Lecture 5 Wth

8/2/2019 Lecture 5 Wth

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Macroeconomics

Until now

Microeconomics

Examine the functioning of individual industries and

the behavior of individual decision-making units, firms

and households.

Macroeconomics deals with the economy as a whole. It deals with aggregate behavior not individual decisions

as in microeconomics.

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Important Macroeconomics Variables

Three of the major concerns of macroeconomics are

Output growth

Unemployment

Inflation and deflation


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Unemployment

unemployment rate The percentage of the labor force that is

unemployed.

Labor Force = Number of employed + Number of unemployed

Unemployment Rate = (Number of unemployed/Labor Force)*100


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Inflation and Deflation

inflation An increase in the overall price level.

hyperinflation A period of very rapid increases in the overallprice level.

deflation A decrease in the overall price level.


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The Three Markets

Goods-and-Services Market

Firms supply to the goods-and-services market.Households, the government, and firms demand fromthis market.

Labor Market

In this market, households supply labor and firmsand the government demand labor.

Money Market

The money supply and demand determines thegeneral price level and the inflation.


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National Income Accounting

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Basic concept of national income accounting is the Gross

Domestic Product (GDP) (Gayri Safi Yurtici Hasila (GSYIH))

GDP is the total market value of all final goods and services

produced domestically within an economy in a given period

of time .


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Final goods and services refers to the goods and

services that are sold to the purchasers for final use.

Intermediate goods are the goods that are produced

by one firm for use in further processing by another firm.

In order to avoid double counting, we do not count

intermediate goods

The value of the final goods already reflect theprice of the intermediate goods contained in it.

Electricity


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Domestically refers to the production located within the

country.

In a given year means that the sale of goods producedin prior years, for example, used cars, are not included in

this years GDP.

Total market value refers to the quantity of goods multipliedby their respective prices. Using prices allows us to express the

value of everything in a common unit of measurement.

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Discussion Question:

Would the following transactions be counted as part of GDP?

a) A seafood restaurant buys 1000 TL worth of fish

b) You pay 175 TL to have your car repaired

c) A supermarket pays 2000 TL for computer maintenance to its computer provider

d) You buy your roommate's monitor for 120 TL

e) You make 20 TL shoveling snow for your neighbor

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Quantity Price Value

2 cars 15,000 30,000

3 computers 3,000 9,000

Gross domestic product 39,000


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Definitions and Derivations of GDP

GDP1: value of all final goods and services produced in an economyduring a given period (monthly, quarterly or monthly)

GDP2: sum of value added in an economy during a period.Value added by a firm: Sales- Payments for the intermediate goods (Value of production for firm- value of intermediate goods)

GDP3: sum of incomes in an economy during a period


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Example : 2 Firms producing milk & smoothie

Firm A: Milk Production in 2010

Revenue from Sales 120,000 TLExpenses 75,000TL

Wages 75,000 TLProfit 45,000TL

Firm B: Smoothie Production in 2010

Revenue from Sales 200,000TLExpenses 155,000 TL

Wages 35,000 TLMilk Purchases 120,000 TL

Profits 45,000TL


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Value Added (Katma Deger)

Value Added is the total income generated in the production of

a good

V = TR - Total Intermediate Input Costs

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p q

Income of workers Income of the capitalist

Total wages + Total gross profit

Total gross profit= Profit Interest + Rent

Total wages Profit Interest + Rent

I R

V W I R


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GDP in terms of value added

GDP = Total value of all final goods and services

= Total value added by all sectors

=

Example

Suppose that there are 3 goods produced in the economy.

x, y and z

Suppose that the current (market) prices of x, y and z are

as follows: Px=1, Py=4 and Pz=2

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W + + I + R


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Input requirements of these goods are as follows:

1 unit of x = 1 unit of Labor

1 unit of y = 2 units of Labor + 0.5 units of x+ 1 unit of z

1 unit of z = 1 unit of Labor + 1 unit of x

Suppose that, in the economy, the total productions are

x=13, y=6 and z=10 units

Net output is the amount of a good that is available for final use.

It is the amount of the good that is not used as an intermediate

good.

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What are the net outputs of x, y, and z?

Net output of x = 0

13 units of x are produced, 13 units of x are used up in

the production of y and z. Hence, 13 units of x is usedup as intermediate goods.

Net output of y = 6 units

6 units of y are produced.

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Net output of z = 4 units10 units of z are produced. 6 units is used in the production

of y, that is, 6 units of z are used as intermediate good.

What is the total value of final goods (GDP)?

GDP =Total value of final goods

= [Py x 6 ] + [Pz x 4] = 32

What is the value added for these three industries?

V i= TR - Total Intermediate Input Costs,

where i indicates the industry

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32

13 0 1 13 13

6 3 6

4 6 1 3 2 6 9

10 10 2 10 1 10 10

x y z

x X

y y X z

z z X

V V V GDP

V p

V p p p

V p p


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Expenditure Approach of GDP

Now, we will discuss the expenditure approach in calculating GDP.

The amount spent on all final goods and services during a

given period should be equal to the GDP

Total Income (GDP) = Total Expenditure

There are four main categories of expenditure:

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1) Consumption Expenditures

i) Private (Personal) Consumption (C): Expenditures on all goods

and services by resident households in an economy.

All expenditures on

Food, drink, clothing, cinema tickets, restaurant meals,

electricity, water, telephone bills, and etc

The largest part of GDP consists of C

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ii) Government Consumption (C g): Expenditures by the governmentfor final goods and services

Expenditures on office supplies, road maintenance,

salaries of all government employees,.

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2) Investment Expenditures (I)

i) Net Investment: All expenditures on newly produced capital

goods by profit-making organizations and the government

Second-hand machine is not net investmentSometimes it is difficult to make the distinction between

what is considered investment and what is considered

consumption

Expenditures by firms for items that last more than a year are counted as investment. Expenditures for

items that last less than a year are seen as purchases

of intermediate goods.24


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ii) Depreciation Expenditure:All expenditures to maintain the

capital stock of the economy

Repairs of the machines, replacing some parts, ..

Indicates no additions to the capital stock but represents

expenditures on the capital stock

iii) Gross investment: Total expenditures in capital by profit-making

organizations and the government.

Gross Investment=Net Investment+ Depreciation

I Gross Investment of profit-making organizations

I g Gross Investment of the government25


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3) Exports Expenditure (X)

Total expenditures of nonresidents on domestically produced

goods and services

Hence,

Total use of goods and services= C + I + G(C g + I g) + X

Total Sources: GDP+M (Import)

Total Use= Total SourcesC + I + G + X= GDP + M

GDP = C + I + G + (X-M)

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all expenditures by residents net exports (trade balance)

Aggregate expenditure (AE)

( - )

GDP C I G X M

GDP AE


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( - ) X M GDP C I G Trade Balance

measures the amount by which the domestic source of goods

and services exceeds total uses of resources by domestic sectors.

If C+I+G>GDP, X


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Basic Concepts Related with GDP

So far, we considered nominal GDP, GDP in current prices.

GDP will increase when prices increase, even if the physical

quantities of the goods produced remain the same.

A measure of total output that does not increase just because

prices increase is called real GDP .

Real GDP takes into account price changes by using the same

prices for both years.29


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Quantity Produced Price Real GDP

Year Cars Computers Cars Computers

2004 4 1 10,000 5,000 45,000

2005 5 3 10,000 5,000 65,000

Quantity Produced Price NominalGDPYear Cars Computers Cars Computers

2004 4 1 10,000 5,000 45,0002005 5 3 12,000 5,000 75,000


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We can calculate the growth of real GDP for this economy:

(65,000 - 45,000)/45,000 = .444, or 44.4%

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Quantity Produced Price Real GDP

Year Cars Computers Cars Computers

2004 4 1 10,000 5,000 45,0002005 5 3 10,000 5,000 65,000

Calculating the Growth of Real GDP


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Price Level Changes

Two different indexes to measure price level changes

GDP Deflator

GDP Deflator = (Nominal GDP/ Real GDP)*100

Nominal GDP in 2005 = P 2005*Q2005Real GDP in 2005 = P 2004*Q2005GDP Deflator =P 2005 /P2004

CPIA price index computed each month by the StateInstitute of Statistics in Turkey using a bundle that ismeant to represent the market basket purchasedmonthly by the typical urban consumer.


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Calculation of CPI in 2004, Assume that the consumption basketincludes 5 basket of apples & 2 oranges a month where 2002 is thebase year.

GDP Deflator and CPI are ratios of price levels. What is the

difference?GDP deflator reflects the prices of all goods and servicesproduced domestically, while CPI concerns all products.


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Gross National Product (GNP)(Gayri Safi Milli HASILA)

GDP is the sum of all incomes of residents of an economy

as a result of domestic activities.

In an open economy,

there will be residents earning income as a result of

providing services to nonresidents.

Consider a Turkish construction firm

undertake construction in Russiaowners earn profits and their workers receive wages

these profits and wages are called as factor income

not included in GDP


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We define Net Factor Incomes from Abroad (NFI)

NFI = Factor income from abroad by residents

- Factor Income paid to nonresidents

The major positive item of NFI in Turkey is the income of

workers especially in Germany.


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Given the NFI , the total income earned by citizens of

a country is GNP,

GNP= GDP+NFI

Sum of domestically earned income and net

factor incomes from abroad


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Example:

Consider Honda factory that is operated in United

States.

Honda corporation is a Japanese firm

The wage of US workers will be counted in US GDP

The profit of the company will be counted in Japanese

GNP, not in Japanese GDP

Because the profit is not earned in Japan.


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Disposable Income and Saving

Disposable Income is the income that is available to the

whole economy for spending on final goods and services.

Disposable Income ( Y ) = GNP + Net Transfers

Net Transfers:

Net Transfers = Transfers Received Transfer Payments

(Aid received by Turkey) (Aid sent by Turkey)


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Disposable income ( Y ) can either be consumed or saved,

Y = Consumption + Saving

Distinguishing savings and consumptions between government

(Sg and Cg) and private (S and C), we have:

Y = C +Cg +S + Sg

We can also divide the Total Disposable Income (Y) as Public

Disposable Income (T) and Private Disposable Income (Yd):Y = Yd + T


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Aggregate Expenditure and Equilibrium Output

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A Basic Model

Closed economy

no transactions between residents and non-residents

No government

no taxes or public expenditures


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Due to the closed form

GDP=GNP=Y

Net Factor Income = 0

Net Transfers = 0

Due to the absence of the government

AE = C + I

G= 0, X-M=0

T=0,Y=Y d

Y= Yd = C + S

So, income not spent on consumption is spent on saving.


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Consumption Function

C=C(Y)=C 0+cY

Consumption depends on the level of income ( Y )

C 0 is called as autonomous consumption , which showsthe minimum amount of consumption

c, the slope term of the consumption function, is called as

marginal propensity to consume (MPC) ,

c=MPC=C/ Y Obviously, c is always positive and less than 1.


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Example

The aggregate consumption function is C = 100 + 0.75 Y

At a national income of zero, consumption is $100.

For every $100 increase in income ( Y ), consumption rises by $75.


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Saving Function

As we know, S =Y C, so

S(Y)=Y - C(Y)

S(Y)=Y (C 0+cY)S(Y)= C 0 +(1-c)Y = C 0 +sY , s=1-c

C 0 = autonomous saving

If your income is too low to meet basic needs, thenyou need to use your previous savings.

s is called as marginal propensity to save(MPS) ,

s=MPS=S/ Y


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Since s=1-c,

MPC+MPS=1

For example, if MPC = 0.6, then 60 cents of each additional

dollar are consumed and 40 cents (MPS = .4) are saved.

Derivation of the aggregate saving function


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C = 100 + 0.75 Y, S=Y-C

AGGREGATEAGGREGATEINCOME,INCOME, Y Y

AGGREGATEAGGREGATECONSUMPTION,CONSUMPTION, C C

AGGREGATEAGGREGATESAVING,SAVING, S S

00 100100 --100100

8080 160160 --8080

100100 175175 --7575

200200 250250 --5050

400400 400400 00

400400 550550 5050

800800 700700 100100

1,0001,000 850850 150150


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Given these, we can define desired aggregate expenditure,

AE(Y) is

I 0 is the desired or planned investment refers to the additions to

capital stock that are planned by firms.

0 0 0planned Investment

( ) ( ) AE Y C Y I C I cY


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Throughout this chapter, we will assume that plannedinvestment is fixed. It does not change when income changes.

When a variable, such as planned investment, is assumed

not to depend on the state of the economy, it is said to be an

autonomous variable .


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Graphical analysis for the desired (planned) AE

Planned AE is found by adding consumption spending ( C )

to planned investment spending ( I ) at every level of income.


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Determination of Equilibrium

The economy is in equilibrium when

Aggregate Income (output) (Y)= Planned AE

Given that AE = C + I 0 , the equilibrium condition

Y =AE

Y= C + I 0

So, the economy is out of equilibrium

Y > AE

Y < AE


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Y > C + I 0

Aggregate output > planned aggregate expenditureAggregate output > planned aggregate expenditure

Unsold output will go to the stocks of the firmsUnsold output will go to the stocks of the firms

Actual investment is greater than planned investment.Actual investment is greater than planned investment.

Y < C + I 0

Aggregate output < planned aggregate expenditureAggregate output < planned aggregate expenditure

Some part of the stocks of firms will be soldSome part of the stocks of firms will be sold

There occurs unplanned disinvestmentThere occurs unplanned disinvestment

Actual investment is less than planned investment.Actual investment is less than planned investment.


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Lets see these concepts on a schedule.

C=100+0.75Y, I 0 =25

(1)(1) (2)(2) (3)(3) (4)(4) (5)(5) (6)(6)

AGGREGATEAGGREGATEOUTPUTOUTPUT

(INCOME) ((INCOME) ( Y Y ))AGGREGATEAGGREGATE

CONSUMPTION (CONSUMPTION ( C C ))PLANNEDPLANNED

INVESTMENTINVESTMENT

PLANNEDPLANNEDAGGREGATEAGGREGATE

EXPENDITURE (EXPENDITURE ( AE AE ))C C ++ I I

UNPLANNEDUNPLANNEDINVENTORYINVENTORY

CHANGECHANGEY Y ((C C ++ I I ))

EQUILIBRIUM?EQUILIBRIUM?((Y Y == AE AE ?)?)

100100 175175 2525 200200 100100 NoNo

200200 250250 2525 275275 7575 NoNo

400400 400400 2525 425425 2525 NoNo

500500 475475 2525 500500 00 YesYes

600600 550550 2525 575575 + 25+ 25 NoNo

800800 700700 2525 725725 + 75+ 75 NoNo

1,0001,000 850850 2525 875875 + 125+ 125 NoNo


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Saving/ Investment Approach to Equilibrium

Given that AE = C + I 0 and Y = C +S

At the equilibrium S(Y)= C 0 +sY = I 0


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The Multiplier

The multiplier of autonomous investment describes the

impact of an increase in planned investment on equilibrium

income.

An increase in planned investment causes output (income)

to go up.

People earn more income, consume some of it, and save the

rest.


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How do we find the multiplier?

We know that the marginal propensity to save is

For equilibrium, S= I

The multiplier is equal to

S MPS

Y

1

I MPS

Y

Y I MPS

1 11

Y I MPS MPC


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Example:

C=10+0.8Y

I 0=30

Given these information

AE= 10+0.8Y+30=40+0.8Y

For the equilibrium AE=Y

40+0.8Y=YY*=200

Or, S= I 0

S=-10+0.2Y = I 0

-10+0.2Y =30 Y*=200

MPS=0.2, Multiplier= 1/MPS=5


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Suppose that I 1=40

I=40 -30=10

Y*= Multiplier. I =5.10=50

So, the new equilibrium income is 200+50=250

Lecture 5 Wth

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