Introduction To Economics

ECO 100Y

Introduction to Economics Topic 12: The National Accounts and Other Macro Concepts Source: LR12, LR11 and LR10, Chapter 19 (exclude international economy until later in the course) and Chapter 20. The derivation in class is not the same as in the text, but the end results are the same!

  ECO 100 W.G. Wolfson

Topic 12: Macro Concepts

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Micro vs. Macro: A Reminder! 

Microeconomics - the study of the choice problems faced by the 2 key economic agents: households and firms  Microeconomics, for instance, examines how the equilibrium price and quantity for a particular commodity is determined

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Macroeconomics - the study of the economy as a whole, “in the aggregate”  Macroeconomics , for instance, examines how the general level of prices and the total quantity produced are determined (not the P and Q of any particular commodity)

ECO 100 W.G. Wolfson

Topic 12: Macro Concepts

Recall the Circular Flow Diagram Labour, land & capital

FACTOR MARKETS

Labour, land & capital

Wages, rent & interest HOUSEHOLDS

FIRMS

Expenditures on goods & services Goods & services

ECO 100 W.G. Wolfson

GOODS MARKETS

Goods & services

Topic 12: Macro Concepts

Slide 3

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Key Macroeconomic Variables      

Aggregate output (GDP) Rate of inflation Rate of unemployment Interest rate Balance of payments Exchange rate

ECO 100 W.G. Wolfson

Topic 12: Macro Concepts

Economic Policy Levers 

Fiscal policy - changes in the level of government expenditures on goods and services and in the level of taxes the government collects and the transfer payments it makes  Spending: direct influence on demand for commodities  (Income) Taxation and Transfers: direct influence on household incomes

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Monetary policy - changes in the stock of money  Affects the rate of interest (in the short run)  In turn, influences business investment and household consumption (of expensive goods in particular)

ECO 100 W.G. Wolfson

Topic 12: Macro Concepts

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Building the National Accounts: GDP and GDE 

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We know the following about a single firm:  Profits = Total Revenues – Total Costs Profits (assume firm is an incorporated enterprise) can be:  Paid to shareholders: Dividends  Paid to government: Corporate Profits Tax  Not paid out: Retained Earnings Revenues are derived from sales  To households  To other firms  To government

ECO 100 W.G. Wolfson

Topic 12: Macro Concepts

Building the National Accounts: GDP and GDE (Cont’d) 

Total costs relate to the inputs  Labour: wages  Land: rents  Financial: interest  Use of physical capital: depreciation  Imposed / provided by gov’t: indirect taxes - subsidies  Purchases from other firms:  “Consumables” (i.e., non-capital goods or services)

ECO 100 W.G. Wolfson

Topic 12: Macro Concepts

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Building the National Accounts: GDP and GDE (see class handout) 

Consider one firm’s Profit and Loss Statement Assume economy consists of many identical firms Sum all firms Profit and Loss Statements

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Delete inter-firm transactions for “consumables”

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 Get “aggregate P & L” for economy as a whole  Get “aggregate Production Statement” 

Reorganize items and rename some to get National Accounts  Gross Domestic Product (GDP)  Gross Domestic Expenditure (GDE)  Other national aggregates

ECO 100 W.G. Wolfson

Topic 12: Macro Concepts

The Concepts of “Value Added” and “Final” Goods and Services 

Value added is the contribution of each firm to production (GDP)  Excludes goods and services provided by other firms

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Final goods and services are commodities purchased by households Intermediate sales are firmto-firm transactions

Sales Revenue ($)

Purchase from other firms ($)

Value Added ($)

Wheat

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Flour

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Bread

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Total

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 Excluded from final goods and services

ECO 100 W.G. Wolfson

Topic 12: Macro Concepts

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Some Attributes of National Income Accounting 

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Current Output – GDP includes only the value of output currently produced  For instance, GDP includes the value of currently produced cars but not the sales of used cars Market Prices – GDP values goods at market prices  Note that the market price of a good includes indirect taxes such as sales taxes (Mostly) Market Driven – In general, only the value of goods and services exchanged in the market are included  Except illegal transaction (e.g., drugs)  Imputations added (e.g., the imputed rent to owners’ occupied houses)

ECO 100 W.G. Wolfson

Topic 12: Macro Concepts

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GDP vs. GNP 

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Gross Domestic Product (GDP) measures production within Canada using both Canadian and non-resident factors of production Gross National Product (GNP) measures production within and outside Canada using only Canadian factors of production GDP is the “traditional” measure of national output used in most countries today

ECO 100 W.G. Wolfson

Topic 12: Macro Concepts

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Nominal vs. Real GDP 

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Nominal GDP measures the value of output in dollar terms at the prices prevailing in the period the output is produced  Changes in nominal GDP could be the result of higher prices, greater physical output, or a combination of both Real GDP measures the output at the prices of some base year  A change in real GDP is exclusively the result of a change in physical output  Determining real from nominal requires a Price Index  Real GDP tends to follow an increasing path over time  In the short-run, however, real GDP fluctuates up and down during the business cycle

ECO 100 W.G. Wolfson

Topic 12: Macro Concepts

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Rate of Inflation and A Price Index 

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The inflation rate is the percentage rate of increase in the level of prices during a given period “t” x 100  Inflation Rate = [Pt − Pt−1] / [Pt−1] To measure the average price level, we can calculate, for example, the Consumer Price Index (CPI) The CPI shows the change in the price level based on a constant bundle of household commodities in period 0  CPI = ∑pitqi0 /∑pi0qi0 x 100 There are other price indices; for example, GDP Deflator A price index may be shown in relation to base yr =100  100, 105, 110 … (5%, 10% …)

ECO 100 W.G. Wolfson

Topic 12: Macro Concepts

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Labour Force and Unemployment 

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The Labour Force (LF) consists of workers who have jobs and workers seeking employment E = Employed; U = Unemployed  LF = E + U The Rate of Unemployment (U rate) is the percentage of the Labour Force who are unemployed  U rate = U / LF Full Employment is not U = 0  Frictional Unemployment relates to job search  Structural Unemployment relates to mismatch between requirements of job vacancies and skills of unemployed workers

ECO 100 W.G. Wolfson

Topic 12: Macro Concepts

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Macroeconomic “Gaps”  

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Potential GDP is GDP at Full Employment The difference between GDPPotential and GDPActual is called the GDP Gap  GDP Gap = GDPPotential - GDPActual As will be seen later,  If GDPPotential > GDPActual , there is a Recessionary Gap  If GDPPotential < GDPActual , there is an Inflationary Gap

ECO 100 W.G. Wolfson

Topic 12: Macro Concepts

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Macro Balances 

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Balance of Trade is the difference between Exports and Imports  B of T = X – M  If X > M, a B of T Surplus  If X < M, a B of T Deficit The Government Budget Balance is the difference between government revenues and expenditures  If Revenues > Expenditures, a Budget Surplus  If Revenues < Expenditures, a Budget Deficit

ECO 100 W.G. Wolfson

Topic 12: Macro Concepts