1. Chapter 5 The Wealth of Nations:
Defining and Measuring
Macroeconomic Aggregates
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2. Chapter Outline 5.1 Macroeconomic Questions
5 The Wealth of Nations: Defining and Measuring Macroeconomic Aggregates
Chapter Outline
5.1 Macroeconomic Questions
5.2 National Income Accounts: Production = Expenditure = Income
EBE In the United States, what is the total market value of annual economic production?
5.3 What Isn’t Measured by GDP?
5.4 Real vs. Nominal
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3. Key Ideas Macroeconomics is the study of aggregate economic activity.
5 The Wealth of Nations: Defining and Measuring Macroeconomic Aggregates
Key Ideas
Macroeconomics is the study of aggregate economic activity.
National income accounting is a framework for calculating gross domestic product (GDP), which is a measure of aggregate economic output.
GDP can be measured in three different ways, and in principle these three methods should all yield the same answer: Production = Expenditure = Income.
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4. 5 The Wealth of Nations: Defining and Measuring Macroeconomic Aggregates
Key Ideas
GDP has limitations as a measure of economic activity and as a measure of economic well-being.
Economists use price indexes to measure the rate of inflation and to distinguish nominal GDP from real GDP (which holds prices fixed).
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5. 5.1 Macroeconomic Questions
Macroeconomics is the study of economic aggregates and economy-wide phenomena like the annual growth rate of a country’s total economic output or the annual percentage increase in the total cost of living.
Instructor: A useful analogy is that macroeconomics is the study of the forest, while microeconomics is the study of individual trees.
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6. In particular, macroeconomics asks the following questions:
5.1 Macroeconomic Questions
In particular, macroeconomics asks the following questions:
What is income per capita?
How do we measure differences in income per capita?
How large are differences in income per capita?
What causes differences in income per capita?
How long will differences in income per capita persist?
Instructor: The long run is typically defined as a period of 5 to 50 years.
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7. The average income per person.
5.1 Macroeconomic Questions
Income per capita
The average income per person.
Calculated by dividing a nation’s aggregate (or total) income by the number of people in that country.
Income per capita in the United States is more than 2 times the level in Portugal, 7 times the level in China, and 100 times the level in Zimbabwe!
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8. 5.1 Macroeconomic Questions
Differences in income per capita are caused by institutional differences (so-called economic rules of the games) and political policies that impact them.
Differences in income per capita can either narrow over time (e.g., China) or widen over time (e.g., Argentina).
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9. Why does economic growth sometimes slow down or even turn negative?
5.1 Macroeconomic Questions
Why does economic growth sometimes slow down or even turn negative?
What is a recession?
Instructor: The short run is typically defined as quarter-by-quarter.
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10. 5.1 Macroeconomic Questions
In the short run, economic growth slows down or even becomes negative when aggregate spending decreases.
A recession is defined as two straight quarters in which aggregate income falls.
Instructor: You may want to talk about how the ability to produce goods and services (supply) determines growth in the long run, while the willingness to buy goods and services (demand) determines growth in the short run.
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11. What is the unemployment rate, and why does it rise during recessions?
5.1 Macroeconomic Questions
What is the
unemployment
rate, and why does
it rise during
recessions?
Why were the Great Recession of 2007–2009 and the Great Depression of 1929–1932 so severe?
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12. 5.1 Macroeconomic Questions
The unemployment rate is defined as the ratio of workers without a job who are actively seeking one divided by the labor force.
There are a multitude of reasons behind the severity of the Great Depression and the Great Recession that we will examine later.
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13. National income accounts
5.1 Macroeconomic Questions
National income accounts
A measure of the level of aggregate economic activity in a country.
National Income and Product Accounts (NIPA)
The system of national income accounts used in the United States.
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14. The production approach The expenditure approach The income approach
5.2 National Income Accounts: Production = Expenditure = Income
Aggregate economic activity in a country can be measured in three different ways:
The production approach
The expenditure approach
The income approach
Instructor: We discuss each approach in three different ways: (1) hypothetical example, (2) full concepts, (3) U.S. data in an evidence-based example.
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15. Penville has 100,000 citizens who are the workers in the factories.
5.2 National Income Accounts: Production = Expenditure = Income
The Production Approach in Penville
Penville is a small country with one employer, Bic Pen, which produces 10 million pens a year. The market price of a pen is $2.
Penville has 100,000 citizens who are the workers in the factories.
Bic Pen owns the inputs and its own machines so only needs to hire workers.
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16. Production = (10 million pens) × ($2.00 / pen) = $20 million
5.2 National Income Accounts: Production = Expenditure = Income
The Production Approach in Penville
To determine the market value of production, we multiply the quantity of pens produced by the market price of each pen:
Production = (10 million pens) × ($2.00 / pen) = $20 million
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17. Expenditure = (10 million pens) × ($2.00 / pen) = $20 million
5.2 National Income Accounts: Production = Expenditure = Income
The Expenditure Approach in Penville
We add up the sales of pens to households, firms, government, and the foreign sector, including unsold inventories:
Expenditure = (10 million pens) × ($2.00 / pen) = $20 million
Instructor: It is important to point out that unsold pens or inventories are included as sales to firms or investment.
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18. We add up payments to labor and payments to capital:
5.2 National Income Accounts: Production = Expenditure = Income
The Income Approach in Penville
We add up payments to labor and payments to capital:
Income = $X + ($20 million ‒ $X) = $20 million
where X is payments to labor
Instructor: Payments to capital or profits is the residual, or what is left over after paying labor.
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19. Production = Expenditure = Income
5.2 National Income Accounts: Production = Expenditure = Income
Aggregate Accounting Identity for Penville
Production = Expenditure = Income
$20 million = $20 million = $20 million
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20. 5.2 National Income Accounts: Production = Expenditure = Income
Instructor: On top, firms produce goods and services (production), and households buy those goods and services (expenditure). On bottom, households supply labor and capital (factors of production) and receive payments (income) in return.
Exhibit 5.1 Circular Flow Diagram
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21. 5.2 National Income Accounts: Production = Expenditure = Income
Each of these approaches is used to measure gross domestic product, or GDP.
GDP
The market value of the final goods and services produced within the borders of a country during a particular time period.
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22. 5.2 National Income Accounts: Production = Expenditure = Income
Production Approach
Production-based accounting sums up each firm’s value added, which is the firm’s sales revenue minus the firm’s purchases of intermediate products from other firms.
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23. There are five main categories.
5.2 National Income Accounts: Production = Expenditure = Income
Expenditure Approach
Expenditure-based accounting sums up the purchases of goods and services by different groups or categories.
There are five main categories.
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24. 5.2 National Income Accounts: Production = Expenditure = Income
Consumption goods and consumption services bought by domestic households (C)
Instructor: Consumption expenditures include all purchases of economic goods (e.g., apples and Apples) and services (e.g., distribution and iTunes) except residential construction.
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25. 5.2 National Income Accounts: Production = Expenditure = Income
2. New physical capital (investment) bought by domestic households and domestic firms (I)
Instructor: Investment includes residential construction, business inventory (e.g., unsold apples and Apples), business structures (e.g., new supermarkets and iStores), and business equipment (e.g., new machines and factories).
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26. Government expenditures on goods and services (G)
5.2 National Income Accounts: Production = Expenditure = Income
Government expenditures on goods and services (G)
Instructor: Government expenditures include purchases of goods (e.g., aircraft) and services (e.g., Medicare and Medicaid payments) by governments but exclude transfer payments (e.g., Social Security, unemployment) and interest payments on government debt.
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27. 5.2 National Income Accounts: Production = Expenditure = Income
4. Exports of goods and services produced domestically and sold abroad (X)
Instructor: Exports is the value of all domestically produced goods and services that are sold to foreign households, firms, and governments.
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28. 5.2 National Income Accounts: Production = Expenditure = Income
5. Imports of goods and services produced abroad and sold domestically (M)
Instructor: Imports is the value of all foreign-produced goods and services that are sold to domestic households, firms, and governments.
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29. 5.2 National Income Accounts: Production = Expenditure = Income
Income Approach
Income-based accounting sums up payments (or income) received by labor and the owners of physical or financial capital.
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30. Aggregate Accounting Identity
5.2 National Income Accounts: Production = Expenditure = Income
Aggregate Accounting Identity
National Income Accounting Identity
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31. Evidence-Based Economics Example:
5 The Wealth of Nations: Defining and Measuring Macroeconomic Aggregates
Evidence-Based Economics Example:
Question: In the United States, what is the total market value of annual economic production?
Answer: The Bureau of Economic Activity estimated in 2013 that U.S. GDP was $16.8 trillion, or $53,100 per resident.
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32. 5 The Wealth of Nations: Defining and Measuring Macroeconomic Aggregates
Question: In 2013, how was GDP divided into the expenditure components?
Instructor: Remind students that imports are subtracted from GDP.
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33. 5 The Wealth of Nations: Defining and Measuring Macroeconomic Aggregates
Answer:
Exhibit 5.3 U.S GDP and GDP Shares (Expenditure-based Accounting)
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34. Evidence-Based Economics Example:
5 The Wealth of Nations: Defining and Measuring Macroeconomic Aggregates
Evidence-Based Economics Example:
Question: Have U.S. expenditure shares fluctuated or remained constant over time?
Answer: The U.S. expenditure shares have been relatively constant over time.
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35. 5 The Wealth of Nations: Defining and Measuring Macroeconomic Aggregates
Instructor: The one exception is World War II in 1941–1945, when the government spending share rose for the war effort.
Exhibit 5.4 U.S. GDP Shares (1929–2013)
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36. 5 The Wealth of Nations: Defining and Measuring Macroeconomic Aggregates
Question: What fraction of income is paid to labor, and what fraction is paid to capital?
Answer: In the United States, labor receives about two-thirds of total income, and capital receives about one-third of total income.
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37. 5 The Wealth of Nations: Defining and Measuring Macroeconomic Aggregates
Instructor: Labor payments are the sum of wages and salaries and benefits.
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38. 5 The Wealth of Nations: Defining and Measuring Macroeconomic Aggregates
Instructor: Capital payments are the sum of rental income, corporate profits, interest payments, and indirect tax payments.
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39. GDP and national income accounting is a useful system for
5.3 What Isn’t Measured by GDP?
GDP and national
income accounting is
a useful system for
taking the temperature of the economy. However, it is not perfect, and it necessarily leaves out a lot of details.
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40. GDP omits depreciation of the physical capital stock and resources.
5.3 What Isn’t Measured by GDP?
GDP omits depreciation of the physical capital stock and resources.
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41. 5.3 What Isn’t Measured by GDP?
GDP excludes home production of cleaning, cooking, and child care done in the household.
Instructor: Tell the students that paid maid service, restaurant cooking, and day care are included in GDP since these are market transactions.
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42. 5.3 What Isn’t Measured by GDP?
GDP does not capture transactions conducted in the underground economy.
Instructor: In developed economies, the underground economy is estimated to be 10% of GDP.
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43. 5.3 What Isn’t Measured by GDP?
GDP does not count negative externalities such as pollution, noise, and crime.
Instructor: Externalities are economic activity that spills over to other people not directly engaged in that activity.
However, purchases to prevent negative externalities like smokestack scrubbers, mufflers, and security devices are counted as positive contributions to GDP.
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44. GDP does not record leisure.
5.3 What Isn’t Measured by GDP?
GDP does not record leisure.
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45. 5.3 What Isn’t Measured by GDP?
19.3 What Isn’t Measured in GDP?
GDP does not include production by U.S. workers and U.S. capital abroad.
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46. 5.3 What Isn’t Measured by GDP?
Gross domestic product, or GDP, records production in the United States regardless of whose labor and capital (domestic or foreign) is used.
Gross national product, or GNP, records production of domestically owned labor and capital in the United States and abroad.
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47. Why is this distinction important?
5.3 What Isn’t Measured by GDP?
Why is this distinction important?
U.S. GDP was $16.8 trillion in 2013.
U.S. GNP was $17.1 trillion in 2013.
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48. 5.3 What Isn’t Measured by GDP?
Do all these limitations mean that GDP is a poor measure of well-being of an economy?
Why don’t we ask people how happy or satisfied they are and compare these responses to GDP?
Instructor: The asking of people in surveys to determine well-being is called the ‘Happiness Literature’
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49. Exhibit 5.6 GDP per Capita and Life Satisfaction
5.3 What Isn’t Measured by GDP?
Instructor: There is a positive relationship in that an increase in GDP per capita (moving left to right) is associated with an increase in life satisfaction (moving bottom to top).
Exhibit 5.6 GDP per Capita and Life Satisfaction
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50. We therefore need to distinguish between nominal GDP and real GDP.
5.4 Real vs. Nominal
An increase in GDP will record both increases in actual production (and income) and increases in prices of those goods and services.
We therefore need to distinguish between nominal GDP and real GDP.
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51. 5.4 Real vs. Nominal
Nominal GDP
The total value of production using current market prices to determine the value of each unit that is produced.
Real GDP
The total value of production using market prices from a specific base year to determine the value of each unit that is produced.
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52. Nominal GDP for 2009: Nominal GDP for 2013: 5.4 Real vs. Nominal
Instructor: The government multiples the quantity of each good or service by its current price to calculate nominal GDP.
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53. Real GDP for 2009 (base year 2009):
5.4 Real vs. Nominal
Real GDP for 2009 (base year 2009):
Nominal GDP for 2013 (base year 2009):
Instructor: The government multiples the quantity of each good or service by the price in the base year to calculate real GDP.
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54. Example: The Nation of Barney
5.4 Real vs. Nominal
The Nation of Barney
Example: The Nation of Barney
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55. Calculate nominal GDP for 2012 and 2013.
5.4 Real vs. Nominal
The Nation of Barney
Calculate nominal GDP for 2012 and 2013.
Calculate real GDP for 2012 and 2013.
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56. Nominal GDP for 2012: Nominal GDP for 2013: 5.4 Real vs. Nominal
The Nation of Barney
Nominal GDP for 2012:
Nominal GDP for 2013:
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57. Real GDP for 2012: Real GDP for 2013: 5.4 Real vs. Nominal
The Nation of Barney
Real GDP for 2012:
Real GDP for 2013:
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58. 5.4 Real vs. Nominal The Nation of Barney
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59. The price level of the overall economy.
5.4 Real vs. Nominal
GDP deflator
The price level of the overall economy.
The ratio of nominal GDP to real GDP:
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60. Consumer Price Index (CPI)
5.4 Real vs. Nominal
Consumer Price Index (CPI)
The price level of a particular basket of consumer goods and services:
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61. The GDP deflator and the CPI formula look nearly identical.
5.4 Real vs. Nominal
The GDP deflator and the CPI formula look nearly identical.
Question: What are the differences?
Hint: Think about what is in each “basket” of goods and services.
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62. The CPI includes imports like Chinese laptops.
5.4 Real vs. Nominal
The GDP deflator includes things not purchased by households, like trains, subways, and submarines.
The CPI includes imports like Chinese laptops.
Housing-related expenditures like shelter and utility bills have a large weight in the CPI.
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63. GDP and the price level are more often quoted in growth rates.
5.4 Real vs. Nominal
GDP and the price level are more often quoted in growth rates.
A growth rate is defined as a percentage change:
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64. The percentage change in a price index.
5.4 Real vs. Nominal
Inflation rate
The percentage change in a price index.
Instructor: one can use either the GDP deflator or the CPI as the price index
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65. 5.4 Real vs. Nominal
Instructor: Point out the negative inflation (or deflation) in the 1930s and the high inflation in the late 1940s and 1970s.
Exhibit 5.5 The Relationship Between the Saving Rate and the Investment Rate (1929–2013)
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66. comparisons across time: In 1909, then U.S. President William Howard
5.4 Real vs. Nominal
We can use a price index
to make meaningful
comparisons across time:
In 1909, then U.S.
President William Howard
Taft was paid $75,000.
In 2013, current U.S. President Barack Obama was paid $400,000.
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67. We can convert Taft’s salary to 2013 dollars by applying this formula:
5.4 Real vs. Nominal
We can convert Taft’s salary to 2013 dollars by applying this formula:
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68. Question: Which president earned more?
5.4 Real vs. Nominal
Question: Which president earned more?
Taft did since his salary in 1909 could buy $1.9 million of goods and services, while Obama’s salary would buy only $400,000 of goods and services.
You can go to to see the CPI and other relative calculations.
Instructor: Tell the students that the president today receives a lifetime pension, medical care, and security detail, so the difference may not be as great as indicated by the income alone.
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