EC114 Introductory Macroeconomics Core Lecture, Week 1
J James Reade
16/01/2015
Who Am I?
- James Reade, j.j.reade@reading.ac.uk, HumSS 191.
- Office hours: 14:30–16, Tuesdays, 11–12:30 Fridays.
- Twitter: jjreade, hashtags #EC114 #pleasebemyfriend
Administration
- Lectures:
- Thursdays 2-3pm: URS LLT, Applications Lecture.
- Apply concepts covered previous week to real life.
- Friday 9-11am: URS LLT, Core Lecture.
- Main sessions: We’ll cover core material here.
- Thursdays 2-3pm: URS LLT, Applications Lecture.
- Textbook: Miles, Scott and Breedon 3e, `Macroeconomics’.
- Should be in Blackwells or online.
- Classes:
- Classes run weeks 3–5, 7–11.
- Pattern:
- Core material, Friday lecture (week \(x\)).
- Application, Thursday lecture (week \(x+1\)).
- Further application, Tuesday class (week \(x+2\)).
- Task for week 3: http://rpubs.com/jjreade/ec114_class1
Outline
Rough syllabus with chapters:
- Week 1: Chapters 1–3: What is Macro, National Accounts, the ``Supply Side’’.
- Week 2: Chapters 4–5: Growth
- Week 3: Chapter 7: Unemployment.
- Week 4: Chapters 8–9: Trade and Globalisation.
- Week 5: Revision and Midterm Test.
- Week 6: Enhancement Week, anyone for Settlers?
- Week 7: Chapter 10: Consumption and Investment.
- Week 8: Chapter 11: Business Cycles.
- Week 9: Chapters 12–14: Money, Prices, Monetary and Fiscal Policy.
- Week 10: Chapters 17–18: Banking, Debt and (Sovereign) Default.
- Week 11: Chapters 19–21: Exchange Rates.
- Unable to cover chapters in full detail.
Reading all the chapters will be beneficial.
Applications Lectures
- Idea: Apply what previously learnt in core lecture.
- Week 2: GDP measurement and the General Election.
- Week 3: Growth/Unemployment numbers (benefits culture)..
- Week 4: Guest Lecture: Joe Grice, Chief Economist at the ONS.
- Week 5: Revision.
- Week 7: Guest Lecture: John Redwood, Conservative MP.
- Week 8: Trade and globalisation (immigration)
- Week 9: Guest Lecture: Sam Juthani, Labour candidate for Henley.
- Week 10: Monetary policy (poss. guest lecture)
- Week 11: Sovereign default
Examination Arrangements
- Week 5: Midterm exam (20%), Friday 13th February, 9am.
- 60 minutes in length.
- Mock by week 3.
- Week 11: Essay (20%), due Friday 27th March, 4pm.
- 2000 words, question TBC.
- Electronic submission only.
- Summer (c. May 11–12): Final exam (60%).
- Summer Exam minor tweak:
- Section A: Definitions of listed concepts.
- Previously definition, description and example.
- Section B: Answer 1 (short) essay question from choice of 3.
- No change.
- Section C: Compulsory (short) essay question.
- Question will be on final topic, exchange rates.
- Section A: Definitions of listed concepts.
Mock exam (with numerous example Section C Qs) will be available by Week 7.
More course details: http://www.reading.ac.uk/modules/document.aspx?modP=EC114&modYR=1415
Macroeconomics
Macroeconomics
- Most media coverage focusses on short-run questions.
Macroeconomics
- But macroeconomics is also about longer-term issues.
The Long Run in Economics
Once one starts to think [about questions of economic growth] it is hard to think about anything else
R. Lucas (Nobel Prize Winner 1995)
Chapter 2: National Accounts
- Quantity supplied/demanded important when considering individual market.
- Underlying this is utility and profit maximisation. Welfare economics.
- On economy-wide scale, welfare concerns still paramount: How measure?
- Focus on output produced: More produced, more needs satisfied…?
- How do we measure total economic output of an economy?
- Key Concept:
- We measure output as Gross Domestic Product.
Gross Domestic Product
- GDP: Total value of goods and services produced.
- Need to know:
- How much was produced (quantity).
- What the production was worth (price).
Example: Company X
| Production in 2010 | Production in 2012 |
|---|---|
| 200 washers at £500 | 300 washers at £600 |
| 100 dryers at £400 | 100 dryers at £450 |
- How to value output in 2010? Price reflects economic value.
- Total produced in 2010: \(200\times500 + 100\times400 = £ 140,000\).
- Value 2012 output similarly: \(300\times600 + 100\times450 = £ 225,000\).
- How compare 2010 output to 2012 output? Has output actually risen?
- It could be that increase in output entirely due to prices rising.1
- Real output: Calculate in common set of prices:
- 2012 output at 2010 prices: \(300\times500 + 100\times400 = £ 190,000\).
- Real growth (2010 prices): \((190000-140000)/140000=35.7\%\).
Chain Linked Prices
- Prices reflect the value society places on particular goods at particular point.
- Preferences change and as such, prices change.
- Different prices matter: (2012 prices) \((225000-165000)/165000=36.4\%\).
Using a previous set of prices imposes particular set of valuations on another year.
- Problem: As prices change, consumers buy more/less of products.
- If prices falling, people buy more. E.g. computers.
- If old prices used, that industry over-represented in GDP and growth may be over-stated.
- Solution: Let prices gradually evolve: Chain-linked prices.
- Take average of growth with each year as base. Yields 36.06% growth.
Real and Nominal GDP
- Nominal: Measured in current prices. Real: Measured in constant prices.
## [1] "UKNGDP"## [1] "GBRRGDPQDSNAQ"
Value Added
- Real world more complicated than single producer of dryers and washing machines.
- Producers use inputs to create outputs like washers and dryers.
- Simpler example: Orange juice producer (Sunny Delight):
- Takes 100 oranges picked by Orange Pickers Ltd for £1 per orange.
- Creates 100 cartons of juice, sells them for £1.50.
- If count each stage, total output of economy is \(100\times1 + 100\times1.5 = 250\).
- But this double counts the oranges.
- Sunny Delight only added 50p of value to product.
- Hence calculation is \(100\times1 + 100\times(1.5-1) = 150\).
- In real world production chains much more complicated, principle remains.
Three Measures of Output
Output method: Sum value added from all sectors.
- £100 + £50 = £150.
- Sometimes referred to as Gross Value Added (GVA).
Income method: Some payments to factors of production.
- Payments to employees, owners and shareholders of Orange Pickers Ltd and Sunny D.
- All incomes of citizens of country referred to as Gross National Income (GNI).
Expenditure method: Some expenditures on final goods and services.
- £150 spent on the Sunny Delight orange juice cartons.
- Generally: C+I+G+NX
All three must sum up to the same amount:
- Gross Domestic Product (GDP) at market (current) prices.
Composition of UK Output 2005
Composition of UK Output 2012
Regional Composition of UK Output 2009
The richer we are, the less we farm
Who Gets What in the Pie?? Income Method
Expenditure Method: Accounting Algebra
Four eventual destinations for goods and services produced:
- Consumption by individuals (C).
- Consumption and investment by government (G).
- Investment by the private sector (I).
- Exports (X).
All four sources sum up to aggregate demand (AD): \[ AD = C+I+G+X. \]
Expenditure Method: Accounting Algebra
- All four sources sum up to aggregate demand (AD): \[ AD = C+I+G+X. \]
This demand can be met either:
- Domestically (total physical output \(Y\)).
- Internationally (imports \(M\)).
\[ Y+M = C + I + G + X. \] - Rearranging gives expenditure measure of output: \[ Y = C + I + G + (X-M) = C+I+G+NX. \]
Expenditure Shares, Historically
Expenditure Components of GDP, Internationally
GDP and GNI — Domestic vs Citizens
Comparisons using Purchasing Power Parity
- How make international comparisons when UK GDP in £, US GDP in $ etc?
- Market exchange rates?
- May mislead as exchange rates volatile.
- Market exchange rates may not reflect cost-of-living differences.
- Purchasing power parity (PPP) exchange rates attempt to circumvent this:
- Account for cost of living differences not forex fluctuations.
- PPP comparison reduces differences between developed world and elsewhere:
- Generally, cost of living much lower in developing world.
Comparisons using Purchasing Power Parity
Problems in GDP Measurement
- Cannot account for black market/underground economy.
- Household activities (e.g. child-rearing) not counted.
- Negatives counted positively (e.g. treatment of stress-related disorders).
- Getting prices right, taxation levied, etc.
- Upshot: Substantial later adjustments to numbers (e.g. wiping out recessions!).
- Environmental impact not accounted for (e.g. depletion of natural resources).
But How Much Output Does GDP Include?
Housework is Not GDP Work
How Difficult it is to Calculate Output
Do We Trust What the ONS Tells Us?
Sustainable Development?
And of Course, Happiness can be Surveyed…
Cameron, Miliband and wellbeing and standards
- Around 2010, Cameron introduced ‘Gross Wellbeing’ (http://goo.gl/nWwdDO).
- Last weekend, Ed Miliband suggested an index of living standards (http://goo.gl/PKn5hG)
- ‘Cost of living crisis’ seemingly never out of the news…
- Week 4 (Feb 5): Joe Grice, Chief Economist at the Office for National Statistics.
Inequality and Welfare… and Respect?
- HDI introduces inequality and other subjective factors to measuring nation’s welfare.
- Does respect matter?
Noah Smith: `Redistribute Wealth? No, Redistribute Respect.’ (goo.gl/kuuqIQ)
- We disrespect particular (usually low paid) jobs.
- Respect seems to be much to closely linked to how much one earns.
- Lack of respect robs many of the poor of many opportunities.
David Henderson: `The Economics of Respect’ (http://goo.gl/ZvFMlC):
- Adam Smith: Wages inversely correlated to how distasteful a job is.
- Hence if we increase respect for low-paid jobs, their pay will fall (further)…?
- Noah Smith: Such impact only at the upper end of wage scale — why?
Henderson: Can we avoid deprivation without redistributing wealth?
Chapter 3: Wealth of Nations, the Supply Side
Interest: Why are some economies rich, others less so?
- How do we grow?
- Do Americans, Brits, feel happier than Mexicans or New Zealanders?
Part of answer: Economic growth — but how do we measure?
- Nominal GDP growth: Change in value of output at current market prices.
- Real GDP growth: Change in value of output at constant prices.
- Real GDP growth per capita: Adjusted for population growth.
Almost all growth in last century
Where the growth was…
Nonetheless…
- Macroeconomics seeks to explain this big picture.
Trend vs Cycle
-
- Increasing trend growth from 2% to 3% worth 20% of current consumption.
- Eradicating business cycles worth 0.1% of current consumption.
Recessions trivial in comparison to long-term growth…
Growth and Inequality, Hand in Hand?
Growth and Poverty
Growth and Inequality, a Complicated Picture
A Mixed Bag
Income Differences, Decomposed
- We can insert terms into the income per capita ratio: \[ \frac{\text{GDP}}{\text{Population}} = \frac{\text{GDP}}{\text{??}}\times\frac{\text{??}}{\text{??}}\times\frac{\text{??}}{\text{??}}\times\frac{\text{??}}{\text{Population}} \]
- This can help us understand what is driving a ratio: \[ \frac{\text{GDP}}{\text{Population}} = \frac{\text{GDP}}{\text{Hours worked}}\times\frac{\text{Hours worked}}{\text{Employment}}\times\frac{\text{Employment}}{\text{Labour Force}}\times\frac{\text{Labour Force}}{\text{Population}} \]
- Many of these are common ratios: \[
\frac{\text{GDP}}{\text{Population}} = \text{Hourly productivity}\times\text{Average Hours worked}\\\times\text{Employment Rate}\times\text{Participation Rate}
\]
- We can look at these ratios for countries around the world to see if variation exists.
Cross Country Comparison (of Developed Nations)
Productivity: The Production Function and Inputs
- Productivity depends on many factors.
Economists simplify to production function:
- Output some function of labour, capital and total factor productivity (TFP).
- Labour: People employed to do a job…
Capital: ``anything that enhances ability to perform economically useful work’’
Residential buildings, non-residential buildings, equipment.
TFP: Everything else.
The Production Function, Graphically
The Labour Force
The population of a country can be broken into four groups:
- The employed.
- The unemployed.
- Those of working age outside the labour force.
- Those not of working age.
The Population, Split
Total Employment is Up…
But Average Hours are Down
Total Factor Productivity
Impact of everything not labour or capital on output.
- Interpretation: Efficiency with which inputs used to produce output.
- Interpretation: A measure of our ignorance.
- If we assume we can accurately measure labour and (particularly) capital inputs.
May include:
- Education levels, workforce skills, technology, geography, institutions, government.
Possibly the most misused economic concept by policymakers:
- Felipe (2008): Policymakers target TFP growth — but it’s a residual.
Growth Accounting
- Growth accounting attempts to understand the sources of growth.
Take Cobb-Douglas production function: \[ Y = AK^\alpha L^{1-\alpha}. \]
- Where \(K\) is capital stock, \(L\) is labour, and \(A\) is TFP.
Take logs: \[ \log (Y) = \log(A) + \alpha \log K + (1-\alpha) \log L.\label{eq:GAstep1} \]
Take differences: \[ \%\Delta\log (Y) = \%\Delta\log(A) + \alpha \%\Delta\log K + (1-\alpha) \%\Delta\log L.\notag \]
Everything apart from \(A\) measurable:
- Treat \(A\) as residual in regression of \(Y\) on \(K\) and \(L\)!
Growth Accounting
Summary, Forecasting and Next Week
World output has increased dramatically since 1850.
- This trend dwarves any cyclical movements in output.
Some can be explained by more people, some by more machines:
- The rest thus far we have left unexplained.
- Next week we flesh this out a little more…
- Next week, 9:30am Wednesday January 21 November and December’s unemployment figures will be released.
- Interested in informal forecasting competition?
- More feedback if you want to provide it:
Although if the price rise reflects better quality washers/dryers, then output has increased in its value to us.↩