introduction to economics · 2016-10-05 · 1.1 basic concepts of macroeconomics • the most...

Chapter 1 The Basics of MacroeconomicsMACROECONOMICS

Introduction to Economics

contents

Basic Concepts of Macroeconomics

Gross Domestic Product

Various Aspects of National Income

National Accounts of Korea

Price Index

1.1

1.2

1.3

1.4

1.5

1.1 Basic Concepts of Macroeconomics

• the most important variable in macroeconomics is national income

- in general, national income is represented by gross domestic product(GDP)

- the figure shown on the next page demonstrates the changes in Korean GDP from 1970 to 2013

- note these two points in the figure

(1) GDP has continuously grown over this period → economic growth

(2) growth rates differ year by year → business fluctuations

Changes in Korean GDP from 1970 to 2013


data: The Bank of Korea (2014), Economics Statistics System


- economic growth refers to a long-term trend of national income(GDP)

- rule of seventy

• suppose a certain variable grows by 𝑥% per year • it takes 𝑦 years for that variable to be doubled in value

Economic Growth

• rule of seventy : y =𝟕𝟎

𝒙

• The average growth rate of the Korean economy during 1960 –1990 was 7% ⇨ national income doubled in size in 10 years


- business fluctuation refers to short-term changes in

national income(GDP)

- actual GDP keeps on fluctuating around the long-term

trend of GDP ⇒ business cycles

- depending upon economic conditions, growth rates can

go higher than the average level and go lower than the

average level

- GDP gap : difference between actual GDP and its long-

term trend

Business Fluctuations

Various Phases of Business Fluctuations


boom

Business Fluctuations


- actual GDP higher than its long-term trend, so GDP gap has a positive value

- highest point of the cycle ⇒ peak

- actual GDP lower than its long-term trend, so GDP gap has a negative value

- lowest point of the cycle ⇒ trough

• boom

• recession

• business cycles show fairly irregular pattern with respect to their lengths and amplitudes

Business Cycles of the Korean Economy



Price Level and Inflation


•in macroeconomics, we are also interested in the changes in price level

•inflation

- the phenomenon of a continuous rise in price level

- from 1970 to 2013, the Korean economy recorded the average inflation rate of 8% per year → compared with 1970, the price level in 2013 was 20 times higher

•recently, deflation gives more headaches in many countries

Changes in Price Level


Balance of Payments and Exchange Rate


•we are also interested in the balance of payments and exchange rate

- (total exports + total imports) / GDP

- tabulation of inflows and outflows of foreign currencies

•dependency ratio

- in 1970, Korea’s dependency ratio was 37% ⇒ 103% in 2013

•balance of payments

•exchange rate

- the rate at which a certain country’s currency is exchanged for other country’s currency

1.2 Gross Domestic Product

- Gross Domestic Product (GDP)

•the sum of monetary values of final goods and services produced in a certain country during a certain period of time

definition of GDP

(1) ‘during a certain period of time’ :it could be a year or a quarter

(2) ‘in a certain county’ : national borders, not people, are the criteria for inclusion or

exclusion

(3) ‘final goods and services’ : intermediate goods and services are excluded

(4) ‘sum of monetary values’

GDP of Macroland


•(3,000×50) + (500×20) + (1,000×10) = 170,000(dollar)

ton

units

pairs

Intermediate Goods and Services & Value Added


•intermediate goods and services

- goods and services which are used as intermediate inputs in producing other goods and services

- inclusion of the value of intermediate goods and services in GDP causes the problem of double counting

•value added

- newly generated value at each production stage

Intermediate Goods and Services & Value Added


• GDP can be calculated by adding up all values added

• GDP = sum of values of final goods and services = sum of values added

• value added is distributed to the suppliers of various factors of

production as their income

Value Added at Each Production Stage


•adding up value added at each production stage will become 3 million dollars, which is equal to the value of bread

$1.7 million + $0.7 million + $0.6 million = $3 million(wheat) (flour) (bread) (sum of values added )

Nominal GDP and Real GDP


- prices of the current year are used to calculate the monetary values of commodities

- in addition to changes in production, changes in prices also affect the value of nominal GDP

nominal GDP

real GDP - prices of the base year are used to calculate the monetary values of commodities

- only changes in production affect the value of real GDP

- appropriate as the measure of the overall level of production

Limits of the Concept of GDP


• includes only the values of commodities traded in the market

ex) the value of household works by housewives ignored

• time consumed as leisure not included

• value of commodities traded in the underground economy not included

• market prices may not reflect the true values of certain commodities

• bad side effects accompanying production activities ignored

ex) environmental damages, congestion

1.3 Various Aspects of National Income

- strictly speaking, GDP we have seen so far is production national income

- production national income = expenditure national income = distribution national income

•various ways of measuring GDPThree kinds of national

income

Composition of Expenditure National Income


•if there is no foreign trade, expenditure national income(Y )

= consumption expenditure(C ) + investment expenditure(I )

+ government expenditure(G)

•part of commodities produced domestically are exported(X ),

and part of domestic expenditures are spent on imports(M )

•net export(χn) = X - M

•expenditure national income can be expressed as

Y = C + I + G + Xn

Gross National Product


Gross National Product (GNP) is a different version of national income

- GNP is the sum of monetary values of final goods and services produced by the people of a certain country

- note that the criterion of inclusion in case of GDP is national borders, not people

- GNP = GDP + net factor income from the rest of the world• net factor income from the rest of the world

= factor income received from the rest of the world − factor income paid to the rest of the world

- GDP more frequently used than GNP

Gross National Income


these days, Gross National Income(GNI) is more frequently used as a measure of total income generated

- GDP and GNP do not reflect the changes in real purchasing power due to changes in the terms of trade

•GNI = GNP + changes in real purchasing power due to changes in the terms of trade

- to solve this problem, we can use the concept of GNI

- GNI can be a good indicator of the level of economic welfare

Disposable Income


• GNI we have seen just before does not mean the amount of money people can

actually spend

• to derive disposable income(DI), we should make some adjustments to GNI

• first of all, we have to subtract depreciation

• retained earnings of firms and various kinds of taxes should also be subtracted

• and transfer payments from firms and government should be added

• DI = GNI – depreciation – retained earnings – various taxes + transfer payments

1.4 National Accounts of Korea

• national accounts- statistical systems of transactions of goods and services

and flows of funds between various sectors of a national economy

• we can ascertain that the following three kinds of national income are the same with each other by checking the national accounts- distribution national income - production national income - expenditure national income

National Accounts of Korea


Composition of Production, Expenditure and Distribution National Income (2013)


•employee earnings 43.7%, business profit 26.5%(1) distribution side

•private consumption expenditure 51.0%(2) expenditure side

•investment expenditure 29.7% (including government investment)

•government (consumption) expenditure 14.9%

•service sector 54.0%, manufacturing sector 28.4%(3) production side

Composition of Production, Expenditure and Distribution National Income (2013)



1.5 Price Index

• price index of the base year = 100

price index of this year = 137

⇒ price level has risen by 37% during that time

• consumer price index (CPI) : consumer goods

• producer price index (PPI) : raw materials and capital

goods

• GDP deflator : all the final goods and services produced in

a country

meaning of price index

Numerical Example of Production and Price

1.5 Price Index

• we can calculate Consumer Price Index and GDP deflator for 2015 using this numerical example

units

sets

units

sets

Consumer Price Index

1.5 Price Index

•in deriving a price index, the choice of weights is a very important matter

•Consumer Price Index is derived by using the quantities of transaction in the base year(2010)

• Consumer Price Index of 2015 =2,000 × 50 + 400 × 20 + 800 × 150

2,000 × 30 + 400 × 15 + 800 × 120× 100 = 140.7

• price index derived by using the quantities of transaction in the base year is called a Laspeyres index


1.5 Price Index

• Consumer Price Index which has the characteristic of a Laspeyres index is

said to exaggerate the degree of a rise in price level to some degree

• how accurately a certain price index represents the actual changes in price

level is an important issue

- government usually adjusts the amount of pension benefits based on

consumer price index

- if CPI exaggerates the degree of a rise in price level, government should

pay more than necessary


1.5 Price Index

• why CPI may exaggerate the degree of a rise in price level?

1) CPI which uses fixed weights cannot take consumers’

responses to price changes into consideration

2) prices of certain commodities such as computers or TV sets fall

dramatically over time while their volume of transaction

increases fast

3) new products usually have better quality which means that

their prices are effectively lower

• economists believe that CPI exaggerates the degree of a rise in price

level by 1% in case of the U.S. economy

GDP Deflator

1.5 Price Index

• GDP deflator of a certain year can be derived by a ratio between nominal GDP and real GDP of that year

- GDP Deflator=𝑛𝑜𝑚𝑖𝑛𝑎𝑙 𝐺𝐷𝑃

𝑟𝑒𝑎𝑙 𝐺𝐷𝑃× 100

- GDP Deflator of 2015=𝟑,𝟎𝟎𝟎 × 𝟓𝟎 +𝟓𝟎𝟎 × 𝟐𝟎 +𝟏,𝟎𝟎𝟎 × 𝟏𝟓𝟎

𝟑,𝟎𝟎𝟎 × 𝟑𝟎 +𝟓𝟎𝟎 × 𝟏𝟓 +𝟏,𝟎𝟎𝟎 × 𝟏𝟐𝟎× 100 = 142.5

GDP Deflator

1.5 Price Index

• we can see that the volumes of transactions in 2015(current

year) are used as weights in case of GDP deflator → Paasche

index

• in contrast to the case of Laspeyres index where the same

weights are used for different years, different weights are

applied for different years in case of Paasche index

- prices of all the final goods and services produced

domestically are reflected

- but prices of imports are not reflected

Changes in Inflation Rates

1.5 Price Index


THANK YOU

E C O N O M I C S

introduction to economics · 2016-10-05 · 1.1 basic concepts of macroeconomics • the most...

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