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…..