2015/2016Introduction to Economics

Augusto Ninni

Main Macroeconomic Aggregates (II)

Questions of the day?

1. Which are the components of the GDP?

2. What is the role of prices in the determination of GDP? What is inflation and how it is measured?

3. What is unemployment and how it is measured?

Composition of GDP

For sake of simplicity GDP (territory) = GNP (residents)

GDP – Measures the final value of production of goods and services

GDP – Measures the final value of demand of goods and services

D = S

It is possible to decompose GDP both on the side of supply and on the side of demand

Suppose at first that we are in a closed economy, without exports or imports

• From the point of view of supply GDP is equal to the sum of the sectorial VAs (2° definition examined in Lecture 14)

• VA Agriculture + VA Industry + VA Services

From the point of view of demand it is possible to decompose the GDP in different categories of expenditure

a) Consumption (C) – Households’ purchase of goods and services

•Durable goods (average life >3 years)•Non-durable goods (average life <3 years)•Services

b) Investment (I) – Firms’ purchase of capital goods that are used as inputs in future production activities (e.g. machines, plants, etc.), often for a lot of years

A particular category is represented by the investment in stockpile (goods that are produced but not sold)

• It is not financial investment

• c) Government expenditure (G) – Purchase of goods and services by the public administration (Government, public bodies, etc.)

The sum C+I+G = expenditure in goods and services by people living in a country (domestic expenditure)

But the economy is not closed

To compute the total demand of goods and services (=demand of goods and services produced in the economy) we must consider that:

•Some goods that are produced in the country are sold abroad (exports)

•Some goods that are produced abroad are purchased in the country (imports)

Therefore, to the national expenditure we must add

•Export (X) – Purchase of national goods and services by the rest of the world (e.g. Italian wine sold in Germany) – element of demand

and subtract

•Import (Q) – Purchase of goods and services produced abroad by the residents of the country (e.g. Swiss cheese sold in Italy) – element of supply

• D = S

• (C+I+G+E)-Q = Z

• C+I+G+E = Z + QTherefore, the aggregate demand of national goods and

services (Z) is equal to:

Z C + I + G + X - Q

Some other important aggregate measures are:

•Commercial balance Difference between import and export

•Public deficit State balance

Difference between Government’s expenditure and Government’s revenues

The role of prices: Real GDP and nominal GDP

GDP = value of the final goods and services

It is a flux value, defined on conventional terms

GDP and the maid…(Pigou)

Value of the goods = quantities * market prices

Which kind of prices? → usually market prices

Nominal GDP: Value of the final goods and services computed using the current quantities and prices

Real GDP: Value of the final goods and services computed using current quantities and prices of a specific year (called “the base year”)

Italian GDP, million of dollars (source: Oecd)

Real GDP and Nominal GDP

A single good

Year Quantity Price

2000 100 100

2001 103 102

Nominal GDP2000 =

price2000 * q.ty2000 = 100*100 =10000

Nominal GDP2001 =

price2001 * q.ty2001 = 102*103=10506

Real GDP and Nominal GDP

Nominal GDP growth=

= 0,0506 = 5,06%

The growth of GDP is computed in order to know how much the production has increased.

But 5,06% considers both the variation of products and the variation of prices.

10000

0000105061

In order to know the actual increase in production we must use the Real GDP

Base year = 2000

Real GDP2000 =

price2000 * q.ty2000 = 100*100 =10000

Important: Real GDP is equal to the nominal GDP in the base year (2000)

Real GDP2001=

price2000 * q.ty2001 = 100*103 = 10300

Important: It is different from the Nominal GDP2001 = 10506 in another year

10000

0000103001

Real GDP growth= 0,03 = 3%The growth of real GDP measures the variation of production given a certain set of fix prices

What differentiates the growth of nominal GDP from the growth of real GDP? → The variation of prices, namely inflation (the growth rate of prices: the contrary is deflation)

P2001 * Q 2001 P2001 Q 2011

____________ / ____ = ______ P2000 * Q 2000 P 2000

Q 2010

Price index

Inflation

Inflation rate (π) = Rise in the general level of prices in an economy over a period of time

Two ways to measure the dynamics of prices (price index=:

•GDP deflator

•Consumer price index (CPI)

Inflation

1) GDP deflator: Diversity in the growth of nominal and real GDP -> price variation

πt GDP Deflator ↑

↑

Inflation

It is also possible to show that

π = n – g

Where

Π = annual rate of growth of prices

g annual rate of growth of real GDP

n annual rate of growth of nominal GDP

InflationIn our example we have•n = 5,06%•g = 3%•π = 2%

Using the above formula we obtain π = n – g = 5,06% - 3% = 2,06% ≅ 2%

The GDP deflator considers the prices of of all final goods produced in the economy.

But in many cases it is more interesting to look at the price increase that characterize the goods that are purchased only by the consumers.

Inflation2) Consumer price index (CPI) = considers only the average goods

that are purchased by the consumers

Example

• Two goods: bread and clothes• On average a consumer buys 1 cloth and 10 kg of bread

every year

Bread ClothesPrice 2000 1 100Price 2001 1.1 101

∆ 10% 1%

Inflation

Inflation -> average of the two variation

Important: no simple average, but average weighted by the value of the goods

InflationComputation of the CPI:

Expenditure 2000 q.ty bread * price bread2000 + + q.ty clothes * price clothes2000 =10*1+1*100 110

Expenditure 2001 q.ty bread * price bread2001 + + q.ty clothes * price clothes2001 10*1.1+1*101 112

Inflationπ

0,0181 = 1.81%

Inflation computed using the CPI measures the average growth in the consumers’ expenditure

Important: 1.8% is an intermediate value between 10% (Δ price of bread) and 1% (Δ price of clothes)

Important: CPI considers a fixed basket of goods which is updated periodically

110110 - 112

Inflation in Italy 1970-2011

0,0

5,0

10,0

15,0

20,0

25,0

1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010

INF

LA

ZIO

NE

(IN

%)

ANNO

Inflation is different depending on the period

(>10% between 1974 and 1984 ; < 3% since 1997)

0,0

5,0

10,0

15,0

20,0

25,0

1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010

INF

LA

ZIO

NE

(IN

%)

ANNO

Inflation

• Why do prices increase?

• How to struggle inflation ?

Some answers during the course….

Labour marketEmployed = Those who currently have a job

Unemployed = Those who have not a job but are looking for a job or are going to start a new job (+ those who are under unemployment protection programs)

Important: those who are not looking for a job are not considered unemployed (e.g., elder people, housewife and students are not considered unemployed)

Labour marketLabour force Employed + Unemployed

Unemployment rate (u)

Important: Those who are not looking for a job are counted neither in the numerator nor in the denominator

The unemployment rate measures the portion of potential workers who are unemployed

Labour market

Another problem: how to measure the portion of workers over the total population -> participation rate

Participation rate =

Unemployment rate in Italy, EU, US 1995-2011

The unemployment rate is usually positive (there are workers who do not find a job)

The unemployment rate is different across countries

3

4

5

6

7

8

9

10

11

12

13

TASS

O D

I DIS

OCC

UPA

ZIO

NE

(IN %

)

ANNO

ITA

UE

USA

Labour market

• Why is there unemployment?

• Why is unemployment different across countries?

• How to struggle unemployment ?

Some answers during the course…..