principles of m lecture 2: measuring a nation’s income ...lecture 2: measuring a nation’s income...

DEFINITION COMPONENTS OF GDP NOMINAL & REAL GDP COST OF LIVING EXERCISE

PRINCIPLES OF MACROECONOMICS

Lecture 2: Measuring a Nation’s Income &the Cost of Living

Instructor: Chi Man Yip

DEFINITION COMPONENTS OF GDP NOMINAL & REAL GDP COST OF LIVING EXERCISE

DEFINITION: GROSS DOMESTIC PRODUCT (GDP)

I GDP: the market value of all final goods & servicesproduced within a country in a given period of time.

DEFINITION COMPONENTS OF GDP NOMINAL & REAL GDP COST OF LIVING EXERCISE

MARKET VALUE

GDP: the market value of all final goods & servicesproduced within a country in a given period of time.

I Suppose we only produce 3 apples today.

I All Final Goods Produced Today: 3 Apples

DEFINITION COMPONENTS OF GDP NOMINAL & REAL GDP COST OF LIVING EXERCISE

MARKET VALUEGDP: the market value of all final goods & servicesproduced within a country in a given period of time.

I Suppose we also produce 1 Orange today.I All Final Goods Produced Today: 3 Apples & 1 Orange.

DEFINITION COMPONENTS OF GDP NOMINAL & REAL GDP COST OF LIVING EXERCISE

MARKET VALUE

GDP: the market value of all final goods & servicesproduced within a country in a given period of time.

I Suppose we also produce 1 Hour of Teaching today.I All Final Goods & Services Produced Today: 3 Apples, 1

Orange, & 1 Hour of Teaching.

DEFINITION COMPONENTS OF GDP NOMINAL & REAL GDP COST OF LIVING EXERCISE

MARKET VALUE

GDP: the market value of all final goods & servicesproduced within a country in a given period of time.

I Keep adding all them up. Do you see the problem?I All Final Goods & Services Produced Today: 3 Apples, 1

Orange, & 1 Hour of Teaching.I Market Value: 3 Apples (CAN$5), 1 Orange (CAN$10), &

1 Hour of Teaching (CAN$10,000)I GDP=CAD$10,015.

Any Question?

DEFINITION COMPONENTS OF GDP NOMINAL & REAL GDP COST OF LIVING EXERCISE

WHERE DO THESE GOODS & SERVICES GO TO?

I We consume the 1 hour of teaching.

DEFINITION COMPONENTS OF GDP NOMINAL & REAL GDP COST OF LIVING EXERCISE

WHERE DO THESE GOODS & SERVICES GO TO?

I We consume the 1 hour of teaching.I Someone in our country consumes one.

DEFINITION COMPONENTS OF GDP NOMINAL & REAL GDP COST OF LIVING EXERCISE

WHERE DO THESE GOODS & SERVICES GO TO?

I We consume the 1 hour of teaching.I Someone in our country consumes one.I Someone in other country consumes one.

DEFINITION COMPONENTS OF GDP NOMINAL & REAL GDP COST OF LIVING EXERCISE

WHERE DO THESE GOODS & SERVICES GO TO?

I We consume the 1 hour of teaching.I Someone in our country consumes one.I Someone in other country consumes one.I The Government may consume one.

DEFINITION COMPONENTS OF GDP NOMINAL & REAL GDP COST OF LIVING EXERCISE

WHERE DO THESE GOODS & SERVICES GO TO?

I We consume the 1 hour of teaching.I Someone in our country consumes one.I Someone in other country consumes one.I The Government may consume one.I Someone plants an orange tree.

DEFINITION COMPONENTS OF GDP NOMINAL & REAL GDP COST OF LIVING EXERCISE

WHAT ARE THESE TERMS IN ECONOMICS?

I Consumption (C1): We consume the 1 hour of teaching.I Consumption (C2): Someone in Canada consumes one.I Export (EX): Someone in other country consumes one.I Government Expenditure (G): Government consumes one.I Investment (I): Someone plants an orange tree.

So, GDP (Y): Y = C1 + C2 + I + G + EX.Any Question?

DEFINITION COMPONENTS OF GDP NOMINAL & REAL GDP COST OF LIVING EXERCISE

DO YOU JUST CONSUME DOMESTIC GOODS &SERVICES?

I Import (IM): We consume imported goods & services.

I Consumption (C): C = C1 + C2 + IMI Net Export (NX): NX = EX − IM

DEFINITION COMPONENTS OF GDP NOMINAL & REAL GDP COST OF LIVING EXERCISE

GDP

I GDP (Y): Y = C1 + C2 + I + G + EX — (1)I Consumption (C): C = C1 + C2 + IM — (2)I Net Export (NX): NX = EX − IM — (3)

Y = C1 + C2 + I + G + EX by (1)Y = C1 + C2 + I + G + EX − IM + IMY = (C1 + C2 + IM) + I + G + (EX − IM)

Y = C + I + G + (EX − IM) by (2)Y = C + I + G + NX by (3)

Any Question?

DEFINITION COMPONENTS OF GDP NOMINAL & REAL GDP COST OF LIVING EXERCISE

EXAMPLE

This example is obtained from Mankiw, N. Gregory, Ronald D. Kneebone,Kenneth J. Mckenzie (2017). Principles of Macroeconomics.Any Question?

DEFINITION COMPONENTS OF GDP NOMINAL & REAL GDP COST OF LIVING EXERCISE

NOMINAL & REAL GDP

I Market Value in 2015: 3 Apples (CAN$5), 1 Orange(CAN$10), & 1 Hour of Teaching (CAN$10,000)GDP in 2015: CAD$10,015.

I Market Value in 2017: 3 Apples (CAN$3), 1 Orange(CAN$10), & 1 Hour of Teaching (CAN$20,000)GDP in 2017: CAD$20,013.

I Do we produce more? NOI Does the GDP reflect our situation? NO

DEFINITION COMPONENTS OF GDP NOMINAL & REAL GDP COST OF LIVING EXERCISE

DEFINITION: NOMINAL & REAL GDP

I Nominal GDP: the production of goods & services valuesat current prices

I Real GDP: the production of goods & services values atconstant prices

DEFINITION COMPONENTS OF GDP NOMINAL & REAL GDP COST OF LIVING EXERCISE

EXAMPLE: NOMINAL & REAL GDPI Nominal GDP: the production of goods & services values

at current pricesI Real GDP: the production of goods & services values at

constant prices

I Market Value in 2015: 3 Apples (CAN$1 each ), 1 Orange(CAN$10), & 1 Hour of Teaching (CAN$10,000)

I Market Value in 2017: 10 Apples (CAN$2 each), 2 Orange(CAN$10), & 1 Hour of Teaching (CAN$20,000)

Nominal GDP in 2015: CAD$10,013.Nominal GDP in 2017: CAD$20,040.Real GDP in 2015 (base year 2017): CAD$20,016.Real GDP in 2017 (base year 2015): CAD$10,030.

Any Question?

DEFINITION COMPONENTS OF GDP NOMINAL & REAL GDP COST OF LIVING EXERCISE

DEFINITION: GDP DEFLATOR

I GDP Deflator: A measure of the price level calculated asthe ratio of nominal GDP to real GDP times 100

GDP deflator =Nominal GDP

Real GDP× 100

DEFINITION COMPONENTS OF GDP NOMINAL & REAL GDP COST OF LIVING EXERCISE

DEFINITION: INFLATION RATE

I A Inflation Rate: the percentage change in some measureof the price level from one period to the next.

DEFINITION COMPONENTS OF GDP NOMINAL & REAL GDP COST OF LIVING EXERCISE

CALCULATION: INFLATION RATEI A Inflation Rate: the percentage change in some measure

of the price level from one period to the next.I GDP Deflator: A measure of the price level calculated as

the ratio of nominal GDP to real GDP times 100I In general, the growth rate is measured as follows:

Growth Rate =Level in Year 2 − Level in Year 1

Level in Year 1× 100

I Applying it to measure the growth rate in price level:

Growth Rate in Price =Price Lvl in Yr 2 − Price Lvl in Yr 1

Price Level in Year 1× 100

I By the definitions of Inflation Rate & GDP Deflator,

Inflation Rate =GDP deflator in Yr 2 − GDP deflator in Yr 1

GDP deflator in Yr 1× 100

DEFINITION COMPONENTS OF GDP NOMINAL & REAL GDP COST OF LIVING EXERCISE

EXAMPLE: NOMINAL & REAL GDP

This example is obtained from Mankiw, N. Gregory, Ronald D. Kneebone,Kenneth J. Mckenzie (2017). Principles of Macroeconomics.Any Question?

DEFINITION COMPONENTS OF GDP NOMINAL & REAL GDP COST OF LIVING EXERCISE

CONSUMER PRICE INDEX (CPI)

Definition of CPI:I CPI: a measure of the overall cost of the goods & services

bought by a typical consumerGoal of CPI:

I measure changes in the cost of living.

DEFINITION COMPONENTS OF GDP NOMINAL & REAL GDP COST OF LIVING EXERCISE

4 STEPS TO CALCULATE CPI

I Step 1: Determine the BasketI Step 2: Find the PricesI Step 3: Compute the Basket’s CostI Step 4: Choose a Base Year & Compute the Index

DEFINITION COMPONENTS OF GDP NOMINAL & REAL GDP COST OF LIVING EXERCISE

4 STEPS TO CALCULATE CPI

This example is obtained from Mankiw, N. Gregory, Ronald D. Kneebone,Kenneth J. Mckenzie (2017). Principles of Macroeconomics.Any Question?

DEFINITION COMPONENTS OF GDP NOMINAL & REAL GDP COST OF LIVING EXERCISE

CALCULATION: INFLATION RATEI A Inflation Rate: the percentage change in some measure

of the price level from one period to the next.I CPI: a measure of the overall cost of the goods & services

bought by a typical consumerI In general, the growth rate is measured as follows:

Growth Rate =Level in Year 2 − Level in Year 1

Level in Year 1× 100

I Applying it to measure the growth rate in price level:

Growth Rate in Price =Price Lvl in Yr 2 − Price Lvl in Yr 1

Price Level in Year 1× 100

I By the definitions of Inflation Rate & CPI,

Inflation Rate =CPI in Yr 2 − CPI in Yr 1

CPI in Yr 1× 100

DEFINITION COMPONENTS OF GDP NOMINAL & REAL GDP COST OF LIVING EXERCISE

3 PROBLEMS IN MEASURING THE COST OF LIVING

I Commodity Substitution Bias:I Prices do not change proportionatelyI Consumers substitute towards goods that are relatively

cheaperI CPI of a fixed basket of goods overstates the increase in the

cost of livingI Introduction of New Goods

I CPI of a fixed basket of goods does not reflect the increasein the value of the dollar

I Unmeasured Quality Change

DEFINITION COMPONENTS OF GDP NOMINAL & REAL GDP COST OF LIVING EXERCISE

EXERCISE 1:

I List the four components of expenditure. What does itmean when net exports have a negative value?

I Define real and nominal GDP. Which is a better measure ofeconomic well-being? Why?

I Which contributes more to GDP—the production of aneconomy car or the production of a luxury car? Why?

This exercise is obtained from Mankiw, N. Gregory, Ronald D. Kneebone,Kenneth J. Mckenzie (2017). Principles of Macroeconomics.

DEFINITION COMPONENTS OF GDP NOMINAL & REAL GDP COST OF LIVING EXERCISE

EXERCISE 2:

I If the price of a hot dog is $2 and the price of a hamburgeris $4, then 30 hot dogs contribute as much to GDP as whatnumber of hamburgers?

I Chi Man the sheep farmer sells wool to Barnaby the knitterfor $20. Barnaby makes two sweaters, each of which has amarket price of $40. Collette buys one of them, while theother remains on the shelf of Barnaby’s store to be soldlater. What is GDP here?

This exercise is obtained from Mankiw, N. Gregory, Ronald D. Kneebone,Kenneth J. Mckenzie (2017). Principles of Macroeconomics.

DEFINITION COMPONENTS OF GDP NOMINAL & REAL GDP COST OF LIVING EXERCISE

EXERCISE 3:

I In the year 2014, the economy produces 100 loaves ofbread that sell for $2 each. In the year 2015, the economyproduces 200 loaves of bread that sell for $3 each. Calculatenominal GDP, real GDP, and the GDP deflator for eachyear. (Use 2014 as the base year.) By what percentage doeseach of these three statistics rise from one year to the next?

This exercise is obtained from Mankiw, N. Gregory, Ronald D. Kneebone,Kenneth J. Mckenzie (2017). Principles of Macroeconomics.

DEFINITION COMPONENTS OF GDP NOMINAL & REAL GDP COST OF LIVING EXERCISE

EXERCISE 4:

This exercise is obtained from Mankiw, N. Gregory, Ronald D. Kneebone,Kenneth J. Mckenzie (2017). Principles of Macroeconomics.

DEFINITION COMPONENTS OF GDP NOMINAL & REAL GDP COST OF LIVING EXERCISE

EXERCISE 5:

This exercise is obtained from Mankiw, N. Gregory, Ronald D. Kneebone,Kenneth J. Mckenzie (2017). Principles of Macroeconomics.

DEFINITION COMPONENTS OF GDP NOMINAL & REAL GDP COST OF LIVING EXERCISE

EXERCISE 6:

This exercise is obtained from Mankiw, N. Gregory, Ronald D. Kneebone,Kenneth J. Mckenzie (2017). Principles of Macroeconomics.

DEFINITION COMPONENTS OF GDP NOMINAL & REAL GDP COST OF LIVING EXERCISE

EXERCISE 7:

I If the price of a military aircraft rises, is the consumer priceindex or the GDP deflator affected more? Why?

I Over a long period of time, the price of a candy bar rosefrom $0.10 to $0.60. Over the same period, the consumerprice index rose from 150 to 300. Adjusted for overallinflation, how much did the price of the candy bar change?

I If the consumer price index was 200 in 1980 and 300 today,then $600 in 1980 has the same purchasing power as whatamount today?

This exercise is obtained from Mankiw, N. Gregory, Ronald D. Kneebone,Kenneth J. Mckenzie (2017). Principles of Macroeconomics.

DEFINITION COMPONENTS OF GDP NOMINAL & REAL GDP COST OF LIVING EXERCISE

EXERCISE 8:

This exercise is obtained from Mankiw, N. Gregory, Ronald D. Kneebone,Kenneth J. Mckenzie (2017). Principles of Macroeconomics.

DEFINITION COMPONENTS OF GDP NOMINAL & REAL GDP COST OF LIVING EXERCISE

EXERCISE 9:

This exercise is obtained from Mankiw, N. Gregory, Ronald D. Kneebone,Kenneth J. Mckenzie (2017). Principles of Macroeconomics.

DEFINITION COMPONENTS OF GDP NOMINAL & REAL GDP COST OF LIVING EXERCISE

EXERCISE 10:

This exercise is obtained from Mankiw, N. Gregory, Ronald D. Kneebone,Kenneth J. Mckenzie (2017). Principles of Macroeconomics.

DEFINITION COMPONENTS OF GDP NOMINAL & REAL GDP COST OF LIVING EXERCISE

EXERCISE 11:

This exercise is obtained from Mankiw, N. Gregory, Ronald D. Kneebone,Kenneth J. Mckenzie (2017). Principles of Macroeconomics.