MACRO I
February 21nd, 2014
Class1. The Gross Domestic Product
Lecturer: Renata Ivanova
Classes: Friday, 12:00-15:00, room S6
Consultation: Fridays (after the class) or by appointment
Course page: http://is.muni.cz/el/1456/jaro2014/BPE_MAC1/
Textbook: Mankiw, N. G. (2012). Principles of Macroeconomics (any edition)
Course Info
• Class is a laptop and cell phones free zone
• Late arrivals will not be tolerated
• Active participation is encouraged
***
Assignments
ü Four homework assignments
ü Term project
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Grading
Final grade (100 %) = Midterm (20 %) +HW (20 %) +
+Term Paper (15 %) + Final (40 %) + Class Participation (5 %)
Class Policies
Macroeconomic goals
•Economic growth (increase in output)
•Price-level stability (low inflation)
•Full employment (low unemployment rate)
•External balance (avoiding trade deficit)
•
Policy tools
•Monetary policy: interest rate and money supply
•Fiscal policy: taxes and government spending
Introduction
What determines the level of economy’s output ?
Short run: several years
•Changes in demand
The IS-LM model (goods + financial markets)
Medium run: a decade
•Supply of factors
•Aggregate supply- Aggregate demand model (AD-AS)
Long run: several decades/ half a century and more
•Technological progress and factors’ accumulation
Time Dimension
Year
GDP (mil CZK)
1990
632,691
1991
815,579
1992
925,476
1993
1,144,645
1994
1,323,328
1995
1,533,676
1996
1,761,575
1997
1,884,924
1998
2,061,583
1999
2,149,023
2000
2,269,695
2001
2,448,557
2002
2,567,530
2003
2,688,107
2004
2,929,172
2005
3,116,056
2006
3,352,599
2007
3,662,573
2008
3,848,411
2009
3,758,979
2010
3,799,547
2011
3,841,370
2012
3,845,926
N!B!
Million = 1,000,000
Billion = 1,000,000,000
Trillion= 1,000,000,000,000
In 2012, GDP of Czech Republic ($):
3,845,926/19.58 = $196,4 billion
Source: Czech Statistical Office (CSU)
• Size of the economy
Czech Republic
Gross Domestic Product
(in current prices)
Source: IMF statistics database
Czech Republic: 51st place
How big is the Czech economy?
§ Production approach
GDP is a market value of all final goods and services produced within an economy in a given period
of time.
• GDP is a measure of output
• Is a single number expressed in monetary units
Why do we care?
Output is correlated with many important variables: standards of living, wages, unemployment,
inflation, budget and trade deficit.
Gross Domestic Product (GDP)
TE The US economy output in 2012: 2 airplanes + 5 hamburgers
GDP is a market value of all final goods and services produced within an economy in a given period
of time
Market value = Market price
Goods
Quantity (Q)
Unit Price (P)
Airplanes
2
$1,000,000
Hamburgers
5
$1
Adding Apples to Oranges
TE McDonald’s hamburger costs $1
Ingredients used for production (meat, veg., bread) cost $0.5 per hamburger
Contribution to GDP: $1 or $1+$0.5 ?
GDP is a market value of all final goods and services produced within an economy in a given period
of time
Final good/service: consumed by the end user and does not require further processing
Intermediate goods: used as inputs for production of other goods
N!B! Some goods can be both final and intermediate
To GDP will be included only $1 (price of a hamburger)
The value of intermediate goods is included in the market price of a final good
Multiple Counts
• Gross value added = Production – Intermediate consumption
• Increase in value that a business creates by undertaking the production process.
Producer
Price of output
Price of inputs
Value added
McDonalds
$1
$0.5
$ 0.5
Farmer
$ 0.5
$0
$ 0.5
Total
$1.5
$ 0.5
$1
GDP is the sum of value added in the economy during a given period
Contribution to GDP
• Firms pay taxes on the value added of their activities (VAT)
• Firms report sales
Value Added
• You are buying a Rembrandt’ s painting from
another collector at the price of 1,000,000 Euros
• You are buying stuff at your neighbor’s
garage sale for 20 CZK
What is the contribution to GDP?
GDP is a market value of all final goods and services produced within an economy in a given period
of time
GDP includes only the value of currently produced goods and services
• Resale of goods represents a transfer of an asset
None
Used Goods
TE Czech Beer Factory operating in Slovakia
GDP is a market value of all final goods and services produced
within an economy in a given period of time
• within a country’s boarder
• Output of Volkswagen operating in CR is counted in Czech GDP
Gross national product (GNP) is a market value of all final goods and services produced in a given
period of time using factors of production owned by the residents of a country
GDP vs. GNP (Output vs. Location)
Does not account for
• Goods and services not sold in the market (home production, child care)
• Underground economy: legal activities hidden from government and illegal activities
• Imputed values
Assumption: The level of inaccuracy in GDP calculations is roughly constant from year to
year
=> Inaccuracy can be neglected
GDP Accuracy
Fundamental identity
Total production = Total income = Total expenditure
2. Income method
Def III: GDP is a nation’s total income
3. Expenditure method
GDP is the total expenditure on national output of goods and service
GDP: Three Equivalent Approaches
Firms
Households
Labor
THE CIRCULAR FLOW MODEL OF MARKET ECONOMY
Bicycles
Expenditure ($)
Income ($)
The rule of accounting: Expenditure of buyers = Income of sellers
Assumptions
• A closed economy (no international trade)
• No government
• No savings
•
Injections
• Government spending (G)
• Exports (EX)
• Investments (I)
•
Leakages
• Taxation (T)
• Imports (IM)
• Savings (S)
The Circular Flow Model
GDP: Expenditure Approach
• Group I: Households
• Group II: Businesses
• Group III: Government
• Group IV: Foreign sector
GDP: Expenditure Approach (Cont.)
§ The National Income Account Identity for an open economy
§
§
§
§
§
§
§
§
§
§
§
§
§
§
§
Y – total output (production)
GDP of Czech Republic: Expenditure Approach
Source: Czech Statistical Office. Ministry of development planning and statistics
Expenditure category
Czech Republic
?
Consumption
71.1%
26.9%
Investment
23.3%
35.3%
Net export
5.6%
37.8%
GDP
100%
100%
TE Consider an economy consisting of two firms
Firm 1: Steel producer
Revenues from sale: €100
Wages: €80
Profit: €20
What is the GDP?
Firm 2: Car manufacturer
Revenues from sale cars: €200
Wages: €70
Profit: €30
Production approach:
€200
Income approach:
€80+ €20 + €70+ €30 = €200
Expenditure approach:
€200
Value added approach:
€100+ (€200- €100) = €200
GDP: Three Equivalent Approaches (Cont.)
• Goods produced in a certain period but not sold
•
TE A farm fails to sell milk and the milk spoils
Is GDP affected?
• Spoiled milk is not sold – no effect on consumer expenditure
• The farm does not obtain addition revenue
• The farm’s revenue after subtracting wages shrinks
=> Neither total expenditure, nor total income are affected
TE The milk is put into inventory to be sold latter
Is GDP affected?
• The farm “purchases” milk for its inventory – total expenditures are affected
• The farm gets additional revenue => additional profit => income is affected
• Later sale out of inventory is treated as a sale of used goods
NO
NO
Treatment of Inventories
§ Housing services
• Home owners pay a “rent” to themselves
• Included in homeowner expenditures and income
Imputed rent: how much it would cost to rent out the owner’s dwelling unit
In the case of no imputations, what effect would the increase in house ownership have on GDP?
§ Government services (Police officers, politician, etc.)
• Wages are used as a value of service
Services and Imputations
GDP would decline
üGDP is a measure of aggregate output
üApproaching from production or income side
ü Aggregate production = Aggregate income = Aggregate expenditure
THREE EQUIVALENT APPROACHES
üGDP as the total expenditure on final goods output
üGDP as a sum of value added
üGDP as a sum of income
• In a given period of time
• In a particular economy
Summary
.
• A purchase of tires by an automobile manufacturer for the installation on a new line of cars
Which of the following will be counted in GDP?
• A purchase of the “Principles of Economics” textbook for our course. After the course, you sell
your text book to a friend who will take the course next semester.
• The value of the teaching service provided by a lecturer to students
• Your haircut made by a friend
• A purchase of aprons by restaurant chefs
• A house constructed in 1950 and sold in 2012
• Sale of the last year fashion collection by ZARA
What are the reasons for such increase in GDP?
•
Comparison Over Time
Nominal values: expressed in current prices
Nominal GDP in 2011-2012
=> Changes in quantity produced or/and prices of goods
Real values: expressed in constant prices
The base year approach: Fixing prices by choosing a base year (2011)
N!B! Nominal GDP = Real GDP in the base year
Real GDP
Year
Nominal GDP
Real GDP
2000
2,269,695.00
2,550,148.00
2001
2,448,557.00
2,629,135.00
2002
2,567,530.00
2,685,643.00
2003
2,688,107.00
2,786,789.00
2004
2,929,172.00
2,918,955.00
2005
3,116,056.00
3,116,056.00
2006
3,352,599.00
3,334,815.00
2007
3,662,573.00
3,526,071.00
2008
3,848,411.00
3,635,344.00
2009
3,758,979.00
3,471,494.00
2010
3,790,880.00
3,557,216.00
2011
3,823,401.00
3,621,908.00
2012
3,845,926.00
3,584,924.00
GDP of Czech Republic
What is the base year?
TE Consider again the pizza-producing economy
• Real GDP (100=2005): Real GDP in 2005 prices
N!B! Change in the base year will lead to different levels of real GDP
Year
Q
P ($)
Nominal GDP
Real GDP (100=2005)
Real GDP (100=2000)
2000
10
5
2005
10
8
2012
15
10
50
80
150
80
80
120
50
50
75
Real GDP (Cont.)
• Percentage change in the quantity of goods produced from year to year
• Growth rate
Year
Q
P ($)
Nominal GDP
Growth rate (%)
2010
10
5
50
--
2011
10
8
80
60
2012
15
10
150
87.5
GDP Growth Rate
• Nominal GDP growth rates reflect changes in both Q & P
Year
Q
P
Nominal GDP
Growth rate (%)
Real GDP (100=2005)
Growth rate (%)
2010
10
5
50
--
80
--
2011
10
8
80
60
80
0
2012
15
10
150
87.5
120
50
Will the real GDP growth rates be affected by the change in the base year?
GDP Growth Rate (Cont.)
NO
GDP Growth Rate (Cont.)
Pizza
Haircuts
Nominal GDP ($)
Year
Q
P ($)
Q
P($)
2011
10
5
5
3
65
2012
15
10
10
5
200
TE Multiple goods
TE Real GDP
TE Real GDP growth rate
Real GDP: The Chain-Weighted Approach
• The value of output expressed in base year (constant) prices
•
Þ Any changes in real GDP are due to changes in quantity of the output only
§ Issues with the base year approach
•The GDP growth rate is affected by the choice of the base year
What year to be used as the base year?
•In practice, the base year is changed every 5 years and GDP is recalculated
What are the consequences? => Economic performance is different
C-W approach updates prices every year => more accurate
Real GDP: The Chain-Weighted Approach (Cont.)
Three steps procedure
Calculating change in real GDP between year t and year t+1
Step 1.
• Use year t as a base year => Real GDP => growth rate
• Use year t+1 as a base year => Real GDP => growth rate
Step 2. Calculate the average of two growth rates
=> Chain-weighted real GDP growth rate
Real GDP: The Chain-Weighted Approach (Cont.)
Step 3. Construct the real GDP index
• Chose an arbitrary base year: 2011
• Nominal GDP in the base year is equal to real GDP
• Chain-weighted real GDP in the following year
•
•
•
N!B! For the years before the base year
Chain to the base year: in order to calculate next year real GDP, we need to know the previous year
figure
GDP as a Measure of Well-Being (Cont.)
Source: Mankiw , G. (2011). Principles of Economics
N!B! GDP is correlated with a well-being indicators, but is an imperfect measure of the well-being
itself
Happiness index
Income per capita (USD)
Next class: Economic Growth
N!B! Reading Assignment: Textbook + Handout