Basic Concepts of Macroeconomics

Nominal GDP and Real GDP

  • Nominal GDP is the value of GDP measured at current Prices. Real GDP is nominal GDP adjusted for price changes. Thus Real GDP is the value of current output measured in constant base year prices.
  • GDP deflator is the measure of overall price level change. Example to Calculate the GDP Deflator for 2014 = (Nominal GDP 2014/Real GDP2014) x 100
  • We can calculate the Inflation Rate using the growth rate of GDP Deflator. For example to calculate the Inflation Rate from 2014 to 2015, Inflation Rate Between 2014 and 2015 = [(GDP Deflator 2015 – GDP Deflator 2014)/GDP Deflator 2014] x 100
  • If real GDP decreased by 1% and nominal GDP increased by 2%, then output decreased and the price level increased.
  • If real GDP increased by 2% and nominal GDP increased by 2%, then output increased and the price level remained unchanged.
  • If real GDP increased by 2% and nominal GDP increased by 4%, then output increased and the price level increased.
  • If real GDP increased by 2% and nominal GDP increased by 1%, then output increased and the price level decreased.
  • If nominal GDP increased from $5,000 billion in 2010 to $5,500 billion in 2011 and the GDP deflator increased from 130 to 140 over the same time period, the 2011 real GDP equal expressed in terms of 2010 dollars would be $5,107 billion.
  • If nominal GDP rises from $5 billion to $6 billion, when the GDP deflator goes from 100 to 110, real GDP rises.
  • If nominal GDP rises from $5 billion to $6 billion, when the GDP deflator goes from 100 to 130, real GDP falls
  • If real GDP increases and the price index also increases the percentage increase in nominal GDP must have been greater than the percentage increase in the price level.
  • Nominal GDP has risen faster than real GDP in the last decade because the price level has increased
  • When real GDP declines in a particular year, nominal GDP will decline at a slower rate than real GDP if there is inflation.
  • If nominal GDP rose by 10 percent and the price index increased from 100 to 105 in a given year, real GDP rose by 5 percent.

National Income Accounting and Calculation of GDP

  • Total income received by households is called personal income
  • Household income after taxes is called disposable personal income.
  • Depreciation is an allowance for the replacement of capital.
  • Personal income includes wages and salaries, income received in the form of transfer payments, interest earnings on bonds.
  • GDP includes business purchases of investment goods, such as factories
  • GDP includes government purchases of military equipment.
  • GDP includes the building of a new apartment complex.

Limitations with using the concept of GDP

  • The problem with using real GDP as a measure of economic well-being is that it does not account for production within the household.
  • Real GDP fails to measure the value of leisure.
  • Real GDP fails to measure the underground economy.
  • Real GDP does not factor in externalities.
  • Measures of well-being include pollution levels, infant mortality rates as well as literacy rates. GDP fails to adequately account for the following factors that affect our well-being such as changes in the quality of goods, externality and leisure.
  • Example of what leads to GDP underestimating our true output: Gretchen begins an accounting and bookkeeping service in her home, accepting cash as payment, which is not reported to tax authorities.

The Underground Economy

  • The underground economy includes both legal and illegal sources of unreported income.
  • The underground economy includes legal activities that are concealed for the purpose of tax evasion.
  • Underground economies represent a greater percentage of GDP in developing countries than in developed countries. Higher taxation and labor regulation are reasons why we see more underground activities.
  • If country A had a smaller underground economy than country B, and country A's citizens worked more hours per week than the citizens of country B, other things equal, then GDP comparisons between the countries would overstate the economic welfare of country A compared to B.
  • The era of Prohibition began in 1920 when the Volstead Act was passed to implement the Eighteenth Amendment to the Constitution, which prohibited the production and sale of liquor and beer. In 1920 much of this activity went underground, and Al Capone became a leading illegal entrepreneur. Assuming the amount of liquor and beer produced stayed the same, what was the effect of the Volstead Act on the GDP in 1920? GDP would have declined, since activities in the underground economy are not included.

Gross National Product Per Capita

  • Real output per capita is measured by real GDP per capita. Real output per capita is total real output (real GDP) divided by the number of persons among whom it will be distributed.
  • Real output per capita is one measure of the average level of economic wellbeing in a country.

Real GDP, Nominal GDP and Price Index

  • Real GDP equals nominal GDP divided by the current price level index, times one hundred.
  • A price index can fall from one year to the next even when nominal GDP falls.
  • A price index can fall from one year to the next even when real GDP falls.
  • A price index can fall from one year to the next even when some individual good's prices rise.

Economic Growth and Shifts in Production Possibility Frontiers

  • Growth in a production possibilities curve diagram is shown as an outward shift of the curve.
  • To achieve a high standard of living, a nation should promote economic growth.
  • A very low birth rate will not cause the production possibilities curve to shift outward.
  • An increased entrepreneurial activity will cause the production possibilities curve to shift outward.
  • Improvements in the stock of land will cause the production possibilities curve to shift outward.
  • Increased educational opportunities will cause the production possibilities curve to shift outward.
  • Many citizens emigrating from a nation when a politically repressive regime takes office did not result in economic growth.
  • After World War II, the U.S. instituting the GI bill, which provided education subsidies to soldiers being released from service duty result in economic growth.
  • Cyrus McCormack inventing a threshing machine for harvesting grains result in economic growth.
  • Installing a network of irrigation ditches and pumping stations in order to grow fruits and vegetables in parts of southern California result in economic growth.
  • improved public education will cause the production possibilities curve to shift outward
  • improved health care systems will cause the production possibilities curve to shift outward
  • Larger budgets for research, development, and exploration will cause the production possibilities curve to shift outward.

The Rule of 70: Doubling of GDP of country

  • The rule of 70 which predicts the time required for the economy of a nation to double, is based on the mechanism of compound interest.
  • Country A and Country B initially have the same real GDP per capita. Country A experiences no economic growth, while Country B grows at a sustained rate of 5 percent. In 14 years, Country A's GDP will be approximately one-half that of Country B.
  • A country will roughly double its GDP in five years if its annual growth rate is 14 percent.

New Theories of Economic Growth

  • If productivity of an economy increases then the amount of goods and services produced by a worker per hour increases.
  • Over the last several decades, the amount of government investment in U.S. infrastructure in real terms has decreased.
  • Most modern economists agree that there is a single factor that can be used to explain economic growth. This is a false statement because nearly all economists believe that economic growth is a complex process without a single dominant factor.
  • increased infant mortality rates is not considered a factor that contributes to economic growth
  • technological advances is considered a factor that contributes to economic growth
  • increased labor productivity is considered a factor that contributes to economic growth
  • The migration of resources from areas of low productivity to areas of high productivity is considered a factor that contributes to economic growth.
  • Growth in the money supply relative to the growth of final goods and services is not considered a factor contributing to economic growth
  • Growth in physical capital inputs (machines, tools, buildings, and inventories) is considered a factor contributing to economic growth
  • Growth in the quantity and quality of labor resources used is considered a factor contributing to economic growth
  • Government protection of property rights is considered a factor contributing to economic growth.
  • When an economy experiences significant economic growth no observed relationship exists between output per capita and adult literacy rates.
  • New growth theorists believe that increased economic growth is primarily driven by technological innovation and ideas.
  • Rapid population growth can threaten sustained economic growth if it leads to diminishing marginal returns in production.
  • Education would be considered investments in human capital
  • If there was both an increase in technology and an increase in labor force participation, real GDP growth would increase and real GDP growth per capita would increase.
  • Malthus made assumptions for a fixed supply of land.
  • Malthus assumed production with only two inputs – land and labor
  • Malthus assumed human desire to increase the population
  • Stable prices was not one of Malthus assumptions?
  • Output per capita will tend to increase if the labor force participation rate in a country rises or if workers put in longer hours.
  • If there was an increase in technology other things equal, real GDP growth would increase and real GDP growth per capita would increase.
  • If people began to retire at a later age and there was an increase in the capital stock, real GDP growth would increase and real GDP growth per capita would increase.
  • Enforcement of property rights is likely to result in more incentives to invest and higher rates of economic growth with political stability and will corruption.
  • Changes in the growth rate of real GDP per capita do not reflect changes in the distribution of income
  • the total production of final goods in the economy affect the growth in real GDP per capita
  • the population affect the growth in real GDP per capita
  • the production of final services in the economy affect the growth in real GDP per capita
  • a lack of enforcement of private property rights will not contribute to increasing the stock of physical or human capital of a nation
  • an increase in savings will contribute to increasing the stock of physical or human capital of a nation
  • the subsidization of higher education will contribute to increasing the stock of physical or human capital of a nation
  • a reduction in taxes on capital gains and stock dividends will contribute to increasing the stock of physical or human capital of a nation
  • A new factory is constructed will affect the size of a nation's physical capital stock. It will increase the physical capital stock.
  • A new machine is installed in company's plant will affect the size of a nation's physical capital stock. It will increase the physical capital stock.
  • An eighteen-year-old enrolls in college as a full-time student affects the size of a nation's human capital stock and will increase it.

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