Chapter 2: Measuring the Macroeconomy Hikaru Saijo University of California, Santa Cruz 2.2 Measuring the State of the Economy • Gross domestic product (GDP): The market value of the final goods and services produced in an economy over a certain period • United States GDP: • $12.5 trillion in 2005 • $14.4 trillion in 2008 ($47,000 per person) • $20.5 trillion in 2018 ($62,00 per person) • Production measure of GDP The number of goods produced in the economy. • Expenditure measure The total purchases in the economy. • Income measure All the income earned in the economy. • All three approaches give identical measures of GDP. • Thus = = • When calculating income, we need to distinguish between “profits” and “economic profits” • Profits Normal competitive return on inputs. • Economic profits Above-normal returns associated with prices that exceed those that prevail under perfect competition. The Expenditure Approach to GDP The national income accounting identity states: Y = + + + Where • Y = GDP (in dollars) • C = consumption • I = investment • G = government purchases • NX = net exports = exports − imports • Net exports (trade balance) for the United States is negative. • The recent trade deficit indicates that the United States is borrowing goods from the rest of the world. • As the trade balance has turned negative, consumption has increased as a share of GDP recently. The Income Approach to GDP • The income approach Measures the sum of all income earned in the economy • Capital • Inputs into production other than labor that are not used up in the production process • Increased by firms through investment • Depreciation • The deterioration of the capital stock due to wear and tear • GDP − = net domestic product • Total shares of GDP to inputs: • Share of GDP to Labor (labor share): • Share of GDP to Capital (capital share): • Labor’s share of GDP has remained approximately constant over time. The Production Approach to GDP • There is no “double counting” in GDP Only the final sale of goods and services count. • Value added • The amount each producer contributes to GDP. • The revenue generated by each producer minus the value of intermediate products. • Only new production of goods and services counts toward GDP. What Is Included in GDP and What’s Not? • Only goods and services that are transacted through markets are included in GDP. • Included: • • • • • Government spending on goods/services Factory production Healthcare expenditures Ingredients and food purchased Kids in day care • Not included: • • • • • Government transfer payments Environmental conditions A measure of a nation’s health Time spent cooking at home Babysitter By How Much Does GDP Rise? 1 2 3 A used car dealer buys a car for $5000 and sells it to a customer for $6000. A factory in the U.S. purchases a new machine from Japan for $1 million. A bookstore that specializes in foreign books buys $2000 worth of books from Germany and sells it to U.S. consumers for $2500. 2.3 Measuring Changes Over Time • When examining GDP over time, we need to take into account changes in prices. • Nominal GDP: • A measure of GDP when prices and quantities have not been separated, using current year prices • nominal GDP = price level × • Real GDP: • Actual quantity of goods and services, using base year prices • real GDP = nominal GDP / • To compute GDP across time, we must use one year’s price. • Real GDP will be measured in a certain year’s dollars. • Nominal GDP is measured in current dollars. • Consider Apples and Computers: nominal GDP = (prices of apples × quantity of apples) + (prices of computers × quantity of computers) A Simple Example: Where Real GDP Doesn’t Change • If the quantity of goods and services produced does not change, but prices do change • Nominal GDP will change. • Real GDP will not change. $900 $1 × 500 apples + × 5 computers = $5, 000 apple computer $2 $1, 00 × 500 apples + × 5 computers = $6, 000 apple computer Quantity Indexes: Laspeyres, Paasche, and Chain Weighting • Calculating real GDP changes over time: • The Laspeyres index Calculates changes in real GDP using the initial prices. • The Paasche index Calculates changes in real GDP using the final year prices. • Over long-time intervals the two indexes can result in substantial differences. • The Fisher index (chain weighting) is the preferred approach to calculating real GDP. • Average of the Laspeyres and Paasche index. • Preferred because new goods are invented while others become obsolete – making early or recent prices inaccurate. • Can be applied on a year-by-year basis if we compute real GDP each year. Price Indexes and Inflation • Recall the formula for nominal GDP: × nominal GDP = • The GDP deflator is the price level that satisfies the equation. • We could compute this formula for two different years to calculate a price change. • We could also use the following math trick: percentage change in nominal GDP ≈ percentage change in price level + percentage change in real GDP • The inflation rate is the percentage change in the price level. Using Chain-Weighted Data • Main reason for using chain-weighted data: Prices of computers rapidly changed in the 1990s • Main disadvantage: The sum of real C , I , G , NX will not equal real chain-weighted GDP because the prices used in constructing the components are different. • General rule to follow: • For particular components of GDP, we look at the ratio of nominal variables. • When you want real rates of economic growth, use the chain-weighted real measures. 2.4 Comparing Economic Performance across Countries • The exchange rate: Price at which different currencies are traded • To make comparisons of GDP across countries: • GDP must be expressed in a common currency by first adjusting it by the exchange rate. • This value of nominal GDP must be multiplied by the ratio of prices in the countries. An Example of Comparisons of Economies • Suppose we are trying to compare GDP in China and the United States. • China’s GDP: 75.2 trillion yuan • Exchange rate: 6.76 yuan per dollar • Goods in China, on average, cost about 62.5 percent of goods in the United States An Example of Comparisons of Economies 1 Use the exchange rate to turn Chinese yuan into U.S. dollars: 2 Adjust for relative price level of goods: