Macroeconomics

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Macroeconomics The global EconomyAce
Institute of ManagementSession 1

• Instructor
• Sandeep Basnyat
• Sandeep_basnyat_at_yahoo.com
• 9841 892281

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Objectives

• To acquaint students with basic knowledge of
  macroeconomic theories
• Define, explain and analyze macroeconomic terms,
  theories and indicators in general
• Apply learning in decision making processes and
  solve real world issues
• Use and explain the macroeconomic and
  developmental problems in a country

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Evaluation Criteria

• Class Participation 5
• Group Presentation 10 (5 Groups)
• Midterm exams 15
• Term exam 40 (End Term)
• Class Tests 10 (2 Tests)
• Assignments 10 (1 Assignment)
• Group Term Paper 10 (Submit at end)

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Case study presentations

• Case study oriented classes
• Possibility of external evaluator
• Evaluation Criteria (10 x 3 30 marks)
• Did the presentation reflect a team work among
  its members?
• Were the students prepared for the presentation?
• Did the students look confident while
  deliberating? (including eye contact voice
  clarity)

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Case study presentations

• Case Study Presentation Schedule
• Group1 Session 3
• Group2 Session 5
• Group 3 Session 6
• Group 4 Session 9
• Group 5 Session 10

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Class tests, Assignment Term paper

• Class Test 1 Session 4
• Class Test 2 Session 11
• Assignment Session 9
• Term Paper
• Preliminary Selection of Topic for term
  paper Session 3
• Development of Research idea on term
  paper Session 5
• Submission and Approval of the Topic with
  plan Session 7
• Submission of term paper Session 12

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What you studied in Microeconomics..

• Basic demand and supply functions of individuals
  and markets
• Profit maximizations of individual firms in
  different markets
• Consumers and Producers welfare theories
• Cost and benefits of firms in different markets.
• And so on
• But NOW .

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Introduction to Macroeconomics
Macroeconomics, the study of the economy as a
whole, addresses many topical issues

• Why does the cost of living keep rising?
• Why are millions of people unemployed, even when
  the economy is booming?
• What causes recessions? Can the government do
  anything to combat recessions? Should it?

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Introduction to Macroeconomics
Macroeconomics, the study of the economy as a
whole, addresses many topical issues

• What is the government budget deficit? How does
  it affect the economy?
• Why does Nepal have such a huge trade deficit?
• Why are so many countries poor? What policies
  might help them grow out of poverty?

And our analysis look...
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U.S. Real GDP per capita (2000 dollars)
long-run upward trend
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U.S. inflation rate( per year)
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U.S. unemployment rate( of labor force)
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Why learn macroeconomics?

• 1. The macroeconomy affects societys well-being.

• Each one-point increase in the unemployment rate
  is associated with
• 920 more suicides
• 650 more homicides
• 4000 more people admitted to state mental
  institutions
• 3300 more people sent to state prisons
• 37,000 more deaths
• increases in domestic violence and homelessness

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Why learn macroeconomics?
2. The macroeconomy affects your well-being.
In most years, wage growth falls when
unemployment is rising.
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Introduction to Macroeconomics

• Macroeconomics
• Deals with the economy as a whole.
• Study of the economy as a whole.
• Its goal is to explain the economic changes that
  affect many households, firms, and markets at
  once.

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How do Macroeconomists think?

• Theory as a Model
• Used to describe the real world eliminating
  unnecessary details

The model teeth
A model of human anatomy
A road map
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How do Macroeconomists think?

• Macroeconomic models Symbols and Equations
• Two important variables in a models
• Exogenous variables and
• Endogenous variables.
• Exogenous (Independent) variables that a model
  takes as given.
• Endogenous (dependent) variables which the
  model tries to explain. (What happens to..??)

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The model of supply and demand

• Assume the following two relationships for CD
  market
• Qd D(P,Y) (i)
• Qs S(P,Pm) (ii)
• Equation (i) shows that Quantity of the CD
  demanded is the function of the Price of the CD
  and Income level of the consumer or the aggregate
  income of the economy.
• Equation (ii) shows that Quantity of the CD
  supplied is the function of the Price of the CD
  and Input price of the materials.
• The equilibrium in the CD market is given by
• Qd Qs

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The model of supply and demand
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The model of supply and demand
Exogenous Variables Aggregate Income,
and Price of the materials (taken as
given) Endogenous Variables Price of the CD,
and Equilibrium quantity of CD
The model explains what happens to Endogenous
variables (Price and Equilibrium Quantity of CD
sold) when one of the Exogenous variables
(Aggregate Income and Price of the materials )
changes.
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Example changes in Exogenous variables
SHIFTS IN DEMAND
SHIFTS IN SUPPLY
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Prices flexible vs. sticky

• General Assumption Market equilibrium of supply
  and demand, (market clearing process).
• Markets clearing continuously, is unrealistic.
• Need prices to adjust instantly to changes in
  supply and demand. But, prices and wages often
  adjust slowly.
• Although market clearing models assume that wages
  and prices are flexible, in actuality, some wages
  and prices are sticky. But they do depict the
  equilibrium toward which the economy gravitates.
• Short term analysis vs Long term analysis for
  Price Sticky vs Price Flexibility

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Gdp, cpi and unemployment
Three statistics that economists and policymakers
use Gross Domestic Product (GDP) is the dollar
value of all final goods and services produced
within an economy in a given period of time. The
consumer price index (CPI) measures the level of
prices. The unemployment rate tells us the
fraction of workers who are unemployed.
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For the economy as a whole, income must equal
expenditure. GDP measures the flow of dollars
in the economy.
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Expenditure Rules for Computing GDP
In general, to compute the total value of
different goods and services, the national income
accounts use market prices. Thus, if
GDP (Price of apples ? Quantity of apples)
(Price of oranges ? Quantity of oranges)
(0.50 ? 4) (1.00 ? 3) GDP 5.00
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GDP Components of Expenditure
Y C I G NX
This is the called the national income accounts
identity.
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Calculating GDP
Components of U.S. GDP, 2004 The Expenditure Approach Components of U.S. GDP, 2004 The Expenditure Approach Components of U.S. GDP, 2004 The Expenditure Approach Components of U.S. GDP, 2004 The Expenditure Approach Components of U.S. GDP, 2004 The Expenditure Approach Components of U.S. GDP, 2004 The Expenditure Approach Components of U.S. GDP, 2004 The Expenditure Approach Components of U.S. GDP, 2004 The Expenditure Approach
BILLIONS OFDOLLARS BILLIONS OFDOLLARS BILLIONS OFDOLLARS PERCENTAGEOF GDP PERCENTAGEOF GDP
Personal consumption expenditures (C) Personal consumption expenditures (C) Personal consumption expenditures (C) 8,214.3 70.0 70.0
Durable goods Durable goods 987.8 8.4
Nondurable goods Nondurable goods 2,368.3 20.2
Services Services 4,858.2 41.4
Gross private domestic investment (l) Gross private domestic investment (l) Gross private domestic investment (l) 1,928.1 16.4 16.4
Nonresidential Nonresidential 1,198.8 10.2
Residential Residential 673.8 5.7
Change in business inventories Change in business inventories 55.4 0.5
Government consumption and gross investment (G) Government consumption and gross investment (G) Government consumption and gross investment (G) 2,215.9 18.9 18.9
Federal Federal 827.6 7.1
State and local State and local 1,388.3 11.8
Net exports (EX IM) Net exports (EX IM) Net exports (EX IM) -624.0 - 5.3 - 5.3
Exports (EX) Exports (EX) 1,173.8 10.0
Imports (IM) Imports (IM) 1,797.8 15.3
Gross domestic product (GDP) Gross domestic product (GDP) Gross domestic product (GDP) 11,734.3 100.0 100.0
Note Numbers may not add exactly because of rounding.Source U.S. Department of Commerce, Bureau of Economic Analysis. Note Numbers may not add exactly because of rounding.Source U.S. Department of Commerce, Bureau of Economic Analysis. Note Numbers may not add exactly because of rounding.Source U.S. Department of Commerce, Bureau of Economic Analysis. Note Numbers may not add exactly because of rounding.Source U.S. Department of Commerce, Bureau of Economic Analysis. Note Numbers may not add exactly because of rounding.Source U.S. Department of Commerce, Bureau of Economic Analysis. Note Numbers may not add exactly because of rounding.Source U.S. Department of Commerce, Bureau of Economic Analysis. Note Numbers may not add exactly because of rounding.Source U.S. Department of Commerce, Bureau of Economic Analysis. Note Numbers may not add exactly because of rounding.Source U.S. Department of Commerce, Bureau of Economic Analysis.
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(No Transcript)
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World Top 10 GDP in Millions of US Dollars in
Market Price (Source IMF2008/2009)
12. India - 1,235,975 109. Nepal - 12,615 160.
Maldives- 1,357 162. Bhutan - 1,269 181. Kiribati
- 130
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Expenditure Rules for Computing GDP

• 1) Used goods are not included in the calculation
  of GDP.
• 2) The treatment of inventories depends on if the
  goods are stored or if they spoil.
• If the goods are stored, their value is included
  in GDP.
• If they spoil, GDP remains unchanged.
• When the goods are finally sold out of
  inventory, they are considered used goods (and
  are not counted).

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Expenditure Rules for Computing GDP
3) Some goods are not sold in the marketplace and
therefore dont have market prices. We must use
their imputed value as an estimate of their
value. For example, home ownership and government
services. 4) Intermediate goods are not counted
in GDP only the value of final goods. Reason
the value of intermediate goods is already
included in the market price. Value added of a
firm equals the value of the firms output less
the value of the intermediate goods the firm
purchases.
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Measuring GDP by the Value Added Method
FIRM
VALUE OF PRODUCT
VALUE ADDED
Cotton Farmer
Value of raw cotton 1.00
Value added by cotton farmer
1.00
Textile Mill
Value of raw cotton woven into cotton fabric
3.00
Value added by cotton textile mill (3.00
1.00)
2.00
Value added by shirt manufacturer (15.00
3.00)
12.00
Shirt Company
Value of cotton fabric made into a shirt 15.00
Value added by L.L. Bean (35.00 15.00)
L.L. Bean
Value of shirt for sale on L.L. Beans Web site
35.00
20.00
Total Value Added
35.00
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Exercise (Problem 2, p. 40)

• A farmer grows a bushel of wheat and sells it to
  a miller for 1.00.
• The miller turns the wheat into flour and sells
  it to a baker for 3.00.
• The baker uses the flour to make a loaf of bread
  and sells it to an engineer for 6.00.
• The engineer eats the bread.
• Compute compare value added at each stage of
  production and GDP

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Other Exclusions from Expenditures

• Expenditure on purchase of goods and services
  during specified time period.
• Previous expenditure reflects the change in
  ownership only.
• Avoid neither good nor a service
• Does not reflect production such as bonds/ stocks
• Avoid expenditure by governments for which it
  does not receive a good or service in return
• Eg. Transfer payments such as Social security,,
  unemployment compensation etc.

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Measuring GDP from Income side

• Sum of income of all factors of production gives
  the GDP from income side
• GDP Rent Wages Interest Profits

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Calculating GDP
U.S. National Income, 1980 (Shapiro Table 2-1, Pg.27 Adjusted) U.S. National Income, 1980 (Shapiro Table 2-1, Pg.27 Adjusted) U.S. National Income, 1980 (Shapiro Table 2-1, Pg.27 Adjusted) U.S. National Income, 1980 (Shapiro Table 2-1, Pg.27 Adjusted) U.S. National Income, 1980 (Shapiro Table 2-1, Pg.27 Adjusted) U.S. National Income, 1980 (Shapiro Table 2-1, Pg.27 Adjusted) U.S. National Income, 1980 (Shapiro Table 2-1, Pg.27 Adjusted) U.S. National Income, 1980 (Shapiro Table 2-1, Pg.27 Adjusted)
BILLIONS OFDOLLARS BILLIONS OFDOLLARS
Gross Domestic Products (GDP) Gross Domestic Products (GDP) Gross Domestic Products (GDP) 2341.3
Compensation of employees Compensation of employees 1804.4 1804.4
Proprietors income Proprietors income 130.6 130.6
Corporate profits Corporate profits 183.8 183.8
Net interest Net interest 190.6 190.6
Rental income Transfer payments to households if any. Rental income Transfer payments to households if any. 31.9 31.9




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Calculating GDP

• Compensation of employees includes wages,
  salaries, and various supplementsemployer
  contributions to social insurance and pension
  funds, for examplepaid to households by firms
  and by the government.

• Proprietors income The income of non-corporate
  businesses such as small farms, shops.

• Rental income The income received by property
  owners in the form of rent.

• Corporate profits The income of corporate
  businesses.

• Net interest The interest received by the
  businesses minus interest they pay plus interests
  earned from the foreigners.

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Remember Gross Domestic Product (GDP)

• Gross domestic product (GDP) is a measure of the
  income and expenditures of an economy which
  includes all items produced in the economy and
  sold legally in markets.
• But
• It excludes items produced and sold illicitly,
  such as illegal drugs.

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Other Measures of income

• Gross National Product (GNP)
• Net National Product (NNP)
• National Income (NI)
• Personal Income (PI)
• Personal Disposable Income (DI)

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National Income Accounting contd..

• GDP NFI from Abroad GNP
• GNP is the monetary value of final goods and
  services produced by the nationals (income earned
  by the nationals on foreign countries minus
  income earned by foreigners at home)
• GNP Depreciation (Capital Consumption) NNP
• Depreciation is the net capital consumption
  during the accounting year
• NNP Indirect Business Tax NI (National
  Income)

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National Income Accounting contd..

• NI Social contributions net interests paid by
  individuals corporate profit tax undistributed
  corporate profit Dividends Govt. business
  transfers to individuals Net interest paid to
  individual PI (Personal Income)
• PI Personal tax and non-tax payments (such as
  parking tickets) DI (Disposable Income)
• Disposable income is the final income that a
  consumer spends on the purchase of goods and
  services
• DI Saving Personal Interest Payment
  Household Transfer Payment Personal Consumption
  Expenditure

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Calculating other measures of Income
GDP, GNP, NNP and National Income, 1980 (adjusted from Income Method) GDP, GNP, NNP and National Income, 1980 (adjusted from Income Method) GDP, GNP, NNP and National Income, 1980 (adjusted from Income Method) GDP, GNP, NNP and National Income, 1980 (adjusted from Income Method) GDP, GNP, NNP and National Income, 1980 (adjusted from Income Method)
DOLLARS(BILLIONS)
GDP at factor cost GDP at factor cost GDP at factor cost 2341.3
Plus Receipts of factor income from the rest of the world Plus Receipts of factor income from the rest of the world 415.4
Less Payments of factor income to the rest of the world Less Payments of factor income to the rest of the world - 127.9
Equals GNP at factor cost Equals GNP at factor cost Equals GNP at factor cost 2628.8
Less Depreciation or capital consumption Less Depreciation or capital consumption - 287.5
Equals Net national product (NNP) Equals Net national product (NNP) Equals Net national product (NNP) 2341.3
Less Statistical discrepancy Less Statistical discrepancy - 219.9
Equals National income (NI) at factor cost Equals National income (NI) at factor cost Equals National income (NI) at factor cost 2121.4

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Calculating other measures of Income
National Income, Personal Income, Disposable Personal Income, and Personal Saving, 1980 (adjusted) National Income, Personal Income, Disposable Personal Income, and Personal Saving, 1980 (adjusted) National Income, Personal Income, Disposable Personal Income, and Personal Saving, 1980 (adjusted) National Income, Personal Income, Disposable Personal Income, and Personal Saving, 1980 (adjusted) National Income, Personal Income, Disposable Personal Income, and Personal Saving, 1980 (adjusted) National Income, Personal Income, Disposable Personal Income, and Personal Saving, 1980 (adjusted)
DOLLARS(BILLIONS)
National income National income National income National income 10,275.9
Less corporate taxes Plus transfer payments Less corporate taxes Plus transfer payments Less corporate taxes Plus transfer payments 39.6
Equals Personal income Equals Personal income Equals Personal income Equals Personal income 2161.0
Less Personal income taxes Less Personal income taxes Less Personal income taxes 338.7
Equals Disposable personal income Equals Disposable personal income Equals Disposable personal income Equals Disposable personal income 1822.2
Less Personal saving Less Personal saving 103.6
Less Personal interest payments Less Personal interest payments 46.5
Less Transfer payments made by households Less Transfer payments made by households 1.1
Equals Personal Consumption Expenditure Equals Personal Consumption Expenditure Equals Personal Consumption Expenditure Equals Personal Consumption Expenditure 1671.1


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Real vs. nominal GDP

• GDP is the value of all final goods and services
  produced.
• Nominal GDP measures these values using current
  prices.
• Real GDP measure these values using the prices of
  a base year.

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Practice problem, part 1
2006 2006 2007 2007 2008 2008
P Q P Q P Q
good A 30 900 31 1,000 36 1,050
good B 100 192 102 200 100 205

• Compute nominal GDP in each year.
• Compute real GDP in each year using 2006 as the
  base year.

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Answers to practice problem, part 1

• nominal GDP multiply Ps Qs from same
  year2006 46,200 30 ? 900 100 ? 192
  2007 51,400 2008 58,300
• real GDP multiply each years Qs by 2006
  Ps2006 46,2002007 50,000 2008 52,000
  30 ? 1050 100 ? 205

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Real GDP controls for inflation

• Changes in nominal GDP can be due to
• changes in prices.
• changes in quantities of output produced.
• Changes in real GDP can only be due to changes in
  quantities,
• because real GDP is constructed using constant
  base-year prices.

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U.S. Nominal and Real GDP, 19502006
Real GDP(in 2000 dollars)
Nominal GDP
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GDP Deflator

• The inflation rate is the percentage increase in
  the overall level of prices.
• One measure of the price level is the GDP
  deflator, defined as

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Practice problem, part 2
Nom. GDP Real GDP GDP deflator Inflationrate
2006 46,200 46,200 n.a.
2007 51,400 50,000
2008 58,300 52,000

• Use your previous answers to compute the GDP
  deflator in each year.
• Use GDP deflator to compute the inflation rate
  from 2006 to 2007, and from 2007 to 2008.

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Answers to practice problem, part 2
Nominal GDP Real GDP GDP deflator Inflationrate
2006 46,200 46,200 100.0 n.a.
2007 51,400 50,000 102.8 2.8
2008 58,300 52,000 112.1 9.3
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Chain-Weighted Real GDP

• Over time, relative prices change, so the base
  year should be updated periodically.
• In essence, chain-weighted real GDP updates the
  base year every year, so it is more accurate
  than constant-price GDP.
• But we usually use constant-price real GDP,
  because
• the two measures are highly correlated.
• constant-price real GDP is easier to compute.

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Exercise 1 For your understanding

• Make a note of
• Real and Nominal GDPs of some of the important
  countries and compare
• Prepare a list of top 10 countries with their
  Real GDP growth rate and PPP growth rate.

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Consumer Price Index (CPI)

• A measure of the overall level of prices
• Uses
• tracks changes in the typical households cost
  of living
• Adjusts for inflation
• allows comparisons of dollar amounts over time

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How to compute CPI

• 1. Survey consumers to determine composition of
  the typical consumers basket of goods.
• 2. Every month, collect data on prices of all
  items in the basket compute cost of basket
• 3. CPI in any month equals

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Exercise Compute the CPI

• Basket contains 20 pizzas and 10 compact discs.

• For each year, compute
• the cost of the basket in each year
• the CPI (use 2002 as the base year)
• the inflation rate from the preceding year

prices pizza CDs 2002 10 15 2003 11 15 2004
12 16 2005 13 15
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Answers

• Cost of Inflation
• basket CPI rate
• 2002 350 100.0 n.a.
• 2003 370 105.7 5.7
• 2004 400 114.3 8.6
• 2005 410 117.1 2.8

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The composition of the CPIs basket
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Reasons why the CPI may overstate inflation

• Substitution bias The CPI uses fixed weights,
  so it cannot reflect consumers ability to
  substitute toward goods whose relative prices
  have fallen.
• Introduction of new goods The introduction of
  new goods makes consumers better off and, in
  effect, increases the real value of the dollar.
  But it does not reduce the CPI, because the CPI
  uses fixed weights.
• Unmeasured changes in quality Quality
  improvements increase the value of the dollar,
  but are often not fully measured.

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CPI vs. GDP Deflator

• prices of capital goods
• included in GDP deflator (if produced
  domestically)
• excluded from CPI
• prices of imported consumer goods
• included in CPI
• excluded from GDP deflator
• the basket of goods
• CPI fixed
• GDP deflator changes every year

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Categories of the population

• employed working at a paid job
• unemployed not employed but looking for a job
• labor force the amount of labor available for
  producing goods and services all employed plus
  unemployed persons
• not in the labor force not employed, not
  looking for work

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Two important labor force concepts

• unemployment rate percentage of the labor force
  that is unemployed
• labor force participation rate the fraction of
  the adult population that participates in the
  labor force

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Exercise 1 For your understanding

• Make a note of
• Real and Nominal GDPs of some of the important
  countries and compare
• Prepare a list of top 10 countries with their
  Real GDP growth rate and PPP growth rate.
• Find CPI Index of various some important
  countries and check the inflation rates.

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Numerical Example 1
Calculate GDP, GNP, NI and DI
Employee compensation (EC) 3,244 Rental income
(RI) 16 Net interest (NETI) 467 Capital
consumption (CC) 567 Corporate taxes (CT)
145 Social Security taxes (SST) 440
Personal taxes (PT) 700 Undistributed
corporate profits (UCP) 37 Corporate profits
(CP) 297 Proprietor's income (PROI)
402 Indirect business taxes (IBT)
470 Transfer payments (TP) 660 Population
(POP) 250 (billions of people)
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Solution to Numerical Example 1
GDP Employee compensation Rental income
Net interest Corporate profits Proprietor's
income Billion 4426 GNP GDP NIF 4426
0 Billion 4426 NI NNP Indirect Business
Taxes GNP Capital Consumption - Indirect
Business Taxes Billion 3389 DI PI
Personal tax and non-tax payments NI Social
contributions corporate profit tax
undistributed corporate profit Govt.
business transfers to individuals
Personal tax and non-tax payments Billion
2727 For Further practice Macroeconomics by N.
G. Mankiw, 6th edition. Q.N. 2, 5, 6 and 7.
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Numerical Questions and Solutions for Practice
1) Abby consumes only apples. In year 1, red
apples cost 1 each, green apples cost 2 each,
and Abby buys 10 red apples. In year 2, red
apples cost 2 each, green apples cost 1 each,
and Abby buys 10 green apples. Compute a consumer
Price index (CPI) for apples for each year.
Assume that year 1 is the base year in which the
consumer basket is fixed. (Mankiw. Pg. 41. Q. 7)
a.
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Solution for Q. 1
Price in Current Year
--------------------------------------
CPI in Year 1
Price in Base Year
(PRed1 x QRed1) (PGreen1 x QGreen1)
--------------------------------------------------
-------------------
1

(PRed1 x QRed1) (PGreen1 x QGreen1)
Price in Current Year
--------------------------------------
CPI in Year 2
Price in Base Year
(PRed2 x QRed1) (PGreen2 x QGreen1)
--------------------------------------------------
-------------------
2

(PRed1 x QRed1) (PGreen1 x QGreen1)
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Numerical Questions and Solutions for Practice

• 2) Suppose that the Nominal and Real GDP for
  country Z in 1998 were 8,798.1 (in billion) and
  8,536, respectively. While for 1999, the figures
  were 9,295.4 and 8,897.7.
• Calculate the implicit GDP deflator for 1998 and
  1999
• Calculate the Inflation rate (Calculated as the
  ratio of differences in GDP Deflator with the GDP
  in base Year).
• (Related to Mankiw. Pg. 41. Q. 6)

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Solutions for Q.2 hint
NGDP 1998
8798.1
----------------------------
-------------------
Deflator in Year 1998

1.0307

RGDP 1998
8536.0
NGDP 1999
9295.4
----------------------------
-------------------
Deflator in Year 1999
1.0447


RGDP 1999
8897.7
Now Calculate Inflations rate yourself
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• Thank You