What is economics and why should we study it?

1. What is economics and why should we study it?

2. Global Economics Globalization is the process of integration of an economy into the world economy. This process involves output markets, labor markets, capital markets…. • Immigration and Economic Development • Technological Changes and Trade • Outsourcing • Foreign Investment and Currency • Currency and Trade • International Economic Shocks and Domestic Economics Stability • These are just some of the major venues through which world economy affects our economy

3. For the US see BEA

4. Income distribution in 2005: GDP per capita based on PPP Less than 1806.50 1806.50 – 4052.40 4052.40 – 7088.70 7088.70 – 19111.60 Greater than 19111.60 No Data Available

5. World Economy in 2005 Source: WDI for 2007

6. The planet Earth in the darkness of the night* * Image source: NASA (http://antwrp.gsfc.nasa.gov/apod/ap001127.html)

7. Correlation between life expectancy and the standard of living as measured by the GDP per capita (PPP) is positive 0.63, see the stats table

10. Economic development = quality of life

11. Evaluating Economic Activity • Output – production, the process of income creation • GDP - the total market value of all final goods and services produced by factors of production • located within a nation’s borders over a period of time • GNP - the total market value of all final goods and services produced by factors of production • owned by a nation over a period of time Relation of Gross Domestic Product and Gross National Product [Billions of dollars] www.bea.gov

12. Output and Income GDP and GNI • GDP is a measure of production, and production represents economic activity. Note that the sale of output is simply a transfer of ownership (or wealth), while the production of output is the process of generating wealth. The production generates incomes to the factors of production, which are then distributed to the inputs: • pay wages to employees • pay interest to lenders • pay profit to capital owners etc. • Therefore total value of output is equal to total income. In what we can consume we are limited by what we produce. • Therefore GDP per capita (GDP/population) is a measure of average income in a country.

13. Understanding GDP • How should the following count? • Purchase of MSFT shares through e-trade broker • Purchase of a previously owned house • Purchase of a new house from a construction company • Purchase of a used car from a private individual • Purchase of a used car from a used car dealer • Purchase of a class at GSU • Build up of dealer inventories? • Cooking your own meal? • Going out to a restaurant?

14. Understanding the GDP II • How should the following count? • Purchase by Ford Comp. of new tires from a tire supplier? • Purchase by me (private car owner) of new tires from a tire supplier • Purchase of oil by an American oil company from another American oil company (oil is domestically extracted) • Purchase of oil by an American oil company form a foreign supplier of oil • Receipt of dividends by a US resident from a Russian company • Production of new Nissan Altima cars by a US based Nissan Facility • Production of new VW Jetta cars by a Mexico-based VW facility

15. Comparing Incomes Across Countries • Real PPP GDP per capita as a measure of the standard • of living. • Standard of living: Income/Prices • Read GDP as a measure of income • Adjustment for the cost of living: difference in prices • Purchasing Price Parity – adjustment for the cost • of living. Prices differ across countries creating • differences in purchasing power of money. For • instance, 1000 USD buys more (today, probably less) in • Moscow than in Atlanta. • Constructing a cost of living index • Fixing a market basket • Tracking that market basket through different locations

16. GNI per capita in 2001, PPP method (current international $) World Bank Development Indicators for 2003 Less than 1710 1710-3560 3560-6250 6250-15110 Over 15110 No data available

17. Income distribution in 2004 Lower income group: GNI per capita PPP< $1878 Lower middle income: GNI per capita PPP < $4244 Middle income group: GNI per capita PPP <7515 Upper middle income group: GNI per capita PPP < $18589 High income group: GNI per capita PPP > $18589

18. Real GDP growth rate in 2000 World Bank Development Indicators 2003 Less than –0.6 -0.6 < . < 0.8 0.8 < / <2.1 2.1 < . < 4.2 Over 4.2 No data available

19. Real GDP growth rate in 2001 World Bank Development Indicators 2003 Less than –0.6 -0.6 < . < 0.8 0.8 < / <2.1 2.1 < . < 4.2 Over 4.2 No data available

20. Evaluating economic activity - Inflation • Inflation – the rate of growth in the average of all prices • Measuring inflation: • Price Index • CPI • PPI • Core Index • Real versus Nominal measures • US statistics: www.bls.gov

21. Real versus Nominal Nominal GDP growth rate = output growth rate + price level growth rate USA

22. Characteristics of Recent US inflation • Low level • Non-uniform • Impact of dollar exchange rate/weaknesses in foreign economies in the 1990’s; a characteristic of globalization in the output markets • Recent impact of the price of Oil

23. Impact of Inflation • Menu costs • Redistribution of wealth • Instability of relative prices • Currency value – the law of one price for internationally traded goods • Increased costs associated with forward looking financial arraignments Sources of Inflation • Tight labor market • Overheated economy: US in the late 1990’s • Strong Monetary Expansion • Germany in the 1920’s; Russia in the early 1990’s • Rapid increases in input costs (other than labor) • US economy today and the price of Oil • Currency depreciation • Recent dollar depreciation, particularly against the currency of China

24. Short international comparison

25. Evaluating economic activity - Unemployment • Defining labor force, unemployment, labor force participation rate • Measuring unemployment • US unemployment statistics: www.bls.gov • Structural and cyclical unemployment

26. In 2001 EMU includedAustria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxemburg, The Netherlands, Spain, Portugal

27. Supply - Demand • Market • Product definition • Geographical boundaries • Demand: Q = F (P, all other relevant factors) • Law of demand: as Price increases quantity demanded decreases • Relevant factors • Income • Normal: Income increases  demand increases • Inferior: income increases  demand decreases • Related in consumption goods • substitutes: Px increases  demand for Y increases • MARTA and GSU parking • Complements: Px increases  demand for Y decreases • GSU parking and gasoline use • And many other factors… • Interesting demand functions: • Vertical demand: no price sensitivity • Gasoline demand in the short-run • Your demand for this class if you are one class away from graduation

28. Supply - Demand • Supply: Q = F (P, all other relevant factors) • Law of supply: as Price increases quantity supplied increases • Relevant factors • Cost of production • Cost of factors of production • Wages, interest rate • Production technology • Productivity and cost of production • Related in production goods • Substitutes in production • Same resources can be used to produce either good • Condos versus single family homes • Complements in production

29. Market equilibrium(private goods with no externalities) • Quantity demanded = quantity supplied • Market clearing • No excess supply or shortage • Properties of the Market Equilibrium • Stability • Efficiency: • Welfare to society • Consumer surplus • Producer surplus

30. ForEx Defining the Market: Institutions facilitating the market: Major Private Banks Central Banks Market Participants: Banks, Central Banks, Corporations, Investors, even consumers.

32. Brief History of the International Monetary System

33. Gold Standard: 1880 - 1914 • Dates of adoption of a gold standard • 1695: United Kingdom at £1 to 113 grains (7.32g) of gold. • 1818: Netherlands at 1 guilder to 0.60561g gold • 1854: Portugal at 1000 reis to 1.62585g gold • 1871: Germany at 2790 Goldmarks to 1kg gold • 1873: Latin Monetary Union (Belgium, Italy, Switzerland, France) at 31 francs to 9g gold • 1873: United States de facto at 20.67 dollars to 1troy oz • 1875: Scandinavian monetary union: (Denmark, Norway and Sweden) at 2480 kroner to 1kg gold • 1876: France internally • 1876: Spain at 31 pesetas to 9g gold • 1878: Finland at 31 marks to 9g gold • 1879: Austria 1893: Russia at 31 Roubles to 24g gold • 1897: Japan at 1 yen to 1.5g gold • Price Stability • Simplified conversion • No Future markets

34. 1918-1939 • Great Depression and lack of international cooperation • 1925 -1931 UK operates on Gold Standard • US remains on Gold Standard till 1933 • Fixed exchange system

35. Post WWII era • Bretton Woods • IMF and the Gold Exchange Standard • Gold Exchange Standard • Fixed system with limited (1% allowable adjustments) • Dollar is convertible into gold at 35 USD per 1 Oz • Very few monetary reforms are undertaken by member states • 1950’s – 1960’s • August of 1971 USD is no longer a convertible currency • The Smithsonian Conference of December of 1971 • 38.02 USD = 1 oz • Dollar remains inconvertible • Increased allowable adjustment to 2.25% • March of 1973 FLOAT begins

36. Spot market • http://www.federalreserve.gov/releases/h10/Update/default.htm • Ask and Bid prices and the spread • Ask – Bank’s asking (bank’s sales price) • Bid – Bank’s purchase price • Spread – return to the market maker, in this case the bank • Consider the following rouble quote: Ask Price: $0.0425; Bid Price: $0.0420 • Alignment of exchange rates • Arbitrage • Simple setting (2 or more currencies): • Consider two banks quoting the rouble: • Bank I: $0.0425 - $0.0430. • Bank II: $0.0435 - $0.0440 • Price difference falling within the spread • Setting 2: implied exchange rate (3 or more currencies): • Consider tw banks providing the following quotes: • Bank I: Between Rouble and Dollar: R1 = $0.0425 Between Rouble and Euro: R1 = EUR 0.030 Implied USD/EUR rate is: USD1 = 0.7059 • Bank II Between Rouble and Dollar: R1 = $0.0425 Between Rouble and Euro: R1 = EUR 0.031 Implied USD/EUR rate is: USD1 = EUR0.7294 • Are profits from arbitrage possible?

37. Currency Index: USD Index by the FED

38. USD weights Source: FED

39. Source: FED

40. Recent performance of the USD $/Euro Source: FederalReserve.gov: http://www.federalreserve.gov/releases/h10/Hist/

41. Source: FRB, NY

42. Role of the exchange rate in the price of oil Source for historical oil price data – US Dept. of Energy, http://tonto.eia.doe.gov/dnav/pet/pet_pri_spt_s1_d.htm

43. The ForEx Market • Supply of the USD • Imports to the US • Goods (trade) • Services (tourism) • US investment abroad • Foreign Financial Markets • Direct investment abroad • Central Banks • Speculation • Demand for the USD • US Exports • Goods • Services (tourism) • Foreign Investment into US • US Financial markets • Direct investment • Central Banks • Speculation

44. The Interesting 90’s • 1991-92: Collapse of the USSR Block, beginning of the Transitional Recession in Eastern Europe • 1994 Mexican Currency Crisis • 1991(2)-95 The Balkan Wars • 1998 Recession in Japan • 1997 (July) Beginning of the Asian Financial Crisis • 1998 major Rouble Crisis

45. The market for USD in the 90’s P of USD Influx of investment stimulated Demand D S Increase in imports stimulated Supply Demand Effect Dominated (thus positively effecting consumers’ standard of living)

46. The post 90’s era • United Europe • 10 New Countries Entered the Union on May 1st of 2004, bringing the total number of member states to 25, with combined population of over 430 million (US population is 293 million). • Growth in Russia and China nearing double digits • Emerging Economies of Brazil and India • Threat of Terrorism to the US • Continuous Growth in US Trade Deficit

47. The market for USD in the post 90’s era P of USD D S Supply effect appears to be dominating The demand effect

48. The BIG picture • Rise in Imports  Increase in Supply  Depreciation • Rise in Exports  Increase in Demand  Appreciation • Influx of Investment  Increase in Demand  Appreciation • Outflow of Investment  Increase in Supply  Depreciation

49. Modern Economic Systems • A modern Mixed Economy: Capitalism with elements of Socialism • An economic system • Capitalism • Socialism • Communism • An economic system and economic efficiency • What? How? For Whom? • Market Economy versus Command Economy

50. Data for 2001, source: World Bank