Economics 1B Lecture 9 S2011

Economics 1B Lecture 9 S2011 - Economics 1B UC Davis UC D i...

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Unformatted text preview: 4/28/2011 Economics 1B UC Davis UC D i Professor Siegler Spring 2011 I. Introduction Suppose $44 billion of new trucks are produced in the pp p U.S. in 2011, compared to $40 billion of new trucks in 2010. Can we conclude that the economy produced 10 percent more trucks in 2011 compared to 2010? We can reach this conclusion only if the average prices of trucks did not change between 2010 and 2011. However, prices always change. Real GDP measures changes in the quantities of final Real GDP measures changes in the quantities of final goods and services, holding prices constant. The question, however, is which prices are held constant? In this case, do we use 2010 or 2011 prices to measure changes in production between 2010 and 2011? 2 1 4/28/2011 II. The Index Number Problem The index number problem is that there is no p unique way to combine the relative changes in the prices and quantities of various products into (1) a single measure of the relative change of the overall price level and (2) a single measure of the relative change of the overall quantity level. 3 II. The Index Number Problem Q Quantity indices (like real GDP) measure the change y ( ) g of aggregate quantities, using price weights. Price indices (like the GDP price deflator or the Consumer Price Index) measure changes in prices, using quantity weights. Typically, relative prices and relative quantities move in the opposite direction. If a price of a good i h i di i If i f d gets relatively more expensive, people buy less of it. In this case, the choice of weighting is crucial. 4 2 4/28/2011 III. ChainWeighted Real GDP Chainweighting was developed by the American economist, Irving Fisher, a century ago to minimize economist Irving Fisher a century ago to minimize the index number problem. Chainweighted indices are also called Fisher indices. Another advantage of chainweighting is that it avoids the rewrites of economic history that come y g y under the benchmark year (fixedweight) system. The disadvantage of the chainweighting is that it is more cumbersome to calculate. The Bureau of Economic Analysis (BEA) moved to chainweighting in 1996. 5 IV. ChainWeighted Real GDP Example Step 1: Select a base ep year to serve as a reference value. In the base year, nominal GDP is equal to real GDP. Let 2010 be the base year in this example: year in this example: Year 2010 2011 2012 P1 $5 $4 $3 Q1 1 3 6 P2 $1 $2 $3 Q2 10 7 4 6 3 4/28/2011 IV. ChainWeighted Real GDP Example Step 2: Calculate the ep growth in production from 2010 to 2011, using 2010 prices as weights: Year Y 2010 2011 2012 P1 $5 $4 $3 Q1 1 3 6 P2 $1 $2 $3 Q2 10 7 4 Production in 2011, using 2010 prices ($5*3)+($1*7) $22 Production in 2011, using 2010 prices = ($5 3)+($1 7) = $22 Production in 2010, using 2010 prices = ($5*1)+($1*10) = $15 Growth from 2010 to 2011 = ($22/$15) = 1.4667 7 IV. ChainWeighted Real GDP Example Step 3: Calculate the ep growth in production from 2010 to 2011, using 2011 prices as weights: Year Y 2010 2011 2012 P1 $5 $4 $3 Q1 1 3 6 P2 $1 $2 $3 Q2 10 7 4 Production in 2011, using 2011 prices ($4*3)+($2*7) $26 Production in 2011, using 2011 prices = ($4 3)+($2 7) = $26 Production in 2010, using 2011 prices = ($4*1)+($2*10) = $24 Growth from 2010 to 2011 = ($26/$24) = 1.0833 8 4 4/28/2011 IV. ChainWeighted Real GDP Example Step 4: Calculate the ep chainweighted growth factor from 2010 to 2011, which is the geometric average of the growth factors from Step 2 and Step 3: Step 3: Year Y 2010 2011 2012 P1 $5 $4 $3 Q1 1 3 6 P2 $1 $2 $3 Q2 10 7 4 ChainWeighted Growth Factor = 9 IV. ChainWeighted Real GDP Example Step 5: Multiply the ep py chainweighted growth factor from Step 4 with real GDP from the previous year to get the current year's chain weighted real GDP: weighted real GDP: Year Y 2010 2011 2012 P1 $5 $4 $3 Q1 1 3 6 P2 $1 $2 $3 Q2 10 7 4 10 5 4/28/2011 IV. ChainWeighted Real GDP Example Step 6: Repeat Steps 2 through 5 to compute real h h5 l GDP for 2012, measured in 2010 chainweighted dollars. Compute growth in production from 2011 to 2012, using 2011 prices Co pute g o t i Compute growth in production from 2011 to 2012, using 2012 prices. Multiply geometric average of these two growth factors to real GDP in 2011 to get real GDP in 2012. Year Y 2010 2011 2012 P1 $5 $4 $3 Q1 1 3 6 P2 $1 $2 $3 Q2 10 7 4 11 Question 9.1 What is real GDP in 2012, measured in 2010 2012 measured in 2010 chainweighted dollars? Recall that real GDP in 2011 was $18.91. A) $19.65 ) $ 09 B) $20.98 C) $22.46 D) $23.16 Answer: B Year Y 2010 2011 2012 P1 $5 $4 $3 Q1 1 3 6 P2 $1 $2 $3 Q2 10 7 4 12 6 4/28/2011 V. GDP Price Deflator Nominal GDP grows faster than real GDP when Nominal GDP grows faster than real GDP when there is inflation. The greater the difference between nominal GDP growth and real GDP growth, the greater the rate of inflation. If there was deflation, with prices falling, then nominal GDP would increase less than real GDP. We can use the ratio of nominal GDP to real GDP as a measure of the aggregate price level. 13 V. GDP Price Deflator The GDP price deflator is a measure of the price The GDP price deflator is a measure of the price level of all the final goods and services included in GDP. In the base year, the GDP price deflator is equal to 100. 14 7 4/28/2011 Question 9.2 Recall that real GDP in 2011 was $18.91 and 2011 was $18 91 and $20.98 in 2012. What is the approximate value of the GDP price deflator in 2012? A) 143 B) 136 C) 123 D) 155 Answer: A Year Y 2010 2011 2012 P1 $5 $4 $3 Q1 1 3 6 P2 $1 $2 $3 Q2 10 7 4 15 VI. Alternative Inflation Measures Consumer Price Index Consumer Price Index It is a fixedweighted price index and not chain weighted, so it overstates the inflation rate (because of the substitution bias) It includes goods and services that urban households purchase, so it omits some domestically produced final goods and services that households don t final goods and services that households don't purchase (like F16 planes), and it includes many imported consumer goods that households purchase, but are not part of U.S. GDP (like many imported consumer electronics). 16 8 4/28/2011 VI. Alternative Inflation Measures There are better measures of overall inflation than either the GDP price deflator or the consumer price index (CPI). The Federal Reserve uses the Personal Consumption Expenditure (PCE) price index, which measures the prices of the goods and services included in "C" in the expenditure approach to computing GDP. There is also a new chainweighted CPI, which the Bureau of Labor Statistics (BLS) publishes. Why is the fixedweighted CPI still so widely used? 17 VII. Real GDP Per Capita Real GDP per capita is the most widely available Real GDP per capita is the most widelyavailable and widelyused measure of the average quality of life in an economy. In the very long run, real GDP per capita is highly correlated with many other quality of life measures. However, there can be substantial deviations between real GDP per capita and other measures of quality of life over relatively long periods of time. 18 9 4/28/2011 Case Study: The Antebellum Paradox 19 Case Study: World War II U.S. Real GDP, 1940 to 1947 , (Billions of 2005 Chain-Weighted Dollars) 2,500.0 2,000.0 1,500.0 1,000.0 1 000 0 500.0 0.0 1940 1941 1942 1943 1944 1945 1946 1947 20 10 4/28/2011 VII. Real GDP Per Capita Limitations of Real GDP Per Capita Limitations of Real GDP Per Capita Excludes household production, leisure, and the underground economy. Excludes quality improvements. Ignores issues of environmental quality, resource depletion, and issues of sustainability. Other quality of life measures are excluded or cause Oh l flf l d d GDP to rise (crime, congestion, civic organizations, sense of community). Ignores issues of poverty and inequality. 21 Incomes Have Grown the Most at the Top Income Shares Bottom Bottom 90% 90 to 95% 95 to 99 % 99 to 99.5% 99.5 to 99.9% 99.9 to 99.99% Top 0.01% 1970 $32,580 $32 580 $96,498 $139,028 $244,162 $382,369 $869,866 2007 $32,421 $32 421 $128,560 $220,105 $486,393 $1,021,643 $4,024,583 Percentage Change 0.005% 0 005% 33.2% 58.3% 99.2% 167.2% 362.7% 789.3% $4,384,107 $35,042,705 Source: Based on Thomas Piketty and Emmanuel Saez (2003), "Income Inequality in the United States, 19131998." Quarterly Journal of Economics 108 (1), pp. 139. See http://www.econ.berkeley.edu/~saez/TabFig2007.xls, for updated data through 2007 as used in most of the figures above. Pretax income in 2007 dollars, including capital gains, adjusted for inflation. 22 11 4/28/2011 VIII. Alternative Quality of Life Measures United Nations Human Development Index (HDI) United Nations Human Development Index (HDI) combines real GDP per capita, educational attainment, and life expectancy into a single measure. In 2010, the rankings are: (1) Norway (2) Australia (3) New Zealand (4) United States 23 VIII. Alternative Quality of Life Measures Subjective Well Being and Happiness Subjective WellBeing and Happiness "Money never made a man happy yet, nor will it. The more a man has, the more he wants." Benjamin Franklin HappinessIncome Paradox or the Easterlin pp Paradox 24 12 4/28/2011 25 VIII. Alternative Quality of Life Measures What Should a Better Measure of Quality of Life y Include? Material living standards (income, consumption, and wealth) Health Education Personal activities including work Personal activities including work Political voice and governance Social connections and relationships Environment (present and future conditions) Insecurity, of an economic as well as a physical nature 26 13 4/28/2011 IX. Measuring Growth Rates Compound growth explains why small differences in p g p y annual rates of growth make such huge differences in l f h k hh diff i real GDP per capita over time. Initial level x (1+g)t = Level in t years (g must be expressed in decimal form so 0.03 is 3 percent) Y0(1+g)t = Yt 27 IX. Measuring Growth Rates Rule of 72 allows you to approximate the effects of Rule of 72 allows you to approximate the effects of compound growth rates. 28 14 4/28/2011 IX. Measuring Growth Rates Country A Country A Average Annual Growth Rate Real GDP per capita in 1867 Real GDP per capita in 2011 (Rule of 72 approximation) Real GDP per capita in 2011 (Actual) 1 percent $2,000 $8,000 Country B Country B 2 percent $2,000 $32,000 Country C Country C 3 percent $2,000 $128,000 $2,000(1+0.01)144 $2,000(1+0.02)144 $2,000(1+0.03)144 =$8,381 =$34,630 =$141,121 29 Question 9.3 The GDP price deflator was 24.3 in 1970 and 110.7 in The GDP price deflator was 24.3 in 1970 and 110.7 in 2010 (2005 = 100). What was the annual rate of inflation in the United States between 1970 and 2010? A) 4.21% B) 3.05% ) C) 3.86% D) 5.23% Answer: C 30 15 4/28/2011 Question 9.4 Suppose your child is born this year and you invest $20,000 for your child. If the average annual rate of $20 000 for your child If the average annual rate of return on this investment is 6 percent per year, approximately how much money will your child have when she reaches the age of 72? A) $320,000 ) $ 0,000 B) $640,000 C) $1,280,000 D) $1,920,000 Answer: C 31 Question 9.5 Which of the following could cause nominal GDP to decrease, but real GDP to increase? decrease but real GDP to increase? A) The price level rises and the quantity of final goods and services produced rises. B) The price level falls and the quantity of final goods and services produced rises. C) The price level rises and the quantity of final goods and services produced falls. goods and ser ices produced falls D) The price level falls and the quantity of final goods and services produced falls. Answer: B 32 16 ...
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This note was uploaded on 02/07/2012 for the course ECON 1b taught by Professor Sheffrin during the Spring '07 term at UC Davis.

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