unit 13 - economic fluctuations and unemployment

GDP definition

the total value of all final goods and services which are produced for the marketplace during a given time period within the nations borders

intermediate goods

goods used up in the process of producing something else

(eg flour is used to make bread)

final good

a product sold to its final user

the product approach for calculating GDP

adding up the market values of goods and services produced, excluding any goods and services which were used up in intermediate stages of production

• market value = revenue

• product approach for each firm = revenue - intermediate goods

income approach for calculating GDP

add together all forms of income generated by production

• wages, profit, rent and interest payments

expenditure approach for calculating GDP

add up the amount spent by all ultimate used of output

• measure the spending on the domestically produced goods and services

• capital stock + investments + inventory + government spending + net exports

categories of spending in the expenditure approach to calculation GDP

consumption (C) → spending by households (includes spending on imports and excludes purchases of used goods eg homes and land)

private investment (I) → spending by firms (ignores depreciation)

• planned investment

• unplanned investment → goes into firms inventory stocks

government purchases (G)

net exports (NX)

private investment equation

private investment roughly = capital formation - the increase of the nation’s capital stock during a given period of time

private investment is the rate of change of capital stock

I = dK/dt = rate of change of K

• K = economies capital stock

• t denotes time

net private investment

gross private investment (I) - depreciation

2 components of government purchases

government investment (capital goods purchased by the government)

government consumption (spending on goods and services that are used up over a period

government expenditure

different to government purchases

includes the purchase of goods as services as well as transfer payments (TR)

equation for the expenditure approach

Y = C + I + G + X - IM

fundamental identity of national income accounting

total production = total income = total expenditure

stock variables

a variable representing a quantity at a moment in time

flow variables

a variable representing a process that takes place over time

gross national product (GNP)

the total values of goods and services produced for the marketplace by domestic factors of production during a given period of time

• capital and labour owned by domestic nationals

net factor payments from abroad (NFP)

income paid to domestic factors of production by the rest of the world - income paid to foreign firms by the home economy

equation for GDP using GNP and NFP

GDP = GNP - NFP

net national product (NNP)

gross national production - depreciation of capital

equation for national saving (in an open economy)

S = Y + NFP - C - G

equation for nation saving (in a closed economy)

S = Y - C - G

equation for the saving rate

s = s/y

• the fraction of GDP that is saved

government saving equation

S = T - (G + TR + INT)

• T = tax revenue

• G = government purchases

• TR = transfer payments

• INT = interest payments

when the government is running a budget surplus government saving is positive

saving identity in a closed economy

• S = Y - C - G

invoke income-expenditure identity for a close economy (Y = C + I + G)

• S = (C+I+G) - C - G

therefore

• S = I

how to calculate an index number

= value of measure in a period t / value of measure in base period x 100

consumer price index (CPI)

an index of the cost, through time, of a market basket of goods and services purchased by the average (typical) household

• goal of CPI is to track the prices paid by consumers

price level (p)

the average level of prices in the economy (either measured by the CPI or the GDP deflator)

inflation rate

the percentage rate of change of the price level from one period to the next

inflation rate % = ((CPIt / CPIt-1) - 1) x100

nominal variables

an economic variable measured using current market prices or that is not adjusted for the £’s changing value

real variables

a variable measured using the prices of a base year or one that has been adjusted for the £’s changing value

real wage rate

nomimal wage rate / price level

problems with GDP

• doesn’t measure quality changes

• doesn’t account for illegal or informal economy

• excludes non-market production

• does not show environmental quality and resource depletion

• doesn’t show poverty and inequality

• omits other aspects of wellbeing

labour force

= employed + unemployed

adult population

those over 16

= labour force + those not in labour force

employment ration

= employed / adult population

frictional unemployment

short term unemployment experienced in between jobs or when first finding a job

structural unemployment

unemployment due to either

• mismatch between workers skills and skills demanded by employers

• mismatch between workers location and employers location

cyclical unemployment

unemployment causes by a downturn in demand and the business cycle

• the different between the actual rate of unemployment and the natural rate of unemployment

Okun’s law

measures the impact of a change in output on unemployment

• the %gap between full employment (Y bar) and the actual output (real GDP, Y) is 2 times the cyclical unemployment rate

why is consumption smooth

due to principal of diminishing marginal returns

• acts as a source of stablisation

limit of smoothing of consumption

• credit constraints or credit market exclusion

• weakness of will

• limited co-insurance

current account balance (CA)

= net factor payments (NFP) - net exports (NX)

factor payments

payments for land, labour and capital

national savings

= private savings + government savings

GDP deflator

index for the price level of all goods and services included in GDP

does not include used goods and imports

real GDP growth rate

g tilde = (1+g)^n - 1

nominal interest rate

nominal interest rate % = ((pricet/pricet-1) -1) x100

real interest rate

nominal interest rate % - inflation rate %

Okun’s law to find full employment output

Okun’s law where we are not given the growth rates