Measurement of Output, Employment & Prices

1. Measurement of Output, Employment & Prices

2. Why Measurement Matters • Before we get into models of economic behaviour we need to look some definitions and some issues in measurement • Measurement economic quantities may seem boring… • But it can give crucial insight even without a model of behaviour • Example: we will look at include the current crisis

3. MACROECONOMIC MEASUREMENT • Need to Look at three sets of measurements • Here we will look at the National Income and Expenditure Accounts (NIE) • Also the measurement of external transactions: Balance of Payments • Prices • Employment

4. NIE Identity • We measure macroeconomic activity primarily by looking at annual (or quarterly) flows of Output (O), Income (Y) and Expenditure (E). • These are different ways of measuring the same thing, so they sum to identical totals • Basic Identity: Y  O  E • Think of why this is the case • Income and Product are identical: Product is Value-Added in Production, i.e sales minus purchases from other firms, which = payment of incomes to Factors (Wages, Interest…) • Expenditure equals Income, because any production not sold is counted as Inventory Investment, and is thus part of Expenditure (the firm purchases its own output from itself) • Note this is an identity not an equilibrium condition • An identity holds for all values • An eqm condition holds only for some values i.e. in eqm • Distinction important later

5. NIE: GDP vs GNP • Open economy: GNP v GDP • GNP  GDP + NFIA • (NFIA is net factor incfrom R.O.W., i.e. inflows minus outflows) • GNY  GNP + EUtrasfers – EUtaxes • GNDY  GNP + NTA (NTA is all net Transfers from R.O.W. incl EU) • GDP + NFIA + NTA  GNDY • Note: Irish GNP was approx 85% of GDP (2007) • For many other countries the distinction is not relevant • Can lead to lots of debate of which is best measure in Ireland

6. NIE: SAVINGS & INVESTMENT IDENTITY • The Income Identity • Y  C + S + T • Accounting rule: Income is either spent saved or taxed • The Expenditure Identity • E= C + I + G + NX • Accounting rule: add up the components of expenditure • Combine the two • C + I + G + NX  C + S + T • Thus: (G – T)  (S – I) – NX • or: (G – T) + NX  (S – I) etc. • clearly, adding in net foreign factor and transfer income, including them in the totals for T and S etc as appropriate, and changing signs we get: • (T - G) + (S - I)  NX  BOP Current A/C • Note: the 2 left hand expressions are National Savings • Note: we could also add in NFIA & For Trans

7. NIE: SAVINGS & INVESTMENT IDENTITY • This is often known as the twin deficits identity • Even though it doesn’t involve any model or description of economic behaviour it can be informative • Implication: a current account surplus can only occur if there is an excess of national savings • Application 1: The US • The US has trade deficit (esp with China) • This is inescapable given it has insufficient savings • China surplus equates to surplus Chinese savings • Application 2: Ireland’s Bubble • We had a bubble (high investment) • Insufficient savings • So high current account deficit

9. EMPLOYMENT AND UNEMPLOYMENT • The labour force (L) = employed (E) + unemployed (U) • The unemployment rate u% = U/L or U/(E + U) • Letting the population of Labour-force Age = P, we also have: • The Labour force participation rate: LFPR% = L/P • Measuring Employment and Unemployment • Surveys: household QNHS in Ireland, quarterly household survey (CPS in USA); business surveys for employment. • Administrative: “Live Register” (Ireland); related to benefit claimants • The precise details of how surveys and other measures are constructed will differ from country to country. Survey methods are generally more comparable. • Key Issue: have to “want” to work to be unemployed as distinct from not working • Surveys try to capture this: “active search” • Issue of how active • Discouraged worker effects • Claimant counts do not – may include people NILF

10. Prices • (See Gordon: Appendix to Ch 2) • Some components of GDP have well-known measures of inflation: the CPI for household consumption • For a more comprehensive measure the implicit price deflator for GDP is used: this relates to all items in the GDP • A price index is a weighted average measure of price changes • Two questions arise: (i) what is included (ii) what kind of weighting system to use • For Consumption the Irish CPI includes a measure of housing costs, the Eurozone HIPC does not (why?) • Generally if an index uses base-year weights (Laspeyre), the resulting inflation is higher than if current year weights are used (Paasche) • Nearly all Consumer Price indices are Laspeyre.

11. LASPEYRE AND PAASCHE INDICES • A Laspeyre index of prices uses the quantities prevailing in some base (e.g. survey) year to weight prices. The index takes the form: • (p1q0/ p0q0)x100 • Note: base-year quantities (q0) are used to compare prices in the two years (p1 and p0 ) • A Paasche index of prices uses the quantities prevailing in the terminal year to weight prices. The index takes the form: • (p1q1/ p0q1)x100 • Note: current-year quantities (q1) are used to compare prices in the two years (p1 and p0) • As relatively cheaper are substituted for dearer goods, the Laspeyre index of prices has an upward substitution bias.

12. THE IMPLICIT GDP DEFLATOR • Instead of constructing an index directly, we take the ratio of nominal to real GDP. • For simplicity let real GDP be this year’s output at last year’s (base year) prices • So the index is: (p1q1 / p0q1) • Note that this is similar in form to a Paasche index of prices. • In some cases the calculation is refined and the implicit deflator is an average (geometric mean) of a Laspeyre and Paasche indices. • As the real to nominal GDP ratio is re-calculated each year, the weighting of the quantities is updated and the resulting implicit deflators are chained together to give a cumulative index over time. • The result is a lesser degree of substitution bias