They are very pretty and informative notes (because I am a perfectionist), so use these to help you do well in your first year. You are welcome! :) Find me on Linked In @HollyHalai for any questions on the course (I did economics and GSD).
• Capita economies tend to grow over time, but random fluctuations can occur due to financial crisis,
COVID-19 etc
Price levels in the UK
• Price level: a measure of the average cost of goods in an economy
• 3 types of price level in the UK:
1. Retail price index – e.g. the costs of housing and mortgages (grows fast)
2. Consumer price index (grows less fast the retail price index)
3. RPIX?
• Inflation: the percentage change in some price level
• In the 1970s, inflation was high and the economy saw average unemployment increase (Philips
curve was key) – the inflation didn’t happen in Germany . This inflation has gone down
• The higher the unemployment, the less inflation there will be in the economy
• The more employment there is, the more bargaining power workers have with firms, and so they
can push the wages up, so the firms push prices up in negotiation with consumers producing
inflation; firms can recapture what they lose through wages by setting higher prices → so more
employment won’t always be a good thing (leads to high inflation)
Inflation and the business cycle
• When the economy is booming, inflation and conflict is higher as output is above trend
The Philips curve
• The relationship with unemployment and inflation
• You plot inflation against a measure of the output gap (the output gap measures unemployment)
• When unemployment is low, inflation is high
• Or when output is above turned (higher than expected employment), inflation is high
Output
• Income makes you better off when you are poor
• There is a positive relationship between income and satisfaction at lower levels of income until a
point where the relationship flattens out
,Measuring GDP: The Income Approach
• The sum of I the wages of
- the employed workers,
- the profits of the capitalists,
- rents due to owners of other factors of production (landlords etc)
• Income is received for production of goods and services
• Income is a measure of the output of the economy (its GDP)
• More income means more stuff and this makes us happier (happier)
Measuring GDP: Expenditure Approach
• We can also measure GDP as
- The total expenditure on the economy’s final output of goods and
services produced in a unit time (usually a year, sometimes a quarter)
where the i = 1 . . . Nf is the sum over all final goods and services. qi is the
quantity of each good (or service) produced and pi is the quantity
Real GDP
• Measures all the quantities produced in the given year, using a fixed set of prices
• You must come up with something so you can compare the price across the world
Why care about GDP growth in rich countries?
• A (long) spell of unemployment is probably the worst thing a developed economy can do to you:
• A. Oswald estimated that the monetary compensation for unemployment in the UK would have to
be c. 10 times the average monthly wage to compensate for the loss of satisfaction felt when
unemployed.
• People do not adjust to unemployment, as opposed to e.g. bereavement
• Unemployment is traditionally associated with violent political extremes, especially in Europe in the
1930s
• Recently slower middle-class income growth has been associated with an increase in largely non-
violent political radicalism
Unemployment and GDP growth
• Being unemployed is the worst thing that a
developed economy can do to you
,Important Insight from GDP calculations
• Expenditure = Income
• We should have (1) = (2) This only holds approximately
• But it shows us an important feature of macroeconomics
• One woman’s expenditure is another’s income e.g. not buying coffee
• This is more than an accounting identity
• If spending declines, income declines, spending declines further ...
• The ‘Multiplier’ Effect
• An externality in individual decision making
• This externality, or multiplier effect, has a big role to play in our discussion of business cycles on
EC107
Business Cycles
• Fluctuations in all aspects of economic activity
• Defined by fluctuations of output about some sort of trend growth rate
• We are also interested in fluctuations in
- Wages e.g. when growth is above average, wages are above average
- Investment
- Prices
- Employment
- Interest rates
• Can get short term and long term fluctuations
• Change weighting is a way of holding prices fixed, so you can make comparisons
• Economies can ‘boom’ or shrink during recessions, or grow below average for long periods of time
(the business cycle)
• Recession: 2 consecutive quarters of negative GDP growth
• The U.S NBER dates expansions and contractions
- Expansion: the economy as a whole is growing
- Contractions/recessions: the economy as a whole is shrinking significantly
NBER Cycles
• The business cycle is very asymmetric
• It has become more so:
- Expansions last a long time compared to recessions
- But recessions are very steep (see below)
• Not at all like a sine wave
• There is no predictable periodicity
Benefit of log scale
• The exponential growth model is approximately correct
• The Great Recession really was the largest since WWII
- Differences in logs are percentage changes in levels
, • Differences in logs are percentage changes in levels
• We have not nearly returned to potential output as you would have defined it before the G.R.
• If something is growing exponentially, it is easier to use logs to show the graphs, to see a trend (a
somewhat linear relationship)
The output gap
• The output gap is a related idea
• The deviation of output from its trend level
• where is some measure of trend or potential output
• If the output gap is positive GDP is above the expected level, or GDP is growing faster than
expected
• If the output gap is negative, GDP is below its expected level. It may be growing less than expected -
but not necessarily shrinking
• In our models we will think about output gaps much more than expansions, booms or recessions
Why use the output gap?
• Potential output is related to the use of available of resources
- Full employment? Full use of capital stock?
- Non-Accelerating Inflation Rate of Unemployment (or output)?
- Full use of all available resources, at best achievable productivity?
• The economy can be far below potential without being in recession
• An economy above potential can also be problematic
• For any definition, the output gap better captures the idea of slack or pressure in the economy
• Therefore better related to interesting covariates: inflation; unemployment
A H.P filtered output gap goes to 0 more than the linear output gap, so it is easier to see trends (a more
flexible model)
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