1 The Economic Way of Thinking 12 th Edition Chapter 12: The
Overall Performance of Economic Systems
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2 Chapter Outline Gross Domestic Product(GDP) GDP or GNP? GDP
as Total Income Created in the Domestic Economy GDP is not a
Measure of All Purchases in the Economy GDP as Total Value Added Is
Value Added Always Positive?
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3 Chapter Outline Loose Ends: Unsold Inventories and Used Goods
Aggregate Fluctuations Unemployment and Non-employment Employed,
Not Employed and Unemployed Labor-Market Decisions Unemployment and
Recessions
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4 Chapter Outline Inflation The Difficulties of Monetary
Calculation Recession and Inflation Since 1960 What Causes
Aggregate Fluctuations? Appendix: Limitations of National Income
Accounting Appendix: The Dangers of Aggregation: A Methodological
Approach
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5 Introduction Microeconomic Analysis supply and demand in a
particular market or industry. Macroeconomic Analysis performance
of the overall economy. Macroeconomic problems are often news
topics , and a source of seemingly endless debate among newpaper
columnists, political figures, ax- grinders the general public, and
even among economists themselves! Everybody seems to have an
opinion!
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6 Introduction Macroeconomic problems Is Chinese economy
strong, or is it weak? Is it growing, ir is it falling into a
recession? Will the future bring us inflation , deflation , or
relatively stable prices? Whats happening to the unemploment rate
in China? Will the Central Bank (i.e.the Peoples bank of China)
raise or lower interest rates?
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7 Introduction Macroeconomic problems(continued) Whats the
status of governments budget? Is it balanced , in a surplus , or in
deficit ? Should taxes be raised or lowered? What impact will that
have on overall economic conditions? What is the present
administration doing to improve the economy?
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8 Introduction We shall begin to clear up the muddle by further
developing the economic way of thinking on these grand,
economy-wide issues in the remaining chapters. This chapter focuses
on the most widely used (and, literally, grossest) indicator of
overall economic performance, Gross Domestic Product
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9 Gross Domestic Product (GDP) How nice it would be if we have
one single concept and, indeed, one single number which could
summarize the overall performance of the economy! if we can
discover strict interdependencies among, say, the total quantity of
money in circulation, total employment, total output of the
economy, etc! It is tempting to do so and would simplify economic
reasoning enormously!
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10 Gross Domestic Product (GDP) GDP is meant to be such a
concept used to measure variations of economic growth and welfare!
GDP market value of final goods and services produced within a
country in a particular time period.
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11 Gross Domestic Product (GDP) 2008 GDP 30.067 4.333 2008 1
--- 6.8346 9% GDP 3313 2008 GDP 14.265 3.9% 47440
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12 Gross Domestic Product (GDP) Market values measured by
market prices. Final goods (and services) purchased by ultimate
user , whether or not that user is in a household, business, or
government bureau. Purchased without the goal of reselling it or
further processed and manufactured. Compare with Intermediate
good
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13 Gross Domestic Product (GDP) Within a country, regardless of
the nationality or citizenship of the people owning or producing
those goods. Time period is usually a year.
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14 GDP or GNP? GDP performance of the domestic economy. GNP
(Gross National Product ) The market value of final goods and
services produced by permanent citizens of a country in a
particular period of time. performance of the nations citizens.
regardless of where they are producing.
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15 GDP or GNP? GNP 1991 GDP GNP
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16 GDP as Total Income Created in the Domestic Economy GDP
Purchases of final goods. One way for measuring GDP Adding up the
monetary value of all the purchases the expenditures on final goods
and services. 2008 GDP 30.067 30.067
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17 GDP as Total Income Created in the Domestic Economy A
purchase always involves a sale. 30.067 30.067 (income) So, GDP can
be regarded as a measure of national income created in the domestic
economy.
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18 GDP as Total Income Created in the Domestic Economy Value of
national output = value of national income Every dollar paid for
output = income for someone Sales taxes = income for
government
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19 GDP Is Not a Measure of All Purchases in the Economy GDP
Purchases of final goods. All income created in the economy. Not
all expenditures,excluding expenditures on intermediate goods. All
expenditures would be double counting. An example
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20 Produceer Begins with Ends with value added $50 $50 $50 $75
$25 $75 $250 $175 $250 $400 $150 = $775 = $400 12-1 GDP Is Not a
Measure of All Purchases in the Economy
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21 GDP as Total Value Added The last columan, value added,
represents the net income enjoyed by each of the producers. Three
ways to conceptually measure GDP: Expenditures on final goods and
services. Total income generated in the economy. Total value added
in the economy.
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22 Is Value Added Always Positive? Nominal wages, rents and
interest will be positive. Profit may be positive, or negative
(i.e.loss). How are losses accounted for in GDP? The example
(continued)
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23 Produceer Begins with Ends with value added $50 $50 $50 $75
$25 $75 $250 $175 $250 $200 -$50 = $575 = $200 12-2 Is Value Added
Always Positive?
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24 Loose Ends: Unsold Inventories and Used Goods Unsold
Inventories = gross business inventory investment . Estimate market
values of unsold goods. Revise GDP with actual market values. Used
Goods GDP accounts for added value market value of the service
provided.
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25 Aggregate Fluctuations Economic growth occurs through cycles
of expansion and contraction . Fluctuations in output and income
are significant. The most troubling consequence, in the public
mind, of reductions in GDP are the increased levels of unemployment
that always follow them
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26 Aggregate Fluctuations The Great Depression in US 1929-1933
Real GDP fell by 30%. 1933 GDP 40% less than would have been
forecasted in 1929 (assume 3% annual growth). Unemployment 1929
3.2% 1933 24.9%
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27 Unemployment and Non-Employment Observations Approximately
half of the people in the US are not employed neither earning a
wage by working for someone else nor working for themselves in a
business that they own. A quarter are under the age of 16
One-eighth are over 65 Many of those between 16 and 65 are quite
fully employed, although not in the sense just described raising
children and caring for a household
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28 Unemployment and Non-Employment How do we distinguish
problem unemployment from non-problem unemployment? Above the level
of purely fractional unemployment? fractional unemployment : the
amount of unemployment that poses no problem because it represents
ordinary labor-market turnover. But ordinary labor-market turnover
is a variable
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29 Unemployment and Non-Employment How do we distinguish the
unemployed from the not employed? It is not easy for an outside
observer to make a distinction.
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30 Employed, Not Employed and Unemployed Unemployment data
Bureau of Labor Statistics in US (BLS ) Current Population Survey
The Bureau of the Census Monthly survey 60,000 households
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31 Employed, Not Employed and Unemployed Who is counted?
Non-institutional people over age 16 16 50 Classifications Employed
Unemployed Not in the labor force
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32 Employed, Not Employed and Unemployed Unemployed In the
non-institutional population. Over age 16. Without employment
during survey week. Made efforts to find employment during the last
4 weeks. Be presently available for work.
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33 Employed, Not Employed and Unemployed Deriving Unemployment
Data Total population under 15 or institutionalized =
noninstitutionalized population not in the labor force = labor
force employed = unemployed
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34 Employed, Not Employed and Unemployed Unemployment Rate =
Unemployed / Labor Force
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35 Labor Market Decisions Economic theory tries to explain all
behavior as the consequence of choice under constraints, of course.
Unempolyment results from the choices people make on the basis of
ones expected relative costs and benefits This doesnt necessarily
means that Everyone has good choices Unemployed people enjoy their
condition
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36 Labor Market Decisions Non-institutional Population Seeks
employment (in the labor force) Does not seek employment (not in
the labor force) Accepts employment (employed) Does not accept
employment (unemployed)
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37 Labor Market Decisions BLS definition of unemployed implies:
A decision to actively seek employment the fork that leads either
to employment or to continued unemployment. A decision not to
accept any of the employment opportunities available the fork that
leads either to being unemployed or being out of the labor
force.
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38 Unemployment and Recessions in US 1950-2000
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39 Unemployment and Recessions in US
RecessionsUnemploymentRecoveryUnemployment Rate Peak Rate 19545.5%
19586.8% 19616.7% 19758.5% 19829.7% 19927.4% 19532.9% 19574.3%
19605.5% 19734.9% 19795.8% 19905.5% 19984.4%
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40 Inflation One cannot use unadjusted changes in GDP to
measure changes in the total output of goods. Why?
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41 Inflation Nominal GDP Product of prices and quantities (P x
Q). If prices increase and quantities remain unchanged, nominal GDP
increases. Question If prices increase and quantities remain the
same, has the real output of the economy increased?
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42 Inflation Adjusting GDP for Price Changes Real GDP The value
of all final goods and services produced in a year stated in
unchanging prices , the prices that held in whatever year is being
used as the base year .
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43 Inflation GDP Deflator Nominal GDP/Real GDP 100% The most
comprehensive measure of changes in the purchasing power of money
But not the best-known measure
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44 Inflation Consumer Price Index (CPI ) Measures changes in
the money price of all the goods and services that enter into the
budgets of typical urban consumers. CPI
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45 Inflation Is not a rise in the cost of living Is basically a
fall in the value or purchasing power of money Is a rise in the
money price of goods, where the key word is money If inflation does
not actually raise the cost of living, why is it a problem?
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46 Inflation Uncertianty caused by inflation! The future value
of money cannot be predicted Inflation distorts the signals that
are provided through market prices
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47 Inflation Deflation A rise in the value or purchasing power
of money It also introduces uncertainty into the calculations of
planners Disinflation A slowing down of the inflation rate.
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48 The Difficulties of Monetary Calculation Inflation,
deflation and disinflation make monetary calculations difficult.
Household budget planning Saving and investment decisions Wage and
salary agreements The entrepreneurial calculation of profit and
loss
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49 Recession and Inflation Since 1960 1960-2000
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50 Recession and Inflation Since 1960 Recessions in US 1960,
1970, 1974, 1975, 1980, 1982, 1990, and 1991 Inflation in US 1960s
2.5% / year 1970s 7.5% / year
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51 Recession and Inflation Since 1960 Stagflation a stagnating
economy with inflation. Inflation can occur during recession. 1974
1975 Severe recession 10% inflation Recession and Inflation are not
simple opposites.
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52 What Causes Aggregate Fluctuations? Fluctuations may reflect
the natural adjustment of markets to external shocks. Fluctuations
may be driven by relatively small changes in one sector of the
economy that multiplies through many sectors.
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53 What Causes Aggregate Fluctuations? Fluctuations may reflect
the natural adjustment of markets to external shocks. Fluctuations
may be driven by relatively small changes in one sector of the
economy that multiplies through many sectors.
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54 Appendix: Limitations of National Income Accounting GDP gets
some sense of economic performance only imperfectly Some
difficulities encountered by GDP
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55 Appendix: Limitations of National Income Accounting Ignores
all non-market forms of production Underestimating actual
performance of the overall economy Ignores illegal production
Underestimating actual performance of the overall economy
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56 Appendix: Limitations of National Income Accounting Ignores
economic profits and losses Economic profit will typically be less
than accounting profit But GDP accounts cant possibly determinate
all the implicit or opportunity costs of all the entrepreneurs
across the economy, so only accounting profits are used to measure
GDP GDP overestimates actual performance of the overall
economy
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57 Appendix: Limitations of National Income Accounting Anything
that leads to a transaction in monetary form is recorded as
positive, no matter what is being sold This goes against common
sense Why should all products and services be treated alike? If I
dont like more nuclear weapons, why should I accept a measurement
that includes them as part of the growth of the economy? GDP
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58 Appendix: Limitations of National Income Accounting GDP
measures, or rather express, as positive the malfunctions of the
economic system or society If cars break down and other disasters
occur, that require repair up goes the GDP If industry pollutes the
air and we creat other industries which remove the polluting
substances up goes the GDP. If we pollute less, then GDP may goes
down. How can one find a measure which tells simultaneously
opposite sides of the functioning of a complex system in one single
scalar number?
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59 Appendix: Limitations of National Income Accounting The
corrections of GDP figures that are made by elimination of the
effect of seasonal variations, of price changes, etc., therefore
obtaining a stable basis, eliminating the influence of distortion
caused by inflation, in on way touch the fundamental issues and
objections!
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60 Appendix: The Dangers of Aggregation Measuring the overall
performance of an economy A rather difficult task More broader
problem: emphasis on statistical aggregates GDP Price level
Unemployment rate Etc.
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61 Appendix: The Dangers of Aggregation One of the temptations
of macroeconomic theory To study the economy by focusing largely
(if not exclusively) on the relationships between the aggregate
variables themselves [ ]
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62 Appendix: The Dangers of Aggregation But this is quite a
problem [ ] It appears that somehow the aggregates are interacting
with one another [ ] Policymakers be tempted merely to get the
aggregates right
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63 Appendix: The Dangers of Aggregation Never forget The
economy is always and everywhere composed of individuals Only
individuals choose Individuals act and interact Individuals attempt
to coordinate their plans through the market process Individuals
seek and creat wealth
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64 Appendix: The Dangers of Aggregation The economy is of high
complexity Therefore, that its description, or rather its change,
could be given and measured accurately by one scalar number is
absurd
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65 Appendix: The Dangers of Aggregation A heavy focus on the
interactions among clusters of data (the aggregates themselves)
might make us lose sight of the specific pieces of information (and
often heterogeneous information) Individual decision makers
themselves use these information to coordinate their everyday plans
and projects E.g. the same increase in the quantity of money will
have very different consequences when it goes to consumers rather
than to producers. This is obscured when one restricts oneself to
the macro entities.
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66 Appendix: The Dangers of Aggregation From 1950s to 1970s
macroeconomists Believe that supply and demand theory, and the
basic conception of the individual decision maker was inherently
limited and couldnt explain overall economic phenomena Placed the
individual chooser in the scrapheap of macroeconomic thoughtuseful
only for micro but not for macroeconomic theory
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67 Appendix: The Dangers of Aggregation Since 1980s more
macroeconomists Believe aggregate analysis itself is limited Search
for the microeconomic foundations of macroeconomics Rediscovered
the value of supply and demand analysis and the formation of
relative market prices, and price expectations
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68 Once Over Lightly Gross Domestic Product GDP GDP
Measurements (3) Unsold Goods Market Values of Services Many people
not employed are not in the labor force and not unemployed.
Difference between not employed and unemployed is not always
clear.
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69 Once Over Lightly Expected advantages of alternative
opportunities determine decisions as to labor force entry.
Inflation is a decrease in purchasing power of money Deflation is a
sustained rise in purchasing power of money.
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70 Once Over Lightly Disinflation is a slowing down of the rate
of inflation. GDP Deflator is a measure of inflation Economic
growth Recession Aggregate Fluctuations Limitations of GDP
measurement The Dangers of Aggregation