your students to compute nominal GDP in each year before revealing the answers. Ask them to compute the rate of increase before revealing the answers.
    In this example, nominal GDP grows for two reasons: prices are rising, and the economy is producing a larger quantity of goods.
    Thinking of nominal GDP as total income, the increases in income will overstate the increases in society’s well-being because part of these increases are due to inflation.
    We need a way to take out the effects of inflation, to see how much people’s incomes are growing in purchasing power terms. That is the job of real GDP.
  • This example shows that real GDP in every year is constructed using the prices of the base year and that the base year doesn’t change.
    The growth rate of real GDP from one year to the next is the answer to this question:
    “How much would GDP (and hence everyone’s income) have grown if there had been zero inflation?”
    Thus, real GDP is corrected for inflation.
  • The table in the top half of this slide merely summarizes the answers from the previous two slides. This table will be used shortly to compute the growth rates in nominal and real GDP and to compute the GDP deflator and inflation rates.
  • Again, the growth rate of real GDP from one year to the next is the answer to this question:
    “How much would GDP (and hence everyone’s income) have grown if there had been zero inflation?”
    This is why real GDP is corrected for inflation.
  • The data in the table are for a hypothetical economy that produces two final goods, A and B. For all parts of this problem, use 2007 as the base year.
    If you’re running short on time, you can skip part A – it’s the least challenging. If you only have time for one of the three, you might skip A and B, as C by itself covers all of the material: it requires students to compute nominal and real GDP before they can compute the GDP deflator.
  • Transcript

    • 1. Introduction to Macroeconomics Copyright © 2004 South-Western
    • 2. MEANING OF ECONOMICS The word ‘Economics’ originates from the Greek work ‘Oikonomikos’ which can be divided into two parts: (a) ‘Oikos’, which means ‘Home’, and (b) ‘Nomos’, which means ‘Management’. •Thus, Economics means ‘Home Management’. •The head of a family faces the problem of managing the unlimited wants of the family members within the limited income of the family. Copyright © 2004 South-Western
    • 3. MEANING OF ECONOMICS • If we consider the whole society as a ‘family’ • then the society also faces the problem of tackling unlimited wants of the members of the society with the limited resources available in that society. • Thus, Economics means the study of the way in which mankind organizes itself to tackle the basic problems of scarcity. Copyright © 2004 South-Western
    • 4. BROAD SCOPE OF ECONOMICS Economic Problems The main economic problems faced by every society are: 1.Unlimited human wants, 2.Limited availability of resources to satisfy those wants, and 3.Fulfillment of unlimited wants with limited resources. Copyright © 2004 South-Western
    • 5. BROAD SCOPE OF ECONOMICS Three Main Economic Questions In recent times, economists have analyzed economic systems from a broad perspective. These modern economists talk about three main economic questions: (1)What to produce, (2)How to produce and , (3)For whom to produce. Copyright © 2004 South-Western
    • 6. What Is Macroeconomics? What Is Microeconomics? • Macroeconomics deals with questions about variables that describe the economy of an entire nation. • Microeconomics deals with questions related to individual economic agents, such as households and firms. • Micro-an individual tree • Macro- the entire forest Copyright © 2004 South-Western
    • 7. The Scope of Economics Microeconomics and Macroeconomics TABLE 1.1 Examples of Microeconomic and Macroeconomic Concerns Divisions of Economics Microeconomics Macroeconomics Production Prices Income Employment Production/output in individual industries and businesses   How much steel How much office    space How many cars Price of individual goods and services   Distribution of income and wealth Employment by individual businesses and industries Price of medical care Price of gasoline Food prices Apartment rents Wages in the auto   industry Minimum wage Executive salaries Poverty Jobs in the steel   industry Number of employees   in a firm Number of   accountants National production/output   Aggregate price level   National income Employment and unemployment in the economy Total industrial output Gross domestic    product Growth of output Consumer prices Producer prices Rate of inflation Total wages and   salaries   Total corporate   profits Total number of jobs Unemployment rate Copyright © 2004 South-Western
    • 8. Macroeconomics • Macroeconomics deals with the economy as a whole. It studies the behavior of economic aggregates such as aggregate income, consumption, investment, and the overall level of prices. • Aggregate behavior refers to the behavior of all households and firms together. • A macroeconomist would ponder questions such as, • what would happen to Pakistan’s unemployment rate if China or EU suddenly stops trading with Pakistan and • what policy should the government of Pakistan then follow? • The focus would always be on Pakistan as a whole. Copyright © 2004 South-Western
    • 9. Areas of concern • • • • Unemployment Prices-inflation Interest rates-rental price of money Govt. budget- fiscal deficit • How much government spends? • How much revenue government earns through taxes? • Productivity –with the given amount of resources how much output do you get • Value of currency- exchange rates • Macroeconomic policy • Fiscal Policy • Monetary policy Copyright © 2004 South-Western
    • 10. Economic Theory in Practice Positive versus Normative Economics • Positive Economics An approach to economics that seeks to understand behavior and the operation of systems without making judgments. It explains what will happen under certain conditions. • Normative Economics An approach to economics that analyzes outcomes of economic behavior, evaluates them as good or bad, and may prescribe courses of action. Also called policy economics. It explains what should happen Introduction to Macroeconomics Copyright © 2004 South-Western
    • 11. Positive vs Normative Economics • For example, the statement, "government should provide basic healthcare to all citizens" is a normative economic statement. • The statement, "government-provided healthcare increases public expenditures" is a positive economic statement. Copyright © 2004 South-Western
    • 12. Positive or Normative? 1. The retirement age should be raised to 70 to combat the effects of our ageing population 2. A rise in average temperatures will increase the demand for sun screen products. 3. The government should increase the minimum wage to £6 per hour to reduce poverty. 4. Higher interest rates will reduce house prices Copyright © 2004 South-Western
    • 13. Measuring a Nation’s Income Copyright © 2004 South-Western
    • 14. THE ECONOMY’S INCOME AND EXPENDITURE • When judging whether the economy is doing well or poorly, it is natural to look at the total income that everyone in the economy is earning. • For an economy as a whole, income must equal expenditure because: • Every transaction has a buyer and a seller. • Every dollar of spending by some buyer is a dollar of income for some seller. Copyright © 2004 South-Western
    • 15. THE MEASUREMENT OF GROSS DOMESTIC PRODUCT • Gross domestic product (GDP) is a measure of the income and expenditures of an economy. • It is the total market value of all final goods and services produced within a country in a given period of time. Copyright © 2004 South-Western
    • 16. THE MEASUREMENT OF GROSS DOMESTIC PRODUCT • The equality of income and expenditure can be illustrated with the circular-flow diagram. Copyright © 2004 South-Western
    • 17. Figure 1 The Circular-Flow Diagram MARKETS FOR GOODS AND SERVICES •Firms sell Goods •Households buy and services sold Revenue Wages, rent, and profit Goods and services bought HOUSEHOLDS •Buy and consume goods and services •Own and sell factors of production FIRMS •Produce and sell goods and services •Hire and use factors of production Factors of production Spending Labor, land, MARKETS and capital FOR FACTORS OF PRODUCTION •Households sell •Firms buy Income = Flow of inputs and outputs = Flow of dollars Copyright © 2004 South-Western
    • 18. The Circular-Flow Diagram-with Saving & investment Revenue Goods and services sold MARKETS MARKETS FOR FOR GOODS AND SERVICES GOODS AND SERVICES •Firms sell •Firms sell •Households buy •Households buy Spending Goods and services bought Saving FIRMS •Produce and sell goods and services •Hire and use factors of production HOUSEHOLDS •Buy and consume goods and services •Own and sell factors of production Financial Market Investment Factors of production Wages, rent, and profit Labour, land, MARKETS and capital FOR FACTORS OF PRODUCTION •Households sell •Firms buy Income = Flow of inputs and outputs = Flow of dollars Copyright © 2004 South-Western Copyright © 2004 South-Western
    • 19. THE MEASUREMENT OF GROSS DOMESTIC PRODUCT • GDP is the market value of all final goods and services produced within a country in a given period of time. Copyright © 2004 South-Western
    • 20. THE MEASUREMENT OF GROSS DOMESTIC PRODUCT • “GDP is the Market Value . . .” • Output is valued at market prices. • Example: If the price of an apple is twice the price of an orange, then an apple contributes twice as much to GDP as does an orange. • “. . . Of All Final . . .” • It includes all items produced in the economy and sold legally in markets. • Example: Vegetable you buy at the grocery store are part of GDP, vegetables you grow in your garden are not. • It records only the value of final goods, not intermediate goods (the value is counted only once). Copyright © 2004 South-Western
    • 21. THE MEASUREMENT OF GROSS DOMESTIC PRODUCT • “. . . Goods and Services . . . “ • It includes both tangible goods (food, clothing, cars) and intangible services (housecleaning, doctor visits). • Example: When you buy a CD, you are buying a good, and the purchase price is part of GDP. • “. . . Produced . . .” • It includes goods and services currently produced, not transactions involving goods produced in the past. • Example: When Honda produces and sells a new car, the value of the car is included in GDP. But when a persons sells a used car to another, the value of the used car is not included in GDP. Copyright © 2004 South-Western
    • 22. THE MEASUREMENT OF GROSS DOMESTIC PRODUCT • “ . . . Within a Country . . .” • It measures the value of production within the geographic confines of a country. • Example: When a U.S. citizen owns a factory in Pakistan, the production at his factory is not part of U.S. GDP (It is part of Pakistan’s GDP). • “. . . In a Given Period of Time.” • It measures the value of production that takes place within a specific interval of time, usually a year or a quarter (three months). Copyright © 2004 South-Western
    • 23. THE COMPONENTS OF GDP • GDP includes all items produced in the economy and sold legally in markets. Copyright © 2004 South-Western
    • 24. THE COMPONENTS OF GDP • What Is Not Counted in GDP? • GDP excludes most items that are produced and consumed at home and that never enter the marketplace. • It excludes items produced and sold illicitly, such as illegal drugs. Copyright © 2004 South-Western
    • 25. THE COMPONENTS OF GDP • GDP (Y) is the sum of the following: • • • • Consumption (C) Investment (I) Government Purchases (G) Net Exports (NX) Y = C + I + G + NX This equation is an identity. Copyright © 2004 South-Western
    • 26. THE COMPONENTS OF GDP • Consumption (C): • The spending by households on goods and services, with the exception of purchases of new housing. • Goods include household spending on durable (such as automobiles and appliances) and non-durable goods ( such as food and clothing). • Investment (I): • The spending on capital equipment, inventories, and structures, including new housing. Copyright © 2004 South-Western
    • 27. THE COMPONENTS OF GDP • Government Purchases (G): • The spending on goods and services by local, state, and federal governments. • Does not include transfer payments ( Social Security benefit to a person or an unemployment insurance benefit) because they are not made in exchange for currently produced goods or services. • Net Exports (NX): • Exports minus imports. Copyright © 2004 South-Western
    • 28. Table 1 GDP and Its Components Copyright©2004 South-Western
    • 29. ACTIVE LEARNING 1 GDP and its components In each of the following cases, determine how much GDP and each of its components is affected (if at all). A. Debbie spends $200 to buy her husband a dinner at the finest restaurant in New York. B. Sarah spends $1800 on a new laptop to use in her publishing business. The laptop was built in China. C. Jane spends $1200 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. D. General Motors builds $500 million worth of cars,
    • 30. ACTIVE LEARNING 1 Answers A. Debbie spends $200 to buy her husband a dinner at the finest restaurant in New York. Consumption and GDP rise by $200. B. Sarah spends $1800 on a new laptop to use in her publishing business. The laptop was built in China. Investment rises by $1800, net exports fall by $1800, GDP is unchanged. 30
    • 31. ACTIVE LEARNING 1 Answers C. Jane spends $1200 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. Current GDP and investment do not change, because the computer was built last year. D. General Motors builds $500 million worth of cars, but consumers only buy $470 million of them. Consumption rises by $470 million, inventory investment rises by $30 million, and GDP rises by $500 million. 31
    • 32. REAL VERSUS NOMINAL GDP • Inflation can distort economic variables like GDP, so we have two versions of GDP: One is corrected for inflation, the other is not. • Nominal GDP values production of goods and services at current prices. It is not corrected for inflation. • Real GDP values the production of goods and services at constant prices (base year). Real GDP is corrected for inflation. Copyright © 2004 South-Western
    • 33. REAL VERSUS NOMINAL GDP • The change in nominal GDP reflects both prices and quantities. • The change in real GDP is the amount that GDP would change if prices were constant (i.e., if zero inflation). • An accurate view of the economy requires adjusting nominal to real GDP by using the GDP deflator. Copyright © 2004 South-Western
    • 34. Table 2 Real and Nominal GDP Copyright©2004 South-Western
    • 35. Table 2 Real and Nominal GDP Copyright©2004 South-Western
    • 36. Table 2 Real and Nominal GDP Copyright©2004 South-Western
    • 37. The GDP Deflator • The GDP deflator is a measure of the price level calculated as the ratio of nominal GDP to real GDP times 100. • It tells us the rise in nominal GDP that is attributable to a rise in prices rather than a rise in the quantities produced. • The GDP deflator is a measure of the overall level of prices. • 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. Copyright © 2004 South-Western
    • 38. The GDP Deflator • The GDP deflator is calculated as follows: N o m in a l G D P G D P d e fla to r = ×100 R eal G D P Copyright © 2004 South-Western
    • 39. The GDP Deflator • Converting Nominal GDP to Real GDP • Nominal GDP is converted to real GDP as follows: R e a l G D P20X X N o m in a l G D P 20X X = ×100 G D P d e f la to r2 0 X X Copyright © 2004 South-Western
    • 40. Table 2 Real and Nominal GDP Copyright©2004 South-Western
    • 41. EXAMPLE: Pizza Coffee year P Q P Q 2005 $10 400 $2.00 1000 2006 $11 500 $2.50 1100 2007 $12 600 $3.00 1200 Compute nominal GDP in each year: 2005: $10 x 400 + $2 x 1000 = $6,000 2006: $11 x 500 + $2.50 x 1100 = $8,250 2007: $12 x 600 + $3 x 1200 MEASURING A NATION’S INCOME = $10,800 Increase: 37.5% 30.9% 41
    • 42. EXAMPLE: Pizza Coffee year P Q P Q 2005 400 500 $2.00 $2.00 $2.50 1000 2006 $10 $10 $11 2007 $12 600 $3.00 1200 Compute real GDP in each year, using 2005 as the base year: 2005: $10 x 400 + $2 x 1000 = $6,000 2006: $10 x 500 + $2 x 1100 = $7,200 2007: $10 x 600 + $2 x 1200 = $8,400 MEASURING A NATION’S INCOME 1100 Increase: 20.0% 16.7% 42
    • 43. EXAMPLE: year 2005 Nominal GDP $6000 Real GDP $6000 2006 $8250 $7200 2007 $10,800 $8400 In each year,  nominal GDP is measured using the (then) current prices.  real GDP is measured using constant prices from the base year (2005 in this example). MEASURING A NATION’S INCOME 43
    • 44. EXAMPLE: year 2005 Nominal GDP $6000 2006 $8250 2007 $10,800 37.5% 30.9% Real GDP $6000 $7200 $8400 20.0% 16.7 %  The change in nominal GDP reflects both prices and quantities.  The change in real GDP is the amount that GDP would change if prices were constant (i.e., if zero inflation). Hence, real GDP is corrected for inflation. MEASURING A NATION’S INCOME 44
    • 45. EXAMPLE: year Nominal GDP Real GDP GDP Deflator 2005 $6000 $6000 100.0 2006 $8250 $7200 114.6 2007 $10,800 $8400 128.6 14.6% 12.2% Compute the GDP deflator in each year: 2005: 100 x (6000/6000) = 100.0 2006: 100 x (8250/7200) = 114.6 2007: 100 x (10,800/8400) = 128.6 MEASURING A NATION’S INCOME 45
    • 46. ACTIVE LEARNING 2 Computing GDP 2007 (base yr) P Good A Good B $30 $100 Q 2008 P 2009 Q 900 $31 1,000 192 $102 200 P Q $36 $100 1050 205 Use the above data to solve these problems: A. Compute nominal GDP in 2007. B. Compute real GDP in 2008. C. Compute the GDP deflator in 2009. 46
    • 47. ACTIVE LEARNING 2 Answers 2007 (base yr) P Good A Good B $30 $100 Q 2008 P 2009 Q 900 $31 1,000 192 $102 200 P Q $36 $100 1050 205 A. Compute nominal GDP in 2007. $30 x 900 + $100 x 192 = $46,200 B. Compute real GDP in 2008. $30 x 1000 + $100 x 200 = $50,000 47
    • 48. ACTIVE LEARNING 2 Answers 2007 (base yr) P Good A Good B Q $30 $100 2008 P 2009 Q 900 $31 1,000 192 $102 200 P Q $36 $100 1050 205 C. Compute the GDP deflator in 2009. 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 48
    • 49. GDP AND ECONOMIC WELLBEING • GDP is the best single measure of the economic well-being of a society. • GDP per person tells us the income and expenditure of the average person in the economy. Copyright © 2004 South-Western
    • 50. GDP AND ECONOMIC WELLBEING • Higher GDP per person indicates a higher standard of living. • GDP is not a perfect measure of the happiness or quality of life, however. Copyright © 2004 South-Western
    • 51. GDP AND ECONOMIC WELL-BEING • Some things that contribute to well-being are not included in GDP. • The value of leisure. • The value of a clean environment. • The value of almost all activity that takes place outside of markets, such as the value of the time parents spend with their children and the value of volunteer work. Copyright © 2004 South-Western