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Unformatted text preview: Midterm Review
Measurement of Economic Performance (T.3) Production and Income (T.4) The Labor Market (T.5) Consumption and Saving (T.6) Investment (T.7) Economic Growth (T.8)
Topics 18 + Presentations + Articles + Book Readings
1 The Economy C GDP I G NX
2 Output Distribution 1
• Production: C = 0.60Y 0.60 G = 0.2Y 0.2 3 Output Distribution 2
• Production: C = 0.60Y 0.60 •C G = 0.2Y 0.2 •G
4 Output Distribution 3
• Production: C = 0.60Y 0.60 •C G = 0.2Y 0.2 •G
5 Output Distribution 4
• Production: C = 0.60Y 0.60 •C G = 0.2Y 0.2 •G • S=I
6 Measurement of Economic Performance TOPIC 3 7 Three Approaches to Measuring GDP GDP
• The Gross Domestic Product (GDP) is a measure of the total economic activity in a country in one year (generally) • It can be measured in three ways:
Production (Value Added) Approach: The total Production amount of output produced, excluding output used excluding up in intermediate stages of production Expenditure Approach: The total amount paid by Expenditure the ultimate purchasers of output ultimate Income Approach: The total income received by the Income producers of output
8 Measuring GDP
• Measures of GDP GDP
Production (Value Added) Approach: Production Sum of VA for all goods & services Expenditure Approach: Expenditure Y = GDP = C + I + G + NX GDP NX Income Approach: Income
National Income (NI) = Compensation + Proprietor’s Income + Rental Income + Proprietor’ Corporate Profits + Net Interest NNP = NI + Indirect Bus Taxes; GNP = NNP + Depr NI GNP
9 Equivalence Of the Approaches
• All three approaches to GDP accounting yield the GDP same result • Fundamental identity of national income accounting: Production = Expenditure = Income Production • First equality arises from using the market value to measure production. Consumers exhaust production with their expenditures • Second equality arises because individuals, businesses, and the government use their incomes to consume and invest
10 Price Indices and Inflation
• Consumer Price Index (CPI) is the most commonly cited measure of prices
CPI = CPI value of typical basket of goods at current prices current ÷ value of the same basket at baseyear prices baseThere are measurement problems with the CPI There CPI which have political repercussions CPI uses a typical basket of consumer goods, while CPI the producer price index (PPI) uses a typical basket of intermediate goods CPI is an example of a fixedweight price index CPI fixed11 CPI Example With Two Goods
CPI 0 = P0, x X 0 + P0, yY0 CPI1 = P , x X 0 + P , yY0 1 1 This shows that CPI is prices weighed by baseyear goods CPI baseconsumed 12 GDP , RGDP, and GDPD RGDP GDPD
• Real vs Nominal GDP GDP
The goal is to measure the increase in GDP coming The GDP from more goods and services and not from higher more prices prices Nominal GDP is the value of output at current Nominal GDP current prices Real GDP is the value of output in base year prices Real GDP (currently 2000)
How else would you measure changes in output? How output 13 GDPD Example With Two Goods
GDP0 = P0,x X0 + P0,y Y0 GDP1 = P1,x X1 + P1,y Y1 RGDP0 = P0,x X0 + P0,y Y0 RGDP1 = P0,x X1 + P0,y Y1
GDPD1 = P , x X 1 + P , yY1 GDP 1 1 1 ≡ RGDP P0, x X 1 + P0, yY1 1 This shows that for GDPD prices are weighed by current goods GDPD produced
14 Production, Labor & Income TOPIC 4 15 CobbDouglas Production Function: Cobb Y= AKαL1α
Y
(Total Output) K2, A K1, A Y L2, A L1, A K2>K1 L2>L1 I.
MPL
(Marginal Product of Labor) L II.
MPK (Marginal
Product of Capital) K K2, A K1, A L2, A L1, A L K
16 Production
• A CD production function: Y = A K0.3L0.7 CIncreases with A (proportionally) Increases Increases with K and L (less than proportionally) Increases • Marginal products of K and L
Slope of the production function Slope
MPL↓ with L, and ↑ with K and A MPL MPK↓ with K, and ↑ with L and A MPK 17 Production
• MPK & MPL are also the demand for K & L MPL demand under perfect competition MPL = W/P, MPK = R/P = r + δ
The MPL & MPK functions define the equilibrium demands for K & L Aggregated over all firms they become the economyeconomywide demand for Labor and Capital 18 Market Equilibrium
EQUILIBRIUM: • Labor market equilibrium determines wage rate and quantity of labor employed
Labor Supplied = Labor Demanded Labor • Capital market equilibrium determines rental rate and quantity of capital and investment
Savings = Investment Savings • Goods market equilibrium ensures
Goods Produced = Goods Demanded Goods
If 2 markets are in equilibrium the 3rd is as well! If
19 Demand For Investment
• I is the gross addition to K in each period • The investment vs. interest rate curve (MPK) is downward sloping
Recall Recall R/P = r + δ A higher real interest rate increases the user cost of higher capital and thus reduces desired investment Desired I = (Desired) K – K0 + δ K0 > 0 decreases as R/P increases, Since K Since (desired) I decreases as R/P increases 20 Supply of Savings
• Household’s decision to consume is based Household’ on its income and the interest rate Savings = Income  Consumption
The consumption and savings decisions are two The sides of the same coin • For now assume that savings are either fixed or ↑ with the interest rate (holding Y constant)
Theory of the consumptionsavings decision will Theory consumptioncome later Supply of Savings is upward sloping Supply
21 Equilibrium
• The demand components in the economy depend on the:
1. Consumptionsaving decision of the Consumptionhouseholds, 2. Investment decision of the firms, and 3. Purchases of the government • These demands jointly determine the equilibrium
Wages, rental rate, output Wages, 22 Growth Accounting
∆Y/Y = ∆A/A + α(∆K/K) + (1  α)(∆L/L) • This is the growth accounting equation growth • Its purpose is to separate
The output growth due to the accumulation of The inputs, and The output growth due to productivity increases The 23 The Labor Market TOPIC 5 24 Individual Labor Supply
• Effect of a temporary increase in the real wage temporary
(i.e., holding wealth constant) The Substitution effect: The Substitution
When current real wage (w = W/P) ↑, opportunity cost of When leisure ↑ This tends to ↑ labor supplied This The Income effect: The Income
Higher wages imply that you can work less and make the same Higher income as before This tends to ↓ labor supplied This We assume that the substitution effect dominates We Therefore, the labor supply curve of an individual worker is Therefore, assumed to be upward sloping 25 Individual Labor Supply (cnt.) cnt.)
To clarify possible confusion: • When wages rise permanently, permanently
The income and substitution effects are still there The income substitution But in this case, the income effect is for now and the But and future So we think of it as a wealth effect So wealth effect
It is the present value of all future income increases It It is represented as a shift in the labor supply curve It shift • Empirically higher permanent income results in lower labor supply
26 Aggregate Labor Supply
• The aggregate labor supply curve is also aggregate upward sloping (by the earlier assumption) • When w ↑, currently working people work more, and people not in the labor force are enticed to work
Recent estimates suggest that the overall wage Recent elasticity of labor supply is high ~ 3.0 27 Labor Market Equilibrium
• Classical (full employment) labor market equilibrium is at the intersection of the labor supply and demand curves
Labor Demand = Labor Supply Labor Labor Demand: the sum of individual employers’ Labor employers’ choices Labor Supply: the sum of individual workers’ Labor workers’ choices 28 Figure 3.11 Labor market equilibrium 29 Unemployment
• Unemployment:
Population over 16 years of age Population Labor force Labor Participation rate Participation Unemployment Unemployment
Frictional Frictional Structural Structural Cyclical Cyclical Involuntary Involuntary Discouraged workers Discouraged 30 Consumption & Saving TOPIC 6 31
The TwoPeriod Model Two• Substitute for S from the second equation into the first to get a single intertemporal budget constraint: S = Y1  C1 C2 = (1 + r) S + Y2 ⇒ C1 + C2 Y = Y1 + 2 1+ r 1+ r PV of Cons. = PV of Income
32 The TwoPeriod Model TwoPresentvalue Budget Constraint (PVBC): C1 + C2/(1+r) = Y1 + Y2/(1+r) C2 (1+r)Y1 + Y2 Save everything today & consume only tomorrow. Wasting resources at this point * Can’t afford this point *
Consume your income every period Borrow to the limit & consume everything today Y2 Y1 Y1 + Y2/(1+r) C1 33 The TwoPeriod Model (cnt.) cnt.) TwoHow do consumers choose how to choose consume? • The budget constraint line gives all the possible consumption combinations
On the line no resources are wasted! On Below the line resources are wasted Below Above the line points are unattainable Above unattainable • The optimum is the highest utility that can be attained with the given budget constraint
The optimum is where the indifference curve is The tangent to the budget constraint
34 The Optimal Point in Detail
C2 (1+r)Y1 + Y2 Y2’ B Optimal Consumption (for consumer with income profile A) C2* (1+r) S Y2 A Y1’ C1* S Y1 Y1 + Y2/(1+ r) C1 What happens to consumer with income profile B (Y1’, Y2’)?
35 Substitution Effect Dominant
(of increase in ‘r’)
C2 (with in r) C2*’ Flatter indifference curve causes Substitution Effect to dominate: S when r . (What we assume) (1+r)Y1 + Y2 C2* Y2 C1*’ C1*
S Y1 Y1 + Y2/(1+ r) C1 (with in r) S’
36 Income Effect Dominant
C2 (of increase in ‘r’)
Steeper indifference curve causes Income effect to dominate: S when r . (1+r)Y1 + Y2 C2* C2*’ Y2 C1* C1*’
S’ Y1 Y1 + Y2/(1+ r) C1 S
37 Figure 4.A.5 LifeCycle Consumption, LifeIncome, and Saving 38 The CoC & Investment
• • • • • • Bottom Line A unit of capital produces MPK
Given the choice of labor, the state of technology, Given etc. Firms pay the real interest rate, r, to raise funds for capital investment Capital also depreciates at the rate δ They will invest more if MPK > r + δ MPK They will invest less if MPK < r + δ The equilibrium is when MPK = r + δ MPK
40 Taxes & Investment
• If τf is the marginal tax rate for firms’ marginal firms’ profits, then: MPK (1τf ) = R/P MPK (1• And this gives:
MPK = 1 R r +δ = 1−τ f P 1−τ f the cost of investment in new capital
Taxes reduce aftertax revenues Taxes after41 THE END 52 ...
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This note was uploaded on 03/02/2010 for the course BUAD 350 taught by Professor Safarzadeh during the Spring '07 term at USC.
 Spring '07
 Safarzadeh

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