Measuring Macroeconomic Data Chapter 2 Measuring Macroeconomic Data

Preview To examine the different approaches to measuring gross domestic product To understand real versus nominal GDP To understand how to measure inflation To understand how to measure unemployment To understand different interest rates

Measuring Economic Activity: National Income Accounting Gross domestic product (GDP) is the total value of goods and services produced in an economy the broadest measure of economic activity

Fundamental identity of national income accounting: Measuring Economic Activity: National Income Accounting (cont’d) National income accounting is an accounting system that measures economic activity and its components Fundamental identity of national income accounting: Total Production = Total Expenditure = Total Income

Measuring GDP: The Production Approach GDP is the current market value of all final goods and services newly produced in the economy during a fixed period of time In the case of apples and oranges, we multiply the their prices and quantities, and then add them up: GDP = (price of apples ✕ quantity of apples) + (price of oranges ✕ quantity of oranges)

Not all goods and services are counted in GDP because they are: Market Value Not all goods and services are counted in GDP because they are: Nonmarket goods and services, which do not have a market price (e.g., household services produced within a family), or Produced in the underground economy Many nonmarket goods and services are counted in GDP by their imputed values 6

Newly Produced Goods and Services GDP includes only goods and services that are newly produced in the current period If you buy a 3-year-old car from a car dealership The cost of the used car is not included in GDP The value of the services provided by the car dealership is included in GDP 7

Valued-Added Technique Value added is the value of a firm’s output minus the cost of the intermediate goods purchased by the firm By adding up the value added from each firm, we get the final value of the goods and services produced 8

Capital Goods A capital good (e.g., a robot) is used in the production of other goods that is not used up in the stages of production New capital goods are classified as final goods because they are not included in spending on other final goods and yet their production is part of economic activity 9

Inventory Investment Inventory investment is the change in inventories (firms’ holdings of raw materials, unfinished goods and unsold finished goods) over a given period of time Inventory investment is included in GDP for the same reason that we include capital goods 10

GDP is a flow, which is an amount per a given unit of time Fixed Period of Time We calculate GDP over a fixed period of time, such as a quarter or a year GDP is a flow, which is an amount per a given unit of time By contrast, a stock is a quantity at a given point in time 11

Policy and Practice: Can GDP Buy Happiness? Is GDP the best measurement of national well-being? In 1972, the king of Bhutan proposed the replacement of GDP by “gross national happiness” that incorporates factors such as spirituality and culture In 1990, the United Nations began to rank countries on a so-called human development index, which is a combination of life expectancy, education, literacy, educational participation, and GDP In 2008, a French economic commission led by Nobel Prize winner Joseph Stiglitz called for modifications to GDP with factors such as political freedom, physical safety, and work-life balance 12

Box: Stocks Versus Flows A stock is often an accumulation of flows over time Examples: Inventory investment is a flow, which accumulates into the stock of inventories Saving is a flow, which accumulates into a person’s wealth 13

FIGURE 2.1 Stocks Versus Flows 14

Measuring GDP: The Expenditure Approach GDP is the total spending on currently produced final goods and services in the economy National income identity: Y = C + I + G + NX where   Y = GDP = total production (output) C = consumption expenditure I = investment G = gov’t purchases of goods & services NX = net exports = exports - imports 15

TABLE 2.1 GDP and Its Components, 2009 16

Consumption Expenditure Total spending for currently produced consumer goods and services Consumption was 70.8% of GDP in 2009 Basic categories: Consumer durables Nondurable goods Services 17

Investment was 11.4% of GDP in 2009 Basic categories: Spending on currently produced capital goods that are used to produce goods and services over an extended period of time Investment was 11.4% of GDP in 2009 Basic categories: Fixed investment Inventory investment Residential investment 18

Box: Meaning of the Word Investment For non-economists, an investment normally refers to the purchase of common stocks or bonds For economists, investment spending refers to the purchase of physical assets, such as new machines or new houses—purchases that add to GDP 19

Government Purchases Spending by the government on currently produced goods and services Government purchases were 20.6% of GDP in 2009 Government consumption includes government purchases for short-lived goods and services like health care and police Government investment includes spending for capital goods like buildings and computers represents Pure government transfers (e.g., Social Security and Medicare) are excluded from G 20

Net exports (or trade balance) are exports minus imports Why subtract imports from GDP? Answer: Spending on imports is included in consumption expenditure, investment, and government purchases, but is not produced in this country 21

FIGURE 2.2 Expenditure Components of U.S. GDP, 1950-2010 22

Changes in the Spending Components of GDP Over Time Consumption grew steadily as a share of GDP from 1970 to 2008 Investment is much more volatile than other components of GDP Government purchases have actually remained quite stable at around 20% of GDP Net exports have been negative 23

Box: An International Comparison of Expenditure Components The United States differ from other countries by having the highest share of GDP going to consumption, the lowest share of investment, and net exports have been negative By contrast, China has the lowest share of consumption, the highest share of investment, and the largest share of net exports 24

FIGURE 2.3 Shares of Expenditure Components for Different Countries 25

Measuring GDP: The Income Approach Compensation of employees – wages and salaries of employees, and employee benefits Corporate profits – profits after taxes of corporations Other income – income of the self-employed, royalty income and net interest earned by individuals, etc. Depreciation – the loss of value of capital from wear and tear net domestic product = GDP – depreciation Net factor income – wages, profits, and rent paid to U.S. residents by foreigners minus factor income paid by U.S. residents to foreigners 26

TABLE 2.2 Income Approach to GDP, 2009 27

Gross national product (GNP) = national income + depreciation Income Measures National income = Compensation of employees + other income + corporate profits Gross national product (GNP) = national income + depreciation total income earned by U.S. residents Gross domestic product (GDP) = GNP + net factor income domestically produced measure of gross product 28

Income Measures (cont’d)   Private Disposable Income = GDP + net factor income + transfer payments received from the government + interest payments on government debt – taxes 29

Income Measures (cont’d)   Net Government Income = taxes – transfers – interest payments on government debt 30

Real Versus Nominal GDP A nominal variable is a measure at current market (nominal) prices (e.g., nominal GDP) A real variable is a measure in terms of quantities of actual goods and services (e.g., real GDP) 31

Real Versus Nominal GDP (cont’d)   or Nominal GDP = Price Level ✕ Real GDP 32

Real Versus Nominal GDP (cont’d) If 2005 is the base year, then real GDP for the year 2010 is: Real GDP in 2012 = (price of apples in 2005 ✕ quantity of apples in 2012) + (price of oranges in 2005 ✕ quantity of oranges in 2012) 33

Real Versus Nominal GDP (cont’d) Raw data on GDP tends to fall in cold and snowy months Therefore, economic statistics like GDP data are seasonally adjusted to account for regular seasonal fluctuations within a year 34

Chain-Weighted Measures of Real GDP If prices of some important goods changed dramatically relative to other goods, using a fixed base-year for prices when calculating real GDP can produce misleading results Chain-weighted measures of GDP allow the base year to change continuously 35

Measuring Inflation Price indexes are measures of the price level Examples: GDP deflator (or implicit price deflator) Personal consumption expenditure deflator Consumer price index 36

GDP Deflator   37

PCE Deflator   38

Consumer Price Index   A measure of the average prices of consumer goods and services, i.e., a cost of living index Calculated monthly by the Bureau of Labor Statistics using a basket of thousands of consumer goods and services 39

Consumer Price Index If the basket consists of 2 apples and 1 orange, then the CPI for 2010 with a base year of 2005 is:   40

Policy and Practice: Policy and Overstatements of the Cost of Living The CPI is used in determining labor contracts and government payments such as Social Security benefits A study led by Michael Boskin of Stanford University found that increases in the CPI overstate increases in the cost of living by 1% point Measurements errors in the CPI could have important implications   41

Inflation Rate   The inflation rate is the % rate of change of the price level over a particular period: where 42

FIGURE 2.4 U.S. Inflation Rates with Different Price Indexes, 1950-2010 43

Percentage Change Method and the Inflation Rate   Because: We know that: 44

Percentage Change Method and the Inflation Rate (cont’d) Because the % change in the price level is the inflation rate, while the % changes in nominal and real GDP are the growth rate:   45

Measuring Unemployment The unemployment rate is the percentage of people in the civilian population who want to work but who do not have jobs The Bureau of Labor Statistics classifies each adult over age 16 into: Employed Unemployed Not in the labor force Discouraged workers (those who would live to work but have given up looking, and those who have voluntarily left the labor force)   46

Measuring Unemployment (cont’d)   47

Measuring Unemployment (cont’d)   48

FIGURE 2.5 Unemployment in the Adult Civilian Population, 2010 49

Macroeconomics In The News: Unemployment and Employment The Bureau of Labor Statistics reports employment and unemployment data using two alternative surveys: the household survey and the survey of business establishments The two surveys sometimes give a different picture of labor market conditions due to: The household survey counts workers, while the establishment survey counts jobs The household survey counts the self-employed as working, while the establishment does not The establishment survey covers more workers   50

Measuring Interest Rates   An interest rate is the cost of borrowing, or the price paid for the rental of funds Interest rates are returns for holding debt securities, such as bonds 51

Macroeconomics In The News: Interest Rates   Interest rates that receive media attention are: Prime rate Federal funds rate London Inter-Bank Offered Rate (LIBOR) Treasury bill rate. Ten-year Treasury bond rate Federal Home Loan Mortgage Corporation rate 52

Real Versus Nominal Interest Rates   A nominal interest rate makes no allowance for inflation The real interest rate is the amount of extra purchasing power a lender must be paid for the rental of his/her money The ex ante real interest rate is adjusted for expected changes in the price level The ex post real interest rate is adjusted for actual changes in the price level 53

Real Versus Nominal Interest Rates (cont’d)   The Fisher equation: 54

Real Versus Nominal Interest Rates (cont’d) Example: For a one-year loan with a 4% nominal interest rate (i=4%) and you expect the inflation to be 6% in a year ( =6%), then: When the real interest rate is low, there are greater incentives to borrow and invest, but fewer incentives to lend.   55

The Important Distinction Between Real and Nominal Interest Rates   Credit markets are where households and businesses get funds (credit) from each other Because the real interest rate reflects the real cost of borrowing, it is likely to be a better indicator of the incentives to borrow, invest, and lend in credit markets than nominal interest rates 56

FIGURE 2.6 Real and Nominal Interest Rates (Three-Month Treasury Bill), 1955-2010 57