Eco 112

1.Discuss short run, long run, and very long run analysis in macroeconomics

Macroeconomics consists of three realms: short run, long run, and the very long run. These are ways in which an analysis of the economy can be conducted with respect to time. Until today, the different types of national government policies are made based on these models of analysis.

short run graph

In the short run, firms cannot change the prices because there is a lack of time for the price to manifest in the market. If prices cannot change, then increasing amounts of labor hired without driving up the price. Graphically, the constant price is represented by the horizontal aggregate supply curve and the demand is represented by the sloped aggregate demand curve. A shift in the aggregate demand curve would mean an increase in the hiring of workers and since prices cannot adjust in the short run, an increase in output of the economy is observed.

In the long run, firms have the ability to change prices because there is now enough time for prices and wages to adjust. The government now becomes ineffective in changing output because if it plans to hire more workers, prices will now adjust thus making it impossible to improve upon the economy. However, the government should have a role in stabilizing the price. Graphically, the aggregate supply curve is now vertical and any change in price or shift in the aggregate demand curve would still result in the same output, the AS curve is perfectly inelastic. This is the AS curve of the neoclassical economists. The neoclassical economists say that if there is 100 pesos lying on the ground, it is not just going to remain there and it will be injected into the economy. 100peso lying on the ground

In the very long run analysis, to increase output we must shift the overall AS curve. Technological progress, everything which we cannot explain that makes our lives better, is the key to a higher AS curve. At a higher AS curve, the same capital and labor would result in a higher output. For example, 5 programmers with 5 laptops produce 100 programs a year, then all of a sudden this output rises to 150 programs a year with the same amount of programmers and laptops, that is technological progress.

In the end, any macroeconomic policy should not be recommended based solely on this piece of evidence. There are many factors in an economy to take into account such as the characteristics of a nation and the political position of a certain macroeconomic policy. For example, the Philippine government has high tariffs on basic consumer goods such as rice, to be able to protect local farmers from the cheaper prices abroad ; A neoclassical economist would be against these trade barriers and support the removal of these tariffs. The removal of these tariffs should result in lower prices, but could cause a riot and political instability which is not considered by an economist.

Short run
Firms cannot change price because there is a lack of time for these changes to take place the government is effective in changing output and unemployment the Keynesian AS curve
Long Run
Firms have the ability to change price the government is ineffective in changing output or unemployment gov't should just stabilize price because policy will only change the price the capacity of output is given
AS curve of the neoclassicals
Very Long Run to increase output we must shift the supply curve we can do this through technological progress, everything which we do not know which makes our lives better ex. education, increase productivity same amount of capital and labor
Neoclassical believe that wages adjust quickly, and according to the graph, AS0 -> AS1 -> AS2 happens in months. The Keynesians believe that prices and wages take time to adjust that AS0 -> AS1 -> AS2 happens in years. For the Keynesians, policy changes at

Mainstream view
Neoclassicals view prices and wages adjust quickly
AS0 -> AS1 -> AS2 in months
Keynesian view prices and wages take time to adjust
AS0 -> AS1 -> AS2 in years
Original Keynesian
Moving along the AS curve AD moves from elastic -> intermediate -> inelastic at lower levels of output policy (price change) is effective in changing income and unemployment ex. Delivery truck to increase output permanently shift in the aggregate supply curve
2. Discuss the main use of GDP and its weakness. Discuss the main use of GDP per capita and its weakness.
Value of all final goods and services produced in the country with a given period (“gawadito sa Pilipinas”)
Income; output
Factors of production
Factor payments
Production function Y=f(N,K) Y =(w x N) + (r x K) + profit Y=C + I + G + (X - M) Y=C + S + T
Weaknesses:
Government services are not directly priced by the market
Fails to account for productive non-market activities
Fails to account for environmental destruction/ loss/ quality improvement
NDP
GDP per Capita

Income per person
Average income
Used to measure standard of living
Weaknesses:
Not a perfect measure
Injustice: rich gets richer; poor gets poorer fails to account for Political rights, Social justice, Religious Freedom, Psychological well being, employment, poverty, standard of living.
3. Discuss nominal GDP, real GDP growth using constant prices, and real GDP growth using chain weighted prices

Nominal GDP measure the physical output in the economy by valuing newly produced goods and services during a fixed period of time at current prices. Physical output refers to the market value. The GDP only takes into account good and services within a fixed period of time. Nominal GDP marks these goods and services at current prices.

Nominal GDP measures the physical output in the economy by valuing all goods and services at current prices gains in nominal GDP is a mix of the change in value of aggregate good and services and changes in prices
Nominal vs Real GDP
If you compute nominal GDP, it can seem like the economy has grown even though only the prices have changed ex. if 100 fishes valued at 20 pesos each is counted in the 2007 GDP then all of a sudden there is a shortage and the 100 fishes that an economy has in 2008 is valued at 50 pesos, the nominal GDP would grow tremendously but the same cannot be said for the value of the products and the economy.
Real GDP growth using constant prices measure the physical output in the economy by valuing all goods and services at prices of a specific period
Real GDP chain weighted measure the physical output in the economy by valuing all goods and services at average price of a specific time range
Constant vs Chain weighted
Probelm with computing real GDP with constant price is that it seems like prices never change. WIth goods whose prices go down and quantities go up get too much weight in GDP calculations.
An orange in 1980 has practically the same value as an orange in 2013, but a computer does not its value and quantity changes with respect to its role in society
4. Differentiate between GDP deflator and CPI

Measures change in P
Everything that is produced in the economy
Innovation and changes in technology
Not as responsive as CPI to price
Suitable for international comparison
CPI
Measures cost of living of a fixed basket of goods and services representative of consumer purchases
Place more weight on more important things
Only those typically consumed by Filipinos
Goods are the same weights are the same
Directly measures important imported goods
Responsive to price
Suitable for domestic comparison
PCE vs CPI
CPI is a fixed basket of goods, meaning if the price in one good changes it affects the CPI
However, the CPI fails to take into account the basic economic concept of substitute goods
For example, if a person buys 10lbs each of fish and meat every week and then one week suddenly the price of meat increases 10 fold due to some cow epidemic, the buyer would have more incentive to buy fish since it is much cheaper, but using the CPI would still assume that meat has the same weight despite its price quality adjustment bias
For example, if the price of an aircon increases 10%, but its quality increases by 10% also then even if the consumer is paying more he is receiving more capacity.
PCE can be revised
5. In an economy with no gov't and no international sector, show how investment equals savings. In an economy with government and no international sector, show how gov't budget deficit can hurt investment. Show how gov't budget surplus can help investment

By using the expenditure approach and the income approach, used to compute GDP,
Expenditure = consumption + investment + government + (export - import)
Income = Consumption + savings + tax
The consumption earned is usually the consumption spent and in equilibrium the number of exports and imports would cancel each other out. This leads to the equation where saving is equal to investment.
Government budget surplus it is when taxes collected exceed government expenditures
A government budget deficit would mean crowding out of private investment because the government uses public investment to balance its budget
The excess taxes can be used to increase investment