Economic Environment Analysis

Ace Institute of Management Executive MBA Program

Session 1
Instructor Sandeep Basnyat Sandeep_basnyat@yahoo.com 9841 892281

Course Structure
Macroeconomic Theory + Individual Presentations Theory: Provide foundations for understanding Individual Presentations: Everyday Newspaper/ Magazine articles provide real life issues (will be provided) Class Test I: multiple choice Assignment I: Economic analysis Research paper: At the end (topic of your choice but should be approved before)

How does the entire economy works

IMPORTANT STATISTICS FOR MACROECONOMISTS Three statistics that economists and policymakers use:

Gross Domestic Product (GDP) is the monetary value of all final goods and services produced within an economy in a given period of time-best single measure of economic well being of a society
Inflation rate measures changes in level of prices. The unemployment rate tells us the fraction of workers who are unemployed.

Gross Domestic Product (GDP)

Two ways of viewing GDP
Total income of everyone in the economy Total expenditure on the economys output of goods and services Income $ Labor
Households Firms

Goods/ Services Expenditure $ For the economy as a whole, income must equal expenditure. GDP measures the flow of dollars in the economy.

Simple Circular flow of income model (Closed economy)

Firms Revenue Market for goods and Services Consumption (C) expenditure Goods/ Services

Government
Investment (I)

Purchase (G)
Taxes (T)

Government

Firms
Loans

Public

Households
Private Savings (S)

Savings (S)

Financial Markets

Income (Y)

Factor Payment

Market for Factors of Production S+T =I+G Total Leakages = Total Injections

If:
$0.50 $1.00

GDP = (Price of apples Quantity of apples) + (Price of oranges Quantity of oranges) = ($0.50 4) + ($1.00 3) GDP = $5.00

Y = C + I + G + NX
Total demand for domestic output (GDP) Investment spending by businesses and households

Net exports or net foreign demand

Government purchases of goods and services

Consumption spending by households

This is the called the national income accounts identity.

Calculating GDP
Components of U.S. GDP, 2004: The Expenditure Approach
BILLIONS OF DOLLARS PERCENTAGE OF GDP

Personal consumption expenditures (C) Durable goods Nondurable goods Services Gross private domestic investment (l) Nonresidential Residential Change in business inventories Government consumption and gross investment (G) Federal State and local Net exports (EX IM) Exports (EX) Imports (IM) Gross domestic product (GDP)
Note: Numbers may not add exactly because of rounding. Source: U.S. Department of Commerce, Bureau of Economic Analysis.

8,214.3 987.8 2,368.3 4,858.2 1,928.1 1,198.8 673.8 55.4 2,215.9 827.6 1,388.3

70.0 8.4 20.2 41.4 16.4 10.2 5.7 0.5 18.9 7.1 11.8

-624.0

- 5.3

1,173.8 1,797.8
11,734.3 100.0

10.0 15.3

Practice Problem-1.1

Consumption Investment Government Purchase Net Export

Calculate GDP from the above data
Answer: 12485.8

: 8746.2 : 2103.1 : 2363.4 : - 726.9

Measuring GDP from Income side

Sum of income of all factors of production gives the GDP from income side (Gross Domestic Income) GDI or GDP (I) = Compensation of employees + Proprietors Income + Rental Income + Corporate Profit + Net Interest

Calculating GDP
U.S. National Income, 1980 (Shapiro: Table 2-1, Pg.27; Adjusted)
BILLIONS OF DOLLARS

Gross Domestic Products (GDP)

Compensation of employees Proprietors income Corporate profits Net interest Rental income

2341.3
1804.4 130.6 183.8 190.6 31.9

Practice Problem-2

Compensation of the employees Corporate Profits Proprietors Income Net Interest Rental Income

: 5299.8 : 856.0 : 663.5 : 507.0 : 143.4

Calculate GDP from the above data Answer: 7469.7

World Top 10 GDP in Millions of US Dollars in Market Price (Source: IMF 2010)

11. India 1,430,020

107. Nepal - 15,108

162. Bhutan - 1,397

1) Used goods. 2) Intermediate goods (use value added method)

Other Exclusions from Expenditures

Expenditure on purchase of goods and services during specified time period.
Previous expenditure reflects the change in ownership only.

Avoid neither good nor a service

Does not reflect production such as bonds/ stocks

Avoid expenditure by governments for which it does not receive a good or service in return
Eg.: Transfer payments such as Social security,, unemployment compensation etc.

All expenditure on goods/services sold illegally

Other derivations from GDP

Gross National Product (GNP) Net National Product (NNP) National Income (NI) Personal Income (PI) Personal Disposable Income (DI)

National Income Accounting contd..

GDP + Income earned from domestic national abroad Income paid to foreign national at home = GNP GNP is the monetary value of final goods and services produced by the nationals (income earned by the nationals on foreign countries minus income earned by foreigners at home) GNP Depreciation (Capital Consumption) = NNP Depreciation is the net capital consumption during the accounting year NNP Indirect Business Tax = NI (National Income)

National Income Accounting (Narrowing to personalized Income)

National Income (NI) Corporate Profit and Tax Social Insurance contribution Net Interest + Dividends + Government Transfer to Individuals + Personal Interest Income = PI (Personal Income)

National Income Accounting (Narrowing to personalized Income)

Personal Income Personal tax (Income Tax) Non-tax payments (such as parking tickets) = DI (Disposable Income) Disposable income is the final income that a consumer spends on the purchase of goods and services DI Personal Consumption Expenditure = Saving Or, DI Saving = Personal Consumption Expenditure
(Note: PCE is the one we add in GDP)

Real vs. nominal GDP

GDP is the value of all final goods and services produced. Nominal GDP measures these values using current prices. Real GDP measure these values using the prices of a base year. (Indicates how much prices have increased over time- Inflation)

Practice problem, part 1

2006 P good A $30 Q 900 P $31 2007 Q 1,000 P $36 2008 Q 1,050

good B

$100

192

$102

200

$100

205

Compute nominal GDP in each year. (Multiply Ps & Qs from same year) Compute real GDP in each year using 2006 as the base year. (Multiply each years Qs by 2006 Ps)

Answers to practice problem, part 1

nominal GDP

multiply Ps & Qs from same year

2006: $46,200 = $30 900 + $100 192

2007: $51,400 2008: $58,300

real GDP

multiply each years Qs by 2006 Ps

2006: $46,200 2007: $50,000 2008: $52,000 = $30 1050 + $100 205

GDP Deflator
The inflation rate is the percentage increase in the overall level of prices. One measure of the price level is the GDP deflator, defined as
Nominal GDP GDP deflator = 100 Real GDP

Practice problem, part 2

Nom. GDP 2006 2007 2008 $46,200 51,400 58,300 Real GDP $46,200 50,000 52,000 GDP deflator Inflation rate n.a.

Use your previous answers to compute the GDP deflator in each year. Use GDP deflator to compute the inflation rate from 2006 to 2007, and from 2007 to 2008.

Answers to practice problem, part 2

Nominal GDP 2006 2007 2008 $46,200 51,400 58,300 Real GDP $46,200 50,000 52,000 GDP deflator 100.0 102.8 112.1 Inflation rate n.a. 2.8% 9.3%

Thank You