PRINCIPLES OF MACROECONOMICS Lecture 2: Measuring a Nation s Income & the Cost of Living

Transcription

1 PRINCIPLES OF MACROECONOMICS Lecture 2: Measuring a Nation s Income & the Cost of Living Instructor: Chi Man Yip

2 DEFINITION: GROSS DOMESTIC PRODUCT (GDP) GDP: the market value of all final goods & services produced within a country in a given period of time.

3 MARKET VALUE GDP: the market value of all final goods & services produced within a country in a given period of time. Suppose we only produce 3 apples today. All Final Goods Produced Today: 3 Apples

4 MARKET VALUE GDP: the market value of all final goods & services produced within a country in a given period of time. Suppose we also produce 1 Orange today. All Final Goods Produced Today: 3 Apples & 1 Orange.

5 MARKET VALUE GDP: the market value of all final goods & services produced within a country in a given period of time. Suppose we also produce 1 Hour of Teaching today. All Final Goods & Services Produced Today: 3 Apples, 1 Orange, & 1 Hour of Teaching.

6 MARKET VALUE GDP: the market value of all final goods & services produced within a country in a given period of time. Keep adding all them up. Do you see the problem? All Final Goods & Services Produced Today: 3 Apples, 1 Orange, & 1 Hour of Teaching. Market Value: 3 Apples (CAN$5), 1 Orange (CAN$10), & 1 Hour of Teaching (CAN$10,000) GDP=CAD$10,015. Any Question?

7 WHERE DO THESE GOODS & SERVICES GO TO? We consume the 1 hour of teaching.

8 WHERE DO THESE GOODS & SERVICES GO TO? We consume the 1 hour of teaching. Someone in our country consumes one.

9 WHERE DO THESE GOODS & SERVICES GO TO? We consume the 1 hour of teaching. Someone in our country consumes one. Someone in other country consumes one.

10 WHERE DO THESE GOODS & SERVICES GO TO? We consume the 1 hour of teaching. Someone in our country consumes one. Someone in other country consumes one. The Government may consume one.

11 WHERE DO THESE GOODS & SERVICES GO TO? We consume the 1 hour of teaching. Someone in our country consumes one. Someone in other country consumes one. The Government may consume one. Someone plants an orange tree.

12 WHAT ARE THESE TERMS IN ECONOMICS? Consumption (C 1 ): We consume the 1 hour of teaching. Consumption (C 2 ): Someone in Canada consumes one. Export (EX): Someone in other country consumes one. Government Expenditure (G): Government consumes one. Investment (I): Someone plants an orange tree. So, GDP (Y): Y = C 1 + C 2 + I + G + EX. Any Question?

13 DO YOU JUST CONSUME DOMESTIC GOODS & SERVICES? Import (IM): We consume imported goods & services. Consumption (C): C = C 1 + C 2 + IM Net Export (NX): NX = EX IM

14 GDP GDP (Y): Y = C 1 + C 2 + I + G + EX (1) Consumption (C): C = C 1 + C 2 + IM (2) Net Export (NX): NX = EX IM (3) Y = C 1 + C 2 + I + G + EX by (1) Y = C 1 + C 2 + I + G + EX IM + IM Y = (C 1 + C 2 + IM) + I + G + (EX IM) Y = C + I + G + (EX IM) by (2) Y = C + I + G + NX by (3) Any Question?

15 EXAMPLE This example is obtained from Mankiw, N. Gregory, Ronald D. Kneebone, Kenneth J. Mckenzie (2017). Principles of Macroeconomics. Any Question?

16 NOMINAL & REAL GDP Market Value in 2015: 3 Apples (CAN$5), 1 Orange (CAN$10), & 1 Hour of Teaching (CAN$10,000) GDP in 2015: CAD$10,015. Market Value in 2017: 3 Apples (CAN$3), 1 Orange (CAN$10), & 1 Hour of Teaching (CAN$20,000) GDP in 2017: CAD$20,013. Do we produce more? NO Does the GDP reflect our situation? NO

17 DEFINITION: NOMINAL & REAL GDP Nominal GDP: the production of goods & services values at current prices Real GDP: the production of goods & services values at constant prices

18 EXAMPLE: NOMINAL & REAL GDP Nominal GDP: the production of goods & services values at current prices Real GDP: the production of goods & services values at constant prices Market Value in 2015: 3 Apples (CAN$1 each ), 1 Orange (CAN$10), & 1 Hour of Teaching (CAN$10,000) Market Value in 2017: 10 Apples (CAN$2 each), 2 Orange (CAN$10), & 1 Hour of Teaching (CAN$20,000) Nominal GDP in 2015: CAD$10,013. Nominal GDP in 2017: CAD$20,040. Real GDP in 2015 (base year 2017): CAD$20,016. Real GDP in 2017 (base year 2015): CAD$10,030. Any Question?

19 DEFINITION: GDP DEFLATOR GDP Deflator: A measure of the price level calculated as the ratio of nominal GDP to real GDP times 100 Nominal GDP GDP deflator = 100 Real GDP

20 DEFINITION: INFLATION RATE A Inflation Rate: the percentage change in some measure of the price level from one period to the next.

21 CALCULATION: INFLATION RATE A Inflation Rate: the percentage change in some measure of the price level from one period to the next. GDP Deflator: A measure of the price level calculated as the ratio of nominal GDP to real GDP times 100 In general, the growth rate is measured as follows: Growth Rate = Level in Year 2 Level in Year 1 Level in Year Applying it to measure the growth rate in price level: Growth Rate in Price = Price Lvl in Yr 2 Price Lvl in Yr 1 Price Level in Year By the definitions of Inflation Rate & GDP Deflator, Inflation Rate = GDP deflator in Yr 2 GDP deflator in Yr 1 GDP deflator in Yr 1 100

22 EXAMPLE: NOMINAL & REAL GDP This example is obtained from Mankiw, N. Gregory, Ronald D. Kneebone, Kenneth J. Mckenzie (2017). Principles of Macroeconomics. Any Question?

23 CONSUMER PRICE INDEX (CPI) Definition of CPI: CPI: a measure of the overall cost of the goods & services bought by a typical consumer Goal of CPI: measure changes in the cost of living.

24 4 STEPS TO CALCULATE CPI Step 1: Determine the Basket Step 2: Find the Prices Step 3: Compute the Basket s Cost Step 4: Choose a Base Year & Compute the Index

25 This example is obtained from Mankiw, N. Gregory, Ronald D. Kneebone, Kenneth J. Mckenzie (2017). Principles of Macroeconomics. DEFINITION COMPONENTS OF GDP NOMINAL & REAL GDP COST OF LIVING EXERCISE 4 STEPS TO CALCULATE CPI

26 CALCULATION: INFLATION RATE A Inflation Rate: the percentage change in some measure of the price level from one period to the next. CPI: a measure of the overall cost of the goods & services bought by a typical consumer In general, the growth rate is measured as follows: Growth Rate = Level in Year 2 Level in Year 1 Level in Year Applying it to measure the growth rate in price level: Growth Rate in Price = Price Lvl in Yr 2 Price Lvl in Yr 1 Price Level in Year By the definitions of Inflation Rate & CPI, Inflation Rate = CPI in Yr 2 CPI in Yr 1 CPI in Yr 1 100

27 3 PROBLEMS IN MEASURING THE COST OF LIVING Commodity Substitution Bias: Prices do not change proportionately Consumers substitute towards goods that are relatively cheaper CPI of a fixed basket of goods overstates the increase in the cost of living Introduction of New Goods CPI of a fixed basket of goods does not reflect the increase in the value of the dollar Unmeasured Quality Change

28 EXERCISE 1: List the four components of expenditure. What does it mean when net exports have a negative value? Define real and nominal GDP. Which is a better measure of economic well-being? Why? Which contributes more to GDP the production of an economy car or the production of a luxury car? Why? This exercise is obtained from Mankiw, N. Gregory, Ronald D. Kneebone, Kenneth J. Mckenzie (2017). Principles of Macroeconomics.

29 EXERCISE 2: If the price of a hot dog is $2 and the price of a hamburger is $4, then 30 hot dogs contribute as much to GDP as what number of hamburgers? Chi Man the sheep farmer sells wool to Barnaby the knitter for $20. Barnaby makes two sweaters, each of which has a market price of $40. Collette buys one of them, while the other remains on the shelf of Barnaby s store to be sold later. What is GDP here? This exercise is obtained from Mankiw, N. Gregory, Ronald D. Kneebone, Kenneth J. Mckenzie (2017). Principles of Macroeconomics.

30 EXERCISE 3: In the year 2014, the economy produces 100 loaves of bread that sell for $2 each. In the year 2015, the economy produces 200 loaves of bread that sell for $3 each. Calculate nominal GDP, real GDP, and the GDP deflator for each year. (Use 2014 as the base year.) By what percentage does each of these three statistics rise from one year to the next? This exercise is obtained from Mankiw, N. Gregory, Ronald D. Kneebone, Kenneth J. Mckenzie (2017). Principles of Macroeconomics.

31 EXERCISE 4: This exercise is obtained from Mankiw, N. Gregory, Ronald D. Kneebone, Kenneth J. Mckenzie (2017). Principles of Macroeconomics.

32 EXERCISE 5: This exercise is obtained from Mankiw, N. Gregory, Ronald D. Kneebone, Kenneth J. Mckenzie (2017). Principles of Macroeconomics.

33 EXERCISE 6: This exercise is obtained from Mankiw, N. Gregory, Ronald D. Kneebone, Kenneth J. Mckenzie (2017). Principles of Macroeconomics.

34 EXERCISE 7: If the price of a military aircraft rises, is the consumer price index or the GDP deflator affected more? Why? Over a long period of time, the price of a candy bar rose from $0.10 to $0.60. Over the same period, the consumer price index rose from 150 to 300. Adjusted for overall inflation, how much did the price of the candy bar change? If the consumer price index was 200 in 1980 and 300 today, then $600 in 1980 has the same purchasing power as what amount today? This exercise is obtained from Mankiw, N. Gregory, Ronald D. Kneebone, Kenneth J. Mckenzie (2017). Principles of Macroeconomics.

35 EXERCISE 8: This exercise is obtained from Mankiw, N. Gregory, Ronald D. Kneebone, Kenneth J. Mckenzie (2017). Principles of Macroeconomics.

36 EXERCISE 9: This exercise is obtained from Mankiw, N. Gregory, Ronald D. Kneebone, Kenneth J. Mckenzie (2017). Principles of Macroeconomics.

37 EXERCISE 10: This exercise is obtained from Mankiw, N. Gregory, Ronald D. Kneebone, Kenneth J. Mckenzie (2017). Principles of Macroeconomics.

38 EXERCISE 11: This exercise is obtained from Mankiw, N. Gregory, Ronald D. Kneebone, Kenneth J. Mckenzie (2017). Principles of Macroeconomics.