Lecture 15 – academic year 2014/15 Introduction to Economics Fabio Landini Main Macroeconomic Aggregates (II)

Questions of the day? What is the role of prices in the determination of GDP? What is inflation and how it is measured? What is unemployment and how it is measured? How can you decompose the GDP?

The role of prices: Real GDP and nominal GDP GDP = value of the goods Value of the goods = quantities x market prices Which prices? Nominal GDP: Value of the final goods and services computed using the current quantities and prices Real GDP: Value of the final goods and services computed using current quantities and prices of a specific year (called “the base year”)

Real GDP and Nominal GDP A single good YearQuantity Price Nominal GDP 2000 = price 2000 x q.ty 2000 = 100x100 =10000 Nominal GDP 2001 = price 2001 x q.ty 2001 = 102x103=10506

Nominal GDP growth= = 0,0506 = 5,06% The growth of GDP is computed in order to know how much the production has increased. But 5,06% considers both the variation of products and the variation of prices. Real GDP and Nominal GDP

In order to know the actual increase in production we must use the Real GDP Base year = 2000 Real GDP 2000 = price 2000 x q.ty 2000 = 100x100 =10000 Important: Real GDP is equal to the nominal GDP 2000 Real GDP 2001 = price 2000 x q.ty 2001 = 100x103 = Important: It is different from the Nominal GDP 2001 = Real GDP and Nominal GDP

Real GDP growth= = 0,03 = 3% It differs from the growth of nominal GDP = 5,06% The growth of real GDP measures the variation of production given a certain set of fix prices What differentiate the growth of nominal GDP from the growth of real GDP? The variation of prices, namely inflation Real GDP and Nominal GDP

Inflation Inflation rate ( π ) = Rise in the general level of prices in an economy over a period of time Two ways to measure the level of prices: GDP deflator Consumer price index (CPI)

Inflation 1) GDP deflator: Diversity in the growth of nominal and real GDP -> price variation GDP Deflator   π t 

Inflation In the preceding example: Nominal GDP 2000  10000; Nominal GDP 2001  Base year = 2000 Real GDP 2000 = ; Real GDP 2001  On the basis of the preceding formula we obtain:

Inflation It is also possible to show that  π = n – g where g  annual rate of growth of real GDP n  annual rate of growth of nominal GDP

Inflation In our example we have n = 5,06% g = 3% π = 2% Using the above formula we obtain π = n – g = 5,06% - 3% = 2,06% ≅ 2% The GDP deflator considers the prices of of all final goods produced in the economy. In many cases it is more interesting to look at the price increase that characterize the goods that are purchased by the consumers.

2) Consumer price index (CPI) = considers only the average goods that are purchased by the consumers Example Two goods: bread and clothes On average a consumer buys 1 cloth and 10 kg of bread every year BreadClothes Price Price 20011,1 101 Inflation

Price bread 2000 = 1 -> Price bread 2001 =1,1 -> Δ = 10% Price clothes 2000 = 100 -> Price clothes > Δ = 1% Inflation -> average of the two variation Important: no simple average, but average weighted by the quantity consumed and the value of the goods Inflation

Computation of the CPI: Expenditure 2000  q.ty bread x price bread q.ty clothes x price clothes 2000  =10x1+1x100  110 Expenditure 2001  q.ty bread x price bread q.ty clothes x price clothes 2001   10x1,1+1x101  112 Inflation

π     0,0181 = 1,81% Inflation computed using the CPI measures the average growth in the consumers’ expenditure Important: 1,8% is an intermediate value between 10% ( Δ price of bread) and 1% ( Δ price of clothes) Important: CPI considers a fixed basket of goods which is updated periodically Inflation

Inflation in Italy

Inflation is usually positive (prices increase over time)

Inflation is different depending on the period (>10% between 1974 and 1984 ; < 3% since 1997)

Why do prices increase? What is it that determines the level of inflation? Some answers during the course…. Inflation

Labour market Employed = Those who currently have a job Unemployed = Those who are looking for a job or are going to start a new job (+ those who are under unemployment protection programs) Important: those who are not looking for a job are not considered unemployed (e.g., housewife and students are not unemployed)

Labour force  Employed + Unemployed Unemployment rate (u)  Important: Those who are not looking for a job are counted neither in the numerator nor in the denominator The unemployment rate measures the portion of workers who are unemployed Labour market

Another problem: how to measure the portion of workers over the total population -> participation rate Participation rate = Labour market

Unemployment rate in Italy, EU, US

The unemployment rate is usually positive (there are workers who do not find a job) The unemployment rate is different across countries

Why is there unemployment? Why is unemployment different across countries? Some answers during the course….. Labour market

Decomposition of GDP GDP – Measures the value of production of goods and services Goods and services are exchange din the market -> Supply and Demand It is possible to decompose GDP both on the side of supply and on the side of demand From the point of view of supply the GDP is equal to the sum of the sectorial A.V. (2° definition examined in Lecture 14)

From the point of view of demand it is possible to decompose the GDP in different categories of expenditure a) Consumption (C) – Households’ purchase of goods and services Durable goods (average life >3 years) Non-durable goods (average life <3 years) Services Decomposition of GDP

b) Investment (I) – Firms’ purchase of capital goods that are used as inputs in future production activities (e.g. machines, plants, etc.) A particular category is represented by the investment in stockpile (goods that are not sold) It is not financial investment Decomposition of GDP

c) Government expenditure (G) – Purchase of goods and services by the public administration (Government, public bodies, etc.) Decomposition of GDP

The sum C+I+G = expenditure in goods and services by the residents of a country (national expenditure) To compute the total demand of goods and services (=demand of goods and services produced in the economy) we must consider that: Some goods that are produced in the country are sold abroad Some goods that are produced abroad are purchased in the country Decomposition of GDP

Therefore, to the national expenditure we must add Export (X) – Purchase of national goods and services by the rest of the world (e.g. Italian wine sold in Germany) and subtract Import (Q) – Purchase of goods and services produced abroad by the residents of the country (e.g. Swiss cheesesold in Italy) Decomposition of GDP

Therefore, the aggregate demand of national goods and services (Z) is equal to: Z  C + I + G + X - Q Some other important aggregate measures are: Commercial balance  Difference between import and export Public deficit  Difference between Government’s expenditure and Government’s revenues Decomposition of GDP