copyright © 2012 pearson addison-wesley. all rights reserved. chapter 2 measuring macroeconomic...

Copyright © 2012 Pearson Addison-Wesley. All rights reserved.

Chapter 2

Measuring Macroeconomic Data

Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-2

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• To examine the different approaches to measuring gross domestic product

• To understand real versus nominal GDP

• To understand how to measure inflation

• To understand how to measure unemployment

• To understand different interest rates


Measuring Economic Activity: National Income Accounting

• Gross domestic product (GDP) is the total value of goods and services produced in an economy– the broadest measure of economic activity


• National income accounting is an accounting system that measures economic activity and its components

• Fundamental identity of national income accounting:

Total Production = Total Expenditure = Total Income

Measuring Economic Activity: National Income Accounting (cont’d)


Measuring GDP: The Production Approach

• GDP is the current market value of all final goods and services newly produced in the economy during a fixed period of time

• In the case of apples and oranges, we multiply the their prices and quantities, and then add them up:

GDP = (price of apples ✕ quantity of apples) + (price of oranges ✕ quantity of oranges)


Market Value

• Not all goods and services are counted in GDP because they are:

– Nonmarket goods and services, which do not have a market price (e.g., household services produced within a family), or

– Produced in the underground economy

• Many nonmarket goods and services are counted in GDP by their imputed values


Newly Produced Goods and Services

• GDP includes only goods and services that are newly produced in the current period

• If you buy a 3-year-old car from a car dealership

– The cost of the used car is not included in GDP– The value of the services provided by the car

dealership is included in GDP


Valued-Added Technique

• Value added is the value of a firm’s output minus the cost of the intermediate goods purchased by the firm

• By adding up the value added from each firm, we get the final value of the goods and services produced


Capital Goods

• A capital good (e.g., a robot) is used in the production of other goods that is not used up in the stages of production

• New capital goods are classified as final goods because they are not included in spending on other final goods and yet their production is part of economic activity


Inventory Investment

• Inventory investment is the change in inventories (firms’ holdings of raw materials, unfinished goods and unsold finished goods) over a given period of time

• Inventory investment is included in GDP for the same reason that we include capital goods


Fixed Period of Time

• We calculate GDP over a fixed period of time, such as a quarter or a year

• GDP is a flow, which is an amount per a given unit of time

• By contrast, a stock is a quantity at a given point in time


Policy and Practice: Can GDP Buy Happiness?

• Is GDP the best measurement of national well-being?• In 1972, the king of Bhutan proposed the

replacement of GDP by “gross national happiness” that incorporates factors such as spirituality and culture

• In 1990, the United Nations began to rank countries on a so-called human development index, which is a combination of life expectancy, education, literacy, educational participation, and GDP

• In 2008, a French economic commission led by Nobel Prize winner Joseph Stiglitz called for modifications to GDP with factors such as political freedom, physical safety, and work-life balance


Box: Stocks Versus Flows

• A stock is often an accumulation of flows over time

• Examples:– Inventory investment is a flow, which

accumulates into the stock of inventories– Saving is a flow, which accumulates into a

person’s wealth


FIGURE 2.1 Stocks Versus Flows


• GDP is the total spending on currently produced final goods and services in the economy

• National income identity:

Y = C + I + G + NXwhere Y = GDP = total production (output)

C = consumption expenditureI = investmentG = gov’t purchases of goods & servicesNX = net exports = exports - imports

Measuring GDP: The Expenditure Approach


TABLE 2.1 GDP and Its Components, 2009


Consumption Expenditure

• Total spending for currently produced consumer goods and services

• Consumption was 70.8% of GDP in 2009 • Basic categories:

1. Consumer durables2. Nondurable goods3. Services


Investment

• Spending on currently produced capital goods that are used to produce goods and services over an extended period of time

• Investment was 11.4% of GDP in 2009• Basic categories:

1. Fixed investment2. Inventory investment3. Residential investment


Box: Meaning of the Word Investment

• For non-economists, an investment normally refers to the purchase of common stocks or bonds

• For economists, investment spending refers to the purchase of physical assets, such as new machines or new houses—purchases that add to GDP


Government Purchases

• Spending by the government on currently produced goods and services

• Government purchases were 20.6% of GDP in 2009

• Government consumption includes government purchases for short-lived goods and services like health care and police

• Government investment includes spending for capital goods like buildings and computers represents

• Pure government transfers (e.g., Social Security and Medicare) are excluded from G


Net Exports

• Net exports (or trade balance) are exports minus imports

• Why subtract imports from GDP?– Answer: Spending on imports is included in

consumption expenditure, investment, and government purchases, but is not produced in this country


FIGURE 2.2 Expenditure Components of U.S. GDP, 1950-2010


Changes in the Spending Components of GDP Over Time

• Consumption grew steadily as a share of GDP from 1970 to 2008

• Investment is much more volatile than other components of GDP

• Government purchases have actually remained quite stable at around 20% of GDP

• Net exports have been negative


Box: An International Comparison of Expenditure Components

• The United States differ from other countries by having the highest share of GDP going to consumption, the lowest share of investment, and net exports have been negative

• By contrast, China has the lowest share of consumption, the highest share of investment, and the largest share of net exports


FIGURE 2.3 Shares of Expenditure Components for Different Countries


Measuring GDP: The Income Approach

• Compensation of employees – wages and salaries of employees, and employee benefits

• Corporate profits – profits after taxes of corporations• Other income – income of the self-employed, royalty

income and net interest earned by individuals, etc.• Depreciation – the loss of value of capital from wear

and tear – net domestic product = GDP – depreciation

• Net factor income – wages, profits, and rent paid to U.S. residents by foreigners minus factor income paid by U.S. residents to foreigners


TABLE 2.2 Income Approach to GDP, 2009


Income Measures

• National income = Compensation of employees + other income + corporate profits

• Gross national product (GNP) = national income + depreciation – total income earned by U.S. residents

• Gross domestic product (GDP) = GNP + net factor income – domestically produced measure of gross product


Income Measures (cont’d)

Private Disposable Income = GDP + net factor income + transfer payments

received from the government + interest payments on government debt – taxes


Income Measures (cont’d)

Net Government Income = taxes – transfers – interest payments on

government debt


Real Versus Nominal GDP

• A nominal variable is a measure at current market (nominal) prices (e.g., nominal GDP)

• A real variable is a measure in terms of quantities of actual goods and services (e.g., real GDP)


Real Versus Nominal GDP (cont’d)

or

Nominal GDP = Price Level ✕ Real GDP

Nominal GDPReal GDP =

Price Level


• If 2005 is the base year, then real GDP for the year 2010 is:

Real GDP in 2012 =

(price of apples in 2005 ✕ quantity of apples in 2012) + (price of oranges in 2005 ✕ quantity of oranges in 2012)



• Raw data on GDP tends to fall in cold and snowy months

• Therefore, economic statistics like GDP data are seasonally adjusted to account for regular seasonal fluctuations within a year



Chain-Weighted Measures of Real GDP

• If prices of some important goods changed dramatically relative to other goods, using a fixed base-year for prices when calculating real GDP can produce misleading results

• Chain-weighted measures of GDP allow the base year to change continuously


Measuring Inflation

• Price indexes are measures of the price level

• Examples:– GDP deflator (or implicit price deflator)– Personal consumption expenditure deflator– Consumer price index


GDP Deflator

GDP Deflator for Year y

Nominal GDP in Year y= 100 x

Real GDP in Year y


PCE Deflator

PCE Deflator for Year y

Nominal PCE in Year y= 100 x

Real PCE in Year y


Consumer Price Index

• A measure of the average prices of consumer goods and services, i.e., a cost of living index

• Calculated monthly by the Bureau of Labor Statistics using a basket of thousands of consumer goods and services


Consumer Price Index

• If the basket consists of 2 apples and 1 orange, then the CPI for 2010 with a base year of 2005 is:

CPI for 2010 =

(10 x price of gas/gallon in 2012)+(2 x price of apples in 2012)100 x

(10 x price of gas/gallon in 2015)+(2 x price of apples in 2015)


Policy and Practice: Policy and Overstatements of the Cost of Living

• The CPI is used in determining labor contracts and government payments such as Social Security benefits

• A study led by Michael Boskin of Stanford University found that increases in the CPI overstate increases in the cost of living by 1% point

• Measurements errors in the CPI could have important implications


Inflation Rate

• The inflation rate is the % rate of change of the price level over a particular period:

where

t t 1 t

tt 1 t 1

P - P P = =

P P

t = inflation rate in period t

tP = period level at time t


FIGURE 2.4 U.S. Inflation Rates with Different Price Indexes, 1950-2010


Percentage Change Method and the Inflation Rate

• Because:

• We know that:

% Change in ( X ) = (% Change in )

+ (% Change in )

x y x

y

% Change in Nominal GDP =

(% Change in the Price Level)

+ (% Change in Real GDP)


Percentage Change Method and the Inflation Rate (cont’d)

• Because the % change in the price level is the inflation rate, while the % changes in nominal and real GDP are the growth rate:

Inflation Rate = (Growth Rate of Nominal GDP)

- (Growth Rate of Real GDP)


Measuring Unemployment

• The unemployment rate is the percentage of people in the civilian population who want to work but who do not have jobs

• The Bureau of Labor Statistics classifies each adult over age 16 into:1. Employed2. Unemployed3. Not in the labor force

• Discouraged workers (those who would live to work but have given up looking, and those who have voluntarily left the labor force)


Measuring Unemployment (cont’d)

Labor Force =

Number of Employed + Number of Unemployed

Number of UnemployedUnemployment Rate =

Number of Employed


Labor ForceLabor-Force Participation Rate =

Adult Population

EmployedEmployment Ratio =

Adult Population

Measuring Unemployment (cont’d)


FIGURE 2.5 Unemployment in the Adult Civilian Population, 2010


Macroeconomics In The News: Unemployment and Employment

• The Bureau of Labor Statistics reports employment and unemployment data using two alternative surveys: the household survey and the survey of business establishments

• The two surveys sometimes give a different picture of labor market conditions due to:• The household survey counts workers, while the

establishment survey counts jobs• The household survey counts the self-employed as

working, while the establishment does not• The establishment survey covers more workers


Measuring Interest Rates

• An interest rate is the cost of borrowing, or the price paid for the rental of funds

• Interest rates are returns for holding debt securities, such as bonds


Macroeconomics In The News: Interest Rates

• Interest rates that receive media attention are:– Prime rate– Federal funds rate– London Inter-Bank Offered Rate (LIBOR)– Treasury bill rate.– Ten-year Treasury bond rate– Federal Home Loan Mortgage Corporation rate


Real Versus Nominal Interest Rates

• A nominal interest rate makes no allowance for inflation

• The real interest rate is the amount of extra purchasing power a lender must be paid for the rental of his/her money– The ex ante real interest rate is adjusted

for expected changes in the price level – The ex post real interest rate is adjusted

for actual changes in the price level


Real Versus Nominal Interest Rates (cont’d)

• The Fisher equation:

e = + i r

e

= nominal interest rate

= nominal interest rate

= expected inflation

i

r

eor = - r i


Real Versus Nominal Interest Rates (cont’d)

• Example: For a one-year loan with a 4% nominal interest rate (i=4%) and you expect the inflation to be 6% in a year ( =6%), then:

• When the real interest rate is low, there are greater incentives to borrow and invest, but fewer incentives to lend.

= 4% - 6% = -2%r

e


The Important Distinction Between Real and Nominal Interest Rates

• Credit markets are where households and businesses get funds (credit) from each other

• Because the real interest rate reflects the real cost of borrowing, it is likely to be a better indicator of the incentives to borrow, invest, and lend in credit markets than nominal interest rates


FIGURE 2.6 Real and Nominal Interest Rates (Three-Month Treasury Bill), 1955-2010

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