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Prof.

Fei DING
The Hong Kong University of Science and Technology

ECON 2123: Macroeconomics

OVERVIEW AND KEY CONCEPTS

QUOTE OF THE DAY

RECAP: ECONOMICS STUDIES HOW

We use scarce resources to improve our well-being;

Our economic decisions affect others in the society;

Government policies influence our economic


decisions.

Resources are scarce need to make choices.

Scientific method need to measure things.

World is complicated need to use models.

MACRO MORE DIFFICULT THAN MICRO!

Macroeconomics considers a group of


individuals as an unit together in the
Short run (a few years),
Medium run (a decade),
Long run (a few decades or more).

Three key variables in macroeconomics


Output
Unemployment rate
Inflation rate

Ch1: A Tour of the World


Ch2: A Tour of the Book

LEARNING OBJECTIVES

Obtain a big picture of the macro economy around the world: US, EU, and China.

Define output, unemployment, inflation.

Understand the components of the national income and product accounts.

Understand key terms at the end of Ch2.


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HOW TO DESCRIBE AN ECONOMY?

CHINA VS. THE UNITED STATES


Table 1-4 Growth and Inflation in China, 19802012

Table 1-2 Growth, Unemployment, and Inflation in the United States, 19802012

3.0

2.6

0.0

-3.5

3.0

1.5

1.8

6.5

5.0

5.8

9.3

9.6

9.1

9.0

4.2

2.8

3.8

-0.3

1.7

2.9

1.2

CHINA VS. THE EURO AREA


Table 1-4 Growth and Inflation in China, 19802012

Table 1-3 Growth, Unemployment, and Inflation in the Euro Area, 19802012

2.2

2.2

0.4

-4.2

1.8

1.6

1.1

9.6

8.5

7.6

9.5

10.1

9.9

9.9

5.2

2.3

3.2

0.3

1.6

2.5

1.5

CHINA

Astonishing growth!
Since 1980, Chinese output has grown at close to 10% per year (compared
to 3.1% for the US over the same period).
At this rate, output doubles every 7 years!
Low unemployment.
Inflation was high before 2000, but has stayed low ever since.
Almost no sign of the global financial crisis.

THE CRISIS
Figure 1-1 Stock prices in the US, the Euro area, and emerging economies, 20072010

Table 1-1 World Output Growth since 2000

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LETS SUMMARIZE
When looking at an economy, we first look for
three key variables:

Output

Unemployment rate

Inflation rate

But what exactly are they, and how are they


calculated?
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AGGREGATE OUTPUT GDP

Aggregate means total in macroeconomics.

GDP Gross Domestic Product

Measured by national income and product


accounts an accounting system used to
measure aggregate economic activity.

Precision and consistency

Refer to Appendix 1 at the end of the textbook for


more details.
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HOW IS GDP CALCULATED?


Steel Company (Firm 1)

Car Company (Firm 2)

Revenues from sales

$100

Expenses
Wages

$80

Revenues from sales

$200

Expenses

$170

$80

Profit

$20

Wages

$70

Steel Purchases

$100

Profit

$30

GDP=?
1) $300 (=$100+$200)
2) $50 (=$20+$30)
3) $200

This is double counting of intermediate goods.


This is capital (or profit) income, not total output.

=$100+($200-$100)

=$80+$20+$70+$30

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GDP EXAMPLE
Steel Company (Firm 1)

Car Company (Firm 2)

Revenues from sales

$100

Expenses
Wages
Profit

$80
$80
$20

Revenues from sales

$200

Expenses

$170

Wages

$70

Steel Purchases

$100

Profit

$30

GDP = $200
1)

Value of final goods, which aim for final consumption.

2)

Value added the value of production minus the value of


intermediate goods used in production. Intermediate goods aim for use
in the production of something else.

3)

Sum of incomes mostly labor income and capital income (and


indirect/sales taxes).
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HOW IS GDP CALCULATED?

From the production side,


Value of the final goods and services produced
domestically
Sum of value-added in the domestic economy

From the income side,

Sum of incomes earned by domestically-located


factors of production

during a given period.

Aggregate Production = Aggregate Income


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REFRESH
A firms value added equals:
1.
2.
3.
4.
5.

its revenue minus its costs.


its revenue minus its wages.
its revenue minus its wages and profit.
its revenue minus its cost of intermediate goods.
none of the above.

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NOMINAL VS. REAL GDP

Nominal GDP is measured in current prices.


Problem: prices of most goods increase over time.
Want to measure output and its change over time
without the effect of increasing prices.

Real GDP is measured in constant prices.

Can use prices in a base year as common prices


Year

Quantity
of Cars

Price
of cars

Nominal
GDP

Real GDP
(in 2005 dollars)

2004

10

$20,000

$200,000

$240,000

2005

12

$24,000

$288,000

$288,000

2006

13

$26,000

$338,000

$312,000
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REAL GDP COMPLICATIONS

In the base year, nominal GDP = real GDP.


The base year is chosen by convention.
What about changes in quality of existing goods?

Hedonic pricing (see focus box p.45)

More than one good, real GDP is a weighted average


of the output of all final goods.

Relative prices determine the weights.


But relative prices change over time!
Use real GDP in chained (2005) dollars.
Refer to the appendix at the end of Ch2 for details.
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NOMINAL VS. REAL GDP US


Figure 2 - 1
Nominal and Real U.S.
GDP, 1960-2010
From 1960 to 2010, nominal
GDP increased by a factor of
28. Real GDP increased by a
factor of about 5.

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NOMINAL VS. REAL GDP HONG KONG


2,500,000

Nominal and Real GDP,


Hong Kong, 1961-2011
2,000,000
(million HK$)

1,500,000
Nominal
Real

1,000,000

500,000

0
1961
1963
1965
1967
1969
1971
1973
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
2011r

From 1961 to 2006,


nominal GDP increased
by a factor of 273. Real
GDP increased by a
factor of about 22.
Real GDP is measured
at price level of 2011.

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GDP LEVEL VS. GROWTH RATE

Real GDP per capita is the ratio of real GDP to the


population of the country.

GDP measures economic size; GDP per capita measures standard of


living.

GDP growth: rate of growth of real GDP

Negative growth recession

Positive growth expansion

(Yt Yt 1 )
Yt 1

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US GDP GROWTH
Figure 2 - 2
Growth Rate of U.S. GDP,
1960-2010
Since 1960, the U.S. economy
has gone through a series of
expansions, interrupted by
short recessions. The most
recent recession was the most
severe recession in the period
from 1960 to 2010.

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-10%
1966 [YR1966]
1967 [YR1967]
1968 [YR1968]
1969 [YR1969]
1970 [YR1970]
1971 [YR1971]
1972 [YR1972]
1973 [YR1973]
1974 [YR1974]
1975 [YR1975]
1976 [YR1976]
1977 [YR1977]
1978 [YR1978]
1979 [YR1979]
1980 [YR1980]
1981 [YR1981]
1982 [YR1982]
1983 [YR1983]
1984 [YR1984]
1985 [YR1985]
1986 [YR1986]
1987 [YR1987]
1988 [YR1988]
1989 [YR1989]
1990 [YR1990]
1991 [YR1991]
1992 [YR1992]
1993 [YR1993]
1994 [YR1994]
1995 [YR1995]
1996 [YR1996]
1997 [YR1997]
1998 [YR1998]
1999 [YR1999]
2000 [YR2000]
2001 [YR2001]
2002 [YR2002]
2003 [YR2003]
2004 [YR2004]
2005 [YR2005]
2006 [YR2006]
2007 [YR2007]
2008 [YR2008]
2009 [YR2009]
2010 [YR2010]

Percentage Changes

HONG KONG GDP GROWTH, 1966-2010


Growth of Real GDP and Nominal GDP of Hong Kong

50%

40%

30%

20%
Growth of Real GDP

Growth of Nominal GDP

10%

0%

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THE GLOBAL RECESSION


Figure 28 1
The Global Recession.
World GDP Growth,
2007-2010.
World GDP declined sharply
in both the last quarter of 2008
and the first quarter of 2009.

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WHAT GDP MISSES

Goods and services without market prices


Government services
Owner-occupied housing

Goods and services that are not traded in


markets
Leisure
Housework

Depletion of natural and environmental


resources
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WHAT GDP CAN AND CANNOT MEASURE

Measure aggregate economic activities,


growth, standard of living

Goods and services available for consumption

Consumers valuation on these items

Not a measure of

Environmental and emotional well-being

Reading: Singapore, Hong Kong face


happiness deficit SCMP, Jan. 19, 2013
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WHAT IS UNEMPLOYMENT?

Employment (N) is the number of people who have a job.

Unemployment (U) is the number of people who do not have a


job but are looking for one.

Discouraged workers are those without jobs who give up looking for work.

The labor force L = N + U.

Participation rate = L/total population of working age

The unemployment rate u = U/L.

We care about unemployment because

It directly impacts the welfare of the unemployed.

It means we are not using resources efficiently.


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UNEMPLOYMENT RATE US
Figure 2 - 3
U.S. Unemployment Rate,
1960-2010
Since 1960, the U.S.
unemployment rate has
fluctuated between 3% and
10%, going down during
expansions and going up
during recessions. The effect
of the crisis is highly visible,
with the unemployment rate
reaching close to 10%, the
highest such rate since the
1980s.

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REFRESH
When an economy slows down, we often observe:
1)

2)

3)

4)

Low unemployment rate and high participation


rate.
Low unemployment rate and low participation
rate.
High unemployment rate and high participation
rate.
High unemployment rate and low participation
rate.
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THE INFLATION RATE

Inflation is a sustained rise in the general level


of prices the price level.

Inflation rate is the growth rate of the price level.

Deflation is a sustained decline in the price level,


i.e., negative inflation.

We care about inflation because

Inflation affects income distribution and welfare.

Inflation leads to uncertainty and other distortions.


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HOW TO MEASURE INFLATION

From the average price of output produced:

The GDP deflator P

Nominal GDP

Real GDP

From the average price of consumption:

$Y

The consumer price index (CPI)

Whats the difference?

Goods sold to firms, government, foreigners

Goods imported from abroad


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HOW TO MEASURE INFLATION

Both GDP deflator and CPI are index numbers.


Level set to 100 in the base year. Level has no
economic meaning.
Their rate of change defines the inflation rate.

Figure 2 - 4
U.S. Inflation Rate, using
the CPI and the GDP
deflator, 1960-2010
The inflation rates, computed
using either the CPI or the
GDP deflator, are largely
similar.

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GDP DEFLATOR EXERCISE


Year

Nominal
GDP

Real GDP
(in 2005 dollars)

GDP
Deflator

Inflation
Rate

2004

$200,000

$240,000

N.A.

2005

$288,000

$288,000

2006

$338,000

$312,000

Compute the GDP deflator for each year.

Compute the inflation rate from 2010 to 2011, and


from 2011 to 2012.

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STYLIZED FACTS IN MACROECONOMICS

Unemployment rises during recessions and


falls during expansions.

Okuns Law: negative relationship between GDP


growth and change in unemployment rate.

Figure 2-5 Changes in the


unemployment rate versus
output growth in the United
States, 19602010

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STYLIZED FACTS IN MACROECONOMICS

On average, higher (lower) unemployment


leads to a decrease (increase) in inflation.

Phillips Curve: negative relationship between


unemployment rate and change in inflation rate.

Figure 2-6 Changes in the


inflation rate versus the
unemployment rate in the
United States, 19602010

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STYLIZED FACTS IN MACROECONOMICS

Combining Okuns Law and the Phillips curve,


what can we say about the relationship
between output, unemployment, and inflation?

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Macroeconomics Facts of Hong Kong


GDP, INFLATION RATE, UNEMPLOYMENT RATE

Where to find Data


Census and Statistics Department:
www.censtatd.gov.hk
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TIME FRAME FOR DETERMINATION OF OUTPUT

Short run a few years changes in output mainly


driven by changes in demand

Medium run a decade output determined by


given supply factors: capital stock, technology, size
and skills of the labor force

Long run a few decades or more output


determined by changes in supply factors:
accumulation of capital, technological growth,
education system, role of government, etc.
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CH2 QUICK CHECK (TEXTBOOK)


True or False?
(a) When the unemployment rate is high, the participation
rate is also likely to be high.
(b) The rate of unemployment tends to fall during expansions
and rise during recessions.
(c) If the Japanese CPI is currently at 108 and the U.S. CPI is
at 104, then the Japanese rate of inflation is higher than
the U.S. rate of inflation.
(d) The rate of inflation computed using the CPI is a better
index of inflation than the rate of inflation computed
using the GDP deflator.
(e) The Phillips curve is a relation between the level of
inflation and the level of unemployment.
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SEE YOU NEXT TIME

Assigned reading:

Textbook Chap. 1 and 2 (exclude appendix)

Textbook, Chap. 3 (for next time)

Remember to download iPRS app to your


mobile phone or get your PRS handset.

Problem set 1 will be posted soon.

Make sure you can submit PS0 via CANVAS.

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