Chapter 2: The Data of Macroeconomics

1. Chapter 2: The Data of Macroeconomics

2. Gross Domestic Product (GDP) • the Consumer Price Index (CPI • Unemployment rate

3. National Income Accounting- measure the economy’s overall performance

4. Business firms- measures its flows of income and expenditures regularly • Usually every 3 months or annually

5. National Income Accounting- operates in much the same way as the economy as a whole. • NSO • NSCB • NEDA

6. This accounting enables the economists and policymakers to: • A. Assess the health of the economy by comparing levels of production at regular intervals.

7. Track the long-run course of the economy whether it has grown, been constant, or declined.

8. Formulate policies that will safeguard and improve the economy’s health.

9. Gross Domestic Product • Definition: Value of total final goods and services produced in an economy in a given period of time (measure of economic activity) • There are two ways to compute it: • Total income of everyone in the economy • Total expenditures on the economy’s goods and services • These two measures must be equal:Expenditure of buyers = Income of sellers

10. Why expenditure = income In every transaction, the buyer’s expenditure becomes the seller’s income. Thus, the sum of all expenditure equals the sum of all income.

11. The Circular Flow

12. Gross Domestic Product (GDP) • Example: an economy with two goods, apples and oranges GDP = (papples×qapples) + (poranges×qoranges) = ($0.50 × 4) + ($1.00 × 3) = $5.00

13. Gross Domestic Product (GDP) • Intermediate Goods • Value Added = value of firm’s output minus value of intermediate inputs

14. Gross Domestic Product (GDP) • GDP is the value of all FINAL goods and services produced and sold in the economy = $1.50 • GDP is also equal to the sum of value added in all stages on production = $0.50 + $1.00 = $1.50

15. The expenditure components of GDP • consumption • investment • government spending • net exports

16. An important identity Y = C + I + G + NX where Y = GDP = the value of total output C + I + G + NX = aggregate expenditure

17. Consumption (C) • durable goodslast a long time ex: cars, home appliances • non-durable goodslast a short time ex: food, clothing • serviceswork done for consumers ex: dry cleaning, air travel. def: the value of all final goods and services bought by households. Includes:

18. U.S. Consumption, 2005

19. Investment (I) def1: spending on [the factor of production] capital. def2: spending on goods bought for future use. Includes: • business fixed investmentspending on plant and equipment that firms will use to produce other goods & services • residential fixed investmentspending on housing units by consumers and landlords • inventory investmentthe change in the value of all firms’ inventories

20. U.S. Investment, 2005

21. Investment vs. Capital • Capital is one of the factors of production. At any given moment, the economy has a certain overall stock of capital. • Investment is spending on new capital.

22. Investment vs. Capital Example (assumes no depreciation): • 1/1/2002: economy has $500b worth of capital • during 2002:investment = $37b • 1/1/2003: economy will have $537b worth of capital

23. Flow Stock Stocks vs. Flows stock flow a person’s wealth a person’s saving # of people with # of new college college degrees graduates More examples:

24. Government spending (G) • G includes all government spending on goods and services. • G excludes transfer payments (e.g. unemployment insurance payments), because they do not represent spending on goods and services.

25. Government spending, 2005

26. Net exports (NX = EX - IM) def: the value of total exports (EX) minus the value of total imports (IM)

27. GDP: An important and versatile concept We have now seen that GDP measures • total income • total output • total expenditure • the sum of value-added at all stages in the production of final goods

28. Some Issues of GDP • Home production • Illegal activities • Underground economy • Environment Quality

29. GNP vs. GDP • Gross National Product (GNP):total income earned by the nation’s factors of production, regardless of where located • Gross Domestic Product (GDP):total income earned by domestically-located factors of production, regardless of nationality. (GNP – GDP) = (factor payments from abroad) – (factor payments to abroad)

30. (GNP – GDP) as a percentage of GDP for selected countries, 1997.

31. Real GDP • Is GDP a good measure of well-being/economic activity? • Recall that: GDP = (papples×qapples) + (poranges×qoranges) Higher GDP does NOT imply higher well-being  GDP can increase if prices increase, with no change in quantities • Real GDP = measure of output keeping prices constant

32. Real GDP In the previous example:

33. Real GDP Let 2002 be the base-year, i.e., real GDP will be calculated using 2002 prices

34. Real GDP Now with 2003 as base-year: Notice that, at the base-year: Real GDP = Nominal GDP

35. Real GDP • Issue: results are sensitive to the choice of base year • Base year 2002, Real GDP goes from $5.00 to $5.50 (growth rate = 10%) • Base year 2003, Real GDP is the same in both years (growth rate = 0) • Solution: Chain-weighting • Take the average of the growth rates = 5%

36. Real GDP • Then use this growth rate to calculate Real GDP in 2003: • RGDP2003 = $5.00*(1 + .05) = $5.25 • RGDP2002 = $5.00 • Advantages: • It does not depend on the base year • Prices are updated as time passes

37. GDP Deflator Reflects changes in the overall price level  how price changes between current year and the base year

38. GDP Deflator In our example, using 2002 as base year: = $5.20/$5.50 = 0.945

39. GDP Deflator  Price level decreased 5.5% from 2002 to 2003

40. Consumer Price Index (CPI) • Measures changes in the price level, i.e., inflation • More specifically, measures how the cost of a given consumption basket evolves over time (cost of living) • The bundle includes goods and services consumed by a typical consumer

41. Consumer Price Index (CPI) For example, suppose a typical consumer buys 5 apples and 2 oranges: In other words, the cost of this basket is 2% lower in 2003 relative to 2002 (the base year)

42. CPI vs. GDP Deflator

43. CPI vs. GDP Deflator

44. CPI GDP deflator Two measures of inflation Percentage change 16 14 12 10 8 6 4 2 0 2 - 1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998 Year

45. Reasons why the CPI may overstate inflation • Substitution bias: The CPI uses fixed weights, so it cannot reflect consumers’ ability to substitute toward goods whose relative prices have fallen. • Introduction of new goods: The introduction of new goods makes consumers better off and, in effect, increases the real value of the dollar. But it does not reduce the CPI, because the CPI uses fixed weights. • Unmeasured changes in quality: Quality improvements increase the value of the dollar, but are often not fully measured.

46. CPI vs. GDP deflator prices of capital goods • included in GDP deflator (if produced domestically) • excluded from CPI prices of imported consumer goods • included in CPI • excluded from GDP deflator the basket of goods • CPI: fixed • GDP deflator: changes every year