RESEARCH METHODS IN ECONOMICS

Lecture 2 (February 19, 2016)

Key Economic Concepts

Pınar DENİZ
pinar.deniz@marmara.edu.tr
 GDP
• GDP is the value of all goods & services produced in the economy in the year.

– GDP measures the output of all labor and capital within the home economy’s
geographical boundary
• GDP = C+I+G+X-M
• It is computed by multiplying the quantity of all goods and services by its
price.

• GNP ≡ GDP + income from investments abroad

– GNP measures the output supplied by permanent residents of the home

economy regardless of where they live and work or where they own capital.

• Gross National Income ≡ GNP + income from unilateral transfers.

• NetNational Income ≡ GNI – depreciation of capital stock

• With growing globalization our economy is increasingly reliant on goods we

produce beyond our national borders. While GNP does not calculate this,
GDP does.
 GDP
Gross Domestic Product (Expenditure Method)

•Final Consumption Expenditure of Resident Households

•Government Final Consumption Expenditure

•Gross Fixed Capital Formation

•Change in Stocks

•Exports of Goods and Service

•(-) Imports of Goods and Services

 When to Announce?
– Announcement by TURKSTAT with
production and expenditure approaches
(both nominal and real) every quarter
I. Quarter : 30 June
II. Quarter : 10 September
III. Quarter : 10 December
IV. Quarter : 31 March (next year)
 GDP
• GDP is not a comprehensive welfare measure. It does not include
some important factors for welfare such as environmental
externalities, leisure, etc.

• Measures of GDP
– Income Approach (interests + profits + wages + statistical adjustments)
– Expenditure Approach (C + I + G + NX)
– Production Approach (Total of value added)

• Potential output = A F(K, N, L)

– where A is total factor productivity, K capital, N labor and L land, in a
neoclassical Cobb Douglas production function

• Output Gap = Actual output - Potential output

 Real vs Nominal
• The nominal value of a good is its value in terms of
money.
• The real value is its value in terms of some other good,
service, or bundle of goods.

• Real GDP ≡ Nominal GDP / GDP deflator

• The real interest rate on money loans will be the stated

(or nominal) rate minus the anticipated rate of inflation.

• Current value refers to nominal value

• Constant value refers to real value
 INFLATION
• Denotes an ongoing rise in the general level of
prices
– If prices rise, a 1 TL will buy less.
– So, inflation means an ongoing fall in the overall
purchasing power of the monetary unit

– Consumer Price Index: the cost of a basket of goods

and services purchased by consumers over time
– Producer Price Index: the cost of a basket of goods
and services bought by firms over time
 Purchasing Power Parity (PPP)

Exchange rate are determined by many factors does not reflect the real
purchasing power parity of the currencies.

– The same amount of money does not buy the same amount of goods
and services. It just reflects the nominal value.

• PPP is a theory of exchange rate determination. It asserts that exchange

rate change between two currencies over any period of time is
determined by the change in the two countries’ relative price levels
(Dornbusch, 1985)

• It is about how integrated goods markets are internationally and how

rapidly prices adjust.
 PPP
• If prices fully-adjust: P = E.P*
• RER = 1, where real exchange rate RER ≡ E. P* / P
• Arbitrage
– Does PPP hold in the SR ? NO
– Does PPP hold in the LR ? MAYBE
• If it is completely costless to transport a good and there are no trade
barriers and free movement of factors of production, law of one price will
hold.

• But it is not possible for PPP to hold. Think about non-tradable goods for
instance.

• (Law of one price applies to individual goods, whereas PPP applies to the
general price level)
 Big Mac Index
• Big Mac Index is an example of a measure of the law of
one price.
• It is popularized by the journal, “The Economist”
– Big Mac Index compares the prices of a Big Mac burger in
McDonald's restaurants in different countries.

• The Economists
– “THE Big Mac index is a lighthearted guide to whether
currencies are at their “correct” level. It is based on the theory of
purchasing-power parity (PPP), the notion that global exchange
rates should eventually adjust to make the price of identical
baskets of tradable goods the same in each country. Our basket
contains just one thing, a Big Mac hamburger.”
(http://www.economist.com/content/big-mac-index)
 Opportunity Cost
• It is the value of the next-highest-valued
alternative use of that resource.
– If, for example, you spend time and money
going to a movie, you cannot spend that time
at home reading a book, and you cannot
spend the money on something else. If your
next-best alternative to seeing the movie is
reading the book, then the opportunity cost of
seeing the movie is the money spent plus the
pleasure you forgo by not reading the book.
 Balance of Payments
• The current account: records exports and imports of goods and services and international
receipts or payments of income
• The financial account: record of sales of assets to foreigners and purchases of assets
located abroad (foreign assets).
• The capital account: debt forgiveness and entering-departing migrants’ transfers

Current Account Balance + Financial Account Balance + Capital Account Balance = 0

The current account

Trade Balance : Exports minus imports of goods and services
Income Balance
Net Unilateral Transfers

The financial account

Foreign direct investment
Portfolio investment
Other investment
Reserve account

National Accounting
GDP=Gross National Expenditure + Trade Balance
 Budget Deficit
• Is the amount by which the governments
expenditures exceed its receipts during
some specified period of time.

• Vice versa is budget surplus

• Is it a problem?
 References
http://www.econlib.org/library/Topics/

http://www.hks.harvard.edu/fs/jfrankel/ITF-
220/readings/Dornbush-PPP-
NBERWP1591.pdf