The economist as scientist o They devise theories, collect data, and then analyze these data in attempt to verify or refute their theories. O Scientific method = the dispassionate development and testing of theories about how the world works. Although economist use theory and observation like other scientists, they face an obstacle that makes their task especially challenging: In economics, conducting experiments is often difficult and sometimes impossible. O To find a substitute for laboratory experiments, economist pay close attention to the natural experiments offered by history.
Economist make assumptions for the same reason: assumptions can simplify the complex world and make it easier to understand. 0 The art scientific thinking: deciding which assumptions to make. Economists use different assumptions to answer different questions. O Economist also use models to learn about the world, but instead of being made of plastic, they are most often composed of diagrams and equations. O As we use models to examine various economic issues throughout the book, we will see that all the models are build on assumptions.
Don’t waste your time!
Order your assignment!
III models – simplify reality to improve our understanding of t. ; Circular-flow-diagram AAA visual model of the economy that shows how dollars flow through markets among households and firms. ; The economist as policy advisor o Positive statements are descriptive – they make a claim about how the world is. O Normative statements are prescriptive – they make a claim about how the world ought to be. ;Why economist disagree o Economists may disagree about the validity of alternative positive theories about how the world works. Economist may have different values and therefore different normative views about what policy should try to accomplish. GAP – measuring a nation’s income ; The statistic might measure the total income of everyone in the economy (GAP), the rate at which average prices are rising (inflation), the percentage of labor force that is out of work (unemployment), total spending at stores (retail sales), or imbalance of trade between the United States and the rest of the world (trade deficit). ; This chapter considers gross domestic product, or simply GAP, which measures the total income Of a nation. The economy’s income and expenditure goop measures two things at once; the total income of everyone in the economy and the total expenditure of the economy s output of goods and services. O For an economy as a whole, income must equal expenditure. O Every dollar of spending by some buyer is a dollar of income for some seller. GOOP measures the flow of money. We can compute it for this economy in one of two ways, by adding up the total expenditure by households or by adding up the total income (wages, rent, and profit) paid by firms. Measurement of Gross Domestic Product goop is the market value of all final goods and services produced within a country in a given period of time. O “GAP is the market value” because it uses racket prices. Because market prices measure the amount people are willing to pay for different goods, they reflect the value of those goods. O Of all ” It includes all items produced in the economy and sold legally in markets. GAP also includes the market value of the housing services provided by the economy’ s stock of housing.
For rental housing this value is easy to calculate – the rent equals both the tenant ‘ s expenditure and the landlord ‘s income. Yet many people own the place where they live and, therefore, do not pay rent. The government includes this owner-occupied housing in GAP by estimating TTS rental value. The imputed rent is included both in the homeowner’s expenditure and in his income, so it adds to GAP. GAP excludes most items sold and produced illegally. Vegetables you grow yourself is not included in the GAP, but the ones you buy in the grocery store is. O “… Final… ” GAP includes only the value of final goods.
This is done because the value of intermediate goods is already included in the prices of the final goods. O “… Goods and services… ” GAP includes both tangible goods (food, cloths, cars) and intangible services (haircuts, housecleaning, doctor visits. ) o “… Produced… GAP includes goods and services currently produced. It does not include transactions involving items produced in the past. O “… Within a country… ” GAP measures the value of production within the geographic confines of a country. O “… In a given period of time… ” GAP measures the value of production that takes place within a specific interval of time.
Usually, that interval is a year or a quarter. ; The components of GAP o To understand ho the economy is using its scarce resources, economist study the composition of GAP among various types of spending. To do this, GAP (Y) is divided into four components: 1. Consumption = spending by households on goods and services, with the exception of purchasing of new housing. 2. Investment = the purchasing of goods that will be used in the future to produce more goods and services. It is the sum of purchases of capital equipment, inventories and structures. Investment in structures includes expenditure on new housing.
By convention, the purchase of a new housing is the one form of household spending categorized as investment rather than consumption. 3. Government purchases = spending on goods and services by local, state, and federal governments. It includes the salaries f government workers as well as expenditures on public works. When the government pays a social security benefit to a person who is elderly or an unemployed insurance benefit to a worker who was recently laid off, the story is different: these are called transfer payments because they are not made in exchange for a currently produced good or service. . Net export = equal the foreign purchases of domestically produced goods (exports) minus the domestic purchases of foreign goods (imports). The net in net export refers to the fact that imports are subtracted from exports. Thus, when a domestic should, firm, or government buys a good or service from abroad, the purchase reduces the net exports, but because it also raises consumption, investment or government purchases, it does not affect GAP. ; Real vs.. Nominal GAP GOOP measures the total spending on goods and services in all markets in the economy.
If total spending rises from one year to the next, at least one of two things must be true, 1 The economy is producing a larger output of goods and services, or 2. Goods and services are being sold at high prices. When studying changes in the economy over time, economist wants to separate these two effects. Economist use a measure called real GAP. Real GAP answers a hypothetical question: what would be the value of goods and services produces this year if we valued these goods and services at the price that prevailed in some specific year in the past? Nominal GAP the production of goods and services values at current price. O Real GAP = the production of goods and services valued at constant price. O To obtain measure of the amount produced that is not affected by changes in prices, we use real GAP, which is the production of goods and services valued at constant prices. We calculate real GAP by first designating one year as the ease year. O To sum up; nominal GAP uses current prices to place a value on the economy ‘ s production of goods and services.
Real GAP uses constant base year prices to place a value on the economy’s production Of G&S. ; The GAP deflator goop deflator, which reflects only the prices of goods and services. The GAP deflator is calculated as follows: ;(Nominal GAP / Real GAP) XSL 00 o Because nominal GAP and real GAP must be the same in the base year, the GAP deflator for the base year always equal 100. O Economist use the term inflation to describe a situation in which the economy’ s overall price level is using.
The inflation rate is the percentage change in some measure of the price level from one period to the next. O Inflation rate in year 2 = ; (GAP deflator in year 2 – GAP deflator In year I)/GAP deflator in year 1 XSL 00 o Recessions are associated not only with lower incomes but also with other forms of economic distress: rising unemployment, falling profits, increased bankruptcies, and so on. O The grey economy = broadly defined, the underground, gray, informal, or shadow economy involves otherwise legal transactions that go unreported or unrecorded. Downsides with GAP “GAP does not allow for the health of our children, the quality of their education, or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages, the intelligence of our public debate or the integrity of our public officials. It measures neither our courage, nor our wisdom, nor our devotion to our country. ” o Because GAP uses market prices to value goods and services, it excludes the value of almost all activity that takes place outside markets.
In particular, GAP omits the value of goods and services produced at home. When a chef prepares a delicious meal and sells t at his restaurant, the value of that meal is part of GAP. But if the chef prepares the same meal for his family, the value he had added to the raw ingredients is left out of GAP . ; International differences in GAP and the quality of life elf large GAP leads to a higher standard of living, then we should observe GAP to be strongly correlated with various measures of the quality of life. And that’s also what one does. Countries with low GAP per person tend to have more infants with low birth weight, higher rates of infant mortality, higher rates of maternal mortality, higher rates of child illumination, and less common access to safe drinking water. In countries with low GAP per person, fewer school-age children are actually in school, and those who are in school must learn with fewer teachers per student. ; Real GAP per capita = real GAP/pupation ICP – measuring the cost of living ; This chapter examines how economist measure the overall cost of living ; That is exactly the job of a statistic called the consumer price index. The ICP is used to monitor changes in the cost of living over time. When the consumer price index rises, the typical family has to spend more money to obtain the same standard of living. Economist use the term inflation to describe a situation in which the economy’ s overall price level is rising. The inflation rate is the percentage change in price level from the previous period. ; The consumer price index: o The ICP is a measure of the overall cost of the goods and services bought by a typical consumer. Each month, the Bureau of Labor Statistics, which is part of the Department of Labor, computes and reports the consumer price index. O Simple economy = only two goods 1. Fix the basket – determine which prices are most important to the typical consumer. Fifth typical consumer buys more hot dogs than hamburgers, hen the price of hot dogs is more important than the price of hamburgers and, therefore, should be given greater weight in measuring the ICP. 2. Find the prices – find the prices of each of the goods and services in the basket at each point in time. . Compute the baskets cost – use the data on prices to calculate the cost Of the basket of goods and services at different times. 4. Choose a base year and compute the index – designate one year as the base year, the benchmark against which other years are compared. ICP = (Price of basket of goods and services in current year/price of basket in base year) solo a. That is, the price of the basket of goods and services in each year is divided by the price of the basket in the base year, and this ratio is then multiplied by 100.
The resulting number is the ICP. 5. Compute the inflation rate -?? use the consumer price index to calculate the inflation rate, which is the percentage change in price index from the preceding period. Inflation rate in year 2 = (ICP in year 2 – ICP in year I)/ICP in year 1 x 100 ; Problems in measuring the cost of living substitution bias = when prices change from one year to the next, they do not all change proportionately: some prices rise more than others.
Consumers respond to these differing changes by buying less of the goods whose prices have risen by relatively large amounts and by buying more of the goods whose prices have risen less or perhaps even have fallen. O Introduction of new goods = when a new good is introduced, consumers have more variety from which to choose, and this in turn reduces the cost of maintaining the same level Of economic well-being. Lo_Smeared quality change = if the quality of a good deteriorates from one year to the next while its price remains the same, the value of a dollar falls, because you are getting a lesser good for the same amount of money.
Similarly, if the quality rises from one year to the next, the value of dollar rises. ; The GAP deflator vs.. The economist and policymakers monitor both the GAP deflator and the consumer price index to gauge how quickly prices are rising. Usually, these two statistics tell a similar story. Yet two important differences can cause them to diverge. O The first differences is that the GAP deflator reflects the prices of all goods and services produced domestically whereas the ICP reflects the prices of all goods and services bought by consumers. The second and subtler difference between GAP deflator and the ICP concerns owe various prices are weighted to yield a single number for the overall level of prices. The consumer ICP compares the prices of a fixed basket of goods and services to the price of the basket in the base year. Only occasionally does the Bureau of Labor Statistics change the basket of goods. By contrast, the GAP deflator compares the price of currently produced goods and services to the price of the same goods and services in the base year. Correcting economic variables for the effects of inflation o The purpose of measuring the overall level of prices in the economy is to permit comparison teen dollar figures from different times. O The formula for turning dollar figures from year T into today’s dollars is the following: ; Amount in today’ s dollars = amount in year T dollars x (Price level today/price level in year T) o A price index such as the ICP measures the price level and thus determines the size of the inflation correction. Indexation Owen some dollar amount is automatically corrected for changes in the price level by law or contract, the amount is said to be indexed for inflation. O E. G. Many long-term contracts between firms and unions include partial or complete indexation of the wage to the Cap. Alienation is also a feature of many laws. Social Security benefits e. G. Are adjusted every year to compensate the elderly for increases in prices. The brackets of the federal income tax – the income levels at which the tax rates change – are also indexed for inflation. Real and nominal interest rates correcting economic variables for the effects of inflation is particularly important, and somewhat tricky, when we look at data on interest rates. The very concept of an interest rate necessarily involves comparing amounts of money at different points in time. O To understand how much a person earns in a saving account, we need to consider both the interest rate and the change in the prices. The interest rate that measures the change in dollar amounts is called nominal interest rate, and the interest rate that corrected for inflation is called the real interest rate.
The nominal interest rate, the real interest rate, and inflation are related approximately as follows: ; Real interest rate = nominal interest rate – inflation rate 0 The nominal interest rate tells you how fast the number of dollars in your bank account rises over time, while the real interest rate tells you how fast the purchasing power of our bank account rises over time. Production and Growth ; The level of real GAP is a good gauge of economic prosperity, and the growth of real GAP is a good gauge of economic progress. First, we examine international data on real GAP per person. ;Second, we examine the role of productivity – the amount of goods and services produced for each hour of a workers time. ; Third, we consider the link between productivity and the economic policies that a nation pursues. ;Economic growth around the world o The worlds riches countries have no guarantee they will stay the riches and he worlds poorest countries are not doomed forever to remain in poverty. ; Productivity explaining the large variation in living standards around the world is, in one sense, very easy.
As we will see, the explanation can be summarized in a single word – productivity. O In a word, productivity, the quality of goods and services produced from each unit of labor input. O Productivity key role in determining living standards is as true for nations as it is for stranded sailors. Recall that an economy ‘ s GAP measures two things at once; the total income earned by everyone in the economy and the total expenditure on the economy’ s output Of goods and services.
GAP can measure these two thing simultaneously because, for the economy as a whole, they must be equal. Put simply, an economy’s income is the economy’s output. O Many factors determine Cursors productivity; we can call physical capital, human capital, natural resources and technological knowledge – has a counterpart in more complex and realistic economies. O Physical capital per worker – the stock of equipment and structures that are used to produce goods and services. Human capital per worker – the knowledge and skills that workers acquire wrought education, training and experience o Natural resources per worker -?? the inputs into the production of goods and services that are provided by nature, such as land, rivers, and mineral deposits. O Technological knowledge – society’s understanding of the best ways to produce goods and services. ; Economic growth and public policy o Because resources are scarce, devoting more resources to producing capital requires devoting fewer resources to producing goods and services for current consumption. Diminishing returns – the property whereby the benefit from an extra unit of an input declines as the quality if the input increases. O In the long run, the higher saving rate leads to a higher level of productivity and income but not to higher growth in these variables. O Amount of capita per worker influences the amount Of output per worker. Other things held constant, the curve becomes flatter as the amount of capital increases because of diminishing returns to capital. Catch-up effect – the property whereby countries that start off poor tend to grow more rapidly than countries that start off rich. Unemployment ; A job loss means a lower living standard in the present, anxiety about the true, and reduced self-esteem ; Although some degree of unemployment is inevitable in a complex economy with thousands of firms and millions of workers, the amount of unemployment varies substantially over time and across countries. The economy’s natural rate of unemployment refers to the amount of unemployment that the economy normally experiences. Cyclical unemployment refers to the year-to-year fluctuations in unemployment around its natural rate, and it is closely associated with the short-run ups and downs of economic activity. ; Bureau of Labor Statistics measure the unemployment every month. Employed – includes those who worked as paid employees, worked in their own business, or worked as unpaid workers in a family members business. Both full-time and part-time workers are included.
This category also includes those who were not working but who had jobs from which they were temporarily absent because of, for example, vacation, and illness or bad weather. O Unemployed – this category includes those who were not employed, were available for work, and had tried to find employment during the previous 4 weeks. It also includes those waiting to be recalled to a job from which they had been laid off. O Not in abort force: this category includes those who fit neither of the first two categories, such as a full-time student, homemaker or retiree. Labor force = number of employed + number of unemployed. Unemployment rate -?? (number of unemployed/labor force) x 100 0 Labor- force participation – the percentage of the adult population that is in the labor force = labor force/adult population solo o Natural rate of unemployment, the normal rate of unemployment around which the unemployment rate fluctuates. O Cyclical unemployment, the deviation of unemployment from its natural rate o Discourage workers, individuals who loud like to work but have given up looking for a job. Most spells of unemployment are short, and most unemployment observed at any given time is long-term. ; Why are some people always unemployed o Frictional unemployment = unemployment that results because it takes time for workers to search for the jobs that best suit their tasted and skills. O Structural unemployment unemployment that results because the number of jobs available in some labor markets is insufficient to provide a job for everyone who wants one. O Job search = the process by which workers find appropriate jobs given their tastes and skills.
Unemployment insurance = a government program that practically protects workers ‘ incomes when they become unemployed. ; If the wage is kept above the equilibrium level for any reason, the result is unemployment. ; union a worker association that bargains with employers over wages, benefits and working conditions. ; Collective bargaining = the process by which unions and firms agree on the terms of employment. ;Strike = the organization withdrawal of labor from a firm by a union. ; Efficiency wages = above-equilibrium wages paid by firms to increase workers productivity.
The Monetary System Back in the days, there were no item in the economy widely accepted in exchange for goods and services. ;People would have to rely on barter – the exchange of goods and services for another -?? to obtain what they needed. ; An economy that relies on barter will have trouble allocating its scarce resources efficiently. In such an economy, trade is said to require the double coincidence of wants – the unlikely occurrence that two people each have a good or service that the other wants. ; Money is the set of assets in an economy that people regularly use to buy goods and services from other people.
Most liquid. ; Medium of exchange = an item that buyers give to sellers when they want to purchase goods and services ; Unit of account = the yardstick people use to post prices and record debts.