New macro exam #1 S.G

inflation

Economic thought is shaped by the

economic context of the time

Key questions in economics

1. prices (theory of value)

2. distribution

3. economic growth

4. economic institutions

5. economic systems (capitalism, free markets, ect)

for the greeks economics was

a moral science - proper management of the household

Adam smith was known as

The father of modern economics

Keynes was known as

father of macoeconomics

economics

the study of the production, consumption, exchange, and distribution of material resources required to sustain the needs of human persons in achieving happiness

positive economics

actual economic behavior - facts, data

normative economics

questions of what ought to be done economically - opinions

macroeconomics

the study of the economy as a whole

the aggregate of all production and consumption decisions made by economic agents overtime

macroeconomics is concerned with

economic activity

employment

inflation

gov policy

financial institutions

international trade

Real GDP

the measure of actual production of goods and services in the economy over time

how production has expanded/contracted since previous period

Unemployment

measures the percentage of the labour force who are unemployed

inflation

the sustained and general increase in prices in all/nearly all markets

high rates of inflation

disrupt economic activity lead to wealth transfers between different groups in society

low rates of inflation/deflation

disrupt investment and turn economic activity

3 national outputs

Gross domestic product

Gross national product

Gross & net national income

Gross domestic product

• Measure of all final goods and services evaluated at market price that are produced per period of time

GDP identity

C + I +G + NX

consumption

domestic consumption of final goods and services by households

consumption example

imputed housing services of owner-occupied homes

investment

• money spent on new equipment, buildings, homes and inventory that will be used to produce goods and services

• increases the productive capacity of the economy and expands potential GDP

3 categories of investment

capital investment by firms

inventory investment by firms

real estate investment by households

government expenditure

• Government purchases of final goods and services

• does not include transfer payments (social security/medicare payments)

Government consumption

expenditure on goods/services used relatively quickly (air-traffic control)

Government investment

expenditure for long-lasting improvements (airports)

Net exports

exports (x) - imports (m)

Exports (x)

goods/services that are produced domestically but sold abroad

Imports (m)

goods/services produced abroad that are purchased domestically

Gross national product (GNP)

total value of goods/services produced by residents of the national regardless of the location of the production

focuses on who : domestic factors of production

GNP formula

GDP + income earned by domestic residents abroad - income earned by foreigners domestically

nominal GDP

measure of the value of output at current market prices

chain-weighted real GDP

add the previous years price + current years price

divide by 2

multiple the current years quantity

Real GDP growth formula

1. new GDP - old GDP

2. divided by old GDP

3. x 100

GDP per capita

measure of the average income of people in a nation

GDP per capita formula

GDP / total population

Weaknesses of GDP/GDP per capita

• ignores non-market (unpaid) productive activity

• excludes black-market

• ignores wealth/income inequality

Gini coefficient

measures the amount of inflation in the economy

Working age population

this refers to all citizens above the age of 15 or 16 years.

Labour force

those in the working-age population who are either employed or unemployed

Employed

includes all persons who, during the reference

week:

• (1) worked at least 1 hour as paid employees, or worked in their own business, profession, or on their own farm, or worked at least 15 hours as unpaid workers in a family-operated enterprise;

• (2) all those who did not work but had jobs or businesses from which they were temporarily absent due to vacation, illness, bad weather, childcare problems, maternity or paternity leave, labor-management dispute, job training, or other family or personal reasons, regardless of whether they were paid for the time off or were seeking other jobs.

Employed

includes all persons who, during the reference week

• (1) had no employment,

• (2) were available for work, except for temporary illness, and

• (3) had actively sought work during the 4-week period ending with the reference week.

Unemployment rate

# of unemployed persons / total # of persons in the labour force

Not in the labour force (NFL)

those in the working-age population who are neither employed or unemployed as defined above.

• retirees, homemakers, students, sick and disabled, consecrated religious.

• also includes discouraged workers

Discouraged workers

people who would like work but have stopped actively seeking work because of discouragement

Labour force particpation

This is the percentage of the working-age population who are in the labour force.

Labour force participation rate

total no. of persons in labour force / no. of people in working-age population

Frictional Unemployment

is short-term unemployment

Seasonal unemployment

arises when certain occupational skills groups and industry sectors experience predictable fluctuations of a systematic nature over the course of the year.

• example: agricultural workers who harvest will experience seasonal unemployment in the seasons where there is no harvest

Structural unemployment

arises when there are enough job vacancies overall to cover thenumber of unemployed, but there are mismatches between the skills demanded and the skills supplied.

• This is often associated with industrial restructuring (e.g. deindustrialization etc.).

Cyclical (demand-deficient unemployment):

arises when there is a shortage of jobs overall relative to the willing supply of labour resources at the current wage levels.

• This is the unemployment that arises due to deficiencies in aggregate demand.

• It is also known as mass unemployment, and due

to the output gap (the gap between potential output and actual output).

Labour flow matrix

The abbreviations can be used to construct a labour flow matrix, which captures how many people are shifting between different labour market categories:

Transition probabilities

a useful statistic to calculate the probabilities of moving from one state of labour to another

3 conditions are required for a rise in prices to be considered inflationary

(1) it must be sustained over time

• (2) it must relate to all or nearly all markets

• (3) the increase in the price level must be sufficiently large

Index number

• a measure of the change in a variable (or group of variables) over time.

• It is typically used in economics to measure trends in a

wide variety of variables including: stock market prices, cost of living (inflation), industrial or agricultural production, imports/exports etc.

• Index numbers are one of the most used statistical tools in economics.

• An index is a time series that has a base year (i.e. a year for which the value of the index is 100), where values for other years show the percentage increase in the level of the underlying variable compared to the base year.

• Formula for an index: 𝐼𝑡 = 𝑋𝑡 / 𝑋0 ∗ 1

Measures of inflation

Consumer Price Index (CPI)

• Personal Consumption Expenditure Index (PCE)

• Wholesale Price Index (WPI)

• Producer Price Index (PPI)

• Wage Price Index

Consumer price index

The most commonly-used index to calculate inflation.

• It is based on the cost of a fixed basket of consumer goods and

services.

base-weighted index (called a Laspeyres index)

• measures the shift in prices of the basket of goods and services using the base period quantities purchased.

• It allows us to see how much a basket that consumers bought in the base period would cost in the current period.

A current-weighted index (called a Paasche index)

measures the current quantity purchased of each good and service in the basket as the weight to compile the average measure.

Personal consumption expenditure index (PCE)

• the measure that is actually preferred by the Federal Reserve when examining inflation.

• has a broader scope than the CPI, as it captures the expenditures

• includes expenditures from non-profit institutions that serve households

Producer price indexes (PPI)

selling prices received by domestic producers of goods and services.

• What’s the difference? The price that consumers pay for a good is often not the price that the producers receives for the good. This is because merchants intermediate between producers and consumers

employment cost index (ECI)

• is a quarterly measure of the change in the price of labour, defined as compensation per employee hour worked.

• an indicator of cost pressures within companies that could lead to price inflation for finished goods and services.

• The index measures changes in the cost of compensation not only for wages and salaries, but also for an extensive list of benefits (pensions, insurance).

Difficulties in measuring inflation

Measurement biases

• Change in the kinds of goods purchased by consumers over time (compositional change and substitution bias)

• Changes in the quality of products can cause change in prices

• Introduction of new products on the market

Housing Component

• The housing component of CPI is large (between a quarter to almost a half of the index). The estimation of housing costs is also fraught with difficulties.

• So inflation measures must be taken with a grain of salt.

4 basic ideas in sectoral balances

the macroeconomy is composed of sectors: domestic private sector (households and firms), the government sector, and the foreign sector.

1. The expenditure of one sector is the income of another sector.

2. If one sector runs a surplus, the other sector must run a deficit, and vice versa.

3. The sector that runs a surplus will see its net assets increase / The sector that runs a deficit will see its net assets decrease.

4. Every financial liability is matched by financial assets. Therefore, the sum of all financial liabilities = the sum of all financial assets

Sectoral balances

• most basic macroeconomics rule is that one person’s spending is another person’s income.

• This is an approach to macroeconomics which tracks the flows of spending and income within and between sectors.

• helping us to understand the relations between the spending and income balance of households, firms, government, and the foreign sector of the economy.

• For one sector to run a surplus, another sector must run a deficit, and vice versa

Private sector balance

𝐆𝐍𝐏 − (𝑻 + 𝑪 + 𝑰) this shows the surplus/deficit of private sector income (GNP) over private sector expenditures (C, I, T).

Government sector balance

𝑻 − 𝑮 this shows the surplus/deficit of government revenue (T) over government expenditure (G)

Foreign sector balance

𝑴 − 𝑿 − 𝑭𝑵𝑰 this shows the surplus of foreign demand for domestic product over the domestic demand for foreign product [Foreign sector balance: (M – X – FNI)

The private domestic financial balance can be written as

S – I, because 𝐒 = 𝐆𝐍𝐏 − 𝐓 − 𝐂

The private domestic balance plus the government

financial balance plus the current account deficit must …

equal zero. This can be seen by re-arranging the equation on the last slide:

𝐒 − 𝐈 + 𝑻 − 𝑮 + (𝑴 − 𝑿 − 𝑭𝑵𝑰) ≡ 0

Stocks & flows

enable us to see the relationship between surplus/deficit (flows) and assets/liabilities (stocks).

Flow variables

are measured over time. GDP is a flow measure, measuring the amount of goods and services produced in monetary terms for a period of time.

• All the components of GDP are flow measures.

• We can distinguish between flows of money (monetary circuit) and flows of factor inputs, goods, and services (real circuit), i.e. monetary flows and real flows

• flows accumulate as stocks

Stock

measured at a point in time

• are assets/liabilities and are represented in balance sheets