Intro & GDP L & V

Difference between micro and macro

Micro: Study of individual people, firms or markets

Macro: The study of aggregate behaviour, interactions between people and firms through markets

Interdependence

The benefits of my actions depend on everyone else’s actions, what works for one firm does not necessarily work when all firms do it together

Paradox of Thrift

• Each household trying to save more (rational individually)

• Can lead to reduced spending overall

• Which causes business revenues to fall

• Leading to job losses

• Resulting in a worse situation for everyone

The main concern of government economic policy

• Promote growth in the long run (increases standards of living)

  • Incentives idea creation and technological processes

  • Promote institutions that determine incentives fir economic activity

• Smooth fluctuations in the short run (prevents negative effects of of high unemployment and or high inflation)

  • Fiscal, Monetary, and Trade Policy

What is Gross Domestic Product (GDP)

Market value of all final goods and services produced in the domestic economy in a given time period

Circular Flow Model

Income - Output - Expenditure

Production Approach

Sum of value added by all firms (value added = revenue - costs of intermediate goods)

Expenditure Approach (most used)

Add up the amount of spending by purchasers of domestically produced final goods and services

Y = C + I + G + NX

Income Approach

Add up income earned by factors of production or inputs (eg. wages, interest payments, dividends, rents)

Returns to factor of production - labour capital land

C

Durable goods + Non Durable Goods + Services

I

Residential investment (equipment used in production) + Non-residential investment + Inventory (non sold things)

G

Federal + State + Local

NX

Exports - Imports

GDP Growth Rate

% change in GDP

= [(GDP in current period - GDP in previous period)/ GDP in Previous Period] *100

2 Ways GDP can increase

Prices (inflation drives up GDP)

Production (more or more valuable goods and services produced)

Nominal GDP

Uses current year prices to measure value of production

NGDP = SUM(Current year prices x Current Year Quantities)

Real GDP

Uses base year’s prices to measure value of production

RGDP = SUM(Base Year Prices x Current Year Quantities)

GDP Deflator

(Nominal GDP / Real GDP) *100

• Measures Price changes between current year and base year

• Measures changes in prices across all goods/services in the economy

• Automatically updates unlike CPI

• Only includes domestically produced G&S

Inflation using GDP Deflator

[(GDP Deflator (t) - GDP Deflator (t-1)) / GDP Deflator (t-1)] *100

Real GDP Per Capita

RGDPC = Real GDP/Population

• Controls for population growth

• Measure of avg living standards

Limits of GDP

• Prices are not values

• Non market activities are excluded

• The shadow economy is missing

• Environmental degradation is not counted

• Leisure does not count

• GDP ignores income distribution and inequality

Why is GDP per capita still a good indicator of well being

• Tends to be closely linked to many other important factors we value, (eg. healthcare, education, life expectancy, child mortality rates, self reported life satisfaction

• When a country produces more goods and services, its citizens typically can afford other desirable aspects of life

Purchasing Power Parity

GDP per capita is measured in “international dollars” to account for local price differences