What is economics and why should we study it

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What is economics and why should we study it?
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Global Economics
Globalization is the process of integration of an
economy into the world economy. This process
involves output markets, labor markets, capital
markets.

• Immigration and Economic Development
• Technological Changes and Trade
• Outsourcing
• Foreign Investment and Currency
• Currency and Trade
• International Economic Shocks and Domestic
  Economics Stability
• These are just some of the major venues through
  which world economy affects our economy

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For the US see BEA
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Income distribution in 2005 GDP per capita based
on PPP
Less than 1806.50 1806.50 4052.40 4052.40
7088.70 7088.70 19111.60 Greater than
19111.60 No Data Available
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World Economy in 2005
Source WDI for 2007
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The planet Earth in the darkness of the night
Image source NASA (http//antwrp.gsfc.nasa.gov/
apod/ap001127.html)
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Correlation between life expectancy and the
standard of living as measured by the GDP per
capita (PPP) is positive 0.63, see the stats table
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Economic development quality of life
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Evaluating Economic Activity

• Output production, the process of income
  creation
• GDP - the total market value of all final goods
  and services produced by factors of production
• located within a nations borders
  over a period of time
• GNP - the total market value of all final goods
  and services produced by factors of production
• owned by a nation over a period of
  time

Relation of Gross Domestic Product and Gross
National Product Billions of dollars www.bea.gov

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Output and Income GDP and GNI

• GDP is a measure of production, and production
  represents economic activity. Note that the sale
  of output is simply a transfer of ownership (or
  wealth), while the production of output is the
  process of generating wealth. The production
  generates incomes to the factors of production,
  which are then distributed to the inputs
• pay wages to employees
• pay interest to lenders
• pay profit to capital owners etc.
• Therefore total value of output is equal to total
  income. In what we can consume we are limited by
  what we produce.
• Therefore GDP per capita (GDP/population) is a
  measure of average income in a country.

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Understanding GDP

• How should the following count?
• Purchase of MSFT shares through e-trade broker
• Purchase of a previously owned house
• Purchase of a new house from a construction
  company
• Purchase of a used car from a private individual
• Purchase of a used car from a used car dealer
• Purchase of a class at GSU
• Build up of dealer inventories?
• Cooking your own meal?
• Going out to a restaurant?

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Understanding the GDP II

• How should the following count?
• Purchase by Ford Comp. of new tires from a tire
  supplier?
• Purchase by me (private car owner) of new tires
  from a tire supplier
• Purchase of oil by an American oil company from
  another American oil company (oil is domestically
  extracted)
• Purchase of oil by an American oil company form a
  foreign supplier of oil
• Receipt of dividends by a US resident from a
  Russian company
• Production of new Nissan Altima cars by a US
  based Nissan Facility
• Production of new VW Jetta cars by a Mexico-based
  VW facility

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Comparing Incomes Across Countries

• Real PPP GDP per capita as a measure of the
  standard
• of living.
• Standard of living Income/Prices
• Read GDP as a measure of income
• Adjustment for the cost of living difference in
  prices
• Purchasing Price Parity adjustment for the cost
• of living. Prices differ across countries
  creating
• differences in purchasing power of money. For
• instance, 1000 USD buys more (today, probably
  less) in
• Moscow than in Atlanta.
• Constructing a cost of living index
• Fixing a market basket
• Tracking that market basket through different
  locations

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GNI per capita in 2001, PPP method (current
international ) World Bank Development
Indicators for 2003
Less than 1710 1710-3560 3560-6250
6250-15110 Over 15110 No data available
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Income distribution in 2004
Lower income group GNI per capita PPPlt
1878 Lower middle income GNI per capita PPP lt
4244 Middle income group GNI per capita PPP
lt7515 Upper middle income group GNI per capita
PPP lt 18589 High income group GNI per capita
PPP gt 18589
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Real GDP growth rate in 2000 World Bank
Development Indicators 2003
Less than 0.6 -0.6 lt . lt 0.8 0.8 lt / lt2.1
2.1 lt . lt 4.2 Over 4.2 No data available
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Real GDP growth rate in 2001 World Bank
Development Indicators 2003
Less than 0.6 -0.6 lt . lt 0.8 0.8 lt / lt2.1
2.1 lt . lt 4.2 Over 4.2 No data available
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Evaluating economic activity - Inflation

• Inflation the rate of growth in the average of
  all prices
• Measuring inflation
• Price Index
• CPI
• PPI
• Core Index
• Real versus Nominal measures
• US statistics www.bls.gov

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Real versus Nominal
Nominal GDP growth rate output growth rate
price level growth rate
USA
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Characteristics of Recent US inflation

• Low level
• Non-uniform
• Impact of dollar exchange rate/weaknesses in
  foreign economies in the 1990s a characteristic
  of globalization in the output markets
• Recent impact of the price of Oil

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Impact of Inflation

• Menu costs
• Redistribution of wealth
• Instability of relative prices
• Currency value the law of one price for
  internationally traded goods
• Increased costs associated with forward looking
  financial arraignments

Sources of Inflation

• Tight labor market
• Overheated economy US in the late 1990s
• Strong Monetary Expansion
• Germany in the 1920s Russia in the early 1990s
• Rapid increases in input costs (other than labor)
• US economy today and the price of Oil
• Currency depreciation
• Recent dollar depreciation, particularly against
  the currency of China

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Short international comparison
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Evaluating economic activity - Unemployment

• Defining labor force, unemployment, labor force
  participation rate
• Measuring unemployment
• US unemployment statistics www.bls.gov
• Structural and cyclical unemployment

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In 2001 EMU included Austria, Belgium, Finland,
France, Germany, Greece, Ireland, Italy,
Luxemburg, The Netherlands, Spain, Portugal
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Supply - Demand

• Market
• Product definition
• Geographical boundaries
• Demand Q F (P, all other relevant factors)
• Law of demand as Price increases quantity
  demanded decreases
• Relevant factors
• Income
• Normal Income increases ? demand increases
• Inferior income increases ? demand decreases
• Related in consumption goods
• substitutes Px increases ? demand for Y
  increases
• MARTA and GSU parking
• Complements Px increases ? demand for Y
  decreases
• GSU parking and gasoline use
• And many other factors
• Interesting demand functions
• Vertical demand no price sensitivity
• Gasoline demand in the short-run
• Your demand for this class if you are one class
  away from graduation

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Supply - Demand

• Supply Q F (P, all other relevant factors)
• Law of supply as Price increases quantity
  supplied increases
• Relevant factors
• Cost of production
• Cost of factors of production
• Wages, interest rate
• Production technology
• Productivity and cost of production
• Related in production goods
• Substitutes in production
• Same resources can be used to produce either good
• Condos versus single family homes
• Complements in production

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Market equilibrium(private goods with no
externalities)

• Quantity demanded quantity supplied
• Market clearing
• No excess supply or shortage
• Properties of the Market Equilibrium
• Stability
• Efficiency
• Welfare to society
• Consumer surplus
• Producer surplus

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ForEx
Defining the Market Institutions facilitating
the market Major Private Banks Central
Banks Market Participants Banks, Central
Banks, Corporations, Investors, even consumers.
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Brief History of the International Monetary System
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Gold Standard 1880 - 1914

• Dates of adoption of a gold standard
• 1695 United Kingdom at 1 to 113 grains (7.32g)
  of gold.
• 1818 Netherlands at 1 guilder to 0.60561g gold
• 1854 Portugal at 1000 reis to 1.62585g gold
• 1871 Germany at 2790 Goldmarks to 1kg gold
• 1873 Latin Monetary Union (Belgium, Italy,
  Switzerland, France) at 31 francs to 9g gold
• 1873 United States de facto at 20.67 dollars to
  1troy oz
• 1875 Scandinavian monetary union (Denmark,
  Norway and Sweden) at 2480 kroner to 1kg gold
• 1876 France internally
• 1876 Spain at 31 pesetas to 9g gold
• 1878 Finland at 31 marks to 9g gold
• 1879 Austria 1893 Russia at 31 Roubles to 24g
  gold
• 1897 Japan at 1 yen to 1.5g gold
• Price Stability
• Simplified conversion
• No Future markets

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1918-1939

• Great Depression and lack of international
  cooperation
• 1925 -1931 UK operates on Gold Standard
• US remains on Gold Standard till 1933
• Fixed exchange system

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Post WWII era

• Bretton Woods
• IMF and the Gold Exchange Standard
• Gold Exchange Standard
• Fixed system with limited (1 allowable
  adjustments)
• Dollar is convertible into gold at 35 USD per 1
  Oz
• Very few monetary reforms are undertaken by
  member states
• 1950s 1960s
• August of 1971 USD is no longer a convertible
  currency
• The Smithsonian Conference of December of 1971
• 38.02 USD 1 oz
• Dollar remains inconvertible
• Increased allowable adjustment to 2.25
• March of 1973 FLOAT begins

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Spot market

• http//www.federalreserve.gov/releases/h10/Update/
  default.htm
• Ask and Bid prices and the spread
• Ask Banks asking (banks sales price)
• Bid Banks purchase price
• Spread return to the market maker, in this case
  the bank
• Consider the following rouble quote Ask Price
  0.0425 Bid Price 0.0420
• Alignment of exchange rates
• Arbitrage
• Simple setting (2 or more currencies)
• Consider two banks quoting the rouble
• Bank I 0.0425 - 0.0430.
• Bank II 0.0435 - 0.0440
• Price difference falling within the spread
• Setting 2 implied exchange rate (3 or more
  currencies)
• Consider tw banks providing the following quotes
• Bank I
• Between Rouble and Dollar R1 0.0425
• Between Rouble and Euro R1 EUR 0.030
• Implied USD/EUR rate is USD1 0.7059

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Currency Index USD Index by the FED
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USD weights
Source FED
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Source FED
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Recent performance of the USD
/Euro
Source FederalReserve.gov http//www.federalrese
rve.gov/releases/h10/Hist/
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Source FRB, NY
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Role of the exchange rate in the price of oil
Source for historical oil price data US Dept.
of Energy, http//tonto.eia.doe.gov/dnav/pet/pet_p
ri_spt_s1_d.htm
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The ForEx Market

• Demand for the USD
• US Exports
• Goods
• Services (tourism)
• Foreign Investment into US
• US Financial markets
• Direct investment
• Central Banks
• Speculation

• Supply of the USD
• Imports to the US
• Goods (trade)
• Services (tourism)
• US investment abroad
• Foreign Financial Markets
• Direct investment abroad
• Central Banks
• Speculation

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The Interesting 90s

• 1991-92 Collapse of the USSR Block, beginning of
  the Transitional Recession in Eastern Europe
• 1994 Mexican Currency Crisis
• 1991(2)-95 The Balkan Wars
• 1998 Recession in Japan
• 1997 (July) Beginning of the Asian Financial
  Crisis
• 1998 major Rouble Crisis

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The market for USD in the 90s
P of USD
Influx of investment stimulated Demand

D
S
Increase in imports stimulated Supply
Demand Effect Dominated (thus positively
effecting consumers standard of living)
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The post 90s era

• United Europe
• 10 New Countries Entered the Union on May 1st of
  2004, bringing the total number of member states
  to 25, with combined population of over 430
  million (US population is 293 million).
• Growth in Russia and China nearing double digits
• Emerging Economies of Brazil and India
• Threat of Terrorism to the US
• Continuous Growth in US Trade Deficit

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The market for USD in the post 90s era
P of USD

D
S
Supply effect appears to be dominating The
demand effect
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The BIG picture

• Rise in Imports ? Increase in Supply ?
  Depreciation
• Rise in Exports ? Increase in Demand ?
  Appreciation
• Influx of Investment ? Increase in Demand ?
  Appreciation
• Outflow of Investment ? Increase in Supply ?
  Depreciation

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Modern Economic Systems

• A modern Mixed Economy Capitalism with elements
  of Socialism
• An economic system
• Capitalism
• Socialism
• Communism
• An economic system and economic efficiency
• What? How? For Whom?
• Market Economy versus Command Economy

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Data for 2001, source World Bank
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Market Economy
Prices play two roles signaling mechanism and
distribution mechanism Consumer and producer
surpluses Welfare economics Income effect on
the demand Consumer sovereignty (voting with
dollars) Price controls and lack of adjustment
on the part of the market Market efficiency
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Presence of government in the production process
Competition Versus Monopoly Mixed industry GSU
versus Emory Can GSU be viewed as a
competitive firm? Large presence of the
government in an industry Primary
education Government Monopoly Provision of some
public utilities in certain areas, such as
water services in Fulton county Soft Budget
Constraint Command Economy
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Command Economies of Eastern Europe and USSR

• History 1917, 1945, 1985, 1989-1991
• Structure of command economy
• Central planning versus price mechanism
• State ownership versus private entities
• State monopoly versus competition
• Quality versus quantity
• Pricing of raw materials (USSR and the Eastern
  Block)
• Emphasis on industrialization (USSR)
• Principal-Agent problem

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Source World Bank
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Economies in Transition Real GDP growth rates
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Reforms in Transitional Economiesplanning is
great if you have the opportunity to do it

• Privatization
• Whats the value of state enterprises?
• How should the shares of those enterprises be
  allocated?
• Poland (intermediate funds), Czech Republic
  (vouchers), Yugoslavia (worker-control), Russia
  (combination of vouchers, management control)
• Effect of the scheme on the scope of
  restructuring
• - income distribution
• - government budget
• - differences between the economies of the USSR
  and those of Eastern Europe
• Price liberalization
• Shock therapy versus gradual approach
• - Poland (January 1, 1990) versus Hungary and
• the experience of Russia
• Sequence of reforms (political and economic) and
  income inequality
• Financial Stability and exchange rate

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Principles of Trade

• Absolute Advantage total cost
• Comparative Advantage relative (opportunity)
  cost
• Consider two economies (A, B), each endowed with
  200 worker-hours. Consider that there are only
  two goods being produced (X, Y). Consider that in
  country A the hourly wage is A10, while in
  country B it is B20, for simplicity assume that
  AB. Table below shows costs in each country

What can be said about the absolute and
comparative advantage principles in this
case? Productivity and trade (education, physical
capital) Currency and Trade