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10 National Accounting, GDP, Growth Introduction to Economics ETH Zürich, Prof. Dr. Jan-Egbert Sturm Winter Term 2006/07 General Information 24.10. Introduction; Transformation Curve, Opportunity Cost Mankiw ch.1,2 31.10. Markets: Demand and Supply Ch. 4 7.11. Elasticities Ch. 5 14.11. Costs, Production Function Ch. 13 21.11. Markets with perfect competiton Ch. 7, 14 28.11. Taxation Ch. 8 5.12. International Trade Ch. 9 12.12. Imperfect competition: Monopoly, and Oligoploy Ch. 15, 16 19.12. Public Goods, Externalities Ch. 10,11 9.1. National Accounting, Gross Domestic Product, Growth Ch. 23, 25 16.1. Money and Inflation Ch. 24, 29, 30 23.1. Business Cycles Ch. 33, 34 30.1. Open Economy Macro Ch. 31 Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF Economics • Microeconomics • Microeconomics is the study of how individual households and firms make decisions and how they interact with one another in markets. • Macroeconomics • Macroeconomics is the study of the economy as a whole. • Its goal is to explain the economic changes that affect many households, firms, and markets at once. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF Macroeconomics • Macroeconomics answers questions like the following: • Why is average income high in some countries and low in others? • Why do prices rise rapidly in some time periods while they are more stable in others? • Why do production and employment expand in some years and contract in others? Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF 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. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF THE ECONOMY’S INCOME AND EXPENDITURE • 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. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF 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. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF THE MEASUREMENT OF GROSS DOMESTIC PRODUCT • The equality of income and expenditure can be illustrated with the circular-flow diagram. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF 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 MARKETS FOR FACTORS OF PRODUCTION •Households sell •Firms buy Labor, land, and capital Income = Flow of inputs and outputs = Flow of dollars Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF 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. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF THE MEASUREMENT OF GROSS DOMESTIC PRODUCT • “GDP is the Market Value . . .” • Output is valued at market prices. • “. . . Of All Final . . .” • It records only the value of final goods, not intermediate goods (the value is counted only once). • “. . . Goods and Services . . . “ • It includes both tangible goods (food, clothing, cars) and intangible services (haircuts, housecleaning, doctor visits). Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF THE MEASUREMENT OF GROSS DOMESTIC PRODUCT • “. . . Produced . . .” • It includes goods and services currently produced, not transactions involving goods produced in the past. • “ . . . Within a Country . . .” • It measures the value of production within the geographic confines of a country. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF THE MEASUREMENT OF GROSS DOMESTIC PRODUCT • “. . . 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). Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF 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. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF 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 Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF THE COMPONENTS OF GDP • Consumption (C): • The spending by households on goods and services, with the exception of purchases of new housing. • Investment (I): • The spending on capital equipment, inventories, and structures, including new housing. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF THE COMPONENTS OF GDP • Government Purchases (G): • The spending on goods and services by local, state, and federal governments. • Does not include transfer payments because they are not made in exchange for currently produced goods or services. • Net Exports (NX): • Exports minus imports. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF Table 1 GDP and Its Components (USA, 2001) Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF Copyright©2004 South-Western GDP and Its Components (USA, 2001) Investment 16% Government Purchases 18% Consumption 69% Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF Net Exports -3 % GDP and Its Components (CH, 2006) Investment 21% Net Exports 7% Government consumption 12% • Estimated GDP in 2006 (in prices of 2005): 456 billion CHF Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF Private consumption 60% Total Demand and Its Components (CH, 2006) Exports 34% Investment 15% Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF Private consumption 43% Government consumption 8% REAL VERSUS NOMINAL GDP • Nominal GDP values the production of goods and services at current prices. • Real GDP values the production of goods and services at constant prices. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF REAL VERSUS NOMINAL GDP • An accurate view of the economy requires adjusting nominal to real GDP by using the GDP deflator. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF Table 2 Real and Nominal GDP Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF Copyright©2004 South-Western Table 2 Real and Nominal GDP Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF Copyright©2004 South-Western Table 2 Real and Nominal GDP Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF Copyright©2004 South-Western 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. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF The GDP Deflator • The GDP deflator is calculated as follows: Nominal GDP GDP deflator = 100 Real GDP Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF Table 2 Real and Nominal GDP Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF Copyright©2004 South-Western Chain-weighted Real GDP • Over time, relative prices change, so the base year should be updated periodically. • In essence, “chain-weighted Real GDP” updates the base year every year. • This makes chain-weighted GDP more accurate than constantprice GDP. • But the two measures are highly correlated, and constant-price real GDP is easier to compute… • …so we’ll usually use constant-price real GDP. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF Figure 2 GDP in Switzerland Nom inal and Real GDP in Sw itzerland 500000 Nominal GDP Millions of CHF 450000 Real GDP (2000 prices) 400000 350000 300000 250000 1990 1992 1994 1996 1998 Year Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF 2000 2002 2004 Konjunkturforschungsstelle Swiss Institute for Business Cycle Research GDP in Switzerland: Some slowdown expected for 2007 Billions CHF Q-to-Q in % 4 BFS: SNA 09/2006, Quartalization by seco KOF-Forecast 10/2006 (quarter) 120 3 118 2 116 1 114 0 2.6% 2.1% 1.5% 112 -1 110 -2 108 2003 2004 2005 2006 Prof. Dr. Jan-Egbert Sturm / [email protected] 2007 2008 GDP AND ECONOMIC WELL-BEING • 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. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF GDP AND ECONOMIC WELL-BEING • Higher GDP per person indicates a higher standard of living. • GDP is not a perfect measure of the happiness or quality of life, however. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF 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. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF Table 3 GDP, Life Expectancy, and Literacy Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF Copyright©2004 South-Western Production and Growth • A country’s standard of living depends on its ability to produce goods and services. • Within a country there are large changes in the standard of living over time. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF Production and Growth • Productivity refers to the amount of goods and services produced for each hour of a worker’s time. • A nation’s standard of living is determined by the productivity of its workers. • Living standards, as measured by real GDP per person, vary significantly among nations. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF Table 1 The Variety of Growth Experiences Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF Copyright©2004 South-Western ECONOMIC GROWTH AROUND THE WORLD • Annual growth rates that seem small become large when compounded for many years. • Compounding refers to the accumulation of a growth rate over a period of time. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF Huge effects from tiny differences percentage increase in standard of living after… annual growth rate of income per capita …25 years …50 years …100 years 2.0% 64.0% 169.2% 624.5% 2.5% 85.4% 243.7% 1,081.4% Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF Huge effects from tiny differences If the annual growth rate of German real GDP per capita had been just one-tenth of one percent higher during the 1990s, Germany would have generated an additional € 112 billion of income during that decade Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF Why Productivity Is So Important • To understand the large differences in living standards across countries, we must focus on the production of goods and services. • Productivity refers to the amount of goods and services that a worker can produce from each hour of work. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF How Productivity Is Determined • The inputs used to produce goods and services are called the factors of production. • The factors of production directly determine productivity. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF How Productivity Is Determined • The Factors of Production • • • • Konjunkturforschungsstelle Swiss Institute for Business Cycle Research Physical capital Human capital Natural resources Technological knowledge KOF How Productivity Is Determined • Physical Capital • is a produced factor of production. • It is an input into the production process that in the past was an output from the production process. • is the stock of equipment and structures that are used to produce goods and services. • Tools used to build or repair automobiles. • Tools used to build furniture. • Office buildings, schools, etc. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF How Productivity Is Determined • Human Capital • the economist’s term for the knowledge and skills that workers acquire through education, training, and experience • Like physical capital, human capital raises a nation’s ability to produce goods and services. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF How Productivity Is Determined • Natural Resources • inputs used in production that are provided by nature, such as land, rivers, and mineral deposits. • Renewable resources include trees and forests. • Nonrenewable resources include petroleum and coal. • can be important but are not necessary for an economy to be highly productive in producing goods and services. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF How Productivity Is Determined • Technological Knowledge • society’s understanding of the best ways to produce goods and services. • Human capital refers to the resources expended transmitting this understanding to the labor force. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF The Production Function • Economists often use a production function to describe the relationship between the quantity of inputs used in production and the quantity of output from production. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF The Production Function • Y = A F(L, K, H, N) • • • • • • • Konjunkturforschungsstelle Swiss Institute for Business Cycle Research Y = quantity of output A = available production technology L = quantity of labor K = quantity of physical capital H = quantity of human capital N = quantity of natural resources F( ) is a function that shows how the inputs are combined. KOF The Production Function • A production function has constant returns to scale if, for any positive number x, xY = A F(xL, xK, xH, xN) • That is, a doubling of all inputs causes the amount of output to double as well. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF The Production Function • Production functions with constant returns to scale have an interesting implication. • Setting x = 1/L, • Y/ L = A F(1, K/ L, H/ L, N/ L) Where: Y/L = output per worker K/L = physical capital per worker H/L = human capital per worker N/L = natural resources per worker Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF The Production Function • The preceding equation says that productivity (Y/L) depends on physical capital per worker (K/L), human capital per worker (H/L), and natural resources per worker (N/L), as well as the state of technology, (A). Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF ECONOMIC GROWTH AND PUBLIC POLICY • Government Policies That Raise Productivity and Living Standards • • • • • • Konjunkturforschungsstelle Swiss Institute for Business Cycle Research Encourage saving and investment. Encourage investment from abroad Encourage education and training. Establish secure property rights and maintain political stability. Promote free trade. Promote research and development. KOF The Importance of Saving and Investment • One way to raise future productivity is to invest more current resources in the production of capital. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF Figure 1 Growth and Investment (b) Investment 1960–1991 (a) Growth Rate 1960–1991 South Korea Singapore Japan Israel Canada Brazil West Germany Mexico United Kingdom Nigeria United States India Bangladesh Chile Rwanda 0 Konjunkturforschungsstelle Swiss Institute for Business Cycle Research South Korea Singapore Japan Israel Canada Brazil West Germany Mexico United Kingdom Nigeria United States India Bangladesh Chile Rwanda 1 KOF 2 3 4 5 6 7 Growth Rate (percent) 0 10 20 30 40 Investment (percent of GDP) Copyright©2003 Southwestern/Thomson Learning International Evidence on Investment Rates and Income per Person Income per person in 1992 (logarithmic scale) 1 00 ,00 0 Canada Denmark Germ any U.S. 1 0,0 00 Mexico E gypt F inland B razi l P aki stan Ivory Coast U.K. Israel It al F rance y Singapore P eru Indonesi a 1 ,00 0 Zimbabwe India Chad 1 00 Japan 0 Uganda 5 Kenya Cam eroon 10 15 20 25 30 35 40 Investment as percentage of output (average 1960 –1992) Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF Diminishing Returns and the Catch-Up Effect • As the stock of capital rises, the extra output produced from an additional unit of capital falls; this property is called diminishing returns. • Because of diminishing returns, an increase in the saving rate leads to higher growth only for a while. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF Diminishing Returns and the Catch-Up Effect • In the long run, the higher saving rate leads to a higher level of productivity and income, but not to higher growth in these areas. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF Diminishing Returns and the Catch-Up Effect • The catch-up effect refers to the property whereby countries that start off poor tend to grow more rapidly than countries that start off rich. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF Conditional convergence: 21 OECD countries Per capita output growth: 1960-92 0.03 y = -0.0141x - 9E-17 2 R = 0.7422 0.02 0.02 0.01 0.01 -1.20 -1.00 -0.80 -0.60 -0.40 -0.20 0.00 0.00 0.20 -0.01 -0.01 -0.02 Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF Log output per capita: 1960 0.40 0.60 0.80 1.00 Investment from Abroad • Governments can increase capital accumulation and long-term economic growth by encouraging investment from foreign sources. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF Investment from Abroad • Investment from abroad takes several forms: • Foreign Direct Investment • Capital investment owned and operated by a foreign entity. • Foreign Portfolio Investment • Investments financed with foreign money but operated by domestic residents. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF Education • For a country’s long-run growth, education is at least as important as investment in physical capital. • In the United States, each year of schooling raises a person’s wage, on average, by about 10 percent. • Thus, one way the government can enhance the standard of living is to provide schools and encourage the population to take advantage of them. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF Education • An educated person might generate new ideas about how best to produce goods and services, which in turn, might enter society’s pool of knowledge and provide an external benefit to others. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF Education • One problem facing some poor countries is the brain drain— the emigration of many of the most highly educated workers to rich countries. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF Property Rights and Political Stability • Property rights refer to the ability of people to exercise authority over the resources they own. • An economy-wide respect for property rights is an important prerequisite for the price system to work. • It is necessary for investors to feel that their investments are secure. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF Free Trade • Trade is, in some ways, a type of technology. • A country that eliminates trade restrictions will experience the same kind of economic growth that would occur after a major technological advance. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF Free Trade • Some countries engage in . . . • . . . inward-orientated trade policies, avoiding interaction with other countries. • . . . outward-orientated trade policies, encouraging interaction with other countries. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF Research and Development • The advance of technological knowledge has led to higher standards of living. • Most technological advance comes from private research by firms and individual inventors. • Government can encourage the development of new technologies through research grants, tax breaks, and the patent system. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF Population Growth • Economists and other social scientists have long debated how population growth affects a society Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF Population Growth • Population growth interacts with other factors of production: • Stretching natural resources • Diluting the capital stock • Promoting technological progress Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF International Evidence on Population Growth and Income per Person Income per person in 1992 (logarithmic scale) 100,000 Germ any U.S. Denmark Canada Israel 10,000 U.K. It al y Japan F inland F rance Mexico Singapore E gypt B razi l P aki stan P eru Indonesi a 1,000 Cam eroon Ivory Coast Kenya India Zimbabwe Chad 100 Konjunkturforschungsstelle Swiss Institute for Business Cycle Research 0 KOF 1 2 Uganda 3 4 Population growth (percent per y ear) (average 1960 –1992) Summary • Because every transaction has a buyer and a seller, the total expenditure in the economy must equal the total income in the economy. • Gross Domestic Product (GDP) measures an economy’s total expenditure on newly produced goods and services and the total income earned from the production of these goods and services. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF Summary • GDP is the market value of all final goods and services produced within a country in a given period of time. • GDP is divided among four components of expenditure: consumption, investment, government purchases, and net exports. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF Summary • Nominal GDP uses current prices to value the economy’s production. Real GDP uses constant base-year prices to value the economy’s production of goods and services. • The GDP deflator—calculated from the ratio of nominal to real GDP—measures the level of prices in the economy. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF Summary • GDP is a good measure of economic well-being because people prefer higher to lower incomes. • It is not a perfect measure of well-being because some things, such as leisure time and a clean environment, aren’t measured by GDP. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF Summary • Economic prosperity, as measured by real GDP per person, varies substantially around the world. • The average income of the world’s richest countries is more than ten times that in the world’s poorest countries. • The standard of living in an economy depends on the economy’s ability to produce goods and services. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF Summary • Productivity depends on the amounts of physical capital, human capital, natural resources, and technological knowledge available to workers. • Government policies can influence the economy’s growth rate in many different ways. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF Summary • The accumulation of capital is subject to diminishing returns. • Because of diminishing returns, higher saving leads to a higher growth for a period of time, but growth will eventually slow down. • Also because of diminishing returns, the return to capital is especially high in poor countries. Konjunkturforschungsstelle Swiss Institute for Business Cycle Research KOF