The Data of Macroeconomics

1
The Data of Macroeconomics

• Chapter Two

2
Introduction

• This chapter focuses on the measurement of three
  statistics that economists and policymakers use
  to make policy decisions
• Gross Domestic Product (GDP) tells us the
  nations total income and the total expenditure
  of its output of goods and services
• Consumer Price Index (CPI) measures the overall
  level of prices
• Unemployment Rate tells us the fraction of
  workers who are unemployed
• These statistics are by far three of the most
  important economic statistics
• Policymakers and businesspersons use them to
  monitor the economy and formulate appropriate
  policies
• Economists use them to develop and test theories
  about how the economy works

3
Measuring the Value of Economic Activity Gross
Domestic Product

• GDP is often used as a measure of how well the
  economy is performing if GDP growth is high then
  the economy is healthy, if GDP growth is low then
  the economy is stagnating.
• The goal of GDP is to summarize in a single
  number the dollar value of economic activity in a
  given period of time.
• There are two ways to define GDP
• Total income earned by domestically-located
  factors of production (owners of labor and
  capital)
• Total expenditure on domestically-produced final
  goods and services
• How can GDP measure both the economys income and
  the expenditure on its output?
• The reason is that these two quantities are
  actually the same for the economy as a whole,
  income must equal expenditure.

4
Why expenditure income?
In every transaction, the buyers expenditure
becomes the sellers income. Thus, the sum of all
expenditure equals the sum of all income.
When Dagny buys steel from Hank for 100,000,
that 100,000 is income for Hank and expenditure
by Dagny. The transaction contributes 100,000
to GDP, regardless of whether we are adding up
all income or adding up all expenditure.
5
Income, Expenditure, and the Circular Flow

• Economy produces 1 good, bread, from 1 input,
  labor
• What does the inner loop represent?
• What does the outer loop represent?
• GDP measures the flow of dollars in this economy
  and can be computed 2 ways GDP is the total
  income from the production of bread wages
  profit top half of the circular flow GDP is
  the total expenditure on purchases of bread
  bottom half of the circular flow chart

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Rules for Computing GDP

• Unlike our single good economy (bread), computing
  GDP in a complex economy is more complicated
• Gross Domestic Product is the market value of all
  final goods and services produced within an
  economy in a given period of time.

Suppose economy produces 4 apples and 3
oranges 1 apple costs 0.50 1 orange costs
1.00 GDP (Price of Apples ? Quantity of
Apples) (Price of Oranges ?
Quantity of Oranges) (0.50 ? 4)
(1.00 ? 3) 5.00
How do we compute the total value of numerous
different goods and services? We use actual
market prices because they reflect how much
people are willing to pay for a good or a service.
7
What about used goods and inventories?

• Suppose that you purchase a 500,000 Van Gogh at
  an art auction Does the 500,000 contribute to
  our GDP? Why or why not?
• The sale of the painting reflects the transfer of
  an asset from one person to another, it does not
  reflect an addition to the economys income or
  output.
• The sale of used goods is not included as part of
  GDP
• Suppose that John Deer hires workers to build 1
  more tractor, pays their wages, and then fails to
  sell the additional tractor how is GDP affected?
• Suppose tractor breaks down before being sold
  what happens to wages? What happens to the
  firms profit? What happens to total expenditure
  in the economy? So what happens to GDP?
• Suppose instead John Deer puts the tractor into
  inventory what happens to wages? What happens
  to the firms profit? What happens to total
  expenditure? So what happens to GDP?
• What happens later when John Deer sells the
  tractor out of inventory?

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Intermediate Goods and Value Added

• Suppose Hank purchases 25,000 worth of iron ore
  from Ken, uses the ore to make steel and then
  sells the steel to Wyatt for 100,000 should GDP
  include both the ore and the steel (a total of
  125,000) or just the steel (100,000)?
• Remember GDP includes only the value of final
  goods why would we not want to include the value
  of intermediate goods (iron ore)?
• This suggests an alternative way to compute GDP
• A firms value added is the value of its output
  minus the value of the intermediate goods the
  firm used to produce that output.
• To compute GDP simply sum the value added at each
  stage of production
• In our case, what is Kens value added (assuming
  he used no other inputs)? What is Hanks value
  added? What is the total value added?
• The sum of all value added must equal the value
  of all final goods and services

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Exercise (Problem 2, p.40)

• A farmer grows a bushel of wheat and sells it to
  a miller for 1.00.
• The miller turns the wheat into flour and sells
  it to a baker for 3.00.
• The baker uses the flour to make a loaf of bread
  and sells it to an engineer for 6.00.
• The engineer eats the bread.
• Compute
• value added at each stage of production
• GDP

10
The Components of Expenditure

• GDP is important but so is the allocation of this
  output among alternative uses
• GDP is divided into 4 broad categories
• Consumption (C)
• Investment (I)
• Government Purchases (G)
• Net Exports (NX)

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Consumption (C)
def the value of all goods and services bought
by households. Includes

• durable goods last a long time ex cars, home
  appliances
• non-durable goodslast a short time ex food,
  clothing
• serviceswork done for consumers ex dry
  cleaning, air travel.

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U.S. Consumption, 2005
13
Investment (I)

• def1 spending on (the factor of production)
  capital.
• def2 spending on goods bought for future use.
• Includes
• business fixed investmentspending on plant and
  equipment that firms will use to produce other
  goods services
• residential fixed investmentspending on housing
  units by consumers and landlords
• inventory investmentthe change in the value of
  all firms inventories

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U.S. Investment, 2005
15
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.
• Example (assumes no depreciation)
• 1/1/2002 economy has 500b worth of capital
• during 2002investment 37b
• 1/1/2003 economy will have 537b worth of
  capital

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Stocks vs. Flows
More examples
stock flow a persons wealth a persons
saving of people with of new
college college degrees graduates the govt.
debt the govt. budget deficit
17
Government Purchases (G)

• G includes all government spending on goods and
  services.
• G excludes transfer payments (e.g. unemployment
  insurance payments), because they do not
  represent spending on goods and services.

18
Net exports (NX EX - IM)
def the value of total exports (EX) minus the
value of total imports (IM)
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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
An identity is an equation that always holds
because of the way the variables are defined.
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Other Measures of Income GDP vs. GNP

• Gross National Product (GNP) is the total income
  earned by the nations factors of production
  regardless of what country those factors of
  production reside.
• Gross Domestic Product (GDP) is the total income
  earned domestically-located factors of production
  regardless of nationality.
• To obtain GNP we add receipts of factor income
  (wages, profit, and rent) from the rest of the
  world and subtract payments of factor income to
  the rest of the world
• GNP GDP Factor Payments from Abroad Factor
  Payments to Abroad

Example Lance Armstrong owns a bicycle shop in
Paris. The income he earns is part of the GDP of
France because it is earned in France but because
this income is a factor payment to a U.S.
national, it is not part of French GNP.
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(GNP GDP) as a percentage of GDP for selected
countries, 1997.
22
Real GDP vs. Nominal GDP

• Is GDP always a good measure of economic
  well-being?
• Consider again the apples/oranges economy
• GDP (Price of Apples ? Quantity of Apples)
  (Price of Oranges ? Quantity of Oranges)

• What are the 2 ways that GDP can change?
• If all prices doubled without any change in
  quantities, what would happen to GDP? Does this
  accurately reflect how much output is being
  produced?
• Nominal GDP the total value of goods and
  services measured at current prices
• A superior measure of economic health would tally
  the economys output of goods and services and
  would not be influenced by changes in prices.
• Real GDP the total value of goods and services
  measured using a constant set of prices
• Changes in real GDP can only be due to changes in
  quantities, because real GDP is constructed using
  constant base-year prices.

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Practice problem, part 1

• Compute nominal GDP in each year
• Compute real GDP in each year using 2001 as the
  base year.

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Answers to practice problem, part 1

• Nominal GDP multiply Ps Qs from same
  year2001 46,200 30 ? 900 100 ? 192
  2002 2003
• Real GDP multiply each years Qs by 2001
  Ps2001 2002 2003

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U.S. Real Nominal GDP, 1967-2001
26
The GDP Deflator

• The GDP Deflator, or the implicit price deflator,
  is defined as the ratio of nominal GDP to real
  GDP

• The GDP Deflator indicates whats happening to
  the overall level of prices.
• Consider again the 1 good (bread) economy GDP
  Deflator ?
• GDP Deflator 100 ? (P ? Q)/(Pbase ? Q) 100 ?
  (P/Pbase)
• Writing it in this way we see that the GDP
  deflator is simply the ratio of current to base
  year prices
• What does it mean if the GDP deflator is gt 100?
  lt 100?

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Practice problem, part 2

• Use your previous answers to compute the GDP
  deflator in each year.
• Use GDP deflator to compute the inflation rate
  from 2001 to 2002, and from 2002 to 2003.

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Understanding the GDP deflator
Example with 3 goods For good i 1, 2, 3 Pit
the market price of good i in year t Qit the
quantity of good i produced in year t NGDPt
Nominal GDP in year t RGDPt Real GDP in year
t
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Understanding the GDP deflator
The GDP deflator is a weighted average of prices.
The weight on each price reflects that goods
relative importance in GDP. Note that the
weights change over time.
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Consumer Price Index (CPI)

• Just as GDP turns the quantities of many goods
  into a single number measuring the value of
  production, the CPI turns the prices of many
  goods into a single index measuring the overall
  level of prices.
• The CPI is computed every month by the Bureau of
  Labor Statistics
• The BLS constructs the CPI in the following way
• Survey consumers to determine composition of the
  typical consumers basket of goods
• Every month, collect data on prices of all items
  in the basket compute cost of basket
• CPI in any month equals

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Exercise Compute the CPI
The basket contains 20 pizzas and 10 compact
discs.

• For each year, compute
• the cost of the basket
• the CPI (use 2000 as the base year)
• the inflation rate from the preceding year

prices pizza CDs 2000 10 15 2001 11 15 2002
12 16 2003 13 15
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answers
cost of inflation basket CPI
rate 2000 n.a. 2001 2002 2003
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The composition of the CPIs basket
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Understanding the CPI
Example with 3 goods For good i 1, 2, 3 Ci
the amount of good i in the CPIs basket Pit
the price of good i in month t Et the cost of
the CPI basket in month t Eb cost of the
basket in the base period
The CPI is a weighted average of prices. The
weight on each price reflects that goods
relative importance in the CPIs basket. Note
that the weights remain fixed over time.
35
CPI vs. GDP deflator

• There are 3 key differences between the CPI and
  the GDP deflator as measures of whats happening
  to the overall level of prices
• GDP deflator measures the prices of all goods
  produced, whereas the CPI measures the prices of
  only the goods bought by consumers.
• Do the prices of capital goods and government
  goods show up in both?
• GDP deflator includes only goods produced
  domestically imported goods are not included.
• An increase in the price of a Nintendo system
  affects which one?
• The CPI assigns fixed weights to the prices of
  different goods, whereas the GDP deflator assigns
  changing weights. The CPI is computed using a
  fixed basket of goods, whereas the GDP deflator
  allows the basket of goods to change over time as
  the composition of GDP changes.
• A drought causes the wheat crop to fail resulting
  in skyrocketing prices for bread. Are both price
  indices greatly affected? Why or why not?

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Two measures of inflation
37
Measuring Joblessness The Unemployment Rate

• The unemployment rate is the statistic that
  measures the percentage of those people wanting
  to work who do not have jobs.
• To compute the official unemployment rate, the
  BLS places survey responders into 1 of 3
  categories
• Employed the person spent some (part-time
  included) of the previous week working at a paid
  job
• Unemployed the person is not employed and has
  been actively seeking a job or is on temporary
  layoff
• Not in labor force a person who fits neither of
  the first 2 categories full-time student,
  retiree, discouraged worker
• The labor force is the sum of the employed and
  unemployed persons
• Labor Force of people employed of people
  unemployed
• The unemployment rate is the percentage of the
  labor force that is unemployed
• Unemployment Rate ( of unemployed)/(labor
  force) ? 100
• The labor-force participation rate is the
  percentage of the adult population that is in the
  labor force
• Labor-Force Participation Rate (Labor
  Force)/(Adult Population) ? 100

38
Exercise Compute labor force statistics
U.S. adult population by group, April
2002 Number employed 134.0 million Number
unemployed 8.6 million Adult population
213.5 million

• Use the above data to calculate
• the labor force
• the number of people not in the labor force
• the labor force participation rate
• the unemployment rate

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Answers

• data E 134 , U 8.6, POP 213.5
• labor force L E U __________
• not in labor force NILF POP L __________
• unemployment rate (U/L) ? 100 __________
• labor force participation rate (L/POP) ? 100
  __________

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Chapter Summary

• Gross Domestic Product (GDP) measures both total
  income and total expenditure on the economys
  output of goods services.
• Nominal GDP values output at current prices real
  GDP values output at constant prices. Changes in
  output affect both measures, but changes in
  prices only affect nominal GDP.
• GDP is the sum of consumption, investment,
  government purchases, and net exports.
• The overall level of prices can be measured by
  either
• the Consumer Price Index (CPI), the price of a
  fixed basket of goods purchased by the typical
  consumer
• the GDP deflator, the ratio of nominal to real
  GDP
• The unemployment rate is the fraction of the
  labor force that is not employed.