3 1 reading 16 aggregate output, prices, and economic growth pdf

LOS Economics • Topics in Demand and Supply Analysis • The Firm and Market Structures • Aggregate Output, Prices, And Economic Growth • Understanding Business Cycles • Monetary and Fiscal Policy • International Trade and Capital Flows • Currency Exchange Rates LOS LOS Calculate and explain gross domestic product (GDP) using expenditure and income approaches GDP is intended to measure total size of a given economy • It is used for calculating the size and growth of countries • There are ways to calculate it: The Income Approach; and The Expenditure Approach  Both methods should arrive at same value LOS LOS Calculate and explain gross domestic product (GDP) using expenditure and income approaches Income Approach • It is the aggregate income earned by all households, companies, and the government of a given economy during a specified time period: GDP = Total National Income + Sales Tax + Depreciation + Net Foreign Factor Income  Equal to the sum of all wages plus rents plus interest and profits LOS LOS Calculate and explain gross domestic product (GDP) using expenditure and income approaches Expenditure Approach • It is the total amount spent on goods and services produced in the economy within a given period of time: GDP = Gross Private Consumption Expenditures + Gross Private Investment + Government Purchases + Exports - Imports • Limiting criteria: i Only include goods and services produced during the period being measured ii Transfer payments not included iii Only include goods and services whose value can be calculated through selling in the market LOS LOS Compare the sum-of-value-added and value-of-final-output methods of calculating GDP There are methods for the Expenditure Approach: • Sum-of-Value-Added: captures value at each stage of production • Value-of-Final-Output: captures value only at final sale Value Captured Sum-of-ValueAdded Farmer sells wheat to miller - $0.40 Value-of-FinalOutput $0.40 Miller sells flour to baker - $0.90 $0.90-0.40=0.50 Baker sells bread to store - $1.10 $1.10-0.90=0.20 Store Sells bread to customer - $1.40 $1.40-1.10=0.30 $1.40 $1.40 $1.40 Total Value:  Both methods have to equal the same final value  The Sum-of-Value-Added has more granular details LOS LOS Compare nominal and real GDP and calculate and interpret the GDP deflator • Nominal GDP represents the market value of goods and services at current prices: Uses the actual prices paid at any point in time • Real GDP represents the market value if prices did not change over time: Holds prices constant to separate actual growth from inflation Example >> LOS LOS Compare nominal and real GDP and calculate and interpret the GDP deflator Example • Last year, automakers sold 1,000 cars at $20,745 each on average • This year, automakers sold 1,000 cars at $21,175 each on average What is the DGP Deflator? Solution • Nominal GDP (last year): $20,745,000 • Nominal GDP (this year): $21,175,000 • Real GDP (last year): $20,745,000 • Real GDP (this year): $20,745,000 • Capture impact of inflation using the GDP Deflator: 𝑵𝒐𝒎𝒊𝒏𝒂𝒍 𝑮𝑫𝑷 𝟐𝟏, 𝟏𝟕𝟓, 𝟎𝟎𝟎 × 𝟏𝟎𝟎 = × 𝟏𝟎𝟎 = 𝟏𝟎𝟐 𝟎𝟕 𝑹𝒆𝒂𝒍 𝑮𝑫𝑷 𝟐𝟎, 𝟕𝟒𝟓, 𝟎𝟎𝟎 LOS LOS Compare nominal and real GDP and calculate and interpret the GDP deflator Example • Last year, automakers sold 1,000 cars at $20,745 each on average • This year, automakers sold 1,000 cars at $21,175 each on average What is the DGP Deflator? Solution • Nominal GDP (last year): $20,745,000 • Nominal GDP (this year): $21,175,000 • Real GDP (last year): $20,745,000 • Real GDP (this year): $20,745,000 • Capture impact of inflation using the GDP Deflator: 𝑵𝒐𝒎𝒊𝒏𝒂𝒍 𝑮𝑫𝑷 𝟐𝟏, 𝟏𝟕𝟓, 𝟎𝟎𝟎 × 𝟏𝟎𝟎 = × 𝟏𝟎𝟎 = 𝟏𝟎𝟐 𝟎𝟕 𝑹𝒆𝒂𝒍 𝑮𝑫𝑷 𝟐𝟎, 𝟕𝟒𝟓, 𝟎𝟎𝟎 LOS LOS Compare nominal and real GDP and calculate and interpret the GDP deflator • In nominal terms, we see 2.07% GDP growth in the previous example Nominal GDP increase from $20,745,000 to $21,175,000 • In real terms, there was 0% GDP growth Real GDP is still 1,000 cars sold  That 2.07% is the inflation in the economy LOS LOS Compare GDP, national income, personal income, and personal disposable income GDP measures: • the value of all goods and services sold in an economy; and also • measures the total income earned by everyone in an economy These must always somewhat be equal GDP Expenditure Formula: GDP = Consumer spending on goods and services + Business Gross Fixed Investment + Change in Inventories + Government Spending on Goods and Services + Government Gross Fixed Investment + Exports - Imports + Statistical Discrepancy LOS LOS Describe how fluctuations in aggregate demand and aggregate supply cause short-run changes in the economy and the business cycle Shifts in aggregate supply and demand levels cause fluctuations in GDP and business cycles • Business cycle results from changes in short-run value of GDP Expansion: GDP increasing, unemployment rate falling, capacity utilization increasing Contraction: GDP decreasing, rising unemployment, capacity utilization decreasing LOS LOS Describe how fluctuations in aggregate demand and aggregate supply cause short-run changes in the economy and the business cycle Types of cyclical changes in GDP caused by fluctuations in aggregate demand and supply: Recessionary Gap: • Reduction in Aggregate Demand causes leftward shift in demand curve Aggregate Demand curve intersecting Aggregate Supply curve at short-run equilibrium below potential GDP • GDP and price levels fall • Corporate profits, employment, commodity prices, interest rates, and demand for credit decline LOS LOS Describe how fluctuations in aggregate demand and aggregate supply cause short-run changes in the economy and the business cycle Inflationary Gap: • Aggregate Demand increases more quickly than Aggregate Supply • Increased govt spending, declining taxes, and increase in money supply can shift Aggregate Demand curve to the right • Increasing prices leads to increased employment and production • Corporate profits, employment, commodity prices, interest rates, and inflation all rise Stagflation: • Combination of stagnation and inflation • Sharp declines in Aggregate Supply can cause prices to increase and economic growth to slow at the same time • Price levels increase, but production and employment decrease • Very costly and difficult to address LOS LOS Distinguish between the following types of macroeconomic equilibria: long-run full employment, short-run recessionary gap, short-run inflationary gap, and short-run stagflation Types of macroeconomic equilibria: Long-Run Full Employment • When Aggregate Demand curve intersects Short-Run Aggregate Supply Curve at a point along the Long-Run Aggregate Supply Curve • Capital and labor are fully utilized • Over long term, potential GPD and equilibrium GDP are equal LOS LOS Distinguish between the following types of macroeconomic equilibria: long-run full employment, short-run recessionary gap, short-run inflationary gap, and short-run stagflation Short-Run Recessionary Gap • Leftward shift of Aggregate Demand Curve • Price levels decrease • Companies reduce production and employment Short-Run Inflationary Gap • Rightward shift of Aggregate Demand Curve • Price levels rise • Companies increase production and employment Short-Run Stagflation • Leftward shift of Aggregate Supply curve • Price levels increase and employment falls • Economic growth slows down while inflation increases LOS LOS Explain how a short-run macroeconomic equilibrium may occur at a level above or below full employment Short-run macroeconomic equilibrium occurs when Aggregate Demand Curve intersects with Short-Run Aggregate Supply Curve Decrease in Aggregate Demand • Price levels fall, unemployment decreases • Aggregate Supply falls • Input prices fall, which increases supply again • New equilibrium has same output but lower prices Increase in Aggregate Demand • Output level becomes greater than normal price levels during full employment • Employment increases above normal levels • Inflation increases LOS LOS Explain how a short-run macroeconomic equilibrium may occur at a level above or below full employment Decrease in Short-Run Aggregate Supply • Prices increase as supply decreases • Output levels fall as input prices go up Increase in Short-Run Aggregate Supply • Unexpected increase in supply shifts curve to the right • Output and income increase beyond normal full employment levels LOS LOS Analyze the effect of combined changes in aggregate supply and demand on the economy Aggregate Demand and Aggregate Supply determine price and output levels for economy • Their intersection represents the current level of GDP equilibrium Levels can be extremely temporary LOS LOS Describe sources, measurement, and sustainability of economic growth Sources of Economic Growth: Physical Capital Stock • Buildings, equipment, and machinery used for production • Increases annual as long as net investments are positive Labor Supply • Number of people available to work • Total Hours Worked= Labor Force x Avg Hours Worked Per Worker Human Capital • Accumulated skills and knowledge of all workers • Difficult to quantify Natural Resources • Can be renewable (trees) or non-renewable (oil and coal) Technology • Advances allow companies to produce goods in greater volumes and higher quality • Can overcome limits due to diminishing marginal returns LOS LOS Describe sources, measurement, and sustainability of economic growth • Measures of Economic Growth: 𝐆𝐫𝐨𝐰𝐭𝐡 𝐢𝐧 𝐏𝐨𝐭𝐞𝐧𝐭𝐢𝐚𝐥 𝐆𝐃𝐏 = 𝐆𝐫𝐨𝐰𝐭𝐡 𝐢𝐧 𝐓𝐞𝐜𝐡𝐧𝐨𝐥𝐨𝐠𝐲 + 𝐖𝐋 + 𝐖𝐂 Where WL = Growth in Labor WC = Growth in Capital • Productivity of Labor is easiest input to calculate as part of potential GDP estimation 𝐑𝐞𝐚𝐥 𝐆𝐃𝐏 𝐋𝐚𝐛𝐨𝐫 𝐩𝐫𝐨𝐝𝐮𝐜𝐭𝐢𝐯𝐢𝐭𝐲 = 𝐀𝐠𝐠𝐫𝐞𝐠𝐚𝐭𝐞 𝐇𝐨𝐮𝐫𝐬 • This input is then used to calculate potential GDP: 𝐏𝐨𝐭𝐞𝐧𝐭𝐢𝐚𝐥 𝐆𝐃𝐏 = 𝐀𝐠𝐠𝐫𝐞𝐠𝐚𝐭𝐞 𝐡𝐨𝐮𝐫𝐬 ∗ 𝐋𝐚𝐛𝐨𝐫 𝐩𝐫𝐨𝐝𝐮𝐜𝐭𝐢𝐯𝐢𝐭𝐲 𝐏𝐨𝐭𝐞𝐧𝐭𝐢𝐚𝐥 𝐠𝐫𝐨𝐰𝐭𝐡 𝐫𝐚𝐭𝐞 = 𝐋𝐨𝐧𝐠 𝐭𝐞𝐫𝐦 𝐠𝐫𝐨𝐰𝐭𝐡 𝐫𝐚𝐭𝐞 𝐨𝐟 𝐥𝐚𝐛𝐨𝐫 𝐟𝐨𝐫𝐜𝐞 + 𝐋𝐨𝐢𝐧𝐠 𝐭𝐞𝐫𝐦 𝐋𝐚𝐛𝐨𝐫 𝐩𝐫𝐨𝐝𝐮𝐜𝐭𝐢𝐯𝐢𝐭𝐲 𝐠𝐫𝐨𝐰𝐭𝐡 𝐫𝐚𝐭𝐞 LOS LOS Describe the production function approach to analyzing the sources of economic growth The Production Function is used to determine underlying source of economic growth: • Implies GDP and productive capacity grow due to: Application and discover of new technologies that enable inputs to be more productive; and Accumulation of raw materials, labor, and capital • Assumptions of the Production Function The function acts as evidence for a decline in input when the extra output will be obtained A percentage increase in input leads to increase in the output (has positive returns to scale) LOS LOS Describe the production function approach to analyzing the sources of economic growth Outcomes expected based on the Production Function: • Economic growth is restricted by levels of inputs If capital grows at a higher rate than labor, capital will become less productive • Growth rates in 3rd world countries will exceed that of developed countries • Declining marginal productivity of capital means there is limit on potential growth  The only way to maintain growth in potential per capita GDP is technology LOS LOS Distinguish between input growth and growth of total factor productivity as components of economic growth Economic growth results from two primary reasons: 1.Increase in productive inputs such as capital and labor Technology advances that allow for more output from the same level of input • Growth is represented by the two-factor production model: 𝒀 = 𝑨 𝒙 𝑭(𝑳, 𝑲) Where Y= Level of aggregate output in the economy L= Quantity of labor K= Capital stock used for production A= Technological knowledge LOS LOS Distinguish between input growth and growth of total factor productivity as components of economic growth Technology scale factor represented as Total Factor Productivity • Increases in inputs have additive effect on growth • Increases in TFP have multiplicative effect on growth  Total Factor Productivity cannot be measured, it must be estimated • Two primary assumptions: Factors of production have constant returns to scale TFP exhibits diminishing marginal returns to individual inputs LOS Economics • Topics in Demand and Supply Analysis • The Firm and Market Structures • Aggregate Output, Prices, And Economic Growth • Understanding Business Cycles • Monetary and Fiscal Policy • International Trade and Capital Flows • Currency Exchange Rates ... $0.90 $0.90-0.40=0.50 Baker sells bread to store - $1. 10 $1. 10-0.90=0.20 Store Sells bread to customer - $1. 40 $1. 40 -1. 10=0 .30 $1. 40 $1. 40 $1. 40 Total Value:  Both methods have to equal the same... inputs LOS Economics • Topics in Demand and Supply Analysis • The Firm and Market Structures • Aggregate Output, Prices, And Economic Growth • Understanding Business Cycles • Monetary and Fiscal... input growth and growth of total factor productivity as components of economic growth Economic growth results from two primary reasons: 1. Increase in productive inputs such as capital and labor