Principles of Macroeconomics Welcome to Day 6 Principles of Macroeconomics

What we did last class: 1) Supply and demand in the labor and financial markets. 2) The incentive and information problems. 3) The invisible hand

Now we are ready to start macroeconomics, the study of why the “entire” economy goes good or bad at the same time.

Before we can understand why the economy goes bad, we have to know what going bad is. What do you want out of the American economy?

1) A job. 2) Lots of material things. 3) Stable prices at the stores 1) A job. 2) Lots of material things. 3) Stable prices at the stores. The economy is going good when we get these things, and going bad when we don’t.

So to know if the economy is going good or bad, we need someway to measure these things. Welcome to everyone’s favorite topic – Economic Statistics.

This chapter is about measuring how much stuff we are making – the most basic macroeconomic measurement.

GDP is the market value of all final goods and services made within a country’s borders in a year.

GDP can be looked at from two sides: the buyers’ side and the sellers’ side. This is because the dollar value of what we buy is equal to the dollar value of what we sell.

How To Find Nominal GDP Apples Oranges. Q. P. Q P. NGDP Y1 7 $1. 5 $4 How To Find Nominal GDP Apples Oranges Q P Q P NGDP Y1 7 $1 5 $4 ? Y2 6 $2 8 $3 ? Multiply the quantity of each thing made by its price and add them together.

Apples Oranges. Q. P Q P. NGDP Y1. 7 X $1 +. 5 X $4. $27 Y2. 6 X $2 + Apples Oranges Q P Q P NGDP Y1 7 X $1 + 5 X $4 $27 Y2 6 X $2 + 8 X $3 $36 Multiply the quantity of each thing made by its price and add them together.

Looking at it from the demand side, the customers we make our products for are usually divided into four groups: 1) Consumers 2) Business Investment 3) The Government 4) Exports

This leads to one of the 2 most famous equations in macroeconomics: GDP = C + I + G + (X-M) X-M = Net Exports

Are things that are not counted in GDP Are things that are not counted in GDP? 1) Intermediate Goods – double counting. Your parents give you a $20,000 car made from $12,000 steel, $4,000 rubber, and $4,000 glass. Are you $20,000 richer or $40,000 richer?

2) Used Goods These do not represent new production in this year.

3) Government Transfer Payments: Social Security, Welfare 3) Government Transfer Payments: Social Security, Welfare. 4) Non-Market Activities:

5) Financial Transactions: Stock and Bonds 6) Illegal Goods: You can figure them out for yourself. We don’t leave them out because of ethics, just because the numbers are not reported to the government.

Here they are all together: 1) Intermediate Goods 2) Used Goods 3) Government transfer payments 4) Non-market activities 5) Financial transactions 6) Illegal goods

Circular Flow Diagram - Arrows represent money flows Can this be a working model? Households Households Businesses Goods Market

Factor Inputs Households Households Businesses Goods Market

Factor Inputs Households Households Businesses Goods Market

Factor Inputs Government Households Households Businesses Goods Market

GDP = C + I + G + (X-M)

Now that we understand GDP, there is a problem with it Now that we understand GDP, there is a problem with it. At least if we want to use it to measure the quantity of output.

Apples Oranges. Q. P. Q P. NGDP Y1 7 $1. 5 $4. $27 Y2 14 $1 10 $4 Apples Oranges Q P Q P NGDP Y1 7 $1 5 $4 $27 Y2 14 $1 10 $4 ? Given that NGDP in year 1 is $27, what does the correct measurement for year 2 have to be?

Apples Oranges. Q. P. Q P. NGDP Y1 7 $1. 5 $4. $27 Y2 14 $1 10 $4 Apples Oranges Q P Q P NGDP Y1 7 $1 5 $4 $27 Y2 14 $1 10 $4 $54 And what does the correct measurement for year 2* have to be? Y2* 7 $2 5 $8 ?

Apples. Oranges. Q. P. Q P. NGDP Y1 7 $1. 5 $4. $27 Y2 14 $1. 10 $4 Apples Oranges Q P Q P NGDP Y1 7 $1 5 $4 $27 Y2 14 $1 10 $4 $54 Y2* 7 $2 5 $8 $54 The quantity measurement is being thrown off by the price changes.

The solution is to not allow the prices to change The solution is to not allow the prices to change. When we do this, we calculate Real GDP. Real GDP is GDP calculated using base year prices. The real value of any economic variable is the statistic after being adjusted for inflation.

Base year is year 1. Apples Oranges. Q. P. Q P. NGDP RGDP Y1 Base year is year 1. Apples Oranges Q P Q P NGDP RGDP Y1 7 $1 5 $4 $27 $27 Y2 7 $2 5 $8 $54 $27 Which statistic is the better measurement of growth?

Now a more complicated problem. What is RGDP in years 1 and 2 Now a more complicated problem. What is RGDP in years 1 and 2? Assume year 1 is the base year. Apples Oranges Q P Q P NGDP RGDP Y1 7 $1 5 $4 $27 ? Y2 6 $2 8 $3 $36 ?

Now a more complicated problem. What is RGDP in years 1 and 2 Now a more complicated problem. What is RGDP in years 1 and 2? Assume year 1 is the base year. Apples Oranges Q P Q P NGDP RGDP Y1 7 $1 5 $4 $27 $27 Y2 6 $2 8 $3 $36 $38

Can I be sure here that RGDP is higher in year 2 rather than year 1 because we made more stuff rather than because prices are higher? Apples Oranges Q P Q P NGDP RGDP Y1 7 $1 5 $4 $27 $27 Y2 6 $2 8 $3 $36 $38

There is a measure of inflation called the GDP deflator There is a measure of inflation called the GDP deflator. We will talk more about inflation later in the class, but for now, the GDP deflator is a price index that measures inflation. You can use it to convert nominal into real values.

What cost $48.30 to buy in 1980, cost $110.00 in 2010. Year Nominal GDP (billions of dollars) GDP Deflator (2005 = 100) 1960 543.3 19.0 1965 743.7 20.3 1970 1,075.9 24.8 1975 1,688.9 34.1 1980 2,862.5 48.3 1985 4,346.7 62.3 1990 5,979.6 72.7 1995 7,664.0 81.7 2000 10,289.7 89.0 2005 13,095.4 100.0 2010 14,958.3 110.0 What cost $48.30 to buy in 1980, cost $110.00 in 2010.

In 1980, California’s minimum wage $3. 10/hour. In 2010, it was $8 In 1980, California’s minimum wage $3.10/hour. In 2010, it was $8.00 an hour. In real terms, was it higher or lower in 2010 than 1980? 110/48.3 = 2.28 Things in 2010 are 2.28 times more expensive than 1980. https://www.dir.ca.gov/iwc/MinimumWageHistory.htm

$3.10/hour x 2.28 = $7.07/hour So yes, the minimum wage worker of 2010 could buy more. How much more? $0.93/$7.07 = 13% increase

Do the same thing to convert nominal GDP to real GDP. Year Nominal GDP (billions of dollars) GDP Deflator (2005 = 100) Calculations Real GDP (billions of 2005 dollars) 1980 2862.5 48.3 2,862.5 / (48.3/100) 5926.5 1985 4346.7 62.3 4,346.7 / (62.3/100) 6977.0 1990 5979.6 72.7 5,979.6 / (72.7/100) 8225.0 1995 7664.0 82.0  7,664 / (82.0/100) 9346.3 2000 10289.7 89.0 10,289.7 / (89.0/100) 11561.5 2005 13095.4 100.0 13,095.4 / (100.0/100) 2010 14958.3 110.0 14,958.3 / (110.0/100) 13598.5

Is the 2016 mountain necessarily bigger? 2016 mountain of goods worth $18.569 trillion. 2015 mountain Of goods worth $18.036 trillion. Is the 2016 mountain necessarily bigger? What if I tell you that GDP deflator was 110.50 in 2015 and 112.23 in 2016?

Two last things to note. 1) The nominal and the real GDP will always be the same in the base year. 2) The real GDP measurement becomes more shaky as more time passes. What was the price of smart phones in 1980?

What we did today: 1) Criteria for judging the macroeconomy What we did today: 1) Criteria for judging the macroeconomy. 2) What nominal GDP is and what is not in it. 3) How to draw a circular flow diagram. 4) What real GDP is. 5) How to use the GDP deflator to convert nominal variables to real ones.

Principles of Macroeconomics Welcome to Day 7 Principles of Macroeconomics

What we did last class: 1) Criteria for judging the macroeconomy What we did last class: 1) Criteria for judging the macroeconomy. 2) What nominal GDP is and what is not in it. 3) How to draw a circular flow diagram. 4) What real GDP is. 5) How to use the GDP deflator to convert nominal variables to real ones. Start of class today: 1) Hand in homework assignment #3. 3) Take quiz #3.

At this scale, we can see the largest recessions, especially the Great Depression and the Great Recession, and World War II.

The St. Louis Federal Reserve Bank runs a web page with all the macroeconomics statistics you could ever want. https://fred.stlouisfed.org/series/GDPC1

Notice the economy can still be bad even https://www.slideshare.net/MrRed/the-business-cycle Notice the economy can still be bad even in a recovery, especially a slow one.

GDP per capita = GDP per person = NGDP/Population

Exchange rates for the U.S. dollar

Country A Country B Country C Produced Produced Produced $40,000 Country A Country B Country C Produced Produced Produced $40,000 $20,000 $40,000 Hours Wrk. Hours Wrk. Hours Wrk. 40 40 20

U.S. hours worked per year 1,789 France hours worked per week 1,473 Are U.S. workers actually richer? http://www.bbc.com/news/34667552

Given the things that are left out (leisure, nonmarket activities, illegal goods), Why are comparisons for the same country across a short number of years more accurate than across countries for the same year?

What we did today: 1) The phases of the business cycle 2) GDP comparisons across countries. 3) GDP comparisons over time.

Principles of Macroeconomics Welcome to Day 8 Principles of Macroeconomics

What we did before the last class: 1) The phases of the business cycle 2) GDP comparisons across countries. 3) GDP comparisons over time.

Test Prep

Principles of Macroeconomics Welcome to Day 9 Principles of Macroeconomics

Test Day