2/14/2008. The circular flow of goods and incomes. firms and households. goods markets. Goods and services. real flows: goods and services

Transcription

1 The circular flow of income Chapter 22 Introduction to Macroeconomics Economics, 4 th edition Stiglitz & Walsh firms and households goods markets real flows: goods and services The Economic Problem Goods and services 1

2 The circular flow of income Goods and services firms and households goods markets real flows: goods and services money flows: consumer expenditure The Economic Problem Goods and services $ Consumer expenditure The circular flow of income firms and households goods markets real flows: goods and services money flows: consumer expenditure factor markets The Economic Problem 2

3 The circular flow of income firms and households goods markets real flows: goods and services Goods and services $ Consumer expenditure money flows: consumer expenditure factor markets real flows: services of labour and other factors The Economic Problem Goods and services $ Consumer expenditure The circular flow of income firms and households goods markets real flows: goods and services money flows: consumer expenditure factor markets real flows: services of labour and other factors money flows: wages and other incomes The Economic Problem Services of factors of production (labor, etc) 3

4 Goods and services $ Consumer expenditure Goods and services $ Consumer expenditure Wages, rent dividends, etc. $ Services of factors of production (labour, etc) Services of factors of production (labour, etc) The circular flow of income (cont.) macroeconomic issues the size of total flows microeconomic issues Simplified circular flow Only labor and product markets with household and the firm sectors. Funds flow from households firms in the form of purchases of goods and services Balanced by the flow of funds from firms households payments for the labor of workers and profits to owners. individual markets choices within goods and factor markets The Economic Problem Circular Flow 4

5 How evaluate performance of the economy? Measure output? How? GDP = the total money value of all final goods and services produced within a nation's borders during a given period of time (such as a year) Nominal GDP in year t = P t good 1 Q t good 1 + P t good 2 Q t good Nominal GDP may change if prices change and quantities are constant. Measurement of Output GDP Nominal Real GDP in year t (using as base year b) = P b good 1 Q t good 1 + P b good 2 Q t good Because real GDP uses base year prices, real GDP only changes when the country produces more output. Nominal GDP = real GDP*(P), where P is a measure of aggregate or average prices P = nominal GDP/real GDP. P is also known as the GDP deflator. Real GDP = nominal GDP/GDP deflator GDP - Real Gross Domestic Product (b) 5

6 Year Quantity of Cars Price of cars Nominal GDP $20,000 $200, $24,000 $288, $26,000 $338,000 Using 2000 dollars to compute real GDP, then: Year Quantity of Cars Price of cars Nominal GDP $24,000 $240,000 ominal and Real GDP U.S. GDP, From 1960 to 2000, nominal GDP increased by a factor of 19. Real GDP increased by a factor of $24,000 $288, $24,000 $312,000 Nominal and Real GDP Nominal and Real GDP GDP growth equals: Yt Yt Y ( t 1 Periods of positive GDP growth are called expansions. Periods of negative GDP growth are called recessions. Nominal and Real GDP 1 ) Potential GDP Labor is employed at the normal levels of overtime. Machinery and equipment are used at the normal rates of utilization. Recession = output and general business activity falling informal definition 2 consecutive quarters of declining output Expansion or booms = output strongly rising U.S. expansion from 1991 to 2001 was the longest in U.S. economic history. Potential GDP (a) 6

7 Q: The financial press often states the definition of a recession as two consecutive quarters of decline in real GDP. How does that relate to the NBER's recession dating procedure? Macro indicators - Joint Economic Committee, Council of Economic Advisors A: Most of the recessions identified by our procedures do consist of two or more quarters of declining real GDP, but not all of them. According to current data for 2001, the present recession falls into the general pattern, with three consecutive quarters of decline. Our procedure differs from the two-quarter rule in a number of ways. First, we consider the depth as well as the duration of the decline in economic activity. Recall that our definition includes the phrase, "a significant decline in economic activity." Second, we use a broader array of indicators than just real GDP. One reason for this is that the GDP data are subject to considerable revision. Third, we use monthly indicators to arrive at a monthly chronology. Recession defined - NBER Indicators - Data Output gap is the difference between output and potential output (in percentage terms). Output gap = 100*(Y Yp)/Yp When the Output gap > 0, output is above potential. Labor and capital are employed above their normal levels. When the Output gap < 0, output is below potential. Labor and capital are employed below their normal levels. During booms output gap is positive. During recessions output gap is negative. Output Gap Potential and Actual Real GDP 7

8 GDP in year t = P t good 1 Q t good 1 + P t good 2 Q t good The sum of the expenditure on each final good Double counting of goods is not allowed. The value of intermediate goods is already included in the value of final goods. Measuring Output I. The Final Goods Approach Final Expenditure on domesticallyproduced goods and services measured at current market prices GDP = C + I + G + (X-M) C: Household spending (consumption) I: Capital Investment spending G: General Government spending X: Exports of Goods and Services M: Imports of Goods and Services GDP by Market (Final Goods) Final consumption expenditure Households Non-profit institutions General government spending Gross capital spending Gross fixed capital formation 438,453 16, , , ,851 20, , , ,235 22, , ,114 Value added = firm's revenue - cost of intermediate inputs Notice again that intermediate goods are not included in measure of GDP Changes in inventories 4,512 4,461 1,206 Acquisitions less disposals of valuables Total exports of goods and services 202, , ,348 Gross final expenditure 919,201 1,085,083 1,207,538 less Total imports of goods and services 205, , ,206 Statistical discrepancy GDP at current market prices GNP at current market prices GDP at 1995 market prices GDP index at 1995 market prices 713, , , , , , AD Data for the UK Economy , , , II. The Value-Added Approach 8

9 A firm's revenue must be somebody's income. GDP = profits (owners) wages (employees) interest payments (creditors lenders) indirect taxes (payments to governments) depreciation (assumed replacement) Net Domestic Product (NDP) = GDP - depreciation III. Income Approach Income Approach Component Amounts The Composition of GDP by Type of Income, 1960 and 2003 (in percent) Labor income Capital income Indirect taxes 8 8 GDP: Production and Income GDP represents all of the goods and services produced in a year. If you buy a used car from a neighbor your income falls but your neighbor's income rises. So on net, aggregate, or total, income in the economy is unchanged. Other measures of a country's standard of living are life expectancy, literacy, and infant mortality,...? Correlation with GDP? Measuring the Standard of Living Start Tues / Wed Labor force = total number of people employed or actively seeking employment If a person is not seeking work, they are not counted in the labor force. Labor force = employed + unemployed = 148 million in 2005, of which 7.6 million were unemployed. The unemployment rate in May 2005 was 5.2% of the labor force. Unemployment: the Magnitude of the Problem 9

10 labor force = employed + unemployed L = + U Unemployment rate: U u= L labor force = employed + unemployed L = + U Unemployment rate: U u= L 57. u 2000 = = % 57. u 2000 = = % The Unemployment Rate The Unemployment Rate Unemployed = those unemployed people who are actively seeking work Unemployment rate = those unemployed people who are actively seeking work as a percentage of the total labor force. U = 100 * (unemployed/labor force) The macroeconomic cost of unemployment is the output lost. In the recession of the early 1980s, estimates of this loss range between $122 and $320 billion per year, or $500 to $1,300 per person per year! Unemployment Statistics Unemployment 10

11 1. Seasonal unemployment 2. Frictional unemployment 3. Structural unemployment 4. Cyclical unemployment The natural rate of unemployment: The unemployment rate when the economy is producing at potential GDP Unemployment - International Forms of Unemployment Frictional unemployment includes people who are temporarily between jobs. They may have quit one job to find another, or they could be trying to find the best opportunity after graduating from high school or college. Cyclical unemployment includes people who are not working because firms do not need their labor due to a lack of demand or a downturn in the business cycle. For example, if people are not buying many goods and services, workers are laid off. Structural unemployment involves mismatches between job seekers and job openings. Unemployed people who lack skills or do not have sufficient education are structurally unemployed. Seasonal 11

12 1. A computer programmer is laid off because of a recession. 2. A literary editor leaves her job in New York to look for a new job in San Francisco. 3. An unemployed college graduate is looking for his first job. 4. Advances in technology make the assembly-line worker s job obsolete. 5. Slumping sales lead to the cashier being laid off. Types of U An individual refuses to work for minimum wage. 7. A high school graduate lacks the skills necessary for a particular job. 8. Workers are laid off when the local manufacturing plant closes because the product made there isn t selling. 9. A skilled glass blower becomes unemployed when a new machine does her job faster. Types of U - 2 Output Gap (%) = -2(U U*) U is the unemployment rate U* is the natural rate of unemployment Currently a one-percentage-point increase in the unemployment rate leads to a twopercentage-point reduction in the output gap. Why a coefficient of -2? There is not a one-to-one relationship between the output gap and increases in the unemployment rate. Labor hoarding during downturns When the economy is at potential, unemployment is at the natural rate. No modern economy has zero unemployment. Okun s Law Okun s Law -2? 12

13 A stock: a variable measured at a moment in time Example 1: the labor force is a stock; today there are 148 million workers in the U.S. labor force Example 2: the unemployment rate and the capital stock are both stocks A flow: a variable measured over a period of time Example 3: GDP is a flow since it is the value of all final goods and services produced within a country during a year Example 4: your income, your consumption and saving are all flow variables Okun s Law (continued) Stocks and Flows Inflation is a sustained rise in the general level of prices the price level. The inflation rate is the rate at which the price level increases. Deflation is a sustained decline in the price level, or a negative inflation rate. The Inflation Rate P t nominal GDPt $ Yt = = real GDP Y The GDP deflator is what is called an index number set equal to 100 in the base year. The rate of change in the GDP deflator equals the rate of inflation: ( Pt Pt 1) P The GDP Deflator t t t 1 13

14 Nominal GDP is equal to the GDP deflator times real GDP From previous slide: nominal GDPt $ Yt Pt = = real GDP Y So, multiplying through: t $Yt = PY t t t Base Year Year 1 15 x $0.20 = $ x $0.22 = $11.00 Total = $14.00 Nominal GDP in Year 1 (in Year 1 $) Current Year Year 5 20 x $0.30 = $ x $0.25 = $15.00 Total = $21.00 Nominal GDP in Year 5 (in Year 5 $) Real GDP Current Year Year 5 20 x $0.20 = $ x $0.22 = $15.00 Total = $17.20 REAL GDP in Year 5 (in Year 1 prices) GDP from Base Year Prices Base Year Year 1 15 x $0.20 = $ x $0.22 = $11.00 Total = $14.00 Nominal GDP in Year 1 (in Year 1 $) Current Year Year 5 20 x $0.30 = $ x $0.25 = $15.00 Total = $21.00 Nominal GDP in Year 5 (in Year 5 $) Real GDP Current Year Year 5 20 x $0.20 = $ x $0.22 = $15.00 Total = $17.20 REAL GDP in Year 5 (in Year 1 prices) Inflation Rate, Using the CPI and the GDP Deflator, The inflation rates, computed using either the CPI or the GDP deflator, are largely similar. GDP from Base Year Prices CPI vs GDP Deflator 14