2. Expenditure Method GDP=Expenditure Y=C+I+G+NX

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1 Lecture 1: Measuring Macrecnmic Perfrmance Evaluating Macrecnmic Perfrmance 1. Rising Living Standards: Tendency fr the level f utput (quantity and quality f gds and services) t increase ver time. a. Output divided by ppulatin = utput per capita 2. Stable Business Cycle: lw vlatility in fluctuatins f actual utput arund its trend r ptential utput 3. Relatively Stable Price Level: lw (psitive)rate f inflatin a. Inflatin has been cncern fr mst develped cuntries ver the last half century b. Japan is an exceptin and has experienced deflatin ver the last decade 4. Sustainable Levels f Public and Natinal Debt a. Public debt-brrwing by public sectr frm private sectr i. Influenced by gvernment budget deficits/surpluses b. Freign debt-brrwing by dmestic residents frm freign cuntries i. Influenced by an ecnmy's current accunt deficits/surpluses 5. Balance Between Current and Future Cnsumptin a. Chice fr an individual i. Hw much shuld I cnsume tday vs tmrrw? b. Similar issue fr aggregate ecnmy i. Hw much shuld an ecnmy save/invest? Save/invest high => current cnsumptin lw, future cnsumptin high and vice versa 6. Full Emplyment: des the ecnmy prduce emplyment fr all individuals seeking wrk? Standard Desired Outcmes fr Macr Variables Relatively high and stable grwth rate f real per-capita utput Stable and lw (but psitive) rate f inflatin Lw unemplyment rate Sustainable level f public/external debt Balance between current and future cnsumptin GDP: The market value f final gds and services prduced in a cuntry during a given perid. ->flw variable (measured ver a perid f time). Excludes: Imprts Gds and services that are prduced in ther cuntries (but might be cnsumed in Australia) Secnd-Hand Gds Gds and services that were prduced in sme earlier perid, but are re-sld in the current perid Intermediate gds and services Gds that are used-up in the prductin prcess 3 Ways t Measure GDP Circular Flw f Incme: The ecnmy's natinal incme that can be equivalently measured using the prductin (value-added), expenditure r incme methds. 1. Prductin (Value Added) Methd Value Added = Sales-Input Csts The market value f firm's prductin less the cst f inputs purchased frm ther firms 2. Expenditure Methd GDP=Expenditure Y=C+I+G+NX

2 Y=C+I+G+X-M Accunting Identity: Expenditure n gds and services by final users must equal the value f their prductin. 3. Incme Methd GDP als equals the aggregate incmes paid t Labur (L) Wages, salaries and incmes f the self-emplyed Abut 75% f GDP Capital (K) Payments t wners f physical capital (factries, machines, ffice buildings) and intangible capital (cpyrights and patents) Prfits earned by business wners, rents paid t wners f land r buildings, interest received by bnd hlders, ryalties received by cpyright/patent hlders in the prductin f gds and services GDP=Labur Incme + Capital Incme =L+K

3 Nminal vs Real GDP Nminal GDP: values f quantities f gds and services prduced at current year prices i.e. prices are subject t change -> Weights by current prices Real GDP: values f quantities f gds and services prduced at base year prices-measure f the actual physical vlume f prductin -> Weights by cnstant set f prices Using initial prices = Laspeyres index Using final prices = Paasche index Real Interest Rate: The percentage increase in the real purchasing pwer f a financial asset. Nminal Interest Rate: The percentage increase in the dllar value f a financial asset. Chain Weighting: average f the tw grwth rates implied by bth the Laspeyres and Paasche indexes. Omissins frm GDP that might matter fr ecnmic welfare: GDP is nt a perfect measure f ecnmic wellbeing. Real GDP is nt the same as ecnmic wellbeing. Leisure time (extra week f hlidays) Wrking later in life, less hurs vs grandparents i.e. after tertiary educatin, 40hr vs 80hr weeks Perks f being an industrialised cuntry Husehld prductin (ck at hme) Als vlunteer services e.g. firefighters etc. Envirnmental degradatin China has experienced extreme grwth in GDP, hwever at the cst f water and air quality Dwnside f their ecnmic grwth Quality f life (happiness) Lw crime rate Minimal traffic cngestin Open space Ecnmic inequality (distributin f incme) Extreme pverty and extreme wealth vs relatively middle class cnsistency Measures f the Price Level Want t measure the average level f prices in the ecnmy Cnsumer Price Index (CPI) CPI: fr a given perid, measures the cst in that perid f a given basket f gds and services relative t their cst in a fixed year-called a base year CPI=Cst f base-year basket f gds and services in current year/cst f base-year basket f gds and services in base year Inflatin/Deflatin: the percentage change in the CPI ver a given perid.

4 Inflatin rate = 0 Prices are cnstant Inflatin rate > 0 Prices are rising Inflatin rate < 0 Prices are falling i.e. deflatin Limitatins with CPI Quality Adjustment and New Gds Bias The bias that causes measured inflatin t verstate changes in the cst f living caused by the failure t adjust adequately fr imprvement in the quality f gds and services Quality imprvements may shw up as higher prices fr gds and services New gds are ften nt included until CPI is re-based Substitutin Bias The bias that causes measured inflatin t verstate changes in the cst f living caused by the failure t cnsider peple's substitutin twards relatively less expensive gds and services Use f a fixed basket means that n allwance is made fr cnsumers substitutin tward relatively less expensive gds Hence, CPI tends t verstate the rate f inflatin Csts f Inflatin Imprtant t distinguish between relative price change and a change in the general price level. She-leather csts Inflating reduces the real purchasing pwer f given amunt f mney Since inflatin erdes the real purchasing pwer f cash t a greater extent the lnger it's held Thus peple leave as much mney in bank accunts where interest is paid n depsits t insulate mney's purchasing pwer frm effects f inflatin Menu csts Real csts f changing prices High inflatin rates wuld mean restaurants wuld have t reprint their menus accrding their new prices ften, r any firm that lists their prices, hence 'menu' csts Intrduces nise int the price mechanism Rise in prices causes suppliers t cnsider whether: Inflatin has ccurred, meaning there isn't actually a greater demand fr their prduct and thus they dn't need t supply mre Relative prices have increased meaning demand has indeed increased They must cnsider the price changes mre clsely Distrts tax systems (if nt indexed t inflatin) Wrkers wh start earning mre and mve int a higher tax bracket may start paying mre tax despite having n real increase in their real incmes, resulting in less purchasing pwer Interference with lng-run planning Unexpected re-distributins f wealth E.g. unin wrkers vs emplyer, brrwers vs lenders Inflatin and Interest Rates Nminal Interest Rate: percentage increase in the nminal (r dllar value) f a financial asset. Real Interest Rate: percentage increase in the real purchasing pwer f financial asset.

5 r = real interest rate I = nminal interest rate π = inflatin rate Fisher Effect: Nminal interest rate = real rate + (expected) inflatin rate