Econ1102 Week 1 Revised

7/29/2019 Econ1102 Week 1 Revised

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Week 1 Lectures 1 & 2

Measuring Macroeconomic Performance: Output and

Prices

Reference: Bernanke, Olekalns and Frank (BOF) -Chapter 1

Key Issues

Indicators of macroeconomic performanceMeasuring output (GDP)Measuring prices and inflation


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2

Evaluating Macroeconomic Performance

1. Rising Living Standards economic growth

Tendency for the level of output (i.e. quantity and qualityof goods and services) to increase over time.

Output divided by population = output per capita

May also care about the distribution of living standards


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3

Real Quarterly GDP per-capita Australia (1973-2011)

6000

7000

8000

9000

10000

11000

12000

13000

14000

15000

16000

Sep-1

973

Sep-1

974

Sep-1

975

Sep-1

976

Sep-1

977

Sep-1

978

Sep-1

979

Sep-1

980

Sep-1

981

Sep-1

982

Sep-1

983

Sep-1

984

Sep-1

985

Sep-1

986

Sep-1

987

Sep-1

988

Sep-1

989

Sep-1

990

Sep-1

991

Sep-1

992

Sep-1

993

Sep-1

994

Sep-1

995

Sep-1

996

Sep-1

997

Sep-1

998

Sep-1

999

Sep-2

000

Sep-2

001

Sep-2

002

Sep-2

003

Sep-2

004

Sep-2

005

Sep-2

006

Sep-2

007

Sep-2

008

Sep-2

009

Sep-2

010

$perqtr


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4

2. Stable Business Cycle low volatility in fluctuations

of actual output around its trendorpotential output.

Australias Real Quarterly GDP Growth Rates DecadeAverages

1960s 1970s 1980s 1990s 2000sMean 1.26 0.78 0.82 0.83 0.75StandardDeviation

1.50 1.49 0.97 0.77 0.52

Ratio 0.84 0.53 0.85 1.08 1.44

Mid-1980s Great Moderation large fall in volatility ofreal output why?


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3. Relatively Stable Price Level low (positive) rate of

inflation

Inflation has been concern for most developed countriesover the last 40 years.

Japan is an exception and has experienced deflation overthe last decade.


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6

Australian Inflation - Consumer Price Index Measure

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

18.0

20.0

Sep-1

970

Oct-1971

Nov-1

972

Nov-1

973

Nov-1

974

Nov-1

975

Nov-1

976

Nov-1

977

Nov-1

978

Nov-1

979

Nov-1

980

Nov-1

981

Nov-1

982

Nov-1

983

Nov-1

984

Nov-1

985

Nov-1

986

Nov-1

987

Nov-1

988

Nov-1

989

Nov-1

990

Nov-1

991

Nov-1

992

Nov-1

993

Nov-1

994

Nov-1

995

Nov-1

996

Nov-1

997

Nov-1

998

Nov-1

999

Nov-2

000

Nov-2

001

Nov-2

002

Nov-2

003

Nov-2

004

Nov-2

005

Nov-2

006

Nov-2

007

Year-ended%c

hange


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7

4. Sustainable Levels of Public and National Debt

Public debt borrowing by public sector from privatesector

Influenced by government budget deficits/surpluses

Foreign debt borrowing by domestic residents fromforeign countries

Influenced by an economys current accountdeficits/surpluses


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8

Budget Balance and Net Government Debt for Australia

-6

-4

-2

0

2

4

6

8

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

2007-08

2008-09

2009-10

2010-11

2011-12

2012-13

2013-14

2013-15

Budget Balance Net Debt


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9

Australias Net External Liabilities

0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

Jun-88

Jun-90

Jun-92

Jun-94

Jun-96

Jun-98

Jun-00

Jun-02

Jun-04

Jun-06

Jun-08

Percent

Net Debt/GDP Net Equity/GDP Net External Liabilities/GDP


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5. Balance between Current and Future Consumption

How much should an economy save/invest?


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11

Australian Private Investment and National Saving

0.00

5.00

10.00

15.00

20.00

25.00

30.00

S

ep-76

S

ep-78

S

ep-80

S

ep-82

S

ep-84

S

ep-86

S

ep-88

S

ep-90

S

ep-92

S

ep-94

S

ep-96

S

ep-98

S

ep-00

S

ep-02

S

ep-04

S

ep-06

S

ep-08

%o

fGDP

National Saving/GDP Private Investment/GDP


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6. Full Employment

Provision of employment for all individuals seeking work


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13

Australian Unemployment Rate Monthly

0.0

2.0

4.0

6.0

8.0

10.0

12.0

Feb-1

978

Jan-1

979

Dec-1

979

Nov-1

980

Oct-1981

Sep-1

982

Aug-1

983

Jul-1984

Jun-1

985

May-1

986

Apr-1987

Mar-1988

Feb-1

989

Jan-1

990

Dec-1

990

Nov-1

991

Oct-1992

Sep-1

993

Aug-1

994

Jul-1995

Jun-1

996

May-1

997

Apr-1998

Mar-1999

Feb-2

000

Jan-2

001

Dec-2

001

Nov-2

002

Oct-2003

Sep-2

004

Aug-2

005

Jul-2006

Jun-2

007

May-2

008

Apr-2009

Mar-2010

Feb-2

011

Percent


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Measuring National or Aggregate Output

GDP Gross Domestic Product

Definition:

The market value of final goods and services produced ina country during a given period.


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The market value of final goods and servicesproduced in

a country during a given period.

GDP is aflow variable measured over a period of time.

Quarter March, June, September, December

Australian GDP in March 2011 = $347.0 billion

Year just add-up GDP over 4 quarters

Calendar Mar-09 + Jun-09 + Sep-09 + Dec-09Financial Sep-09 + Dec-09 + Mar-10 + Jun-10


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The market value of final goods and services produced in


GDP is measure of aggregate production or output

Use market prices to value (or weight) quantities ofvarious goods and services

Example: Quantity Market Price10 cars $20,000 per car

100 apples $1 per apple

GDP = $200,000 + $100 = $200,100


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What about goods and services with no observed

market price?

Some are included in GDP:

National defense use costs of provision (costs ofbuying equipment, wages of soldiers, etc.)

Some are excluded from GDP

Unpaid housework


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The market value offinal goods and services produced in


GDP excludes intermediate goods and services. Thesegoods are used-up in the production process.

Example: In the production of a loaf of bread, the flourused is an intermediate input and is not counted in GDP.

Concept ofValue Added: The market value of a firms

production less the cost of inputs purchased from otherfirms


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Value Added in Computer Sales: Chapter 1, Problem 2

(Textbook)

Firm Sales Cost of inputs Value AddedIntel Incorp 20,000 0 20,000

Macro Soft 5,000 0 5,000Bell 80,000 25,000 55,000PC Charlies 100,000 80,000 20,000

PC Charlies final sales = $100,000

Sum of Value Added = $100,000


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3 Ways to Measure GDP

1. Production Method

2. Expenditure Method

3. Income Method


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Expenditure Method

Accounting IdentityExpenditure on goods and services by final users mustequal the value of their production.

Components of Expenditure

Consumption (C) purchases by HouseholdsInvestment (I) purchases by FirmsGovernment (G) Government purchasesNet Exports (NX ) net purchases by foreign sectorNX = Exports Imports


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National Income Accounting Identity

GDP=Expenditure

Y = C + I + G + NX


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Australian GDP March Quarter 2011

Expenditure Approach

$billionHousehold Consumption 185.3

Private Investment 74.7Government (Public) Spending 83.0Change in Inventories 0.7Exports 71.8

Less Imports 68.7

Total 346.8Statistical discrepancy 0.2GDP 347.0


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Income Method

GDP also equals the aggregate incomes paid to

Labour (L)Capital (K)

in the production of goods and services.

GDP = Labour Income + Capital Income


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Australian GDP March Quarter 2011

Income Approach

$ BillionCompensation of Employees 168.3

Gross Operating Surplus 117.6Gross Mixed Income 27.2GDP (at factor cost) 313.0

Taxes Subsidies 33.4

GDP (Market Prices) 346.4Statistical discrepancy 0.6GDP 347.0


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Nominal vs. Real GDP

Nominal

values quantities of goods and services produced atcurrent yearprices

Real

values quantities of goods and services produced atbase yearprices measure of the actual physicalvolume of production


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Example

2007 2008 % ChangeNo. of Cars 10 10 0Price of Cars $20,000 $40,000 100

No. of Apples 100 100 0Price of Apples $1 $2 100

Nominal GDP $200,100 $400,200 100

Real GDP2007 prices $200,100 $200,100 02008 prices $400,200 $400,200 0


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Choice of Base Year (Bit Technical)

In the above example whether we use 2007 or 2008 asbase year prices gives the same answer for the growthrate of real GDP

This is not the case in general, particularly if you arecomparing real GDP over a 5-10 year period.

Using initial prices (i.e. 2007) is know as aLaspeyres indexUsing final prices (i.e. 2008) is known as a Paasche

index


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Chain Weighting

For any two consecutive years compute the growth ratesof real GDP implied by both theLaspeyres and thePaasche indexes.

Then take the average of the two growth rates and this isthe chain-weighted growth rate. This can be used tocompute a real chained-weighted GDP.

Finally to compute a change index over a long period, theabove approach is applied on a year-by-year basis.


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Example2007 2008

No. of Cars 10 10 Price of Cars $20,000 $40,000

No. of Apples 100 1000 Price of Apples $10 $25

Nominal GDP $201,000 $425,000

Real GDP2007 prices $201,000 $210,000


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Chain-weighted measure of Real GDP

Take average of growth rates implied by 200

prices.

5.05% = (4.5% + 5.6%)/2

Choose either 2007 or 2008 as the base-year

(nominal=real GDP). Lets pick 2007

2007 2008

Nominal GDP 201,000 425,000Real GDP 201,000 211,151 (=201,00


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Is GDP A Good Measure of Economic Wellbeing?

Some OmissionsLeisure TimeHousehold productionEnvironmental DegradationQuality of LifeEconomic Inequality

It is likely that GDP is positively related (correlated) witheconomic wellbeing

Variety of goods and servicesHealth and Education


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Measures of the Price Level

Want to measure the average level of prices in theeconomy.

Main Measures

Consumer Price Index (CPI)GDP Deflator/Price Index

CPI For a given period, measures the cost in that periodof a given basket of goods and services relative to theircost in a fixed year called a base year.


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Construct a CPI

Choose a basket of goods and servicesBasket 2000 (base) 2008Rent (2 bedroom flat) $500 $630Hamburgers (60) $150 $150CDs (2) $30 $70Total Expenditure $680 $850

CPI =Cost of base-year basket of goods and services in current

yearCost of base-year basket of goods and services in baseyear


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CPI = $850/$680 = 1.25

Cost of living is 25 percent higher in 2008 than it wasin 2000

Average prices are 25 percent higher in 2008 than in2000

Australian CPI

Published quarterly by ABSHousehold Expenditure Survey used to determine

typical basket

Base year changes every 5 years


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Inflation (and Deflation)

Inflation is measured by the percentage change in the CPIover a given period.

Inflation rate = 100*])1()1(

[

CPI

CPICPI

Inflation rate = 0 implies prices are constant

Inflation rate > 0 implies prices are rising

Inflation rate < 0 implies prices are falling Deflation


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Limitations with CPI

Quality Adjustment and New Goods Bias

Quality improvements may show up as higher pricesfor goods and services

New goods are often not included until CPI is re-based

Substitution Bias

Use of a fixed basket means that no allowance ismade for consumers substitution toward relativelyless expensive goods.

CPI tends to overstate the rate of inflation.


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Costs of Inflation

Important to distinguish between relative price changeand a change in the generalprice level

Shoe-leather costs inflation reduces the realpurchasing power of a given amount of money

Menu costs real costs of changing pricesIntroduces noise into the price mechanismDistorts tax systems (if not indexed to inflation)Unexpected re-distributions of wealth


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Inflation and Interest Rates

Nominal Interest Rates percentage increase in thenominal (or dollar) value of a financial asset.

Real Interest Rate percentage increase in the realpurchasing power of a financial asset.

= ir r= real interest ratei = nominal interest rate = inflation rate


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Fisher Effect

Nominal interest rate = real rate + (expected) inflationrate

eri +=


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Inflation and Nominal Interest Rate

-2.0

0.0

2.0

4.06.0

8.0

10.0

12.0

14.0

16.0

Mar-86

Mar-88

Mar-90

Mar-92

Mar-94

Mar-96

Mar-98

Mar-00

Mar-02

Mar-04

Mar-06

Mar-08

%perannum

Inflation (year-ended) 10 Year Bond Rate

Documents

Econ1102 Week 1 Revised