chapter:
23
>> Tracking the
Macroeconomy
Krugman/Wells
©2009  Worth Publishers
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WHAT YOU WILL LEARN IN THIS CHAPTER
 How economists use aggregate measures to track
the performance of the economy.
 What gross domestic product , or GDP, is and
the three ways of calculating it.
 The difference between real GDP and nominal
GDP and why real GDP is the appropriate measure
of real economic activity.
 What a price index is and how it is used to
calculate the inflation rate.
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The National Accounts


Almost all countries calculate a set of numbers
known as the national income and product
accounts.
The national income and product accounts, or
national accounts, keep track of the flows of money
between different parts of the economy.
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The National Accounts





Households earn income via the factor markets
from wages, interest on bonds, dividends on
stocks, and rent on land.
A stock is a share in the ownership of a company
held by a shareholder.
A bond is borrowing in the form of an IOU that
pays interest.
In addition, households receive government
transfers from the government.
Disposable income, total household income minus
taxes, is available to spend on consumption or to
save.
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The National Accounts


Private savings, equal to disposable income
minus consumer spending, is disposable income
that is not spent on consumption.
The banking, stock, and bond markets, which
channel private savings and foreign lending into
investment spending, government borrowing, and
foreign borrowing, are known as the financial
markets.
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The National Accounts


Government purchases of goods and services
(G) is paid for by tax receipts as well as by
government borrowing.
Exports (X) generate an inflow of funds into the
country from the rest of the world, while imports
(IM) lead to an outflow of funds to the rest of the
world.
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The National Accounts




Inventories are stocks of goods and raw materials
held to facilitate business operations.
Investment spending is spending on productive
physical capital, such as machinery and
construction of structures, and on changes to
inventories.
Final goods and services are goods and services
sold to the final, or end, user.
Intermediate goods and services are goods and
services—bought from one firm by another firm—
that are inputs for production of final goods and
services.
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Aggregate Spending


Aggregate spending, the sum of consumer
spending, investment spending government
purchases of goods an services, and exports minus
imports, the total spending on domestically produce
final goods and services in the economy.
CIG(X-M) or CIGX Where X = Net Exports
(Exports-Imports)
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Gross Domestic Product

Gross domestic product or GDP measures the
total value of all final goods and services produced
in the economy during a given year.

total value : In current year prices.
final goods and services: Intermediate goods do not
count .
in the economy: Within the physical boundaries of a
nation.
given year: Only G&S produced in that year count.



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PITFALLS
GDP: What’s In and What’s Out
Included
 domestically produced final goods and services (including
capital goods)
 new construction of structures
 changes to inventories
Not Included
 intermediate goods and services
 inputs
 used goods
 financial assets like stocks and bonds
 foreign-produced goods and services
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GDP…
“… does not allow for the health of
our children, the quality of their
education, or the joy of their play. It
does not include the beauty of our
poetry or the strength of our
marriages, the intelligence of our
public debate or the integrity of our
public officials. It measures neither
our courage, nor our wisdom, nor our
devotion to our country. It measures
everything, in short, except that which
makes life worthwhile, and it can tell
us everything about America except
why we are proud that we are
Americans.”
- Senator Robert Kennedy, 1968
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Calculating Gross Domestic Product

GDP can be calculated three ways:

Add up the value added of all producers

Add up all spending on domestically-produced
final goods and services. This results in the
equation: GDP = C + I + G + (X – IM)

Add up all income paid to factors of production
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Calculating Gross Domestic Product
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Calculating Gross Domestic Product
$15,000
Components of GDP (billions of
dollars)
Value added by government
= 11.5%
Value added by households
= 11.5%
10,000
5,000
Value added by business
= 77.1%
Government purchases of goods
and services
= 19.4%
Investment spending
= 15.4%
C+I+G
= $14,515
Consumer spending
= 70.3%
0
Value added by sector
Net exports X – IM = –$708 (–
5.1%)
-5,000
Spending on domestically
produced final goods and
services
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Real vs. Nominal GDP

There are two possible reasons for total spending
to rise from one year to the next:


The economy may be producing a larger output of goods
and services.
Goods and services could be selling at higher prices.
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Real vs. Nominal GDP

Nominal GDP is the value of all final goods and
services produced in the economy during a given
year, calculated using the prices current in the year
in which the output is produced.

Real GDP is the total value of the final goods and
services produced in the economy during a given
year, calculated using the prices of a selected base
year.

B/c prices are constant, real GDP reflects the change in
goods and services produced. It is the best measure of
aggregate production.
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Real vs. Nominal GDP


Except in the base year, real GDP is not the same
as nominal GDP, output valued at current prices.
GDP per capita is a measure of average GDP per
person, but is not by itself an appropriate policy
goal.
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Real vs. Nominal GDP
DO IT! Calculating Nominal GDP and Real GDP
Year 1
Year 2
Quantity of apples (billions)
2,000
2,200
Price of apple
$0.25
$0.30
Quantity of oranges (billions)
1,000
1,200
Price of orange
$0.50
$0.70
Nominal GDP (billions of dollars)
Real GDP (billions of year 1 dollars)
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The GDP Deflator


The GDP deflator is a measure of the overall
level of prices.
Definition:
nominal GDP
GDP deflator = 100 x
real GDP
One way to measure the economy’s inflation rate is to
compute the percentage increase in the GDP deflator from
one year to the next. We will do this in Chapter
24…Something to look forward to!!!!
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EXAMPLE:
year
Nominal
GDP
Real
GDP
GDP
Deflator
2002
$6000
$6000
2003
$8250
$7200
100.0
114.6
2004
$10,800
$8400
128.6
14.6%
12.2%
Compute the GDP deflator in each year:
2002: 100 x (6000/6000) =
100.0
2003: 100 x (8250/7200) =
114.6
2004: 100 x (10,800/8400) =
128.6
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Consumer Price Index

Consumer price index (CPI) – a measure of the overall
cost of the goods and services bought by a typical
consumer.

How the CPI is Calculated:
•
•
•
•
Fix the number of goods in the basket.
Find their prices.
Compute the baskets cost.
Choose a base year and compute the index.
æ
ö
ç cost of basket in current year ÷
CPI = ç
*100
÷
ç cost of basket in base year ÷
è
ø
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Inflation Rate, CPI, and other Indexes


The inflation rate is the yearly percentage change
in a price index, typically based upon Consumer
Price Index, or CPI, the most common measure of
the aggregate price level.
The consumer price index, or CPI, measures the
cost of the market basket of a typical urban
American family.
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

CPI - Fix the basket: 3 footballs and 4 basketballs
Find the Price:
YEAR
1
1 Football ($)
$10
1 Bball ($)
$12
2
3
$12
$14
$15
$18

Cost of Basket:

Compute Index (year 1 is base)

Compute Inflation Rate:
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YEAR
1
2
3
Price
Football
$10
$12
$14
Quantity
Footballs
120
200
180
Price
Bball
$12
$15
$18
Quantity
Bballs
200
300
275
GDP DEFLATOR  Calculate Nominal GDP’s

Calculate Real GDP’s (Year 1 is Base)

Calculate GDP Deflator
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The GDP Deflator vs. the CPI


GDP deflator reflects the price of all goods
produced domestically, while CPI reflects the
price of all goods bought by consumers.
Since GDP takes all domestic goods and
services into account, it automatically takes
changes in these goods and services into
account. CPI must do so manually by
adjusting the basket (300 employees doing
this)
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Consumer Price Index
Motor fuel
7%
Apparel
4%
Transportation
13%
Medical care
5%
Housing
40%
Recreation
5%
Education and
communication Other goods
6%
and services
4%
Food and
beverages
16%
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Other Price Measures



A similar index to CPI for goods purchased by firms
is the producer price index.
Economists also use the GDP deflator, which
measures the price level by calculating the ratio of
nominal to real GDP.
The GDP deflator for a given year is 100 times the
ratio of nominal GDP to real GDP in that year.
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The CPI, the PPI, and the GDP Deflator
Percent change in
CPI, PPI, GDP
deflator
25%
20
15
10
5
0
-5
-10
-15
-20
1930
2007
1940
1950
1960
1970
1980
1990
2000
Year
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The End of Chapter 23
coming attraction:
Chapter 24:
Unemployment and Inflation
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