Macroeconomics I

Chapter 2: The Data of Macroeconomics

2Lecture Notes

Gross Domestic Product: ���Expenditure and Income

Two definitions:

§ Total expenditure on domestically-produced ���final goods and services in a given period.

§ Total income earned by domestically-located ���factors of production in a given period.

Expenditure equals income because ���every dollar spent by a buyer ���becomes income to the seller.

3Lecture Notes

The Circular Flow

Households Firms

Goods

Labor

Expenditure ($)

Income ($)

4Lecture Notes

3 approaches to measuring GDP

1.  Expenditure Approach

2.  Income Approach

3.  Value Added Approach

5Lecture Notes

1. The Expenditure Components of GDP

§  consumption, C

§  investment, I

§  government spending, G

§  net exports, NX

An important identity:

Y = C + I + G + NX

aggregate expenditure

value of total output

6Lecture Notes

Consumption (C)§  durable goods ���

last a long time ���e.g., cars, home appliances

§  nondurable goods ���last a short time ���e.g., food, clothing

§  services���work done for consumers ���e.g., dry cleaning, ���air travel

definition: The value of all goods and services bought by households. Includes:

7Lecture Notes

Investment (I)§  Spending on goods bought for future use ���

(i.e., capital goods)

§  Includes:§ Business fixed investment ���

Spending on plant and equipment

§ Residential fixed investment ���Spending by consumers and landlords on new housing units

§  Inventory investment ���The change in the value of all firms’ inventories

8Lecture Notes

Investment vs. Capital

Note: Investment is spending on new capital.

Example (assumes no depreciation):

§  1/1/2012: ���economy has 500b TL worth of capital

§  during 2012: ���investment = 60b TL

§  1/1/2013: ���economy will have 560b TL worth of capital

9Lecture Notes

Stocks vs. Flows

A flow is a quantity measured per unit of time. E.g., “U.S. investment was $2.5 trillion during 2010.”

Flow Stock

A stock is a ���quantity measured ���at a point in time.

E.g., ���“The U.S. capital stock was $26 trillion on January 1, 2010.”

10Lecture Notes

Stocks vs. Flows - examples

the govt budget deficitthe govt debt

# of new college graduates this year

# of people with college degrees

a person’s ���annual saving

a person’s wealth

flowstock

Example: ���Stock or Flow?

§  the balance on your credit card statement

§  the inflation rate

§  the unemployment rate

12Lecture Notes

Government spending (G)

§  G includes all government spending on goods and services.

§  G excludes transfer payments ���(e.g., unemployment insurance payments), because they do not represent spending on goods and services.

13Lecture Notes

Net exports (NX)

§ NX = exports – imports§ exports: the value of g&s sold to other countries§  imports: the value of g&s purchased from other

countries

§  Hence, NX equals net spending from abroad on our g&s

14Lecture Notes

Components of Turkish GDPPri C Gov C Pri I Gov I X M Stat. Disc.

2000 68.26% 10.92% 16.85% 4.96% 21.42% 22.93% -0.52%2001 67.61% 11.46% 12.00% 4.20% 23.61% 18.29% 0.58%2002 66.70% 11.42% 13.21% 4.28% 23.77% 20.83% -1.44%2003 69.82% 10.57% 15.52% 3.45% 24.13% 24.44% -0.96%2004 70.84% 10.25% 19.32% 2.95% 24.53% 27.01% 0.88%2005 70.48% 9.69% 20.72% 3.40% 24.41% 27.94% 0.75%2006 69.00% 9.83% 22.29% 3.26% 24.36% 27.94% 0.79%2007 69.55% 10.00% 21.85% 3.31% 24.96% 29.54% 0.13%2008 68.87% 10.11% 19.75% 3.71% 25.48% 28.14% -0.21%2009 70.72% 11.45% 16.08% 3.87% 25.42% 25.34% 2.21%2010 69.11% 10.70% 19.69% 4.17% 24.08% 28.02% -0.27%2011 68.41% 10.29% 22.14% 3.75% 23.89% 28.51% -0.02%2012 66.59% 10.69% 20.64% 4.01% 27.28% 27.82% 1.40%2013 67.67% 10.40% 20.83% 4.94% 26.71% 30.23% 0.32%

Average 68.83% 10.55% 18.64% 3.88% 24.58% 26.21% 0.26%

15Lecture Notes

2. Income Approach to Measuring GDP

§  Indirect vs. direct taxes?§  In Developed countries: 65% of tax revenues: direct taxes versus remaining

35%: indirect taxes

§  In Developing Countries: 40% via direct taxes and 60% via indirect taxes

§  In Turkey, 2011: Direct 33%, indirect 67%

Y= w+r+π+τ-s+δ

Compensation to Workers

Rental Income on Capital

Business Profits

Indirect Taxes

SubsidiesDepreciation

16Lecture Notes

3. Value Added Approach

Value added: ���The value of output minus ���the value of the intermediate goods ���used to produce that output

17Lecture Notes

Example:���Identifying value-added§  A farmer grows a bushel of wheat ���

and sells it to a miller for 1.00 TL

§  The miller turns the wheat into flour ���and sells it to a baker for 3.00 TL

§  The baker uses the flour to make a loaf of ���bread and sells it to an engineer for 6.00 TL

§  The engineer eats the bread.

Calculate value added at each stage ���of production and GDP

18Lecture Notes

Final goods, value added, and GDP

§  GDP = value of final goods produced

= sum of value added at all stages of production.

§  The value of the final goods already includes the value of the intermediate goods, ���so including intermediate and final goods in GDP would be double-counting.

19Lecture Notes

GDP: ���An important and versatile conceptWe have now seen that GDP measures:

§  total income

§  total output

§  total expenditure

§  the sum of value-added at all stages ���in the production of final goods

20Lecture Notes

GNP vs. GDP§  Gross National Product (GNP): ���

Total income earned by the nation’s factors of production, regardless of where located

§  Gross Domestic Product (GDP): ���Total income earned by domestically-located factors of production, regardless of nationality

GNP – GDP = factor payments from abroad ��� minus factor payments to abroad

§  Examples of factor payments: wages, profits, rent, interest & dividends on assets

GNP vs. GDP in select countries, 2009

Country GNP GDPGNP – GDP (% of GDP)

Bangladesh $99,391 $89,378 11.2%Japan $5,198,865 $5,067,526 2.6United States $14,345,303 $14,256,300 0.6China $4,937,980 $4,984,731 –0.9Canada $1,323,476 $1,336,067 –0.9Turkey $609,750 $615,000 – 1.3Mexico $860,849 $874,902 –1.6Greece $316,267 $329,924 –4.1Nigeria $155,303 $168,994 –8.1Ireland $183,174 $227,193 –19.4

GNP and GDP in millions of current U.S. dollars

22Lecture Notes

Real vs. Nominal GDP

§  GDP is the value of all final goods and services produced.

§  Nominal GDP measures these values using current prices

§  Real GDP measures these values using the prices of a base year

NGDP= PicurrentQi

current

i =1

N∑

RGDP= PibaseQi

current

i =1

N∑

Example: ���Real & Nominal GDP

§  Compute nominal GDP in each year.

§  Compute real GDP in each year using 2006 as the base year.

2010 2011 2012

P Q P Q P Q

good A $30 900 $31 1,000 $36 1,050

good B $100 192 $102 200 $100 205

Example: ���Answers

nominal GDP multiply Ps & Qs from same year ���

2010: $46,200 = $30 x 900 + $100 x 192 ���

2011: $51,400 ���

2012: $58,300

real GDP multiply each year’s Qs by 2010 Ps ���

2010: $46,200���

2011: $50,000 ���

2012: $52,000 = $30 x 1050 + $100 x 205

25Lecture Notes

Real GDP controls for inflation

§  Changes in nominal GDP can be due to:§ changes in prices. § changes in quantities of output produced.

§  Changes in real GDP can only be due to changes in quantities,

because real GDP is constructed using ���constant base-year prices.

26Lecture Notes

U.S. Nominal and Real GDP,���1960-2009

$0

$2,000

$4,000

$6,000

$8,000

$10,000

$12,000

$14,000

$16,000

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

(bill

ions

)

Nominal GDP

Real GDP ���(in 2000 dollars)

Turkish Nominal and Real GDP,���1960-2012

$0

$100

$200

$300

$400

$500

$600

$700

$800

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

Nominal  GDPReal  GDP  (in  2005  US  Dol lars)

(billion  USD

 $)

28Lecture Notes

Measures of Aggregate Prices

§  1- GDP Deflator

§  Inflation rate: the percentage increase in the overall level of prices

§  One measure of the price level: GDP deflator

Definition:

GDP deflator = 100 × Nominal GDPReal GDP

Example: ���GDP deflator and inflation rate

§  Use your previous answers to compute ���the GDP deflator in each year.

§  Use GDP deflator to compute the inflation rate from 2010 to 2011, and from 2011 to 2012.

Nom. GDP Real GDPGDP ���

deflatorInflation���

rate

2010 $46,200 $46,200 n.a.

2011 51,400 50,000

2012 58,300 52,000

Example: ���Answers

Nominal GDP

Real GDPGDP ���

deflatorInflation���

rate

2010 $46,200 $46,200 100.0 n.a.

2011 51,400 50,000 102.8 2.8%

2012 58,300 52,000 112.1 9.1%

31Lecture Notes

Understanding the GDP deflator

Example with 3 goods

For good i = 1, 2, 3

Pit = the market price of good i in month t

Qit = the quantity of good i produced in month t

NGDPt = Nominal GDP in month t

RGDPt = Real GDP in month t

32Lecture Notes

Understanding the GDP deflator

GDP deflator

t=

NGDPt

RGDPt

=P

1tQ

1t+ P

2tQ

2t+ P

3tQ

3t

RGDPt

=Q

1t

RGDPt

⎛

⎝⎜

⎞

⎠⎟ P

1t+

Q2t

RGDPt

⎛

⎝⎜

⎞

⎠⎟ P

2t+

Q3t

RGDPt

⎛

⎝⎜

⎞

⎠⎟ P

3t

The GDP deflator is a weighted sum of prices.

The weight on each price reflects ���that good’s relative importance in GDP.

Note that the weights change over time.

33Lecture Notes

Chain-Weighted Real GDP

§  Over time, relative prices change, so the base year should be updated periodically.

§  In essence, chain-weighted real GDP ���updates the base year every year, ���so it is more accurate than constant-price GDP.

§  Your textbook usually uses ���constant-price real GDP, because:

§  the two measures are highly correlated.

§ constant-price real GDP is easier to compute.

34Lecture Notes

Chain-Weighted Real GDP (cont’d)

§  Growth in period t+1

RealGDP t+1 year t prices

RealGDP t year t prices ×

RealGDP t+1 year t+1 prices

RealGDP t year t+1 prices

=RealGDP

t+1 year t prices

NominalGDPt year

×NominalGDP

t+1 year

RealGDP t year t+1 prices

35Lecture Notes

Measures of Aggregate Prices2- Consumer Price Index (CPI)

§  A measure of the overall level of prices

§  A fixed basket of goods – “market basket”

§  In Turkey: 1987, 1994, 2003 are the base years.

§  Household income and consumption expenditure surveys conducted

§  Number of goods in the “representative” basket and their weights determined

§  How is the CPI calculated?

§  In Turkey: TURKSTAT (TÜİK)

§  Monthly

§  423 goods & services

36Lecture Notes

Consumer Price Index (CPI)

§  Uses:

§  tracks changes in the typical household’s ���cost of living

§ adjusts many contracts for inflation (“COLAs”)

§ allows comparisons of dollar amounts over time

37Lecture Notes

How the TurkStat constructs the CPI

1. Survey consumers to determine composition of the typical consumer’s “basket” of goods

2. Every month, collect data on prices of all items in the basket; compute cost of basket

3. CPI in any month equals

100 × Cost of basket in that month

Cost of basket in base period

Example: ���Compute the CPI

Basket: 20 pizzas, 10 compact discs

prices:pizza CDs

2010 $10 $152011 $11 $152012 $12 $162013 $13 $15

For each year, compute

§  the cost of the basket

§  the CPI (use 2010 as the base year)

§  the inflation rate from the preceding year

Example: ���Answers to CPI exercise

Cost of Inflationbasket CPI rate

2010 $350 100.0 n.a.

2011 370 105.7 5.7%

2012 400 114.3 8.1%

2013 410 117.1 2.5%

Components of the US Basket

15.1%

42.4%

3.8%

17.4%6.2%

5.6%

3.0%

3.1%

3.5%

Food and bev.

Housing

Apparel

Transportation

Medical care

Recreation

Education

Communication

Other goodsand services

41Lecture Notes

CPI(1994=100) CPI(2003=100)

Food, beverages & tobacco 31.09% Food and beverages 29.42%

Alcoholic drinks & tobacco 4.67%

Clothing and shoes 9.71% Clothing and shoes 8.09%

Housing 25.80% Housing 16.90%

House‐ware 9.35% House‐ware 6.47%

Health 2.76% Health 2.71%

Transportation 9.30% Transport 10.42%

Communication 4.82%

Entertainment&culture 2.95% Entertainment & culture 3.60%

Education 1.59% Education 2.15%

Restaurant,café & hotels 3.07% Restaurant, café & hotels 5.87%

Miscellaneous 4.38% Miscellaneous 4.87%

Components of the Turkish Basket

42Lecture Notes

One other index:WPI/PPI§  WPI –Wholesale Price Index

§ Wholesale prices§  A fixed basket

§  In Turkey, as of February 2005, PPI (Producer Price Index) replaced the WPI

§  The basket weights did not change much

WPI (1994=100) PPI (2003=100)

Agriculture 22.22% 20.65%

Mining & Stone Quarrying 2.47% 1.51%

Manufacturing Industry 71.12% 72.07%

Electricity, Gas,Water 4.19% 5.77%

43Lecture Notes

Understanding the CPIExample with 3 goods

For good i = 1, 2, 3

Qi = the amount of good i in the CPI’s basket

(note that it does not depend on time)

Pit = the price of good i in month t

Et = the cost of the CPI basket in month t

Eb = the cost of the basket in the base period

44Lecture Notes

Understanding the CPI

CPI in month t =

Et

Eb

=P

1tQ

1+ P

2tQ

2+ P

3tQ

3

Eb

=Q

1

Eb

⎛

⎝⎜

⎞

⎠⎟ P

1t+

Q2

Eb

⎛

⎝⎜

⎞

⎠⎟ P

2t+

Q3

Eb

⎛

⎝⎜

⎞

⎠⎟ P

3t

The CPI is a weighted sum of prices.

The weight on each price reflects ���that good’s relative importance in the CPI’s basket.

Note that the weights remain fixed over time.

45Lecture Notes

Two measures of inflation in the U.S.

0%

5%

10%

15%

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

Perc

enta

ge c

hang

e ���

from

12

mon

ths

earl

ier

CPI

GDP deflator

46Lecture Notes

Two measures of inflation in Turkey

0%

20%

40%

60%

80%

100%

120%

140%

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

CPI  InflationGDP  Deflator  Inflation

47Lecture Notes

Why the CPI may overstate inflation§  Substitution bias: ���

The CPI uses fixed weights, so it cannot reflect consumers’ ability to substitute toward goods whose relative prices have fallen.

§  Introduction of new goods: ���The introduction of new goods makes consumers better off and, in effect, increases the real value of the dollar. But it does not reduce the CPI, because the CPI uses fixed weights.

§  Unmeasured changes in quality: ���Quality improvements increase the value of the dollar, but are often not fully measured.

48Lecture Notes

The size of the CPI’s bias

§  In 1995, a Senate-appointed panel of experts estimated that the CPI overstates inflation by about 1.1% per year.

§  So the BLS made adjustments to reduce the bias.

§  Now, the CPI’s bias is probably under 1% per year. ���

49Lecture Notes

CPI vs. GDP DeflatorPrices of capital goods:

§  included in GDP deflator (if produced domestically)§ excluded from CPI

Prices of imported consumer goods:§  included in CPI§ excluded from GDP deflator

The basket of goods:§ CPI: fixed§ GDP deflator: changes every year

50Lecture Notes

Labor-related Categories of the Population§  employed ���

working at a paid job

§  unemployed ���not employed but looking for a job

§  labor force ���the amount of labor available for producing goods and services; all employed plus unemployed persons

§  not in the labor force ���not employed, not looking for work

51Lecture Notes

Two important labor force concepts

§  unemployment rate ���percentage of the labor force that is unemployed

§  labor force participation rate ���the fraction of the adult population ���that “participates” in the labor force

Example: ���

data: E = 139.1, U = 14.8, POP = 238.5§  labor force

§  L = E +U = 139.1 + 14.8 = 153.9§  not in labor force

§  NILF = POP – L = 238.5 – 153.9 = 84.6§  unemployment rate

§  U/L x 100% = (14.8/153.9) x 100% = 9.6%§  labor force participation rate §  L/POP x 100% = (153.9/238.5) x 100% = 64.5%

53Lecture Notes

Measuring the Unemployment Rate Turkey (2011) Population 73,700,000

Population (16+) 53,800,000

Labor Force Participation (F) 28.1%

Labor Force Participation (M) 71.4%

Labor Force Participation (T) 49.5%

Unemployment Rate (F) 11.3%Unemployment Rate (M) 9.2%Unemployment Rate (T) 9.8%

•  Non‐agriculture unemployment rate: ~12.5%•  Youth Unemployment:~18%•  48% of the economy ıs informal in Turkey (estimate)•  U(Urban)>U(Rural) (~11% vs ~5.5)

54Lecture Notes

How do we actually measure it?§  Until recently, mostly people who were registered at unemployment

offices were counted as unemployed

§  Today most countries rely on large surveys of households

§  For example, the Current Population Survey (CPS) in the US

§  60000 households are interviewed every month

§  If an individual has a job during the month of interview à employed§  If an individual is looking for a job during the month of interview à

unemployed§  If not employed and not looking for a job à not in the labor force

§  Discouraged workers: This method tends to underreport the rate of unemployment

55Lecture Notes

Two arithmetic tricks for ���working with percentage changes

EX: If your hourly wage rises 5% ���

and you work 7% more hours, ���

then your wage income rises ���

approximately 12%.

1. For any variables X and Y,

percentage change in (X ×Y )���≈ percentage change in X��� + percentage change in Y

d(XY)=Y dX + X dY à d(XY)/XY = dX/X + dY/Y

56Lecture Notes

Two arithmetic tricks for ���working with percentage changes

EX: GDP deflator = 100 × NGDP/RGDP.

If NGDP rises 9% and RGDP rises 4%, ���

then the inflation rate is approximately 5%.

2.  percentage change in (X/Y )���≈ percentage change in X���

− percentage change in Y

d(X/Y)=(Y dX - X dY)/Y2 à

d(X/Y)/(X/Y) = (Y dX - X dY)/Y2 ÷ (X/Y)= dX/X - dY/Y

Example: ���

Calculate percentage changes in ���labor statistics

Suppose §  population increases by 1%§  labor force increases by 3%§  number of unemployed people increases by 2%

Calculate the percentage changes in the labor force participation and unemployment rates.

Example: ���Answers

LFPR = L/POP

L increases 3%, POP increases 1%, so���LFPR increases 3% – 1% = 2%

U rate = U/LF

U increases 2%, LF increases 3%, so���U-rate increases 2% – 3% = –1%

Note: the changes in LFPR and U-rate are shown as percent of their initial values, not in percentage points! E.g., if initial value of LFPR is 60.0%, a 2% increase would bring it to 61.2%, because 2% of 60 equals 1.2.

Chapter Summary§  Gross Domestic Product (GDP) measures both total

income and total expenditure on the economy’s output of goods & services.

§  Nominal GDP values output at current prices; ���real GDP values output at constant prices. Changes in output affect both measures, ���but changes in prices only affect nominal GDP.

§  GDP is the sum of consumption, investment, government purchases, and net exports.

Chapter Summary§  The overall level of prices can be measured ���

by either:§  the Consumer Price Index (CPI), ���

the price of a fixed basket of goods purchased by the typical consumer, or

§  the GDP deflator, ���the ratio of nominal to real GDP

§  The unemployment rate is the fraction of the labor force that is not employed.