2015/2016 Introduction to Economics Augusto Ninni Main Macroeconomic Aggregates (II)

Questions of the day? 1.Which are the components of the GDP? 2.What is the role of prices in the determination of GDP? What is inflation and how it is measured? 3.What is unemployment and how it is measured?

Composition of GDP For sake of simplicity GDP (territory) = GNP (residents) GDP – Measures the final value of production of goods and services GDP – Measures the final value of demand of goods and services D = S It is possible to decompose GDP both on the side of supply and on the side of demand Suppose at first that we are in a closed economy, without exports or imports

From the point of view of supply GDP is equal to the sum of the sectorial VAs (2° definition examined in Lecture 14) VA Agriculture + VA Industry + VA Services

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

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

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

The sum C+I+G = expenditure in goods and services by people living in a country (domestic expenditure) But the economy is not closed 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 (exports) Some goods that are produced abroad are purchased in the country (imports)

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) – element of demand and subtract Import (Q) – Purchase of goods and services produced abroad by the residents of the country (e.g. Swiss cheesesold in Italy) – element of supply

D = S (C+I+G+E)-Q = Z C+I+G+E = Z + Q 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  State balance Difference between Government’s expenditure and Government’s revenues

The role of prices: Real GDP and nominal GDP GDP = value of the final goods and services It is a flux value, defined on conventional terms GDP and the maid…(Pigou) Value of the goods = quantities * market prices Which kind of prices? → usually market 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”)

Italian GDP, million of dollars (source: Oecd)

Real GDP and Nominal GDP A single good YearQuantity Price Nominal GDP 2000 = price 2000 * q.ty 2000 = 100*100 =10000 Nominal GDP 2001 = price 2001 * q.ty 2001 = 102*103=10506

Real GDP and Nominal GDP 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.

In order to know the actual increase in production we must use the Real GDP Base year = 2000 Real GDP 2000 = price 2000 * q.ty 2000 = 100*100 =10000 Important: Real GDP is equal to the nominal GDP in the base year (2000) Real GDP 2001 = price 2000 * q.ty 2001 = 100*103 = Important: It is different from the Nominal GDP 2001 = in another year

Real GDP growth= 0,03 = 3% The growth of real GDP measures the variation of production given a certain set of fix prices What differentiates the growth of nominal GDP from the growth of real GDP? → The variation of prices, namely inflation (the growth rate of prices: the contrary is deflation)

P2001 * Q 2001 P2001 Q 2011 ____________ / ____ = ______ P2000 * Q 2000 P 2000 Q 2010 Price index

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

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

Inflation It is also possible to show that  π = n – g Where Π = annual rate of growth of prices 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. But in many cases it is more interesting to look at the price increase that characterize the goods that are purchased only by the consumers.

Inflation 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 ∆ 10% 1%

Inflation Inflation -> average of the two variation Important: no simple average, but average weighted by the value of the goods

Inflation Computation of the CPI: Expenditure 2000  q.ty bread * price bread q.ty clothes * price clothes 2000  =10*1+1*100  110 Expenditure 2001  q.ty bread * price bread q.ty clothes * price clothes 2001   10*1.1+1*101  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 in Italy

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

Inflation Why do prices increase? How to struggle inflation ? Some answers during the course….

Labour market Employed = Those who currently have a job Unemployed = Those who have not a job but 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., elder people, housewife and students are not considered unemployed)

Labour market 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 potential workers who are unemployed

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

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

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