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What is Macroeconomics?
Production Method: Measure the Value Added summed across all firms (value
added = sale price less cost of raw materials)
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A simple example of how GDP is measured:
What is the total value (in dollars) of the economic activity generated by these 2
firms?
GDP (Y) is a measure of Market Production! Market value = how much you have
to spend to buy
What is produced in the market has to show up as being purchased or held by some
economic agent;
Who are the economic agents we will consider on the expenditure side?
We will predominantly spend our time working with the Expenditure Approach:
Y = C + I + G + NX
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We produce oranges and I can potentially:
Sell them to some domestic customer (Consumption), Sell them to some business
(Investment), Keep them in my stock room as inventory (Investment)
, Sell them to the city of Istanbul for the shelters (Government spending), Sell them
to some foreign customer (Net Export).
Components of Expenditure:
• Consumption (C):
• Investment (I):
Land purchases are not counted as part of GDP (land is not produced)
Stock purchases are not counted as part of GDP (stock transactions do not represent
production – they are saving)
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Only include expenditures for goods that are “produced”.
How would these transactions be counted as part of 2008 U.S. GDP Calculation?
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• Income Distribution
• Crime/Safety
Defining Savings:
Yd = Disposable Income = Y - T + Tr
Y: Income
Yd = C + S
Sp = Y - T + Tr–C
So, S = Y - G – C and S = I + NX
Y : GDP
C: households spending on consumption
S: saving
S ≡ Y - C or Y ≡ C + S
Y or GDP by expenditure
Y ≡ C +I or
Y≡C+I=C+S
thus S ≡ I
Note: Gross domestic product (GDP) measures the output produced by factors of
production located in the domestic economy
Gross national product (GNP) measures the total income earned by domestic
citizens
GNP = GDP + net income from abroad.
Inflation:
Using current market values allows summing different types of goods and services,
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but how to compare variables over time?
Production today Production tomorrow
20 computers 20 computers
20 bicycles 20 bicycles
• If prices of computers and bicycles double between today and tomorrow, the
current market value of GDP (i.e., nominal GDP) also doubles. However, the
amount of physical production remains unchanged.
• What is wrong? Nominal GDP today is expressed in terms of dollars of today and
nominal GDP tomorrow is expressed in terms of dollars of tomorrow. If there is
inflation, the purchasing power of the dollar has changed over time.
• By looking at the current market value of goods changes over time, you can’t tell
whether this change reflects changes in the goods produced or in their prices. That
is why we need to look at the “real” GDP or at constant prices.
To compare the market value of output over time, we need to know how does the
purchasing power of 1$ change over time. For that we need a price index.
How Are Prices Measured? Price Indexes measure the cost of a fixed ‘basket’ of N
goods over time
P(t) = ∑Ni=1 wi . pi (t)
GDP Deflator (one prominent price index): Value of Current Output at Current
Prices / Value of Current Output at Base Year Prices
An Example:
2000 2008
Q P Y Q P Y
A 10 1 10 20 2 40
B 15 3 45 20 4 80
C 50 0.5 25 40 1 40
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Nominal GDP went up by 100%
Quality - Actually, not measuring the same goods in your basket over time.
Technology advances drive down the price of ‘same’ goods over time
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1930s). See Sloman and W ride C hapter 17. Note at the outset two important
assumptions:
Slope = b = MPC
Yd
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Consumption function is given by: C = a + b* Y where “a” is autonomous
spending and “b” is the marginal propensity to consume which is the slope of the
function) is “b” – i.e. for each additional $1 of income, $ “b” is consumed.
For c = 0.7 and a=8, savings function is given by:
The marginal propensity to save –MPS- (the slope of the function) is 0.3 – i.e. for
each additional $1 of income, 30 cents is saved. Since all income is either saved or
spent on consumption, MPS+MPC=1. In this example, 0.3 + 0.7 = 1.
Note that this is a simple consumption function because:
Consumption depends not only on current income by on what households expect
their future (sometimes called permanent) income to be. Thus if income were to
drop temporarily households reduce their consumption by less than if they thought
the fall was permanent. Over the long run, a is smaller and b is larger.
Consumption may depend on wealth (which is a stock) as well as current income
(which is a flow). E.g. owner occupiers seem to spend more when the value of their
house goes up.
Uncertainty may matter. If people are particularly uncertain about the future, they
may save more and consume less now.
Equilibrium:
• Aggregate demand (AD)
Consumption + investment equals to the output supplied by firms
• AD = Y or C + I = Y
Firms supply all the output demanded by households and firms.
In this simple model price level is fixed, supply decisions do not depend on price
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, and rear ranging:
• Firms are ready to produce and actually produce what ever demanded at the
7KH³PXOWLSOLHU´ is the factor by which autonomous spending is multiplied to get
same price level.
national income.YIn= the
In equilibrium, C + simplest
I. model it is one minus the M PC .
45ȗ line
Z (Z = Y)
Z = a + bY + I
a+I
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" From the national accounts we know that AD = Y; Expenditure equals Output , so:
Y = [1 / (1-b)] ( a + I)
An Example:
Suppose that consumption is C = 100 + 0.75*Y and I = 100. We have
Y = 100 + 0.75*Y +100 or Y* (1 - 0.75) = 200
Y = 200/0.25 = 800
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Suppose now that firms become more optimistic about the future. They decide to
invest more, and so investment spending rises to I = 200.
Then, Y = 300/0.25 = 1200 and aggregate income goes up by:
ΔY = 400 = [1/(1 – b)] * ΔI = 4*100
Next:
Paradox of Thrift, Introducing Government and Foreign Sector, Money Market…..
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