BUS 530: ECONOMIC CONDITIONS ANALYSIS LECTURE: 1 Introduction and Data of Macroeconomics

1. BUS 530: ECONOMIC CONDITIONS ANALYSIS LECTURE: 1 Introduction and Data of Macroeconomics

2. Course Overview • Prerequisites • Bus 525 • Requirements and Grading • Four class tests (20%) • One midterm (20%) • Paper (20%) • Final (40%) • Class Materials • N Gregory Mankiw. Macroeconomics. Sixth Edition. • Web-page: http://fkk.weebly.com • Office: NAC 751 • Office hours: Friday 2pm-3pm, Sunday 5pm-6:30 pm.

3. Activity Schedule : BUS 530

4. Make-up Policy • There will be only one make-up for all examinations (mid-terms and final, no make-up for class tests ) towards the end of the course to accommodate force majeure. All examination dates are pre-announced. Please make necessary arrangements with your office. • Historically, the performance of students taking make-up examinations were always poorer compared to students taking examinations on schedule. • I hope you will appreciate that it is not practical to offer a customized course for any or group of individual student(s).

5. Learning Objectives We will begin with: • the issues macroeconomists study • the tools macroeconomists use • some important concepts in macroeconomic analysis

6. Important Issues in Macroeconomics Macroeconomics, the study of the economy as a whole, addresses many topical issues: • Why does the cost of living keep rising? • Why are millions of people unemployed, even when the economy is booming? • What causes recessions? • Can the government do anything to combat recessions? Should it?

7. Important Issues in Macroeconomics Macroeconomics, the study of the economy as a whole, addresses many topical issues: • What is the government budget deficit? How does it affect the economy? • Why does countries such as the U.S. have such a huge trade deficit and China have huge trade surplus ? • Why are so many countries poor? • What policies might help them grow out of poverty?

8. The Historical Performance of Bangladesh Economy Source: Bangladesh Bank

9. GDP versus Population Growth Rates in the 1980’s GDP Growth Rate in the 1980’s GDP and Population Growth Rates Source: BBS and World Bank 9

10. The Historical Performance of Bangladesh Economy Source: Bangladesh Bank

11. Growth rate remains robust…2010 11

12. The Historical Performance of Bangladesh Economy Source: Bangladesh Bank

13. Inflation situation • Source: Central bank of respective country

14. The Historical Performance of Bangladesh Economy The unemployment rate of Bangladesh does not show the correct picture. According to CIA Factbook, 40% are under employed.

15. Trend in the value of Bangladeshi Taka against US $ Source: Bangladesh Bank 15

16. 9/11/2001 First oil price shock Great Depression Second oil price shock World War II U.S. Real GDP Per Capita (2000 dollars) long-run upward trend…

17. U.S. Inflation Rate(% per year)

18. U.S. Unemployment Rate(% of labor force)

19. Why Learn Macroeconomics? 1. The macroeconomy affects society’s well-being. In the US, each one-point increase in the unemployment rate is associated with: • 920 more suicides • 650 more homicides • 4000 more people admitted to state mental institutions • 3300 more people sent to state prisons • 37,000 more deaths • increases in domestic violence and homelessness

20. change from 12 mos earlier percent change from 12 mos earlier Why Learn Macroeconomics? 2. The macroeconomy affects your well-being. In most years, wage growth falls when unemployment is rising.

21. How Economists Think? Economists use models to understand what goes on in the economy. Economic models: …are simplified versions of a more complex reality • irrelevant details are stripped away …are used to • show relationships between variables • explain the economy’s behavior • devise policies to improve economic performance

22. Endogenous vs. Exogenous Variables The values of Endogenous variables are determined in the model. The values of Exogenous variables are determined outside the model: the model takes their values & behavior as given. In the model of supply & demand for cars,

23. A Multitude of Models No one model can address all the issues we care about. e.g., our supply-demand model of the car market… can tell us how a fall in aggregate income affects price & quantity of cars. cannot tell us why aggregate income falls. So we will learn different models for studying different issues (e.g., unemployment, inflation, long-run growth). For each new model, you should keep track of its assumptions which variables are endogenous, which are exogenous the questions it can help us understand, and those it cannot

24. What is a Macro Model? • A macro model is a mathematical structure that describes the economy. A mathematical structure is a set of equations, which allow us to understand the economy more fully and to predict what happens to it.

25. Feature of a Good Macro Model • Should include the variable that we want to predict • Should capture the most important factors whose effects we want to determine • Its equations should be consistent with the way the variables are defined and measured • Its equations should be easily defended • Should make predictions that are qualitatively in line with the real world • Should be easy to use

26. A Simple Sample Model Y = C + I + G Here, Y = income C = consumption I = investment G = government spending This comes from the definition of GDP and the way it is measures. Remember, that GDP is a measure of output, income and spending

27. Another Simple Sample Model C = 0.9 (Y – T) It relates consumption to income taxes. When income tax is deducted from a person’s paycheck, disposable income is found. The equation suggests people spend 90% of their disposable income and save the rest

28. Class Exercise 1 1. Solve for Y, given G = 2000 T=2000 I = 900 2. What is Y, if taxes fall from 2000 to 1900?

29. The Data of Macroeconomics Now, we will discuss… …the meaning and measurement of the most important macroeconomic statistics: • Gross Domestic Product (GDP) • The Consumer Price Index (CPI) • The Unemployment Rate

30. GDP, CPI, Unemployment Rate • Gross Domestic Product (GDP) is the market value of all finalgoods and servicesnewly producedin a countryin a given period of time. • The Consumer Price Index (CPI) measures the level of prices. • The Unemployment Rate tells us the fraction of workers who are unemployed.

31. Gross Domestic Product: Expenditure and Income Two definitions: • Total expenditure on domestically-produced final goods and services. • Total income earned by domestically-located factors of production. Expenditure equals income because every Taka spent by a buyer becomes income to the seller.

32. Income Expenditure and the Circular Flow Income (Tk.) Labor Goods Expenditure (Tk.) Firms Households

33. Value Added Definition: A firm’s value added is the value of its output minus the value of the intermediate goods the firm used to produce that output.

34. Class Exercise 2 • A farmer grows a bushel of wheat and sells it to a miller for $1.00. • The miller turns the wheat into flour and sells it to a baker for $3.00. • The baker uses the flour to make a loaf of bread and sells it to an engineer for $6.00. • The engineer eats the bread. Compute & compare value added at each stage of production and GDP

35. Final goods, Value added, and GDP • GDP = value of final goods produced = sum of value added at all stages of production. • The value of the final goods already includes the value of the intermediate goods, so including intermediate and final goods in GDP would be double-counting.

36. Rules for computing GDP 1) To compute the total value of different goods and services, the national income accounts use market prices. Thus, if If apples cost $0.50 each and oranges cost $1.00 each GDP = (Price of apples Quantity of apples) + (Price of oranges  Quantity of oranges) = ($0.50  4) + ($1.00  3) GDP = $5.00 2) Used goods are not included in the calculation of GDP. 3) The treatment of inventories depends on if the goods are stored or if they spoil. If the goods are stored, their value is included in GDP. If they spoil, GDP remains unchanged. When the goods are finally sold out of inventory, they are considered used goods (and are not counted).

37. Rules for Computing GDP 4) Intermediate goods are not counted in GDP– only the value of final goods. Reason: the value of intermediate goods is already included in the market price. Value addedof a firm equals the value of the firm’s output less the value of the intermediate goods the firm purchases. 5) Some goods are not sold in the marketplace and therefore don’t have market prices. We must use their imputed value as an estimate of their value. For example, home ownership and government services.

38. Real GDP Versus Nominal GDP The value of final goods and services measured at current prices is called nominal GDP. It can change over time either because there is a change in the amount (real value) of goods and services or a change in the prices of those goods and services. Hence, nominal GDP or Y = P  y, where P is the price level and y is real output– and remember we use output and GDP interchangeably. Real GDP or, y = YP is the value of goods and services measured using a constant set of prices.

39. Real GDP is computed in our apple and orange economy. For example, if we wanted to compare output in 2002 and output in 2003, we would obtain base-year prices, such as 2002 prices. Real GDP in 2002 would be: (2002 Price of Apples 2002 Quantity of Apples) + (2002 Price of Oranges  2002 Quantity of Oranges). Real GDP in 2003 would be: (2002 Price of Apples  2003 Quantity of Apples) + (2002 Price of Oranges  2003 Quantity of Oranges). Real GDP in 2004 would be: (2002 Price of Apples  2004 Quantity of Apples) + (2002 Price of Oranges  2004 Quantity of Oranges).

40. Example GDP 2008 (nominal) = 500 * 6 + 200 * 30 = 9000 GDP 2009 (nominal) = 600 * 5 + 150 * 60 = 12000 GDP 2009 (real) = 600 * 6 + 150 * 30 = 8100 So nominal GDP rose, while real GDP actually fell

41. Chain-Weighted Measure of Real GDP In some cases, it is misleading to use base year prices that prevailed 10 or 20 years ago (i.e. computers and college). In 1995, the US Bureau of Economic Analysis decided to use chain-weighted measures of real GDP. The base year changes continuously over time. This new chain-weighted measure is better than the more traditional measure because it ensures that prices will not be too out of date. Average prices in 2001and 2002 are used to measure real growth from 2001 to 2002.Average prices in 2002 and 2003are used to measure real growth from 2002 to 2003 and so on. These growth rates are united to form a chain that is used to compare output between any two dates.

42. Chain-Weighted Real GDP Over time, relative prices change, so the base year should be updated periodically. In essence, chain-weighted real GDPupdates the base year every year, so it is more accurate than constant-price GDP. Your textbook usually uses constant-price real GDP, because: the two measures are highly correlated. constant-price real GDP is easier to compute.

43. Total demand for domestic output (GDP) Investment spending by businesses and households is composed of Net exports or net foreign demand Government purchases of goods and services Consumption spending by households Components of Expenditure Y = C + I + G + NX This is the called the national income accounts identity.

44. Bangladesh GDP Composition, 2009 - 2010 Tk. crore % of GDP Consumption Investment 169511 24.41 Government 110523 15.38 Net Exports -62093 -8.9 BDT 554771 79.9% Source: Bangladesh Bank & Unnayan Onneshon

45. Consumption (C) Definition: The value of all goods and services bought by households. Includes: • Durable goodslast a long time ex: cars, home appliances • Nondurable goodslast a short time ex: food, clothing • Serviceswork done for consumers ex: dry cleaning, air travel.

46. U.S. Consumption, 2005 $ billions % of GDP Consumption Durables 1,026.5 8.2 Nondurables 2,564.4 20.5 Services 5,154.9 41.3 $8,745.7 70.0%

47. Investment (I) Definition 1: Spending on [the factor of production] capital. Definition 2: Spending on goods bought for future use Includes: • Business Fixed InvestmentSpending on plant and equipment that firms will use to produce other goods & services. • Residential Fixed InvestmentSpending on housing units by consumers and landlords. • Inventory InvestmentThe change in the value of all firms’ inventories.

48. U.S. investment, 2005 $ billions % of GDP Investment Business fixed 1,329.8 10.6 Residential 756.3 6.1 Inventory 18.9 0.2 $2,105.0 16.9%

49. Investment vs. Capital Note: Investment is spending on new capital. Example (assumes no depreciation): • 1/1/2006: economy has $500b worth of capital • during 2006:investment = $60b • 1/1/2007: economy will have $560b worth of capital

50. Flow Stock Stocks vs. Flows A stock is a quantity measured at a point in time. E.g., “The U.S. capital stock was $26 trillion on January 1, 2006.” A flow is a quantity measured per unit of time. E.g., “U.S. investment was $2.5 trillion during 2006.”