1. Introduction to Macroeconomics
Chapter 4
Measuring Output of the Macroeconomy

2. Chapter 4. Measuring the Macroeconomy
1. Measuring Total Output
2. How to Measure GDP
3. GDP Accounting Complications
Nominal and Real GDP
Measuring Price Changes
6. Empirical Applications
Introduction to Macroeconomics

3. 1. Measuring Total Output
Monetary Measure of Value
GDP versus GNP
Omissions from GDP - does not measure social welfare
Introduction to Macroeconomics

4. 1. Measuring Total Output Monetary Measure of Value
Quantity times Price equals Market Value
Cars 1,000 x $20,000 = $20,000,000
Dolls 10,000 x $ = $ ,000
Total Value of Output = $20,100,000
Introduction to Macroeconomics

5. 1. Measuring Total Output GDP versus GNP
Nominal Gross Domestic Product (GDP) - the market value of final goods and services (i.e., sold to final consumers) produced by a nation during a specific period, usually 1 year.
Nominal Gross National Product (GNP) - the market value of final goods and services produced by labor and property supplied by the residents of a nation during a specific period, usually 1 year.
Toyota plant Ford plant
in Tennessee in Mexico
GDP included excluded
GNP excluded included
Introduction to Macroeconomics

6. 1. Measuring Total Output Omissions from GDP
GDP is a poor measure of social welfare:
Leisure
Home and volunteer labor
(non market production)
Depletion of nonrenewable resources
Unregulated pollution
Distribution of income
Differences in preferences
Social Welfare
Examples not in text.
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. A country with a lower GDP per capita may have a “better” distribution of income.
Preferences - Aunt on isle of Mull (West Coast of Scotland). One road goes around the island. Many houses do not have electricity. No lawnmower - sheep. A country with lower GDP per capita may prefer it that way.
Introduction to Macroeconomics

7. Circular Flow Expenditure Approach Income Approach
2. How to Measure GDP
Circular Flow
Expenditure Approach
Income Approach
Introduction to Macroeconomics

8. 2. How to Measure GDP Circular Flow of Income and Expenditures
Resources
Business
Firms
Households
Goods and Services
Expenditures
Solid Lines - Flow of Money
Dashed lines - Flow of Goods and Services
Introduction to Macroeconomics

9. 2. How to Measure GDP Expenditure Approach
GDP = Consumption Spending (C)
+ Private Domestic Investment (I)
+ Government Spending (G)
+ Exports - Imports (net exports, NX)
GDP = C + I + G + NX
Introduction to Macroeconomics

10. 2. How to Measure GDP Expenditure Approach: Expenditure Shares
2002 U.S. Nominal Gross Domestic Product
Government Spending
18.8 %
Consumption
69.9 %
Investment
15.2 %
Net Exports = % (not shown in slide)
Introduction to Macroeconomics

11. 2. How to Measure GDP Expenditure Approach: Consumption
U.S.
Japan
1999
U.S %
Japan %
Consumption:
Durable goods: cars, appliances
Non-durable goods: food, gasoline
Services: haircuts, lawyers, education
Is this a valid comparison between US and Japan? What other explanations for differences in consumption?
- Government spending
socialized medicine
education
Introduction to Macroeconomics

12. 2. How to Measure GDP Expenditure Approach: Government
U.S.
Japan
1999
U.S %
Japan %
Government spending includes:
Salaries of government workers
Spending on roads, schools, etc.
Does not includes:
Transfer payments (e.g., social security, unemployment benefits)
Payment on Federal debt
Introduction to Macroeconomics

13. 2. How to Measure GDP Expenditure Approach: Investment
Japan
U.S.
1999
U.S %
Japan %
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
Introduction to Macroeconomics

14. 2. How to Measure GDP Expenditure Approach: Net Exports
Japan
U.S.
Net Exports = Exports - Imports
Also called Trade Balance
U.S. imports more than it exports
1999
U.S %
Japan 1.5 %
Introduction to Macroeconomics

15. 2. How to Measure GDP Income Approach
National Income = GDP (with corrections)
Personal Income = National Income
(with corrections)
Personal Income Personal income taxes Social Security withholding = Disposable Personal Income
Introduction to Macroeconomics

16. 3. GDP Accounting Complications
Double Counting
Depreciation
Introduction to Macroeconomics

17. 3. GDP Accounting Complications Double Counting
Intended for “final” use
excludes intermediate products
Value Added
excludes used goods
Introduction to Macroeconomics

18. 3. GDP Accounting Complications Depreciation
Gross Investment
- Depreciation
= Net Investment
Gross Domestic Product (GDP)
= Net Domestic Product (NDP)
Depreciation
Net investment (In) = Gross Investment (Ig) - Depreciation
NDP = GDP - Depreciation
GDP = C + Ig + G + NX
NDP = C + In + G + NX
Introduction to Macroeconomics

19. Definitions Sample Problem GDP Growth 4. Nominal and Real GDP
Introduction to Macroeconomics

20. 4. Nominal and Real GDP Definitions
Nominal GDP
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
Introduction to Macroeconomics

21. 4. Real GDP Sample Problem
Was the economy better or worse off in 1994 compared with 1992?
What was the rate of inflation between 1992 and 1994?
Introduction to Macroeconomics

22. 4. Real GDP Definition of Nominal GDP
= Current year Quantities
x Current year Prices
Introduction to Macroeconomics

23. 4. Real GDP Sample Problem: 1992 Nominal GDP
= 1992 Quantities x 1992 Prices
= 1992 Spending on
Food Housing Fun Machines
= 4 • $ • $9 + 3 • $ • $20
= $48 + $27 + $12 + $40
= $127
Introduction to Macroeconomics

24. 4. Real GDP Sample Problem: 1994 Nominal GDP
= 1994 Quantities x 1994 Prices
= 1994 Spending on
Food Housing Fun Machines
= 5 • $ • $ • $ • $20
= $70 + $30 + $20 + $40
= $160
Introduction to Macroeconomics

25. 4. Real GDP Definition of Real GDP
= Current year Quantities
x Base year Prices
Introduction to Macroeconomics

26. 4. Real GDP Sample Problem: 1992 Real GDP
= 1992 Quantities x 1992 Prices
Food Housing Fun Machines
= 4 • $ • $9 + 3 • $ • $20
= $48 + $27 + $12 + $40
= $127
Introduction to Macroeconomics

27. 4. Real GDP Sample Problem: 1994 Real GDP
= 1994 Quantities x 1992 Prices
Food Housing Fun Machines
= 5 • $ • $9 + 4 • $ • $20
= $60 + $27 + $16 + $40
= $143
Introduction to Macroeconomics

28. 4. Real GDP Sample Problem: GDP Growth
Growth in Nominal GDP
= ( ) • 100 = 26%
127
Growth in Real GDP
= ( ) • 100 = 13%
Introduction to Macroeconomics

29. 5. Measuring Price Changes
Price index
GDP deflator
Consumer price index
Problems with price indexes
Introduction to Macroeconomics

30. Measuring Price Changes Price indexes
Price Index: a measure of the change in the average level of prices
GDP Deflator
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
Introduction to Macroeconomics

31. Measuring Price Changes GDP deflator
GDP Deflator = Nominal GDP • 100
Real GDP
1992 GDP Deflator = 127• 100 = 100.0
127
1994 GDP Deflator = 160 • 100 = 111.9
143
Introduction to Macroeconomics

32. Measuring Price Changes 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
Introduction to Macroeconomics

33. Measuring Price Changes 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
Introduction to Macroeconomics

34. 6. 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.
Introduction to Macroeconomics

35. 6. Empirical Applications Compare Per Capita rather than Aggregates
Introduction to Macroeconomics

36. 6. Empirical Applications Compare growth rates rather than levels
Introduction to Macroeconomics