layout: true background-image: url(figs/tcb-logo.png) background-position: bottom right background-attachment: fixed; background-origin: content-box; background-size: 10% --- class: title-slide .row[ .col-7[ .title[ # Principles of Macroeconomics ] .subtitle[GDP] .author[ ### Dennis A.V. Dittrich ] .affiliation[ ] ] .col-5[ ] ] --- ## Measuring Progress Matters <img src="fig01/unnamed-chunk-1-1.png" width="75%" /> .row[.col-6[ A staggering 80% of India’s population was poor (living on less than 2$ per day) in 1983 and the number is about the same in 2004. But more than 100m Indians already lived at an American/European standard of living. ] .col-6[ India's economy is growing rapidly. In 2019, the poverty rate is below 3%. ]] --- class: practice-slide # 1. .col-8[ Good living standards, stability and security, sustainability: Which of these goals do you think should have the highest priority? Why? ] --- # Aggregate Accounting .col-7[ * **Aggregate accounting** (or national income accounting) is a set of rules and definitions for measuring economic activity in the aggregate economy -- that is, in the economy as a whole * Aggregate accounting is a way of measuring total, or aggregate production * **Gross domestic product (GDP)** is the total value of all **final** goods and services produced in an economy in a one year period * Calculating GDP requires adding together millions of different services and products * All of the quantities of goods and services produced are multiplied by their market price per unit to determine a value measure of the good or service * This is weighting the importance of each good by its price * The sum of all of these values is GDP ] --- # GDP is a Flow Concept .col-7[ * GDP is a flow concept, the amount of total final output a country produces per year * **Wealth accounts** is a balance sheet of an economy's assets and liabilities and it is a stock concept * **Real wealth** is the value of the productive capacity of the assets of an economy measured by the goods and services it can produce now and in the future * **Nominal wealth** is the value of those assets measured at current market prices * Wealth is a nation's stock of useful goods and resources at a given point in time. GDP is the flow of goods and services and thus is the annual addition to this stock. ] --- # Growth .col-7[ Economists measure growth as changes in real gross domestic product (**GDP**), the market value of final goods and services produced in an economy, stated in the prices of a given year **Per capita real output** is real GDP divided by the total population; even if total output is increasing, the population may be growing even faster, so per capita real output may fall ] --- ## Business Cycles <img src="fig01/unnamed-chunk-2-1.png" width="100%" /> .row[.col-6[ Sometimes GDP grows above the trend; at other times GDP falls below the trend ] .col-6[ A business cycle is the upward or downward movement of economic activity, or real GDP, that occurs around the growth trend ] ] --- class: practice-slide # 2. .col-8[ Why are macroeconomic fluctuations a cause for concern? ] ??? Economic fluctuations make it hard for people to plan for the future. High unemployment is associated with many signs of social stress, including suicide, domestic violence, stress-related illnesses and crime. --- # The Phases of the Business Cycle .row[.col-5[ The four phases of the business cycle are: * The peak * The downturn * The trough * The upturn ] .col-7[ ![](img02/2402.jpg) ]] .row[.col-6[ * A **recession** is a decline in real output that persists for more than two consecutive quarters of a year * A **depression** is a large recession * An **expansion** is an upturn that lasts at least two consecutive quarters of a year ] .col-6[ Why business cycles occur remains a controversy... * Keynesians generally favor activist government policy * Classicals generally favor laissez-faire policies ]] --- # What is Counted in GDP? .row[.col-6[ Not Counted * Value of resale goods * Sales of stocks or bonds * Government transfer payments * Work of house-spouses ] .col-6[ Counted * Value added by a used car dealer * Commissions paid to stock brokers ] ] --- class: practice-slide # 3. .col-8[ Are the following included in U.S. GDP? Briefly explain why or why not: 1. Used cars sold at a used car store 2. Your used car sold at your cousin’s garage sale 3. Wine made in Napa Valley at a vineyard owned by Australians 4. Wine made in Australia at a vineyard owned by Americans 5. The price paid by a French tourist when staying at a San Francisco hotel 6. The price paid by an American tourist staying at a Paris hotel 7. A ticket for a Lakers game ] ??? 1. No. Used items aren’t “produced” during that year so they are not included in GDP, but the services produced by the college bookstore in selling the textbooks would be included in GDP. 2. No. Used items don’t count, and because of measuring problems, the services of people who sell items at garage sales are not included in GDP either. 3. Yes. What matters is where it’s made, not whether an Australian company owns the factory. 4. No. What matters is where it’s made, not whether an American company owns the factory. 5. Yes. The transaction made in the country itself! So, technically, it counts as an “exported service.” 6. No. GDP is about production in the country. This service transaction occurred in Germany. So, if we are considering U.S. GDP, it will not be included in GDP. 7. Yes. Entertainment services are part of the country’s income and to be included in GDP. --- # National and Domestic Concepts .col-7[ * GDP is the total value of all final goods and services produced in an economy in a one-year period * GDP is output produced within a country's borders * **Gross National Product (GNP)** is the aggregate final output of citizens and businesses of an economy in one year * GNP is output produced by a country's citizens * GNP = GDP + Net foreign factor income * Net foreign factor income is the income from foreign domestic factor sources minus foreign factor income earned domestically ] --- class: practice-slide # 4. .col-8[ What is the national spending identity? What is the national income identity? ] --- # The Components of GDP GDP is divided into four expenditure categories: 1. **Consumption (C)** is spending by households on goods an services 2. **Investment (I)** is spending for the purpose of additional production 3. **Government spending (G)** is goods and services that the government buys 4. **Net exports (NX)** is spending on exports (X) minus spending on imports (M) * Since all production is categorized into one of these four divisions, by adding up these four categories, we get total production of U.S. goods and services GDP = Consumption + Investment + Government spending + Net exports `$$GDP = C + I + G + (X-M)$$` --- # The Income Approach Aggregate income is the total income earned by citizens and businesses in a country in a year * Aggregate income consists of: * Employee compensation * Rent * Interest * Profits Aggregate income = Employee compensation + Rents + Interest + Profits --- # Equality of Income and Expenditures .col-7[ * Whenever a good or service is produced (output), somebody receives an income for producing it `$$\text{Aggregate Income} \equiv \text{Aggregate Production}$$` * Profit is a residual that makes the income side equal the expenditures side * This aggregate identity allows us to calculate GDP either by adding up all values of final outputs (C, I, G, NX) or by adding up the values of all earnings or income ] .col-7[ ### Which Approach is the Right One? The answer depends on what you want to study: Want to understand business fluctuations? It's worthwhile to study the national spending approach. Want to study how the income from production is divided amongst people and resources? It's worthwhile to focus on the factor income approach. ] --- class: practice-slide # 5. .col-8[ a. Would spending on education be counted as investment in the GDP calculation? b. Would buying shares in a company be considered investment in the GDP calculation? ] --- class: practice-slide # 6. .row[.col-8[ Calculate GDP in this simple economy: ]] .row[ ] .col-8[ | Category | Amount | |---|---| |Consumer purchases:| $100 per year| |Investment purchases:| $50 per year| |Government purchases:| $20 per year| |Total exports:| $50 per year| |Total imports:| $70 per year| ] ??? Y = C + I + G + NX = $100 + $50 + $20 + ($50 - $70) = $150 per year --- ## Economic Welfare Over Time ![](fig01/unnamed-chunk-3-1.png)<!-- --> .row[.col-7[ Using GDP to compare the economy's performance over time is much better than relying on perceptions ]] .row[.col-6[ * GDP figures are affected by inflation: If increases in GDP are due to increases in prices, then welfare does not increase ] .col-6[ * Changes in welfare over time are best indicated by changes in **real GDP**: nominal GDP adjusted for inflation ]] --- # Inflation .col-7[ * **Inflation** is a continual rise in the price level * **Deflation** is a continual fall in the price level * Inflation and deflation are measured with changes in price indexes * **Price index** is a number that summarizes what happens to a weighted composite of prices of a selection of goods over time ] --- # Real and Nominal Concepts .col-7[ * Nominal GDP is the total amount of goods and services produced, measured at current prices * Real GDP is the total amount of goods and services produced, adjusted for price level changes `$$\text{Real Output} = \frac{\text{Nominal Output} \times 100}{\text{Price Index}}$$` `$$\text{GDP deflator} = \frac{\text{Nominal GDP}}{\text{Real GDP}} \times 100$$` ] --- class: practice-slide #7. By definition, is nominal GDP higher than real GDP? ??? No. The “price level” is just a number. The exact number is arbitrary so long as we use the same system to compare real GDP in different years.We could say the price level in year one is 100 and calculate that in year 10 the price level is 200, for example, or we could say that the price level in year one is 7 and calculate that in year 10 it is 14. It’s the same idea as with temperature; we can measure in the Fahrenheit scale or Celsius scale so long as when we compare two temperatures, we use the same scale. Bottom line is that nominal GDP could be higher or lower than real GDP, depending on how we define the price level. --- class: practice-slide # 8. .col-8[ If prices rise, people’s income from selling goods increases. The growth of real GDP ignores this gain. Why then, do economist prefer **real GDP** as a measure of economic well-being? ] --- class: practice-slide # 9. .col-8[ Suppose that the country of Atlantis is investing and exporting a great deal, while it imports little. What can you say about its level of national saving? Suppose the country of Olympus invests more than it saves. How can this be? ] ??? Atlantis must have high savings, as indicated by the identity Saving = Investment + Net Exports. Olympus must be borrowing, as indicated by the identity Saving = Investment – Net Foreign Borrowing. --- class: practice-slide # 10. .col-8[ What might be a potential problem if government debt is held by foreigners instead of the country’s citizens? ] ??? When government debt is held by foreigners (that is, overseas parties have bought government bonds), this adds to Net Foreign Borrowing for the nation as a whole. This can potentially put the country “in hock”—the funds raised from future taxpayers to pay interest and principle will need to flow to parties outside the country, decreasing prosperity inside the country. By contrast, internally held debt may have redistributive consequences within a nation in the future but it does not require a net outflow of funds to pay it down and therefore does not necessarily reduce future prosperity within the country. --- .row[.col-5[ # 11. Oxford analysts report that living standards in Britain are set to rise above those in America for the first time since the nineteenth century. Real GDP per person in Britain will be £23,500 this year, compared with £23,250 in America, reflecting not only the strength of the pound against the dollar but also the UK economy’s record run of growth since 2001. But the Oxford analysts also point out that Americans benefit from lower prices than those in Britain. Source: The Sunday Times, January 6, 2008 If real GDP per person is more in the United Kingdom than in the United States but Americans pay lower prices, does this comparison of real GDP person really tell us which country has the higher standard of living? ] .col-7[ ![](fig01/unnamed-chunk-4-1.png)<!-- --> ]] ??? This comparison does not determine which nation has a higher standard of living. The analysis uses the exchange rate to transform prices in one country into prices of the other country. But a more accurate analysis would use purchasing power parity (PPP) prices to value the goods and services in both countries. By using PPP prices, the analysis can better measure the goods and services available to citizens of each country. --- .row[.col-5[ # Comparing GDP ## Among Countries * Per capita GDP can be used to compare relative standards of living among various countries * Because of differences in non-market activities and difference in product prices, per capita GDP may be a misleading measure of living standards * **Purchasing power parity** adjusts for relative price differences before making comparisons ] .col-7[ ![](fig01/unnamed-chunk-5-1.png)<!-- --> ]] --- class: practice-slide # 12. .col-8[ You read a newspaper report that compares wages paid to employees at Starbucks in India and in the United Kingdom. At the time, 1 pound was equal to 87 rupees. The report says that Starbucks baristas in India are paid a mere 56 pence an hour, which is lower than the cheapest coffee that Starbucks sells in the United Kingdom. A friend of yours who read the report is appalled by this information and thinks that Starbucks ought to raise its salaries substantially in India. Is your friend necessarily correct? Explain your answer. ] ??? No, your friend is not necessarily correct. The flaw in the report is that it converts the wages paid in India to pounds using the current exchange rate but does not account for the cost of living (or the prices of goods) in India. So, while the wages paid to Starbucks employees in India may seem extremely low or exploitative, it is entirely possible that the cost of living in India is lower than the cost of living in the United Kingdom. If the cost of living in India is substantially lower than that in the United Kingdom, then the Starbucks employee in India is not necessarily worse off than a Starbucks employee in the United Kingdom. --- class: practice-slide .row[.col-7[ # 13. What are the disadvantages of using Big Macs to measure purchasing power parity? ] .col-5[ [Economist Big Mac Index](https://www.economist.com/big-mac-index) ![](img02/bigmac.png) ]] ??? The price of a Big Mac is used as an alternative measure of the exchange rate between two countries. One of the problems with using Big Macs to measure purchasing power parity is that, instead of a bundle of diverse goods, this index simply compares a bundle consisting of just one good. Also, Big Macs are only a very small fraction of people’s consumption, so their prices will not reflect true cost-of-living differences across countries. --- # The Benefits and Costs of Growth .col-7[ * Per capita economic growth allows everyone in society, on average, to have more * Growth, or the prediction of growth, allows governments to avoid hard questions * Growth comes with costs: * Pollution * Resource exhaustion * Destruction of natural habitat ] --- class: practice-slide # 14. .col-8[ Is GDP a good measure for national welfare? - What is human well-being about? Are there any alternative measures? ] ??? Real GDP is sometimes used to measure the standard of living but real GDP can be misleading for several reasons. Real GDP does not include household production, productive activities done in and around the house by the homeowner. Because these tasks often are an important component of people’s work, this omission creates a major measurement problem. Real GDP omits the underground economy, economic activity that is legal but unreported or that is illegal. In many countries the underground economy is an important part of economic activity, and its omission creates a serious measurement problem. The value of leisure time is not included in real GDP. People value their leisure hours and an increase in people’s leisure that enhances people’s economic welfare can lower the nation’s real GDP. Environmental damage is excluded from real GDP. So an economy wherein real GDP grows but at the expense of its environment, as was the case with Eastern European countries under communism, falsely appears to offer greater economic welfare than a similar economy that grows slightly more slowly but at less environmental cost. --- ## Some Limitations of Aggregate Accounting .col-7[ * GDP measures only official economic activity * GDP does not measure happiness, nor does it measure economic welfare * GDP does not count underground activity * GDP dies not count non-market production * results in biases over time (change from unpaid housework to paid nannies and housekeepers) * results in biases across nations (non-market activity is more prevalent in less developed countries) * GDP does not count leisure * GDP does not count Bads (environmental costs like pollution, loss of species, crime) * GDP does not measure the distribution of income ]