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UIUC ECON 303 - growth2_ch4_cp

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UIUC Econ 303Intermediate Macro Zhao 1Section I: Growth theoryChapter 2,7,4: GDP growth and Production function Price index• Base year price index = 100• Price index compares prices of a basket of goods in current year with prices of a (similar) basket of goods in the base year.• Price index shows the changes of purchasing power of money over time.• Say base year is 2000• Price index 2015 = 150, means …• Price index 1980 = 40, means…UIUC Econ 303Intermediate Macro Zhao 2Inflation Rate Calculated from the CPI and from the GDP DeflatorWe use CPI to adjust for cost of living.We use GDP deflator to adjust national accounts.CPI vs. GDP deflatorIn each scenario, determine the effects on the CPI and the GDP deflator. A. Starbucks raises the price of Frappuccinos.B. Caterpillar raises the price of the industrial tractors it manufactures at its Illinois factory.C. Armani raises the price of the Italian jeans it sells in the U.S.D. Price of Airbus, which is made in France and sold to the US, falls.UIUC Econ 303Intermediate Macro Zhao 3Another look at the CPI calculationFixed at the base yearCPI is expenditure weighted average of individual price changeRecreation5%Education and communication6%Other goods and services4%Food and beverages16%Motor fuel7%Housing40%Apparel4%Transportation13%Medical care5%UIUC Econ 303Intermediate Macro Zhao 4Current dollar vs. constant (2010) dollar year CPIcurrent dollars constant dollars current dollars constant dollars2010 180810 180810 20000 20000 1002000 145220 183865 17920 22689 791990 94748 153224 12500 20215 621980 50661 127629 7478 18839 401970 23175 116129 3688 18480 20lower limit of top 5% upper limit of bottom 20%In 2010 dollarsnominal incomereal incomeCost of living adjustments (page 16)UIUC Econ 303Intermediate Macro Zhao 5History of US federal minimum wage increasesRaise to $10.10?Core inflationUIUC Econ 303Intermediate Macro Zhao 6Long-Run Economic Growth• Long-run economic growth is the sustained upward trend in the economy’s output (real GDP) over time.• A country can achieve a permanent increase in the standard of living of its citizens only through long-run growth of – real GDP per capita• Once one starts to think about them (growth), it is hard to think about anything else. -- Robert E. LucasThe power of compoundingYear Country Linear Country Exponential2014 1000 10002015 1000 + 50 1000 + 1000 * 5% = 1000 + 502016 1000 + 50 + 50 (1000+ 50) + (1000+ 50) * 5%= 1000 + 50 + 50 + 50*5%2014+n• Linear and Exponential, both, have real GDP per capita $1,000 in 2011. • In country Linear, GDP per capita increases on average $50 per year. In country Exponential, GDP per capita grows on average 5% per year.UIUC Econ 303Intermediate Macro Zhao 70500100015002000250030003500400045002010 2015 2020 2025 2030 2035 2040 2045Power of compounded growth IExponentialLinearReal GDP per Capita of the United StatesYear Percentage of 1907 real GDP per capitaPercentage of 2007 real GDP per capita1907 100% 16%1927 129 211947 175 281967 283 461987 430 692007 620 100UIUC Econ 303Intermediate Macro Zhao 8Average annual growth rate• How did the United States manage to produce over six times as much per person in 2007 than in 1907? • A little bit at a time. • From 1907 to 2007, real GDP per capita in the United States increased an average of 1.8% each year.In general, average annual growth rate over n-year period • Exact method • ApproximatelyUIUC Econ 303Intermediate Macro Zhao 9Some algebra with growth rate (page 17)Property of natural log functionUIUC Econ 303Intermediate Macro Zhao 10Based on the property of log function• Three variables x,y, and, z• Three variables x,y, and z• For a constant α and two variables x and zAnnual growth rate 0.70% 2% 4% 5% 8%Years to double 100 35 17.5 14 8.75US 2006‐10 US 1965‐2005 South Korea 1996‐2010 India 1996‐2010 China 1980‐2010The Rule of 70The time it takes GDP, that grows gradually over time, to double is approximately 70 divided by the annual growth rate.UIUC Econ 303Intermediate Macro Zhao 11Solve for unknowns (page 18)Power of growth (page 19)UIUC Econ 303Intermediate Macro Zhao 12Income Around the World, 2007UIUC Econ 303Intermediate Macro Zhao 13Big disparity in growth rateEconomists’ very abstract description of production process• Output (GDP), Y• Inputs (factors): land, labor, and capital• A function that describe the relationship between input and output is called production function. • The Cobb-Douglas production function capital laborUIUC Econ 303Intermediate Macro Zhao 14Function that describes the US aggregate production 1965GDP (thousands 1985 $) 2,263,505,500Labor force (thousands) 80,693Capital (thousands 1985 $) 1,412,683,700Total Factor productivity 918z: TFP, Solow


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