Individual Economic Decision-Making in Macroeconomics

Looks at how individual economic agents (I. E. Consumers/ households and producers/firms) make their day-to-day decisions. Macroeconomics: Looks at the overall behavior of the entire economy of a country. So in addition to households and firms, it also looks at the government and frequently at the rest of the world. The four target variables that all macroeconomics’s are concerned about are: (1) Gross Domestic Product (GAP): This looks at how much goods and services are being produced in the country (or how much is everyone’s income taken together).

They try o maximize this. (2) Unemployment: This has to do with how many people have Jobs and how many don’t. They try to minimize this. (3) Inflation: This looks at how the prices of goods and services are changing. They try to Meltzer this. (4) Economic Growth: This looks at the rate at which GAP Is going up or down. They try to maximize this. Gross Domestic Product (GAP) Goods: Tangible things firms produce and consumers buy.

An example is a Philly cheese steak. Services: Intangible castles firms provide and consumers buy.

An example Is a haircut. Definition of GAP: It is the value of new final goods and services intended for the racetrack produced within a country in a given period of time. (Note: We will concentrate only on gross domestic product in this class. The book also talks about the related concepts of gross national product, net national product, national income, personal Income, etc. You do not need to study them.

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) Keynoters in the definition: Value: This refers to the market price. New: Only newly produced goods and services are counted as part of the GAP.

So if you buy a second hand 2010 Toyota Campy, then that will not be counted as a part of the GAP for the year 2014. The reason is that this car had already been counted once n the GAP for the year 2010 and to count your purchase again would be counting It twice. In other words, the good Is being sold twice, but It was produced only once. Final: A final good is intended for consumption in the form it is in, whereas an intermediate good is a good that is often used to make other goods. Intermediate goods should not be confused with capital, which is a good that is manufactured for the sole purpose of making other goods.

For example, If you buy an ice cream shake, then the Ice cream Is an intermediate $2, the milk and the chocolate sauce is worth $1, the labor is worth $0. 0 and the shop wants to keep a profit margin of $0. 50, then the price of the milkshake to the consumer is $4. So when you buy the milkshake, which is a final good as it is consumed in that form, the GAP goes up by $4. But if we had also counted intermediate goods, then we would also have counted the $2 worth of ice cream and the GAP would have gone up by $6, which would again have lead to double counting.

What if you don’t purchase an ice cream shake but purchase two scoops of ice cream instead? Then ice cream would be a final good as you are consuming it in that form. Intended for the Marketplace: We only count as part of the GAP goods and services that are produced for the market. So we will not count home production, because when you prepare dinner for yourself in the kitchen then you don’t go to the market to sell it. But if you are a gourmet cook and start a take-out business from your home, then your cooking will be counted as a service in the GAP as you are selling your culinary skills to others.

We will also not count illegal transactions as part of the GAP as when we talk about markets we don’t mean black markets. So money spent on buying pot in Old Town East in Columbus ill not be a part of the U. S. GAP. Even if someone buys recreational marijuana in Colorado or medical marijuana in California (both of which are legal at the state level), the transactions will not be a part of the U. S. GAP as they are not legal at the federal level. Within a Country: The good or service has to be produced within the geographical boundaries of the country.

Hence exports will be a part of your country’s GAP whereas imports will be a part of the other country’s GAP. In a Given Period of Time: This is usually a quarter or a year. We only count the good ND services that were produced in that quarter or year, as those produced in other periods will be counted as part of the production in those respective periods. Stock: A stock is a variable whose quantity is measured at a particular point in time. For example, capital is a stock, and so is wealth. Flow: A flow is a variable whose quantity is measured per unit of time.

For example, investment is a flow, and so is GAP. A few other flow variables are consumption, government purchases and net exports. Measuring National Income / GAP There are three ways of measuring the GAP of a country. All three methods give us the same final result. (1) Expenditure Approach: GAP is the sum of the total amount spent on new goods and services in an economy over a period of time. GAP = Consumption + Investment + Government Purchases + Net Exports Therefore GAP consists of four components. Net Exports: Net Exports = Exports – Imports.

So if Chevrolet sells an Impala worth $25,000 to a Mexican living in Cacao, then the transaction is going to raise U. S. Net exports by $25,000 and reduce Mexican net exports by $25,000. (2) Income Approach: GAP is the sum of the total income paid to economic agents in GAP = compensation of employees (wages, salaries, perks) + rent + interest + profit + indirect taxes (why not direct taxes too? ) + depreciation (3) Value-added Approach: We’ll look at this with the help of an example. (a) Suppose cotton is harvested in Alabama. The bale of cotton is priced at $2.

This means that there has been a value added of $2 into the cotton by the seeds, fertilizer, pesticides, (b) A factory in Los Angles purchases that bale of cotton and manufactures cloth with it. The cloth is priced at $6. This means that there has been a value added of $4 n this round by the machinery used, the electricity consumed, the labor used and the profit margin retained by the factory owner from the sale of the cloth. (c) An American Apparel plant in Los Angles then purchases that cloth and manufactures a shirt with it. The shirt is priced at $24.

This means that there has been a value added of $18 in this round, once again by the machinery, buttons and threads, labor, profit margin, etc. So the total value-added in the three rounds put together is $(2 + 4 + 18) = $24. So the value-added in the production of one American Apparel shirt is $24. Multiplying this y the total number of American Apparel shirts produced in the U. S. And repeating this exercise for every other good and service produced, the total number that we get the GAP. In the absence of statistical errors, the three methods should give us the same answer.

In reality, no country uses the value added method as it is extremely cumbersome. Unemployment Determining a person’s status in the labor market: Working Age Population In the Labor Force Employed Not in the Labor Force Unemployed Working Age Population: The number of people 16 and over who are not in Jail, hospital, or some other form of institutional care. Labor Force: Labor force is composed of people who are employed and people who are unemployed. Employed: These are the people who have either a full-time Job or a part-time Job.

Unemployed: These are the people who are: and one of the following: (IA) are without work but have made specific efforts to find a Job within the previous four weeks (bib) are waiting to be called back to a Job from which he or she has been laid off. (ICC) are waiting to start a new Job within the next 30 days. Not in the Labor Force: These are the people who don’t satisfy the criteria for either employed or unemployed. Examples are stay-at-home parents, retired people, college students and discouraged workers (I. E. Unemployed people who gave up looking for a new Job at least four weeks ago).

Labor Market Indicators: We use three main indicators to measure the health of the labor market: (1) Unemployment Rate: Percentage of people who are in the labor force who are unemployed. This tells us how many people want Jobs but can’t find one. OUR = (No. Of Unemployed / Labor Force)*100 (2) Labor Force Participation Rate: Percentage of working age population who are members of the labor force. This tells us how many people of working age are willing to take a Job. LEAF = (Labor Force / Working Age Population)*100 (3) Employment-to-population Ratio: Percentage of working age people who have Jobs.

This tells us about the availability of Jobs and how well Jobs are matching the peoples’ skill sets. DEPT = (No. Of Employed / Working Age Population)*100 For the U. S. , according to the 2011 census, the civilian non-institutional population 16 and older was 239,618,000, the labor force was 1 and the number of employed was 139,869,000. Hence the number of unemployed was 13,747,000 and he population that was not in the labor force was 86,001 ,OHO. The unemployment rate would then be 8. 95%, the labor force participation rate 64. 11% and the employment-to-population ratio 58. 7%. Inflation Price level is the average price for all goods and services in the economy. Inflation is an increase in the price level. What if we don’t have inflation? We can then have two other possible situations: (1) Deflation: This is the case when prices are falling. (2) Disinflation: This is the case where there is no movement in the price level. Measuring the price level and the inflation rate: Inflation is measured by calculating the percentage change in the price level. Hence, in order to measure inflation, we need to be able to measure the price level.

The three most common ways of measuring the price level are: (1) Consumer price index (ICP) or Cost of living index: This measures the change in prices of goods used by consumers. In order to construct the ICP, the U. S. Bureau of Labor Statistics monitors the spending habits of consumers over a certain time period (which is currently 1993-1995) and prepares a basket of the goods consumers commonly buy. It chooses basket in that period. It then adds up the individual prices of all these goods to get the total price of the basket in the base period. Let us suppose that the base period price of the basket comes out to be $210.

Next they find the prices of all goods contained in the basket in the current period (say January 2014). Adding up, suppose the current period price of the basket comes out to be $250. Price of the basket in the current period occupancy 2014 the base period 250 = _ * 100 210 = 119. – * 100 Price of the basket in How do we calculate the inflation rate from this? The inflation rate is simply the argental change in the price level. occupancy 2014= 119 suppose ICP January 2013 = 109. occupancy 2014 – occupancy 2013 Inflation rate = 119-109 * 100 109 * 100 ICP January 2013 ICP for the base period is equal to 100 by definition.

Recently the government has switched from using the ICP-W (ICP for urban wage earners and clerical workers) to the C-ICP-U (chained ICP for all urban consumers). The C-ICP-U takes substitution effects into account (for example, if the price of pork goes up then pork is now more expensive but consumers might switch to less pork and more beef to keep their expenditure on meat at around the same level); ICP-W does not. As a result, C-ICP-U increases more slowly than ICP-W (0. 3% less per year according to the COB). This saves the government money as it slows cost of living adjustments given to social security payments. 2) Producer price index (PIP): This measures the change in the prices of goods used by producers. The PIP leads the ICP. The PIP measure price change from the perspective of the seller. This contrasts with other measures, such as the Consumer Price Index (ICP), that measure price change from the purchaser’s perspective. Sellers’ and purchasers’ prices may differ due to government subsidies, sales and excise taxes, and distribution costs. Pips measure average changes in prices received by domestic producers of commodities in all stages of processing (I. E. For both intermediate and final goods).

Because producer price indexes are designed to measure only the change in prices received for the output of domestic industries, imports are not included. The U. S. Bureau of Labor Statistics conducts surveys and releases approximately 10,000 Pips for individual products and groups of products each month. Pips are available for the products of virtually every industry in the mining and manufacturing products of industries in the transportation, utilities, trade, finance, and services sectors of the economy. The PIP and the inflation rate based on it are calculated in exactly the same way as with the ICP. 3) GAP deflator: This is the third way of measuring the price level. Distinction between nominal and real variables: Nominal means that the variable has not been adjusted for inflation. Real means that the variable has been adjusted for inflation. Whenever we need to meaningfully compare between two time periods, we need to invert the variables into real terms. Otherwise we will end up with erroneous results. To see why, consider the following example. Let us consider an economy that only produces books. In 2012 it produced 10 books, while in 2013 it produced 12 books.

Hence book production grew by: 12 – 10 10 Now let’s bring prices into the picture. Suppose the price of a book in 2012 was $5 and it increased to $7 in 2013. Hence the nominal GAP in 2012 was = $50 and the nominal GAP in 2013 was = $84. Hence the growth rate of nominal GAP was: 84 – 50 50 Obviously this number is wrong. The reason because of which this number is so high s that we did not adjust it for the increase in price. The right way to compare the situations in 2012 and 2013 is to use the same price level to calculate the value of the GAP for the two different years.

For example, if we use the base period (I. E. 2012) price, then the real GAP in 2012 would be = $50 and the real GAP in 2013 would be $(5*12) = $60. If we now compute the growth rate, then it comes out to be the correct number: 60 – 50 Nominal GAP GAP Deflator = Real GAP ___*OHIO Unlike a price index, the GAP deflator is not based on a fixed basket of goods and services. The basket is allowed to change with people’s consumption and investment patterns. Therefore, new expenditure patterns are allowed to show up in the deflator as people respond to changing prices.

However, the disadvantage of this approach is that the GAP deflator measures changes in both prices and the composition of the basket, and so should not be used as a measure of pure price changes in the economy. In practice, the difference between the deflator and a price index on the same set of goods and services is relatively small. The GAP and GAP deflator are both calculated by the Bureau of Economic Analysis (SEA). Economic Growth short period of time in which producers can only vary the labor they employ, and not the capital stock.

Long run: A longer period of time, in which both labor and capital stock employed in a firm can be changed. The long run trend in the GAP represents economic growth. This trend is positive for most countries, but can be negative (as is the case with some sub-Sahara African countries). The short run fluctuations around the trend represent business cycles. There are often business cycle downturns around a positive trend. If the GAP goes up from one ratter to the next, then we say that we are in the expansionary phase of the business cycle.

If the GAP goes down from one quarter to the next, then we say that we are experiencing a contraction. If the GAP goes down for at least two successive quarters, then we say that the economy is in a recession.