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Macroeconomics Prof. Juan Gabriel Rodríguez Chapter 1 National Accounts Question How can we measure aggregate economic activity? National income and product accounts are essential for the understanding of macroeconomic functioning in society… National Accounts The output of a country is measured by National Accounts. National Accounts is an accounting system that registers all transactions between economic agents in an economy. The Fundamental Macroeconomic Variables – Aggregate Output – The Unemployment Rate – Main determinant of standard of living Productivity is the key! Main source of earnings for people The Inflation Rate Reduces real wages…which affects income distribution Modifies relative prices Increases uncertainty Reduces the propensity to save Reduces investment Reduces the competitiveness of national firms What about the Income Distribution?... GDP per Capita and Life Expectancy BASIC DEFINITIONS GROSS DOMESTIC PRODUCT (GDP) INFLATION RATE UNEMPLOYMENT RATE TRADE DEFICIT BUDGET DEFICIT GROSS DOMESTIC PRODUCT It is mainly used to measure economic activity Measure of aggregate output in the national income accounts (The accounting system is on a statistical basis) SOME ISSUES – SUM OF APPLES AND ORANGES: value (not quantity) – NOMINAL AND REAL FIGURES – DOUBLE COUNTING: Intermediate goods… RATE OF GROWTH - Expansions - Recessions FLOW - A GIVEN PERIOD APPLES AND ORANGES… GDP is the value of the final goods and services produced in the economy during a given period – – A final good is a good used for consumption or investment An intermediate good is a good used in the production of another good Output FinalValue Final p Q APPLES AND ORANGES… GNP is the value of the final goods and services produced by national residents during a given period Example: a owned plant in U.S. is not included in Spanish GDP Net National Product (NNP) = GNP – consumption of fixed capital (depreciation) National Income = Net National Product – Statistical discrepancies NOMINAL Vs REAL GDP Nominal GDP – Sum of final goods produced times their current price Growth due to quantity Growth due to prices nominal GDPt pt Qt Real GDP – Sum of final goods produced times their base year price real GDPt p0 Qt Nominal and real GDP in the U.S. From 1960 to 2003, nominal GDP increased by a factor of 21. Real GDP increased by a factor of 4. Double Counting Revenues=200 Wages=70 Profit=30 Aggregate output can be measured by the value of final goods produced in the economy. Revenues=100 Intermediate Costs=100 Wages=80 Profit=20 Final good (Car company) Intermediate good (Steel company) Double Counting Revenues=200 Wages=70 VA2 Profit=30 Aggregate output can be measured by summing the value added of all goods in the economy. Revenues=100 Intermediate Costs=100 Wages=80 Profit=20 Car company Steel company VA=Revenues –intermediate costs VA1 Double Counting Revenues=200 Wages=70 Profit=30 Intermediate Costs=100 Final good Aggregate output can be measured by summing the incomes in the economy (wages, profits, …, interests, taxes,…). Wages=80 Profit=20 Intermediate good CALCULATING GDP AGGREGATE OUTPUT – Value of the final goods and services produced by the economy in a given period. SUM OF VALUED ADDED – Value added equals the value of a firm´s production minus the value of the intermediate goods it uses in production. SUM OF INCOMES IN THE ECONOMY – Value received by the factors of production for their participation in the process. GDP - METHOD OF OUTPUT FINAL GOODS FINAL SERVICES •CONSUMPTION •INVESTMENT •GOVERNMENT SPENDING •IMPORTS / EXPORTS Example Revenues=200 Wages=70 Profit=30 Intermediate Costs =100 Car company Car purchases … - Families Consumption - Firms Investment - State Public Expenditure - Foreign Sector Exports GDP - METHOD OF OUTPUT The composition of GDP: Output C + I + G + (X-IM) Consumption (C): current expenditure of families in consumption goods and services in one year. Investment (I): expenditure of firms in nonresidential investment, families in residential investment and inventory investment in one year. Government Spending (G): purchases of goods and services by central, state and local governments in one year. Net Exports (X-IM): difference between exports (X) and imports (IM). Types of investment Fixed Investment or GFFC: • • Nonresidential investment: new plants, new machines … Residential investment: new houses and apartments. Inventory Investment: the difference between goods produced and goods sold in a given year. Production = Sales + inventory investment Is important the inclusion of inventory investments? Type Production (€) Sales (€) Goods and services bought by families 600 550 Goods bought by firms 120 120 Output: consumption (600) + investment (120), that is, 720. But considering sales….Output=670 !! Output = Consumption (550) + Fixed Investment (120) + Inventory Investment (50) = 720 Government Spending Government Spending (G): • It includes those services provided by the State (they are valued by their cost). It does not include Public Transfers (Tr) to families and firms, e.g. Social Security payments, subsidies, interest payments on the government debt,…. GDP - METHOD OF INCOMES LABOR INCOME CAPITAL INCOME – INTEREST – PROFIT INDIRECT TAXES •CONSUMPTION •SAVINGS •GOVERNMENT INCOME •TAXES •TRANSFERS BASIC IDENTITIES Y = C + I + G +X - IM Y = YD + T = C + S + T T = Direct + Indirect - Subsidies - Transfers Gross Investment = Net Investment + Depreciation Gross Variable - Depreciation = Net Variable BASIC IDENTITIES DEMAND PRODUCTION INCOME C I G X IM Y C S T S I G T X IM PRIVATE SECTOR PUBLIC SECTOR EXTERNAL SECTOR BASIC IDENTITIES Debt Identity S I T G ( X IM ) • G<T: budget surplus. • G>T: budget deficit. • IM<X: Trade surplus. • IM>X: Trade deficit. Investment-Saving Identity S I G T ( X IM ) INTERNATIONAL ACCOUNTS Country S-I S-I S-I T-G T-G T-G (2007) (2009) (2011) (2007) (2009) (2011) EEUU -2.4 +8.1 +6 -2.9 -11.1 -10 Japan 8.5 9.8 11.1 -5.3 -7 -9.7 China 9.8 7 -0.4 -1 Euro Area 1 5.7 4.3 -2 -6.3 -4.5 Germany 6.6 8.3 6.7 0 -3.3 -2 Spain -13 6.1 2.2 2.2 -11.2 -6.3 The Balance of Payments The U.S. Balance of Payments, 2006 (in billions of U.S. dollars) Current Account Exports 1,436 Imports 2,200 Trade balance (deficit = ) (1) -763 Investment income received 620 Investment income paid 629 Net investment income (2) -9 Net transfers received (3) -84 Current account balance (deficit = -) (1) + (2) + (3) -856 Capital Account Increase in foreign holdings of U.S. assets (4) 1,764 Increase in U.S. holdings of foreign assets (5) 1,049 Capital account balance (deficit = -) (4) (5) 715 Statistical discrepancy 141 Sell products and services The Market of Goods Production (= GDP) Firms (sellers) Spend money to buy goods and services The circular flow of income Model Pay salaries, interests, rents and profits Income (= GDP) Spending (= GDP) Families (buyers) Monetary Flow Real Flow Supply labor, land and capital The Market of Factors PARTICIPATION RATE Noninstitutional Civilian Population (excluding those under 16, in the armed forces or behind bars) = Labor force + Participation rate = NO Labor Force (neither working nor looking for work) Labor force Noninstitutional Civilian Population UNEMPLOYMENT RATE Labor force (L) = Unemployment rate Employed (N) = + Unemployed (U) Unemployed (U) Labor force (L) Labor force < Population Low participation rate is often linked to high unemployment. Discouraged workers in Recessions! Statistics about unemployment in Spain Registered unemployment by the Instituto Nacional de Empleo (INEM). Labor Force Survey (Encuesta de Población Activa- EPA). – – – Random sample of 60.000 households. A person is considered to be occupied if she/he declares that she/he is working during the week of survey. A person is considered to be unocuppied if she/he is not working and has been looking for a job in the last four weeks. The unemployment rate in Spain Economic growth phase (15 years) Oil Crisis Incorporation of Spain to the EU Openness of Spain to competence Housing Bubble The participation rate in Spain Why do economists care about unemployment? Two reasons: Direct effects on the welfare of the unemployed family problems, health problems, poverty, violence, ….. Signal that the economy may not be using some of its resources efficiently rigidities in mobility, no correspondence between the characteristics of workers and jobs. THE INFLATION RATE A price index (P) is a measure of weighted prices for a set of goods that considers a base year. One good: Two goods: Pt g A A t A 0 pt Pt p0 p p gB p p Weights B t B 0 , gA p A QA p A QA p B QB Expenses on A Total expenses The GDP Deflactor The GDP deflactor in the year t is the quotient between Nominal GDP and Real GDP in the year t: nominal GDPt Pt real GDPt The GDP deflactor is 100 in the base year. The variation rate of the GDP deflactor is the inflation rate: ( Pt Pt 1 ) Pt 1 The Consumer Price Index (CPI) The GDP deflactor is an average price for all goods and services that are produced in a country. The CPI is an average price for all goods and services that are consumed by families in a country. It measures the cost of living. The CPI measures the cost of a basket of goods that typically a representative family consumes in one period of time. Construction of the CPI We know that… B p At B pt CPI t g A g B p0 p0 A Family expenses on A , g Total expenses A Relative Prices Monthly survey in establishments. Weights Encuesta Continua de Presupuestos Familiares (ECPF). Weights must change from time to time to adapt the index to changes in family consumption habits. Calculating the CPI in Spain The inflation rate in Spain Spain The GDP growth rate The GDP growth rate is: (Yt Yt 1 ) Yt 1 According to the Federal Reserve System: Two consecutive quarters of positive GDP growth is an expansion. Two consecutive quarters of negative GDP growth is a recession. Economic Growth GDP per cápita is: Yt GDP per capita GDPpct Popt It indicates the standard of living in a country: ln GDPpct ln( Yt ) ln( Popt ) ln GDPpct ln( Yt ) ln( Popt ) A country may present a low GDPpc (and therefore, a low standard of living) but a large rate of GDP growth China The Evolution of Macroeconomics Foundation – Hume, Locke, Cantillon The clasics and neoclasics – – Smith, Ricardo, Marx Marshall, Fisher, Wicksell The Quantitative Theory of Money The quantity of money determines the level of prices David Hume, 1711-1776 The Evolution of Macroeconomics – – National Accounts (W. Mitchell) The Great Depresion – Deflation, stagnation of production, unemployment Failure of classic macroeconomics Unemployment queue in Germany, 1930 The Evolution of Macroeconomics John Maynard Keynes – – – – “The general theory of employment, interest and money” (1936) Rigidities in prices and salaries Government action Principle of the efective demand John Maynard Keynes, 1883-1946 The Evolution of Macroeconomics The neoclassical synthesis (1940-1970) – – – The IS-LM model Samuelson and Tobin Microeconomic foundation of macroeconomics – Consumption function, investment function, money demand, etc Macroeconomic models Paul Samuelson, 1915-2009 The Evolution of Macroeconomics Monetarism (1960-1970) – – – Inflation (años 60) Stagflation (70’s) Fiscal policy is ineffective Return to the quantitative theory of money Milton Friedman, 1912-2006 The Evolution of Macroeconomics The new classical macroeconomics (1970...) – – Inclusion of expectations Hipothesis of rational expectations (Robert Lucas) – Individuals learn and anticipate Policy is ineffective Real Business Cycles (Edward Prescott) Relevance of tecnological progress Robert Lucas, 1937 The Evolution of Macroeconomics The New Keynesianism – – Expectations are important but limited There are ridigities in markets Wages… Menu costs, .... Joseph Stiglitz, 1943