Economics 2 Notes

Macroeconomics: we are interested as the economy as a whole.

Week 1:
DAY ONE
Overview:
1) Short run issues
a. What explains SR fluctuation in the economy? (Business cycle, Recessions, Boosts, etc.)
b. Government policy (monetary and fiscal policy)
c. Price level fluctuations
d. Interest rates
2) Long Run issues
a. What explains LR economic growth?

GDP: Gross Domestic Product
1) Definition: the market value of all newly produced final goods and services within an economy over a given period of time.
a. Market value is where we used current market price to value goods. (in principle: GDP= p1q1+p2q2…+pnqn where q is the quantity and p is the market price)
b. Buzz word: PRODUCTION
c. Must adjust for inflation (when price increases)
d. Intermediate good: a newly produced good “used up” in production of another good in that given period. (exclude to avoid double counting)
e. GDP in a given period does not include resale of goods produced in previous periods
f. Within a country…:U.S. GDP includes ALL newly produced goods regardless of who owns the inputs
2) Components of GDP (Y): Y=C+I+G+NX
a. Consumption (C): includes consumption spending on goods and services (68%)f
i. Includes durable (cars) and nondurable (food) goods. ii. Services include medical, entertainment, education, etc. (includes housing services : Gov’t calculates and imputed rental value)
b. Investment (I): 16%...
i. Fixed investment: Purchase of a newly produced capital goods ii. Inventory investment: This refers to the change in level of inventories. (beginning of year, end of year inventory) iii. Capital goods: an input which is itself produced iv. Inputs (“factors of production”) … labor and capital and human capital
3) Accounting identities
4) Nominal vs Real GDP

DAY TWO:
National Income Accounting: Y= C+ I + G+ NX
Fixed Investment: Residential (New Homes) , Non-residential (Business stuff)

Calculating GDP…
Income = Expenditure
Ex. 3 goods: electricity, steel, cars…
Electric company: produces $1000 of electricity (500 goes to households, 500 goes to car company)
Steel company: $1000 of steel (all goes to car company)
Car company: $5000 cars sold to home.
Therefore $5500 is the GDP
Ex.
Electric company: $700 wages (1000-700=300)
Steel company: $500 Wages (1000-500=500)
Car company: $3500 Wages (5000-3500-1000-500= 0)
WAGES+PROFITS= GDP= TOTAL INCOME
NOMINAL GDP VS REAL GDP
Real GDP is calculated with a base year market price.
Nominal GDP is calculated by using current market price.
Nominal GDP is GREATER than Real GDP for a given year when price level is higher than base year

Week 2:
DAY 3 www.cia.gov: World fact book
#2 is the U.S.
What we care about is the real GDP per capita.
RGDP per capita= RGDP/population
Developed does not equal rich.
Human Development Index (HDI) Shows how developed a country is.
1) Income
2) Health (Lifespan)
3) Education
Why do we care?
GDP measures the std. of living.
Robust and sustained growth
Ex. 1970-2002  US Growth rate= RGDP per capita = 2% RGDP= 3%
(Per capita is 1% less is due to population growth) (40%) Immigration+ (60%) Natural cause
Rule of 70 (actually 72)
70/growth rate= how much time it takes to double
Earthquake in Haiti (200,000 died) and Chili (1,000 died)
Simple Growth Model: (Solow)
Y= Real GDP, L= Labor, N= Natural Resources, A= Level of technology, H= human capital (labor with education), K= physical capital (tools, trucks, building)
Y= A F(K,L,H,N) Aggregate production function.
Productivity
Divide both sides by Labor.
Y/L= A F(K/L, L/L, H/L, N/L) y= K/L
Ceteris paribus: All else equal (Holding everything else constant) This is used so we can compare 2 variables
Capital per worker graph increases at a decreasing rate (y vs k) . (Law of diminishing marginal returns)
Catch-up effect or “convergency”: small economies tend to grow faster than large economies.
What makes an economy grow?
1) Education
2) R&D (Research and development) leads to improvement in technology coefficient (A))
3) Property rights (patent, copyrights)
4) Political stability
5) Investment (I) (like PP&E from 1A)
6) Nutrition (Fogel: 1790-1980 30% increase in economic growth) Netherlands has tallest people
7) Free Trade: Stiolitz, export orientated (chile is a good example, japan, south korea) - Import-sub/ inward-oriented: these policies are often implemented. (tariffs are put on imports to create own economy) (1947 India!) They wanted self sufficient villages. FREE TRADE PROMOTES ECONOMY.
FDI (Foreign Direct Investment)
1) Political instability leads to worse investments
2) Portfolio investment: purchases of stocks and bonds (Greece, billions of dollars left the country.)

Day 4:
Video clip: comparing the poor and sick and the wealthy and healthy. Eventually the western countries became wealthier and healthier. The gap between countries is closing (converging theory) www.bea.gov (GDP) and www.bls.gov (Inflation and unemployment) www.cia.gov (world factbook, country comparison)
Financial Market: Loanable Funds Market
Commercial banks: accept deposit interest % Supply or savings (lending) make loans interest is reward for those who save Demand (borrowing)
Higher interest rate= incentive to save $ funds
Where the supply and demand cross is the equilibrium interest. (Long term interest rate)
Who borrows the funds?
Households
Student loans
Businesses
Government: must finance their deficit.
Either through public or foreign countries
Larger deficit= large demand so shift to the RIGHT
CROWDING OUT EFFECT: increasing pressure on interest rate eventually discourages investment
Nation Saving  Savings Private + Savings Public (Closed economy: no exports and imports NX=0)
Y=C+I+G
Y-C-G=I  Y-C-G+T-T = I+T-T
Y (income) – T – C = Savings Private
T-G= Savings Public
Savings Public +Savings Private = I
Therefore National Savings= I + NX (Open)
Increase in deficit, Savings in public is going down. Therefore supply decreases.

Factors that shift supply of funds:
1) Incentive such as IRA for savings (Individuals retirement account)  shift right
2) S. Korea (save money shift right)
Factors that shift demand for funds:
1) Optimistic view
2) Tax incentive or credit for investment
Inverse Relationship between Bonds and Interests:
BOND: A written agreement to pay a certain amount principle (or face or per value) and interest at certain time (maturity date)
How much to pay? $1 is worth more today than tomorrow. There is always risk.
PV=FV/(1+i)^n
Some bonds don’t pay interest (Zero-Coupon bond)

Week 3:
­Day 5: (Consumption is the most stable component of GDP)

Numerical example of SeI.
Y= 10,000 (GDP) C= 6,000 (Consumption) T= 1,500 G=1,700 I= 3,300 – 100i (where i is the interest rate)
Find S(private), S(public), S(national), I and i
S(private)= Y-T-C= 10,000-1,500-6,000= 2,500
S(public)= T-G= 1,500-1,700= -200
I= S(private) + S(public)= 2,500 – 200 = 2,300
S(National) = I+NX = 2,300
2,300 = 3,300 – 100i …… i=10

Numerical Example of Bond:
Consider a bond with $1,000 face value. (there is also par value and principle)
This bond expires 1 year from now. (Maturity rate)
This bond pays no interest. (zero-coupon bond)
Why buy a bond with no interest? (B/C you buy for a discounted price)
Suppose the current price is $950.
Rate of return (RR or interest rate) = earnings/cost of investment. 50/950 = 5.26%
What is demand of bond increase, then Price of the bond increases too.
Conclusion: Bond prices and interest rate are “INVERSELY RELATED”
Principle Value = $1,000/(1+d)^n
Conclusion 2: Equally risky assets must have the same return. (Arbitrage)
3 rating agencies  Moody’s, S&P, Fitch.
1) AAA is the best ranking
a. Johnson and Johnson
b. Exxon
c. Microsoft
2) BB- is the worst – junk bond.
3) USA is now AA. Used to be AAA.
4) Has to do with political stability.

Lehmon Brothers: Amount of borrowing  leverage ratio (debt/equity)
Example: Purchase a house for $400,000. Unpaid mortgage = $320,000. Equity = $80,000
Leverage for this person is $400,000/$80,000 = 5
Housing Boom in 2007> Leverage ratio was up to 44.
10% drop in assets. 105  94.5. (Net worth = Assets – Liabilities) (When a company owns less than it owes it is called Insolvency)

Unemployment: Current UR = 5.6% as of December 14.

Starts with the total population. 320 million from census. (U.S.) World = 7.2b
320 million – children (under 16) – military personnel – institutionalized population (75 million)
This is known as the adult, non-institutionalized, civilian population = 245 million.
This can be split again into 2 groups
Labor Force (LF)=155m
Employed = 147m
Unemployed= 8.3m
NLF = 90 million
UR = unemployed = 5.6%
LFPR (Labor Force Participation Rate) = L.F./Adult Pop = 63%
U.S. Population Survey  60,000 Households.
1) Did you work for one hour for pay in the past week?
If volunteer work is < 20 hours it is considered unemployed.
2) Are you looking for a job?
NLF  Discouraged Worker (FFFFFFFFFFF)
P/T and F/T job
Quality of jobs (underemployment)
UR differs a lot. (5.6% is a nation average)
North Dakota UR= 2%