ECON1102: Macroeconomics

GDP

Gross Domestic Product: The final value of goods and services produced in an economy over a certain period of time.

Intermediate Goods

Things like grain and flour, the ingredients in the making of the final product. They are not counted towards GDP, only the FINAL product of bread would be counted.

Market Value

Provides a convenient way of aggregating many different goods produced in an economy however not all economically valuable goods and services are bought and sold in the market. For example, an unpaid homemaker adds value, but their service is not part of the market and therefore does not count towards GDP

Capital Good

A long-lived good such as houses, machines, factories or apartments. Newly produced capital goods are classified as final goods.

GDP Formula

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

Real GDP

Real GDP measures an economy's total production adjusted for price changes (inflation/deflation) using constant base-year prices, showing true output growth.

Nominal GDP

Calculates production at current market prices, incorporating inflation.

CPI

Consumer Price Index is measure of cost of living for consumers based on prices in a period for a typical basket of goods and services.

Quality Adjustment Bias

Sometimes price increases are associated with improved quality of products. For example, a new computer would cost more than its previous year’s version because the new technology in it would justify the price increase, therefore CPI does not always capture true inflation rate.

Substitution Bias

The CPI focused on a basket of goods. Consumers may switch from more expensive goods to cheaper goods when prices increase.

Shoe Leather Costs

Refers to the time, effort and resources that people waste managing their money to combat high inflation such as frequent trips to the bank to move cash into interest-bearing accounts.

Economic Costs of Inflation

• Shoe leather costs

• Noise in the Price System

• Distortion of the Tax System

• Unexpected Redistribution of Wealth

• Interference with Long-Term Planning

• Menu Costs

Noise in the Price System

Inflation makes it difficult to see if price changes are associated with changes in demand and supply or because of inflation. Makes markets inefficient

Distortion in the Tax System

In Australia, taxes are not indexed to inflation. Nominal wages may increase due to inflation, however real wages may not. If nominal wage increases it may mean that people pay higher income tax even though their real wage has fallen.

Unexpected Redistribution of Wealth

Inflation can cause winners and losers. Workers on contracted wages miss out if inflation increases.

Interference with Long-Term Planning

An individual can’t save money for the future if inflation rate is unpredictable. A company can’t produce long-term growth strategies for the same reason.

Menu Costs

Inflation itself causes the cost of having to keep changing prices.

Every time restaurants need to change their prices due to inflation, they need to reprint menus which can be costly if inflation is high.

Deflation

A situation where the average level of prices are falling and inflation rate is negative. Problematic as it can discourage spending and lending in economy. If nominal interest rate hits 0, lenders will no longer lend out money as it means they will be paid less than the amount they lent out. Just as bad as inflation.

Savings

Defined as current income minus current spending on goods and service

Savings Rate

Amount of savings as a proportion of income

Wealth (Net Worth)

Is equal to assets minus liabilities

Assets

Anything of value that someone owns, either financial or real

Liabilities

Debts that someone owes to other parties

Flow

A measure that is defined per unit of time, such as $20 per hour

Stock

A measure that is defined at a specific point in time, such as wealth of $3000 on 30th March 2023

Why People Save

1. Lifecycle Savings

2. Precautionary Savings

3. Bequest Savings

Lifecycle Savings

Saving to meet long-term objectives. E.g. for retirement, school fees, to buy a home etc.

Precautionary Savings

Saving for a rainy day, to protect oneself against unexpected circumstances such as natural disaster or job loss

Bequest Savings

Saving to leave money, an inheritance, to heirs like children

Real Interest Rate ( r )

The most relevant rate of interest in savings.

r = i (nominal interest rate) - π (inflation rate)

National Savings (Aggregate Savings)

The sum of all savings from different sectors of the economy (firms, households and government).

Formula for National Savings

S = (Y - T - C) + (T - G)

Where

Y = Income

T = Taxes

C = Consumption

G = Government Spending

(Y - T - C) is the private sector savings and (T - G) is public sector savings.

Cost Benefit Principle

Is the expected cost of investment less than the expected benefit of investment (equal to the value of the marginal product it provides)?

On the cost side, the factors are the price of capital goods and the real interest rate, that is the real cost of paying back the debt to borrow funds to purchase capital goods.

On the benefit side, the main factor to consider is the value of marginal product of new capital, how much revenue will that capital provide us?

Crowding Out

Higher interest rates makes investment less attractive, so investment decreases. The government’s borrowing can crowd out private investment

Perfectly Competitive Market for Labour

This model assumes that firms and workers are wage takers. Hence, they cannot affect the price of “price” of labour which is the wage rate. The market sets the wages.

5 Key Trends in Australian Labor Market

1. Australian workers have enjoyed substantial growth in real earnings since 1970.

2. Around 1980s real wage growth slowed for men due to women joining labour force.

3. There has been increased inequality among top-earners and bottom-earners with top-earners having a higher increase in real wages.

4. The proportion of population working has increased from 57% to 64% over last 50 years

5. Australia’s unemployment rate is considerably lower than the EU area and on par with the US

Factors that can shift Labour Demand Curve

1. An increase in relative price of worker’s output: If marginal value product of worker output increases, then more workers can be employed at a given level of output and wages.

2. A change in worker’s productivity: If marginal value product decreases, less workers would be employed at given level of wage and output.

Employed

People who worked full-time or part-time in the last week

Unemployed

People who did not work in the past week but made some effort to find a job (e.g. went to an interview)

Not in the Labour Force

People who did not work in paid employment or did not look for a job (e.g. housewives, full-time students etc.)

Unemployment Rate

Calculated by

Number of Unemployed People / Number of People in Labour Force

Economic Costs of Unemployment

Total workforce is not being utilised, meaning reduction in nation’s output. There is also a drain on government’s budget via a loss in income tax revenue and an increase in unemployment payments.

Psychological Costs of Unemployment

Can lead to low self-esteem, depression and suicidal behaviour.

Social Costs of Unemployment

Can lead people to facing financial difficulties and despair. Associated with higher rates of crime, domestic violence and drug abuse.

Discouraged Workers

People who have stopped looking for work as they are despondent about job options.

Underemployed

People who work jobs that do not match their qualifications.

Natural Rate of Unemployment

The unemployment rate never falls to zero as there are always people changing jobs

Frictional Unemployment

These are people changing to new jobs, e.g. new graduates entering the labour market. People who quit their job to seek new employment. This type of unemployment is not too costly.

Structural Unemployment

When a worker’s skills or aspirations do not match the type of jobs available. There is a mismatch of jobs and workers in the economy. The costs of this employment are much higher than frictional as it is often long-term

Cylical Unemployment

Occurs due to the nature of the business cycle. When the economy is slowing down, usually due to a recession. This type of unemployment is typically very costly to the economy.

Minimum Wage Law

It has been argued that if min. wage is set too high, it will cause unemployment. Min. wage can hurt the people it is supposed to help.

Other Government Regulations

Health and Safety regulations and other regulations can impact the costs of business which effects demand for labour.

Trade Union Membership

The Australian labour market has been characterised by high trade union membership. Unions can negotiate wages for workers with their employers. This can push wages up and cause unemployment

Unemployment Benefits

Countries with high unemployment benefits find it hard to achieve natural rate of unemployment. Benefits can act as an disincentive to find work for unemployed people.

Impediments to Achieving the Natural Rate of Unemployment

1. Minimum Wage Law

2. Other Government Regulations

3. Trade Union Membership

4. Unemployment Benefits

Real GDP per person

The total real GDP (expressed as y) divided by the total population of the country (expressed as POP).

Average Labour Productivity

How much real GDP (y) each person who is employed produces (expressed as N).

Real GDP per person equation

y / POP = y / N x N / POP

where y = GDP

N = each person who is employed

POP = total population of country

6 Factors that Explain Difference in Average Labour Productivity Across Countries

1. Human Capital

2. Physical Capital

3. Land and Other Natural Resources

4. Technology

5. Entrepreneurship and Management

6. Political and Legal Environment

Human Capital

Important for Workers’ Productivity as higher levels of education, skills and training leads to greater labour productivity.

Physical Capital

Refers to machinery and factories. More and better physical capital yields greater labour productivity. However diminishing returns exist where physical capital is only more productive to a certain extent.

Land and Other Natural Resources

More natural resources such as fertile land, energy and raw materials for manufacturing can increase workers’ productivity.

Technology

Plays significant role in increasing average labour productivity through improved communications and efficiency.

Entrepreneurship and Management

Entrepreneurs create economic enterprises critical to a dynamic economy. E.g. Henry Ford created the production line for cars, allowing for faster production and assembly line.

Political and Legal Environment

Rigid and Sound political and legal environment helps worker productivity. Countries with well-defined property rights see more productive workers. Political stability is also important.

Costs of Economic Growth

• Environmental Degradation

• Decrease in workers’ leisure time

• Building factories and machinery

Promoting Economic Growth: Policies to Improve Human Capital

• Skilled workers are more productive than unskilled workers

• Therefore, government should try to improve education of its workforce.

• Can be done via schooling, university and vocational education as well as training programs.

Promoting Economic Growth: Policies that Promote Savings and Interest

• Workers’ productivity increases when they can access capital stock

• To support creation of new capital, government can encourage high rates of savings and investment

• The government can offer public investment such as creation of bridges, roads, airports etc.

Promoting Economic Growth: Policies that Support Research and Development

• Technology is an outcome of Research and Development

• Technology improves worker productivity

• Government can support R & D through research grants such as those given through Australian Research Council

Promoting Economic Growth: Political and Legal Framework

• Governments need to provide a framework for the private sector to operate productively

• Aspects of this framework include secure property rights, a well functioning legal system and an economic environment that encourages entrepreneurship.

Production Function

Provides a unifying framework for economic growth.

MPk

Marginal Product of Capital, the amount of extra output that is obtained if capital stock is increased by one unit.

MRPk

Marginal Revenue Product of Capital, the extra revenue a firm would get if capital stock was increased by one unit.

MRPl

Marginal Revenue Product of Labour, the extra revenue that firm can produce from employing one additional unit of labour

MPl

Marginal Product of Labour, the amount of extra output that a firm can produce by one additional unit of labour

Growth Accounting

A method of dividing a country’s historical growth experience into whether it is caused from the primary or secondary factors of production.

Expenditure Approach

Method of calculating GDP by summing all final spending on goods and services within an economy over a certain period of time.