Time for tasty homework Is your assignment properly saved as yourlastname.docx? For questions 1-2, Read the “In the News” column on in 10-5 pp. 202-203 of your textbook entitled “No Sex, Please, We’r

Time for tasty homework Is your assignment properly saved as yourlastname.docx? For questions 1-2, Read the “In the News” column on in 10-5 pp. 202-203 of your textbook entitled “No Sex, Please, We’r
22 Principles of Macroeconomics Assignment 6 – Gross Domestic Product Chapter 10 – Measuring a Nation’s Income This week we will study the first of 3 important macroeconomic statistics – Gross Domestic Product or GDP. Next week we will study the other two: inflation and unemployment. The GDP chapter in Mankiw is Chapter 10, which he calls “Measuring a Nation’s Income.” Mankiw begins the chapter by applying what we learned in Ch. 2 to this study of GDP. Notice how on in the Introduction and 10-1, pp. 188-189 he goes over the macro/micro distinction again, and then notes using the now familiar circular flow model how an economy’s income must equal its expenditure. I would add that GDP actually measures three things at once, all of which must be equal for an entire economy: Income = Expenditures or Spending = The Value of Production. News reports frequently state that the economy is growing or shrinking. But how do we know this is the case? The answer is: we measure the size of the economy by calculating a statistic called Gross Domestic Product. The formal definition of GDP is: The market value of all final goods and services produced in a country in a given period of time. Greg Mankiw parses this definition 10-2, on pp. 190-192 to help you understand what GDP does, and does not count. “GDP is the market value. . .” GDP only counts goods and services sold in organized markets. Any production not sold in an organized market is not counted. So if you mow your own lawn, and I pay a lawn service to mow my lawn which then reports that income to the government, the lawn service I pay for in an official market will be counted in GDP ,but your lawnmowing will not be counted because you did it yourself. If I pay the kid next door to mow my yard, and this is a non-reported cash transaction, it would not be counted in GDP. But in all 3 cases our economy is producing a mowed lawn. Illegal drug sales, any unreported income for cash like all that babysitting you got paid for in high school, barter transactions for new goods – all of that is not counted in GDP. But it probably should be since we are trying to count what we produce. Economists do try to estimate the value of various countries’ underground economies. This chart, from the Institute for Applied Economic Research (IAW) in Tuebingen, Germany shows the size of the underground economy as a percentage of GDP for various rich countries: Not on the list, but a very high number in my old McConnell textbook listed Bolivia’s underground economy at 68% of GDP! To think about why Switzerland and the U.S. have such a small underground economy, and why Greece and Italy such larger ones, consider a few factors: Countries with higher tax rates probably have higher underground economies because higher taxes give citizens a greater incentive to conduct business ‘under the table.’ The efficiency of the tax collection system and degree of corruption among government officials will also determine how much business can be watched and recorded. For poorer countries like Bolivia or India (which also has a high number) a lot more transactions are either cash or barter transactions not being recorded on official income tax forms, so we would expect them to have larger underground economies. Poor countries also can’t afford to hire as many economists and statisticians to more accurately track economic statistics. Not counting this production means the official GDP statistic understates true GDP, or makes it look smaller than it really is. “. . .of all final goods and services. . .” GDP excludes the production of intermediate goods, or goods used to produce other goods. For example, if the Italian Garden restaurant buys tomatoes and uses them to make a spaghetti dinner, those tomatoes are not counted in GDP. The dinner will be counted, and the reasonable assumption economists make is that the cost of those tomatoes is included in the final price of the dinner. But if you buy tomatoes and take them home and use them to make a spaghetti dinner, those tomatoes are counted in GDP because they were a final good to you. If you buy gas to power your lawnmower, it is a final good, but if the lawn service that mows my yard buys gas, it is not counted in GDP; what will be counted is the price of the lawn mowing service when they sell it to me. It seems incredible that economists are able to separate out final and intermediate goods, but many economists working for the Bureau of Economic Analysis, which calculates GDP, earn a very nice living doing just that. The reason we don’t count intermediate goods is it would lead to double counting, and greatly overstate GDP. Suppose all the inputs for a $15.00 spaghetti dinner at Olive Garden, including the labor needed to produce it, the profit for the entrepreneur, the ingredients, etc. added up to $15.00. If we counted the tomatoes, the spaghetti, and all the other ingredients and the labor and then also the $15.00 dinner, it would look like $30.00 of GDP had been produced. But what has actually been produced is just the $15.00 dinner so we only count the final product. “. . .produced within a country. . .” GDP is a geographical measure. There is another statistic – GNP – or Gross National Product – that measures all the goods and services Americans produce abroad, and subtracts what foreigners produce here – but sometime in the 1990s economists decided GDP was a better measure of what the domestic economy is actually producing. Transnational corporations made it increasingly difficult to determine the nationality of some producers, whereas counting what is done in a given geographic country is more accurate. Mankiw discusses some of the alternative measures of income in the FYI box in 10-2g on p. 192. “. . .in a given period of time.” This means we count goods and service produced this quarter, or this year. We do not count the resale of used goods. So in 2006 I bought a car that was produced in 2002. We did not count my purchase of this used car in 2006 because it was already counted in GDP when it was produced and sold in 2002. This also means that GDP is a flow, not a stock. The same distinction applies to many related economics concepts. Your income, for example is a flow because it is measured over time. Your wealth, on the other hand, is a stock that represents all the assets you have accumulated over time. My current income is much higher than that of my retired parents, but their wealth is much higher than mine because they prudently saved for 45 years of their working lives. Another flow-stock dichotomy we will study later this semester is the difference between the deficit (a one-year budget shortfall, or a flow) and the debt (the total of all previous shortfalls, or a stock.) Please note this has nothing to do with the stock market. One other place you might have heard the word ‘stock’ used this way is discussing wildlife. The number of fish swimming into a lake from a river is the flow of fish, but the number of fish in the lake at any given time is the stock of fish. GDP is calculated quarterly by the Bureau of Economic Analysis (BEA). ‘Quarterly’ means the BEA calculates GDP every 3 months. The most recent quarter the BEA has calculated was first quarter 2022 GDP. In the first 3 months of 2022 the U.S. economy actually shrank 1.5%. These estimates were released on May 26th, 2022. https://www.bea.gov/news/2022/gross-domestic-product-second-estimate-and-corporate-profits-preliminary-first-quarter Note the tremendous aberration that COVID caused in 2020. Normally GDP rises 2-3% per quarter, but in Q2 last year it fell 31% and in Q3 it rose 33%! This is one of the most dramatic graphs I’ll ever show in class. You’ve probably never heard of the BEA, but it is another institution that helps us grow. Prosperous countries invest a little tax money hiring capable economists and statisticians to produce accurate statistics about our economy so private citizens can make smarter decisions. Note the report is actually the second estimate made by the BEA.The BEA is constantly revising old estimates, so when 2nd Quarter GDP statistics are released in July there will be one final revision to the Q1 number based on better data and analysis. A recession is technically defined as a decline in GDP that lasts for two consecutive quarters. By that definition, the recession caused by the housing market crash in 2008 ended in the Fall of 2009 when the economy grew 2.2 percent in the third quarter after declining in the second quarter 0.7 percent. This picture below, taken from older BEA data, shows how severe the housing market crash was. However, one feature of the last two recoveries (after the housing market crash in 2008, and the dot.com bubble bursting in 2001) is that job recovery did not respond very quickly, and many people found it hard for a long time to find work again. As we will see when we study unemployment, until March of 2020 the economy was near full employment, and we had essentially recovered from the long housing crash depression. But GDP decline dramatically because of Corona in the first quarter of 2020. Notice the BEA had to actually change the vertical scale of the chart to capture the monster decline we had in Q2 of 2020 I should note here the difference between a ‘recession’ and a ‘depression.’ Formally, a recession is two consecutive quarters of a decline in GDP. A depression has no formal definition, but I hear many economists define it loosely as a prolonged period of subpar economic activity. By this vague definition, we were probably in a mild Depression from 2009-2013. An old economists’ joke is that a recession is when other people lose their jobs, and a depression is when you lose your job:P The decline in GDP that occurred in the first quarter of 2020 ended the longest expansion of GDP in U.S. history – over 9 years of growth without a recession! If you had asked me and most economists in February of 2020, we would have predicted our economy would continue to grow. We were actually hoping for some second quarter growth as the economy ‘bounced back’ from the Corona shutdown. However, because we irresponsibly chose to open up too fast (this happened around Memorial Day 2020) activity continued to decline in Q2 so we were officially in a recession after that. We made this same mistake 100 years ago when the 1918 flu pandemic occurred. Our initial social distancing was quite effective, but people grew impatient and this lack of discipline led to many more deaths and a much longer period of suffering than was necessary from that pandemic. Economists were consistent during the COVID lockdown that the choice between fighting Corona and restoring economic growth was a false choice; people will not start going back out to restaurants and vacation spots until they know it is safe. To restore the economy, we first had to bring the virus under control. Before discussing the definition of GDP, Mankiw notes that “For an economy as a whole, income must equal expenditure.” To which I note these two things must also equal the value of production. This is also true for individuals. Although a few lucky people may wake up on a pile of money they inherited or won in a lottery, most of us have to work for a living. The more value you produce, the more money the market can afford to pay you. And the more money you make, the more money you can spend. And the more production you add to GDP, the more money you can make. So for the economy as a whole, it must be true that Output = Income = Spending, although for any individual these three factors might not be equal. Students, for example, are very often in the dissavings portion of their economic lifecycle, as are retirees. Both groups typically spend more money than they earn, either by running up debt or drawing down retirement savings. As a 57-year old, I am in the savings portion of my lifecycle, in which my spending is far less than my income because I am saving for retirement. But for the entire population, Output = Income = Spending. Another way to view the fact that for the entire economy, income = expenditure, is to realize that every transaction has a buyer and a seller. Every dollar you spend on goods and services is a dollar of income for the people who sell you goods and services. Economists break GDP down into 4 components. This produces the GDP equation shown in 10-3 on page 193. Y = C + I + G + NX This means: GDP is the sum of Consumption expenditures, Investment expenditures, Government spending, and Net Exports. Net Exports are exports minus imports. We add our exports since that is spending by foreigners in the American economy, but subtract our imports because that represents money leaving the American economy and being spent abroad. To make this distinction more apparent, sometimes you will see the GDP equation written as Y = C + I + G + (X – M). I don’t have any tattoos, but sometimes dream about getting that GDP equation tattooed on my wrist:P Mankiw discusses what is included in each component in 10-3 on pages 193-195. For example, the sale of new homes is not included in consumption, but instead investment. You’ll need to read those 3 pages for some of your homework. Consumption expenditures exclude transfer payments like Social Security checks since this is just money being shifted from one group to another, although a lot of those Social Security checks do eventually get into GDP when they are spent on consumption goods. Mankiw notes in 10-3a on p. 193 that education spending might better fit in Investment, since it is a long-term expenditure designed to build more human capital, but in fact education is included in consumption. The relative share of each component in GDP for 2018 is given in 10-3 on page 195. Consumption makes up 68% of the nation’s economy. Investment is only 18% but it is an important 18% because investment is what will allow us to have future economic growth. When I ask students in class to guess how much of our economy is government spending they often say some high number like 50%. Actually, only about 1 dollar in 6 in our economy is government spending, so when discussing Mankiw’s principle that “Markets are usually a good way to organize economic activity” I add that what “usually” means for the United States is about 80% of the time. And Net Exports subtract 3% because the United States tends to import more than we export, so NX is negative. Notice the top GDP number also confirms the $63,000 for real per capital GDP I used for my ‘back of the envelope’ in assignment 5. The next topic Mankiw addresses is the distinction between Real GDP and Nominal GDP, in 10-4 on pp. 196-198. I am not going to have you do the calculations in Table 2, nor the GDP deflator, because we will be working with the more common measure of inflation – the Consumer Price Index – next week when we do inflation. But you do need to know what economists are talking about when we distinguish between a “real” statistic and a “nominal” statistic. Economists make this distinction for many statistics – real income versus nominal income; real interest rates versus nominal interest rates. Real GDP is adjusted for inflation, and so is measured in constant dollars. Nominal GDP is not, and is instead measured in current dollars. Adjusting for inflation often gives us a more realistic statistic, hence we use the word “real” to describe a statistic that has been adjusted for price changes. We’ll study this more when we get to inflation in chapter 11. In Assignment 5 when we considered the Rockefeller question, I noted his real income in today’s dollars was about $200 billion. In fact, he actually had $8 billion in 1921. So nominal terms, he had $8 billion, but in real terms that money today would be worth $200 billion. The way you will one day practically apply this distinction is like this: last year I got a 2% pay raise, but inflation was 3%, so although my nominal income rose 2%, my real income actually fell 1% because prices increased faster than my income. Normally I get about a 1% real increase every year, but because of the Corona downturn and enrollment declines at JCCC, JCCC faculty had to take a small pay cut. Figure 2 in 10-4 on page 199 shows how real GDP in the United States has risen over time. Recessions, defined as two consecutive quarters, or 6 months of decline in GDP, are shown as shaded vertical bars. Notice how outstanding economic growth was between 1983 and 2008 – indeed, the greatest 25-year period of economic growth in American history. There were two brief recessions in 1991 and 2001, and otherwise remarkable increases in output. The severity of the 2008-2009 recession is also apparent in this picture. When the next edition of this text comes out, it will show the sharp Corona downturn and recovery of 2020-21. Although the COVID-D surge slowed economic growth last summer, our economy still grew very strongly last year, and economists expect this will continue in 2022. Although real GDP has more than tripled since 1983, unfortunately that prosperity has not been shared as equally as was the case for the U.S. economy in earlier periods. This rising inequality of both income and wealth is a problem many economists are thinking a lot more about now. And in my opinion the unequal way prosperity has been distributed also explains why candidates outside the mainstream like Donald Trump or Bernie Sanders have had increasing success with more populist campaign themes. Mankiw concludes his chapter by asking in 10-5 on p. 200-203 “Is GDP a good measure of economic well-being?” There is a great quote by Robert Kennedy at the start of this section, on pp. 200 that expresses doubt about the usefulness of GDP as a statistic. GDP counts “bads” as well as goods. For example, if your economics instructor breaks his leg walking home tonight, GDP would increase. The ambulance services and medical services needed to repair my leg would all increase GDP. But clearly we would be better off if I had not broken my leg, because those medical services could have been used to improve someone else’s health AND I could have had a healthy leg. One can think of similar ‘bads” that raise GDP like wars and pollution and crime. Mistakenly thinking that negative events like a natural disaster are actually good for the economy because we have to spend money to clean them up is called “The Broken Window Fallacy” in economics. GDP also does not measure how clean our environment is, for example. Or increases in leisure time. If you earn the same amount of money next year you earn this year, but do it working 5 less hours a week, you are a lot better off, but your contribution to GDP would be the same. I will add it is a sign of Mankiw’s fair-mindedness that, although he is a moderately conservative economist he is providing space in his textbook for Robert Kennedy, who was one of America’s great liberal leaders. Nonetheless, Mankiw thinks GDP is as good measure of well-being, and so do I. Last summer I heard another great economist, Nobel Lauriat Paul Krugman, say that “GDP isn’t perfect, but for what it is trying to measure, it does a pretty good job.” I just listened to a great conversation between the liberal Ezra Klein, and the libertarian Tyler Cowen, and they agree for all its faults, GDP is highly correlated with many measures of well-being. Why is GDP a decent measure of the quality of life? Because many of the things that do make for a high quality of life are highly correlated with high GDP. Prosperous countries like the United States and Japan and the United Kingdom and Botswana and Italy and Singapore all have good schools and efficient justice systems and clean water and the right of their citizens to peaceably assemble and petition our governments for the redress of grievances. So it may be reasonable to ask if enjoying lots of goods and services makes us happy, but there does seem to be a high correlation between a high GDP and a high quality of life. Still, more people are talking about alternative measures to GDP, and you’ll consider one of these in your homework this week. Time for tasty homework Is your assignment properly saved as yourlastname.docx? For questions 1-2, Read the “In the News” column on in 10-5 pp. 202-203 of your textbook entitled “No Sex, Please, We’re French.” Why are several European countries like Spain, Italy, and the U.K. now including illegal activities like prostitution and drugs in their GDP calculations? (4 points) What is the French reason for not including these transactions in their GDP calculations, and why do you agree or disagree with this reasoning. (8 points) A fallacy is a mistaken idea. In my notes I discuss the Broken Window Fallacy. Explain in a paragraph of at least 3 sentences what it is and why it is a fallacy. (6 points) Near the end of my notes and Mankiw’s chapter, in 10-5 on pp. 202-203, a quote about GDP from Robert Kennedy is discussed. I also include a link to a youtube video that has the audio of that speech. Here it is again. https://www.youtube.com/watch?v=77IdKFqXbUY Pro-Tip: if a link like that ever does not work, try it on anther device. You can also gather from my question you could search “Robert Kennedy GDP speech” and find many alternative versions of the link I provided. All the blue links in my notes can be accessed directly with Ctrl + click. In a paragraph of at least 4 sentences, give me one reaction you have to that quote – either something supportive or perhaps a critique of Kennedy’s statement. (8 points) Here is an article on several measures of well-being that are being experimented with as alternatives to the GDP statistic. https://ethical.net/politics/gdp-alternatives-7-ways-to-measure-countries-wealth/ I want you to pick one of the several alternative measures discussed in that article and write me a paragraph of at least 4 sentences explaining why you chose that measure, what improvements and problems it might have over our GDP statistic, etc. Please don’t just summarize her pros and cons; think for yourself