EC6012 Lecture 2 Review of Basic Concepts

First, we’ll need some data to work with. We live in Ireland, so let’s look at Irish National Income Accounts.

First, Irish National Income. Second, Expenditure on Gross National Income at Current market Prices.

If you missed the lecture, hopefully your mates kept you a handout. If not, email me and make something up and I’ll email it to you.

Now first, we’ll graph the changes in consumption, investment, etc that are shown in these accounts.

Then we’ll go through a review of some basic international macro stuff, and work back up to a PBL exercise in class. So this lecture will be a hybrid: part one is a traditional chalk and talk, bash you over the head with information-type lecture, the second half is a PBL exercise.

Underlying Model

“Real” Sector

Markets for:

Goods and Services

Labor Services

Land, Structures, Capital Goods



Actors:

Households (consumers)

Producers

Government

The Basic Questions

What  determines the rate of growth of an economy?

What determines the rate of inflation?

Why are there periods of high and persistent unemployment?

The Basic Questions

Why are there fluctuations in economic activity?

How does being part of a global system affect a nation’s economy?

What role can and should government play in promoting full employment, stable prices, and economic growth?

Measures of Economic Performance

The basic performance measure for an economy is the measurement of its ability to “produce” goods and services.

Gross Domestic Product

Gross Domestic Product (GDP) is a measure of the output of an economy in a given time period.

GDP is the total value of all final goods and services produced in the economy during a given time period.

Gross Domestic Product

GDP measures the total goods and services available to the various potential consumers: - households, firms, and government.

In principle GDP equals income (GDI): - the value of all payments by producers to factors of production: - labor, land, and capital.

How is GDP measured?

It includes only the value of goods produced this period and not the value of all goods bought and sold this period.

GDP includes only the value of final goods and services produced. Intermediate products sold to other producers and embodied in goods sold to final consumers are not included in the GDP calculation.

What does GDP not include?

Value of non-market production; e.g., home produced goods, volunteer work, value of “public” goods.

Non-market costs; e.g., pollution costs.

Value of transactions in existing assets; e.g., sale of a used car or house.

Price Changes and GDP

GDP uses market values as units of measurement.

When comparing GDP from different time periods, we will be comparing numbers based on different measurement systems if prices have changed.

The price problem -  Example

Computers count for 10 GDP  units in 1999 but for only 8 in 2000.

Apples count for 3 GDP units in 1998 and for 4 in 1999.

Solution: - Price Index

We need units common to both years.

Could choose either 1999 or 2000 prices as units of measurement.

Choosing 1999 as the base, we would then re-value 2000 at 1999 prices.

This would yield a 2000 GDP of  €335        (€10×20 + €3×45).

The GDP Deflator

The GDP deflator shows how the cost of different bundles of goods would vary holding prices constant.

The GDP deflator holds base period prices fixed while the CPI holds base period quantities fixed.

Price Level Changes (CPI-U): 1970 - 2000



Measuring Inflation – Consumer Perspective

Can be measured in different ways.

Standard measurement in to compute the cost of an “average” bundle of goods and services consumed by households.

This is frequently referred to as the “headline” rate.

Overall Macro Model

Basic Questions of Macro

GDP again

The CPI- Indexes

Growth and Measuring Growth

The Business Cycle

Unemployment

What is the CPI?

The standard bundle is based on survey of consumer buying habits.

Prices and Inflation

Inflation is a problem in a monetised economy. If inflation is too high, people will be unwilling to hold money.

Inflation and deflation redistribute wealth. Inflation redistributes wealth from lenders to borrowers.

Deflation is a problem – Japan in the 1990’s is an example.

Overall Macro Model

Basic Questions of Macro

GDP again

The CPI- Indexes

Growth and Measuring Growth

The Business Cycle

Unemployment

Measuring Growth

One way to measure growth is growth in total output.

In terms of individual well-being, growth can be measured in per capital terms.

Ireland’s 
Real GDP Growth – 1960 -2000, compared with EU-6



Overall Macro Model

Basic Questions of Macro

GDP again

The CPI- Indexes

Growth and Measuring Growth

The Business Cycle

Unemployment

The Business Cycle


Ireland’s Output Gap

Effects of Cycles

In recessions, unemployment rate increases and price inflation tends to moderate.

In expansions, unemployment falls as GDP grows.

As the economy nears a peak, price inflation tends to accelerate.

Business Cycles

Business cycles are the (irregular) pattern of recession (flat or negative GDP growth) followed by expansion (positive GDP growth).

Overall Macro Model

Basic Questions of Macro

GDP again

The CPI- Indexes

Growth and Measuring Growth

The Business Cycle

Unemployment

Unemployment

Two reasons for concern with unemployment:

Unemployment represents waste. There are resources which could produce output not employed.

Unemployment is a distribution problem. The “burden” is not shared equally across the working population.

Measuring Unemployment

Questions, questions!

Why does unemployment occur. Why don’t markets seem to work to eliminate it?

Why are there such dramatic differences in unemployment rates.

Can governments do anything about unemployment?

Summary

Macroeconomics tries to explain the BIG questions

Why is there unemployment? Why are there fluctuations in the BC?

What is the correct interest rate to set?

Should there be full employment? How do we get there?