Lecture 2: National Income Accounting

1. Lecture 2: National Income Accounting L11200 Introduction to Macroeconomics 2009/10 Reading: Barro Ch.2 28 January 2010

2. Introduction • Last time: introduction to the course • Textbook: Barro, R.J. ‘Macroeconomics: A Modern Approach (International Edition) • 2 central topics in the course: economic growth and economic fluctuations • This lecture: national income accounting • Defining and explaining basic terminology and measurement for macroeconomics • GDP, unemployment, inflation etc..

3. 1. Gross Domestic Product (GDP) • An economy is composed of: • Non-productive wealth: • Houses, parks, cds, furniture, ipods, paintings. • Productive assets: (the factors of production) • Capital: machines, factories, computers • Labour: workers (including their skills) • If we added up the value of all this, we could measure ‘the total value of the U.K.’

4. GDP Basics • Non-productive wealth doesn’t make anything • Productive assets can be used to make: • More productive assets (e.g making new machines). We call this investment. • Goods and services for consumption. • Durables, which add to wealth (e.g. furniture) • Non-durables, which are one-off consumption (e.g. ice-creams, hair cuts) • The total value of goods + services + investment is known as Gross Domestic Product (GDP).

5. GDP Basics • So GDP is a flow variable: a stream of output. • i.e. if the economy froze for 1 year, total wealth would be unchanged, but GDP would be 0. • GDP growth is the change in GDP between the last period and this one. • So GDP growth can be positive or negative (at the moment it is negative).

6. Real GDP • GDP is measured in £s (nominal GDP). • Figures have to be adjusted to take account of inflation (real GDP)

7. Real GDP • So can calculate ‘GDP at constant prices’ • But prices change over time to reflect changing value of production, not just inflation • e.g. computers have fallen in cost over time, so using 1995 prices would overstate true price • Instead use average prices over consecutive years • This is know as chain-weighted real GDP, see example in Barro Ch.2

8. Measuring GDP • Three ways to measure GDP • Total expenditure = personal consumption + gross private domestic investment + government purchases + (exports – imports) • Total income = value added by all stages in production process • Total production = total value of all output produced in the economy • All 3 measures should be identical

9. 2. Employment and Unemployment • Every person is either • Out of the labour force: doesn’t want a job e.g. retired, sick, looking after children • In the labour force: wants a job • Of which some are employed (have a job) • Or unemployed (do not have a job) • The term ‘working age population’ refers to everyone aged 16-65 (men) 16-60 (women) • i.e. above school age and before retirement age

10. 3. Prices and Inflation • The aggregate price level is calculated by: • Recording the price of goods and services • Weighting goods and services by how much consumers purchase (using a survey) • Calculating a weighted average using the above • The change in the price level is the inflation rate • 2% inflation rate means prices are, on average, 2% higher this year than last year

11. 4. Interest Rates • The price of money is given by an interest rate • The price applies for a time period (how long you want to borrow the money for • Historically, influencing interest rates in the economy has been a policy tool • Changes to the price of money impact on borrowing / saving, and so influence demand • The key interest rat is the bank of England repo rate (‘base rate’) which affects all other rates.

12. Summary • Key variables in macroeconomics: GDP, unemployment, inflation, interest rates • More detail on calculation and measurement in Barro Ch.2 • Next time: begin first major section of course on economic growth