GDP, CPI and Unemployment

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GDP, CPI and Unemployment
Gross Domestic Product (GDP) is the market value
of all final goods and services produced within
an economy in a given period of time. The
consumer price index (CPI) measures the level of
prices. The unemployment rate tells us the
fraction of workers who are unemployed.
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For the economy as a whole, income must equal
expenditure. GDP measures the flow of dollars
in this economy.
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Rules for Computing GDP
1) To compute the total value of different goods
and services, the national income accounts use
market prices. Thus, if
GDP (Price of apples ? Quantity of apples)
(Price of oranges ? Quantity of oranges)
(0.50 ? 4) (1.00 ? 3) GDP 5.00
2) Used goods are not included in the calculation
of GDP. 3) The treatment of inventories depends
on if the goods are stored or if they spoil. If
the goods are stored, their value is included in
GDP. If they spoil, GDP remains unchanged. When
the goods are finally sold out of inventory, they
are considered used goods (and are not counted).
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More Rules for Computing GDP
4) Intermediate goods are not counted in GDP
only the value of final goods. Reason the value
of intermediate goods is already included in the
market price. Value added of a firm equals the
value of the firms output less the value of the
intermediate goods the firm purchases. 5) Some
goods are not sold in the marketplace and
therefore dont have market prices. We must use
their imputed value as an estimate of their
value. For example, home ownership and government
services.
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Real vs. Nominal GDP
The value of final goods and services measured at
current prices is called nominal GDP. It can
change over time either because there is a change
in the amount (real value) of goods and services
or a change in the prices of those goods and
services. Hence, nominal GDP Y P ? y, where P
is the price level and y is real output and
remember we use output and GDP interchangeably.
Real GDP or, y Y?P is the value of goods and
services measured using a constant set of prices.
This distinction between real and nominal can
also be applied to other monetary values, like
wages. Nominal (or money) wages can be denoted by
W and decomposed into a real value (w) and a
price variable (P). Hence, W nominal wage P
w w real wage w/P
This conversion from nominal to real units allows
us to eliminate the problems created by having a
measuring stick (dollar value) that essentially
changes length over time, as the price level
changes.
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For example, if we wanted to compare output in
2002 and output in 2003, we would obtain
base-year prices, such as 2002 prices. Real GDP
in 2002 would be (2002 Price of Apples ? 2002
Quantity of Apples) (2002 Price of Oranges ?
2002 Quantity of Oranges). Real GDP in 2003 would
be (2002 Price of Apples ? 2003 Quantity of
Apples) (2002 Price of Oranges ? 2003 Quantity
of Oranges). Real GDP in 2004 would be (2002
Price of Apples ? 2004 Quantity of Apples)
(2002 Price of Oranges ? 2004 Quantity of
Oranges).
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GDP Deflator
Nominal GDP measures the current dollar value of
the output of the economy. Real GDP measures
output valued at constant prices. The GDP
deflator, also called the implicit price deflator
for GDP, measures the price of output relative
to its price in the base year. It reflects whats
happening to the overall level of prices in the
economy.
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Chain-Weighted Measures of GDP
In some cases, it is misleading to use base year
prices that prevailed 10 or 20 years ago
(i.e. computers and college). In 1995,
the Bureau of Economic Analysis
decided to use chain-weighted measures of
real GDP. The base year changes continuously
over time. This new chain-weighted
measure is better than the more
traditional measure because it ensures
that prices will not be too out of date.
Average prices in 2001 and 2002 are used to
measure real growth from 2001 to 2002. Average
prices in 2002 and 2003 are used to measure real
growth from 2002 to 2003 and so on. These
growth rates are united to form a chain that
is used to compare output between any two dates.
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Components of Expenditure
Y C I G NX
This is the called the national income accounts
identity.
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Other Measures of Income
To see how the alternative measures of income
relate to one another, we start with GDP and add
or subtract various quantities. To obtain gross
national product (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
GDPFactor Payments from Abroad -Factor Payments
to Abroad Whereas GDP measures the total income
produced domestically, GNP measures the total
income earned by nationals (residents of a
nation). To obtain net national product (NNP),
we subtract the depreciation of capital-- the
amount of the economys stock of plants,
equipment, and residential structures that wears
out during the year NNP GNP - Depreciation
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Computing the CPI
The Consumer Price Index (CPI) turns the prices
of many goods and services into a single index
measuring the overall level of prices.
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CPI Versus the GDP Deflator
The GDP deflator measures the prices of all goods
produced, whereas the CPI measures prices of only
the goods and services bought by consumers. Thus,
an increase in the price of goods bought by firms
or the government will show up in the GDP
deflator but not in the CPI. Also, another
difference is that the GDP deflator includes only
those goods and services produced domestically.
Imported goods are not a part of GDP and
therefore dont show up in the GDP deflator. The
final difference is the way the two aggregate the
prices in the economy. The CPI assigns fixed
weights to the prices of different goods, whereas
the GDP deflator assigns changing weights.
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Measuring Unemployment
The labor force is defined as the sum of the
employed and unemployed, and the unemployment
rate is defined as the percentage of the labor
force that is unemployed. The labor force
participation rate is the percentage of the adult
population who are in the labor force.
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The negative relationship between unemployment
and GDP is called Okuns Law, after Arthur Okun,
the economist who first studied it. In short, it
is defined as Percentage Change in Real GDP
3 - 2 ? the Change in the Unemployment Rate If
the unemployment rate remains the same, real GDP
grows by about 3 percent. For every percentage
point the unemployment rate rises, real GDP
growth typically falls by 2 percent. Hence, if
the unemployment rate rises from 6 to 8 percent,
then real GDP growth would be Percentage Change
in Real GDP 3 - 2 ? (8 - 6) - 1
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Key Concepts of Ch. 2
National income accounts identity Consumption
Investment
Government Purchases Net Exports
Labor force
Labor-force participation rate
Okuns Law
Gross domestic product (GDP) Consumer Price
Index (CPI) Unemployment Rate
National income accounting Stocks and
flows Value added
Imputed value
Nominal versus real GDP
GDP deflator