CHAPTER
2
The Data of Macroeconomics
Adapted for EC 204 by
Prof. Bob Murphy
MACROECONOMICS
SIXTH EDITION
N. GREGORY MANKIW
PowerPoint® Slides by Ron Cronovich
© 2007 Worth Publishers, all rights reserved
In this chapter, you will learn…
…the meaning and measurement of the
most important macroeconomic statistics:
 Gross Domestic Product (GDP)
 The Consumer Price Index (CPI)
 The Unemployment rate
CHAPTER 2
The Data of Macroeconomics
slide 1
Gross Domestic Product:
Expenditure and Income
Two definitions:
 Total expenditure on domestically-produced
final goods and services.
 Total income earned by domestically-located
factors of production.
Expenditure equals income because
every dollar spent by a buyer
becomes income to the seller.
CHAPTER 2
The Data of Macroeconomics
slide 2
The Circular Flow
Income ($)
Labor
Firms
Households
Goods
Expenditure ($)
CHAPTER 2
The Data of Macroeconomics
slide 3
Gross Domestic Product:
Expenditure and Income
One caveat:
 Measurement of income and expenditure is
imperfect.
 Difference in GDP and Gross Domestic Income
GDI) is called the “Statistical Discrepancy.”
See Supplement 2-1
CHAPTER 2
The Data of Macroeconomics
slide 4
Value added
definition:
A firm’s value added is
the value of its output
minus
the value of the intermediate goods
the firm used to produce that output.
CHAPTER 2
The Data of Macroeconomics
slide 5
Final goods, value added, and GDP
 GDP = value of final goods produced
= sum of value added at all stages
of production.
 The value of the final goods already includes the
value of the intermediate goods,
so including intermediate and final goods in GDP
would be double-counting.
CHAPTER 2
The Data of Macroeconomics
slide 7
The expenditure components of
GDP




consumption
investment
government spending
net exports
CHAPTER 2
The Data of Macroeconomics
slide 8
Consumption (C)
definition: The value of all
goods and services bought
by households. Includes:
 durable goods


CHAPTER 2
last a long time
ex: cars, home
appliances
nondurable goods
last a short time
ex: food, clothing
services
work done for
consumers
ex: dry cleaning,
air travel.
The Data of Macroeconomics
slide 9
U.S. consumption, 2005
$ billions
Consumption
CHAPTER 2
% of GDP
$8,745.7
70.0%
Durables
1,026.5
8.2
Nondurables
2,564.4
20.5
Services
5,154.9
41.3
The Data of Macroeconomics
slide 10
Investment (I)
Definition 1: Spending on [the factor of production]
capital.
Definition 2: Spending on goods bought for future use
Includes:
 business fixed investment
Spending on plant and equipment that firms will use
to produce other goods & services.
 residential fixed investment
Spending on housing units by consumers and
landlords.
 inventory investment
The change in the value of all firms’ inventories.
CHAPTER 2
The Data of Macroeconomics
slide 11
U.S. investment, 2005
$ billions
Investment
Business fixed
Residential
Inventory
CHAPTER 2
$2,105.0
% of GDP
16.9%
1,329.8
10.6
756.3
6.1
18.9
0.2
The Data of Macroeconomics
slide 12
Investment vs. Capital
Note: Investment is spending on new capital.
Example (assumes no depreciation):
 1/1/2006:
economy has $500b worth of capital
 during 2006:
investment = $60b
 1/1/2007:
economy will have $560b worth of capital
CHAPTER 2
The Data of Macroeconomics
slide 13
Stocks vs. Flows
Flow
Stock
A stock is a
quantity measured
at a point in time.
E.g.,
“The U.S. capital stock
was $26 trillion on
January 1, 2006.”
A flow is a quantity measured per unit of time.
E.g., “U.S. investment was $2.5 trillion during 2006.”
CHAPTER 2
The Data of Macroeconomics
slide 14
Stocks vs. Flows - examples
CHAPTER 2
stock
flow
a person’s wealth
a person’s
annual saving
# of people with
college degrees
# of new college
graduates this year
the govt debt
the govt budget deficit
The Data of Macroeconomics
slide 15
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.
CHAPTER 2
The Data of Macroeconomics
slide 17
U.S. government spending, 2005
Govt spending
Federal
% of GDP
$2,362.9
18.9%
877.7
7.0
Non-defense
290.6
2.3
Defense
587.1
4.7
1,485.2
11.9
State & local
CHAPTER 2
$ billions
The Data of Macroeconomics
slide 18
Net exports: NX = EX – IM
def: The value of total exports (EX)
minus the value of total imports (IM).
2%
0
0%
-200
-2%
-400
-4%
-600
-6%
-800
1950
-8%
1960
1970
NX ($ billions)
1980
1990
2000
NX (% of GDP)
percent of GDP
billions of dollars
200
U.S. Net Exports, 1950-2006
An important identity
Y = C + I + G + NX
value of
total output
CHAPTER 2
aggregate
expenditure
The Data of Macroeconomics
slide 20
A question for you:
Suppose a firm
 produces $10 million worth of final goods
 but only sells $9 million worth.
Does this violate the
expenditure = output identity?
CHAPTER 2
The Data of Macroeconomics
slide 21
Why output = expenditure
 Unsold output goes into inventory,
and is counted as “inventory investment”…
…whether or not the inventory buildup was
intentional.
 In effect, we are assuming that
firms purchase their unsold output.
CHAPTER 2
The Data of Macroeconomics
slide 22
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
CHAPTER 2
The Data of Macroeconomics
slide 23
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)
CHAPTER 2
The Data of Macroeconomics
slide 24
Discussion question:
In your country,
which would you want
to be bigger, GDP, or GNP?
Why?
CHAPTER 2
The Data of Macroeconomics
slide 25
(GNP – GDP) as a percentage of GDP
U.S.A.
Angola
Brazil
Canada
Hong Kong
Kazakhstan
Kuwait
Mexico
Philippines
U.K.
CHAPTER 2
1.0%
-13.6
-4.0
-1.9
2.2
-4.2
9.5
-1.9
6.7
1.6
selected countries, 2002
The Data of Macroeconomics
slide 26
Other Measures of Income
 National Income = GNP - Depreciation
 National Income = Compensation of Employees
+ Proprietors’ Income + Rental Income +
Corporate Profits + Net Interest + Indirect
Business Taxes
 Note: Supplement 2-7 describes recent change
in definition of National Income to include
Indirect Business Taxes.
CHAPTER 2
The Data of Macroeconomics
slide 27
Components of National Income
Indirect Business
Taxes and Other
9%
Net Interest
4%
Corporate Profits
12%
Rental Income
1%
Proprietors' Income
9%
CHAPTER 2
The Data of Macroeconomics
Compensation of
Employees
65%
slide 28
Other Measures of Income
 Personal Income = National Income - Indirect
Business Taxes - Corporate Profits - Social
Insurance Contributions - Net Interest +
Dividends + Government Transfers to
Individuals + Personal Interest Income
 Disposable Personal Income = Personal
Income - Personal Tax and Nontax Payments
 Disposable Personal Income is what
households and noncorporate businesses have
to spend (or save).
CHAPTER 2
The Data of Macroeconomics
slide 29
Real vs. nominal GDP
 GDP is the value of all final goods and services
produced.
 nominal GDP measures these values using
current prices.
 real GDP measure these values using the prices
of a base year.
CHAPTER 2
The Data of Macroeconomics
slide 30
Real vs. nominal GDP
n
GDPt =  Pit Qit
i1
n
RGDPt =  PiBQit
i1
CHAPTER 2
The Data of Macroeconomics
slide 31
Real GDP controls for inflation
Changes in nominal GDP can be due to:
 changes in prices.
 changes in quantities of output produced.
Changes in real GDP can only be due to
changes in quantities,
because real GDP is constructed using
constant base-year prices.
CHAPTER 2
The Data of Macroeconomics
slide 34
U.S. Nominal and Real GDP,
1950–2006
14,000
12,000
(billions)
10,000
8,000
Real GDP
(in 2000 dollars)
6,000
4,000
Nominal GDP
2,000
0
1950
CHAPTER 2
1960
1970
1980
The Data of Macroeconomics
1990
2000
slide 35
GDP Deflator
 The inflation rate is the percentage increase in
the overall level of prices.
 One measure of the price level is
the GDP deflator, defined as
Nominal GDP
GDP deflator = 100 
Real GDP
CHAPTER 2
The Data of Macroeconomics
slide 36
Practice problem, part 2
Nom. GDP
Real GDP
2006
$46,200
$46,200
2007
51,400
50,000
2008
58,300
52,000
GDP
deflator
Inflation
rate
n.a.
 Use your previous answers to compute
the GDP deflator in each year.
 Use GDP deflator to compute the inflation rate
from 2006 to 2007, and from 2007 to 2008.
CHAPTER 2
The Data of Macroeconomics
slide 37
Answers to practice problem, part 2
Nominal
GDP
Real GDP
GDP
deflator
Inflation
rate
2006
$46,200
$46,200
100.0
n.a.
2007
51,400
50,000
102.8
2.8%
2008
58,300
52,000
112.1
9.1%
CHAPTER 2
The Data of Macroeconomics
slide 38
Two arithmetic tricks for
working with percentage changes
1. For any variables X and Y,
percentage change in (X  Y )
 percentage change in X
+ percentage change in Y
EX:
If your hourly wage rises 5%
and you work 7% more hours,
then your wage income rises
approximately 12%.
CHAPTER 2
The Data of Macroeconomics
slide 41
Two arithmetic tricks for
working with percentage changes
2. percentage change in (X/Y )
 percentage change in X
 percentage change in Y
EX: GDP deflator = 100  NGDP/RGDP.
If NGDP rises 9% and RGDP rises 4%,
then the inflation rate is approximately 5%.
CHAPTER 2
The Data of Macroeconomics
slide 42
Measuring Economic Growth
n
n
i1
i1
RGDPt / RGDPt 1 =  PiBQit /  PiBQit 1
n

P Q
i1
iB
Q / Q 
it 1 
it 1  it
n
P Q
i1
CHAPTER 2
The Data of Macroeconomics
iB
it 1
slide 43
Measuring Economic Growth
n
RGDPt / RGDPt 1 =
P Q
i1
iB
Q / Q 
it 1  it
it 1 
n
P Q
i1
1 g  
t

CHAPTER 2
iB
it 1
n



Q
/
Q
 i  it it 1 
i1
The Data of Macroeconomics
slide 44
Measuring Economic Growth
A problem arises when using fixed
base-year weights: Growth will vary
depending on base year chosen.
Rapidly growing sectors with declining
relative prices will be weighted “too
much” as base year becomes further
and further in the past. Opposite for
slowly growing sectors.
CHAPTER 2
The Data of Macroeconomics
slide 45
Chain-Weighted Real GDP
 Over time, relative prices change, so the base
year should be updated periodically--which BEA
used to do.
 In essence, chain-weighted real GDP
updates the base year every year,
so it is more accurate than fixed base-year GDP.
 Official measure of GDP now produced by BEA.
 See Supplement 2-4.
CHAPTER 2
The Data of Macroeconomics
slide 46
Chain-Weighted Real GDP
n
Step 1:
[1 gt ]t-1 =
P
i1
Q / Q 
Q
i t-1 it 1  it
it 1 
n
P
i1
Q
i t-1 it 1
Rewrite as:
1 g  
t  t-1

CHAPTER 2
n

i1
The Data of Macroeconomics
Q / Q 
i t-1  it
it 1 
slide 47
Chain-Weighted Real GDP
n
Step 2:
[1 gt ]t =
P Q
i1
it
Q / Q 
it 1  it
it 1 
n
P Q
i1
it
it 1
Rewrite as:
1 g  
t t

CHAPTER 2
n

i1
The Data of Macroeconomics
Q / Q 
i t  it
it 1 
slide 48
Chain-Weighted Real GDP
Step 3:
[1 gt ] = {[1 gt ]t  [1 gt ]t-1}
0.5
To get level of real GDP, use nominal GDP for a given
year and apply growth rate:
RGDPt  1 gt  1 gt 1  1 gt 2  1 gt 3  GDPt-4
Real GDP is measured here in year t-4 dollars.
CHAPTER 2
The Data of Macroeconomics
slide 49
When is the Economy in a Recession?
 Rule of Thumb: Two quarters of decline in Real GDP
 National Bureau of Economic Research uses more nuanced
approach (see Supplement 1-3):
 Monthly Indicators rather than Quarterly.
 “A significant decline in activity spread across the
economy, lasting more than a few months, visible in
industrial production, employment, real income, and
wholesale-retail trade.”
CHAPTER 2
The Data of Macroeconomics
slide 50
Monthly Change in
Employment
600
500
400
300
200
100
0
-100
-200
-300
19
88
19
89
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
-400
CHAPTER 2
The Data of Macroeconomics
Source: Department of Labor, Bureau of Labor Statistics.
slide 51
Monthly Change in Employment
(thousands)
600
400
200
0
-200
-400
-600
-800
2000
CHAPTER 2
2001
2002
2003
2004
2005
The Data of Macroeconomics
Source: Department of Labor, Bureau of Labor Statistics.
2006
2007
2008
slide 52
Real Personal Income Net of Transfers
(billions of 2000 dollars,
seasonally adjusted annual rate)
9000
8500
8000
7500
7000
6500
6000
5500
5000
4500
4000
8
8
19
8
19
9
9
19
CHAPTER 2
0
91 992 993 994 995 996 997 998 999 000 001 002 003 004 005 006 007
9
1
1
1
1
1
1
1
1
1
2
2
2
2
2
2
2
2
The Data of Macroeconomics
Source: Department of Commerce, Bureau of Economic Analysis.
slide 53
Real Personal Income Net of
Transfers
(billions of 2000 dollars,
9000
8500
8000
7500
7000
6500
2000
CHAPTER 2
2001
2002
2003
2004
2005
The Data of Macroeconomics
Source: Department of Commerce, Bureau of Economic Analysis.
2006
2007
2008
slide 54
Change in Industrial Production
(percent change at an annual rate)
40%
30%
20%
10%
0%
-10%
-20%
19
88
19
89
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
-30%
CHAPTER 2
The Data of Macroeconomics
Source: Board of Governors of the Federal Reserve.
slide 55
Change in Industrial Production
(percent change at an annual rate)
30%
20%
10%
0%
-10%
-20%
-30%
-40%
-50%
2000
CHAPTER 2
2001
2002
2003
2004
2005
The Data of Macroeconomics
Source: Board of Governors of the Federal Reserve.
2006
2007
2008
slide 56
Monthly Real Retail
Sales
350000
330000
310000
290000
270000
250000
230000
210000
190000
170000
150000
2
9
19
93
9
1
CHAPTER 2
4
9
19
5
9
19
6
9
19
7
9
19
8
9
19
9
9
19
0
20
0
1
0
20
0
20
2
0
20
3
0
20
4
The Data of Macroeconomics
Source: Department of Commerce, Bureau of the Census and Bureau of Economic Analysis.
5
0
20
6
0
20
07
0
2
slide 57
Monthly Real Retail Sales
(millions of 2000 dollars)
330000
320000
310000
300000
290000
280000
270000
260000
250000
240000
2000
CHAPTER 2
2001
2002
2003
2004
2005
2006
The Data of Macroeconomics
Source: Department of Commerce, Bureau of the Census and Bureau of Economic Analysis.
2007
2008
slide 58
Consumer Price Index (CPI)
 A measure of the overall level of prices
 Published by the Bureau of Labor Statistics
(BLS)
 Uses:
 tracks changes in the typical household’s
cost of living
 adjusts many contracts for inflation (“COLAs”)
 allows comparisons of dollar amounts over time
CHAPTER 2
The Data of Macroeconomics
slide 59
How the BLS constructs the CPI
1. Survey consumers to determine composition
of the typical consumer’s “basket” of goods.
2. Every month, collect data on prices of all items
in the basket; compute cost of basket
3. CPI in any month equals
Cost of basket in that month
100 
Cost of basket in base period
CHAPTER 2
The Data of Macroeconomics
slide 60
The composition of the CPI’s “basket”
Food and bev.
17.4%
Housing
Apparel
6.2%
5.6%
3.0%
3.1%
3.8%
3.5%
Transportation
Medical care
Recreation
15.1%
Education
Communication
Other goods
and services
CHAPTER 2
42.4%
The Data of Macroeconomics
slide 63
Understanding the CPI
n
CPI 
Et
EB
=
Q
i1
n
Q
i1
P
iB it
P
iB iB
n
=
Q P
i1
iB
n
Q
i1
CHAPTER 2
P / P 
iB  it
iB 
The Data of Macroeconomics
P
iB iB
slide 66
Understanding the CPI
CPI 
Et
EB
where the weights are
given by:
 iB 
n
=   iB Pit / PiB 
i1
QiBPiB
n
Q P
i1
CHAPTER 2
iB iB
The Data of Macroeconomics
slide 67
Understanding the CPI
The CPI is a weighted average of prices relative
to their value in the base period.
The weight on each “price relative” reflects
that good’s relative importance in the CPI’s
basket.
Note that the weights remain fixed over time.
CHAPTER 2
The Data of Macroeconomics
slide 68
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. Has to do with how
prices of goods are measured.
CHAPTER 2
The Data of Macroeconomics
slide 69
The size of the CPI’s bias
 In 1995, a Senate-appointed panel of experts
estimated that the CPI overstates inflation by
about 1.1% per year.
 So the BLS made adjustments to reduce the bias.
 Now, the CPI’s bias is probably under 1% per
year.
 See Supplements 2-10 and 2-11.
CHAPTER 2
The Data of Macroeconomics
slide 70
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
CHAPTER 2
The Data of Macroeconomics
slide 72
Two measures of inflation in the U.S.
Percentage change
from 12 months earlier
15%
12%
9%
6%
3%
0%
-3%
1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005
GDP deflator
CHAPTER 2
The Data of Macroeconomics
CPI
slide 73
Categories of the population
 employed
working at a paid job
 unemployed
not 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 force
not employed, not looking for work
CHAPTER 2
The Data of Macroeconomics
slide 74
The Household Survey: Two
important labor force concepts
 unemployment rate
percentage of the labor force that is unemployed
(see Supplement 2-12 for alternative measures
of the unemployment rate)
 labor force participation rate
the fraction of the adult population
that “participates” in the labor force
CHAPTER 2
The Data of Macroeconomics
slide 75
The Establishment Survey
 The BLS obtains a second measure of
employment by surveying businesses, asking
how many workers are on their payrolls.
 Neither measure is perfect, and they
occasionally diverge due to:
 treatment of self-employed persons
 new firms not counted in establishment survey
 technical issues involving population inferences
from sample data
CHAPTER 2
The Data of Macroeconomics
slide 79
Percentage change
from 12 months earlier
Two measures of employment
growth: Household Survey and the
Establishment Survey
8%
6%
4%
2%
0%
-2%
-4%
1960
1965
1970
1975
1980
1985
Establishment survey
CHAPTER 2
The Data of Macroeconomics
1990
1995
2000
2005
Household survey
slide 80