Aggregate Output, Prices, and Economic Growth Flashcards
What are the broad categories that affect the overall level of activity in a country?
- level of inflation
- unemployment level
- consumption
- govt spending
- investment
Aggregate output of a country
- the value of all goods and services produced during a per
Aggregate income of an economy
- the value of all payments earned by the suppliers of the factors used in the production of G/S
- wages, rent, interest for lending funds, profits
Aggregate expenditure
the total amount spend on G/S produced in an economy during a given per
- aggregate expenditure = aggregate output = aggregate income
The two ways of defining GDP:
- the aggregate income earned by all households, all companies, and the government in a given period of time
- the market value of all FINAL G/S produced within an economy in a given period of time
- only counted if G/S was produced during the measurement period
- includes G/S input prices (but excludes commuting to work and by products like air/water pollution)
- uses market value of FINAL G/S: intermediate goods are not included, (ie a car’s final value is included, but not the tires, dashboard, whipers and other intermediate goods. Those are all rolled up into the final value)
The ways to calculate GDP
- income approach: the total income earned by households, businesses, and the government
expenditure approach: the total amount spent on G/S. it has two methods
1. sum-of-value-added method
2. value-of-final-output-method
each will equal the same
Nominal GDP measures
- measures the value of G/S at their current prices
NGDP = current Q * current P
Real GDP measures
- current-year output using prices from a base year. This eliminates the effect of inflation
- RGDP reflects the actual quantity of output available for consumption and investment
RGDP = current Q * base yr P
GDP deflator is
- used to measure inflation across all sectors
- reported as a price index number used to convert NGDP into RGDP by removing the effects of changes in price
GDP deflator equations
= (NGDP / RGDP) * 100
= (current yr Q * current yr P) / (current yr Q * BASE yr P) * 100
The major components of GDP based on the expenditure approach:
C - consumer spending on FINAL G/S
I - gross private domestic investment and delta inventory
G - government spending on FINAL G/S; both current consumption and investment in capital goods
X-M - net exports (exports - imports)
GDP formula for expenditure approach
GDP = C + I + G + (X-M)
Savings (S)
- part of income of households is saved
National Savings: total savings by households, business, and govt
Investment (I)
- the purchase of new capital (PPE) and inventory
- excludes labor
- it is financed by household S and capital flow from ROW
Transfer payments that the govt makes for unemployment and health care are
- are NOT included in government expenditure (G)
if G > T,
there is a fiscal deficit
Trade deficit:
- if domestic savings is less than domestic investment + government fiscal balance
aka - the economy is spending more on imports than foreign countries are spending on domestic G/S
Gross domestic income =
GDI = compensation of employees + gross operating surplus + gross mixed income + taxes on production + taxes on products and imports + statistical discrepancy
GDI = E + GOS + GMI + T + SD
Personal income definition and formula:
AKA primary household income
- measures the consumers’ ability to make purchases
PI = compensation of employees + net mixed income from unincorporated businesses + net property income
Household disposable income
Household net savings
HDI
- measures the amount of after-tax income that households have to spend on G/S
HDI = personal income - next current transfers paid
Household net savings = HDI - household final consumption expenditures + net change in pension entitlements
Net domestic income =
= GDP - consumption of fixed capital - statistical discrepancy
Aggregate expenditure = aggregate income
C + I + G + (X - M) = C + S + T
C + I + G + (X - M) = C + S + T can be rewritten as:
- S = I + (G - T) + (X - M)
- G - T = (S - I) - (X - M) (govt fiscal deficit in terms of private savings, investments and net exports
- S - I = (G - T) + (X - M)
Marginal propensity to save (MPS) =
= 1 - MPC
Because of declining in housing costs, savings are up. Assume investment and fiscal deficit are unchanged. What is the impact on net exports and capital outflows?
S = I + (G - T) + (X - M)
- if I and G-T are unchanged and S increased, then net exports must also increase
- if net exports increase (imports decrease or total exports increases), then money is lent to foreigners
- when S increases, capital outflows also increase
Aggregate demand and aggregate supply
- AD: the quantity of G/S demanded by consumers at any given price level
- AS: the amount of G/S firms will produce in an economy (real GDP) at any given price level
If the govt deficit increases and net exports remain constant, then the excess of private savings over private investments must:
increase
(G - T) = (S - I) - (X - M)
INC FLAT
must INC to balance
If interest rates increase then,
- real money demand decreases
- investment decreases
- savings decreases
AD curve:
- y-axis: avg price level in an economy using and an indicator such as GDP deflator
- x-axis: income, output, Real GDP, Y. We move along the AD curve as income also changes along with output. which is different than in micro econ
The AD curve is downward sloping because of 3 factors:
- wealth effect
- interest rate effect
- real exchange rate effect
Real exchange rate effect: and increase in price levels then
- P increases causes RER to increase
- so the domestic currency appreciates
- which makes dom goods more expensive to foreigners, which reduces exports, imports increase
the overall impact is a decrease of domestic G/S
AS curve:
- very short run AS
- short run AS
- long run AS
- very long run AS
VRAS
- curve is almost flat: firms will increase or decrease output without changing prices
SRAS
- upward sloping: a decrease in P will reduce the Q supplied
- labor and capital are sticky in the SR
LRAS
- curve is vertical at a given level of output
- called “potential GDP”
- called “full-employment GDP”
VLRAS
- there is a shift in the LRAS when costs of production change
Price levels increasing cause …
- movements on the AD curve, not shifts
Shifts in AD curve: - consider an increase in the following factors, the shift is R or L stock prices housing prices consumer confidence business confidence capacity utilization - (Fiscal policy) govt spending taxes - (Monetary policy) bank reserves exchange rates
global growth
stock prices R housing prices R consumer confidence R business confidence. R capacity utilization R - (Fiscal policy) govt spending R taxes L: higher taxes = lower disposable income = lower consumption = lower investment by businesses - (Monetary policy) bank reserves R exchange rates L: domestic currency is stronger; lower exports, higher imports. NET EXPORTS ARE LOWER
global growth R: exports increase to emerging markets
Shifts in AS curve:
- consider an increase in the following factors, the shift is R or L
Effects both LRAS and SRAS supply of labor supply of natural resources supply of human capital supply of physical capital productivity and technology
effects SRAS only nominal wages input prices expectations of future prices business taxes subsidy exchange rates
Effects both LRAS and SRAS supply of labor R supply of natural resources R supply of human capital R supply of physical capital R productivity and technology R
effects SRAS only
nominal wages L: inc cost of production, wages are largest component of firm’s costs
input prices L: inc cost of production
expectations of future prices R
business taxes L: inc cost of production
subsidy R
exchange rates R: lowers cost of production
A leftward shift in the AD curve causes:
a recessionary gap
- lower GDP and lower prices
- unemployment increases
- equilibrium GDP is below potential GDP
decreases:
- corporate profits
- commodity prices
- interest rates
- demand of credit
A rightward shift in the AD curve causes:
an inflationary gap
- output and prices increase
- SR equilibrium GDP is above potential GDP
- economy is over-utilizing its resources, workers are putting in more hours
- wage pressure and input prices increase
increases:
- corporate profits, commodity prices, interest rates, and inflationary pressures
A leftward shift of SRAS causes…
STAGFLATION
- output decreases
- unemployment levels increase
- prices increase
- in short - high unemployment and increased inflation
Per capita GDP formula
= overall GDP / size of population
- tells us if the standard of living is improving or not
- GDP needs to grow at a higher rate than the population to improve
Sustainable rate aka
- productive capacity or
- potential GDP
Diminishing marginal productivity’s implication on potential GDP:
- it is not sustainable to grow an economy by adding more and more capital in the LR
- but, adding more capital in developing countries leads to substantially higher productivity (a higher rate of output) relative to developed countries
Growth accounting equation
Growth in potential GDP = growth in tech + growth in labor + growth in capital
growth in tech = 2 (intercept)
share of labor in national income = .7
share of capital in national income = .3
if all stays constant, a 1% growth in labor will result in 0.7% growth in potential GDP
or, if all stays constant, a 1% growth in capital will result in 0.3% growth in potential GDP
Sources of economic growth
- increase in labor supply
- increase in human capital
- increase in physical capital
- investments in technology
- natural resources
- public infrastructure
- R&D and public education
**technology is the main factor that affects economic growth in developed countries
Potential GDP equations
PGDP = aggregate hours worked * labor productivity
PGDP = long-term growth rate of labor force + long-term labor productivity growth rate
labor productivity can be used to est the rate of sustainable growth of the economy and differences in living standards
Which of the following is the most practical approach to estimate sustainable growth rate?
Weighted average of capital and labor growth rates.
Growth in labor force plus growth of labor productivity.
Growth in total factor productivity plus growth in the capital-to-labor ratio.
Growth in labor force plus growth of labor productivity.
B is correct.
Potential GDP = Aggregate hours worked * Labor productivity.
Potential growth rate = long-term growth rate of labor force + long-term labor productivity growth rate.
Labor productivity = Real GDP / Aggregate hours
Y / L = A * F (1, K / L)
An increase in any of the factors – capital, technology – improves productivity of the labor force.
Output growth is equal to the growth rate of labor force plus the growth rate of labor productivity i.e. output per worker. Unlike total factor productivity, output per worker is observable, so this is the most practical way to approach estimation of sustainable growth rate.
