Download Principles of Macroeconomics

Foundation of Economic Analysis
3250:600
Instructor: Richard W. Stratton
Meets: Thursday 5:20 – 7:50 pm
CAS 134
Administration

This Week’s Assignments
Farnham Chapter 11 (NIPA)
 Homework 06 (due next week)


Next Week’s Assignments
Farnham Chapter 12 (Aggregate
Expenditures)
 Homework 07 (review)

5/23/2017
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Decision Tree
2
Decision Tree
Review
Circular Flow
Economic Measurement
Measuring price changes
Measuring employment activity
Policy Issues
Circular flow
Purpose: To provide an overview of
U.S.A. economic activity
 Focuses on transactions (flows)
between groups of participants
through markets.
 To simplify diagram, usually or
monetary flows shown

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Circular flow

List the main sectors


Household, Firm, Government, Foreign
List the markets

Product and Factor markets


Asset markets
Flows with foreign sector deserve
special attention
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The inner arrows
represent the
REAL flows
Consumption
EQUAL
Revenues
Product
Markets
Goods and
Services Sold
Goods and Services
Purchased
Households
The outer arrows
represent the
MONEY flows
Firms
So far we have
focused on the
internal workings of
markets
Factors Supplied (Labor,product
Land,
Factors Received (Labor, Land,
Capital, Entrepreneurship)
Income (Wages,
Rent, Interest,
Profits)
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Capital, Entrepreneurship)
Factor
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of Akron
Markets
Expenses (Wages,
Rent, Interest, Profits)
6
Foreign Sector detail
Consumption
Imported
Goods and
Services
Revenues
Product
Markets
Import
Payments
Export
Receipts
Exported
Goods and
Services
Foreign
Sector
Households
Loans
Firms
Borrowing
Borrowing
Imported
Production
Factors
Income
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Financial
Markets
Import
Payments
Export
Receipts
Factor
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of Akron
Markets
Exported
Factors
Expenses
7
Imports
Consumption
Foreign
Sector
Exports
Product
Markets
Investment
Government
Expenditures
Net Personal Taxes
Households
Revenues
Net Business Taxes
Governments
Borrowing
Firms
Borrowing
Borrowing
Saving
Income
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Financial
Markets
Factor
The University
of Akron
Markets
Expenses
8
Decision Tree
Review
Circular Flow
Economic Measurement
Measuring price changes
Measuring employment activity
Policy Issues
Economic measurements
Introduction of concepts
 National Income and Product
Accounts (NIPA)
 Finding the data

Decision Tree
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Economic measurements
Distinguishing Flow and Stock
statistics
 Distinguishing Economic Activity and
Social Well-being

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Economic measurements
Stock statistics
examples
Flow statistics
examples
Volume of water in a
pond
Rate of water in-flow
and out-flow
Inventory
Production and sales
Wealth
Saving, Income and
Consumption
Can you provide other economic examples?
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Economic measurements
Remember the definition of each?
 Stock statistic


Measurement of the quantity of an item
at a point in time
Flow statistic
Measurement of the quantity of a rate or
quantity per of time
 Unit of measure must include a unit of
time

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Economic measurements
Distinguishing Economic Activity and
Social Well-being
 One purpose of economic systems
(societies) is to provide for the wellbeing of its individuals
 Economic activity contributes to that
well-being, but is not a complete
picture of well-being
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Economic measurements
We have seen that exchange and
markets tend to provide for the needs
and desires of individuals
 Well working competitive markets
provides the highest valued output at
the lowest opportunity cost
 Thus we can measure economic
activity (and its contribution to wellbeing) by summing market activity

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Economic measurements
Gross Domestic Product is a comprehensive
measure of economic activity
 Individually


Write a definition of Gross Domestic Product
Groups


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Compare definitions, discuss differences
Identify important components of the definition
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Economic measurements
What are the important components of
a definition of GDP?
Final goods and services
 What
market prices
 How valued
 Where
within the country
during a given time period (1 year)
 When
 Provide examples of included items.
 Provide examples of excluded items.
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Economic measurements
Examples of excluded items
 Household Production
Self-supplied goods and services
 Home care
 Child care

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Economic measurements
Examples of excluded items
 Underground economy
Non-market exchanges
 Imputed values for owner occupied
housing
 Illegal activities

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Economic measurements
Examples of excluded items
 Transfer payments

Public
Subsidies to individuals
 Subsidies to firms


Private
Voluntary transfers
 Involuntary transfers (theft)

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Economic measurements
Other excluded items
 Environment
 Length of work day (leisure time)
 Health and Life expectancy
 Justice and Freedom
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Measuring Economic Activity
National Income and Product Accounts
 Methodology for measuring economic
activity
 Let’s return to the circular flow
diagram to guide our discussion
Real flows = Monetary flows
 Value of expenditures in the product
market = Revenues to firms = Payments
to households in the factor markets

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Imports
Consumption
Foreign
Sector
Exports
Product
Markets
Investment
Government
Expenditures
Net Personal Taxes
Households
Revenues
Net Business Taxes
Governments
Borrowing
Firms
Borrowing
Borrowing
Saving
Income
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Financial
Markets
Factor
The University
of Akron
Markets
Expenses
23
Measuring Economic Activity
Thus we can measure activity by
summing expenditures in product
markets
 Or summing income payments in the
factor markets
 Measure activity by expenditures

Household, Firm, Government, Foreign
 C + I + G + (X – M) = C + I + G + F

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Minus
Imports
Foreign
Sector
Exports
Net Exports
Consumption
Product
Markets
Government
Expenditures
Households
5/23/2017
Governments
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Investment
Firms
25
Measuring Economic Activity

Measure activity by expenditures
Household, Firm, Government, Foreign
 C + I + G + (X – M) = C + I + G + F

Sum the final sales
 Sum the value added at each stage in
the production chain


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Sales – Costs of materials
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Economic measurements
Introduction of concepts
 National Income and Product
Accounts (NIPA)
 Finding the data

Decision Tree
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NIPA Expenditures

Consumption
Durable goods
 Nondurable goods
 Service

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NIPA Expenditures

Investment
Business and nonresidential fixed
investment
 Changes in business inventories
 Residential fixed investment


NOT INVESTMENT
Purchase bonds, equity stocks, mutual
funds, etc.
 Portfolio allocations NOT investment

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NIPA Expenditures

Government expenditures
Consumption
 Investment
 Includes all levels of government
 Excludes transfer payments

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NIPA Expenditures
Net Exports
 Exports – spending by foreigners on
domestically produced goods and
services
 Imports – spending by domestic
residents on goods and services
produced abroad
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Economic measurements
Introduction of concepts
 National Income and Product
Accounts (NIPA)
 Finding the data

Decision Tree
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NIPA Expenditures
Bureau of Economic analysis
Table 1.1.5 Gross Domestic Product
Seasonally adjusted, annual rates
Real GDP is found in Table 1.1.6
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NIPA Income
Measure activity by incomes
 Payment for labor services


Employee compensation
Payment for land (natural resources)


Rental income
Payment to capital


Net interest
Payment for entrepreneurship

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Corporate profits
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What of the self-employed?
Labor
Land
Capital
Entrepreneurship
Households
Firms
Factor
Markets
Rent
Employee
Compensation
5/23/2017
Interest
Profit
The University of Akron
Proprietor’s
Income
35
Measuring Economic Activity
Bureau of Economic analysis
From GDP to Personal Income
Table 1.7.5
Personal Income to Consumption and
Saving
Table 2.1
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Economic measurements
Introduction of concepts
 National Income and Product
Accounts (NIPA)
 Finding the data

Decision Tree
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37
Decision Tree
Review
Circular Flow
Economic Measurement
Measuring price changes
Measuring employment activity
Policy Issues
Measuring Price Changes




5/23/2017
Measuring price changes
Price Indexes
Calculating Inflation
Calculating Real values
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39
Measuring Price Changes
NIPA uses current market prices to
value (and weight) the real (physical)
flows
Thus, economic activity as
measured by GDP can increase if:




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Real (physical) flows increase
The price weights increase
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40
Measuring Price Changes
A thought experiment
You are given $5000 to spend.
The catch –
1) you must spend all of it on items
from Sears
2) you may choose either the 1903 OR
the 2005 catalog, BUT ONLY ONE!
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Measuring Price Changes
You are given $5000 to spend.
 Which catalog (1903 or 2005) would
you choose? Why?
 What would be the advantage of
choosing the 1903 catalog?
 What would be the advantage of
choosing the 2005 catalog?
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Measuring Price Changes
Consumption
Revenues
Product
Markets
Goods and
Services Sold
Goods and Services
Purchased
The real (physical) flows (inner
arrows) are valued (and weighted)
by current market prices
Households
Factors Supplied (Labor, Land,
Capital, Entrepreneurship)
Income (Wages,
Rent, Interest,
Profits)
5/23/2017
Factor
The University
of Akron
Markets
Firms
Factors Received (Labor, Land,
Capital, Entrepreneurship)
Expenses (Wages,
Rent, Interest, Profits)
43
Measuring Price Changes
NIPA uses current market prices to
value (and weight) the real (physical)
flows
Thus, economic activity as
measured by GDP can increase if:




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Real (physical) flows increase
The price weights increase
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Measuring Price Changes
For example
 Consider an economy with 3 goods
 In following table, determine total
economic activity (GDP) in each year
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Measuring Price Changes
Item
Draft
beer
Movie
Ticket
Pizza
GDP
Quantity
(2002)
400
Price
(2002)
$5.00
Quantity
(2003)
450
Price
(2003)
$5.00
50
$6.00
75
$6.00
100
$10.00
120
$10.00
$3300
$3900
Increase real output => increase in GDP
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Measuring Price Changes
Item
Draft
beer
Movie
Ticket
Pizza
GDP
Quantity
(2002)
400
Price
(2002)
$5.00
Quantity
(2003)
400
Price
(2003)
$6.00
50
$6.00
50
$8.00
100
$10.00
100
$10.50
$3300
$3850
Increase prices => increase in GDP
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Measuring Price Changes
Item
Draft
beer
Movie
Ticket
Pizza
GDP
Quantity
(2002)
400
Price
(2002)
$5.00
Quantity
(2003)
450
Price
(2003)
$4.50
50
$6.00
40
$8.00
100
$10.00
120
$10.50
$3300
$3605
Has the economic activity increased?
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Measuring Price Changes
So if we want to compare real (physical)
output flows over time, we need to
compensate for price changes




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This is the role of price Indexes
Consumer price index (CPI)
Producer price index (PPI)
Gross domestic product deflator
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Measuring Price Changes




5/23/2017
Measuring price changes
Price Indexes
Calculating Inflation
Calculating Real values
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Price Indexes
A price index uses a fixed basket of
goods (quantities) to allow
measurement of the impact of
changing prices
General formula:
Basket of Goods * Current Prices
Basket of Goods * Base Year Prices
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Price Indexes
Consumer price index (CPI) uses a
market basket of a typical urban
family’s purchasing patterns in the
base year
Urban Basket in base year * Current Prices
Urban Basket in base year * Base Year Prices
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Price Indexes
Producer price index (PPI) uses a
market basket of goods used in
production (raw materials,
intermediate products, and
wholesale goods) in the base year
Producers’ Basket in base year * Current Prices
Producers’ Basket in base year * Base Year Prices
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Price Indexes
Gross domestic product deflator uses
the entire production in the current
year as the market basket of goods
GDP goods in current year * Current Prices
GDP goods in current year * Base Year Prices
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CPI (interpretation)
Show graph of CPI
 What is being shown?
 Explain what you understand the
graph to mean.
 How might this be used in an essay?
 Why the difference between the “All
items” and the “Core” index?

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CPI: All items and Core
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CPI (interpretation)
Groups
 Do you agree on what is being shown?
About how it might be used in an essay?
 Compare understandings of the graph
 Compare understanding of the difference
between the “All items” and the “Core”
index?
 Has there been a long term inflationary
trend? If so, what is it?
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CPI (interpretation)

Class

Compare team responses and discuss
Do we agree on what is being shown?
 Compare understanding of the
difference between the “All items”
and the “Core” index?
 How might this be used in an essay?

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CPI (interpretation)

How does this help you understand
the recent past?

If this is all the information you have,
what would be your inflation
forecast?
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CPI: All items and Core
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Measuring Price Changes




5/23/2017
Measuring price changes
Price Indexes
Calculating Inflation
Calculating Real values
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Calculating Inflation
Define Inflation
 General increase in prices
 Decline in the purchasing power of
money
Calculation
[(Index period 2 / Index period 1) – 1.0] * 100
[(Index period 2 - Index period 1) / Index period 1] * 100
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Measuring Price Changes




5/23/2017
Measuring price changes
Price Indexes
Calculating Inflation
Calculating Real values
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Calculating Real values
So we can compare real (physical)
output flows over time, by
compensating for price changes
 Nominal values = Output valued at
current prices
 Real values = Output valued at
constant prices

5/23/2017
Adjusted for price changes
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Calculating Real values
In general:
Real value = (Nominal value / Index) * 100
(Real value * Index) / 100 = Nominal value
Index = (Nominal value / Real value) * 100
Real GDP = (Nominal GDP / GDP deflator) * 100
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Calculating Real Growth
It is important to measure the growth in
real economic activity
Growth is usually measured by
percentage increase in a value
Growth of real GDP = percentage increase
(decrease) in real GDP
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Calculating Real Growth
Calculating the percentage rate of
growth:
[(Real GDP2 / Real GDP1) – 1.0] * 100
[(Real GDP2 – Real GDP1) / Real GDP1] * 100
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Measuring Price Changes




5/23/2017
Measuring price changes
Price Indexes
Calculating Inflation
Calculating Real values
The University of Akron
68
Decision Tree
Review
Circular Flow
Economic Measurement
Measuring price changes
Measuring employment activity
Policy Issues
Labor Markets
Categorizing individuals by their
participation in the economy
From total population to the labor force
Pop – children – institutional =
Non-institutionalized population
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Labor Markets
Venn Diagram
1 Children Under age of 16
2 Institutionalized
persons
4 Not in Labor
Force
3 Unemployed persons
5 Employed persons
6 Military personnel
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Labor Markets
Categorizing individuals by their participation
in the economy
Non-institutionalized population
Employed if working for pay, etc
Unemployed if not employed and looking for
work
Not in labor force if neither employed or
unemployed
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Labor Markets
The Current Population Survey (CPS)
classifies all individuals in the noninstitutionalized populations into 3
groups (categories)
Employed
 Unemployed
 Not in Labor Force
 Labor Force – Employed + Unemployed

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Labor Markets
Venn Diagram
1 Children Under age of 16
2 Institutionalized
persons
4 Not in Labor
Force
3 Unemployed persons
5 Employed persons
6 Military personnel
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Labor Markets
1
1.1
1.2
2.2
2.1
2
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Labor Markets
Three measures
 Labor Force Participation Rate


Employment rate


LF / Non-institutionalized Pop
Employed / Non-institutionalized Pop
Unemployment Rate

5/23/2017
Unemployed / LF
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Labor Markets

Four (4) primary types of
unemployment based on the reasons
for the unemployment and their
duration.
Frictional
 Seasonal
 Cyclical
 Structural

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Labor Markets

Discouraged workers


Individuals who stop looking for work
but would accept a job if offered
Natural rate of unemployment
Non-inflationary level of unemployment
 LM in equilibrium
 No Cyclical unemployment
 Definition of “full-employment”

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Labor Markets
1
1.1
1.2
2.2
2.1
2
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Labor Markets
Other measures of labor input
Aggregate hours
 Aggregate earnings
 Labor Productivity

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Decision Tree
Review
Circular Flow
Economic Measurement
Measuring price changes
Measuring employment activity
Policy Issues
Policy Issues
What determines spending levels
 How do changes in spending affect
economic activity (GDP)?
 How do policy makers influence the
economy?
 Can policy makers “control” the
economy?


5/23/2017
Stable prices, full-employment,
economic growth
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Decision Tree
Review
Circular Flow
Economic Measurement
Measuring price changes
Measuring employment activity
Policy Issues