Econ1102 Week 1

August 4, 2017 | Author: Join Today | Category: Consumer Price Index, Gross Domestic Product, Inflation, Government Budget Balance, Interest
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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 performance  Measuring output (GDP)  Measuring prices and inflation

Evaluating Macroeconomic Performance 1. Rising Living Standards – economic growth Tendency for the level of output (i.e. quantity and quality of goods and services) to increase over time. Output divided by population = output per capita May also care about the distribution of living standards

2

Dec-2014

Sep-2013

Jun-2012

Mar-2011

Dec-2009

Sep-2008

Jun-2007

Mar-2006

Dec-2004

Sep-2003

Jun-2002

Mar-2001

Dec-1999

Sep-1998

Jun-1997

Mar-1996

Dec-1994

Sep-1993

Jun-1992

Mar-1991

Dec-1989

Sep-1988

Jun-1987

Mar-1986

Dec-1984

Sep-1983

Jun-1982

Mar-1981

Dec-1979

Sep-1978

Jun-1977

Mar-1976

Dec-1974

Sep-1973

$, cvm

Real Quarterly GDP per-capita – Australia (1973-2015) 18000

16000

14000

12000

10000

8000

6000

4000

2000

0

3

2. Stable Business Cycle – low volatility in fluctuations of actual output around its trend or potential output. Australia’s Real Quarterly GDP Growth Rates – Decade Averages 1960s 1970s 1980s 1990s 2000s 2010s Mean 1.25 0.83 0.84 0.84 0.77 0.63 Standard 1.50 1.42 1.09 0.79 0.52 0.38 Deviation Ratio 0.83 0.58 0.77 1.06 1.48 1.66 Mid-1980s Great Moderation – large fall in volatility of real output – why?

4

Australia’s Growth Rate vs. Volatility: Decade Averages 1.40

60s 1.20

Mean growth per qtr

1.00

80s

90s

0.80

70s

2000s 2010s

0.60

0.40

0.20

0.00

0.00

0.20

0.40

0.60

0.80

1.00

1.20

1.40

1.60

Std of quarterly growth

5

3. Relatively Stable Price Level – low (positive) rate of inflation Inflation has been concern for most developed countries over the last half century. Japan is an exception and has experienced deflation over the last decade.

6

10.0

5.0 Year-ended percentage change

Australian Inflation - Consumer Price Index Measure 20.0

15.0

0.0

Mar-2014 Mar-2011 Mar-2008 Mar-2005 Mar-2002 Mar-1999 Mar-1996 Mar-1993 Mar-1990 Mar-1987 Mar-1984 Mar-1981 Mar-1978 Mar-1975 Mar-1972 Mar-1969

Mar-1966 Mar-1963 Mar-1960 -5.0

7

4. Sustainable Levels of Public and National Debt Public debt – borrowing by public sector from private sector Influenced by government budget deficits/surpluses Foreign debt – borrowing by domestic residents from foreign countries Influenced by an economy’s current account deficits/surpluses

8

5 Percent of GDP

Budget Balance and Net Government Debt for Australia 20

15

10

0

2017-18 2016-17 2015-16 2014-15 2013-14 2012-13 2011-12 2010-11

Net Debt Budget Deficit (underlying)

2009-10 2008-09 2007-08

2006-07 2005-06 2004-05 2003-04 2002-03 2001-02 2000-01 -5

-10

9

30 Percent

Australia’s Net External Liabilities (% of nominal GDP) 70

60

50

40

20

10

0

Mar-2014 Sep-2012 Mar-2011

Sep-2009 Mar-2008 Sep-2006 Mar-2005 Sep-2003 Mar-2002

Total Equity Debt

Sep-2000 Mar-1999

Sep-1997 Mar-1996 Sep-1994 Mar-1993 Sep-1991 Mar-1990 Sep-1988 -10

10

5. Balance between Current and Future Consumption How much should an economy save/invest?

11

I/Y Mar-2015

Dec-2013

Sep-2012

Jun-2011

Mar-2010

Dec-2008

Sep-2007

Jun-2006

Mar-2005

Dec-2003

Sep-2002

Jun-2001

Mar-2000

Dec-1998

Sep-1997

Jun-1996

Mar-1995

Dec-1993

Sep-1992

Jun-1991

Mar-1990

Dec-1988

Sep-1987

Jun-1986

Mar-1985

Dec-1983

Sep-1982

Jun-1981

Mar-1980

Dec-1978

Sep-1977

Jun-1976

Mar-1975

Dec-1973

Sep-1972

Jun-1971

Mar-1970

Share of GDP

Australian Investment and National Saving 0.40

0.35

0.30

0.25

0.20

0.15

0.10

0.05

0.00

NS/Y

12

6. Full Employment Provision of employment for all individuals seeking work

13

Feb-2015

Feb-2014

Feb-2013

Feb-2012

Feb-2011

Feb-2010

Feb-2009

Feb-2008

Feb-2007

Feb-2006

Feb-2005

Feb-2004

Feb-2003

Feb-2002

Feb-2001

Feb-2000

Feb-1999

Feb-1998

Feb-1997

Feb-1996

Feb-1995

Feb-1994

Feb-1993

Feb-1992

Feb-1991

Feb-1990

Feb-1989

Feb-1988

Feb-1987

Feb-1986

Feb-1985

Feb-1984

Feb-1983

Feb-1982

Feb-1981

Feb-1980

Feb-1979

Feb-1978

Percent

Australian Unemployment Rate – Monthly 12.0

10.0

8.0

6.0

4.0

2.0

0.0

14

Measuring National or Aggregate Output GDP = Gross Domestic Product

15

Which of the following is the correct definition of GDP? (a)Value of all goods and services bought and sold during a year (b) Value of all new goods and services produced during a year (c) Value of all final goods and services purchased during a year (d) None of the above

16

GDP = Gross Domestic Product Definition: The market value of final goods and services produced in a country during a given period.

17

The market value of final goods and services produced in a country during a given period. GDP is a flow variable – measured over a period of time. Quarter – March, June, September, December Australian GDP in March 2015 = $403.5 billion Year – just add-up GDP over 4 quarters  Calendar – Mar-09 + Jun-09 + Sep-09 + Dec-09  Financial – Sep-09 + Dec-09 + Mar-10 + Jun-10

18

The market value of final goods and services produced in a country during a given period.  Excludes goods and services that are produced in other countries (but might be consumed in Australia) Imports  Excludes goods and services that were produced in some earlier period, but are re-sold in the current period – second-hand goods

19

The market value of final goods and services produced in a country during a given period. GDP is measure of aggregate production or output Use market prices to value (or weight) quantities of various goods and services Example:

Quantity 10 cars 100 apples

Market Price $20,000 per car $1 per apple

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

20

What about goods and services with no observed market price? Some are included in GDP:  National defense – use costs of provision (costs of buying equipment, wages of soldiers, etc.)  Roads Some are excluded from GDP  Unpaid housework (Household production)

21

The market value of final goods and services produced in a country during a given period. GDP excludes intermediate goods and services. These goods are used-up in the production process. Example: In the production of a loaf of bread, the flour used is an intermediate input and is not (double) counted in GDP. Concept of Value Added: The market value of a firm’s production less the cost of inputs purchased from other firms

22

Value Added in Computer Sales: Chapter 1, Problem 2 (Textbook) Firm Added Intel Incorp Macro Soft Bell PC Charlie’s

Sales

Cost of inputs

20,000 5,000 80,000 100,000

0 0 25,000 80,000

Value 20,000 5,000 55,000 20,000

PC Charlie’s final sales = $100,000 Sum of Value Added = $100,000

23

The Verge Café offers a big breakfast of bacon, eggs, tomato and toast for $10. What is the best measure of the value added of a big breakfast? (a)$10 (b)$10 less the cost of the bacon, eggs, tomato and toast (c)$10 plus the cost of the bacon, eggs, tomato and toast (d)the cost to Verge Café of purchasing the bacon, eggs, tomato and toast (e)$10 less the cost of the bacon eggs, tomato, toast and the labour cost (waiter and cook) required to produce the big breakfast 24

(a)$10 (contribution to GDP, not value added of big breakfast at Verge Café) (b)$10 less the cost of the bacon, eggs, tomato and toast (Yes, price less cost of intermediate inputs) (c)$10 plus the cost of the bacon, eggs, tomato and toast (d) the cost to Verge Café of purchasing the bacon, eggs, tomato and toast (cost of intermediate inputs) (e)$10 less the cost of the bacon eggs, tomato, toast and the labour cost (waiter and cook) required to produce the big breakfast (Labour cost is not intermediate input)

25

3 Equivalent Ways to Measure GDP 1. Production Method 2. Expenditure Method 3. Income Method

26

Expenditure Method Accounting Identity Expenditure on goods and services by final users must equal the value of their production. Components of Expenditure  Consumption (C) – purchases by Households  Investment (I) – purchases by Firms  Government (G) – Government purchases  Net Exports (NX ) – net purchases by foreign sector NX = Exports (X) – Imports (M) 27

National Income Accounting Identity GDP=Expenditure Y = C + I + G + NX Y=C+I+G+X–M Y+M=C+I+G+X Supply of G & S = Demand for G & S

28

Australian GDP March Quarter 2015 Expenditure Approach $billion Household Consumption 229.4 Private Investment 88.0 Government (Public) Spending 89.7 Change in Inventories 0.2 Exports 82.6 Less Imports 86.3 Total 403.6 Statistical discrepancy -0.1 GDP 403.5 http://www.abs.gov.au/AUSSTATS/[email protected]/DetailsPa ge/5206.0Mar%202015?OpenDocument 29

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

30

Australian GDP March Quarter 2015 Income Approach $billion Compensation of Employees 192.7 Gross Operating Surplus 137.5 Gross Mixed Income 33.7 Total Factor Income 363.9 Taxes – Subsidies 41.2 Total 405.1 Statistical discrepancy -1.5 GDP (Market Prices) 403.5 http://www.abs.gov.au/AUSSTATS/[email protected]/DetailsPa ge/5206.0Mar%202015?OpenDocument 31

Which of the following is the correct definition of GDP? (a)Value of all goods and services bought and sold during a year (This would include second-hand goods) (b) Value of all new goods and services produced during a year (This would include intermediate goods) (c) Value of all final goods and services purchased during a year (Option says purchased (not produced) so includes imported goods and services) (d) None of the above (Correct choice)

32

Nominal vs. Real GDP Nominal  values quantities of goods and services produced at current year prices

Real (or constant price or chain volume measure)  values quantities of goods and services produced at base year prices – measure of the actual physical volume of production

33

Example No. of Cars Price of Cars No. of Apples Price of Apples Nominal GDP

2007 10 $20,000 100 $1 $200,100

Real GDP 2007 prices 2008 prices

$200,100 $400,200

2008 % Change 10 0 $40,000 100 100 0 $2 100 $400,200 100

$200,100 $400,200

0 0

34

Choice of Base Year (Bit Technical) In the above example whether we use 2007 or 2008 as base year prices gives the same answer for the growth rate of real GDP This is not the case in general, particularly if you are comparing real GDP over a 5-10 year period.  Using initial prices (i.e. 2007) is known as a Laspeyres index  Using final prices (i.e. 2008) is known as a Paasche index

35

Chain Weighting For any two consecutive years compute the growth rates of real GDP implied by both the Laspeyres and the Paasche indexes. Then take the average of the two growth rates and this is the chain-weighted growth rate. This can be used to compute a real chained-weighted GDP. Finally to compute a change index over a long period, the above approach is applied on a year-by-year basis.

36

Example No. of Cars Price of Cars No. of Apples Price of Apples Nominal GDP

2007 10 $20,000 100 $10 $200,100

Real GDP 2007 prices 2008 prices

$200,100 $402,500

2008 % Change 10 0 $40,000 100 1000 900 $25 150 $425,000 112

$210,000 $425,000

4.9 5.6

37

Chain-weighted measure of Real GDP Take average of growth rates implied by 2007 and 2008 prices. 5.25 = (4.9 + 5.6)/2 Choose either 2007 or 2008 as the base-year (nominal=real GDP). Let’s pick 2007 2007 Nominal GDP 200,100 Real GDP 200,100

2008 425,000 210,605 (200,100×1.0525)

38

Chain Volume Measures of GDP and Components RBA Website http://www.rba.gov.au/statistics/tables/index.html#prices _inflation ABS Website http://www.abs.gov.au/websitedbs/d3310114.nsf/Home/ Home?OpenDocument

39

Is GDP A Good Measure of Economic Wellbeing? GDP per capita = GDP/Pop (see slides 2 and 3) Omissions from GDP that might matter for economic welfare  Leisure Time (extra week of holidays)  Household production (cook at home)  Environmental Degradation  Quality of Life (happiness)  Economic Inequality (distribution of income)

40

Is GDP positively correlated with economic welfare? Yes: medical care No:

Income distribution over last 20 years

Maybe: Income and measures of Happiness

41

Alternatives (complements) to GDP 1. Direct measures of Happiness - Survey-based measures (ask people how happy they are on a scale of 1 to 10. http://www1.eur.nl/fsw/happiness/index.html

2. Indexes of variables that might affect welfare http://www.smh.com.au/national/wellbeing-index-showsimpact-of-jobless-on-society-20140606-39okt.html 42

Measures of the Price Level Want to measure the average level of prices in the economy. Main Measures  Consumer Price Index (CPI)  GDP Deflator/Price Index CPI – For a given period, measures the cost in that period of a given basket of goods and services relative to their cost in a fixed year – called a base year.

43

Construct a CPI Choose a basket of goods and services Basket 2000 (base) Rent (2 bedroom flat) $500 Hamburgers (60) $150 Books (2) $30 Total Expenditure $680

2015 $630 $150 $70 $850

CPI = Cost of base-year basket of goods and services in current year Cost of base-year basket of goods and services in base year CPI = $850/$680 = 1.25 44

 Cost of living is 25 percent higher in 2015 than it was in 2000  Average prices are 25 percent higher in 2015 than in 2000 Australian CPI  Published quarterly by ABS  Household Expenditure Survey used to determine typical basket  Base year changes every 5 years

45

Was Charles Dickens the Taylor Swift of the 19th Century? According to a recent biography of the 19th century novelist Charles Dickens, in 1862 he could earn 190 pounds per night for giving a reading from his novels. According to The Richest (website) Taylor Swift earns revenue of about US $1.2 million from a concert. What information would you need to be able to calculate what Dickens’ earnings are in current UK pounds? http://www.measuringworth.com/calculators/ppoweruk/ 46

Inflation (and Deflation) Inflation is measured by the percentage change in the CPI over a given period. Inflation rate

CPI  CPI (1) = [ CPI (1) ] *100

Inflation rate = 0 implies prices are constant Inflation rate > 0 implies prices are rising Inflation rate < 0 implies prices are falling – Deflation

47

Limitations with CPI Quality Adjustment and New Goods Bias  Quality improvements may show up as higher prices for goods and services  New goods are often not included until CPI is rebased Substitution Bias  Use of a fixed basket means that no allowance is made for consumers’ substitution toward relatively less expensive goods. CPI tends to overstate the rate of inflation. 48

Costs of Inflation Important to distinguish between relative price change and a change in the general price level  Shoe-leather costs – inflation reduces the real purchasing power of a given amount of money  Menu costs – real costs of changing prices  Introduces noise into the price mechanism  Distorts tax systems (if not indexed to inflation)  Unexpected re-distributions of wealth

49

Inflation and Interest Rates Nominal Interest Rates – percentage increase in the nominal (or dollar) value of a financial asset. Real Interest Rate – percentage increase in the real purchasing power of a financial asset.

r  i  r = real interest rate i = nominal interest rate π = inflation rate

50

Fisher Effect Nominal interest rate = real rate + (expected) inflation rate

i  r 

e

51

8.0 Percent

Inflation and Nominal Interest Rate 18.0

16.0

14.0

12.0

10.0

6.0

4.0

2.0

0.0

Sep-2014 Mar-2013 Sep-2011 Mar-2010 Sep-2008 Mar-2007 Sep-2005

Mar-2004 Sep-2002 Mar-2001 Sep-1999 Mar-1998

Sep-1996

Inflation rate (year-ended) 10 year bond rate

Mar-1995 Sep-1993 Mar-1992 Sep-1990

Mar-1989 Sep-1987 Mar-1986 Sep-1984 Mar-1983

Sep-1981 Mar-1980 -2.0

52

The nominal interest rate on a one year government bond is 8 percent per annum. Investors require an annual real return of 3 percent. What is the expected rate of inflation? (i) (ii) (iii) (iv) (v)

11 percent 8 percent 5 percent 3 percent Insufficient information to calculate

53

The nominal interest rate on a one year government bond is 8 percent per annum. Investors require an annual real return of 3 percent. What is the expected rate of inflation? (i) 11 percent (ii) 8 percent (iii) 5 percent (iv) 3 percent (v) Insufficient information to calculate Use Fisher effect

𝑖 = 𝑟 + 𝜋𝑒 𝜋𝑒 = 𝑖 − 𝑟 = 8 − 3 54

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