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: