Measurement of Output, Employment & Prices

Why Measurement Matters Before we get into models of economic behaviour we need to look some definitions and some issues in measurement Measurement economic quantities may seem boring… – But it can give crucial insight even without a model of behaviour – Example: we will look at include the current crisis

MACROECONOMIC MEASUREMENT Need to Look at three sets of measurements 1.Here we will look at the National Income and Expenditure Accounts (NIE) 2.Also the measurement of external transactions: Balance of Payments 3.Prices 4.Employment

NIE Identity We measure macroeconomic activity primarily by looking at annual (or quarterly) flows of Output (O), Income (Y) and Expenditure (E). These are different ways of measuring the same thing, so they sum to identical totals – Basic Identity: Y  O  E Think of why this is the case – Income and Product are identical: Product is Value-Added in Production, i.e sales minus purchases from other firms, which = payment of incomes to Factors (Wages, Interest…) – Expenditure equals Income, because any production not sold is counted as Inventory Investment, and is thus part of Expenditure (the firm purchases its own output from itself) Note this is an identity not an equilibrium condition – An identity holds for all values – An eqm condition holds only for some values i.e. in eqm – Distinction important later

NIE: GDP vs GNP Open economy: GNP v GDP – GNP  GDP + NFIA – (NFIA is net factor inc from R.O.W., i.e. inflows minus outflows) – GNY  GNP + EUtrasfers – EUtaxes – GNDY  GNP + NTA (NTA is all net Transfers from R.O.W. incl EU) – GDP + NFIA + NTA  GNDY – Note: Irish GNP was approx 85% of GDP (2007) – For many other countries the distinction is not relevant – Can lead to lots of debate of which is best measure in Ireland

NIE: SAVINGS & INVESTMENT IDENTITY The Income Identity – Y  C + S + T – Accounting rule: Income is either spent saved or taxed The Expenditure Identity – E= C + I + G + NX – Accounting rule: add up the components of expenditure Combine the two – C + I + G + NX  C + S + T Thus: (G – T)  (S – I) – NX – or: (G – T) + NX  (S – I) etc. clearly, adding in net foreign factor and transfer income, including them in the totals for T and S etc as appropriate, and changing signs we get: (T - G) + (S - I)  NX  BOP Current A/C Note: the 2 left hand expressions are National Savings Note: we could also add in NFIA & For Trans

NIE: SAVINGS & INVESTMENT IDENTITY This is often known as the twin deficits identity Even though it doesn’t involve any model or description of economic behaviour it can be informative Implication: a current account surplus can only occur if there is an excess of national savings Application 1: The US – The US has trade deficit (esp with China) – This is inescapable given it has insufficient savings – China surplus equates to surplus Chinese savings Application 2: Ireland’s Bubble – We had a bubble (high investment) – Insufficient savings – So high current account deficit

EMPLOYMENT AND UNEMPLOYMENT The labour force (L) = employed (E) + unemployed (U) The unemployment rate u% = U/L or U/(E + U) Letting the population of Labour-force Age = P, we also have: The Labour force participation rate: LFPR% = L/P Measuring Employment and Unemployment – Surveys: household QNHS in Ireland, quarterly household survey (CPS in USA); business surveys for employment. – Administrative: “Live Register” (Ireland); related to benefit claimants The precise details of how surveys and other measures are constructed will differ from country to country. Survey methods are generally more comparable. Key Issue: have to “want” to work to be unemployed as distinct from not working Surveys try to capture this: “active search” – Issue of how active – Discouraged worker effects Claimant counts do not – may include people NILF

Prices (See Gordon: Appendix to Ch 2) Some components of GDP have well-known measures of inflation: the CPI for household consumption For a more comprehensive measure the implicit price deflator for GDP is used: this relates to all items in the GDP A price index is a weighted average measure of price changes Two questions arise: (i) what is included (ii) what kind of weighting system to use For Consumption the Irish CPI includes a measure of housing costs, the Eurozone HIPC does not (why?) Generally if an index uses base-year weights (Laspeyre), the resulting inflation is higher than if current year weights are used (Paasche) Nearly all Consumer Price indices are Laspeyre.

LASPEYRE AND PAASCHE INDICES A Laspeyre index of prices uses the quantities prevailing in some base (e.g. survey) year to weight prices. The index takes the form: (  p 1 q 0 /  p 0 q 0 )x100 Note: base-year quantities (q 0 ) are used to compare prices in the two years (p 1 and p 0 ) A Paasche index of prices uses the quantities prevailing in the terminal year to weight prices. The index takes the form: (  p 1 q 1 /  p 0 q 1 )x100 Note: current-year quantities (q 1 ) are used to compare prices in the two years (p 1 and p 0 ) As relatively cheaper are substituted for dearer goods, the Laspeyre index of prices has an upward substitution bias.

THE IMPLICIT GDP DEFLATOR Instead of constructing an index directly, we take the ratio of nominal to real GDP. For simplicity let real GDP be this year’s output at last year’s (base year) prices So the index is: (  p 1 q 1 /  p 0 q 1 ) Note that this is similar in form to a Paasche index of prices. In some cases the calculation is refined and the implicit deflator is an average (geometric mean) of a Laspeyre and Paasche indices. As the real to nominal GDP ratio is re-calculated each year, the weighting of the quantities is updated and the resulting implicit deflators are chained together to give a cumulative index over time. The result is a lesser degree of substitution bias