Measuring Macroeconomics

Aggregate Output

National income accounts An accounting system used to measure aggregate economic activity.

The typical measure of aggregate output in the national income accounts is gross domestic product, or GDP.

GDP: Production and Income

There are three ways of defining GDP:1. The value of the final goods and

services produced in the economy.

2. The sum of value added in the economy.

3. The sum of the incomes in the economy.

Nominal and Real GDP Nominal GDP is the sum of the

quantities of final goods produced times their current price.

Nominal GDP usually increases over time because:1. production increases…2. prices increase...

Real GDP is constructed as the sum of the quantities of final goods times constant (rather than current) prices.

Nominal and Real GDP

Using 1996 dollars to compute real GDP, then:

Year Quantity of Cars

Price of cars(in ,000)

Nominal GDP

1995 10 $20 $200

1996 12 $24 $288

1997 13 $26 $338

Year Quantity of Cars

Price of cars(in ,000)

Nominal GDP

1995 10 $24 $240

1996 12 $24 $288

1997 13 $24 $312

Nominal and Real GDP Nominal GDP is also called

dollar GDP GDP in current dollars

Real GDP is also called GDP in constant dollars GDP adjusted for inflation GDP in 1996 dollars

Nominal and Real GDP

From 1960 to 2000, nominal GDP increased by a factor of 19. Real GDP increased by a factor of 4.

Nominal and Real Nominal and Real GDP U.S. GDP, GDP U.S. GDP, 1960-20001960-2000

“GDP is obviously the most important macroeconomic variable.” (?)

Two other variables that inform us on other important aspects of how an economy is performing:

1. Unemployment2. Inflation

The Unemployment Rate

labor force = employed + unemployed L = N + U

Unemployment rate:L

Uu

The Inflation Rate The inflation rate is the rate at

which the price level changes (typically increases).

Two ways to measure inflation: GDP Deflator CPI

The GDP Deflator

The rate of change in the GDP deflator equals the rate of inflation:

PY

Ytt

t

nom ina l G D P

rea l G D Pt

t

$

( )P P

Pt t

t

1

1

The Consumer Price Index

The GDP deflator measures the average price of domestic output, while the consumer price index (CPI) measures the average price of consumption (the cost of living).

The composition of the CPI’s “basket”

16.2%

40.0%

4.5%

17.6%5.8% 5.9%

2.8%

2.5%

4.8%

Food and bev.

Housing

Apparel

Transportation

Medical care

Recreation

Education

Communication

Other goods andservices

Measurement Issues - CPI

The ‘average’ (?) consumption basket.

Accounting for quality of products. Updating the consumption basket

over time. Substitution of cheaper goods for

more expensive ones (or vice versa).

The CPI and the GDP Deflator

The inflation rates, computed using either the CPI or the GDP deflator, are largely similar.

Effects of InflationEffects of Inflation

Inflation makes buyers poorer. Inflation makes sellers richer. Since most people are both buyers

(as consumers) and sellers (as owners of factors of production), the average person’s income and wealth should not change because of inflation.

Inflation Redistributes IncomeInflation Redistributes Income

Inflation redistributes income from those who cannot raise their prices to those who can. People do not raise prices if inflation is

unanticipated. People can not raise their prices if they are

fixed by a contract. Inflation redistributes income from

lenders to borrowers

Dead-Weight Costs of InflationDead-Weight Costs of Inflation

Informational Costs Uncertainty Costs Menu Costs Shoe-leather Costs

A Road-Map for the course

Output is determined by: demand in the short run, say, a few years, the level of technology, the capital stock, and

the labor force in the medium run, say, a decade or so.

factors such as education, research, saving, and the quality of government in the long run, say, a half century or more.