The Expenditure Method

(Method of Measuring GDP)

• A method of measuring GDP
• Calculates GDP by adding up the value of expenditures on all final goods and services in the economy

• Makes up ~ 70% of GDP
• Includes durable and nondurable goods, and services

• Accounts for ~ 15% of GDP
• Includes Fixed Investment (Nonresidential such structures, equipment and software...or Residential)
• Change in private inventories

• Accounts for ~20% of GDP
• Includes Federal spending for national defense and nondefense
• Also, state and local spending

• About -5% of GDP in 2010
• Imports - Exports
• (negative value means more is imported than exported)

Value-Added Method

(Measuring GDP)

• Calculates GDP by adding up the value added at each stage of the production process

Income Method

(Measuring GDP)

• Calculates GDP by adding up the incomes generated at each stage in the production process

An estimate of what GDP would have been if all factors of production (ex: labor and capital) had been used at their 'normal' rates

Measure of a country's capacity to produce, not it's actual production

• The value of all goods and services measured at current prices
• 2009 GDP = pN09*QN09

• The value of all goods and services measured at a constant price level
• Using 2005 as a base year...
• 2009 Real GDP = P05N*Q09N

• Measure of the Price Level
• Ratio of Nominal GDP to Real GDP times 100
• =100 for the base year
• Measures the current level of prices relative to the level of prices in the base year

The Consumer Price Index

(CPI)

• Measures changes in the price of things that an average consumer buys
• The most closely watched indicator of what is happening to prices
• Release of a new CPI number can have a big impact on financial markets
• Calculated/Published by the Bureau of Labor Statistics (BLS)
• Released monthly in the middle of the month
• Uses - track changes in the typical household's cost of living, adjusts many contracts for inflation, allows comparisons of dollar amounts over time

How the BLS constructs the CPI

1. Survey consumers to determine composition of the typical consumer's "basket" of goods
2. Every month, collect prices of all items in basket; compute price of basket.
3. Choose a base year (currently an avg. of prices between 1982-1984)
4. Calculate CPI in a given month as follows:
   Cost of basket in that month/Cost of basket in that base period x 100

• ~42% = Housing
• ~17% = Transportation
• ~15% = Food&Beverage
• ~6% = Medical Care
• ~6% = Recreation
• ~3% = Education
• ~3% = Communication
• ~3% = Other Goods/Services

• CPI includes only goods typically bought by consumers while GDP deflator includes all goods
• CPI includes imported goods while GDP deflator only includes domestic goods
• CPI uses a fixed basket of goods while GDP deflator uses a changing basket of goods

• The CPI uses fixed weights, so it cannot reflect consumer's ability to substitute toward goods whose relative prices have fallen

Increase in Quality Bias

(Reason CPI overstates inflation)

• Some of the increase in the price of a product may reflect an increase in the product's quality, while the rest reflects true inflation. These two are hard to separate.

New Product Bias

(Reason CPI overstates inflation)

Outlet Bias

(Reasons CPI overstate inflation)

• Increasingly, consumers buy from discount or lower-price-on-line retailers. BLS primarily collects data from full-price retail stores, not taking into account lower-price outlets.

Distributional Effects

(The costs of inflation)

• Some worker's incomes will not keep up with inflation

"Shoeleather Costs"

(The cost of inflation)

• the resources wasted when inflation encourages people to reduce their money holdings
• includes the time and transaction costs of more frequent bank withdrawals

Menu Costs

(The Cost of Inflation)

• The cost of changing prices
• ex: printing new menus, mailing new catalogues, etc...

Confusion and Inconvenience

(The cost of inflation)

• Inflation changes the yardstick we use to measure transactions.
• Complicates long-range planning and the comparison of dollar amounts over time.

Tax Distortion

(The Cost of Inflation)

• Inflation makes nominal income grow faster than real income
• Taxes are based on nominal income, some are not adjusted for inflation
• So, inflation causes people to pay more taxes even when their real income hasn't increased

A Special Cost of Unexpected Inflation is the Arbitrary Redistribution of Wealth

• Higher-than-expected inflation transfers purchasing power from creditors to debtors: Debtors get to repay their debt with dollars that aren’t worth as much. 

• Lower-than-expected inflation transfers purchasing power from debtors to creditors. 
• High inflation is more variable and less predictable than low
  inflation. So, these arbitrary redistributions are frequent when inflation is high. 

i = r + pi

Nominal Interest Rate = Real Interest Rate + Inflation Rate

As Price Level (P) goes up, Inflation Rate (pi) goes up

Calculating what a past amount would be worth in a later year

Value in later year dollars

= (value in earlier year dollars)*(CPI_{later /}CPI_earlier)

• This happens when inflation is going down
• Prices are still increasing, just not as fast

• This is when prices are going down.

• Worked, even part time, in the last week.

• Did not work in the last week, but did look for a job in the past month.

• Percentage of labor force that is unemployed
• = (#Unemployed/#Labor Force) x 100%

• Did not work in the last week or actively search for a job in the past month
• Includes retirees, full time students..etc

• Constituted by Structural and Frictional Unemployment
• Normal Rate of unemployment around which the unemployment rate fluctuates

• Deviation of unemployment from its natural rate

• Percentage of adult population that is in the labor force
• = (labor force/adult population)x100%

• Above equilibrium wages paid by firms to increase worker productivity
• reduces worker turnover, and abseenteism
• increases productivity and attracts high-quality job applicants, motivates workers
• often leads to decrease in firm's cost...but efficiency wages can increase unemployment

• Training Programs = can reduce structural unemployment (ex: Trade Adjustment Assistance Program)
• Unemployment Compensation = tends to increase frictional unemployment as people will take longer to search for a job, reduces opportunity cost for unemployment (in US, its about half wage for about 6 months)
• Labor Market Policies = Legal restrictions on hours, vacations, retirements, and especially firing (especially restrictive in Europe)
• Minimum Wage Laws = Nationally is $7.25...Minimum wage laws force the wage to remain above equilibrium which causes the quantity of labor supplied to be greater than the quantity of labor demanded (especially affects teens)
• Labor Unions = bargain with employers over wages, benefits, working conditions (important in airlines, autos, steel, and telecom)...this can keep wages above equilibrium in unionized industries, leading to unemployment (but only 9% of private work force is unionized so little effect on national unemployment rate)

• Founder of Ford Motor Company
• introduced modern techniques of production and built cars on assembly lines (unskilled workers were taught to perform same simple tasks over and over again)
• increased daily wage to $5 in 1914 (twice going wage)...this was successful

• Change in Real GDP over time
• Growth Rate = annual percentage change in Real GDP (%ΔY)

• %Δ Y - %Δ Population
• Correlates most closely to changes in living standards

Growth Calculations

= ((GDP in later year-GDP in earlier year)/(GDP in earlier year)) x 100%

• Measures how many years it will take for the real GDP per capita to double
• Number of years to double = 70/Growth Rate

Productivity

• The quantity of goods and services that can be produced by 1 hour of work
• 'Person hour' = 1 worker working 1 hour
• Productivity = GDP/Person Hours
• = Y/L ... (Y= Real GDP (quantity of output produced)...L = Number of labor hours)
• •When a nation’s workers are very productive, real GDP is large and incomes are high. When productivity grows rapidly, so do living standards. 
• Productivity and growth rate are determined by capital and technological change.

Physical Capital

• is K
• The stock of equipment and structures used to produce g&s

Technology

Processes a firm uses to turn inputs into outputs

Technological Change

an increase in the quantity of output firms can produce with a given quantity of inputs

3 Sources of Technological Change

•Better machinery and equipment
ex) Computers, software, machine tools, electronics

Per Worker Production Function

The relationship between real GDP per hour worked and capital per hour worked, holding the level of technology constant.

•  If workers have little K, giving them more increases productivity a lot. If workers already have a lot of K, giving them more increases productivity little.
• Equal increases in capital per worker, lead to diminishing increases in output per hour worked (diminishing returns).
• Technological change causes the per-worker-production function to shift up.

New Growth Theory

A model of long-term economic growth that emphasizes that technological change is influenced by economic incentives and so is determined by the working of the market system.

Key to Economic Growth - accumulation of knowledge capital (which is subject to increasing returns)

3 Ways Government Policy Increases the Accumulation of Knowledge Capital

1. Subsidizing education
2. Subsidizing research and development
3. Protecting intellectual property with patents and copyrights
   Patent = The exclusive right to produce a product for a period of 20 years from the date the product is invented.

Convergence

Why Convergence Happens

  (1)  Technology transfer

  (2)  Poorer countries can attract more capital

 Low K stock → High MPK → High returns to investment → Higher domestic saving and higher investment by foreigners

Environmental Approach

(Approaches to Development)

• geography
• climate
• endemic disease
• inaccessibility of trade routes
• lack of natural resources
• policy implications

International Trade Approach

(Approaches to Development)

• 2 Dimensions of integration into world economy
  
  Trade in goods&services
  -import-substituting industrialization
  
  Capital Inflows
  -Financial Capital
  -FDI (Foreign Direct Investment)
• Against the critique of globalization

Institutional Approach

• Legal System
• Political System
• Monetary Stability
• Corruption

Microfinance

• Small lending to rural poor in developing countries
• 18th&19th Centuries: clubs to make small loans to members
• Early 20th Century: Bank of America

Criticisms of MicroFinance

• Doesn't reach the poorest of the poor
• diverts money from more important large-scale projects
• critics contend there is little evidence it serves to lift incomes in the long run