200566115302

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Published on April 13, 2008

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Principles of Economics:  Principles of Economics Session 10 Topics To Be Covered:  Topics To Be Covered Macroeconomics vs. Microeconomics History of Macroeconomics Major Concerns of Macroeconomics Objectives of Macroeconomics Instruments of Macroeconomics Markets and Players of Macroeconomics Topics To Be Covered:  Topics To Be Covered Definition of Gross Domestic Product Measurement of GDP GDP, GNP, NNP, NI, PI, and DPI Price Indexes AS, AD, and Macroeconomic Equilibrium Macroeconomics vs. Microeconomics:  Macroeconomics vs. Microeconomics Microeconomics is the study of how individual households and firms make decisions and how they interact with one another in markets. Macroeconomics is the study of the economy as a whole. Its goal is to explain the economic changes that affect many households, firms, and markets at once. History of Macroeconomics:  History of Macroeconomics The Great Depression was a period of severe economic contraction and high unemployment that began in 1929 and continued throughout the 1930s. History of Macroeconomics:  History of Macroeconomics Classical economists applied microeconomic models, or “market clearing” models, to economy-wide problems. The failure of simple classical models to explain the prolonged existence of high unemployment during the Great Depression provided the impetus for the development of macroeconomics. History of Macroeconomics:  History of Macroeconomics In 1936, John Maynard Keynes published The General Theory of Employment, Interest, and Money. Keynes believed governments could intervene in the economy and affect the level of output and employment. Fine-tuning was the phrase used to refer to the government’s role in regulating inflation and unemployment. History of Macroeconomics:  History of Macroeconomics The use of Keynesian policy to fine-tune the economy in the 1960s, led to disillusionment in the 1970s and early 1980s. Stagflation occurs when the overall price level rises rapidly (inflation) during periods of recession or high and persistent unemployment (stagnation). Major Concerns of Macroeconomics:  Major Concerns of Macroeconomics Macroeconomics answers questions like: Why do production expand in some years and contract in others? Why do prices rise rapidly in some time periods while they are more stable in others? Why are some people unable to have the opportunity to work although they do want to work? Major Concerns of Macroeconomics:  Major Concerns of Macroeconomics Output (GDP change) Price level (Inflation) Employment (Unemployment) Objectives of Macroeconomics:  Objectives of Macroeconomics Output growth Stable prices High employment Instruments of Macroeconomics:  Instruments of Macroeconomics Macroeconomic tools mainly consist of fiscal policy and monetary policy. Fiscal policy refers to government policies concerning taxes and expenditures. Monetary policy consists of tools used by the central bank to control the money supply. Markets and Players of Macroeconomy:  Markets and Players of Macroeconomy Markets and Players of Macroeconomy:  Markets and Players of Macroeconomy Markets and Players of Macroeconomy:  Markets and Players of Macroeconomy Households and the government purchase goods and services from firms in the goods-and services market, and firms supply to the goods and services market. In the labor market, firms and government purchase labor from households. Markets and Players of Macroeconomy:  Markets and Players of Macroeconomy The financial market consists of money market, capital market, and foreign exchange market in the open economy. In the money market, the government (central bank) supplies money and households and firms demand money for transaction and speculation. Markets and Players of Macroeconomy:  Markets and Players of Macroeconomy In the capital market, households purchase stocks and bonds from firms. In the foreign exchange market, those who want to invest in foreign countries exchange domestic currency for foreign currencies, while those foreigners who want to invest in this country supply foreign currencies and demand domestic currencies. Gross Domestic Product:  Gross Domestic Product GDP is the market value of all final goods and services produced within a country in a given period of time. Gross Domestic Product:  Gross Domestic Product GDP is the best single measure of the economic well-being of a society. GDP per person tells us the income and expenditure of the average person in the economy. Higher GDP per person indicates a higher standard of living. Gross Domestic Product:  Gross Domestic Product Country Real GDP per Person (1997) Life Expectancy Adult Literacy United States $29,010 77 years 99% Japan 24,070 80 99 Germany 21,260 77 99 Mexico 8,370 72 90 Brazil 6,480 67 84 Russia 4,370 67 99 Indonesia 3,490 65 85 China 3,130 70 83 India 1,670 63 53 Pakistan 1,560 64 41 Bangladesh 1,050 58 39 Nigeria 920 50 59 Gross Domestic Product:  Gross Domestic Product It is estimated that: China's GDP will surpass that of France in 2005 China is expected to become the world's third economic power in 2020 China is likely to outstrip Japan in 2050 to become the world’s second largest economic power. Gross Domestic Product:  Gross Domestic Product The 16th CPC Party Congress established the objective to double the 2000 GDP by 2010, and further by 2020 quadruple its 2000 GDP. To attain the goal, what should be the annual GDP growth of China? Gross Domestic Product:  Gross Domestic Product A rough solution to such issue can be resorted to the rule of 70. According to the rule of 70, if some variable grows at a rate of x percent per year, then that variable doubles in approximately 70/x years. For example, $5,000 invested at 7 percent interest per year, will approximately double in size in 10 years. The Measurement of GDP:  The Measurement of GDP Output is valued at market prices. It records only the value of final goods, not intermediate goods (the value is counted only once). It includes both tangible goods (food, clothing, cars) and intangible services (haircuts, housecleaning, doctor visits). The Measurement of GDP:  The Measurement of GDP It includes goods and services currently produced, not transactions involving goods produced in the past. It measures the value of production within the geographic confines of a country. It measures the value of production that takes place within a specific interval of time, usually a year or a quarter (three months). The Measurement of GDP:  The Measurement of GDP The term final goods and services refers to goods and services produced for final use. Intermediate goods are goods produced by one firm for use in further processing by another firm. The Measurement of GDP:  The Measurement of GDP Aggregate Output (GDP) = Aggregate Income Aggregate Output (GDP) =Aggregate Expenditure Aggregate Expenditure = Aggregate Income The Measurement of GDP:  GDP can be computed in two ways: The expenditure approach (product approach) A method of computing GDP that measures the amount spent on all final goods during a given period. The income approach (cost approach) A method of computing GDP that measures the income—wages, rents, interest, and profits—received by all factors of production in producing final goods. The Measurement of GDP The Expenditure Approach:  The Expenditure Approach C = Consumption I = Investment G = Government Purchases NX = Net Exports Y= C + I + G + NX NX = Export - Import The Expenditure Approach:  The Expenditure Approach Consumption (C): Durable goods (cars, televisions, etc.) Non-durable goods Services Investment (I): Houses purchased by households Plant and equipment purchased by firms Inventory changes The Expenditure Approach:  The Expenditure Approach Government Purchases (G): The spending on goods and services by local, state, and federal governments. Does NOT include transfer payments because they are not made in exchange for currently produced goods or services. Net Exports (NX): Exports minus imports. The Income Approach:  The Income Approach Components of the income approach: Wages, salaries, and supplements Net interest Rental income of persons Income of unincorporated enterprises Corporate profits before taxes Indirect taxes Depreciation The Income Approach:  The Income Approach In calculating GDP, we can either sum up the value added at each stage of production, or we can take the value of sales of final goods and services. We do not use the value of total sales in an economy to measure how much output has been produced. If we do, we are committing the fault of double counting. The Income Approach:  The Income Approach One practical income approach to avoid the problem of double counting is to use the value added method. Value added is the difference between the value of goods as they leave a stage of production and the cost of the goods as they entered that stage. The Income Approach:  The Income Approach GDP and Its Components (1998):  GDP and Its Components (1998) GDP and Its Components (1998):  GDP and Its Components (1998) GDP and Its Components (1998):  GDP and Its Components (1998) Consumption 68 % GDP and Its Components (1998):  Investment 16% GDP and Its Components (1998) Consumption 68 % GDP and Its Components (1998):  Consumption 68 % Government Purchases 18% GDP and Its Components (1998) Investment 16% GDP and Its Components (1998):  Net Exports -2 % GDP and Its Components (1998) Consumption 68 % Investment 16% Government Purchases 18% Inappropriateness of GDP:  Inappropriateness of GDP GDP excludes most items that are produced and consumed at home and that never enter the marketplace. It excludes value of leisure and clean environment. It excludes items produced and sold illicitly, such as illegal drugs. Other Measures of Income:  Other Measures of Income Gross National Product (GNP) Net National Product (NNP) National Income (NI) Personal Income (PI) Disposable Personal Income (DPI) Gross National Product:  Gross National Product Gross national product (GNP) is the total income earned by a nation’s permanent residents (called nationals). It differs from GDP by including income that our citizens earn abroad and excluding income that foreigners earn here. Net National Product :  Net National Product Net National Product (NNP) is the total income of the nation’s residents (GNP) minus losses from depreciation. Depreciation is the wear and tear on the economy’s stock of equipment and structures. NNP=GNP– Depreciation National Income:  National Income National Income is the total income earned by a nation’s residents in the production of goods and services. It differs from NNP by excluding indirect business taxes (such as sales taxes). NI=NNP – Indirect Taxes Personal Income:  Personal Income Personal income is the income that households and noncorporate businesses receive. Unlike NI, it excludes retained earnings, which is income that corporations have earned but have not paid out to their owners. In addition, it includes household’s interest income and government transfers. PI=NI – Retained Earnings+Interest Income + Government Transfers Disposable Personal Income:  Disposable Personal Income Disposable personal income is the income that household and noncorporate businesses have left after satisfying all their obligations to the government. It equals personal income minus personal taxes and certain nontax payments. DPI=PI – (Personal Taxes + Nontax Payments) GNP, NNP, NI, PI, and DPI:  GNP, NNP, NI, PI, and DPI NNP=GNP– Depreciation NI=NNP – Indirect Taxes PI=NI – Retained Earnings+Interest Income + Government Transfers DPI=PI – (Personal Taxes + Nontax Payments) Price Level and Price Indexes:  Price Level and Price Indexes The price level can be expressed in terms of price indexes. If the economy’s overall price level is rising, we call such situation inflation. If the overall price level is decreasing, we call such situation deflation. Common price indexes include the consumer price index (CPI), GDP deflator, and producer price index (PPI). The Consumer Price Index:  The Consumer Price Index The consumer price index (CPI) is a measure of the overall cost of the goods and services bought by a typical consumer. It is used to monitor changes in the cost of living over time. The Consumer Price Index:  The Consumer Price Index Steps to determine the CPI and the inflation rate: Fix the basket Find the prices Compute the basket’s cost Choose a base year Compute the index Compute the inflation rate The Consumer Price Index:  The Consumer Price Index Fix the Basket: Determine what prices are most important to the typical consumer. The Bureau of Labor Statistics (BLS) identifies a market basket of goods and services the typical consumer buys. The BLS conducts monthly consumer surveys to set the weights for the prices of those goods and services. What’s in the CPI’s Basket?:  What’s in the CPI’s Basket? 40% 16% 17% 6% 5% 6% 5% 5% The Consumer Price Index:  The Consumer Price Index Find the Prices: Find the prices of each of the goods and services in the basket for each point in time. Compute the Basket’s Cost: Use the data on prices to calculate the cost of the basket of goods and services at different times. The Consumer Price Index:  The Consumer Price Index Choose a Base Year and Compute the Index: Designate one year as the base year, making it the benchmark against which other years are compared. Compute the index by dividing the price of the basket in one year by the price in the base year and multiplying by 100. The Consumer Price Index:  The Consumer Price Index Compute the inflation rate: The inflation rate is the percentage change in the price index from the preceding period. The Consumer Price Index: An Example:  The Consumer Price Index: An Example Step 1:Survey Consumers to Determine a Fixed Basket of Goods The Consumer Price Index: An Example:  The Consumer Price Index: An Example Step 2: Find the Price of Each Good in Each Year The Consumer Price Index: An Example:  The Consumer Price Index: An Example Step 3: Compute the Cost of the Basket of Goods in Each Year The Consumer Price Index: An Example:  The Consumer Price Index: An Example Step 4: Choose One Year as the Base Year (2001) and Compute the Consumer Price Index in Each Year The Consumer Price Index: An Example:  The Consumer Price Index: An Example Step 5: Use the Consumer Price Index to Compute the Inflation Rate from Previous Year The Consumer Price Index: Another Example:  The Consumer Price Index: Another Example Base Year is 1998. Basket of goods in 1998 costs $1,200. The same basket in 2000 costs $1,236. CPI = ($1,236/$1,200) X 100 = 103. Prices increased 3 percent between 1998 and 2000. Problems with CPI:  Problems with CPI The CPI is an accurate measure of the selected goods that make up the typical bundle, but it is not a perfect measure of the cost of living. Problems with CPI:  Problems with CPI Substitution bias Introduction of new goods Unmeasured quality changes Substitution Bias:  Substitution Bias The basket does not change to reflect consumer reaction to changes in relative prices. Consumers substitute toward goods that have become relatively less expensive. The index overstates the increase in cost of living by not considering consumer substitution. Introduction of New Goods:  Introduction of New Goods The basket does not reflect the change in purchasing power brought on by the introduction of new products. New products result in greater variety, which in turn makes each dollar more valuable. Consumers need fewer dollars to maintain any given standard of living. Unmeasured Quality Changes:  Unmeasured Quality Changes If the quality of a good rises (falls) from one year to the next, the value of a dollar rises (falls), even if the price of the good stays the same. The BLS tries to adjust the price for constant quality, but such differences are hard to measure. Problems with CPI:  Problems with CPI The substitution bias, introduction of new goods, and unmeasured quality changes cause the CPI to overstate the true cost of living. The issue is important because many government programs use the CPI to adjust for changes in the overall level of prices. The CPI overstates inflation by about 1 percentage point per year. GDP Deflator:  GDP Deflator The GDP deflator measures the current level of prices relative to the level of prices in the base year. It tells us the rise in nominal GDP that is attributable to a rise in prices rather than a rise in the quantities produced. Real versus Nominal GDP:  Real versus Nominal GDP Nominal GDP values the production of goods and services at current prices. Real GDP values the production of goods and services at constant prices. GDP Deflator:  GDP Deflator The GDP deflator is calculated as follows: Converting Nominal GDP to Real GDP:  Converting Nominal GDP to Real GDP Nominal GDP is converted to real GDP as follows: Real and Nominal GDP:  Real and Nominal GDP Real and Nominal GDP:  Real and Nominal GDP Real and Nominal GDP:  Real and Nominal GDP Real and Nominal GDP:  Real and Nominal GDP CPI vs. GDP Deflator:  CPI vs. GDP Deflator Economists and policymakers monitor both the GDP deflator and the consumer price index to gauge how quickly prices are rising, but the results of the two indexes often differ. There are two important differences between the indexes that can cause them to diverge. CPI vs. GDP Deflator:  CPI vs. GDP Deflator The GDP deflator reflects the prices of all goods and services produced domestically. However, the CPI reflects the prices of all goods and services bought by consumers. CPI vs. GDP Deflator:  CPI vs. GDP Deflator The GDP deflator compares the price of currently produced goods and services to the price of the same goods and services in the base year. However, the CPI compares the price of a fixed basket of goods and services to the price of the basket in the base year (only occasionally does the BLS change the basket). Slide81:  1965 Percent per Year 15 10 5 0 1970 1975 1980 1985 1990 1995 2000 Two Measures of Inflation Producer Price Index :  Producer Price Index The producer price index (PPI), which measures the cost of a basket of goods and services bought by firms rather than consumers. Nominal and Real Salaries from Different Times:  Nominal and Real Salaries from Different Times Suppose someone earned $8,000 in 1931 and we know the price level in 1931 is 15.2 while the price level in 2000 is 166. Convert the earning of 1931 to that of 2000. The Most Popular Movies of All Time, Inflation Adjusted:  The Most Popular Movies of All Time, Inflation Adjusted AS and AD Curves:  AS and AD Curves The aggregate demand curve (AD) shows the quantity of goods and services that households, firms, and the government want to buy at each price level. The aggregate supply curve (AS) shows the quantity of goods and services that firms produce and sell at each price level. AS and AD Curves:  AS and AD Curves Aggregate demand is equal to aggregate expenditure, so: AD= C + I + G + NX Aggregate Demand Curve:  Aggregate Demand Curve 0 Aggregate Supply Curve:  Aggregate Supply Curve Price Level 0 Macroeconomic Equilibrium:  Macroeconomic Equilibrium 0 Government’s Increase in Infrastructure Investment:  Government’s Increase in Infrastructure Investment 0 P1 AD Q1 Government’s Increase in Infrastructure Investment:  Government’s Increase in Infrastructure Investment The government’s increase in infrastructure investment leads to an increase in AD for government purchase (G) is part of AD. The AD increase means a higher price level and a greater output. RMB Value Remains Constant During Asian Financial Crisis:  RMB Value Remains Constant During Asian Financial Crisis 0 P1 AD Q1 RMB Value Remains Constant During Asian Financial Crisis:  RMB Value Remains Constant During Asian Financial Crisis In the Asian financial crisis of 1997, many countries currencies depreciated. Since the RMB value remains constant, the Chinese goods became relatively more expensive those those of its neighbors. China’s export was negatively affected and the NX decreased, so the AD curve shifts left, which means a lower price level and less output. RMB Value Remains Constant During Asian Financial Crisis:  RMB Value Remains Constant During Asian Financial Crisis Since some inputs of Chinese firms are imported from other Asian countries, so the firms production costs decreased. With the cost decrease, the AS curve shifts right, which means a even lower price level. Assignment:  Assignment Review Chapter 20 and 21. Answer questions on P389 and 410. Search for information on China’s GDP in recent years and its prospect in the future. Preview Chapter 22, 23, 24. Thanks:  Thanks

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