Download - Econ1102 Week 1 Revised
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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 performanceMeasuring output (GDP)Measuring prices and inflation
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Evaluating Macroeconomic Performance
1. Rising Living Standards economic growth
Tendency for the level of output (i.e. quantity and qualityof goods and services) to increase over time.
Output divided by population = output per capita
May also care about the distribution of living standards
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Real Quarterly GDP per-capita Australia (1973-2011)
6000
7000
8000
9000
10000
11000
12000
13000
14000
15000
16000
Sep-1
973
Sep-1
974
Sep-1
975
Sep-1
976
Sep-1
977
Sep-1
978
Sep-1
979
Sep-1
980
Sep-1
981
Sep-1
982
Sep-1
983
Sep-1
984
Sep-1
985
Sep-1
986
Sep-1
987
Sep-1
988
Sep-1
989
Sep-1
990
Sep-1
991
Sep-1
992
Sep-1
993
Sep-1
994
Sep-1
995
Sep-1
996
Sep-1
997
Sep-1
998
Sep-1
999
Sep-2
000
Sep-2
001
Sep-2
002
Sep-2
003
Sep-2
004
Sep-2
005
Sep-2
006
Sep-2
007
Sep-2
008
Sep-2
009
Sep-2
010
$perqtr
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2. Stable Business Cycle low volatility in fluctuations
of actual output around its trendorpotential output.
Australias Real Quarterly GDP Growth Rates DecadeAverages
1960s 1970s 1980s 1990s 2000sMean 1.26 0.78 0.82 0.83 0.75StandardDeviation
1.50 1.49 0.97 0.77 0.52
Ratio 0.84 0.53 0.85 1.08 1.44
Mid-1980s Great Moderation large fall in volatility ofreal output why?
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3. Relatively Stable Price Level low (positive) rate of
inflation
Inflation has been concern for most developed countriesover the last 40 years.
Japan is an exception and has experienced deflation overthe last decade.
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Australian Inflation - Consumer Price Index Measure
-2.0
0.0
2.0
4.0
6.0
8.0
10.0
12.0
14.0
16.0
18.0
20.0
Sep-1
970
Oct-1971
Nov-1
972
Nov-1
973
Nov-1
974
Nov-1
975
Nov-1
976
Nov-1
977
Nov-1
978
Nov-1
979
Nov-1
980
Nov-1
981
Nov-1
982
Nov-1
983
Nov-1
984
Nov-1
985
Nov-1
986
Nov-1
987
Nov-1
988
Nov-1
989
Nov-1
990
Nov-1
991
Nov-1
992
Nov-1
993
Nov-1
994
Nov-1
995
Nov-1
996
Nov-1
997
Nov-1
998
Nov-1
999
Nov-2
000
Nov-2
001
Nov-2
002
Nov-2
003
Nov-2
004
Nov-2
005
Nov-2
006
Nov-2
007
Year-ended%c
hange
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4. Sustainable Levels of Public and National Debt
Public debt borrowing by public sector from privatesector
Influenced by government budget deficits/surpluses
Foreign debt borrowing by domestic residents fromforeign countries
Influenced by an economys current accountdeficits/surpluses
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Budget Balance and Net Government Debt for Australia
-6
-4
-2
0
2
4
6
8
2000-01
2001-02
2002-03
2003-04
2004-05
2005-06
2006-07
2007-08
2008-09
2009-10
2010-11
2011-12
2012-13
2013-14
2013-15
Budget Balance Net Debt
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Australias Net External Liabilities
0.0
10.0
20.0
30.0
40.0
50.0
60.0
70.0
Jun-88
Jun-90
Jun-92
Jun-94
Jun-96
Jun-98
Jun-00
Jun-02
Jun-04
Jun-06
Jun-08
Percent
Net Debt/GDP Net Equity/GDP Net External Liabilities/GDP
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5. Balance between Current and Future Consumption
How much should an economy save/invest?
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Australian Private Investment and National Saving
0.00
5.00
10.00
15.00
20.00
25.00
30.00
S
ep-76
S
ep-78
S
ep-80
S
ep-82
S
ep-84
S
ep-86
S
ep-88
S
ep-90
S
ep-92
S
ep-94
S
ep-96
S
ep-98
S
ep-00
S
ep-02
S
ep-04
S
ep-06
S
ep-08
%o
fGDP
National Saving/GDP Private Investment/GDP
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6. Full Employment
Provision of employment for all individuals seeking work
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Australian Unemployment Rate Monthly
0.0
2.0
4.0
6.0
8.0
10.0
12.0
Feb-1
978
Jan-1
979
Dec-1
979
Nov-1
980
Oct-1981
Sep-1
982
Aug-1
983
Jul-1984
Jun-1
985
May-1
986
Apr-1987
Mar-1988
Feb-1
989
Jan-1
990
Dec-1
990
Nov-1
991
Oct-1992
Sep-1
993
Aug-1
994
Jul-1995
Jun-1
996
May-1
997
Apr-1998
Mar-1999
Feb-2
000
Jan-2
001
Dec-2
001
Nov-2
002
Oct-2003
Sep-2
004
Aug-2
005
Jul-2006
Jun-2
007
May-2
008
Apr-2009
Mar-2010
Feb-2
011
Percent
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Measuring National or Aggregate Output
GDP Gross Domestic Product
Definition:
The market value of final goods and services produced ina country during a given period.
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The market value of final goods and servicesproduced in
a country during a given period.
GDP is aflow variable measured over a period of time.
Quarter March, June, September, December
Australian GDP in March 2011 = $347.0 billion
Year just add-up GDP over 4 quarters
Calendar Mar-09 + Jun-09 + Sep-09 + Dec-09Financial Sep-09 + Dec-09 + Mar-10 + Jun-10
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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 ofvarious goods and services
Example: Quantity Market Price10 cars $20,000 per car
100 apples $1 per apple
GDP = $200,000 + $100 = $200,100
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What about goods and services with no observed
market price?
Some are included in GDP:
National defense use costs of provision (costs ofbuying equipment, wages of soldiers, etc.)
Some are excluded from GDP
Unpaid housework
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The market value offinal goods and services produced in
a country during a given period.
GDP excludes intermediate goods and services. Thesegoods are used-up in the production process.
Example: In the production of a loaf of bread, the flourused is an intermediate input and is not counted in GDP.
Concept ofValue Added: The market value of a firms
production less the cost of inputs purchased from otherfirms
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Value Added in Computer Sales: Chapter 1, Problem 2
(Textbook)
Firm Sales Cost of inputs Value AddedIntel Incorp 20,000 0 20,000
Macro Soft 5,000 0 5,000Bell 80,000 25,000 55,000PC Charlies 100,000 80,000 20,000
PC Charlies final sales = $100,000
Sum of Value Added = $100,000
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3 Ways to Measure GDP
1. Production Method
2. Expenditure Method
3. Income Method
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Expenditure Method
Accounting IdentityExpenditure on goods and services by final users mustequal the value of their production.
Components of Expenditure
Consumption (C) purchases by HouseholdsInvestment (I) purchases by FirmsGovernment (G) Government purchasesNet Exports (NX ) net purchases by foreign sectorNX = Exports Imports
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National Income Accounting Identity
GDP=Expenditure
Y = C + I + G + NX
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Australian GDP March Quarter 2011
Expenditure Approach
$billionHousehold Consumption 185.3
Private Investment 74.7Government (Public) Spending 83.0Change in Inventories 0.7Exports 71.8
Less Imports 68.7
Total 346.8Statistical discrepancy 0.2GDP 347.0
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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
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Australian GDP March Quarter 2011
Income Approach
$ BillionCompensation of Employees 168.3
Gross Operating Surplus 117.6Gross Mixed Income 27.2GDP (at factor cost) 313.0
Taxes Subsidies 33.4
GDP (Market Prices) 346.4Statistical discrepancy 0.6GDP 347.0
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Nominal vs. Real GDP
Nominal
values quantities of goods and services produced atcurrent yearprices
Real
values quantities of goods and services produced atbase yearprices measure of the actual physicalvolume of production
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Example
2007 2008 % ChangeNo. of Cars 10 10 0Price of Cars $20,000 $40,000 100
No. of Apples 100 100 0Price of Apples $1 $2 100
Nominal GDP $200,100 $400,200 100
Real GDP2007 prices $200,100 $200,100 02008 prices $400,200 $400,200 0
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Choice of Base Year (Bit Technical)
In the above example whether we use 2007 or 2008 asbase year prices gives the same answer for the growthrate of real GDP
This is not the case in general, particularly if you arecomparing real GDP over a 5-10 year period.
Using initial prices (i.e. 2007) is know as aLaspeyres indexUsing final prices (i.e. 2008) is known as a Paasche
index
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Chain Weighting
For any two consecutive years compute the growth ratesof real GDP implied by both theLaspeyres and thePaasche indexes.
Then take the average of the two growth rates and this isthe chain-weighted growth rate. This can be used tocompute a real chained-weighted GDP.
Finally to compute a change index over a long period, theabove approach is applied on a year-by-year basis.
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Example2007 2008
No. of Cars 10 10 Price of Cars $20,000 $40,000
No. of Apples 100 1000 Price of Apples $10 $25
Nominal GDP $201,000 $425,000
Real GDP2007 prices $201,000 $210,000
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Chain-weighted measure of Real GDP
Take average of growth rates implied by 200
prices.
5.05% = (4.5% + 5.6%)/2
Choose either 2007 or 2008 as the base-year
(nominal=real GDP). Lets pick 2007
2007 2008
Nominal GDP 201,000 425,000Real GDP 201,000 211,151 (=201,00
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Is GDP A Good Measure of Economic Wellbeing?
Some OmissionsLeisure TimeHousehold productionEnvironmental DegradationQuality of LifeEconomic Inequality
It is likely that GDP is positively related (correlated) witheconomic wellbeing
Variety of goods and servicesHealth and Education
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Measures of the Price Level
Want to measure the average level of prices in theeconomy.
Main Measures
Consumer Price Index (CPI)GDP Deflator/Price Index
CPI For a given period, measures the cost in that periodof a given basket of goods and services relative to theircost in a fixed year called a base year.
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Construct a CPI
Choose a basket of goods and servicesBasket 2000 (base) 2008Rent (2 bedroom flat) $500 $630Hamburgers (60) $150 $150CDs (2) $30 $70Total Expenditure $680 $850
CPI =Cost of base-year basket of goods and services in current
yearCost of base-year basket of goods and services in baseyear
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CPI = $850/$680 = 1.25
Cost of living is 25 percent higher in 2008 than it wasin 2000
Average prices are 25 percent higher in 2008 than in2000
Australian CPI
Published quarterly by ABSHousehold Expenditure Survey used to determine
typical basket
Base year changes every 5 years
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Inflation (and Deflation)
Inflation is measured by the percentage change in the CPIover a given period.
Inflation rate = 100*])1()1(
[
CPI
CPICPI
Inflation rate = 0 implies prices are constant
Inflation rate > 0 implies prices are rising
Inflation rate < 0 implies prices are falling Deflation
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Limitations with CPI
Quality Adjustment and New Goods Bias
Quality improvements may show up as higher pricesfor goods and services
New goods are often not included until CPI is re-based
Substitution Bias
Use of a fixed basket means that no allowance ismade for consumers substitution toward relativelyless expensive goods.
CPI tends to overstate the rate of inflation.
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Costs of Inflation
Important to distinguish between relative price changeand a change in the generalprice level
Shoe-leather costs inflation reduces the realpurchasing power of a given amount of money
Menu costs real costs of changing pricesIntroduces noise into the price mechanismDistorts tax systems (if not indexed to inflation)Unexpected re-distributions of wealth
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Inflation and Interest Rates
Nominal Interest Rates percentage increase in thenominal (or dollar) value of a financial asset.
Real Interest Rate percentage increase in the realpurchasing power of a financial asset.
= ir r= real interest ratei = nominal interest rate = inflation rate
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Fisher Effect
Nominal interest rate = real rate + (expected) inflationrate
eri +=
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Inflation and Nominal Interest Rate
-2.0
0.0
2.0
4.06.0
8.0
10.0
12.0
14.0
16.0
Mar-86
Mar-88
Mar-90
Mar-92
Mar-94
Mar-96
Mar-98
Mar-00
Mar-02
Mar-04
Mar-06
Mar-08
%perannum
Inflation (year-ended) 10 Year Bond Rate