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Measuring Economic Activity: Understanding GDP and Its Variations, Appunti di Macroeconomia

Università Cattolica del Sacro Cuore - Milano (UNICATT MI)Macroeconomia

An introduction to measuring economic activity through the concept of Gross Domestic Product (GDP). It discusses how GDP is calculated, its variations such as Net Domestic Product (NDP) and Gross National Product (GNP), and the relationship between demand and supply in determining market equilibrium. The document also covers the concept of unwanted inventories and their impact on the economy.

Tipologia: Appunti

2020/2021

Caricato il 13/05/2022

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INTRODUCTORY MACROECONOMICS
LESSON 1 - 21/09/2021
An introduction to Macroeconomics
Microeconomics (how individuals/firms make decision) Macroeconomics
Macroeconomics focuses on aggregate variables by looking at the broad picture of the economy.
So, for example, it’s about the overall production in the economy, the aggregate consumption, the
total investments, the exchange rates and the average level of prices.*
The 2 important steps are:
1. How do we measure level of aggregate levels of economic activity;
2. How this level of aggregate economic activity changes overtime, in fact these changes in the
level of economic activity are important for economists, because if it increases, it means the
economic is growing whereas if it decreases it means the economy is shrinking.
Examples of recent fluctuations in the level of economic activity:
the huge crisis induced by Covid 19 that caused a severe shrinking of the level of economic
activity*
The 2008 crisis, which we imported from the US related to a failure in the financial system
In 2011 the European crisis, called “public debt crisis”.
We are interested not only in production but
also for example potential increasing
inflation (= change in the overall level of
prices). At the moment inflation is very low
due to several reasons including the
adoption of the Euro currency.*
There have been periods of high inflation
and while low inflation has been observed
throughout the last decade.
This graph shows the percent changes in
prices- inflation= (Pt-Pt-1)/Pt
An introduction to National Accounting
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INTRODUCTORY MACROECONOMICS

LESSON 1 - 21/09/

An introduction to Macroeconomics Microeconomics (how individuals/firms make decision)  Macroeconomics Macroeconomics focuses on aggregate variables by looking at the broad picture of the economy. So, for example, it’s about the overall production in the economy, the aggregate consumption, the total investments, the exchange rates and the average level of prices. The 2 important steps are:

  1. How do we measure level of aggregate levels of economic activity;
  2. How this level of aggregate economic activity changes overtime, in fact these changes in the level of economic activity are important for economists, because if it increases, it means the economic is growing whereas if it decreases it means the economy is shrinking. Examples of recent fluctuations in the level of economic activity:  the huge crisis induced by Covid 19 that caused a severe shrinking of the level of economic activity  The 2008 crisis, which we imported from the US related to a failure in the financial system  In 2011 the European crisis, called “public debt crisis”. We are interested not only in production but also for example potential increasing inflation (= change in the overall level of prices). At the moment inflation is very low due to several reasons including the adoption of the Euro currency. There have been periods of high inflation and while low inflation has been observed throughout the last decade. This graph shows the percent changes in prices- inflation= (Pt-Pt-1)/Pt An introduction to National Accounting

GDP (Gross Domestic Product) The GDP is used as a synthetic measure of the overall production and income generated in an economy. This concept will be introduced by means of a simple example, which we will use to illustrate the different definitions of GDP. Example of a simple economy which produces only cars

  1. The mining sector produces iron for 10€ and coal for 6€. One monetary unit of coal is used to light the mines. So, 10€ of iron and the remaining 5€ of coal are sold to the steel industry. The steel maker takes the 15€ of inputs (10€ of iron and 5€ of coal) and transform them in 25€ of steel;
  2. The agricultural sector produces 5€ of rubber, which are sold to the chemical industry which transforms the 5€ of rubber into 15€ of tires, linings, …
  3. The car maker takes 25€ of steel and 15€ of tires and produces 10 cars worth 70€ and he sells them to the car dealers. Finally, the car dealers sell 10 cars to the final consumer for 100€. How do we evaluate the overall product (GDP) that has been generated in this economy? The GDP is the value of all the goods (and the services) that are going to the final consumers that are produced within a given country in a given period of time (we calculate for example the GDP of Italy in a specific year). The final objective of an economic system consists in fact in satisfying the needs of final consumers. In our example the GDP is 100€ (the final value of the car). But where do they come from? We must investigate the national accounting to understand how this value has been generated.  MINING SECTOR 15€  STEEL INDUSTRY 10€ (25-15)  AGRICULTURAL SECTOR 5€  CHEMICAL INDUSTRY 10€ (15-5)  CAR MAKER 30€ (70-25-15)  CAR DEALERS 30€ (100-70) = 100€ The sum of all the added values is 100 €. The sum of all the added values for each stage of the production is equal to the GDP. The added value is the increase in the level of production in each stage of the production with respect to what you had in the previous stage. BUT where does the added value of 15€ of the mining sector go? They constitute the incomes that are distributed among those who are operating in the sector, in form of wages of miners, entrepreneurs’ renumerations, managers… In the event such incomes are lower than the value added, the firm would obtain an extra-profit, which can be considered as an income for the firm’s owners.  The valued added in each stage of production is equal to the value of all the incomes distributed in that production stage GDP = VA (in each stage) = GROSS INCOME

The “Net Domestic Product” (NDP) considers as part of “final goods” only the value of investments that exceed the share needed to replenish depreciated capital.

NDP=GDP-share of investment accounting for depreciated capital.

(We are not going to cover how to calculate the share of investment accounting for depreciated capital) Gross National Product (GNP) The GNP is obtained by adding to a country GDP the net incomes of the citizens of that country that live abroad and by subtracting the incomes produced in that country by foreign citizens. Ex: USA case

  • The USA are characterized by substantial immigration flows,
  • USA firms own several foreign companies, have foreign branches, etc.,
  • USA is a highly indebted country, held by foreign citizens  We can think that there will be a “substantial” difference between GDP and GNP But, overall, the different effects balance, at least partially, as shown in the data, so it’s more convenient to use only GDP as statistics. GDP at Factor costs

Among the many activities of the State, one has to include also taxes, subsidies, and different incentives to (at least some) industrial sectors. To sterilize GDP from the effects induced by taxes and subsidies, economists often refer to the notion of “GDP at factor costs”, which is given by:

GDP (at market prices) – Indirect Taxes + Transfers to firms

The underlying intuition is that the GDP at factors costs measures the incomes (such as wages, profits, etc.) that are actually distributed in the economic system. Nominal and Real GDP The nominal GDP is the GDP evaluated at current prices (of the current year). In an economy where there are n final goods, the nominal value of GDP in year t is given by the sum of the current values (prices times quantities) of all transactions referring to the n final goods. The real GDP , or GDP at constant prices (of a given base year), is obtained by multiplying for each final good the quantity in the current year (t) times the price in the base year (0) and summing up the values obtained in this way. Assume, for example, that a country produces two goods: fish – f – and chips – c. In 2000 the corresponding quantities are: f00=10, c00=20, with prices pf00=2, pc00=1.5.  The nominal GDP in the year 2000 is: f00 x pf00 + c00 x pc00 = 50. Assume now that the quantities of the two goods in 2010 are: f10=10, c10=30, with prices pf10=2, pc10=3.  The nominal GDP in the year 2010 is: f10 x pf10 + c10 x pc10 = 110.  The real GDP in 2010 at 2000 prices is given by: f10 x pf00 +c10 x pc00 = 10 x 2 + 30 x 1. = 65. We conclude that the real increase in GDP across the decade (at 2000 prices) has been (65-50)/50= 30%.  The real GDP in the year 2000 at 2010 prices is equal to 80. (10 x 2 + 20 x 3) Using this, it is immediate to conclude that the real increase in GDP at 2010 prices is given by (110-80)/80=37.5% (ALWAYS SUBTRACTING FINAL GDP- ORIGINAL GDP) These 2 increases in GDP are different, such an example shows also as index numbers – in this case concerning quantities – are always characterized by some degrees of arbitrariness. Price indexes

In order to understand how the market equilibrium is determined  DEMAND and SUPPLY MODEL Both the demand and supply are functions of price, in fact:

  • Supply is increasing in prices (positive slope)
  • Demand is decreasing in prices (negative slope) Because the price of a good reflects the renumeration of the factors of production, so if the factors of production get renumerated more, the firms will produce more in order to take advantage of this larger renumeration (A higher price induces larger production, given a higher renumeration of production factors). In the standard case, demand and supply jointly determine the market equilibrium, demand and supply determine market equilibrium. The short run In the first part of the course, we focus on an economic system in which prices are assumed to be (mostly) fixed. As we will note, this assumption implies that demand – alone – determines produced quantity. The fix-price assumption is not always an innocuous one: it may seem to go against the very same idea of market, it seems natural to assume that goods prices are changed quite infrequently (say once or twice per year).

In practice, firms suffer different costs when changing prices, such as changes in price lists, revising contracts, informing customers, …  Focus on the determination of the AGGREGATE DEMAND AGGREGATE DEMAND What are the components of the aggregate demand?

  1. Private consumption (individuals) - C
  2. Investments (firms)- I
  3. Government/ public spending (State)- G Private consumption ( C ) is given by the goods and services that are purchased by households; they usually represent about 60-65% of GDP. Investments (I) are given by the purchases of new plants, machineries, buildings. Investments are usually made by firms, although they include the purchases of new houses by households. Investments represent approximately 15-20% of the GDP of industrialized countries. Government spending (G) is given by the goods and services that are purchased by the State or by other public administrations, G includes the services provided by public sector employees, evaluated based on their remunerations. Public expenditures (government spending) account for about 20-25% of GDP in industrialized countries. Z (AGGREGATE DEMAND) = C+G+I=Y (GDP) In the graphs, the 3 components are assumed to be exogenous, so Z is a flat line)