Chapter 2 Measuring Output and The Price Level

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Chapter 2 -- Measuring Output and The Price Level

• Data complied at the National Income and Product
  Accounts (NIPA)

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Measuring Output -- Gross Domestic Product (GDP)

• Gross Domestic Product -- The total market value
  of all currently produced final goods and
  services over a period of time.
• Nominal GDP -- GDP in current dollars
• Real GDP -- GDP in constant dollars.

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Aspects of GDP Definition

• Over a Period of Time ? GDP is a flow
  measure.
• Currently Produced ? GDP excludes
  the following
• -- sales of used items
• -- transfer payments
• -- purchases of stocks, bonds,
• or land

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• Market Value -- the transaction must be
  recorded and have a specific dollar figure
  attached ? GDP excludes
• -- illegal purchases
• -- household production

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Final Goods and Services and Measuring GDP

• Example -- Production of a pair of shoes.

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GDP and Making Shoes

• Step Value Value Added
• Farmer 3 3
• Packing Plant 7 4
• Tannery 13 6
• Shoe
• Manufacturer 25 12
• Wholesaler 40 15
• Retailer 75 35
• Total 163 75

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What Real GDP (Y) Signifies

• Total Production or Output of final goods and
  services
• Total Sales on Final Goods and Services
  (Approximately)
• Total Income
• Correlated With Total Employment

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Computing GDP -- The Expenditure Approach

• Operative Equation
• Y C I G NX

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Consumption (C)

• Defined as consumer purchases of final goods and
  services
• components of consumption
• -- nondurable goods
• -- durable goods
• -- services
• largest component of GDP

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Investment (I)

• Business Purchases of New Plant and Equipment
• New Residential Housing
• Changes In Inventories

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Output Versus Sales -- The Approximation

• Example -- 18,000 car, produced in 2000, sold in
  2001
• Year ?C ?I ?G ?NX ?Y
• 2000 0 18 0 0 18
• 2001 18 -18 0 0 0

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Investment Goods Versus Intermediate Goods

• The Similarity -- Transactions between
  businesses.
• The Conceptual Difference -- Producing Final
  Goods Versus Being Part of a Final Good
• The Operational Difference -- Is it used repeated
  times?

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Government Purchases of Goods and Services (G)

• Not the same as government expenditure (does not
  include transfer payments)
• In the US, the government is a purchaser, not a
  producer.

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Net Exports (NX)

• NX Exports - Imports
• exports are all final goods and services
• GNP versus GDP -- the accounting of multinational
  firms

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Real GDP and Quality of Life

• Real GDP does not account for the following
  changes
• -- leisure time
• -- quality differences
• -- crime
• -- environmental impacts

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More Quality of Life Variables Not in Real GDP

• -- nonmarket production activities
• (I) household production
• (II) underground economy
• -- income distribution

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Other Measures of Output or
Income

• Gross Domestic Product (GDP)
• -- Depreciation
• Net Domestic Product (NDP)
• -- Indirect Business Taxes
• National Income (NI)

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• National Income
• -- Undistributed Corporate Profits
• (Business Saving)
• -- Social Security Taxes
• Transfer Payments and Net
• Interest Income
• Personal Income (PI)
• -- Personal Income Taxes
• Disposable Income (YD)

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Disposable Income and Personal Saving

• Define -- Personal Saving (SP)
• SP YD - C
• Define -- Total Private Saving (S), S
  Personal Saving
• Business Saving

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A Macro Identity

• Let T Net Taxes
• Net Taxes Tax Revenues - (Transfer Payments
  Interest on the Government Debt)
• Then the identity is
• S I (G - T) NX.

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Interpreting the Identity Saving Investment

• Identity S I (G-T) NX
• Rearrange Identity Into
• ? S (T - G) -NX I
• Special Case (T - G) 0, NX 0
• ? S I

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Measuring The Price Level

• Measures of the Price Level (P)
• -- Consumer Price Index (CPI)
• -- Producer Price Index (PPI)
• -- GDP Deflator
• -- Personal Consumption
• Expenditure (PCE) Deflator

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Common Features Price Level Measures

• They are indexes -- compares current prices with
  those of a given base year.
• They consist of a ratio of weighted expenditure
  of prices of selected goods and services (market
  basket) in current year to a weighted average of
  prices in the base year.

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• Weights are based upon quantities of goods and
  services in the market basket.
• Inflation Rate Percentage Change in the Index.
• Example Inflation Rate for 2007
• Inflation Rate2007 P2007 P2006
• 
  P2006

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Distinctions in Price Level
Measures

• Whats in the market basket?
• Method of computation -- fixed weight index
  versus chain weight index.

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Measure 1 -- The Consumer Price
Index (CPI)

• Market Basket Set of goods and services
  purchases by consumers (including used items).
• Fixed Weight Index

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Computing a CPI

• Example -- Compute the CPI for 2007 with 1992 as
  the base year.
• CPI2007
• (Cost of 1992 Market Basket
• Purchased in 2007)
• (Cost of Actual Consumer
• Purchases in 1992)

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Biases in CPI (as a Fixed
Weight Index)

• Goods leaving and entering the market basket --
  base year versus year in question.
• Quality Bias
• Outlet Bias
• Substitution Bias -- changing quantities due to
  demand response.

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Implications -- CPI Bias

• CPI inflation overstates true inflation rate.
• By how much?

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Measure 2 -- The Producer Price Index (PPI)

• Market Basket -- producer materials
• Fixed Weight Index -- same computation method as
  CPI.
• Indicator of future inflation?

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Measure 3 -- The GDP Deflator

• Market Basket -- set of final goods and services
  that are used to compute GDP.
• Chain Weighted Measure -- reduces biases
  associated with fixed weight index.

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Measure 4 The PCE Deflator

• Market Basket -- set of final goods and services
  that are used to compute Consumption within GDP.
• Chain Weighted Measure -- reduces biases
  associated with fixed weight index.

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Converting Nominal GDP to Real
GDP

• Example -- find Real GDP 2007
• Real GDP2007 Nominal GDP2007
• GDP
  Deflator2007
• Real GDP for other years is computed the same
  way.
• Real GDP Growth Percentage Change in Real GDP.

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Sources to Obtain Macroeconomic Data

• The Economic Report of the
• President (Historical Data)
• www.gpoaccess.gov/eop/index.html
• Economic Indicators (Recent)
• www.gpoaccess.gov/indicators/ index.html

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More Websites for Macro Data and
Information

• www.federalreserve.gov (Federal
  Reserve)
• research.stlouisfed.org/fred2/ (Federal
  Reserve Economic Data)
• www.bea.gov
  (Bureau of Economic Analysis)
• www.bls.gov
  (inflation, unemployment,
• labor productivity)