Chapter 7-9 Notes

7/30/2019 Chapter 7-9 Notes

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Chapter 7 GDP: Measuring Total Production and Income

(Summaries)

7.1

In a nutshell macroeconomics is the study of the economy as a whole. In a business cycle there are two

alternating periods one is of expansion and other of recession. In both of these cases there will be a

change in the production and employment. Recession indicates to us the bad side while conversely

expansion is the good side. The inflation rate is the average level of prices in a year where as economic

growth talks about the increase in the production of goods and services (output) over a period of time.

GDP measures the total goods and services produced in an economy in a year and the formula is as

follows = C+I+G+X-M = GDP

C = Consumer Spending = This indicates the spending by households

Investment on the other hand is focused upon capital goods and that is by private firms. This

investment is for the purpose of procuring capital goods. Government purchases comprise of purchases and transfer payments. Purchases are what the

govt. purchases hence the name while transfer payments is money given by the govt. to its

citizens

X-M measures the trade balance i.e. net exports. This seeks to measure the difference between

exports and imports

7.2

In brief GDP measures the production in an economy but it fails to measure two aspects related with

production. That is of the underground economy and on the other hand the household production iswhen households produce goods/services on their own and solely for their own consumption. While

GDP fails to measure the wellness in an economy and this is the reason why it has been criticized. It fails

to measure human beings leisure despite the fact of producing more output consequently the leisure

hours have fallen down. On the other hand it fails to quantify social problems and the

pollution/production related negative externalities therefore the costs to compensate these problems

are not included in the GDP. Lastly GDP does not measure how equally spread out is the output.

7.3

Nominal GDP produces the total value of final goods and services using the prices of the current yearswhile Real GDP on the other hand uses prices of the base year multiplied into the quantity of the current

year. The limitation of real GDP is that it ignores the current year prices and therefore does only use the

base year and not current year in terms of prices. While in real since the prices are fixed we assume the

purchasing power is constant which is untrue since prices are changing and are not constant. GDP

deflator measures the price level in an economy putting the nominal/real x 100 = GDP deflator and the

base year is 100 since real = nominal GDP. Whereas before the base year the real GDP > nominal GDP


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but after base year the real GDP < nominal GDP since the real GDP is used from the base year (just

started)

7.4

GNP is the sum of GDP (of domestic production taking place within the country borders) while s

well on the other hand it also takes into account the home production but this time taking placeoutside the home country

NNP = GNP Depreciation This is known as the consumption of fixed capital

National Income = NNP Value of Sales Taxes This tells us on average how much income is

available in total for the people of the country. i.e. total income earned by a countrys residents

In short the income received by the households (personal income)

Personal income includes compensation from a number of sources - salaries, wagesand bonuses received from employment or self-employment; dividends anddistributions received from investments; rental receipts from real estateinvestments; profit-sharing from a business and so on. In most jurisdictions,personal income above a certain exemption threshold is subject to taxation.Personal income is generally computed on a pre-tax basis.

Disposable income = personal income taxation Division of income = is through what means a person earns such as wages, interest received,

profit, rent received etc.

Chapter 9 economic growth, financial system and business cycles

9.1

In a nutshell long term economic growth is simpy measured by increase in the real GDP per capital and

this is an indicator of the std. of living. For this to work well the productivity must improve that is the

quantity of goods and services produced by 1 person in just 1 hour. In short Ratio of output to input.Whereas labor productivity is dependent on the human capital i.e. the skills and knowledge of the

person and as well the level of technology does matter. It does matter for technology that the

capital/hour must be high enough only then it will improve productivity as a whole. Capital per hour

is the ratio of capital services to hours worked.

Productivity in short is linked to the human capital, capital per hour, technologicaladvancements and therefore this is in sync with economic growth since producitivty isthe prerequisite to improve growth therefore real GDP per capita rises therefore

enhancing the std. of living.


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9.2.

The financial system comprises of the financial market (direct earning for firms) and financialintermediaries (indirect earnings for firms). This is extremely important for economic growth since

firms earn money from households in 2 ways as mentioned above. Financial system of markets and

intermediaries are the ways in which firms acquire money from households.

Firms will earn money from households directly through financial markets (markets where financial

securities are bought and sold) such as stocks, bond markets and indirectly through intermediaries

(borrow funds from savers and lend them to other borrowers )such as banks, pension funds, insurance

companies. These funds reach firms through savings and savings are private (households)households

retain income (after tax and purchasing goods) and public (govt.)- it is also the tax revenue the govt.

retains after paying for govt. purchases and making transfer payments to households!

In conclusion value of total saving = total investment spending. Savings are comprised of public and

private. Private for households who retain income after paying for goods and services and paying for

taxes and public on the other hand is the tax revenue retained after govt. makes purchases and does

its transfer payments. Investment = total income consumption govt. purchases andsavings for

private is income(GDP) + transfer payments (received) purchases of goods and services taxes and

for public savings it simply taxes revenue govt. purchases transfer payments and therefore savings

(pub + pvt) = investments (GDP consumption govt. purchases). GDP measures total production asnd

income in an economy!

Govt. spending = tax revenue is known as a balanced budget while on the other hand if spending Is

greater than tax revenue it is a budget deficit. Consequently this leads to Dissaving is known asnegative saving in where tax revenues earned by govt. are less than the govt. purchases + transfer

payments made to customers (spending) . (this is a budget deficit which is aforementioned as

dissaving). Therefore less savings mean less investment since there will be less money availiable. It is

a gap between taxes and spending. Also households will borrow more than they save the total level

of savings will decline. Budget surplus is when the tax revenue is greater than the govt. spending. This

increases the public saving and total saving and a likelihood of higher level of investment spending.


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In Prcis: The market for loanable funds (9.2)

The supply of loanable funds is the total amount of fundssupplied by lenders. On the contrary thedemand is the total amount of fundsdemanded by borrowers. It is the interaction between theborrowers and lenders of money which in turn determines the interest rate and the quantity ofloanable funds accordingly. The interest rate is the cost of demanding or borrowing loanable funds.Alternatively, the interest rate is the rate of return from supplying or lending loanable funds and the quantity ofloanable funds means funds that are available for borrowing.

The demand curve slopes downwards because the lower the interest rate the greater the quantity of loanable fundsdemanded therefore leading to investment taking place. Whereas on the supply side the greater the interest ratelenders are willing to supply more to the borrowers. In supply it means total amount of good/serviceavailable for purchase

The market for loan able funds is determined through the borrowers and lenders since this determines marketinterest rate and quantity of loan able funds demanded and supplied. It is basically quantity demand and supplywhich determines the market interest rate and equilibrium quantity of the loan able funds exchanged. Interactionbetween borrower and lender (demand and supply)

Rate of return on capital and the demand for loanable funds. The demand for loanable funds takes

account of the rate of return on capital (investment).The rate of return on capital is the additional

revenue that a firm can earn from its employment of new capital. Firms will demand loanable funds as long

as the rateof return on capital is greater than or equal to the interest rate paid on funds borrowed. If

capital becomes more productivethat is, if the rate of return on capital increasesthe demand curve for

loanable funds will shift out and to the right, causing the equilibrium interest rate to rise, ceteris paribus.

The demand for loanable funds takes account of the rate of return on capital. The rate of return on capital is

the additional revenue that a firm can earn from its employment of new capital. Firms will demand

loanable funds as long as the rate of return on capital is greater than or equal to the interest rate paid on

funds borrowed. Ifcapital becomes more productivethat is, if the rate of return on capital increases

the demand curve for loanable funds will shift out and to the right, causing the equilibrium interest rate to

rise. This means The return on investment with the interest rate they pay to borrow money is

taken into consideration

Thriftiness and the supply of loanable funds. The supply of loanable funds reflects the economy ofhouseholds and other lenders. If households become economicalthat is, ifhouseholds decide tosavemorethe supply of loanable funds increases. The increase in the supply of loanable funds shifts the


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supply curve for loanable funds and to the right, causing the equilibrium interest rate to fall. In supply itmeans total amount of good/service available for purchase


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9.3

The business cycle will have phases all related to production, employment and income. Expansion stage

is when all the 3 are at its peak and recession is the opposite of that. Recessions are difficult to predict

since they have many causes not just one. In recession the production is cut off and therefore

unemployment rises. Spending on capital goods by firms and household goods by consumers will be low

in this time. Inflation is low and interest rates are high then!

Chapter 8

unemployment and inflation8.1

The labor force is the total number of people who both are employed and unemployed (but are actively

searching for a job). Unemployment rate is the percentage of labor force unemployed. Discouraged

workers are available for work but arent searching for a job. Not counted as unemployed. Labor force

participation rate is the % of the working-age population in the labor force.


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8.2

Frictional unemployment is short term unemployment that arises from the process of matching workers

with jobs. Seasonal unemployment is a part of frictional unemployment. It is caused by calendar related

events and weather and variations in tourism. Structural unemployment arises due to unemployment

resulting from industrial reorganization, typically due to technological change, rather than fluctuations

in supply or demand. Natural rate of unemployment comprises of = structural + frictional

unemployment

8.3

Govt. policies can reduce frictional + structural unemployment by helping the search for jobs and

retraining workers. However some policies do increase unemployment such as unemployment insurance

payments by extending the time that unemployed workers search for jobs. Unemployed workers spend

greater time searching for jobs because they receive payments. It helps maintain their income and

spending which therefore lessens personal hardship of being unemployed and also helps reduce severity

of recessions. Wage above market levels can raise unemployment. Minimum wage is above marketwage determined by demand and supply of labor. This will lead to excess supply of labor. Wages are

above market levels. Labor unions in here also min wages > market wages as a result less workers are

hired. Efficiency wages are a higher than market wage a firm pays to raise worker productivity. This is

done in order to raise profits. Level of wages = level of worker productivity is the link. Efficiency wages

are higher-than-market wage that a firm pays to motivate workers to be more productive. The same

case here is efficiency wage is above the market wage. It results in qty. labor supplied greater than

demand like minimum wage laws and unions. It however does help lower firms costs of production due

to increase in productivity is greater than the cost of the wage.

8.4

Price level measures average price of goods and services. Inflation rate is equal to percentage change in

price level from one year to the next. CPI is an average of prices of goods and services purchased by the

typical urban family of 4. PPI (producer price index) is prices received by producers of goods and services

at all stages of production. CPI = Expenditure (current year) / expenditure (base year) x 100.

8.5

Price indexes measure change in price level over time.This real variable will be measured in

dollars/cuurency of the base year for price index. Economic variables calculated in current year prices

= nominal variables while real variables = we are interested in tracking changes in economic variableover time rather seeing value in todays currency.

Formula = Value in current year dollars etc. = value in base year dollars/currency * (CPI current year/CPI

base year)

8.6


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Nominal interest rate is the stated interest rate on a loan while the real interest rate is nominal interest

rate inflation rate. Real interest rate measures true cost of borrowing and lending. It measures the

effect on inflation on purchasing power. Nominal interest rate is always greater than real interest rate

unless there is deflation. Real interest rate= nominal rate inflation (declines). Real takes into account

the inflation and it measures purchasing power accordingly. Nominal rate constant = higher inflation

rate = lower real interest rate.

8.7

Inflation makes money lose its value and firms incur menu costs such as changing prices on products and

printing new catalogs. If inflation is unexpected and the actual inflation rate is higher than expected, the

income distribution will be unequal. If incomes rise faster than rate of inflation = purchasing power

increases and vice versa. People on fixed incomes will be hurt by inflation. Extent to which inflation

redistributes income depends on if it is anticipated or unanticipated if they see it coming or not.

Chapter 10 Long-Run economic growth: sources and policies

10.1

The real GDP per capital is a measure of a countrys standard of living. Economic growth rises when the

real GDP per capital rises. Consequently the standard of living rises. This is what happened during and

after the Industrial revolution. In the long run small differences in economic growth rates result in big

differences in the living standards. There are different groups of countries based on the economic

growth and standard of living; high income countries, developing countries and newly industrializing

countries.

10.2

Capital services refer to the flow of productive services provided by an asset that isemployed in production. Capital services reflect a (physical) quantity, not to be confusedwith the value, or price concept of capital. Capital services are the appropriate measureof capital input in production analysis.

Capital services are the productive inputs, per period, that flow to production from acapital asset. The value of capital services is the quantity of services provided by theasset multiplied by the price of those services

Reflect the amount of 'service' each asset provides during a period.

Capital per hour worked = capital services (price x quantity)/hours worked

Basically labor productivity is improved through quantity of capital per hour worked and the

level of technology.

Therefore labor productivity in general, helps improve the growth of an economy i.e. real GDP


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You can improve the technology (technological change) = It is the change in the quantity of

output a firm can produce using a given quantity of inputs.

Technology can be changed through better machinery and equipment, better means of

organizing and managing production and last of all increase in human capital (accumulated

knowledge and skills that workers acquire from education and training/life experiences)

In brief = higher standard of living more capital per hour more human capital better

capital (quality) better organization in production

Per worker production functionrelationship between capital per hour worked and output

per hour worked+ technology = constant

A rule of thumb that estimates the change in labor productivity based onchanges in capital per hour of labor. Specifically, the one-third rule statesthat on average an increase of 1% in capital per hour of labor will

result in approximately a 0.33% increase in labor productivity.Thisrule assumes no changes in technology or human capital

Increases in labor productivity represent increases in real GDP perperson, and thus labor productivity can usually be used as a guide to thelevel of standard of living. Growing labor productivity relies on threemain factors: investment and savings in physical capital, technologyand human capital

Productivity curve = The relationship between real GDP per hour oflabour and the quantity of capital per hour of labour with a given state oftechnology

What are the 3 growth factors of labour productivity? =

1. Saving and investment in physical capital2. Expansion of human capital3. Discovery of new technologies

What are the two reasons for labour productivity growth? =

An increase in capital per hour of labour brings movement along the productivitycurve

An increase in human capital or technological advancesthis leads to shift up inthe per-worker production function, resulting in more output per hour worked atevery level of capital per hour worked.


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Diminishing Returns =Each additional unit of capital per hour oflabour produces a successively smaller additional amount of real GDP perhour of labour.

One-third rule = The obsevation that on the average with no changein human capital and technology, a one percent increase in capital per hourof labour bring a one-third percent increase in labour productivity

How does real GDP increase or decrease? = Real GDP perperson grows only if real GDP grows faster than the population grows. If

the growth rate of the population exceeds the growth of real GDP, real GDP

per person falls

New growth= The theory that our unlimited wants will lead us to evergreater productivity and perpetual economic growth model of long run

economic growth that emphasizes that technological change is influenced by how

individuals and firms respond to economic incentives.

What are the 3 facts that the New Growth Theory emphasizes about marketeconomies? =

1. Human capital grows because of choices2. Discoveries results from choices3. Discoveries bring profit and competition destroys profit

Governments can promote technological change = by granting patents

Definition of new growth theory = an economic growth theory that positshumans' desires and unlimited wants foster ever-increasing productivity

and economic growth. The new growth theory argues that real GDP per

person will perpetually increase because of people's pursuit of profits. As

competition lowers the profit in one area, people have to constantly seek

better ways to do things or invent new products in order to garner a higher

profit.

Capital per hour worked = capital services/hours worked

Capital services assets= equipment, structure, land and machines-it isthe quantity of goods and services received from each asset therefore


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capital services > input costs

10.4WHY ISNT THE WHOLE WORLD RICH?

Reasons of poor growth in some countries = wars/revolutions, poor educationand health, poor law enforcement and last of all low saving/investment

Globalization = open countries to foreign trade and investment FDI =PURCHASE/BUILDING BY A CORPORTATION/FIRMOF A FACILITY

AS THE NAME SUGGESTS: IN A FOREIGN LAND

FOREIGN PORTFOLIO INVESTMENT =PURCHASE BY ANINDIVIDUAL/FIRM OF STOCKS/BONDS -- ISSUED IN ANOTHER COUNTRY

Chapter 7-9 Notes

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