ECO 306 Home Page http www depaul edujberdell

ECO 306 Home Page http: /www. depaul. edu/~jberdell Select Eco 306 ID: macro PW: theory 1

Last time W 1 B Outline Maths Appendix growth rates, exponents and logs, several variables National Accounts historical genesis and war 1600’s Mercantilism, Petty and Davenant Bolsheviks and WWI: Input Output Analysis WWII: Keynes, Kuznets and Stone Product vs. Expenditure vs. Income Measures Text on Savings identities Real vs Nominal GDP Chain Method Hedonic Methods CPI vs. PCE price indices Wellbeing vs GDP (Time Permitting) 2

Exponent Notation+facts Z 0=1 Za. Zb= Za+b So Z 1/2 Z-1/2= Z 0=1 (Za)b= Za*b So (Z-a)-1 = Za 5*k 1/2=(1/10)*k What is k? 3

Last Time Quarterly-Annual 4

Last Time Growth Rates 5

Logs elasticity and growth 6

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GNP vs GDP is gross domestic product. gross because it includes depreciation domestic because it is a geographic concept (One that captures production in the geographic confines of the US regardless of the nationality of factors used in production. ) GNP is gross national product, it is a nation’s total income and output whether generated at home or abroad. GNP=GDP+ Net Factor Payments Received from the ROW (ROW means Rest Of the World) Or GNP=Y+NFP 8

Savings-NI Identites Net Factor Payments are defined as “income paid to domestic factors of production by the rest of the world minus income paid to foreign factors of production. . ” (our text chapter 2) e. g. interest payments and payments to guest workers. NX are defined as the value of exports less the value of imports so: CA=NFP+NX CA includes payment for all current goods and services, Including the services of factors. Includes interest on debt. 9

S, I and the CA S-I=CA The current account reflects the difference between national saving and investment. If we save more than we invest at home it is invested abroad. I-S=-CA if we invest more than we save it comes from ROW. S=I+CA our savings is either invested at home or abroad. 10

S Private and Public savings sometimes seem a little messy, but total national savings is very simple: S=GNP-C-G, its our national income minus our consumption where the text assumes that all government provided goods and services “G” are used for current consumption. 11

S-I=CA may look odd we can relate it to: Y=C+I+G+NX Add NFP to each side Y+NFP=C+I+G+NX+NFP GNP=C+I+G+CA GNP-C-G-I=CA S-I=CA 12

This Time W 2 A 1) Finish GDP Accounting 1. 1 Real Nominal 1. 2 Hedonic Methods and New Goods 1. 3 Wealth vs. Wellbeing 2) Production and Labor Demand The Cobb Douglas Production Function factor shares and elasticities How do changes in technology affect labor? 3) Okun’s Law How are unemployment and growth related? Regression estimates 13

Hedonic Methods NIPA uses “hedonic” methods Goods are separated into characteristics Each characteristic is then priced and tracked It’s not a computer its 256 k. Ram, 20 MB drive…. *****This does not solve the problem of fundamentally new goods which need to be initially entered at cost. See Krugman on Viagra ******* 14

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Deflation Nov 2007: -1. 7% 16 CPI-U from BLS, extracted 10 January 2009

• 1+G=(1+g)^12 • G=((1+g)^12) - 1 With a negative g use absolute value We need to use proportional rates so 1. 7% is 0. 017 0. 22=((1+0. 017)^12) -1 So at an annual rate that is deflation of 22%! 17

Figure 2. 02 The inflation rate in the United States, 1960 -1998 18

Figure 2. 03 Nominal and real interest rates in the United States, 1960 -1998 19

Extension Topics We may have time for. . GDP vs Well Being Tibor Sciovsky On The Joyless Economy Andrew Oswald on Suicide and Growth Nordhaus on Health and Wealth Social Impact of Downturns GDP components in the 2000 -01 downturn. 20

Health of Nations The Health of Nations: The Contribution of Improved Health to Living Standards William D. Nordhaus, Yale University January 25, 2002 http: //www. econ. yale. edu/~nordhaus/homepage/health_nber_1. doc 21

Little Understood It is little understood outside the priesthood of national accountants that there is no serious attempt to measure the “real output” of the health-care industry. The techniques used to measure the price and quantity of health care highly defective, and there are no attempts to account for improvements in the length of life into current measures of living standards. 22

US Per Capita Consumption Does this overstate or understate rising living standards? 23

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Consider… Now consider the following choice. You must forgo either the health improvements over the last half-century or the non-health improvements. That is, you must choose either (a) 1948 health conditions and 1998 non-health living standards or (b) 1998 health conditions and 1948 non-health living standards. Which would you choose? 25

Don’t worry…. be happy 26 FT 10 Jan 05 p. 4 Kahneman “ I hope [the happiness index] could, years from now, become be as important as GDP

W 2 A Labor Demand The production function Logs, Elasticities and factor shares Participation and Productivity Okun’s Law and Full Employment Output 27

Production and Distribution 28

Production and Distribution 29

Constant Returns and Shares Y 30

Income Shares 31

Income Shares and Elasticities This is a Cobb-Douglas production function. Douglas was a U of C Econ Prof and Senator. Formulated in 1920’s It is Constant Returns to Scale and homothetic. CRS: if N and K double their %change is 100 % change Y= alpha*100+(1 -alpha)*100=100 32

Income Shares and Elasticities With marginal productivity factor pricing, elasticities are identical to factor shares. 33

Income Shares and Elasticities • SL and Sk are the shares of labor and capital in national income. • %Change Y=(SL)*%Change L+ (Sk)*%Change K + Technical Change • Technical Change is found as a ‘residual’: • Technical Change= %Change Y(SL)*%Change N -(Sk)*%Change K 34

Income Shares and Elasticities USA 1960 -85 Labor share=0. 67, Capital share=0. 33 %change Y = 3. 1% per year % change K = 3. 2% (0. 33 x 3. 2 = 1. 1) % change L = 1. 9% (0. 67 x 1. 9 = 1. 3) % change Technology = %chg. Y - 0. 33 %chg. K - 0. 67 %chg. L 0. 7 = 3. 1 - 1. 3 So technology is a big contributor to economic growth. Smith regards trade as a key component of technical change. http: //pages. stern. nyu. edu/~nroubini/NOTES/HAND 4. HTM Nouriel Roubini Understanding the World Macroeconomy Handout for Chapter 4: Productivity and Growth 35

Figure 3. 01 The production function relating output and capital 36

Figure 3. 02 The Marginal product of capital 37

Figure 3. 03 The production function relating output and labor 38

Figure 3. 04 An adverse supply shock that lowers the MPN 39

Figure 3. 05 The determination of labor demand 40

Figure 3. 06 The effect of a beneficial supply shock on demand 41

Figure 3. 07 The labor supply curve of an individual worker 42

Figure 3. 08 The effect on labor supply of an increase in wealth 43

Figure 3. 09 Average weekly hours, U. S. manufacturing 44

Figure 3. 10 The workweek and real GDP person in 36 countries As income up people work less. What shape would that give to Labor Supply? Shouldn’t We care about Participation Rates as well? 45

Figure 3. 11 Labor market equilibrium 46

labor market Figure 3. 12 Effects of a temporary adverse supply shock on the labor market 47 Or will nominal and or real wages be sticky?

Sticky Wages vs Market Clearing With a perfectly functioning market an adverse supply shock will lower wages and employment. With “sticky wages” that shock would cause a greater fall in employment as well as unemployment rather than a falling real wage. W S D D’ N S W D’ Wages may be sticky for different reasons. Some reasons suggest that it is the nominal wage that is sticky, other logics suggest that the real wage is 48 sticky. Chapter 11 discusses the notion. D N

Keynesian vs Classical View of Ue K view: shocks to labor demand come from both the supply side (productivity and oil prices) and the demand side (C+I+G+X-IM). sticky wages cause labor demand shocks to become unemployment rather than lower wages. C view: shocks to labor demand come essentially from productivity shocks. 49

e U Duration Most spells are short but at any moment in time the Unemployed population is dominated by longer term Unemployed. 2 mo. Spells, 60 m spells for the year, 10 m at any time 1 yr spells, 20 m at any time Average spell= (60/80)2 mo+(20/80)12 mo=4. 5 50

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Figure 3. 15 Change in employment status in a typical month 52

Employment Situation • Has both Household and Establishment Data • Household survey has been showing more job growth. • Changes are small in comparison to totals • The Employment Situation from the BLS 53

BLS retrieved 10 Jan 2009, http: //www. bls. gov/LAU 54

BLS retrieved 10 Jan 2009, http: //www. bls. gov/LAU 55

Big Numbers • 2. 4 million jobs lost (reduction in employment) over 2008. • 1. 9 m in last 4 months of year (post panic from Lehman Brothers collapse. ) • 2. 6 m long term unemployed (27 weeks or more). (Table A-12, Current Employment Situation, Friday Jan 9 2009) 56

2 sources of employment data household establishment 57

Change in employment 58

Dismal on Participation 59 http: //www. economy. com/dismal/pro/article. asp? aid=2715

Participation 90’s-08 60

Participation 48 -08 61

Male Participation 62

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• Productivity and the overall growth rate – Oil shocks mattered • Relative wages and technical change. 65

Figure 3. 13 Relative price of energy, 1960 -1997 66

Decomposing Productiviy A Productivity Primer By Mark Zandi, September 11, 1999 67

Figure 3. 14 The effects of skill-biased technical change on wage inequality 68

US Real Wages Q: Why did US real wages fall in 70’s A: oil shocks Q: Why was pick up so weak in good times? Possibly due to: 1) Skill biased tech change 2) Changing relative prices 69

Shifting Solow Production Func. Dismal: Productivity Conundrum. By Mark Mc. Mullen 5/14/03 http: //www. economy. com/dismal/pro/article. asp? aid=2222 70

Differential Real Wages in USA 71

Skill premium in USA 72

Changing relative goods P’s • As globalization has risen the price of traded goods has fallen faster than non traded goods. Hence even though manufacturing labor productivity has been good the relative price of manufactured goods has been falling. This has driven a growing wedge between the ‘real wage’ as a consumption basket and the ‘real wage’ as the marginal product of labor. • MVPL=Poutput*MPL, MPL up, Pmnf dn. 73

Okun’s law How does unemployment vary with output. (level form) How does unemployment vary in response to the Growth rate of output? (growth form) What is the potential growth rate of the economy? 74

Arthur Okun’s Level Law At a moment in time, for every percentage point that the unemployment rate exceeds (is below) the natural rate, real GDP will be 2 percentage Points below (above) the full-employment level of GDP. The level version as an equation: 100( Y - Y)/ Y = 2(u - un), where u is measured in percentage points, i. e. , u = 5. 5%, not. 055. 75 F

Text on Okun’s Level Law 2. 5% GDP gap corresponds to 1% more Ue text forgot the 100 76

Okun’s Growth Rate Law II. The basic idea underlying the growth rate version is that when output grows more slowly than full employment output, unemployment will rise (i. e. , the utilization of productive factors will be falling). This version of Okun’s Law is particularly useful forecasting: For every 2 percentage points that the rate of growth of real GDP exceeds the rate of growth of full-employment GDP over the course of a year, the unemployment rate will fall by one percentage point. The growth rate version as an equation: D%Y = 3 - 2 Du 77 http: //www. amherst. edu/~econ 53/Okun. PDF

From Level to Growth Form of Okun’s law (an approximation) 78

Figure 3. 16 Okun’s law in the United States: 1954 -1998 79

In 1974 -95 annual data alpha (2. 39, 2. 86, 3. 34) beta (-1. 28, -1. 84, 80 From BEA data

In 1980 -90 annual data alpha (2. 4, 2. 87, 3. 32) beta (-2. 57, -2. 11, 81

De. Long on Okun’s Law 82 J. Bradford De. Long, 2000 Macroeconomics.

Economagic Okun’s Law 11 data points: to 2001 83

Economagic on Okun’s Law Y = Annual Change in real GDP, Percentage Points X = Annual Change in Unemployment Rate, Percentage Points Y = 2. 8702 - 1. 8368*X, (-1. 8368 is “Beta”) Std Err = 0. 48889 t value = -3. 7572 (The most standard method for judging the “significance” of beta is to ask if beta > 2*standard error) r = -0. 78145 R 2 = 0. 61067 Standard deviation of errors = 0. 94494 Number of observations = 11 84

Paul Krugman, ‘How Fast Can The US Economy Grow? HBR July/Aug 1997 2. 4% Potential Growth Rate 85