Macroeconomics Study Guides
Principles of Macroeconomics Lecture Notes
PART I: GDP
Gross Domestic Product (GDP)
- GDP is a measure of output!
- Why Do We Care?
Because output is highly correlated (at certain times) with things we care about (standard of living, wages, unemployment, inflation, budget and trade deficits, value of currency, etc…)
- Formal Definition:
GDP is the Market Value of all Final Goods and Services Newly Produced on Domestic Soil During a Given Time Period (different than GNP)
Three ways of measuring GDP
- Production Method: Measure the Value Added summed across all firms (value added = sale price less cost of raw materials)
- Income Method: Labor Income (wages/salary) + Capital Income (rent, interest, dividends, profits)+ Government Income (taxes)
- Expenditure Method: Spending by consumers (C) + Spending by businesses (I) + Spending by government (G) + Net Spending by foreign sector (NX)
- Fundamental identity of national income account:
total production = total income = total expenditure
A simple example of how GDP is measured
Orange Inc Transactions
Wagos paid to Orange Inc employees
Taxes paid to government
Revenue received from sale of oranges
• Oranges sold to public
• Oranges sold to Juice Inc
Juice Inc Transactions
Wagos paid to Juice Inc employees
Taxes paid to government
Oranges purchased from Orange Inc
Revenue received from sale of orange juice
What is the total value (in dollars) of the economic activity generated by these 2 firms?
Production Method (value added: sales – intermediate good): 35K + (40K– 25K) = 50K
Income Method (Wages + Profits + Taxes) = 15K + 10K + 15K + 3K + 5K + 2K = 50K
Expenditure approach (expenditure by final users): 10K + 40K = 50K
"Production" Equals "Expenditure"
- GDP (for us Y) is a measure of Market Production!
Market value = how much you have to spend to buy
- What is produced in the market has to show up as being purchased or held by some economic agent;
- Who are the economic agents we will consider on the expenditure side?
- Consumers (refer to expenditure of consumers as "consumption")
- Businesses (refer to expenditure of firms as "investment")
- Governments (refer to expenditures of governments as "government spending")
- Foreign Sector (refer to expenditures of foreign sector as "net exports")
- For us, we will predominantly spend our time working with the Expenditure Approach:
Back to a Simple Example
- I produce oranges and I can potentially:
- sell them to some domestic customer (Consumption)
- sell them to some business (Investment)
- keep them in my stock room as inventory (Investment)
- sell them to the city of Boston for their shelters (Government spending)
- sell them to some foreign customer (Net Export)
Defining the Expenditure Components
- Consumption (C):
- The Sum of Durables, Non-Durables and Services Purchased Domestically by NonBusinesses and Non-Governments (ie, individual consumers).
- Includes Haircuts (services), Refrigerators (durables), and Apples (non-durables).
- Does Not Include Purchases of New Housing.
- Investment (I):
- The Sum of Durables, Non-Durables and Services Purchased Domestically by Businesses
- Includes Business and Residential Structures, Equipment and Inventory Investment
- Land purchases are NOT counted as part of GDP (land is not produced!!)
- Stock purchases are NOT counted as part of GDP (stock transactions do NOT represent production – they are saving!)
There is a difference between financial and economic investment!!!!!!!
- Government Spending (G): Goods and Services Purchased by the domestic government.
- For the U.S., 2/3 of this is at the state level (police and fire protection, school teachers, snow plowing) and 1/3 is at the federal level (President, Post Office, Missiles).
- NOTE: Welfare and Social Security are NOT Government Spending. These are Transfer Payments. Nothing is Produced in this Case.
- Net Exports (NX): Exports (X) - Imports (IM);
- Exports: The Amount of Domestically Produced Goods Sold on Foreign Soil
- Imports: The Amount of Goods Produced on Foreign Soil Purchased Domestically.
More on Expenditure Components
- Only include expenditures for goods that are "produced".
- If I give $10 to a movie theater to watch a movie, it is counted as expenditure.
- If I give $10 to my friend for a birthday present, it is not counted as expenditure.
- If I give $10 to the ATM machine to put in my savings account, it is not counted as expenditure.
- The second example would be considered a "transfer" (once I give $10 to my friend, he can go to the movies if he wants to – once that $10 is spent, it will show up in GDP).
- "Transfers" are defined as the exchange of economic resources from one economic agent to another when no goods or services are exchanged.
- The third example is considered "saving" (I am delaying expenditure until the future). Once I spend the $10 in the future, it will show up in GDP.
Examples of Expenditure Method
- How would these transactions be counted as part of 2008 U.S. GDP Calculation?
(Assume the production/transaction took place in 2008 if not otherwise specified)
- I purchase a $500 Swiss watch.
- I receive $200 unemployment check from the state government.
- The city of Chicago spends $1 million this year repairing its streets.
- US steel purchases a new $10 million steel rolling machine for its factory.
- Ford Motor Company purchases $10 worth of steel for building fenders.
- I buy a 1998 Ford Escort from a Dealer.
- I buy a plot of land for $100,000.
- I pay a local accountant $175 for her help in filling in my taxes.
- A U.S. travel agent is paid $1000 for services rendered to U.S. customers while in Tokyo for a year.
Preview: Accounting vs Economics
- Macroeconomics studies the determinants of Y (= aggregate supply) and C+I+G+NX (aggregate demand), and shows how, in equilibrium, prices/wages/interest rates/exchange rates have to adjust such that AS = AD.
- Classic economics believes prices/wages move immediately to attain equilibrium.
- Keynesian economics sticky prices/wages give rise to unemployment and an active role to monetary policy.
- With this basic setup we can understand how changes in the determinants of aggregate demand and supply affect growth and prices in an economy.
What GDP Is Not!
- GDP is not, or never claims to be, an absolute measure of well-being!
- Size effects: But even GDP per capita is not a perfect measure of welfare
- Ideally, what we would like to measure is quality of one's life:
- Present discounted value of utility from one's own consumption and leisure and that of one's loved ones.
More on What GDP Is Not!
- GDP Does Not Measure:
- Non-Market Activity (home production, leisure, black market activity)
- Environmental Quality/Natural Resource Depletion
- Life Expectancy and Health
- Income Distribution
The saving of any economic unit is its current income minus its current needs
For simplicity, I abstract from business saving (things like retained earnings and depreciation). For those interested, see the text.
A Look at Actual U.S. Household Saving Rates: 1970 – 2008
Defining Saving (continued)
• Includes Federal, State and Local Saving