1. Introduction to Macroeconomics
Chapter 20. Measuring the Macroeconomy

2. Measuring the Macroeconomy
1. Measuring Total Output
2. How to Measure Total Output
3. GDP Accounting Complications
4. Measuring Price Changes
5. Empirical Applications

3. 1. Measuring Total Output
Monetary Measure of Value
GDP versus GNP
Omissions from GDP - does not measure social welfare
Social Welfare
Examples in text - unregulated pollution. Home and volunteer labor.
Chicken waste - chicken prices are lower -> GDP lower
also seafood production from Chesapeake Bay lower.
Additional examples not in text.
Depletion of nonrenewable natural resources. When nonrenewable resources like oil and minerals are extracted and sold, their total sale value is included in GDP in the final products produced from them. But, the reduction in wealth in terms of the abundance of nonrenewable natural resources is not recognized.
Distribution of income. Some economists suggest that redistribution of income from the very rich to the very poor raises the welfare of the poorer persons more than it reduces the welfare of the rich so that in total there is an increase in society’s net welfare.

4. 2. How to Measure GDP
Expenditure Approach
Income Approach

5. Circular Flow of Income and Expenditures

6. Expenditure Approach
GDP = Consumption Spending (C) Private Domestic Investment (I)
+ Government Spending (G)
+ Exports - Imports (NX)
GDP = C + I + G + NX

7. Expenditure Shares 1998 U.S. Nominal Gross Domestic Product
Government Spending
17.5 %
Consumption
66.8 %
Investment
17.5 %
Net Exports = % (not shown in slide)

8. Consumption Trends U.S. Japan 1998 U.S. 66.8 % Japan 59.7 %
Is this a valid comparison?
What other explanations for differences in consumption?
- Government spending
socialized medicine
education

9. Government Spending Trends
U.S.
Japan
1998
U.S %
Japan %
Government spending includes:
Salaries of gov’t workers
Spending on roads, schools, etc.
Does not includes:
Transfer payments (e.g., social security, unemployment benefits)

10. Investment Trends Japan U.S. 1998 U.S. 17.5 % Japan 20.0 %
Investment = production and accumulation of goods for future use in production processes. Capital resources = any resources that are used to produce other goods
and are themselves produced.
Investment represents a foregone opportunity for consumption
Investment includes
Purchases of durable plant and equipment by firms
New homes
Inventory change (may be positive or negative)
Investment does not include:
purchases of financial capital (e.g., stocks and bonds)
purchase of land
investment in human capital (education)
Gross versus Net Investment
Net = Gross - depreciation Discussed under Accounting Complications

11. Net Export Trends
Japan
1998
U.S %
Japan 2.1 %
U.S.

12. National Income National Income with corrections = GDP
National Income with corrections = Personal Income
Personal Income Personal income taxes
- Social Security withholding
= Disposable Personal Income

13. 3. GDP Accounting Complications
Double Counting
Intended for “final” use
excludes intermediate products
Value added
excludes used goods
Depreciation
Depreciation
Net investment (In) = Gross Investment (Ig) - Depreciation
NDP = GDP - Depreciation
GDP = C + Ig + G + NX
NDP = C + In + G + NX

14. Depreciation Gross Domestic Product (GDP) - Depreciation
= Net Domestic Product (NDP)

15. Depreciation of Private Capital Stock
Percent of Gross
Private Investment
Percent of GDP

16. 4. Measuring Price Changes
Price Index - a measure of the change in the average level of prices
GDP Deflator
Consumer Price Index

17. GDP Deflator Nominal GDP Real GDP GDP Deflator
Value of output measured at actual prices (current dollar output)
Does not correct for inflation
Real GDP
Value of output based on prices of some base period (“constant” dollar output)
eliminates effect of inflation
GDP Deflator
= Nominal GDP ÷ Real GDP

18. Simple Economy
Was the economy better or worse off in 1994 compared with 1992?
Nominal GDP:
1992 = 12*4 + 9*3 + 4* *2 = $195
1994 = 14*5 + 10*3 + 5* *2 = $220
Real GDP:
1994 = 12*5 + 9*3 + 4* *2 = $191
GDP Deflator = ( Nominal GDP / Real GDP ) * 100
1992 GDP Deflator = (195/195) * 100 = 100
1994 GDP Deflator = (220/191) * 100 = 115.1
Economy worse off - Decline in real GDP.
Inflation = 100 * (Index2 - Index1) / Index1 = 15.1%

19. Current year Quantities
Nominal GDP
Current year Quantities
x Current year Prices

20. 1992 Nominal GDP = 1992 Quantities x 1992 Prices = 1992 Spending on
Food Housing Fun Machines
= 4 • $ • $9 + 3 • $ • $20
= $48 + $27 + $12 + $40
= $127

21. 1994 Nominal GDP = 1994 Quantities x 1994 Prices = 1994 Spending on
Food Housing Fun Machines
= 5 • $ • $ • $ • $20
= $70 + $30 + $20 + $40
= $160

22. Current year Quantities
Real GDP
Current year Quantities
x Base year Prices

23. 1992 Real GDP = 1992 Quantities x 1992 Prices
Food Housing Fun Machines
= 4 • $ • $9 + 3 • $ • $20
= $48 + $27 + $12 + $40
= $127

24. 1994 Real GDP = 1994 Quantities x 1992 Prices
Food Housing Fun Machines
= 5 • $ • $9 + 4 • $ • $20
= $60 + $27 + $16 + $40
= $143

25. GDP Growth Growth in Nominal GDP Growth in Real GDP
= ( ) • 100 = 26%
127
Growth in Real GDP
= ( ) • 100 = 13%

26. GDP Deflator GDP Deflator = Nominal GDP • 100 Real GDP
127
1994 GDP Deflator = 160 • 100 = 111.9
143

27. Inflation Change in Average Level of Prices
= Percent Change in GDP Deflator
Inflation from 1992 to 1994
= (1994 Deflator Deflator) • 100
1992 Deflator
= ( ) • 100 = 11.9%
100.0

28. Price Indexes GDP Deflator Consumer Price Index Base-year prices
Quantities variable
Imports excluded
Consumer Price Index
Base year quantities
Prices variable
Imports included
CPI Market basket
Consumer Expenditure Survey of over 30,000 families
Collects monthly prices on 71,000 goods and services at about 22,000 retail outlets
Survey of 35,000 rental units to determine cost of housing

29. Problems With Price Indexes
Substitution bias - changes in relative prices
between goods (butter vs margarine)
between stores (small vs large discounters)
Quality changes and new products
Chain-weighted indexes
Why are changes in cost of living so hard to measure?
literally millions of goods and services available in modern market economies
a single supermarket may contain 30,000 differently price items
WalMart store over 40,000
CPI overstated by about 1.1 percent due to
Substitution bias:
between goods percent
between stores percent
Quality changes and new products percent

30. 5. Empirical Applications
Use Real rather than Nominal values
Compare Per Capita rather than Aggregates
Compare Growth Rates rather than Levels
Two types of empirical studies:
Longitudinal - time trends
Examining single sector at different points in time - use Real or Real per capita to eliminate effects of both inflation and population differences
Comparing sectors over a period of time use Real growth rates or Real per capita growth rates
Cross-sectional
Comparing different sectors at same point in time - either nominal or real OK
Comparing different geographic areas (e.g., countries) - use per Capita Nominal or Real
Purchasing power parity corrects for differences in average price levels
.Indexes - not mentioned in text but used in earlier slides. Consumption as a share of total GDP. Eliminates problem of differences in population. Differences in inflation between the part and the whole can usually be ignored.