Measuring and modeling the economy Flashcards
What is the GDP?
Gross Domestic Product (GDP) = is the total monetary or market value of all the finished goods and services produced within a country’s borders in a specific time period.
As a broad measure of overall domestic production, it functions as a comprehensive scorecard of a given country’s economic health.
What is disposable income?
An accurate general definition of income is not easy to provide. Income includes wages and salaries, interest and dividend payments from financial assets, and rents and net profits from businesses.
income remaining after deduction of taxes and social security charges, available to be spent or saved as one wishes.
GDP per capita ≠ Disposable income
How is the GDP measured in national accounts?
There are 3 equivalent ways to measure GDP:
- Total spending on domestic products.
- Total domestic production (measured as value added, i.e. the increase in value of aproduct or service as it goes through the stages of being developed and produced).
- Total domestic income.
How do we account for international transactions in GDP?
Foreign production is domestic consumption (imports); or domestic production is foreign consumption (exports)
→ We include exports and exclude imports, so that GDP includes value added, income from, or consumption of, domestic production.
How do we incorporate government in GDP?
→ Treat it as another producer – public services are “bought” via taxes
→ Assume that cost of production captures the value added
What are the components of the GDP?
- Consumption (C) = Expenditure on consumer goods and services
- Investment (I) = Expenditure on newly produced capital goods (incl. equipment, buildings, and inventories = unsold output)
- Government spending (G) = Government expenditure on goods and services (excluding transfers to avoid double-counting)
- Net exports (trade balance) = Exports (X) minus Imports (M)
GDP = C + I + G + X – M (Also known as Y, or aggregate demand, used to measure growth)
Economic growth vs development
Growth: the increase of income or national product (gross domestic product).
Economic growth is measured by:
- dividing the GDP by the number of inhabitants (GDP or per capita income).
- calculating the percentage increase in GDP compared to the previous period.
Development: the improvement of the well-being (wealth) and the quality of lifeof a community of people belonging to a specific country or region.
Economic development is measured by:
– quantitative economic indicators, but also qualitative and extra-economic factors, such as the literacy rate of the community, life expectancy, income distribution, quality of the environment,
etc.
What is the Human Development Index?
An alternative way of measuring development by combining indicators of life expectancy,
education, and income into a composite index called the HDI: Human Development Index.
It is a measure that frames both economic and social development.
The HDI defines minimum and maximum values (goalposts) for each dimension and shows
where each nation is, within these ranges, with a value of 0 -1.
What is an economic model?
An economic model is a simplified description of reality, designed to yield hypotheses about economic behavior that can be tested. An important feature of an economic model is that it is necessarily subjective in design because there are no objective measures of economic outcomes.
What happens in an economy depends on the actions and interactions of millions of people. Models are used to see the big picture.
To create an effective model we need to distinguish between: • the essential features of the economy that are relevant to the question we want to answer, which should be included in the model. Unimportant details that can be ignored
Models necessarily omit many details. This is their feature, not a bug.
How to build an economic model?
- Capture the elements of the economy that we think matter for our question
- Describe how agents act, and how they interact with each other and the elements of the model
- Determine the outcomes of these actions (an equilibrium)
- Study what happens when conditions change
Equilibrium of a model = situation that is self-perpetuating. Something of interest does not change unless an external force is introduced that alters the model’s description of the situation.
What is a good model?
It is clear: it helps us better understand something important
It predicts accurately: its predictions are consistent with evidence
It improves communication: it helps us to understand what we agree (and disagree) about
It is useful: We can use it to find ways to improve how the economy works
Less is more: simplification that involves “holding other things (in/outside the model) constant”: keep it simple…but not simpler
What is the basic model for measuring economic growth?
The basic model for studying economic growth consists of three functions:
- the production function, given by the relationship between the size of national income and the quantities of production factors used to generate it;
- The savings function, which determines the proportionality with respect to income;
- The capital function that links savings to the amount of the capital stock.
What is the production function?
The production function, in economics, is an equation that expresses the relationship between the quantities of productive factors (such as labour and capital) used and the amount of product obtained.
What is the Cobb-Douglas production function?
In 1928, Charles Cobb and Paul Douglas presented the view that production output is the result of the amount of labor and physical capital invested. This analysis produced a calculation that is still in use today, largely because of its accuracy.
The Cobb-Douglas production function reflects the relationships between its inputs - namely physical capital and labor - and the amount of output produced. It’s a means for calculating the impact of changes in the inputs, the relevant efficiencies, and the yields of a production activity.
Y = Kα× Lβ× Rδ
Y = size of national income per year, K = size of the capital stock, L =amount of labour used, and R = amount of natural resources used. While α, β and δ are the parameters of the function.
When a Cobb–Douglas production function satisfies the condition α + β + δ = 1 it is said to exhibit constant returns to scale.
What is the capital function?
The capital function describes how the stock of capital evolve over time, thanks to investments:
Kt = Kt-1 + It
where Kt−1 is the size of the capital stock at the beginning of year t, Kt is its size at the end of that year, and It is investment during the year t. Here, for simplicity, the capital does not depreciate, then there is no distinction between gross and net investment.
