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Chapter 5 - Aggregate output, prices, and economic growth. This chapter calculate and explain gross domestic product (GDP) using expenditure and income approaches, compare the sum-of-value-added and value-of-final-output methods of calculating GDP, compare nominal and real GDP, and calculate and interpret the GDP deflator,....
Chapter Aggregate Output, Prices, and Economic Growth Presenter’s name Presenter’s title dd Month yyyy Introduction • • The focus of this chapter is on macroeconomics, which is the theory and analysis of a nation’s - income and output; - competitive and comparative advantages; - productivity of the labor force; - price levels and inflation; and - government and central bank actions Macroeconomics enables understanding of the effect that a nation’s economy, government actions, and economic trends have on industries and companies Copyright © 2014 CFA 2 Aggregate output and income • • • The aggregate output of an economy is the value of all the goods and services produced in a period of time (e.g., one year or one quarter) The aggregate income of an economy is the value of all the payments earned by the suppliers of factors used in the production of goods and services in a period of time Forms of payment include the following: Compensation to employees Rent (payment for the use of property) Interest (payment of the use of funds) Profit (return for the use of capital and the assumption of risk) The aggregate expenditure is the total amount spent on goods and services in an economy Copyright © 2014 CFA Gross domestic Product • • • Gross domestic product (GDP) is the market value of all final goods and services produced within the economy in a period of time - Expenditures approach: The amount spent for all goods and services - Income approach: Aggregate income earned by all households, companies, and the government within the economy Key elements of GDP: - Represents all goods and services produced during the period - Excludes transfer payments from the government (e.g., welfare) - Excludes capital gains - Determined by being sold in a market - Includes only final goods, not intermediate (i.e., items to be resold) Measurement alternatives (for an example, see Exhibit 5-2) Copyright © 2014 - Receipts from CFA the final customer Methods of calculating GDP Consider the manufacture and sale of a doll using both the expenditures method and the value-added method of measuring gross domestic product Sales value Value added $1.50 0.25 $1.75 $1.75 Stage 2: Assemble dolls $4.00 2.25 Stage 3: Sell to wholesaler $7.00 3.00 Stage 4: Sell to retailer $10.00 3.00 Total expenditures $10.00 Stage 1: Produce materials Plastic Textile Total value added Copyright © 2014 CFA $10.00 Nominal and real GDP • Real GDP is GDP calculated as if the price level did not change - Real GDP per capita is often used as a measure of the standard of living • Nominal GDP is GDP unadjusted for any price-level change Relationships: Nominal GDPt = Pt ì Qt Real GDPt = PB × Qt where Pt is the price in year t PB is the price in the base year B Qt is the quantity in year t Copyright © 2014 CFA GDP deflator Copyright © 2014 CFA Components of GDP Copyright © 2014 CFA GDP and other income measures • • • National income is the income received by all factors of production used in the generation of final output in an economy less a capital consumption allowance - Sum of compensation of employees, business and government enterprise profits, interest income, rent, and indirect business taxes less subsidies - Capital consumption allowance (CCA) is an estimate of the depreciation of capital stock attributed to the production of goods and services Personal income is a measure of household income - A measure of the ability of consumers to make purchases - A measure of national income to households - Equal to national income less indirect business taxes, corporate income taxes, and undistributed corporate profits, and plus transfer payments Personal disposable income (PDI) is personal income less personal taxes A measure of what is available for spending Copyright â 2014 CFA - The Fiscal balance The fiscal balance is the difference between government expenditures (G) and taxes (T): Fiscal balance = G – T - If G > T, the fiscal balance is a deficit (spending more than taking in) - If G < T, the fiscal balance is a surplus (taxing more than spending) The role of automatic stabilizing: - As income declines, the deficit grows - As income increases, the deficit shrinks or becomes a surplus Copyright © 2014 CFA 10 Effects of a shift in aggregate demand and Aggregate supply on business cycles • • Equilibrium is the price level and output at which the aggregate demand and aggregate supply curves intersect A business cycle consists of expansion and contraction - • A recession is an economic situation in which the growth in GDP is negative - • Shifts in aggregate demand and aggregate supply determine changes in the economy Typical definition: two or more quarters of negative GDP growth Sensitivity of investments to the economy: - A cyclical company is one in which the earnings are likely to decline in the event of an economic slowdown - A defensive company is one in which earnings may increase during an economic slowdown Copyright © 2014 CFA 19 Effects of a shift in aggregate demand and Aggregate supply on business cycles At long-run full employment, the economy is at potential GDP, and equilibrium output is at an equilibrium where LRAS = SRAS = AD Price level LRAS SRAS P1 AD Income, Output, Y Copyright © 2014 CFA 20 Effects of a shift in aggregate demand and Aggregate Supply on business cycles A short-run recessionary gap exists when the economy is in a recession and equilibrium output is less than potential GDP Price level LRAS SRAS P1 P2 AD2 Y2 Y1 Copyright © 2014 CFA AD1 Income, Output, Y 21 Effects of a shift in aggregate demand and Aggregate supply on business cycles A short-run inflationary gap exists when the economy drives GDP beyond the potential GDP When price levels increase, short-run supply increases and the economy returns to the long-run equilibrium LRAS SRAS P2 P1 AD2 AD1 Y1 Copyright © 2014 CFA Y2 Income, Output, Y 22 Effects of a shift in aggregate demand and Aggregate supply on business cycles Short-run stagflation occurs when there is high unemployment and increased inflation brought on by a drop in aggregate supply The downward pressure on wages and input prices eventually brings long-run full employment LRAS SRAS P2 P1 AD1 Y2 Y1 Copyright © 2014 CFA Income, Output, Y 23 Effects of a shift in aggregate supply and aggregate demand on the economy: Summary Change Change in GDP Unemployment rate Aggregate price level ↑ AD ↓ AD ↑ AS ↑ ↓ ↑ ↓ ↑ ↓ ↑ ↓ ↓ ↓ AS ↓ ↑ ↑ Copyright © 2014 CFA 24 Economic growth and sustainability Copyright © 2014 CFA 25 Sources of Economic growth Copyright © 2014 CFA 26 Sources and Measures of Economic growth Copyright © 2014 CFA 27 Sustainability of Economic growth Copyright © 2014 CFA 28 Production Function and Growth Copyright © 2014 CFA 29 Input growth and the growth of total factor productivity Copyright â 2014 CFA 30 Conclusions and Summary • • • GDP is the market value of all final, newly produced goods and services within a country in a given time period; valued by looking at either the total amount spent on goods and services produced in the economy or the income generated in producing those goods and services - Nominal GDP is the value of production using the prices of the current year - Real GDP measures production using the constant prices of a base year Households earn income in exchange for providing the factors of production (labor, capital, and natural resources, including land) Businesses produce most of the economy’s output/income and invest to maintain and expand productive capacity The government sector collects taxes from households and businesses and purchases goods and services from the private business sector Capital markets provide a link between saving and investing in the economy From the expenditure side, GDP includes personal consumption, gross private Copyright © 2014 CFA 31 domestic investment, government spending, and net exports • Conclusions and Summary • • • • • • National income is income received by all factors of production used in the generation of final output: GDP minus the capital consumption allowance Personal income reflects pretax income received by households, whereas personal disposable income equals personal income minus personal taxes Consumption spending is a function of disposable income, whereas investment spending depends on the average interest rate and the level of aggregate income Aggregate demand and aggregate supply determine the level of real GDP and the price level The aggregate supply curve is the relationship between the quantity of real GDP supplied and the price level, keeping all other factors constant Movements along the supply curve reflect the impact of price on supply The long-run aggregate supply curve is vertical because input costs adjust to changes in output prices, leaving the optimal level of output unchanged Copyright © 2014 CFA 32 Conclusions and Summary • • • The long-run aggregate supply curve shifts because of changes in labor supply, the supply of physical and human capital, and productivity/technology The short-run supply curve shifts because of changes in potential GDP, nominal wages, input prices, expectations about future prices, business taxes and subsidies, and the exchange rate The business cycle and short-term fluctuations in GDP are caused by shifts in aggregate demand and aggregate supply - • • Stagflation, a combination of high inflation and weak economic growth, is caused by a decline in short-run aggregate supply The sustainable rate of economic growth is measured by the rate of increase in the economy’s productive capacity or potential GDP Growth in real GDP measures how rapidly the total economy is expanding The sources of economic growth include the supply of labor, the supply of physical and human capital, raw materials, and technological knowledge Copyright © 2014 CFA 33 • ... Aggregate income - - • This results in the investment savings (IS) curve, which is the relationship between savings less investment (S – I) and income, Y The IS curve represents the demand for money... of investments to the economy: - A cyclical company is one in which the earnings are likely to decline in the event of an economic slowdown - A defensive company is one in which earnings may increase... income in exchange for providing the factors of production (labor, capital, and natural resources, including land) Businesses produce most of the economy’s output/income and invest to maintain