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Chapter 2 THE DATA OF MACROECONOM I CS

Chapter 2 THE DATA OF MACROECONOM I CS. Goals and Outline of Chapter 2:. Gross Domestic Product (GDP) What is Gross Domestic Product and how we measure it? Why is this measure important? What are the definitions of the major expenditure components?

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Chapter 2 THE DATA OF MACROECONOM I CS

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  1. Chapter 2 THE DATA OF MACROECONOMICS

  2. Goals and Outline of Chapter 2: Gross Domestic Product (GDP) What is Gross Domestic Product and how we measure it? Why is this measureimportant? What are the definitions of the major expenditure components? What are the trends in these components over time? 2. Inflation What is the difference between ‘Real’ and ‘Nominal’ variables? How is inflationmeasured? 3. Unemployment How is Unemploymentmeasured? Why do we care about Unemployment?

  3. GDP is a measure of output! Why Do We Care? Because output is highly correlated (at certain times) with things we care about (standard of living, wages, unemployment, inflation, budget and trade deficits, valueof currency, etc…) Formal Definition: GDP is the market value of all final goods and services newly produced on domestic soil during a given time period (different than GNP) GDP

  4. Gross Domestic Product GDP is the best single measure of the economic well-being of a society. Production Method: Measure the Value Added summed across allfirms (value added = sale price less cost of rawmaterials) Income Method: Labor Income (wages/salary) + Capital Income (rent, interest, dividends, profits)+ Government Income (taxes) Three ways of measuring GDP Expenditure Method: Spending by consumers (C) + Spending by businesses(I) + Spending by government (G) + Net Spending byforeign sector (NX) Fundamentalidentityofnationalincomeaccount: Totalproduction=totalincome=totalexpenditure

  5. CalculatingGDP (example) To see how all these approaches work we consider a simple example. Consider a very simple economy where there is a coconut producer, a restaurant,some consumers and a government.

  6. CalculatingGDP The product approach (or value added) In this approach, to calculate the GDP: we add the value of all goods and servicesproduced and then subtract the value of all intermediate goods used in production. intermediate goods Goods that are produced by one firm for use in further processing by another firm. We subtract the value of the intermediate goods to avoid double counting in thecalculation. Using this approach the GDP is simply defined as the sum of value added to goodsand services across all productive units in the economy.

  7. CalculatingGDP The product approach (or value added)

  8. CalculatingGDP The expenditure approach In this approach, GDP is defined as: the total spending on all final goods and servicesproduced in theeconomy in a given period of time. Notice: the word final in the definition implies that we do not count spending on intermediategoods. Y = GDP = the value of total output C + I + G + NX = aggregateexpenditure

  9. CalculatingGDP The expenditure approach (components)

  10. I produce applesand I can potentially: • Sell them to some domestic customer (Consumption) • Sell them to some business (Investment) • Keep them in my stock room as inventory (Investment) • Sell them to the othercityfor their shelters (Government spending) • Sell them to some foreign customer (Net Export) Simple example

  11. CalculatingGDP The expenditure approach From our example, using the expenditure approach we have that I = 0 and NX = 0. There is no investment in our example and no international trade. The GDP is then given by: C + G

  12. CalculatingGDP The income approach Components of the income approach: • Wages, salaries, and supplements • Net interest • Rental income of persons • Income of unincorporated enterprises • Corporate profits before taxes • Indirect taxes • Depreciation

  13. CalculatingGDP The income approach In this approach, GDP is defined as the sum of all income received by economic agentscontributingto production. Income includes the profits of firms.

  14. The different components of aggregate • expenditure: • Consumption (C) • the value of all goods and services bought by households. • Includes: • durable goods • Goods that last a relatively long time, such as cars and household appliances. • nondurable goods • Goods that are used up fairly quickly, such as food and clothing. • services • The things we buy that do not involve the production of physical things, • such as legal and medical services and education.

  15. The different components of aggregate expenditure: Investment(I) gross private domestic investment (I) Totalinvestment in capital—that is, the purchase of new housing, plants, equipment, and inventory by the private (or nongovernment) sector. nonresidential investment Expenditures by firms for machines, tools, plants, and so on. residential investment Expenditures by households and firms on new houses and apartment buildings. change in business inventories The amount by which firms’ inventories change during a period. Inventories are the goods that firms produce now but intend to sell later. Land purchases are NOT counted as part of GDP (land is not produced!) Stock purchases are NOT counted as part of GDP (stock transactions do NOT represent production – they are saving!)

  16. The different components of aggregate expenditure: Government spending(G) Governmentspending includes all government spending ongoodsand services. Governmentspending excludestransfer payments (e.g.unemployment insurance payments), because they do not represent spending on goods and services.

  17. The different components of aggregate expenditure: Net exports (NX = EX - IM) The difference between exports (sales to foreigners of country-produced goods and services) and imports (country purchases of goods and services from abroad). The figure can be positive or negative.

  18. Another Measure of Total Income GNP vs. GDP Gross National Product (GNP): total income earned by the nation’s factors ofproduction, regardless of where located Gross Domestic Product (GDP): total income earned by domestically-locatedfactors of production, regardless of nationality. GNP = GDP + Net Factor Income from Abroad (NFIA) NFIA = Receipts of factor income from the rest of the World – Payments of factor income to the rest of the World

  19. Another Measure of Total Income NNP net national product (NNP) Gross national product minus depreciation; a nation’s total product minus what is required to maintain the value of its capital stock. NNP = GNP – Depreciation personal income The total income of households.

  20. Real vs. Nominal GDP • GDP is the value of all final goods andservices produced. • Nominal GDP measures these valuesusing current prices. • Real GDP measure these values usingthe prices of a base year. • base year • The year chosen for the weights in a fixed-weight procedure. • fixed-weight procedure • A procedure that uses weights from a given base year. • Nominal GDP = Current year Quantities x Current year Prices • Real GDP = Current year Quantities x Base year Prices Real GDP = Nominal GDP / price index

  21. Changes in nominal GDP can be due to: • changes in prices • changes in quantities of outputproduced • Changes in real GDP can only be due tochanges in quantities, • because real GDP is constructed using constant base-year prices. Real GDP controls for inflation

  22. Computenominal GDP in 2012 and 2013 • Compute real GDP in each year using2012 as the base year. Practice problem

  23. Solutions : Nominal GDP multiply Ps & Qs from same year 2012: $1 x 10 + $10 x 3 = $40 2013: $2 x 15 + $15 x 4 = $90 Real GDP multiply each year’s Qs by 2012 Ps 2012: as above: $40 2013: $1 x 15 + $10 x 4 = $55 (2012$) So in real terms, GDP did not rise as much asit would seem from nominal terms.

  24. The inflation rate is the percentageincrease in the overall level of prices. One measure of the price level isthe GDP Deflator, defined as GDP deflator identifies an index that measures the overall pricelevelin a given year. Inflation rate is the rate of change of that index from one year to the following. Calculating the GDP Deflator

  25. Example with 3 goods: For goodi = 1, 2, 3 Pit= the market price of good iin month t Qit = the quantity of good iproduced in month t NGDPt= Nominal GDP in month t RGDPt= Real GDP in month t The GDP deflator is a weighted average of prices. The weight on each price reflectsthat good’s relative importance in GDP. Note that the weights change over time. Understandingthe GDP deflator

  26. The Consumer Price Index CPI A price index computed each month by the Statistical institute using a bundle that is meant to represent the “market basket” purchased monthly by the typical urban consumer. The CPI market basket shows how a typical consumer divides his or her money among various goods and services. Most of a consumer’s money goes toward housing, transportation, and food and beverages.

  27. Contents of the CPI Market Basket

  28. Understandingthe CPI Example with 3 goods: For goodi = 1, 2, 3 Ci= the amount of good iin the CPI’s basket Pit= the price of good i in month t Et = the cost of the CPI basket in month t Eb = cost of the basket in the base period The CPI is a weighted average of prices. The weight on each price reflectsthat good’s relative importance in the CPI’s basket. Weights remain fixed over time.

  29. 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 CPI vs. GDP deflator

  30. Measures of inflation inTurkey Percentage change

  31. employed working at a paid job unemployed not employed but looking for a job labor force the amount of labor available for producinggoods and services; allemployed plusunemployed persons Labor Force = Employed +Unemployed not in the labor force not employed, not looking for work. Not in The Labor Force= Population – Labor Force Measuring Unemployment: Categories of the population

  32. Unemployment Rate = Number of Unemployed Labor Force  100 LaborForce Participation Rate = Labor Force Adult Population  100 unemployment rate percentage of the labor force that isunemployed labor force participation rate the fraction of the adult populationthat ‘participates’ in the labor force Two important labor force concepts

  33. Number employed = 146.1 million Number unemployed = 6.9 million Adult population = 231.7 million Labor Force = 146.1 + 6.9 = 153.0 Not in The Labor Force= 231.7 – 153 = 78.7 Unemployment Rate= (6.9/153) x 100% = 4.5% LaborForce Participation Rate = (153.0/231.7)x100 %= 66 % Practice problem

  34. A stock is aquantity measuredat a point in time. A flow is a quantity measured per unit of time. Stock Flow a person’s wealth a person’s annual saving # of people with college degrees # of new college graduates this year the government debt the government budget deficit Stock Variables vs Flow variables

  35. Gross domestic product (GDP) Consumer Price Index (CPI) Unemployment rate National income accounting Stocks and flows Value added Imputed value Nominal versus real GDP GDP deflator National income accounts identity Consumption Investment Government purchases Net exports Labor force Labor-force participation rate Key Concepts of Chapter 2

  36. Measuring GDP using the Income Approach and the Expenditure Approach - watch the video - https://www.youtube.com/watch?v=ZdGnhusKnRU

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