Current GDP, Real GDP and The Implicit GDP Deflator Index Lecture 9 Dr. Jennifer P. Wissink ©2018 Jennifer P. Wissink, all rights reserved. September 20, 2018 1

Announcements-MACRO Fall 2018 Hand Written Problem Set (HWPS) #1 was handed out at last lecture. Copies are in the back of auditorium or via our pset web page. HWPS #1 is due in lecture on Thursday September 27. Absolutely NO extensions will be given. You are free to turn your paper in early or have a friend turn it in for you in lecture. No electronic versions will be accepted. You must do the problem set with paper and pencil/pen/marker. An answer key will be posted on Friday September 28. We will loosely grade your HWPS if you turn it in. Each HWPS will contribute to your Pay-It-Forward Extra Credit at the end of the semester. See: https://courses.cit.cornell.edu/econ1120jpw/syllabus.htm to remind yourself of the grading rubric for the class and how everything works. Cornell Economics Society INFO SESSION GO! Good group!! MEL Quiz #4 due tonight! Get it done. Start MEL Quiz #5, it’s long! Quiz #5 is last quiz for stuff for prelim 1. Quiz #5 is all macro stuff!

Coal Mine Car Plant Car Dealer Steel Mill Iron Works Key $ amount for upstream inputs Key wages: 20 rents: 10 interest: 30 profits: 10 $ amount of value added Car Plant Steel Mill Car Dealer wages: 18 rents: 2 interest: 0 profits: 0 wages: 10 rents: 0 interest: 0 profits: 20 wages: 50 rents: 0 interest: 0 profits: -20 wages: 90 rents: 100 interest: 0 profits: 0 Iron Works

Billions of Dollars ($) TABLE 6.2 Components of U.S. GDP, 2014: The Expenditure Approach, GDP = C + I + G + (EX – IM) Billions of Dollars ($) Percentage of GDP (%) Personal consumption expenditures (C) 11,930.3 68.5 Durable goods 1,302.5 7.5 Nondurable goods 2,666.2 15.3 Services 7,961.7 45.7 Gross private domestic investment (l) 2,851.6 16.4 Nonresidential 2,210.5 12.7 Residential 559.1 3.2 Change in business inventories 82.0 0.5 Government consumption & gross investment (G) 3,175.2 18.2 Federal 1,219.2 7.0 State and local 1,956.1 11.2 Net exports (EX – IM) −538.2 −3.1 Exports (EX) 2,337.0 13.4 Imports (IM) 2,875.2 16.5 Gross domestic product 17,418.9 100.0 Source: U.S. Bureau of Economic Analysis, March 27, 2015.

The Expenditure Approach to GDP Personal consumption expenditures (C) are expenditures by consumers on the following: Durable goods: Goods that last a relatively long time, such as cars and appliances. Nondurable goods: Goods that are used up fairly quickly, such as food and clothing. Services: Things that do not involve the production of physical things, such as legal services, medical services, and education.

The Expenditure Approach to GDP Gross private domestic investment (I) Total investment by the private sector (stuff taken off the shelf but not for consumption). It includes the purchase of new housing, plants, equipment, and inventory by the private sector. Nonresidential investment includes expenditures by firms for machines, tools, plants, and so on. Residential investment includes expenditures by households and firms on new houses and apartment buildings. Change in inventories computes the amount by which firms’ inventories change during a given period. Inventories are the goods that firms produce now but intend to sell later.

The Expenditure Approach to GDP Gross Investment vs. Net Investment Gross investment is the total value of all newly produced capital goods (plant, equipment, housing, and inventory) produced in a given period. Depreciation/Capital Consumption Allowance is the amount by which an asset’s value falls in a given period. Net investment equals gross investment minus depreciation. Capital Stock K Today K Tomorrow

The Expenditure Approach to GDP Government consumption and gross investment (G) Counts expenditures by federal, state, and local governments for final goods and services. Does not include transfer payments. Net exports (EX – IM) The difference between exports and imports. Exports (EX) are sales to foreigners of U.S. produced goods and services. Imports (IM) are U.S. purchases of goods and services from abroad.

The Income Approach to GDP

GDP Observations & Limitations Population matters... Leisure matters... Quality matters... Home production matters... Illegal markets matter... Distribution matters... Social Benefits/Costs matter... What’s produced matters... Depreciation matters... So what do we do? Try the best we can. Look at various indicators and scale them or compare them in meaningful ways. How Happy Is America? http://www.npr.org/blogs/money/2013/02/08/171414674/how-happy-is-america

Interesting Numbers United States 2015 GDP per capita, PPP (current international $) 56,116 GDP, PPP (current international $) 18.037 trillion Source: World Development Indicators database Pop in US: 321,418,820 China 2015 GDP per capita, PPP (current international $) 8,029 GDP, PPP (current international $) 11.008 trillion Source: World Development Indicators database Pop in China: 1,371,000,000

http://data.worldbank.org/indicator/NY.GDP.PCAP.CD

Touchstones For GDP Questions Did it go through a legal market? Omit “under the table” illegal stuff. Omit “home” production. Omit “unmarketed” externalities. Was it currently produced? Omit transactions in which money or goods changes hands but in which no new goods and services are produced. Omit capital gains on resale of assets (but include the value of currently rendered services or currently produced items that were a part of the transaction). Omit transfer payments – nothing produced. Are we making sure we’re only calculating “final” values? Omit double counting intermediate goods (but you can use these IF you are using value added summed up all along the way, rather than final good sales). Include gross investment. Include currently produced inventory. Was it produced within the borders of the country? Omit output produced by citizens working abroad.

i>clicker question This economy produced more in year 2 than it did in year 1. A. True False Hard to say A Three-Good Economy PRODUCTION YEAR 1 YEAR 2 Q1 Q2 Good A 6 11 Good B 7 4 Good C 10 12 15

Nominal GDP vs Real GDP Nominal GDP is GDP measured in current dollars, or the current prices we pay for things. When any variable is measured in current dollars, it is described in nominal terms. Real GDP is GDP measured in reference to some base year so we can control for overall price changes. Simple Old Method (used prior to 1996) Picked a base year as the year chosen to be the reference year. Used the set of prices in the base year to evaluate quantities produced in the base years and in other years. A more complicated procedure is now used to perform these calculations. We will only learn how to perform the old procedure.

Calculating Nominal GDP and Real GDP A Three Final Good Economy (1) (2) (3) (4) (5) (6) (7) (8) GDP IN YEAR 1 YEAR 2 IN PRODUCTION PRICE PER UNIT PRICES Q1 Q2 P1 P2 P1 x Q1 P1 x Q2 P2 x Q1 P2 X Q2 Good A 6 11 $.50 $ .40 Good B 7 4 .30 1.00 Good C 10 12 .70 .90 Total 17

GDP %Changes %change in nominal GDP From our calculations: Nominal GDP in Year 1 = $12.10 Nominal GDP in Year 2 = $19.20 Real GDP in Year 2 (when Base Year = Year 1) = $15.10 Real GDP in Year 1 (when Base Year = Year 2) = $18.40 %change in nominal GDP %change in real GDP (Year 1 is base year) %change in real GDP (Year 2 is base year)

The Process of Deflating & the Implicit GDP Deflator Index Deflating: changing a measure from a current or nominal value to a real value by use of a deflator. implies you have a deflator!   To deflate (if you have a deflator): Conveniently: the government reports the following $nominal GDP $real GDP So subbing-in and cross-multiplying we get... And...to make it an index just multiply it by 100! And now it’s called the implicit GDP deflator index!

Nominal GDP, Real GDP & the IGDPDI IGDPDI for 2009 IGDPDI for 2015 Inflation between the base year and 2015 Inflation between 2012 & 2015 IGDPDI for 2015 = IGDPDI for 2012 = Nominal GDP, Real GDP & the IGDPDI year Real GDP, Billions of Chained 2009 Dollars GDP, Billions of Dollars  Implicit GDP deflator Index 2000 12559.7 10148.2   2001 12682.2 10564.6 2002 12908.8 10876.9 2003 13271.1 11332.4 2004 13773.5 12088.6 2005 14234.2 12888.9 2006 14613.8 13684.7 2007 14873.7 14322.9 2008 14830.4 14752.4 2009 14418.7 14414.6 2010 14783.8 14798.5 2011 15020.6 15379.2 2012 15354.6 16027.2 2013 15612.2 16498.1 2014 15982.3 17183.5 2015 16397.2 17803.4 22

Using An Index Like the Implicit GDP Deflator Index In 1975/76 Cornell tuition + fees + room & board cost approximately $5,000 per YEAR! So, based solely on the implicit GDP deflator index, what should Cornell have cost in 2015/2016? 23