TOPIC 7MACROeconomicsChapter 12

1. What is macroeconomics? 2. What is GDP?

In the long run, the Australian economy has experienced economic growth and rising living standards, and in the short run the economy has experienced a series of business cycles.

Growth and the business cycle

• Microeconomics: The study of how households and firms make choices & how they interact in markets.

Macroeconomics: The study of the economy as a whole, including topics such as inflation, unemployment, and economic growth.

Macroeconomics is a study of the business cycle

Business cycle: Alternating periods of economic expansion and economic contraction relative to trend growth

Macroeconomics

GDP and Economic Growth Economic growth: The expansion of society’s

productive potential - usually measured by the rate of growth in real GDP.

Expansion: The period of a business cycle during which total production and total employment are increasing above trend growth.

Contraction: The period of a business cycle during which total production and total employment are falling below trend growth.

What is a recession?

GDP measures total production● Gross Domestic Product (GDP): The market

value of all final goods and services produced in a country during a given period of time. GDP does not includes the market value of

intermediate goods and services (goods used as inputs, such as a tyre on a truck).

GDP includes only current production. GDP does not include the value of used (second-hand) goods.

Review Which of the following headlines would be more closely related to what macroeconomists study than what microeconomists study?A) Avocado prices rise due to a late frost in

Queensland.B) The United Auto Workers sign a contract

raising wages 7% over the next 3 years.C) Real GDP grows by 2.3% in the second

quarter.D) Airlines raise ticket prices in response to rising

fuel costs.

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Review Which of the following goods is directly counted in GDP?A) the lettuce that Subway purchases for its

sandwichesB) the bread that Subway purchases for its

sandwichesC) a 12-inch Subway sandwich purchased by a

studentD) the plastic bags that Subway purchases to

wrap its sandwiches

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Review If you make dinner for yourself A) the market value of your dinner is added to

GDP.B) your service in preparing the meal is valued

at a cook's wage and added to GDP.C) none of what you bought to prepare for

dinner is included in GDP.D) only the market value of ingredients that

you purchased this year is added to GDP.

Calculating GDP

Production and Price Statistics for Economy XProduct Quantity Price per unit ($)TVs 50 1000

Pizzas 500 10

Espressos 1000 4

Assume a simple economy (Economy X) which produces only three goods: TVs, pizzas and espressos. Use the information in the table below to calculate GDP for this economy.

Production and Price Statistics for Economy XProduct Quantity Price ($) Value ($)TVs 50 1000 50,000Pizzas 500 10 5,000 Espressos 1000 4 4,000

TOTAL (GDP): $59,000

Calculating GDP

The Australian Bureau of Statistics (ABS) uses three alternative methods to measure GDP:

1. The production method2. The expenditure method2. The income method

Methods of measuring GDP

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The circular-flow diagram shows the flow of spending and money in the economy.

It illustrates the equality between GDP measured from the income and expenditure methods.

The income generated in the production of goods and services is equal to the value of expenditure on these goods and services.

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Methods of measuring GDP

The circular flow and measurement of GDP

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Components of GDP Expenditure Method: The ABS divides GDP into four major categories of expenditures on Australian produced goods & services. Spending by households: consumption (C) Spending by firms: investment (I) Spending by government: (G) Spending by overseas: (X)Some spending by households, firms & government is on imports – so this must be subtracted from total spending

Components of GDP Consumption (C): Spending by households

Non-durable goods – food & clothing Durable goods – furniture, appliances, cars Services – health, education, leisure (Note – C does not include spending on new

houses. Consumption is the largest category of GDP What factors affect Consumption spending? Which type of spending is more volatile –

durable or non-durable goods?

Components of GDP Investment (I): includes 3 categories

Business fixed investment – spending by firms on new factories, office buildings, machinery, computers

Inventories – goods produced but not yet sold Residential investment – spending by

households on new housing What factors affect investment? Investment is the most volatile category. Why?

Components of GDP Government purchases (G): Spending by

federal, state, and local governments on goods and services. Can be divided into government C spending &

government I spending Note: spending on transfer payments is not

included in G Net exports (NX): The value of exports minus

expenditure on imports. Exports are included because it is domestic

production Imports are subtracted because it is foreign

production

Components of GDP • An equation for GDP (where Y = GDP or

total output):

Y = C + I + G + NX

Components of GDP, 2012/13$ millions Per cent

Consumption 815 073 53Investment 360 374 24Government 337 321 22Net Exports Exports 334 716 Imports 320 265 Total 14 451 1Stat Disc. -1 778TOTAL GDP 1 525 441 100

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Consump-tion

Investment Government Net Exports0

100000200000300000400000500000600000700000800000900000

GDP 2012-13$

mill

ions

C

I G

NX

What types of production are left out of GDP?1. Household production: Goods and

services people produce for themselves.Examples: Home cooking, cleaning, child care, gardening.

2. The ‘black economy’: Buying and selling of goods and services that is concealed from the government to avoid taxes or regulations or because the goods and services are illegal.

Does GDP measure what we want it to measure?

GDP was designed to measure a country’s production but it is often used as a ‘proxy’ to measure wellbeing

Is GDP a ‘good’ measure of well being? We need to be aware of the following

shortcomings of GDP:1. The distribution of GDP is not captured in

GDP measures. 2. The value of leisure is not included in GDP.

Does GDP measure what we want it to measure?

3. The level, quality of, and access to health care & education is not measured in GDP.

4. GDP is not adjusted for pollution or other negative effects of production.

5. GDP is not adjusted for changes in crime and other social problems

Does GDP measure what we want it to measure?

It is important to separate a measured rise in GDP that may be due only to price changes from real quantity changes. Nominal GDP: The market value of final goods

and services evaluated at current year prices. Real GDP: The market value of final goods and

services evaluated at base year prices. Nominal GDP can change over time due to

changes in either price or output. Real GDP shows changes in output only.

Real GDP versus Nominal GDP

Our economy produces only three goods; TVs, pizzas and lattes. Use the information in the table below to calculate nominal GDP for this economy in year 2

Calculating Nominal & Real GDP

Year 1 Year 2Product Qty Price $ Value Qty Price $ ValueTVs 50 1000 50000 52 1000 52000Pizzas 500 10 5000 510 11 5610Espresso 1000 4 4000 1025 5 5125GDP 59000 62735

Nominal GDP has increased by 6.3%

[(62,735 – 59,000) / 59,000 x 100] Calculate real GDP for Year 2 How? By multiplying the prices of each item for Year 1

times the quantity of all three goods for Year 2, and then summing the three values.

Calculating Nominal & Real GDP

Calculating Real GDPYear 1 Year 2

Product Price ($) Quantity Value ($)TVs 1000 52 52000Pizza 10 510 5100Espressos 4 1025 4100

REAL GDP: $61 200

Nominal GDP increased by 6.3% but how much has real GDP increased?Growth rate = ($61,200 - $59,000) / $59,000 x 100

Real GDP has grown by 3.7%

Example: Real GDP for Australia was: 2012-13: $ 1 525 283 million.2013-14: $ 1 568 626 million.

Calculate the economic growth rate as follows:

$1 568 626 m - $1 525 283 m = $43 343 m43 343 /1 525 283 x 100 = 2.84%

Is this good, average or poor?

Calculating the economic growth rate

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Australia’s Real GDPQuarter Real GDP Qrtly Growth

$m RateJun 2013 384 535Sep 2013 387 203 0.7Dec 2013 390 419 0.8Mar 2014 394 541 1.1Jun 2014 396 463 0.5Annual growth rate: 3.1%

Jun-2010 Dec-2010 Jun-2011 Dec-2011 Jun-2012 Dec-2012 Jun-2013 Dec-2013 Jun-20140

0.5

1

1.5

2

2.5

3

3.5

4

4.5

5

GDP Annual Growth RateTarget growth rate

Below trend growth

Long-run economic growth is the key to rising living standards The ultimate goal for any economy is to

improve living standards over time. Real GDP per capita is used to measure

changing living standards over time. Why?

population

GDP Real capita per GDP Real

190119021903190419051906190719081909191019111912191319141915191619171918191919201921192219231924192519261927192819291930193119321933193419351936193719381939194019411942194319441945194619471948194919501951195219531954195519561957195819591960196119621963196419651966196719681969197019711972197319741975197619771978197919801981198219831984198519861987198819891990199119921993199419951996199719981999200020012002200320042005200620072008200920100

1000

2000

3000

4000

5000

6000

7000

1966

-67

pric

es (d

olla

rs)

Real GDP per capita, Australia, 1901–2010

Real GDP/capita hasincreased 6 fold

What determines the rate of long-run growth? Increases in real GDP per capita depend on

increases in labour productivity.

Labour productivity: The quantity of goods and services that can be produced by one worker or by one hour of work.

Long-run economic growth is the key to rising living standards

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Two key factors determine labour productivity:1. Increases in capital per hour worked.

Capital: Manufactured goods that are used to produce other goods and services; examples include computers, factory buildings, and machines.

Human capital: The accumulated knowledge and skills that workers acquire from education and training, or from their life experiences.

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Long-run economic growth is the key to rising living standards

2. Technological change: This is change in the ability of a firm to produce a given level of output with a given quantity of inputs. Accumulating more inputs such as labour,

capital, and raw materials will not ensure that an economy experiences economic growth unless technological change also occurs.

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Long-run economic growth is the key to rising living standards

Potential GDP: The level of GDP attained when all firms are producing at capacity.

Potential real GDP increases every year as the labour force & capital stock increase & as technology improves

Growth in potential GDP is estimated to be approximately 3.5% per year.

Actual real GDP fluctuates around the long-run potential due to the business cycle.

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Potential GDP

Actual and potential GDP, Australia, 1960–2011

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 20100

50

100

150

200

250

300

350

Real

GD

P (b

illio

ns o

f dol

lars

)

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Which graph represents potential GDP?

Which graph represents actual GDP?

Review If you purchase a new car it would be

included inA) consumption expenditures on services.B) consumption expenditures on nondurable

goods.C) consumption expenditures on durable

goods.D) investment expenditures.

Review The largest component of GDP in Australia, as measured by the expenditure method, isA. consumption expenditure. B. government expenditure. C. net exports. D. investment expenditure.

Review Which of the following is an example of the investment component of GDP? A. You purchase shares in BHP. B. You put money into your bank

account. C. You put money into your savings

account. D. BHP builds a new processing plant.

Review When consumers are less confident about their jobs or incomes, they are more likely toA) reduce purchases of durable goods than

nondurable goods.B) reduce purchases of nondurable goods

and increase purchases of durable goods.C) increase investment spending and

decrease consumption spending.D) increase consumption spending and

decrease investment spending.

Review Real GDP will increaseA) only if the price level rises.B) only if the price level falls.C) only if the quantity of final goods and

services produced rises.D) if either the price level rises or the

quantity of final goods and services produced rises.