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Chapter 2: The Data of Macroeconomics. Gross Domestic Product (GDP) the Consumer Price Index (CPI Unemployment rate. National Income Accounting- measure the economy’s overall performance. Business firms- measures its flows of income and expenditures regularly

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slide2
Gross Domestic Product (GDP)
  • the Consumer Price Index (CPI
  • Unemployment rate
slide4

Business firms- measures its flows of income and expenditures regularly

  • Usually every 3 months or annually
slide6

This accounting enables the economists and policymakers to:

  • A. Assess the health of the economy by comparing levels of production at regular intervals.
gross domestic product
Gross Domestic Product
  • Definition: Value of total final goods and services produced in an economy in a given period of time (measure of economic activity)
  • There are two ways to compute it:
    • Total income of everyone in the economy
    • Total expenditures on the economy’s goods and services
  • These two measures must be equal:Expenditure of buyers = Income of sellers
why expenditure income
Why expenditure = income

In every transaction, the buyer’s expenditure becomes the seller’s income.

Thus, the sum of all expenditure equals the sum of all income.

gross domestic product gdp
Gross Domestic Product (GDP)
  • Example: an economy with two goods, apples and oranges

GDP = (papples×qapples) + (poranges×qoranges)

= ($0.50 × 4) + ($1.00 × 3) = $5.00

gross domestic product gdp1
Gross Domestic Product (GDP)
  • Intermediate Goods
    • Value Added = value of firm’s output minus value of intermediate inputs
gross domestic product gdp2
Gross Domestic Product (GDP)
  • GDP is the value of all FINAL goods and services produced and sold in the economy = $1.50
  • GDP is also equal to the sum of value added in all stages on production = $0.50 + $1.00 = $1.50
the expenditure components of gdp
The expenditure components of GDP
  • consumption
  • investment
  • government spending
  • net exports
an important identity
An important identity

Y = C + I + G + NX

where Y = GDP = the value of total output

C + I + G + NX = aggregate expenditure

consumption c
Consumption (C)
  • durable goodslast a long time ex: cars, home appliances
  • non-durable goodslast a short time ex: food, clothing
  • serviceswork done for consumers ex: dry cleaning, air travel.

def: the value of all final goods and services bought by households. Includes:

investment i
Investment (I)

def1: spending on [the factor of production] capital.

def2: spending on goods bought for future use.

Includes:

  • business fixed investmentspending on plant and equipment that firms will use to produce other goods & services
  • residential fixed investmentspending on housing units by consumers and landlords
  • inventory investmentthe change in the value of all firms’ inventories
investment vs capital
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.
investment vs capital1
Investment vs. Capital

Example (assumes no depreciation):

  • 1/1/2002: economy has $500b worth of capital
  • during 2002:investment = $37b
  • 1/1/2003: economy will have $537b worth of capital
stocks vs flows

Flow

Stock

Stocks vs. Flows

stock flow

a person’s wealth a person’s saving

# of people with # of new college college degrees graduates

More examples:

government spending g
Government spending (G)
  • G includes all government spending on goods and services.
  • G excludes transfer payments (e.g. unemployment insurance payments), because they do not represent spending on goods and services.
net exports nx ex im
Net exports (NX = EX - IM)

def: the value of total exports (EX) minus the value of total imports (IM)

gdp an important and versatile concept
GDP: An important and versatile concept

We have now seen that GDP measures

  • total income
  • total output
  • total expenditure
  • the sum of value-added at all stages in the production of final goods
some issues of gdp
Some Issues of GDP
  • Home production
  • Illegal activities
  • Underground economy
  • Environment Quality
gnp vs gdp
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)

real gdp
Real GDP
  • Is GDP a good measure of well-being/economic activity?
  • Recall that:

GDP = (papples×qapples) + (poranges×qoranges)

Higher GDP does NOT imply higher well-being  GDP can increase if prices increase, with no change in quantities

  • Real GDP = measure of output keeping prices constant
real gdp1
Real GDP

In the previous example:

real gdp2
Real GDP

Let 2002 be the base-year, i.e., real GDP will be calculated using 2002 prices

real gdp3
Real GDP

Now with 2003 as base-year:

Notice that, at the base-year:

Real GDP = Nominal GDP

real gdp4
Real GDP
  • Issue: results are sensitive to the choice of base year
    • Base year 2002, Real GDP goes from $5.00 to $5.50 (growth rate = 10%)
    • Base year 2003, Real GDP is the same in both years (growth rate = 0)
  • Solution: Chain-weighting
    • Take the average of the growth rates = 5%
real gdp5
Real GDP
  • Then use this growth rate to calculate Real GDP in 2003:
    • RGDP2003 = $5.00*(1 + .05) = $5.25
    • RGDP2002 = $5.00
  • Advantages:
    • It does not depend on the base year
    • Prices are updated as time passes
gdp deflator
GDP Deflator

Reflects changes in the overall price level  how price changes between current year and the base year

gdp deflator1
GDP Deflator

In our example, using 2002 as base year:

= $5.20/$5.50 = 0.945

gdp deflator2
GDP Deflator

 Price level decreased 5.5% from 2002 to 2003

consumer price index cpi
Consumer Price Index (CPI)
  • Measures changes in the price level, i.e., inflation
  • More specifically, measures how the cost of a given consumption basket evolves over time (cost of living)
  • The bundle includes goods and services consumed by a typical consumer
consumer price index cpi1
Consumer Price Index (CPI)

For example, suppose a typical consumer buys 5 apples and 2 oranges:

In other words, the cost of this basket is 2% lower in 2003 relative to 2002 (the base year)

two measures of inflation

CPI

GDP deflator

Two measures of inflation

Percentage

change

16

14

12

10

8

6

4

2

0

2

-

1948

1953

1958

1963

1968

1973

1978

1983

1988

1993

1998

Year

reasons why the cpi may overstate inflation
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.
cpi vs gdp deflator2
CPI vs. GDP deflator

prices of capital goods

  • included in GDP deflator (if produced domestically)
  • excluded from CPI

prices of imported consumer goods

  • included in CPI
  • excluded from GDP deflator

the basket of goods

  • CPI: fixed
  • GDP deflator: changes every year