Chapter 02 Flashcards
Gross domestic product GDP
is often considered the best measure of how well an economy is performing.
What is GDP
The total income of everyone in the country, or the total expenditure of the economy’s output of goods and services.The more income people earn in an economy, the more they can afford the goods and services they want.
How can GDP measure the economy’s income and expenditure on output at the same time
It can do so because these two quantities are really the same. For the economy as a whole, income must equal expenditure. This equality follows from an even more fundamental fact: Because every transaction has a buyer and a seller, every dollar of expenditure by a buyer must become a dollar of income to a seller.
Stocks and Flows
Many economic variables measure a quantity of something — a quantity of money, a quantity of goods, and so on. Economists distinguish between two types of quantity variables: stocks and flows. A stock is a quantity measured at a given point in time, whereas a flow is a quantity measured per unit of time.
Stock
a quantity measured at a given point in time. Examples: Capital Stock,
Money Supply, National Debt, Wealth
Flow
a quantity measured per unit of time. Examples: GDP (tells us how many dollars are flowing around the economy per unit of time.), Investment, Government Budget deficit
Examples stocks vs flows
-A person’s wealth is a stock; his income and expenditure are flows.
-The number of unemployed people is a stock; the number of people losing their jobs is a flow.
-The amount of capital in the economy is a stock; the amount of investment is a flow.
-The government debt is a stock; the government budget deficit is a flow.
Precise definition of GDP
is the market value of all final goods and services produced within an economy in a given period of time
Used goods (gdp)
Used goods do not account to the value of CURRENTLY PRODUCED GOODS AND SERVICES. So, it does not account for GDP. For example an old rare trading card merely reflects an exchange of assets between two people but not an addition to the economy’s income
Imagine a bakery hires workers to produce more bread, pays them wages, and then fails to sell the additional bread. How does this transaction affect GDP?
The answer depends on what happens to the unsold bread. If bread spoils, there is no affect on GDP. If it is put into inventory to be sold later, the owners of the firm are assumed to have “purchased” the bread for the firm’s inventory, and the firm’s profit is not reduced by the additional wages it has paid. Because the higher wages paid to the firmʼs workers raise total income, and the greater spending by the firmʼs owners on inventory raises total expenditure, the economyʼs GDP rises.
Intermediate goods
suppose a cattle rancher sells one- quarter pound of meat to McDonaldʼs for $1, and then McDonaldʼs sells you a hamburger for $3. Should GDP include both the meat and the hamburger (a total of $4) or just the hamburger ($3)?
The answer is that GDP includes only the value of final goods. Thus, the hamburger is included in GDP, but the meat is not: GDP increases by $3, not by $4. To add the intermediate goods to the final goods would be double counting — that is, the meat would be counted twice.
Imputations
Although most goods and services are valued at their market prices when computing GDP, some are not sold in the marketplace and therefore do not have market prices. If GDP is to include these goods and services, we must use an estimate of their value. Such an estimate is called an imputed value.
Underground economy
no imputation is made for the value of goods and services sold in the underground economy. The underground economy is the
part of the economy that people hide from the government either because they wish to evade taxation or because the activity is illegal. Examples include domestic workers paid “off the books” and the illegal drug trade.
Real GDP vs Nominal GDP
Economists call the value of goods and services measured at current prices nominal GDP. Notice that nominal GDP can increase either because prices rise or because quantities rise. (P*Q) this measure does not accurately reflect how well the economy can satisfy the demands of households, firms, and the government.
real GDP, which measures the value of goods and services using a constant set of prices. That is, real GDP shows what would have happened to expenditure on output if quantities had changed but prices had not. (P of year X * Quantity current year)
GDP Deflator
The GDP deflator is the ratio of nominal GDP to real GDP = NGDP/RGDP. it reflects whatʼs happening to the overall level of prices in the economy. The GDP deflator measures the price of output relative to its price in the base year.
Chain-Weighted Measures of Real GDP
We have been discussing real GDP as if the base-year prices used to compute this measure never change. If this were true, over time the prices would become more and more dated. To solve this problem, the BEA. now uses chain-weighted measures of real GDP. With these new measures, the base year changes continuously over time. In essence, average prices in 2020 and 2021 are used to measure real growth from 2020 to 2021, average prices in 2021 and 2022 are used to measure real growth from 2021 to 2022, and so on. These various year-to-year growth rates are then put together to form a “chain” that can be used to compare the output of goods and services between any two dates.
Working with percentage changes / useful arithmetic
- The percentage change of a product of two variables is approximately the sum of the percentage changes in each of the variables. % change in P*Y somewhate = % change in P + % change in Y.
2.The percentage change of a ratio is approximately the percentage change in the numerator minus the percentage change in the denominator. I.e. % change in (Y/L) somewhat = % change in Y - % change in L.
Components of Expenditure
The national income divides GDP into four BROAD categories of speding.
- Consumption C
- Investment I
- Government Purchases (G)
- Net Exports (NX)
Y=C+I+G+NX
Consumption (C)
Consists of household expenditures on goods and services.
Investment
consists of items bought for future use. Investment is divided into three subcategories: business fixed investment, residential fixed investment, and inventory investment. (buying a house is considered investment not consumption)
Government purchases
the goods and services bought by federal, state, and local governments. This category includes such items as military equipment, highways, and the services provided by government workers. It does not include transfer payments to individuals, such as Social Security and welfare. Because transfer payments reallocate existing income and are not made in exchange for goods and services, they are not part of GDP.
Net Exports
accounts for trade with other countries. Net exports are the value of goods and services sold to other countries (exports) minus the value of goods and services that other countries sell to us (imports). Net exports are positive when
the value of our exports exceeds the value of our imports and negative when the value of our imports exceeds the value of our exports.
Other Measures of Income (Gross National Product)
GNP = GDP + Factor payments from abroad - Factor payments to abroad.
, we add to GDP receipts of factor income (wages, profit, and rent) from the rest of the world and subtract payments of factor income to the rest of the world.
Whereas GDP measures the total income produced domestically, GNP measures the total income earned by nationals (residents of a nation). For instance, if a Japanese resident owns an apartment building in New York, the rental income he earns is part of U.S. GDP because it is earned in the United States. But because this rental income is a factor payment to abroad, it is not part of U.S. GNP
Seasonal Adjustment
All these measures of income exhibit a regular seasonal pattern. The output of the economy rises during the year, reaching a peak in the fourth quarter (October, November, and December) and then falling in the first quarter (January, February, and March) of the next year. These regular seasonal changes are substantial. From the fourth quarter to the first quarter, real GDP falls on average about 8 percent
Measuring the cost of living: The Consumer Price Index (CPI)
CPI turns the prices of many goods and services into a single index measuring the overall level of prices. The CPI is the price of this basket of goods and services relative to the price of the same basket in some base year.
For example, suppose that the typical consumer buys five apples and two oranges every month. Then the basket of goods consists of five apples and two oranges, and the CPI is
Core inflation
measures the increase in price of a consumer basket that excludes food and energy products. Because food and energy prices exhibit substantial short-run volatility, core inflation is sometimes viewed as a better gauge of underlying inflation trends.
Many times, however, core inflation is used as a measure to “mask” inflation from consumers.
Differences between CPI and GDP deflator
- GDP deflator measures the prices of all goods and services produced, CPI only the goods and services bought by the consumers.
- GDP deflator includes only those goods produced domestically. Imported goods are not part of GDP and do not show up in the GDP deflator, but it shows up in the CPI.
- Most subtle difference… The CPI assigns fixed weights to the prices of different goods, whereas the GDP deflator assigns changing weights. In other words, the CPI is computed using a fixed basket of goods, whereas the GDP deflator allows the basket of goods to change over time as the composition of GDP changes.
Substitution bias
A fixed basket tends to overstate the increase in the cost of living because it does not take into account that consumers can substitute goods whose relative prices have fallen for goods whose relative prices have risen. this is called the substitution effect.
PCE deflator - personal consumption expenditures
Rather than reflecting all of GDP, it is based on just the consumption component. PCE deflator is calculates as the ratio of nominal consumer speanding to real consumer spending.
Like the CPI, the PCE deflator includes only the prices of goods and services that consumers buy, and it includes the prices of imported goods. But, like the GDP deflator the PCE deflator allows the basket of goods to change over time as the composition of consumer spending changes. Because of this mix of attributes, the Federal Reserve uses the PCE deflator as its preferred gauge of inflation
Ways the CPI overstate inflation
- Substitution bias - Because the CPI measures the price of a fixed basket of goods, it does not reflect the ability of consumers to substitute toward goods whose relative prices have fallen.
- Introduction of new goods. When a new good is introduced into the marketplace, consumers are better off because they have more products from which to choose.
- unmeasured changes in quality. When the quality of a good changes, the change in the goodʼs price reflects not only a change in the cost of living but also the quality change.
Unemployment Rate
Employed - has a job. also includes those who were not working but who
had jobs from which they were temporarily absent due to, for example, vacation, illness, or bad weather.
Unemployed. This category includes those who were not employed, were available for work, and had tried to find employment during the previous four weeks. It also includes those waiting to be recalled a er a temporary layoff.
Not in the labor force. This category includes those who fit neither of the first two categories, such as a full-time student, homemaker, or retiree. Notice that a person who wants a job but has given up looking — a discouraged worker — is counted as not being in the labor force.
The labor force is the sum of the employed and unemployed, and the unemployment rate is the percentage of the labor force that is unemployed. That is, UE rate = #of unemployed/ labor force.
Labor force participation rate
the percentage of the adult population that is in the labor force: = LF / Adult Pop.
- _______GDP measures the value of the economyʼs output at current prices and is a _______ variable.
B. Nominal, flow
- The largest component of GDP is
Consumption
. The Ford Motor Company makes a car in 2020 and sells it to
the Jones family in 2021. This event increases
d. consumption in 2021 and GDP in 2020.
- If nominal GDP and real GDP both rise by 10 percent, then
the GDP deflator
d. is unchanged.
. Which of the following events would affect the CPI but not the GDP deflator?
B. Volvo, the Swedish auto maker, raises the prices of the cars it sells in the United States.
If a person quits his job to become a stay-at-home parent,
the labor-force participation rate ______ unemployment rate _______
falls, rises
