EC 204
Slides to Accompany
Chapters 1 and 2
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The Data of Macroeconomics
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Gross Domestic Product
Two Perspectives:
1. Total Expenditure on domesticallyproduced final goods and services.
2. Total Income earned by domesticallylocated factors of production.
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Gross Domestic Product
Precise Definition: “Market value
of all final goods and services
produced within an economy in a
given period of time.”
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Issues in Measuring GDP
•
•
•
•
•
•
Adding apples and oranges
Used goods
Inventories
Intermediate goods and value added
Housing and other imputations
Real versus Nominal
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Nominal and Real GDP
NGDPt = SPitQit
RGDPt = SPioQit
where summation is over i.
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Fixed Base-Year Weighting
RGDPt = SPioQit
1+gt = RGDPt/RGDPo
= S[PioQit]/S[PioQio]
= Swi[Qit/Qio]
where
wi = PioQio/ S[PioQio]
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Computer Prices and Problems
Measuring Real GDP
Price of Computers Declined Sharply in 1980s to 1990s
Implying That Base Year Price of Computers Is Much
Higher Than Current Year Price
Leads to Bias Upward in Real GDP for Recent Years
Leads to Bias Downward in Real GDP for Earlier Years
New Chain-weighted Measure of Real GDP Allows for
More Frequent Updating of Prices
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Chain-weighted Real GDP
• Over time, relative prices change, so the base year should
be updated periodically.
• In essence, “chain-weighted Real GDP” updates the base
year every year.
• This makes chain-weighted GDP more accurate than
constant-price GDP.
• See Supplements 2.1, 2.2, 2.4, and 2.6 for more information
on GDP.
• See Supplements 1.2 and 1.3 for a discussion of using GDP
growth to predict the outcome of Presidential elections and a
discussion of how to tell when we are in a recession.
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Chain-Weighted Real GDP
Example: Two goods: Apples (A) and Oranges (O).
Growth Rate Using a Fixed Base-Year Measure:
Growth Rate Using a Chain-Weighted Measure:
“Chain” the Growth Rates to get the Level (Index) of Real GDP:
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GDP Price Index
Similar approach allows measurement of the overall rate of
change for the prices of goods and services in GDP:
“Chain” the Inflation Rates to get the GDP Price Index:
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Real GDP, Nominal GDP and
the GDP Price Index
And, if one chooses a base year where in which to set real
and nominal GDP equal:
Thus, the simple rule for approximating percent change
continues to hold:
Change in Price = Percent Change in Nominal GDP minus Percent
Change in Real GDP
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Percent Change in Chain-type Real GDP
(quarterly at annual rate)
8%
7%
6%
5%
4%
3%
2%
1%
0%
-1%
-2%
2000
2001
2002
2003
2004
The Data of Macroeconomics
2005
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GDP and the Components of Expenditure, 2004
Total
Per Person
(billions of dollars) (dollars)
Gross domestic product.......
Personal consumption expenditures.
Durable goods...................
Nondurable goods...... ..........
Services........................
Gross private domestic investment.
Nonresidential................
Residential...................
Change in private inventories...
Net exports of goods and services.
Exports.........................
Imports.... .....................
Government co nsumption
and gross investment...... .......
Federal.........................
National defense..............
Nondefense.. ..................
State and local.................
11734.3
8214.3
987.8
2368.3
4858.2
1928.1
1198.8
673.8
55.4
-624.0
1173.8
1797.8
39925.2
27948.6
3360.9
8058.0
16529.7
6560.2
4078.8
2292.6
188.5
-2123.1
3993.8
6116.9
2215.9
827.6
552.7
274.9
1388.3
7539.5
2815.9
1880.5
935.3
4723.6
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Expenditure Components:
Share of GDP, 2004
75%
70.0%
65%
55%
45%
35%
25%
18.9%
16.4%
15%
5%
-5%
-5.3%
-15%
Consumption
Investment
Net Exports
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Government
Purchases
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Consumption, 2004
$ billions
Consumption
% of
GDP
8214.3
70.0%
987.8
8.4%
Nondurables
2368.3
20.2%
Services
4858.2
41.4%
Durables
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Investment, 2004
$ billions
Investment
% of
GDP
1928.1 16.4%
Business fixed
1198.8 10.2%
Residential fixed
Inventory
The Data of Macroeconomics
673.8
5.7%
55.4
0.5%
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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.
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Stocks vs. Flows
Flow
Stock
More examples:
stock
flow
a person’s wealth
a person’s saving
# of people with
college degrees
# of new college
graduates
the govt. debt
the govt. budget deficit
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Government spending, 2004
$ billions
Gov spending
% of
GDP
2215.9
18.9%
827.6
7.1%
Defense
552.7
4.7%
Non-defense
274.9
2.3%
1388.3
11.8%
Federal
State & local
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Net exports (NX = EX - IM)
U.S. Net Exports, 1960-2004
100
0
-100
-200
-300
-400
-500
-600
-700
1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004
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An important identity
Y = C + I + G + NX
where:
Y = GDP = the value of total output
C + I + G + NX = aggregate expenditure
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Why does output =
expenditure?
• Unsold output goes into inventory,
and is counted as “inventory investment”…
…whether the inventory buildup was
intentional or not.
• In effect, we are assuming that
firms purchase their unsold output.
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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)
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(GNP – GDP) as a percentage of GDP
(selected countries, 1997)
U.S.A.
Bangladesh
Brazil
Canada
Chile
Ireland
Kuwait
Mexico
Saudi Arabia
Singapore
0.1%
3.3
-2.0
-3.2
-8.8
-16.2
20.8
-3.2
3.3
4.2
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Some Useful Identities
GDP = C + I + G + NX
GNP = GDP + Factor Paymen ts From Abroad – Facto r Paymen ts
to Abroad
NNP = GNP – Deprec iation
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Other Measures of Income
National In come = NNP – Ind irec t Busine ss Taxes
Personal In come = National Income
– Corpora te Profits
– Social In surance Cont ribu tions
– Net In tere st
+ Divid ends
+ Govt. Trans fers to Ind ividua ls
+ Personal In tere st
Dispos able Personal Income = Personal Income
Π Personal Tax and Non-t ax P aymen ts
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Components of National Income
2004
Net Interest
5%
Corporate Profits
13%
Rental Income
1%
Proprietors'
Income
9%
Compensation of
Employees
72%
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Percent of Personal Disposable Income
Personal Saving Rate
12
10
8
6
4
2
0
-2
1980
1983
1986
1989
1992
1995
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1998
2001
2004
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Consumer Price Index (CPI)
• A measure of the overall level of prices
• Published by the Bureau of Labor
Statistics (BLS)
• Used to
– track changes in the
typical household’s cost of living
– adjust many contracts for inflation
(i.e. “COLAs”)
– allow comparisons of dollar figures from
different years
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How the BLS constructs the CPI
Surveys consumers to determine composition
of the typical consumer’s “basket” of goods.
Every month, collect data on prices of all items
in the basket; compute cost of basket
CPI in any month equals the cost of this basket
divided by its cost in the “base” year multiplied
by 100.
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The Composition of the CPI’s “Basket”
Food and bev.
5.8%
17.6%
Housing
2.8%
Apparel
Transportation
5.9%
2.5%
4.5%
4.8%
Medical care
Recreation
16.2%
Education
Communication
40.0%
Other goods and
services
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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.
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The CPI’s bias
• The Boskin Panel’s “best estimate”:
The CPI overstates the true increase in the cost
of living by 1.1% per year.
• Result: the BLS has refined the way it calculates
the CPI to reduce the bias.
• It is now believed that the CPI’s bias is slightly
less than 1% per year.
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GDP Deflator (Price Index) versus CPI
• GDP Price Index measures prices of all goods and
services produced, CPI only measures prices of
goods and services bought by consumers.
• GDP Price Index includes only goods produced
domestically, CPI includes imports.
• Weighting used to compute indexes differs: GDP
Price Index uses changing weights, CPI uses fixed
weights.
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Alternative Inflation Measures
16
14
GDP Price Index
PCE Price Index
CPI
Percent Change
12
10
8
6
4
2
0
1980
1982
1984
1986
1988
1990
1992
1994
1996
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1998
2000
2002
2004
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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.
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Two important labor force concepts
• unemployment rate
percentage of the labor force that is
unemployed
• labor force participation rate
the fraction of the adult population
that ‘participates’ in the labor force
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Three Groups of the Population
Millions, 16 years & older
2004
Population = 223.4
76.0
Employment
Unemployment
Not in Labor Force
139.3
8.1
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Three Groups of the Population
(16 years and older)
2004
34%
Employment
Unemployment
Not in Labor Force
62%
4%
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Three Groups of the Population
16 years and older
2002
33%
Employment
Unemployment
Not in Labor Force
63%
4%
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Unemployment and Employment
(Millions, 2004)
8.1
Labor Force = 223.4
Employment
Unemployment
139.3
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Unemployment and Employment
(Percent of Labor Force, 2004)
5.5%
Employment
Unemployment
94.5%
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20
04
20
00
19
96
19
92
19
88
19
84
19
80
19
76
19
72
19
68
19
64
19
60
Percent of Labor Force
Unemployment Rate
12
10
8
6
4
2
0
48
Okun’s Law states
that a one-percent
decrease in
unemployment is
associated with two
percentage points
of additional growth
in real GDP
Okun’s Law
Percentage change
10
in real GDP
8
6
1951
1984
2000
4
1999
1993
2
1975
0
-2
-3
1982
-2
-1
0
1
2
3
4
Change in
unemployment rate
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