ECON201 MIDTERM REVIEW 1 Marco Economics 3 major variables Output Y value of goods and services produced by economy Unemployment Rate UR of population that wants to work but can t Inflation rate at which overall prices are growing OUTPUT Y HOW IS IT MEASURED Nominal Gross Domestic Product NGDP the market value at current prices of all final goods and services produced domestically this period Ex suppose in 2010 price quantity Guns 30 20 NGDP 2010 20x 30 100x 2 800 Butter 2 100 NOTE 1 ONLY goods and services produced this period NOT used 2 ONLY domestically produced ex Import car 30k sell in US for 50k 20k USGDP 3 only FINAL goods and services sold to their ultimate user as opposed to intermediate transaction NGDP is the sum of the value added VA at every step of the production process VA sale price of a transaction minus cost of material inputs Categories of final goods and services Consumption c most household spending Investment I spending on tangible physical capital assets not paper asset Gov t Purchases G federal state and local purchases of goods and services Exports X all exports included NOTE intermediate actions can count if police military schools they are G or X NOT INCLUDED transfer payment TR social security and interest on national debt National Income Accounting Identity Y C I G X M Net Export export import NOTE exports are added to GDP while imports are subtracted to reflect that part of C I G spending goes to imports Changes in GDP reflect change in price and quantity If p level change overtime due to inflation then comparisons of NGDP will be misleading RGDP correct NGDP for changes in p RGDP 1 choose 1 year as base year 2 Use formula to convert nominal to real RGDP for yearX NGDP in yearX x Pbase year PyearX GOAL to have some measure of society s material output that allows meaningful comparison across time across countries RGDP corrects NGDP for changes in price levels over time RGDP is superior in NGDP allowing for meaningful comparisons over time Furthermore can use exchange rates to convert RGDP for other countries into other terms make comparisons across countries Also RGDP can be divided by population to get Per Capita RGDP PCRGDP best measurement of a countries material living standards Limitations of Real GDP or PCRGDP as a measurement of material living standards RGDP omits most non market output Comparisons can be misleading if the value of non market production varies significantly over time and place o Home Production Child care Subsistence farming home garden farm o Underground economy illegal under the table gambling drugs prostitution ex Russia 30 vs US 10 economy underground o Leisure time ex France 35 hrs wk 8 wk vaca vs US 40 hr wk 3wk vaca o Environmental Quality clean air water Facts about OUTPUT Y Long run growth RGDP and PCRGDP have tended to rise since 1800s in advanced nations gRGDP 0 most years Business Cycles growth is bumpy not smooth o Trend component due to LR growth LR average What Y would be if LR grew at average o Business cycles are fluctuations of actual y around the trend Booms actual output is above trend Recession actual output is below trend oImportant Booms mid 60s late 90s mid 2000s oImportant Recessions 1974 74 stagflation OPEC 1982 3 Regan 1990 1 Bush 2008 present Decomposing GDP growth into components Y C I G NX level decomposition Growth rate output gy contributions from gC contribution form gI contribution from gG contribution from gNX RULE contribution to GDP growth from C gC x share of C in GDP ECONOMIC GROWTH The best measure of long run economic growth gPCRGDP gPCRGDP gRGDP gPopulation For US since 1870 average o gRGDP 3 1 o gPop 1 3 o gPCRGDP 1 8 LR growth in PCRGDP has created a rise in material living standards in US since 1800 How is it possible for small growth rates of PCRGDP to create such enormous increase in livings standards RULE OF 70 DOUBLING TIME Suppose LR average trend growth rate is g then the level of that variable will double every 70 g YEARS US gPCRGDP 2 living standard doubles every 70 2 35 years o Suppose gPCRGDP 2 in A and 1 in B in 70 years living standard will double in B and quadruple in A o Suppose I put 100 in a bank account with 4 interest How much will I have in 35 years 400 100 will double every 70 4 17 5 years 200 x 2 35 2 17 5 Facts about Growth Economic growth is a recent phenomenon in world history o Almost no livings standards pre 1800s Level and growth rate of PCRGDP vary a lot across countries What causes Growth Y Y x Labor Hrs Pop Labor hrs Pop Labor productivity Per capita hrs In other Countries Per Capita Hours have trended down overtime Child labor laws Longer retirement spans of elderly Shorter work week Rising female labor force participations countervails trend Growth in PCRGDP in west was entirely due to increase in LABOR PRODUCTIVITY Investment in physical capital machines structures roads Investment in human capital education Investment in technological progress new product processes Implication Growth carries an opportunity cost Investment requires diversion of resources away from current consumption Ex ppl who are in school cannot be working during the same time education has an opportunity cost trade off between ed and consumption More growth isn t necessarily better some countries Soviet Union may have over emphasized growth at expense of current living standard there can be a trade off Why is growth faster in some countries More investment opportunities in some countries periods of history What factors matter for GROWTH What explain cross country era differences 1 Institutions legal system property rights Successful high growth countries Stable political systems secure property rights enforcement of contracts indv Businesses have INCENTIVE to invest Unsuccessful low growth countries Political instability unsecure property rights weak institutions low incentives for investment Explanation for Lack of growth pre 1800 Medieval Europe 500 1500 Weak government property rights not secure to crime invasion Early Modern Europe 1500 1800 Absolute monarchy insecure property rights from government confiscation Modern Europe Strong but limited government that promoted property rights Institutions can also explain for differences in growth across countries political stability is very strongly correlated with growth across countries 2 Culture need openness toward new ideas science technology and acceptance and value of wealth accumulation Medieval Europe anti growth culture
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