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What is GDP(Gross Domestic Product) and what counts towards GDP?

the market value - of all final goods and services(not financial transactions) - produced within a country - during a given period of time.


What are the two approaches to measure GDP?

1) Income approach: GNP = National Income (wages, corporate profits, rent income…) + Indirect Business Taxes (property tax, sales tax) + Depreciation

GDP = GNP - Factor Payments from abroad (Americans earn outside the U.S) + Factor Payments to abroad (foreigners earn inside the U.S.)

2) Expenditure approach: GDP = C + I + G + NX

C = Consumption Expenditure (Durable, nondurable, and services)
I = Gross Private Investment (inc. unsold goods)
G = Government Purchases (Federal, state, and local)
NX = Net Exports(Exports – Imports)


What are some limitations of GDP?

1) Nonmarket productive activities are left out
2) Underground economy is left out
3) Leisure and human costs are left out
4) Environmental quality is ignored


Real GDP vs Nominal GDP

Nominal GDP is measured in “the current dollar value”
Real GDP is measured in “the constant dollar value(adjusted for inflation)


How to convert Nominal GDP to Real GDP using Price Index?

Real GDPa = (Nominal GDPa/P.I.a) x P.Ib

Definition of GDP deflator: a measure of the price level calculated as the ratio of nominal GDP to real GDP times 100.


How do you calculate the real value of something using CPI?

Real Valuea = (Nominal GDPa/CPIa) x CPIb

Definition of consumer price index (CPI): a measure of the overall cost of the goods and services bought by a typical consumer.


GDP per capita

GDP divided by population (to measure the average level of income/general standard of living).


What does the PPP adjusted mean?

A nation's GDP adjusted for purchasing power parity is the sum value of all goods and services produced in the country valued at prices prevailing in the United States.


How is the Consumer Price Index Is Calculated?

1. Fix the basket - The Bureau of Labor Statistics uses surveys to determine a representative bundle of goods and services purchased by a typical consumer.
2. Find the prices - Prices for each of the goods and services in the basket must be determined for each time period.
3. Compute the basket’s cost - By keeping the basket the same, only prices are being allowed change. This allows us to isolate the effects of price changes over time.
4. Choose a base year and compute the index -
a. The base year is the benchmark against which other years are compared.
b. The formula for calculating the price index is:
CPI = (cost of basket in current year/cost of basket in base year) x 100


How do you compute the inflation rate?

inflation rate = (CPIyear2 - CPIyear1/CPIyear1 ) x 100

Definition of inflation rate: the percentage change in the price index from the preceding period.


How Is Unemployment Measured?

1. The Bureau of Labor Statistics (BLS) surveys 60,000 households every month.
2. The BLS places each adult (aged 16 or older) of the Civilian Population into several categories that break down:
Not In Labor Force - In Labor Force
disabled - employed or unemployed


Give the definition and equation for Labor Force.

the total number of workers, including both the employed and the unemployed.

Labor force = Number of employed + Number of unemployed


Give the definition and equation for Unemployment rate.

the percentage of the labor force that is unemployed.

Unemployment rate =(Number of unemployed/Labor force) x 100


Give the definition and equation for Labor-Force Participation rate.

the percentage of the adult population that is in the labor force.

LFPR = (Labor Force/Adult Population) x 100


Problems of Measuring the Unemployment Rate

(1) Discouraged workers - people who have been out of work and given up looking for a job.
(2) people that claim that they are unemployed but have no intention to find a job.


Saving vs. Investment

Saving is the leftover of income after paying taxes and consumption. It does not matter how you store your saving(saving account, in stocks, or in bonds)
Investment, in economics, refers to investment in real physical capital, such as leasing new airplanes, building new factory, or buying more equipment.


Derive from GDP equation the Closed economy Saving-Investment Identity

GDP(Y) = C + I + G + NX
in a closed economy, no exports so:
Y = C + I + G
so, Y - C - G = I
when we derive G
(Y – C –T) + (T – G) = I
Private Saving (Y – T – C): Income-after-tax subtracts consumption
Public Saving (T – G): Tax revenues minus government spending → saving by public sector
Private saving + Public saving = Investment(National S)
S = I


What is the Open economy Saving-Investment Identity

S – I = NX

Consider If S – I 0


How do we compute a country’s openness?

Openness = (X + M)/GDP

the degree of free trade or trade liberalization


Uses GDP per capita to divide countries by income groups.

World Bank Income category

Low income countries:


How do we measure Gini Coefficient?

degree of income inequality among households

Step 1: Ordering data on inequality(Quintiles)
Step 2: compute the cumulative share of income for each quintile (example, the cumulative share for 3rd quintile would be bottom q + second q + 3rd quint)
Step 3: Draw the Lorenz curve- plots the cumulative share of income(Y axis) versus the percent of households(quintiles) (X axis)
Step 4: Computing the Gini coefficient - The Gini coefficient is a measure of inequality based on the distance between the Lorenz curve and the 45° degree line.
Gini coefficient = (Area A)/(Area A + Area B) [see 2 pg 7]
-The Gini coefficient is a number between 0 and 1. The higher the number is, the bigger the income inequality


The Rate of Natural Increase and Population Growth

Birth rate (b) − death rate (d) = rate of natural increase (r).

Population growth = r/1000 x 100

ch 2, pg 8


Life Expectancy at Birth

also a measure of overall quality of life in a country and summarizes the mortality at all ages.

-It can also be thought of as indicating the potential return on investment in human capital


High-Performing Asian Economies (HPAEs)

a group of eight Asian countries that experienced spectacular economic growth at different points in time during the second half of the twentieth century

consist of 3 different groups of countries based on yr:
1950’s: Japan
1960’s: 4 Asian Tigers – Hong Kong, Taiwan, South
Korea, and Singapore.
Late 1970’s: ASEAN 3 – Malaysia, Thailand, and

World Bank called these eight Asian countries the HPAEs in their report “the East Asian Miracle”


Economic Freedom Index

This statistic assigns score to a country for its degree of economic freedom

The index of economic freedom is based on business freedom, trade freedom, government size, money and investment freedom, financial freedom, labor freedom, property rights, and freedom from corruption.

-The most free country in the word is Hong Kong.


8 Common Characteristics among HPAEs
-(2 entire lecture notes)

1. Rapid and sustained economic growth
2. Declining income inequality and reduced poverty
3. Declining in agriculture’s share, but rising
agriculture productivity
4. Rapid growth of exports
5. Rapid demographic transitions
6. High investment and saving rates
7. Rapid human capital formation
8. Rapid productivity growth


What is the rule of 70

a variable that grows at a constant rate of "x% per period", will double in value in approximately "70/x periods"

example:the U.S. real income per person grew at
the average annual rate of 2%. According to the “Rule
of 70,” it will take 35 years(70/2) for the real income to double in the U.S.


How did the World Bank measure the income inequality in their East Asian Miracle report?

Income inequality = Income of richest 20%/Income of poorest 20%

(How many times the rich earn more than the poor.)


What is the Kuznets curve and why is it important?

“inverted U-shaped” curve that shows how inequality might first increase as a nation makes transition from agricultural economy to an industrial economy. As the economy continues to develop, the income inequality declines.


What is Land Reform?

Definition: the redistribution of property or rights in land for benefit of landless, tenant farmers.

Political view: shifts in the domestic balance of power
between feudal estates to landless peasants.

Economic view: land distribution from diseconomies of large-scale enterprise to increase returns to a land.

-However, decision for land reform is usually purely political!


What is Dependency ratio?

Dependency ratio = (youth population +elderly population)/working population

Definition: Dependency ratio is the
economic burden that the productive
portion of population must support


What is Total Factor Productivity (TFP)?

amount of output that can be achieved with a given amount of factor input. It measures how efficient resources are being used typically through technology.

TFP growth is the technological progress that improves
production efficiency or productivity.

-TFP growth is one key force of economic growth.


World Bank has grouped the HPAEs into 2 groups:

1. Investment-driven economies: Indonesia, Malaysia,
2. Productivity-driven economies: Taiwan, HK, S. Korea, and Thailand


According to the Solow Model, economic growth depends on:

1) Factor Accumulation-increase in capital stock (K) and increase in the labor force (L).
2) Productivity Growth: an increase in the amount of output produced by improved efficiency.


Factors that affect the capital stock(k)

Investment and depreciation so ∆𝑘 = 𝑖 − 𝑑𝑘

Changes in the capital stock
Say y=100, k=100, s=0.2, and d=0.1
-Suppose that we start the year with 100 (k =100) existing units of capital
-We buy s.y= 0.2x100=20 new units
-Depreciation dk= 0.1*100=10 unit of capital wears out
-At the end of the year, we have additional sy-dk = 20-10= +10 units of capital.
-You will have 110 units of capital at the end of the year (k become 110). Since k increases, y will also increase.


What is the steady state?

When depreciation(d*k) = saving/investment(s*y)

The steady state represents the long-run equilibrium of the economy.


Give the Growth accounting formula of the Solow Model.

GY = (GL x WL ) + ( GK x WK) + GT
Growth output= (Contributions from Labor force) + (Contributions from Capital Owners) + technological progress

-Technological progress is also called the growth of Total Factor Productivity (TFP)/Solow’s residual


How does technological progress affect the steady-state level of output per worker? How does it affect the growth rate of output per worker?

y=A*f(K) the technology variable times the production function. Thus, technological progress (a continuous increase in A) will shift the production curve upward every period. As the output curve shift upward, the saving curve (s.y) also shift upward continuously. This causes the steady-state levels of k and y to rise each period.

Since the steady-state equilibrium levels of k* increase every period, the output per worker will continue to rise. The growth rate of the output per worker will rise as fast as the rate of technological progress.


The sources of economic growth in the HPAEs have become a wide debate among economists. Two groups that expressed opposite views in the growth of Asia:

Fundamentalists: Krugman (1994)) (Young (1992), Kim and Lau (1994)
-Growth in the region was mainly input-driven.

Assimilationists (Romer (1993), Pack (1993), Pack and Page (1994))
The HPAEs had ability to adapt and adopt foreign technology, which enhanced their technological progress. With high TFP growth, the countries experienced rapid economic growth.


Radelet et al found three keys elements that explain rapid growth in East Asia

1. Openness and manufactured exports
2. Higher saving and investment
3. Strong Macroeconomic Management


Lim S Curve Hypothesis (Lim, Chong Yah, 2009)

1. Turtle economies
2. Horse economies
3. Elephant economies

Form slanted S shape in graph


Flying Geese Hypothesis of Asian Economic Development Akamutsu (1935)

The hypothesis focuses on graphic presentation of three catching-up process. The sequential appearance of these curves resembles geese flying in orderly ranks.

1. Product-life cycle
2. Inter-industry sequencing
3. Inter-regional catching up


What is the low-level equilibrium trap? How would a turtle economy break away from this trap?

The low-level equilibrium trap is a vicious circle, which starts from a country with low income and thus low saving. Low saving causes low investment and thus low economic growth. Because of low growth, the country continues to be poor.

The poor country (a turtle) can break away from the low-level equilibrium trap and become a horse economy by increase its domestic saving to increase
-Foreign borrowing, foreign direct investment, and foreign aid can substitute domestic saving.


What is “Neo-Malthusian Trap”/Malthus trap?

economies may succeed in increase growth rate,as a result, there would be an explosive population growth and the quality of life remains poor (ex. the Philippines)


According to Radelet, Sachs, and Lee (1997) empirical research paper, what are the factors that positively affect the economic growth? What are the factors that negatively related to economic growth?

Positively related variables:
-Government saving
- Quality of government institution
-Growth of working-age population
Negatively related variables:
-Natural resource abundant
-Population growth


What are two economic views that HPAE governments used for handling the economy?

Neoclassical View.
Revisionist View.


Describe the viewpoints of Neoclassical View.

Rather than highly intervening in the market, they create “stable macroeconomic environment.” They follow the idea of “invisible hand” which allows market mechanism to allocate resources.

-Keep inflation stable and moderate
-Keep exchange rate stable
-If intervene, keep intervention policies very short.
-Limit policies that cause price distortions in international traded goods
-Encourage competition in the market


Describe the viewpoints of Revisionist View.

Extensively and selectively promote individual sectors

-Governments identify strategic industries – “picking winners”
- Governments use selective policy to promote winning industries.
o South Korea: Heavy machinery and chemical
o Japan: Advance technology
o China: Steel and automobile
-High degree of protections and intervention such as investment incentive
schemes, tax credits, and direct lending


The HPAEs’ Policy Choices for economic growth:

1. Sound Fundamentals: Stable macro-economy(inflation, budget, debt, exchange rate, shocks), invest in human capital,etc.
2. Selective Interventions: (promote exports, promote borrowing, lending/subsidies, promote industries)
3. Cooperation: with business on both ends. This includes being the first investor in a new market to help w/ externalities.


What sector became south Asia's priority in the 70s?

Agriculture. -95% of total exports in these countries, still 50% today.


What were the 2 main problems with traditional farming, and what government policies were implemented to help?

1. Low productivity 2. Limit access to credit market
1. Invest in rural infrastructures(irrigation, transportation, electricity.
2. Invest in health and education
3. Land reform(incl. property rights)
4. Microfinance(goverment lending to agr.)
5. Research and provide modern inputs(Green Revolution:International effort to research and development high-varieties of crops. The miracle rice IR-8 was an example of the success.)
6.Price stabilization to help w/ Export Cartel(see practice problem), Buffer harvest stock)


Why were Latin-American and African countries who adopted similar selective intervention policies not successful in replicating HPAEs performance? (Review)

-Poor macroeconomic management (large budget deficit, volatile exchange rate, hyper –inflation, low human capital investment)
-Falling investment in education at all levels.
-Technology policies fail to create incentives in firms to innovate
-Poor exchange rate policy
-Poor infrastructure


What is Industrial Policy?

any type of selective interventions that attempts to alter the structure of production toward sectors that are expected to offer better prospect for economic growth instead of relying on the market mechanism(ex:push towards electronics).


Types of Industrial Policies:

a)Tax policies: fiscal incentives given to favored industries
b) Export Processing Zone(EPZ):Government creates a region or a zone (usually around a port) for industrial development.
c)Import Substitution (Inward Orientation):Implement tarrifs/quotas. Focus on the production of consumer goods to substitute for imports. (creates problems).
d)Export Promotion (Outward Orientation)


Justifications of adopting industrial policy

1. The infant industry argument(high costs/problems at start)
2. Inter-industry spillover(helps everyone)
3. Industrial targeting(push "profitable" industries")
4. Coordination Failures(requires simultaneous investments)
5. Informational externalities:(govt. helps)
6. Inward foreign direct investment (FDI): creates industry demand that encourages small businesses to start.


What are the two types of Asian conglomerates

1) Chaebol: Large business conglomerates, typically owned by a single family, operate with authoritarian management and with substantial government assistance. Horizontally diversified.

2) Keiretsu: The Japanese word keiretsu simply means “a series of affiliations.” Has both Horizontal and Vertically "diversified". Companies in the same keiretsu provide all steps on the supply chain. Requires strong relationships. (Ex:Big Six in Japan)

Differences: Chaebol were family dominated. Chaebol were prevented from buying controlling shares of banks. Chaebol often formed subsidiaries to produce components.


Market-based competition vs. Contest-based competition.

Mb: Western-style, free market, many small firms compete(sometimes w/ 1-2 large).

Cb: Asian style, few firms but evenly matched, compete for govt. help, govt. acts as referee.


Foreign exchange market

the financial market where exchange rates are determined. It is mostly comprising of large commercial banks buying and selling foreign exchange from and to each other. Cash transactions are a very small part of the total market. Mostly the market comprises transactions on paper that are done between banks and large industrial companies.

-an avg. of $ 1,210 billion a day
-60% of that is in US dollars
-a lot of that is speculation


Exchange rate

the price of a foreign currency expressed in terms of a home


Spot exchange transactions

involve the immediate exchange of currency, mostly involving bank deposits. This is the price of a currency for current delivery.

Ex: 1USD = 0.71 euro (0.71 euro can be exchanged for 1 U.S. dollar) can be expressed as:

0.71 €/$ → E€/$

or in $/€ terms by computing a reciprocal of the €/$ exchange rate:

1 /.71 = 1.40 $/€


(Currency) appreciation

an increase in the value of a currency as measured by the amount of foreign currency it can buy.


(Currency) depreciation

a decrease in the value of a currency as measured by the amount of foreign currency it can buy.


What happens when the U.S. dollar appreciates? depreciates?

One Japanese yen gets fewer U.S. dollars.
-The U.S. products become relatively more expensive and Japanese products
become relatively cheaper.
-U.S. exports will decrease; imports will increase; and lead to trade
deficits for the U.S.

*and vise versa for depresiates


Fixed (or Pegged) Exchange Rate

where a currency's value is fixed against either the value of another currency/ies and fluctuates in a narrow band against that it over a sustained period (> 1 year).

-Government actively intervenes in the foreign exchange market to peg the rate.


Floating (Flexible) Exchange Rate

currency price is set by the forex market based on supply and demand compared with other currencies and allowed to fluctuate in a wide range.

Government makes no attempt to fix it against any other base currency.


Name the ranges of exchange range systems

1. “Dollarization”
2. Currency Board
3. Peg
4. Target band
5. Managed floating
6. Floating

The scale ranges from (1) where the central bank of the country has completely given up control of the money supply to way out to (6) where the floating rate gives the central bank complete control over the money supply in the country. In between the central bank has some degree of control over the money supply.


Name the 3 types of Pegs

1. Dollarization (peg): adopt someone else’s currency as your own
2. Currency Board: fixed rate with 100% foreign reserves in central bank. A monetary regime based on an explicit legislative commitment to exchange domestic currency for a specified foreign currency at a fixed exchange rate,
3. Standard Peg:A shift in the supply of or demand for a currency leads to currency fluctuations. To prevent any excessive exchange rate movements, the Central bank has to directly intervene in the foreign exchange market


Why peg and who should?

-Limits fluctuations of exchange rate
(good for trade and foreign direct
-Provide price stability (no hyperinflation)

1. Small economies
2. Open economies (lots of trade)
3. Highly concentrated trade (peg with a country you trade a lot)
4. Harmonious inflation rates (similar monetary policy to country that they peg with)


Why floating and who should?

-Currency crisis avoidance (smooth, automatic and continuous adjustment to equilibrium).
-Policy independence (allow country to determine its monetary policy independently).

1. Large economies
2. Closed economies (small proportion of trade to GDP)
3. Diversified trade
4. Divergent inflation rates


Target bands

A method that was seen as combining the good aspects of the peg and floating. Allowed to vary within officially set bands. When the band limits were reached, the Central Bank would intervene (as in a standard peg) to push the rate back within the bands again.

-it proved in a way to have the worst of both.


What are the Exchange Rate Policies in Asian Countries?

Managed Float - Cambodia, India, Indonesia, Laos, Malaysia, Singapore, Taiwan, Thailand

Free Float - Japan, Philippines, South Korea

Crawling Peg - China

Currency Board - Hong Kong

Pegged - Vietnam


Managed Float vs Free Floating

Managed – government intervene to reach unspecified target rates
Free – NO intervention (or very little)


What is the Big Mac Index?

The Economist uses the price of the universal McDonald's meal to calculate the index which shows how far from fair value different world currencies are.

-Based on the theory of purchasing-power parity (PPP)


Give the overall stages of the financial crisis.

Weak Fundametals + External Shocks + Panic-Contagion( “herding
behavior”) > Foreign Exchange Crisis > Stock Market Crisis + Property Market Crisis > Banking Crisis > Economic Crisis > Political Crisis


What is a current account deficit?

means the value of imports of goods / services / investment incomes is greater than the value of exports. It is sometimes referred to as a trade deficit.

Recall from the Lecture Note 2.2 S – I = NX


Where (and when) did the Asian Crisis start? How many countries were

July 2, 1997 - After using $33 billion in foreign exchange, Thailand
announces a managed float of the baht. The Philippines intervenes to
defend its peso.

Japan did hint Early May (1997) that it might raise interest rates to defend the yen. The threat never materializes, but it shifts the perceptions of global investors who begin to sell Southeast Asian currencies and sets off a tumble both in currencies and local stock markets.


Who are the 8 crisis-ridden countries during the 1997-98 Asian Crisis?

1. Hong Kong
2. Indonesia
3. Malaysia
4. Philippines
5. Singapore
6. South Korea
7. Taiwan
8. Thailand


What is the “sudden stop”? How did it relate to the Asian Crisis?

-Sudden or large drop in capital inflow
-Basically the pull out of many foreign aides resulting in the crisis of the Asian market


Name the 4 weak fundamentals/vulnerabilities of the Asian Financial Crisis,

1. Dependence on massive capital inflow(this means dependence on exports).
2. Chronic current account deficits (IMF called it a “fundamental disequilibrium.”)
3. Fixed exchange rate system
4. Weak financial sector -risky behavior by banks, possible bailout


How was Moral Hazard a part of the Asian financial crisis.:

Banks had incentive to take on risky options, because the cost of failure would be borne by someone else(bailouts).


What is Maturity Mismatch?

when there is mismatch its balance sheet by possessing more short-term liabilities than short-term assets. (Borrow “short”, lend “long”.)

example:you borrow cash from your credit card at 20% monthly and lend to your brother at 3% for a year to open a ramen noodle shop. You will have to roll over your debt every month and cannot collect money from your brother for a long time.


Describe general details of the IMF Rescue Package:

All of the crisis-ridden countries (except Malaysia) turned to the IMF for help. Big impressive packages($36 billion for Indonesia, $58 billion for Korea, and $17 billion for Thailand.)

-Had IMF Conditionality


Purposes of IMF Rescue Package:

-Compensate for the lack of private lending during the crisis
-Restore investor confidence that gov’t have enough reserve holdings
-Limit contagion effect


What was the IMF Conditionality:

A process of negotiation – IMF offers support in exchange for a government
commitment to certain change in domestic policies.

Conditionality: the policies a member is expected to follow to ensure that the
member will overcome its payment problems and able to repay back the funds.

-Reduce current account deficit to 3% of GDP
-Raise interest rate
-Raise taxes
-Cap inflation rate at 5%
-Force closing unviable banks and allow foreign takeover.


What is the IMF? What does it do?

original purpose was to monitor the bretton wood system

current role: Advisory members' economic

-Give financial assistance for
troubled economy from
financial crisis

-Issue SDR


What is SDR?

The SDR is an artificial "basket" currency used by the IMF (International Monetary Fund) for internal accounting purposes. by some countries as a peg for their own currency,
settle international accounts and lending
used as an international reserve asset


Negotiated monetary between US, Canada, W. Europe, Australia and Japan in which they adopted a monetary policy that maintained the exchange rate (± 1 percent) by tying its currency to gold and the ability of the IMF to bridge temporary imbalances of payments.

Bretton Woods system.

-not the same as Gold Standard even if it was tied to gold.


Explain The Absorption Approach of the IMF Conditionality and how it was meant to affect the macro determinators.

See Practice problems. last problem for the IMF Conditionality Absorption Approach Chart for macro determinators.


How do speculative attacks works? How does it lead to currency crisis?

-Massive selling of a country’s currency assets by both domestic and foreign investors
-When government intervene to keep the exchange rate fix, it builds up more pressure for speculative attack