Understanding Macroeconomics: GDP, Unemployment, and Inflation Dynamics

Topic 2: Macroeconomics GDP Unemployment Inflation

Gross Domestic Product (GDP) • Gross Domestic Product (GDP) is the value of all goods and services produced in an economy during a given period of time. i.e., what is earned by people working in the US. • Gross National Product (GNP) is the value of all goods and services produced by a country’s citizens during a given period of time. i.e., what Americans earn supplying labor in the US and elsewhere. • Gross means it doesn’t account for wearing out (e.g., how many cars die each year?). Net accounts for wearing out.

What we care about, what we observe • Most policy makers are more concerned with National Income (Y) or NDP, rather than GDP • GDP is easier to measure • We will refer to any these items as “output”, and treat them as approximate equals

Guidelines for calculating GDP • It must go through the market place. Otherwise, ignore it. e.g., the neighborhood babysitter. • Should involve the 3 factors of production that year. Ignore payments towards future production, or things produced last year. • Don’t include transfers in ownership without production, or pure paper money transfers. i.e., buying stock doesn’t county, unless there are broker fees. Buying a used car from my brother doesn’t count either. • Nothing illegal. Limo driver or mafia wheel man?

Ways to measure GDP • Option 1: Count only final sales. (If all transactions happen in the same year.) • Option 2: Count value added (sales - inputs). VA = final sales - intermediate goods GDP = ΣVA • DON’T double count. Avoid counting Value Added and Final Sales.

GDP Example • In an economy, there are three producers: a grape farm, a winery, and a liquor store. All production goes towards the production of wine.

GDP Example • If a thief steals $10k in wine from the liquor store… • If the store owner drinks $10k in wine himself… • If the vineyard produced the grapes and sold them to the winery in 2007, but the winery and liquor store didn’t do anything themselves until 2008… • If the liquor store only sells $150k worth of wine in 2007, then sells the other $150k worth of wine in 2008…

Liquor Store Value Added • The liquor store bought inputs for $200K, sold outputs for $300K, and added value of $100K. • What did the liquor store produce? • Is value added equal to profit?

GDP in the long-run • Graphing economic growth • Why do we care about the downturns and upswings? • Two main macroeconomic dangers?

Economic Growth • Economic Growth = Sustained rise in real GDP per capita • Causes: • Increased workforce participation • Increase output per worker hour • Better quality (education & skills) of the work force • More capital • Better capital (improved technology) • Declining share in agriculture (can work year round)

Economic Growth • Representing economic growth on the PPF • Graph: GDP per capital over time

Unemployment • Who’s considered unemployed? Ask three questions:

Unemployment The labor market in a recession • Demand for workers decreases • Wages are slow to respond (“Sticky” wages) Why might wages be sticky?

3 types of unemployment • Structural – comes from the rigidity of the labor market • Frictional – the natural flow of people between jobs or careers, or transition into the workforce • Cyclical – unemployment resulting from economic downturns Natural Rate of Unemployment = Structural + Frictional

Types of unemployment • A mother returns to work after raising her children? • Graduate from college and must find a job? • Unemployment caused by a minimum wage law? • Unemployment resulting from lack of information about available jobs? (i.e., bad matching) • You move to NYC then start looking for a job?

Types of unemployment • Real estate brokerage lays off some of its agents? • A steel plant lays off some of its works after the government eliminates steel tariffs • GM lays off workers due to poor economic conditions? • GM lays off workers due to changing production technology?

Inflation • Inflation = “An increase in the overall price level” • Usually measured by the consumer price index (CPI) • CPI = A price index computed each month by the Bureau of Labor Statistics using a pre-defined “market basket” purchased monthly by the typical urban consumer.

CPI Example – 3 good basket Inflation between 1998 and 1999 = “Price of basket in 1999” / “Price of basket in 1998”

CPI Example – 3 good basket Inflation between 1998 and 1999 = “Price of basket in 1999” / “Price of basket in 1998” - 1

CPI Example – 3 good basket If 1998 is the “base year” for the CPI (i.e., the CPI in 1998 = 100), then what is the CPI for 1999?

CPI Example – 3 good basket If 1998 is the “base year” for the CPI (i.e., the CPI in 1998 = 100), then what is the CPI for 1999? CPI = “current year price” / “base year price” x 100 =______

CPI Example 2 • Suppose that • The CPI in 1980 equals 82.4 • The CPI in 1990 equals 130.7 • Inflation between 1990 and 2000 was 31.75% • Questions: • What was inflation between 1980 and 1990? • What is the CPI in 2000? • What was inflation between 1980 and 2000?

Inflation • Types of Inflation: • Demand-Pull Inflation (increase in demand drives up prices) • Cost-Pull Inflation (wage price spiral) • Supply-shocks (oil price driven) • Why does it matter?

Understanding Macroeconomics: GDP, Unemployment, and Inflation Dynamics