Download Econ Exam 1 Chapter 1- The Bid Ideas Objective of Economics: use

Econ Exam 1
Chapter 1- The Bid Ideas
Objective of Economics: use stories/theories to help understand the world.
Use graphs and charts to organize data (patterns consistent with theories?)
Assess how the economy is performing based on factors measuring welfare
Production – the level of growth rate of a nation’s income
GDP – “gross domestic product”
Decisions are made “on the margin” – margin=incremental (small change)
Voluntary trade allows for specialization
- people to produce goods based on comparative advantage
- an individual has an absolute advantage in production if he can produce
more of a good with the same amount of resources
- an individual has the comparative advantage if he can produce the goods
at a lower opportunity cost
- voluntary trade and specialization allow for more production than what
would be done if an individual or country tried to produce all goods and
services on their own
Incentives Matter
- “it is not from the benevolence of the butcher, the brewer, or the baker,
that we expect our dinner, but from their regard to their own selfinterest”
- Good institutions align self-interest with the social interest
- “when markets work well, those who pursue their own interest end up
promoting the social interest” – greed is good
- when markets don’t properly align self interest with the social interest,
government can sometimes improve the situation by changing incentives
with taxes, subsidies, or regulations
- Trade offs are everywhere – ex. Drug lag – the greater the cost of testing,
the fewer new drugs there will be. Unsafe drugs can be approved and
some safe drugs have not yet been approved (drug lag)
Wealth Matters
- individuals in wealthier economies typically have better health outcomes
- individuals in wealthier economies have lower infant mortality rates
- “” have better environments
- if we want to improve the living standards, health outcomes, and the
environmental quality, we want to have in place institutions that promote
wealth accumulation (distribution of wealth matters)
- institutions matter
institutions – the rules of the game that help determine outcomes. Ex.) laws,
customs, cultural values, principles, superstitions. They set people up to invest in
the future.
- rules shape how decisions are made
-
decisions determine outcomes
institutions that are growth promoting should have the following
properties/ characteristics:
 honest government – little or no corruption, does not
deviate from its commitments, no risk of expropriation
(taking private property and using it for public)
 political stability – limited internal conflict between
individuals with different beliefs or backgrounds and
limited attempts to overthrow by invaders/outsiders
 protect property rights – the right to receive any
benefits from the property, right to sell or transfer, right
to exclude others from using. Lack of property rights
ex.) tragedy of the commons – no ownership means no
incentive to take care of property
 dependable legal system
 competitive and open markets – encourage competition
– firms will compete on price and quality; open markets
allow firms to produce
Institutions promote investments in the future. They encourage more education,
more physical capital, entrepreneurship, and efficient use of the economy’s
resources.
Economic Booms and Busts Cannot be Avoided but Moderated
- recessions and expansions are inevitable but we hope that economic
policies can mitigate recessions
- The Great Moderation – period from the early 1980’s when policy makers
thought they could better “fine tune” the economy. Central bankers could
adjust money supply and interest rates to keep inflation and GDP growth
in narrow range and fiscal authority would provide a stable environment
- why inflation? – due to too much money being printed
- inflation = too much money chasing too few goods
- prices rise when the government produces too much money = increase in
general level of prices
Chapter 6 – The Wealth of Nations and Economic Growth
US Standard of Living Overtime
- life expectancy at birth has increased dramatically over time (doubled
over 40 years)
- height in cm has increased over time – height is related to good health
- average income has increased over time (50% inc. GDP per person every
25 years)
- real GDP per capita affects the standard of living
Gross Domestic Product – the market value of all goods and services that are newly
produced in an economy during a period of time
- measure of production and income
- measures the total income of an entire economy
- GDP = market value of goods
- Measures all final goods and services produced within a country (doesn’t
include intermediate inputs)
Calculating GDP (growth rate of GDP)
- percent change from one year to the next
- Growth Rate = ((Yt – Yt-1)/Yt-1)*100
Why does GDP grow?
-
additional production
an increase in average level of prices
increase in production is a good thing
increase in the average level of prices is not
-Nominal GDP - market value of all final goods and services produced within a year
using current prices
- Real GDP – markert value of all final goods and services using a fixed, “base year”
prices
- nets out inflation (change in price over time). Nominal GDP growth minus
inflation
- real variables adjust for changes in the average price level
- typically we are more interested in real variables (real GDP, quantity of goods and
services)
To Model the economy, we will consider real GDP as a quantity index – that is real
GDP is a single measure that captures the total quantity of goods produced in the
economy
We can think of the ratio of nominal GDP to real GDP as a measure of the price level
- since 1960, average real GDP growth has been roughly 3.1%. 1982 – 2007=
the period of the great moderation. Since 2007 real GDP growth has been low and
below the long term average
Per Capita Real GDP is a better reflection of changing living standards
Higher GDP growth = economy is expanding, Negative growth = economy
contracting
Recessions – a significant, widespread decline in economic activity spread across
the economy lasting for more than a few months, visible as a decline in Real GDP,
real income, employment, production, and wholesale-retail sales
Procyclical Variable – if growth rate of a macroeconomic variable is positively
correlated with deviations from the trend in Real GDP
Countercyclical Variable – negatively correlated with the trend in Real GDP
Acyclical Variable – no correlation
How GDP is Computed
-
adding up Expenditures – add up purchases by consumption, investment,
government expenditures, and net exports
adding up Income
Consumption – private household spending on goods and services. Goods = non
durable and durable goods. Consumption of approximately 64.5% of GDP and by
2000 it increased to 70%. Output growth is more “volatile” than consumption
growth
Investment – spending on tools, plants, and equipment that is used to produce
future output. Includes:
fixed private investment – plants, machines, and equipment
inventory investment – produced but not yet sold
residential investment – purchase of houses
Investment DOES NOT mean purchase of stocks and bonds. Investment growth is
more volatile than consumption growth
Government Expenditures – spending by all levels of government on final goods and
services (ex. If gov. builds an airport).
- transfer payments and entitlement programs are not included in gov.
purchases (SS, medicare, Medicaid)
- gov. expenditures = about 20.5% of GDP
- no strong correlation btw. Growth in gov. expenditure growth and GDP
growth
Income Approach
- Y = employee compensation + rent + interest income + profits
- Y = wages + income to entrepreneurs + capital income
- there are many goods and services for which we do not know the market value.
GDP does not include non-recorded cash transactions
- illegal activities (drug deals)
- off the book transactions
GDP does not count non-priced production – occurs when goods and services are
produced but no explicit payment is made ex) when kids do “chores” (home
production)
GDP as a Measure of Welfare
If GDP if a measure of well-being, there are some things we value not included in
GDP for example, leisure time
GDP does not include production of “bads”
- pollution
- depletion of resources
- loss of animal/plant species
- crime
Most economies agree “bads” should be subtracted but agreement on how to value
them is not widely agreed upon
Problems With GDP as a Measure of…
- production – some not accounted for
- well-being – miss some aspects
- cross country comparison – makes comparisons difficult
Problems with GDP as a Measure of Output
- doesn’t include non-recorded cash transactions
- doesn’t count non-priced production
GDP doesn’t measure the disposition of income (only measures the average person)
- growth in per capita income doesn’t mean EVERYONE’s income is higher
While growth in GDP is necessary for improvements in standards of living, but may
not be sufficient numbers of the population
Biases in GDP Statistics
o -Home production in the 50’s and 60’s – stay at home parent work not
counted
o Biases across countries – hard to compare incomes across countries,
in poorer countries there is more production that occurs in household
(non market activity)
3 Ways to Measure GDP

National spending approach


Factor income approach
Value added
GDP statistics are imperfect
GDP was developed to quantify economic growth and fluctuations
Chapter 7 – Growth, Capital Accumulation, and the Economics of Ideas
Preventing Early Deaths
- every year 1.8 million children die from diarrhea
- preventing these deaths requires 1 thing: economic growth
- health and wealth go together
Growth Facts
1. Per capita GDP varies enormously among nations
2. Everyone used to be poor
3. There are growth miracles and growth disasters
The Rule of 70 – how long does it take for income in a country to double?
- doubling time = 70/growth rate
The US is one of the wealthiest countries due to long-run steady growth
Real growth of other countries can be evaluated by comparing to US
Growth Miracles
- China – Real GDP per capita 19 times higher than in 1970. GDP growth rate
of 8% per year
- South Korea – 10 times higher than in 1970
- India – 6 times higher than in 1970
Growth Disasters
- Argentina – 1900: one of the richest countries in the world. Now – per
capita GDP is 1/3 that of US
- Nigeria – poorer now that in 1974
Output if Determined by the Factors of Production
- Physical Capital - the stock of tools, structures, and equipment
- Human Capital – knowledge and skills that workers acquire through
education and experience
- Technical Knowledge – knowledge about how the world works that’s used
to produce goods and services
Countries that have lots of physical and human capital tend to have higher living
standards
Physical capital makes workers more productive as well as education and training
Once we account for physical and human capital there is a lot left unexplained
Total Factor Productivity – everything that influences how productive labor and
capital are
Proximate Cause – something that appears to have enabled an outcome
Ultimate Cause – underlying reason outcome occurred
ex.) The Ultimate Cause for high output (aka countries being rich) is
institutions and incentives. Amount of resources only tells part of the story