Ppt notes for studying introduction of macroeconomics PDF

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The notes for each chapter of the introduction of macroeconomics by Mankwi...

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Chapter 23. Measuring a Nation’s Income

(0) It would be helpful to have your students bring their calculators to class for this chapter so they can practice calculating real and nominal GDP and so forth. This is the first purely macro chapter in the textbook. It covers the definition of GDP, the spending components of GDP, real vs. nominal GDP, the GDP deflator, and why GDP is a useful but not perfect measure of a nation’s well-being.

(2) This is the first strictly macro chapter of the textbook, so it’s worth spending a moment emphasizing the difference between microeconomics and macroeconomics. Examples of questions that microeconomics seeks to answer: •

How do consumers decide how much of each good to buy?

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How do firms decide how much output to produce and what price to charge?

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What determines the price and quantity of individual goods and services?

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How do taxes on specific goods and services affect the allocation of resources?

Examples of questions that macroeconomics seeks to answer: •

How do consumers decide how to divide their income between spending and saving?

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What determines the total amount of employment and unemployment?

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What determines the overall level of prices and the rate of inflation?

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Why does the economy go through cycles, where things are great for a few years (like the late ’90s) and then lousy for a year or two (like 2001-2002)?

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When unemployment is high, what can the government do to help?

(3) 1. The text in the first bullet point is NOT the formal textbook definition of GDP. The formal definition is given and discussed in detail immediately after the Circular-Flow Diagram. 2. “g&s” = goods and services A good way to judge how well someone is doing economically is to look at his or her income. We can judge how well a country is doing economically by looking at the total income that everyone in the economy is earning. GDP is our measure of the economy’s total income, often called “national income.” GDP also measures total expenditure on the goods and services produced in the economy, and the value of the economy’s output (production) of goods and services. Thus, GDP is also referred to as “output.” The equality of income and expenditure is an accounting identity (not, for example, an equilibrium condition): it must be true that income equals expenditure.

(6) In this diagram, the green arrows represent flows of income/payments. The red arrows represent flows of goods & services (including services of the factors of production in the lower half of the diagram). To keep the graph simple, we have omitted the government, financial system, and foreign sector, as discussed on the next slide. Changing the animation on this slide: If you wish, you can easily change the order in which the markets and arrows appear. From the “Slide Show” drop-down menu, choose “Custom Animation…” Then, a box will appear (maybe along the right-hand-side of your PowerPoint window) that allows you to modify the order in which things appear (as well as other aspects of the animation). For further information, open PowerPoint help and search on “change the sequence of animations.”

(8) This slide and the five that follow focus on the meaning of each part of this critically important definition. Note that transactions occurring in the so-called “underground economy” are also omitted from the official measure of GDP. In the textbook, near the end of this chapter, an “In the News” box contains an excellent article on the underground economy.

(15) Mostly, the term “consumption” refers to what students probably already think of as total consumer spending. The note about the treatment of owner-occupied housing is an exception, and some of the test bank questions are designed to see if students remember this exception.

(16) More on the treatment of owner-occupied housing: In the national income and product accounts, a house is considered a piece of capital that is used to produce a flow of services – housing services. When a consumer (as a tenant) rents a house or apartment, the consumer is buying housing services. These services are considered consumption, so the price paid for these services – rent – is counted in the “consumption” component of GDP . When someone buys a new house to live in, she is both a producer and a consumer. As a producer, she has made an investment (the purchase of the house) that will produce a service. She is also the consumer of this service, which is valued at the market rental rate for that type of house. So, the accounting conventions treat this situation as if the person is her own landlord and rents the house to/from herself. When students begin to understand this, they may wonder why certain other goods (like cars) that produce a flow of consumer services are not also treated this way. There really is no good answer. It’s just a convention of the national income and product accounts.

(17) You might tell your students that transfer payments, like Social Security checks, are excluded from G to avoid double-counting: retired persons spend part or all of their Social Security benefits on food, rent, prescriptions, and so forth, all of which count in

consumption. If we also counted the Social Security check as part of G, then the same money would be counted twice, which would make GDP look bigger than it really is.

(18) The “net” in “net exports” refers to the fact that we are subtracting imports from exports. This subtraction is important, because imports are also counted in the other components of GDP; failing to subtract them would cause GDP to measure not just the value of goods produced domestically, but also goods produced abroad and imported.

(22) Regarding part C: Jane’s purchase causes investment (for her own business) to increase by $1200. However, the computer is sold out of inventory, so inventory investment falls by $1200. The two transactions cancel each other, leaving aggregate investment and GDP unchanged. Regarding part D: This problem illustrates why expenditure always equals output, even when firms don’t sell everything they produce due to lackluster demand. The point here is that unsold output is counted in inventory investment, even when that “investment” was unintentional.

(24) In this example, nominal GDP grows for two reasons: prices are rising, and the economy is producing a larger quantity of goods. Thinking of nominal GDP as total income, the increases in income will overstate the increases in society’s well-being because part of these increases are due to inflation. We need a way to take out the effects of inflation, to see how much people’s incomes are growing in purchasing power terms. That is the job of real GDP.

(28) The graph shows that nominal GDP rises faster than real GDP. This should make sense, because growth in nominal GDP is driven by growth in output AND by inflation. Growth in real GDP is driven only by growth in output. The two lines cross in the year 2000 (the base year for the real GDP data in this graph). This should make sense because real GDP equals nominal GDP in the base year. (Better yet, ask your students whether there’s anything significant about the point where the two lines cross.) Before the base year, real GDP > nominal GDP. For example, in 1970, nominal GDP is about $1 trillion, while real GDP is about $3.8 trillion (in 2000 dollars). This should make sense because prices were so much higher in 2000 than in 1970, so using those high 2000 prices to value 1970 output would lead to a bigger result than valuing 1970 output using 1970 prices. Similarly, after 2000, nominal GDP is higher than real GDP because prices are higher in later years than they were in 2000.

(36) Much of what Robert Kennedy said about GDP is correct.

(37) Because a large GDP does in fact help us to lead a good life. GDP does not measure the health of our children, but nations with larger GDP can afford better health care for their children. GDP does not measure the beauty of our poetry, but nations with larger GDP can afford to teach more of their citizens to read and enjoy poetry. GDP does not take account of our intelligence, integrity, courage, wisdom, or devotion to country, but all of these laudable attributes are easier to foster when people are less concerned about being able to afford the material necessities of life. In short, GDP does not directly measure those things that make life worthwhile, but it does measure our ability to obtain the inputs into a worthwhile life.

Chapter 24. Measuring the Cost of Living

(6) Part A is not difficult but requires an intermediate step: students must compute the cost of the basket in 2005 to find the CPI in 2005. Part B has two intermediate steps: computing the cost of the basket in 2006, then computing the CPI in 2006.

(10) Students understand substitution bias better if they work a concrete example like the one on this slide. Before displaying the questions (A + B), you might want to ask your class why households bought different quantities of beef and chicken in 2006 than they did in 2005. Or if that seems too easy, just mention before displaying questions A and B that households are responding to the change in relative prices: beef has become a lot more expensive relative to chicken, so households buy less beef and more chicken.

(16) In the 1990s, it was estimated that the CPI’s bias cost taxpayers $1 trillion every 12 years in unnecessary COLAs in Social Security and government pension payments!!!

(19) To make this exercise more challenging, move the preceding slide so that it appears immediately after the answers to this exercise. If you are outside the U.S., please make the following changes: •

In (b), change the example to “A local manufacturer raises the price on industrial tractors it produces.”

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In (c), change “U.S.” to your country’s name, unless your country is Italy. In that case, change the example to something involving an imported consumer good.

(20) Explanations: A. Frappuccinos are produced in the U.S., so their prices are part of the GDP deflator. They are purchased by consumers, so their prices are part of the CPI. Hence, an increase in the price of Frappuccinos causes both the CPI and GDP deflator to increase. B. Since the tractors are produced here in the U.S., the price increase causes the GDP deflator to rise. However, industrial tractors are a capital good, not a consumer good, so the CPI is unaffected. C. Italian jeans appear in the U.S. consumer’s shopping basket, and hence the increase in their price causes the CPI to rise. However, the GDP deflator is unchanged because it only includes prices of domestically produced goods and excludes the prices of imports.

(26) If prices were as high in 1986 as they were in 2006, then tuition & fees in 1986 would have been $2,629, less than half as much as actual tuition & fees in 2006! Tuition and fees have risen much faster than the overall cost of living.

(30) Notice that the nominal and real interest rates often do not move together, indicating that the real interest rate varies over time.

Chapter 25. Production and Growth

(5) GDP per capita is in PPP$. “Growth rate” is the average annual growth rate of real GDP per capita (local currency), computed as … {ln(2005 value)-ln(1960 value)}/45 Exceptions: The growth rates shown for Canada and Saudi Arabia were computed over 1965-2005 and 1968-2005, respectively, due to missing early years of real GDP data in the World Development Indicators. This table is similar to Table 1 in the textbook. There are two differences. First, the set of countries is slightly different. I have excluded Mexico and the U.K. because they (and data on their GDP per capita) were featured in the photos. I have excluded Germany because unification there makes earlier data not comparable with recent data, and thus complicates the calculation of the growth rate. Other countries from Table 1 excluded here are Brazil, Indonesia, Pakistan, and Bangladesh. The table on this slide includes the following countries, which do not appear in Table 1: Singapore, Spain (I wanted at least one country from Europe), Israel (it’s in the news often), Saudi Arabia (I wanted at least one OPEC country), Colombia (they make good coffee there, plus I wanted a couple countries from S. America), New Zealand (Oceania’s representative here), the Philippines, Rwanda and Haiti (representative poor countries, different from Table 1 just for variety). Second, growth rates here are computed over 1960-2005 (except Canada and S. Arabia, as noted above). The purpose of this table (and of Table 1 in the text) is to convey the following two facts: 1) There are great differences in the standard of living across countries. 2) There are great differences in the growth rates across countries. A corollary is that the rankings of countries can change over time: Countries at the bottom need not remain there – witness Japan and China, both of whom were far poorer in 1960.

(11) It is common to refer to physical capital as just “capital,” hence the brackets around “physical.” Here, though, the distinction is important, because the following slide discusses human capital. The last bullet point on this slide dovetails into the FYI box on the production function (which, in this PowerPoint presentation, follows the determinants of productivity). If you are not covering that material, you can delete the last bullet point.

(14) This definition of technology is more broad than what most people think of as technology. To most people, improvements in technology mean a smaller cell phone, a faster computer, a higher-definition television set, an MP3 player that can hold more songs, and so forth. But “technology” doesn’t just mean computer-related stuff. Technology refers to the knowledge that allows producers to transform inputs into output.

Here’s an important example of technological progress that doesn’t involve computers at all: Henry Ford discovered that he could boost productivity in his auto factory simply by rearranging the workers and machines, and reassigning the workers’ tasks.

(15) You might also add that technological knowledge can easily be shared among infinitely many producers. Human capital is generally tied to the individuals that expend the effort to acquire it. For example, if someone discovers a more cost-effective way to manufacture cars, this knowledge can be shared with all auto manufacturers, causing a general increase in productivity in the auto sector. If someone acquires some skills or experience that enable him or her to do his or her job better, then his productivity rises, but not that of all persons in his occupation.

(16) Students may wonder why the technology variable (A) is multiplying the F( ) function rather than inside it. For now, tell them only inputs go inside the F( ) function. Ask them to wait until you show them the following slide, where it may be easier to see why we treat “A” differently than the other determinants of productivity.

(18) Why “1” is inside the production function: Students may wonder what the number “1” is doing inside the F( ) function. On the preceding slide, the aggregate production function was written as Y = A F(L, K, H, N). We multiplied all of the inputs by 1/L, and because of constant returns to scale, output is also multiplied by 1/L: Y/L = A F(L/L, K/L, H/L, N/L) The first term in the F( ) function is L/L, which just equals 1. Read literally, this equation says that output per worker depends on technology, the number of workers per worker, the amount of physical and human capital per worker, and natural resources per worker. But the number of workers per worker is always 1. Why “A” is outside the production function: What matters for productivity is not “technical knowledge per worker” but simply “technological knowledge.” Unlike physical capital or other resources, technological knowledge can be freely shared among all workers. If the number of workers increases, you must purchase new capital for the new workers (or spread the existing capital more thinly), but technological knowledge can be freely shared with the new workers.

(21) Remember one of the 10 principles: people face tradeoffs. The tradeoff between current and future consumption is a good example of one.

(23) This slide replicates Figure 1 from the text, which illustrates the relationship between productivity (output per worker) and one of its determinants: capital per worker. The curve is drawn for given values of the other determinants of productivity (human capital per worker, natural resources per worker, technology). A change in any of these

other determinants would shift the curve. The graph is positively sloped: productivity is higher when the average worker has more capital. The graph is curved, reflecting diminishing returns to capital: as the average worker gets more and more capital, productivity rises at a decreasing rate. Students may find it easier to understand the following statement (especially if this is their first course in economics): If workers don’t have very much capital, giving them more will increase their productivity a lot. If workers already have a lot of capital, giving them more won’t increase their productivity very much.

(24) Notice that K/L increases by the same amount in both countries. But thanks to diminishing returns, the increase in K/L has a bigger effect in the poor country than in the rich country. As a result, the poor country enjoys a higher growth rate than the rich country, and the gap between them shrinks over time. In the literature, this is known as “convergence.” In this principles-level book, it is called the “catch-up effect.” In order for the catch-up effect to work, it must be true that both countries have the same technology and hence production function. If the poor country has inferior technology, its production function will be lower; then, it won’t necessarily grow faster than the rich one, and the gap won’t necessarily shrink over time.

(28) Brazil has implemented a policy which gives families cash payments if their children attend school faithfully. Other developing countries have similar policies, which experts predict will raise productivity and living standards in the long run. This is from an “In The News” box entitled “Promoting Human Capital” appearing in this chapter.

(29) You might want to point out that the positive correlations between living standards and education or health & nutrition could result from causality in either direction: Investing in human capital – either through education or improving health & nutrition – can indeed lead to higher incomes in the long run. But it is equally true that countries with higher incomes can afford to devote more resources to schooling or improving health & nutrition.

(42) Students may name other policies, such as: (1) promote free trade or pursue outward-oriented trade policies (2) crack down on corruption or otherwise protect and enforce property rights Based on the discussion in this chapter, it may not be obvious which of the determinants of productivity these policies affect. One could make the case that (1) and (2) affect “A” (boosting economic efficiency) and that (2) also affects K/L....