SURVEY OF ECONOMIC ANALYSIS

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SURVEY OF ECONOMIC ANALYSIS

• LECTURE 14
• MACROECONOMIC MEASURES

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SURVEY OF ECONOMIC ANALYSIS

• LECTURE 14
• MACROECONOMIC MEASURES

MACROECONOMIC QUESTIONS
HOW DOES AN ECONOMY PROVIDE FOR CYCLICAL
STABILITY? HOW DOES AN ECONOMY PROVIDE FOR
ECONOMIC GROWTH?
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CIRCULAR FLOW OF ECONOMIC ACTIVITY
FIRMS
HOUSEHOLDS
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CIRCULAR FLOW OF ECONOMIC ACTIVITY
PAYMENTS FOR GOODS AND SERVICES
FIRMS
HOUSEHOLDS
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CIRCULAR FLOW OF ECONOMIC ACTIVITY
PAYMENTS FOR GOODS AND SERVICES FIRMS REVENUE
FIRMS
HOUSEHOLDS
WAGES, SALARIES,PROFITS, RENT FIRMS COSTS OR
FACTOR PAYMENTS
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CIRCULAR FLOW OF ECONOMIC ACTIVITY
PAYMENTS FOR GOODS AND SERVICES FIRMS REVENUE
FIRMS
HOUSEHOLDS
WAGES, SALARIES,PROFITS, RENT FIRMS COSTS OR
FACTOR PAYMENTS
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CIRCULAR FLOW OF ECONOMIC ACTIVITY
PAYMENTS FOR GOODS SERVICES FIRMS REVENUE
LABOR,CAPITAL,LAND ENTREPRENEURIALSHIP
FIRMS
HOUSEHOLDS
REAL GOODS SERVICES
WAGES , SALARIES,PROFITS, RENT FIRMS COSTS
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CIRCULAR FLOW OF ECONOMIC ACTIVITY
PAYMENTS FOR GOODS SERVICES FIRMS REVENUE
LABOR,CAPITAL,LAND ENTREPRENEURIALSHIP
FIRMS
HOUSEHOLDS
REAL GOODS SERVICES
WAGES, SALARIES,PROFITS, RENT FIRMS COSTS OR
FACTOR PAYMENTS
SUBSIDIES
SUBSIDIES
GOVT
TAXES
TAXES
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Aggregation in Economics

• In their principles of economics text, Baumol and
  Blinder make the following somewhat surprising
  statement.
• An economic aggregate is nothing but an
  abstraction that people use to describe some
  salient features of economic life.
• For example, while we observe the prices of
  gasoline, telephone calls and movie tickets
  everyday, we never actually see the price level
  

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• So the concept of the gross domestic product
  which we will discuss in greater detail shortly
  is really an abstraction used to represent the
  total production of a nation.
• Its as if we were discussing a product that
  represents the output of society. Equilibrium in
  the goods market determines the level of
  aggregate product and the price level.

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Aggregate Supply
Aggregate Demand
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Aggregate Supply
Aggregate Demand
Equilibrium GDP
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Aggregate Supply
ONE PRICE
Equilibrium Aggregate Price Level
ONE QUANTITY
Aggregate Demand
Equilibrium GDP
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ISSUES MACROECONOMIC GOALS AND MEASURES
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CYCLICAL STABILITY ISSUES
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ISSUE 1 UNEMPLOYMENT

Unemployment lines in the 1930s
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• ECONOMIC CONSEQUENCES LOSS OF POTENTIAL OUTPUT
• SOCIAL CONSEQUENCES (social stability)
• HUMAN TRAGEDY

PUBLIC GOODS
Dust bowl family
PRIVATE GOODS
Unemployed worker in 1930s
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• UNEMPLOYMENT
• ECONOMIC CONSEQUENCES
• SOCIAL CONSEQUENCES
• HUMAN TRAGEDY

PEOPLE WHO ARE WILLING AND ABLE TO WORK ARE NOT
BEING PRODUCTIVELY EMPLOYMENT
PUBLIC GOODS
PRIVATE GOODS
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THE UNEMPLOYMENT RATE

• THE RATIO OF THE NUMBER OF PERSONS SEEKING
  EMPLOYMENT (SOUGHT WORK IN THE FOUR WEEKS PRIOR
  TO THE BLS SURVEY) TO THE TOTAL LABOR FORCE.
• TOTAL LABOR FORCE EQUALS THE NO. OF PERSONS
  EMPLOYED PLUS THE NO. OF PERSONS UNEMPLOYMENT.
• DISCOURAGED WORKERS ARE NOT INCLUDED IN THE LABOR
  FORCE.

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UNEMPLOYMENT RATE
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OBSERVATIONS ABOUT THE UNEMPLOYMENT STATISTICS

• UNEMPLOYMENT IS PERSISTENT-- NEVER FALLING TO
  ZERO.
• THE LEVEL OF UNEMPLOYMENT FLUCTUATES
  DRAMATICALLY.
• THERE ARE MARKED DIFFERENCES IN THE UNEMPLOYMENT
  RATE AMONG DIFFERENT GROUPS OF PEOPLE AND
  DIFFERENT COUNTRIES. NOT PICTURED IN DIAGRAM.

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FORMS OF UNEMPLOYMENT

• SEASONAL UNEMPLOYMENT
• FRICTIONAL UNEMPLOYMENT
• STRUCTURAL UNEMPLOYMENT
• CYCLICAL UNEMPLOYMENT

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• Seasonal unemployment Unemployment due to the
  end of the agricultural season or holiday season.
• Frictional unemployment Unemployment
  attributable to changing jobs out of work moving
  between jobs.
• Structural unemployment Unemployment due to
  changes in technology or foreign trade
  agreements long-term shifts in the structure of
  the economy.
• Cyclical unemployment Unemployment due to
  deficiencies in aggregate demand.

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ISSUE 2 INFLATION
Continental Dollars
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• INFLATION IS A SUSTAINED INCREASE IN THE GENERAL
  LEVEL OF PRICES.
• INFLATION RATE IS THE RATE AT WHICH THE GENERAL
  LEVEL OF PRICES INCREASE.
• HYPERINFLATION IS A RATE OF INFLATION EXCEEDING
  50 PERCENT PER MONTH.

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MEASURING INFLATION

• THE PRICES OF DIFFERENT GOODS RISE AT DIFFERENT
  RATES DURING A GIVEN PERIOD SOME PRICES MAY
  EVEN FALL.
• TO DETERMINE THE CHANGE IN THE GENERAL LEVEL OF
  PRICES , ECONOMISTS CALCULATE A WEIGHTED AVERAGE
  PERCENTAGE INCREASE IN PRICES.
• THE PRICE INDEX MEASURES THE PRICE LEVEL IN ANY
  GIVEN YEAR RELATIVE TO A COMMON BASE YEAR.

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CONSUMER PRICE INDEX AN EXAMPLE

• THE CONSUMER PRICE INDEX TELLS US HOW MUCH MORE
  THE MARKET BASKET OF GOODS COSTS IN THIS
  (CURRENT) PERIOD IN COMPARISON TO A BASE PERIOD.

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EXAMPLE OF A PRICE INDEX
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CONSUMER PRICE INDEX AN EXAMPLE

• THE CONSUMER PRICE INDEX TELLS US HOW MUCH MORE
  THE MARKET BASKET OF GOODS COSTS IN THIS PERIOD
  IN COMPARISON TO A BASE PERIOD.

COST OF MARKET CONSUMER
PRICE BASKET
INDEX 1993 857
857/ 857 1.00
2001
1174 1174 / 857
1.3698
1.37
THE CPI ROSE 37 PERCENT BETWEEN 1993 AND
2001.
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CONSUMER PRICE INDEX AN EXAMPLE

• THE CONSUMER PRICE INDEX TELLS US HOW MUCH MORE
  THE MARKET BASKET OF GOODS COSTS IN THIS PERIOD
  IN COMPARISON TO A BASE PERIOD.

COST OF MARKET CONSUMER
PRICE BASKET
INDEX 1993 857
857/ 857 1.00
2001
1174 1174 / 857
1.3698
1.37
THE CPI ROSE 37 PERCENT BETWEEN 1983 AND
2001.
BASE YEAR
CURRENT YEAR
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• IF THE MARKET BASKET COST 412 IN 1983 , THEN WE
  COULD COMPARE 1983 WITH THE BASE YEAR 1993 .

COST OF MARKET CONSUMER
PRICE BASKET
INDEX 1993 857
857/ 857 1.00
1983
412 412 / 857
0.4807
.48
THE CPI WAS 52 PERCENT LOWER IN 1983 THAN IN
1993.
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• IF THE MARKET BASKET COST 412 IN 1983 , THEN WE
  COULD COMPARE 1983 WITH THE BASE YEAR 1993 .

COST OF MARKET CONSUMER
PRICE BASKET
INDEX 1993 857
857/ 857 1.00
1983
412 412 / 857
0.4807
.48
THE CPI WAS 52 PERCENT LOWER IN 1983 THAN IN
1993.
BASE YEAR
CURRENT YEAR
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STATISTICS ON THE RATE OF INFLATION
Disinflation
WWI
WWII
Deflation
Recession
Panic of 1907
Great Depression
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OBSERVATIONS ON THE INFLATION RATE

• PRICES WERE RELATIVELY STABLE FOR MUCH OF THE
  CENTURY i.e., WITH THE EXCEPTION OF THE PERIODS
  AROUND WWI , WWII , AND 1973-1981.
• WE HAVE EXPERIENCED PERIODS OF DEFLATION. THAT IS
  , THE GENERAL LEVEL OF PRICES CAN FALL
• RECESSION OR DEPRESSION PERIODS
• PERIODS OF DEBT DEFLATION
• THERE HAVE BEEN PERIODS OF RAPID PRICE INCREASES.

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WHY IS FIGHTING INFLATION SUCH A HIGH
MACROECONOMIC PRIORITY ?

• INFLATION CAN CAUSE PERVERSE REDISTRIBUTION OF
  INCOME.( NOTE THE RUSSIAN-MEXICAN EXPERIENCES)
• INFLATION INTERFERES WITH THE RELATIONSHIP
  BETWEEN DEBTORS AND CREDITORS .
• IN GENERAL, RAPID AND UNPREDICTABLE CHANGES IN
  THE VALUE OF MONEY DISTORT ECONOMIC DECISIONS.

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LONG-TERM ECONOMIC GROWTH ISSUE
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ISSUE 3 GROWTH

• IF AN ECONOMY IS TO COMPETE EFFECTIVELY AND GROW
  RAPIDLY , IT MUST USE ITS RESOURCES EFFICIENTLY
  AND IT MUST INVEST IN INCREASING ITS PRODUCTIVE
  POTENTIAL.

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ILLUSTRATION OF GROWING PRODUCTIVE CAPACITY
CAPITAL GOODS
3
2
1
SOCIAL CHOICES
CONSUMPTION GOODS
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ILLUSTRATION OF GROWING PRODUCTIVE CAPACITY
CAPITAL GOODS
SOCIAL CHOICES
1
CONSUMPTION GOODS
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ILLUSTRATION OF GROWING PRODUCTIVE CAPACITY
CAPITAL GOODS
2
SOCIAL CHOICES
1
CONSUMPTION GOODS
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ILLUSTRATION OF GROWING PRODUCTIVE CAPACITY
CAPITAL GOODS
3
2
SOCIAL CHOICES
1
CONSUMPTION GOODS
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How can we increase economic growth in the future?

• Economic growth is a function of the
  technological innovation and the amount and
  quality of labor and capital in the economy
• As more people are employed, the amount of
  capital increases, education levels increase, the
  quality of capital changes, or the technology
  increases, the productive capacity of the economy
  increases. Therefore, the economy can increase
  its output giving consumers more disposable
  income, promoting an increase in consumption
  spending, and providing resources for business to
  use for further investment and government to use
  to provide public goods and services.
• Increased labor force participation increases
  output. Expanded, improved education creates more
  productive workers. Business and government
  spending on research and development enhance our
  abilities to produce and allow each worker to
  become more productive, increasing incomes for
  all.
• Finally, to achieve a higher level of GDP in the
  future, consumers need to limit consumption
  spending and increase savings today, permitting
  businesses to invest more in capital goods. If
  resources are invested into building an economy
  now, future generations will enjoy a higher level
  of economic growth our businesses will produce
  more goods and consumers can purchase more goods.
  Expansion of output at rates faster than our
  population growth is what gives us the
  opportunity to enjoy higher standards of living.

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MEASURING AGGREGATE OUTPUT
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MEASURING OUTPUT

• GROSS DOMESTIC PRODUCT (GDP) IS THE SUM OF THE
  MONEY VALUE OF ALL FINAL GOODS AND SERVICES
  PRODUCED BY THE RESIDENTS OF A NATION DURING A
  SPECIFIED TIME PERIOD.
• GDP IGNORES INCOME RECEIVED FROM AND PAID TO
  FOREIGN INTEREST. THESE ITEMS ARE INCLUDED IN THE
  GNP.

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What is the Difference Between GNP and GDP ?

• GNP is the total output produced with capital,
  labor, and other inputs owned by U.S.residents.
• GDP is the output produced with capital, labor,
  and other inputs located inside the U.S.

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NOMINAL AND REAL GDP

• NOMINAL GDP UNADJUSTED, MONEY() GDP.
• REAL GDP THE MONEY VALUE OF ALL GOODS AND
  SERVICES PRODUCED BY THE ECONOMY DIVIDED BY A
  MEASURE OF THE PRICE LEVEL -- A PRICE INDEX

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• REAL GDP NOMINAL GDP / PRICE INDEX
• ( P Q) / P Q
• THE PRICE LEVEL MEASURE IN THIS CASE IS THE GDP
  DEFLATOR . THAT IS , WHAT IT COSTS TO PURCHASE
  THE TOTAL MIX OF GOODS AND SERVICES COMPOSING THE
  GDP TODAY AND WHAT IT COST IN THE BASE YEAR.

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STATISTICS ON THE GDP
Recession
Recession
Recession
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OBSERVATION ABOUT THE GDP

• POTENTIAL GDP WHAT THE ECONOMY COULD PRODUCE IF
  LABOR AND CAPITAL WERE USED TO THEIR FULL
  CAPACITY.
• OUTPUT DOES NOT GROW SMOOTHLY AND ACTUAL OUTPUT
  HAS FALLEN BELOW POTENTIAL OUTPUT AT TIMES. ( A
  RECESSION IS DATED BY A FALL IN GDP FOR AT LEAST
  TWO CONSECUTIVE QUARTERS.)
• RECESSION MEANS THAT AGGREGATE OUTPUT IS
  BELOW POTENTIAL.

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Recession Statistics
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Definition of GDP in More Detail

• Definition of Gross Domestic Product
• Gross Domestic Product (GDP) is one measure of
  economic activity, the total amount of goods and
  services produced in the United States in a year.
  It is calculated by adding together the market
  values of all of the final goods and services
  produced in a year.
• It is a gross measurement because it includes the
  total amount of goods and services produced, some
  of which are simply replacing goods that have
  depreciated or have worn out.
• It is domestic production because it only
  includes goods and services produced within the
  U.S.
• It measures current production because it only
  includes what was produced during the year.
• It is a measurement of the final goods produced
  because it does not include the value of a good
  when sold by a producer, again when sold by the
  distributor, and once more when sold by the
  retailer to the final customer. We only count the
  final sale.
• Changes in GDP from one year to the next reflect
  changes in the output of goods and services and
  changes in their prices. To gain a better
  understanding of what actually is occurring in
  the economy, real GDP is also calculated. In
  fact, these changes are more meaningful, as the
  changes in real GDP show what has actually
  happened to the quantities of goods and services,
  independent of changes in prices.

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Explanations of GDP and its Components

• GDP C I G NX where NX Exports (X)
  Imports(M)
• Consumption spending (C) consists of consumer
  spending on goods and services. It is often
  divided into spending on durable goods,
  non-durable goods and services. These purchases
  accounted for 68 percent of GDP in the third
  quarter of 2001.
• Durable goods are items such as cars, furniture,
  and appliances, which are used for several years.
  (10)
• Non-durable goods are items such as food,
  clothing, and disposable products, which are used
  for only a short time period. (20)
• Services include rent paid on apartments (or
  estimated values for owner occupied housing),
  airplane tickets, legal and medical advice or
  treatment, electricity and other utilities. (38)
  Services are the fastest growing part or
  consumption spending.

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• Investment spending (I) consists of
  nonresidential fixed investment, residential
  investment, and inventory changes. Investment
  spending accounts for 19 percent of GDP, but
  varies significantly from year to year.
• Nonresidential fixed investment is the creation
  of tools and equipment to use in the production
  of other goods and services. Examples are the
  building of factories, the production of new
  machines, and the manufacturing of computers for
  business use (15).
• Residential investment is the building of a new
  homes or apartments. (4)
• Inventory changes consist of changes in the level
  of stocks of goods necessary for production and
  finished goods ready to be sold. (Less than 1)

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• Government spending (G) consists of federal,
  state, and local government spending on goods and
  services such as research, roads, defense,
  schools, and police and fire departments. This
  spending does not include transfer payments such
  as Social Security, unemployment compensation,
  and welfare payments, which do not represent
  production of goods and services. (17)

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• Net Exports (NX) is equal to exports (X) minus
  imports (M). Exports are items produced in the US
  and purchased by foreigners . Imports are items
  produced by foreigners and purchased by US
  consumers. Currently, the US imports more than
  it exports so that net exports are negative,
  about -4 of the GDP.

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Revisions in GDP Announcements

• Real GDP for each quarter is announced three
  times. The month following the end of the quarter
  is described as the advance GDP the second
  announcement or revision is described as the
  preliminary announcement and the third month is
  the final. While labeled as the final version,
  even it will eventually be revised after the
  final data for a year are published. An example
  of previous revisions, the three announcements
  for the annual rates of change in 2000-01 are
  shown on the next slide.

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• Annual rates of change in Real GDP
• Advance
  Preliminary Final
• Second Quarter, 2000 5.2 5.3 5.6
• Third Quarter, 2000 2.7 2.4 2.2
• Fourth Quarter, 2000 1.4 1.1 1.0
• First Quarter, 2001 2.0 1.3

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• Revisions in inventory investment and the
  international trade data are often the cause of
  changes in the GDP figures. Because changes in
  inventories and international trade date make up
  significant portions of the current report, one
  should be particularly cautious in using the
  "advance" figures.

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Are estimates of GDP accurate measures of our
well-being?

• GDP fails to account for many forms of production
  that improve a person's well-being. For example,
  if you make a meal at home, the labor is not
  included. However, if you were to go out to a
  restaurant and consume that same meal, the labor
  is included in GDP. Unpaid work at home or for a
  friend and volunteer work is not included and
  thus GDP does not reflect production of all we
  produce.
• External effects of production, such as
  pollution, are not subtracted from the value of
  GDP. Although two countries may have similar GDP
  growth rates, one country may have significantly
  cleaner water and air, and therefore is truly
  better off than the other country. If as economic
  growth accelerates, producers begin to employ
  production techniques that create more pollution,
  the effects of the growth are overstated.
• GDP includes police protection, new prisons, and
  national defense as goods and services. It is not
  always clear that if we have to devote increased
  resources for such purposes that we are better
  off as a result.
• GDP includes the effects of price changes. An
  increase in GDP due solely to inflation does not
  signal an improvement in living standards. Real
  GDP is a better measure. Nor does GDP reflect
  population growth. Changes in the income
  distribution are not measured. It is also
  difficult to compare rates of growth for
  different countries, as countries use different
  means of estimating income and price levels in
  their economy.
• There are a variety of other weaknesses and
  inaccuracies, but GDP accounting is the best that
  we have. Real GDP does provide sound signals as
  to the direction of change of a selected large
  part of what we produce each year. Government
  statisticians and academics are constantly
  working to improve its accuracy and its ability
  to reflect our well-being.

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MEASURING THE AGGREGATE PRODUCT
From Stiglitz, Economics, pp. 660 - 666
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MEASURING GDP THE VALUE OF OUTPUT

• FINAL GOODS APPROACH
• VALUE -ADDED APPROACH
• INCOME APPROACH

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FINAL GOODS APPROACH

• FINAL GOODS ARE THOSE SOLD TO THE ULTIMATE
  CONSUMER . REMEMBER THE VALUE OF FINAL GOODS
  INCLUDE THE VALUE OF INTERMEDIATE GOODS .
• THE FINAL GOODS APPROACH TO GDP ADDS UP THE TOTAL
  DOLLAR VALUE OF GOODS AND SERVICES PRODUCED IN A
  GIVEN YEAR --CATEGORIZED BY THERE ULTIMATE USER .

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CATEGORIES OF FINAL GOODS WHERE FINAL GOODS GO

• CONSUMPTION
• INVESTMENT
• GOVERNMENT
• NET EXPORT

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NOTATION

• C AGGREGATE CONSUMPTION
• Cd DOMESTIC PRODUCTION OF
• CONSUMPTION GOODS
• Mc IMPORTS OF CONSUMPTION GOODS
• Xc EXPORTS OF CONSUMPTION GOODS
• ALLOCATION OF THE DOMESTIC PRODUCTION OF
  CONSUMPTION GOODS
• Cd Xc ( C - Mc ) C ( Xc - Mc )

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• I AGGREGATE INVESTMENT
• Id DOMESTIC PRODUCTION OF
• INVESTMENT GOODS
• MI IMPORTS OF INVESTMENT GOODS
• XI EXPORTS OF INVESTMENT GOODS

• ALLOCATION OF THE DOMESTIC PRODUCTION OF
  INVESTMENT GOODS

• Id XI ( I - MI ) I ( XI - MI )

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• G TOTAL GOVERNMENT
• EXPENDITURES
• Gd DOMESTIC PRODUCTION OF
• GOVERNMENT GOODS
• Mg IMPORTS FOR GOVERNMENT
• EXPENDITURES
• Xg EXPORTS OF GOVERNMENT GOODS

• ALLOCATION OF THE DOMESTIC PRODUCTION OF
  GOVERNMENT GOODS

• Gd Xg ( G - Mg ) G ( Xg- Mg)

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AGGREGATE OUTPUT GDP

• GDP Cd Id Gd
• ALSO , X Xc XI Xg
• M Mc MI Mg
• GDP Xc C - Mc XI I - MI Xg G - Mg

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AGGREGATE OUTPUT GDP

• GDP CDd Id Gd
• ALSO , X Xc XI Xg
• M Mc MI Mg
• GDP Xc C - Mc XI I - MI Xg G - Mg

Cd
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AGGREGATE OUTPUT GDP

• GDP CDd Id Gd
• ALSO , X Xc XI Xg
• M Mc MI Mg
• GDP Xc C - Mc XI I - MI Xg G - Mg

Id
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AGGREGATE OUTPUT GDP

• GDP CDd Id Gd
• ALSO , X Xc XI Xg
• M Mc MI Mg
• GDP Xc C - Mc XI I - MI Xg G - Mg

Gd
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AGGREGATE OUTPUT GDP

• GDP CDd Id Gd
• ALSO , X Xc XI Xg
• M Mc MI Mg
• GDP Xc C - Mc XI I - MI Xg G - Mg

GDP
Gd
Id
Cd



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• REARRANGE THE TERMS
• C I G ( Xc XI Xg ) - ( Mc MI Mg )

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• REARRANGE THE TERMS
• C I G ( Xc XI Xg ) - ( Mc MI Mg )

X
M
76

• REARRANGE THE TERMS
• C I G ( Xc XI Xg ) - ( Mc MI Mg )

X
M
GDP C I G ( X - M )
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• REARRANGE THE TERMS
• C I G ( Xc XI Xg ) - ( Mc MI Mg )

X
M
GDP C I G ( X - M )
OUTPUT
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• REARRANGE THE TERMS
• C I G ( Xc XI Xg ) - ( Mc MI Mg )

X
M
GDP C I G ( X - M )
OUTPUT
TOTAL SPENDING FOR FINAL GOODS
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VALUE-ADDED APPROACH

• THIS APPROACH STUDIES THE INTERMEDIATE GOODS
  DIRECTLYi.e., VALUE - ADDED AT EACH STAGE OF THE
  PRODUCTION PROCESS.
• VALUE - ADDED FIRMS REVENUE MINUS COST OF
  INTERMEDIATE GOODS.
• GDP SUM OF THE VALUE ADDED FOR
• ALL FIRMS IN THE ECONOMY

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INCOME APPROACH SUM OF THE FACTOR PAYMENT

• THIS APPROACH FOCUSES ON THE INCOME GENERATED BY
  SELLING THE FIRMS PRODUCTS.
• FIRM REVENUES WAGES INTEREST PAYMENTS COST
  OF INTERMEDIATE GOODS TAXES PROFITS
• REVENUES MINUS COST OF INTERMEDIATE GOODS
  VALUE-ADDED

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• GDP SUM OF THE VALUE-ADDED
• WAGES INTEREST PAYMENTS
• TAXES PROFITS