Finance 30220: Macroeconomics

Introduction to The US Economy

How do we measure a country’s size? Total production would be a good start, but the global economy complicates things….

Choose the “American” Product

BMW X5IPhone

Canada

China

Egypt

India

MexicoJapan

South Africa

USA

Germany

Where do BMWs come from?

Spartanburg, South Carolina• 8,000 Employees• Produces 300,000 vehicles annually• Produces ALL X3, X4, X5, and X6

models (even for export to Europe)

Where does your IPhone come from?

Imports of the iPhone in 2009 contributed $1.9 billion to the U.S. trade deficit with China.

Two measures of a country’s production

Gross Domestic Product represents the total current market value of all goods and services produced within a country over the course of some time period

Gross National Product represents the total current market value of all goods and services produced by a country’s citizens over the course of some time period

VS

By the Standard of GDP, a BMW X5 is an American car, but the IPhone is an Chinese phone (actually, a global phone)

By the Standard of GDP, a BMW X5 is an German car, (The IPhone is still a global phone)

Gross Domestic Product: $1.3BGross National Product: $7.54B (+580%)

Why East Timor’s GNP is almost six times as high as its GDP

Foreign Aid

Gross Domestic Product: $210.3BGross National Product: $164.2B (-25%)

Why is Ireland’s GNP so much lower than its GDP?

(Do a google search on this)

“Double Irish with a Dutch Sandwich”

The Bureau of Economic Analysis (BEA) reports Gross Domestic Product (GDP) for the United States on a quarterly basis:

For the first quarter of 2015, GDP in the United States was (on an annualized basis) was...

$17,665,000,000,000.00

* Source: www.bea.gov

Gross National product

$17,827,100,000,000.00

Let’s stick with GDP for now. How does the US Economy compare in size to other countries around the world? (World Economy = $108T ; the countries listed below are 75% of the total)

Japan

$4.807T

United States

$17.46T

European Union

$17.61T

Australia

$1.1TBrazil

$3.07T

PPP Method 2014 est. * Source: CIA Factbook

China$17.63T

India

$7.277T

Russia$2.5T

California

$2.0T

Mexico

$2.14T

England

$2.4T

The average price of a Big Mac in the United States is*

$4.62

The average price of a Big Mac in China is*

16.60 Yuan

Problem: How do we compare economies with different currencies?

The Market Exchange rate method involves converting foreign prices to US dollars using the current market exchange rate.

Y16.60 x .16 = $2.65

The Purchasing Power Parity method uses prevailing US prices $4.62

1 Chinese Yuan = .16 U.S. dollars

Which if these is more accurate?

In this case, you could make money by buying Big Macs in China and then resell them in The US. There is a unique exchange rate that eliminates this profit opportunity.

16.60 x exchange rate = 4.62

exchange rate =4.62

16.60= .28 ($ per Yuan) (3.57 Yuan per $)

(This is known as the PPP exchange rate)

The average price of a Big Mac in the United States is*

$4.62

The average price of a Big Mac in China is*

16.60 Yuan = $2.651 Chinese Yuan = .16 U.S. dollars

In principle, it shouldn’t matter…arbitrage would eliminate any price differentials

Do markets really eliminate profit opportunities?

.28

.16

55%Yua

n P

er U

S D

olla

r

PPP Based off of Big Macs, the Yuan is “undervalued” by 55%

Valuing currencies using the Big Mac Standard

“Overvalued”

“Undervalued”

China

The method by which countries are evaluated sometimes greatly change the results!

PPP Approach Market Exchange Rate

Country GDP Rank GDP Rank

China $17.63T #1 $10.36T #3

European Union $17.61T #2 $18.14T #1

USA $17.46T #3 $17.46T #2

India $7.277T #4 $2.048T #7

Japan $4.807 #5 $4.77T #4

Germany $3.621 #6 $3.82T #5

Russia $3.568 #7 $2.06T #6

*2014 Estimate

** Source: CIA Factbook

Nominal GDP around the world (PPP Method)

*Source: CIA Factbook

Note how concentrated GDP is among a few countries….

* Source: www.bea.gov

Lets use the PPP method as a reasonable method for comparing countries. Per Capita GDP is calculated by dividing total GDP by the current population. This gives a better sense of average well being.

Per Capita GDP = $17T320M

= $53,125

Qatar

Luxem

bourg

Liech

tenst

ein

Mac

au

Berm

uda

Isle

of M

an

Singap

ore

Monac

o

Brunei

Kuwait

25,000

45,000

65,000

85,000

105,000

125,000

145,000

165,000

* Source: CIA FactbookNote: 2014 GDP estimates measured on a Purchasing Power Parity Basis

In Per Capita Terms, the United States ranks #18 while China sits at #113 ($12,900)!! The European Union comes in at #42 ($38,300)

*Source: CIA World FactbookGDP Per Capita around the World

Again, per capita GDP is highly concentrated is a few countries

* Source: Census Bureau

Median Household Income by County (2012)

Recall, GDP per capita is around $53,000

Even within the US, income is heavily concentrated!

* Source: World Bank

Did you know that if you earn $20,000 or more per year, you are in the top 4% of the global income distribution

$20,000 is in the bottom 20% of the US income distribution

Side note: Calculating rates of growth

t = 0 t = 1 t = 2 t = 3 t = 4

100150

220

340

540

Suppose that we have the following data. How would you calculate the rate of growth between time 0 and time 4.

Side note: Calculating rates of growth

t = 0 t = 1 t = 2 t = 3 t = 4

100150

220

340

540

540 100*100 440%

100Growth

440% (Of 100)

Calculating a percentage change like this assumes that the growth takes place all at once

Side note: Calculating rates of growth

t = 0 t = 1 t = 2 t = 3 t = 4

100150

220

340

540

ln 540 ln 100 *100 168%Growth

168%

Using natural logs allows the growth process to be a smooth, continual process

Side note: Calculating rates of growth

t = 0 t = 1 t = 2 t = 3 t = 4

100150

220

340

540

1

4540 1 *100 52.5%

100Average Annual Growth

52%

52%

52%

52%

Again, this assumes a discrete process (happening at regular intervals)

Side note: Calculating average annual rates of growth

t = 0 t = 1 t = 2 t = 3 t = 4

100150

220

340

540

ln 540 ln 100*100 42%

4Growth

42%

42%

42%

42%

Using natural logs allows the growth process to be a smooth, continual process

Period GDP (Billions)

2014Q1 17,044

2014Q2 17,328

2014Q3 17,599

2014Q4 17,703

2015Q1 17,655

Another measure of economic performance would be the rate of growth in output rather than the level of output

Year on Year growth (2015Q1-2014Q1)

ln 17,655 ln 17,044 *100 3.5%

Year on Year Growth

Annualized Growth

Annualized Growth (2015Q1)

ln 17,655 ln 17,703 *4*100 1.08%

Period GDP (Billions) Price Level

2014Q1 17,044 107.66

2014Q2 17,328 108.23

2014Q3 17,599 107.60

2014Q4 17,703 108.64

2015Q1 17,655 108.61

We can approximate real growth by subtracting the inflation rate

* Source: www.bea.gov

Year on Year Inflation (2013Q3- 2014Q3)

ln 108.61 ln 108.64 *4*100 .11%

Year on Year growth (2013Q3-2014Q3)

Real Growth = 2.63%

Annualized Growth (2014Q3)

Annualized Inflation (2014Q3)

ln 108.61 ln 107.66 *100 .87% Real Growth = -.97%

- -

ln 17,655 ln 17,044 *100 3.5% ln 17,655 ln 17,703 *4*100 1.08%

Mac

au

Turk

men

ista

nCha

d

Mon

aco

Mon

golio

Dem. R

epub

lic C

ongo

Burm

a

Moz

ambi

que

Ethio

pia

Sierr

a Le

one

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

* Source: CIA FactbookNote: 2014 GDP estimates measured on a Purchasing Power Parity Basis

In terms of real GDP Growth the US drops to #131

Real GDP Growth by State: 2013

*Source: Bureau of Economic Analysis

Economic growth in the US is also pretty concentrated

Growth Rates of Real GDP around the world*Source: IMF's October 2012 World Economic Outlook

Note that this picture of economic growth is almost a mirror image of the picture for GDP per capita (the fastest growing regions are the lower income regions…we will come back to this)

Year GDP Price

1947Q1 $237B 12.6

2015Q1 17,655 108.6

Let’s look at longer term averages for the US…

ln 17,655 ln 237*100 6.3%

68

Total Growth Price Growth (Inflation)

ln 108.6 ln 12.6*100 3.2%

68

Real Growth = 6.4% - 3.2% = 3.1%

Average Real Growth = 3.2%

Note that the US seems to be slowing…this began in the 1970s

???

Something definitely happened in the 1970s and 1980s…

1947 1957 1967 1977 1987 1997 20070

50

100

150

200

250

300

350

400

450

Real GDP Per Hour Real Compensation Per Hour

From the late 1970’s on, we have developed a “wage gap”

Index: 1947 = 100

Since the late 1970’s we have seen the emergence of a “wage gap”. That is, we see a difference between productivity and wages

1947 1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 2007 201256

58

60

62

64

66

68

70Percent

65%

Historically, labor’s share of income has been constant at around 65%, but has decreased since the 1980s.

So, where is the extra income going?

This “wage gap” translates into a lower labor share of income

*Source: Thomas Piketty and Emmanuel Saez

As labor’s share of total income declines, a larger share of income is going to capital owners (i.e. to rich people)

Real GDP Per Capita (1993 = 100)

Real Median Household Income (1993 = 100)

Note the divergence of median with mean in the late 1990’s

* Source: US Census Bureau

US Income Distribution in 2012 (Real Mean Household income = $60,000)

# of Households = 121M

Source: US Census Bureau (www.census.gov)

$105,910+

$65,501 - $105,910

$40,187 - $65,501

$20,900 - $40,187

$0 - $20,900

Average Income by Quintiles (2013)

The Lorenz curve plots the cumulative distribution of US income

The Lorenz Curve

The Gini Coefficient

0 = Perfect Equality

1 = Perfect inequality

BA

AGini

The US currently has a Gini coefficient of .45

Gini Coefficient in the US by County

* Source: Census Bureau

* Source: CIA Fact book

Gini Coefficients around the world

Note that income inequality in the US was worse back in the 1920’s, but has grown dramatically since the 1970s

Income inequality really accelerated in the 1990’s!

The Good Old Days: Economic Growth from 1947-1973

The Times, They are a Changin’: Economic growth from 1977-1989

Here we can see both the declining growth as well as the rising inequality.