EC 204 Slides to Accompany Chapters 1 and 2

1. EC 204Slides to Accompany Chapters 1 and 2 The Data of Macroeconomics

2. The Data of Macroeconomics

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5. Gross Domestic Product Two Perspectives: 1. Total Expenditure on domestically-produced final goods and services. 2. Total Income earned by domestically-located factors of production. The Data of Macroeconomics

6. Gross Domestic Product Precise Definition: “Market value of all final goods and services produced within an economy in a given period of time.” The Data of Macroeconomics

7. Issues in Measuring GDP • Adding apples and oranges • Used goods • Inventories • Intermediate goods and value added • Housing and other imputations • Real versus Nominal The Data of Macroeconomics

8. Nominal and Real GDP NGDPt = SPitQit RGDPt = SPioQit where summation is over i. The Data of Macroeconomics

9. Fixed Base-Year Weighting RGDPt = SPioQit 1+gt = RGDPt/RGDPo = S[PioQit]/S[PioQio] = Swi[Qit/Qio] where wi = PioQio/ S[PioQio] The Data of Macroeconomics

10. Computer Prices and Problems Measuring Real GDP Price of Computers Declined Sharply in 1980s to 1990s Implying That Base Year Price of Computers Is Much Higher Than Current Year Price Leads to Bias Upward in Real GDP for Recent Years Leads to Bias Downward in Real GDP for Earlier Years New Chain-weighted Measure of Real GDP Allows for More Frequent Updating of Prices The Data of Macroeconomics

11. 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. • This makes chain-weighted GDP more accurate than constant-price GDP. • See Supplements 2.1, 2.2, 2.4, and 2.6 for more information on GDP. • See Supplements 1.2 and 1.3 for a discussion of using GDP growth to predict the outcome of Presidential elections and a discussion of how to tell when we are in a recession. The Data of Macroeconomics

12. Chain-Weighted Real GDP Example: Two goods: Apples (A) and Oranges (O). Growth Rate Using a Fixed Base-Year Measure: Growth Rate Using a Chain-Weighted Measure: “Chain” the Growth Rates to get the Level (Index) of Real GDP: The Data of Macroeconomics

13. GDP Price Index Similar approach allows measurement of the overall rate of change for the prices of goods and services in GDP: “Chain” the Inflation Rates to get the GDP Price Index: The Data of Macroeconomics

14. Real GDP, Nominal GDP and the GDP Price Index And, if one chooses a base year where in which to set real and nominal GDP equal: Thus, the simple rule for approximating percent change continues to hold: Change in Price = Percent Change in Nominal GDP minus Percent Change in Real GDP The Data of Macroeconomics

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16. GDP and the Components of Expenditure, 2004 The Data of Macroeconomics

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18. Consumption, 2004 The Data of Macroeconomics

19. Investment, 2004 The Data of Macroeconomics

20. Investment vs. Capital • Capital is one of the factors of production. At any given moment, the economy has a certain overall stock of capital. • Investment is spending on new capital. The Data of Macroeconomics

21. Flow Stock Stocks vs. Flows stock flow a person’s wealth a person’s saving # of people with # of new college college degrees graduates the govt. debt the govt. budget deficit More examples: The Data of Macroeconomics

22. Government spending, 2004 The Data of Macroeconomics

23. Net exports (NX = EX - IM) The Data of Macroeconomics

24. An important identity Y = C + I + G + NX where: Y = GDP = the value of total output C + I + G + NX = aggregate expenditure The Data of Macroeconomics

25. Why does output = expenditure? • Unsold output goes into inventory, and is counted as “inventory investment”… …whether the inventory buildup was intentional or not. • In effect, we are assuming that firms purchase their unsold output. The Data of Macroeconomics

26. 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) – (factor payments to abroad) The Data of Macroeconomics

27. (GNP – GDP) as a percentage of GDP (selected countries, 1997) The Data of Macroeconomics

28. Some Useful Identities The Data of Macroeconomics

29. Other Measures of Income The Data of Macroeconomics

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32. Consumer Price Index (CPI) • A measure of the overall level of prices • Published by the Bureau of Labor Statistics (BLS) • Used to • track changes in the typical household’s cost of living • adjust many contracts for inflation (i.e. “COLAs”) • allow comparisons of dollar figures from different years The Data of Macroeconomics

33. How the BLS constructs the CPI Surveys consumers to determine composition of the typical consumer’s “basket” of goods. Every month, collect data on prices of all items in the basket; compute cost of basket CPI in any month equals the cost of this basket divided by its cost in the “base” year multiplied by 100. The Data of Macroeconomics

34. The Composition of the CPI’s “Basket” The Data of Macroeconomics

35. Reasons 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. The Data of Macroeconomics

36. The CPI’s bias • The Boskin Panel’s “best estimate”:The CPI overstates the true increase in the cost of living by 1.1% per year. • Result: the BLS has refined the way it calculates the CPI to reduce the bias. • It is now believed that the CPI’s bias is slightly less than 1% per year. The Data of Macroeconomics

37. GDP Deflator (Price Index) versus CPI • GDP Price Index measures prices of all goods and services produced, CPI only measures prices of goods and services bought by consumers. • GDP Price Index includes only goods produced domestically, CPI includes imports. • Weighting used to compute indexes differs: GDP Price Index uses changing weights, CPI uses fixed weights. The Data of Macroeconomics

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39. Categories of the population • employedworking at a paid job • unemployednot 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 forcenot employed, not looking for work. The Data of Macroeconomics

40. 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 The Data of Macroeconomics

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47. 8 6 4 2 0 -2 -3 0 1 2 3 4 -1 -2 Okun’s Law states that a one-percent decrease in unemployment is associated with two percentage points of additional growth in real GDP Okun’s Law Percentage change in real GDP 10 1951 1984 2000 1999 1993 1975 1982 Change in unemployment rate The Data of Macroeconomics