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Copyright © 2012 Pearson Addison-Wesley. All rights reserved.
Chapter 2
Measuring Macroeconomic Data
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• To examine the different approaches to measuring gross domestic product
• To understand real versus nominal GDP
• To understand how to measure inflation
• To understand how to measure unemployment
• To understand different interest rates
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Measuring Economic Activity: National Income Accounting
• Gross domestic product (GDP) is the total value of goods and services produced in an economy– the broadest measure of economic activity
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• National income accounting is an accounting system that measures economic activity and its components
• Fundamental identity of national income accounting:
Total Production = Total Expenditure = Total Income
Measuring Economic Activity: National Income Accounting (cont’d)
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Measuring GDP: The Production Approach
• GDP is the current market value of all final goods and services newly produced in the economy during a fixed period of time
• In the case of apples and oranges, we multiply the their prices and quantities, and then add them up:
GDP = (price of apples ✕ quantity of apples) + (price of oranges ✕ quantity of oranges)
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Market Value
• Not all goods and services are counted in GDP because they are:
– Nonmarket goods and services, which do not have a market price (e.g., household services produced within a family), or
– Produced in the underground economy
• Many nonmarket goods and services are counted in GDP by their imputed values
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Newly Produced Goods and Services
• GDP includes only goods and services that are newly produced in the current period
• If you buy a 3-year-old car from a car dealership
– The cost of the used car is not included in GDP– The value of the services provided by the car
dealership is included in GDP
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Valued-Added Technique
• Value added is the value of a firm’s output minus the cost of the intermediate goods purchased by the firm
• By adding up the value added from each firm, we get the final value of the goods and services produced
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Capital Goods
• A capital good (e.g., a robot) is used in the production of other goods that is not used up in the stages of production
• New capital goods are classified as final goods because they are not included in spending on other final goods and yet their production is part of economic activity
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Inventory Investment
• Inventory investment is the change in inventories (firms’ holdings of raw materials, unfinished goods and unsold finished goods) over a given period of time
• Inventory investment is included in GDP for the same reason that we include capital goods
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Fixed Period of Time
• We calculate GDP over a fixed period of time, such as a quarter or a year
• GDP is a flow, which is an amount per a given unit of time
• By contrast, a stock is a quantity at a given point in time
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Policy and Practice: Can GDP Buy Happiness?
• Is GDP the best measurement of national well-being?• In 1972, the king of Bhutan proposed the
replacement of GDP by “gross national happiness” that incorporates factors such as spirituality and culture
• In 1990, the United Nations began to rank countries on a so-called human development index, which is a combination of life expectancy, education, literacy, educational participation, and GDP
• In 2008, a French economic commission led by Nobel Prize winner Joseph Stiglitz called for modifications to GDP with factors such as political freedom, physical safety, and work-life balance
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Box: Stocks Versus Flows
• A stock is often an accumulation of flows over time
• Examples:– Inventory investment is a flow, which
accumulates into the stock of inventories– Saving is a flow, which accumulates into a
person’s wealth
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FIGURE 2.1 Stocks Versus Flows
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• GDP is the total spending on currently produced final goods and services in the economy
• National income identity:
Y = C + I + G + NXwhere Y = GDP = total production (output)
C = consumption expenditureI = investmentG = gov’t purchases of goods & servicesNX = net exports = exports - imports
Measuring GDP: The Expenditure Approach
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TABLE 2.1 GDP and Its Components, 2009
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Consumption Expenditure
• Total spending for currently produced consumer goods and services
• Consumption was 70.8% of GDP in 2009 • Basic categories:
1. Consumer durables2. Nondurable goods3. Services
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Investment
• Spending on currently produced capital goods that are used to produce goods and services over an extended period of time
• Investment was 11.4% of GDP in 2009• Basic categories:
1. Fixed investment2. Inventory investment3. Residential investment
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Box: Meaning of the Word Investment
• For non-economists, an investment normally refers to the purchase of common stocks or bonds
• For economists, investment spending refers to the purchase of physical assets, such as new machines or new houses—purchases that add to GDP
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Government Purchases
• Spending by the government on currently produced goods and services
• Government purchases were 20.6% of GDP in 2009
• Government consumption includes government purchases for short-lived goods and services like health care and police
• Government investment includes spending for capital goods like buildings and computers represents
• Pure government transfers (e.g., Social Security and Medicare) are excluded from G
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Net Exports
• Net exports (or trade balance) are exports minus imports
• Why subtract imports from GDP?– Answer: Spending on imports is included in
consumption expenditure, investment, and government purchases, but is not produced in this country
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FIGURE 2.2 Expenditure Components of U.S. GDP, 1950-2010
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Changes in the Spending Components of GDP Over Time
• Consumption grew steadily as a share of GDP from 1970 to 2008
• Investment is much more volatile than other components of GDP
• Government purchases have actually remained quite stable at around 20% of GDP
• Net exports have been negative
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Box: An International Comparison of Expenditure Components
• The United States differ from other countries by having the highest share of GDP going to consumption, the lowest share of investment, and net exports have been negative
• By contrast, China has the lowest share of consumption, the highest share of investment, and the largest share of net exports
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FIGURE 2.3 Shares of Expenditure Components for Different Countries
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Measuring GDP: The Income Approach
• Compensation of employees – wages and salaries of employees, and employee benefits
• Corporate profits – profits after taxes of corporations• Other income – income of the self-employed, royalty
income and net interest earned by individuals, etc.• Depreciation – the loss of value of capital from wear
and tear – net domestic product = GDP – depreciation
• Net factor income – wages, profits, and rent paid to U.S. residents by foreigners minus factor income paid by U.S. residents to foreigners
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TABLE 2.2 Income Approach to GDP, 2009
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Income Measures
• National income = Compensation of employees + other income + corporate profits
• Gross national product (GNP) = national income + depreciation – total income earned by U.S. residents
• Gross domestic product (GDP) = GNP + net factor income – domestically produced measure of gross product
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Income Measures (cont’d)
Private Disposable Income = GDP + net factor income + transfer payments
received from the government + interest payments on government debt – taxes
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Income Measures (cont’d)
Net Government Income = taxes – transfers – interest payments on
government debt
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Real Versus Nominal GDP
• A nominal variable is a measure at current market (nominal) prices (e.g., nominal GDP)
• A real variable is a measure in terms of quantities of actual goods and services (e.g., real GDP)
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Real Versus Nominal GDP (cont’d)
or
Nominal GDP = Price Level ✕ Real GDP
Nominal GDPReal GDP =
Price Level
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• If 2005 is the base year, then real GDP for the year 2010 is:
Real GDP in 2012 =
(price of apples in 2005 ✕ quantity of apples in 2012) + (price of oranges in 2005 ✕ quantity of oranges in 2012)
Real Versus Nominal GDP (cont’d)
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• Raw data on GDP tends to fall in cold and snowy months
• Therefore, economic statistics like GDP data are seasonally adjusted to account for regular seasonal fluctuations within a year
Real Versus Nominal GDP (cont’d)
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Chain-Weighted Measures of Real GDP
• If prices of some important goods changed dramatically relative to other goods, using a fixed base-year for prices when calculating real GDP can produce misleading results
• Chain-weighted measures of GDP allow the base year to change continuously
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Measuring Inflation
• Price indexes are measures of the price level
• Examples:– GDP deflator (or implicit price deflator)– Personal consumption expenditure deflator– Consumer price index
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GDP Deflator
GDP Deflator for Year y
Nominal GDP in Year y= 100 x
Real GDP in Year y
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PCE Deflator
PCE Deflator for Year y
Nominal PCE in Year y= 100 x
Real PCE in Year y
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Consumer Price Index
• A measure of the average prices of consumer goods and services, i.e., a cost of living index
• Calculated monthly by the Bureau of Labor Statistics using a basket of thousands of consumer goods and services
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Consumer Price Index
• If the basket consists of 2 apples and 1 orange, then the CPI for 2010 with a base year of 2005 is:
CPI for 2010 =
(10 x price of gas/gallon in 2012)+(2 x price of apples in 2012)100 x
(10 x price of gas/gallon in 2015)+(2 x price of apples in 2015)
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Policy and Practice: Policy and Overstatements of the Cost of Living
• The CPI is used in determining labor contracts and government payments such as Social Security benefits
• A study led by Michael Boskin of Stanford University found that increases in the CPI overstate increases in the cost of living by 1% point
• Measurements errors in the CPI could have important implications
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Inflation Rate
• The inflation rate is the % rate of change of the price level over a particular period:
where
t t 1 t
tt 1 t 1
P - P P = =
P P
t = inflation rate in period t
tP = period level at time t
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FIGURE 2.4 U.S. Inflation Rates with Different Price Indexes, 1950-2010
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Percentage Change Method and the Inflation Rate
• Because:
• We know that:
% Change in ( X ) = (% Change in )
+ (% Change in )
x y x
y
% Change in Nominal GDP =
(% Change in the Price Level)
+ (% Change in Real GDP)
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Percentage Change Method and the Inflation Rate (cont’d)
• Because the % change in the price level is the inflation rate, while the % changes in nominal and real GDP are the growth rate:
Inflation Rate = (Growth Rate of Nominal GDP)
- (Growth Rate of Real GDP)
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Measuring Unemployment
• The unemployment rate is the percentage of people in the civilian population who want to work but who do not have jobs
• The Bureau of Labor Statistics classifies each adult over age 16 into:1. Employed2. Unemployed3. Not in the labor force
• Discouraged workers (those who would live to work but have given up looking, and those who have voluntarily left the labor force)
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Measuring Unemployment (cont’d)
Labor Force =
Number of Employed + Number of Unemployed
Number of UnemployedUnemployment Rate =
Number of Employed
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Labor ForceLabor-Force Participation Rate =
Adult Population
EmployedEmployment Ratio =
Adult Population
Measuring Unemployment (cont’d)
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FIGURE 2.5 Unemployment in the Adult Civilian Population, 2010
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Macroeconomics In The News: Unemployment and Employment
• The Bureau of Labor Statistics reports employment and unemployment data using two alternative surveys: the household survey and the survey of business establishments
• The two surveys sometimes give a different picture of labor market conditions due to:• The household survey counts workers, while the
establishment survey counts jobs• The household survey counts the self-employed as
working, while the establishment does not• The establishment survey covers more workers
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Measuring Interest Rates
• An interest rate is the cost of borrowing, or the price paid for the rental of funds
• Interest rates are returns for holding debt securities, such as bonds
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Macroeconomics In The News: Interest Rates
• Interest rates that receive media attention are:– Prime rate– Federal funds rate– London Inter-Bank Offered Rate (LIBOR)– Treasury bill rate.– Ten-year Treasury bond rate– Federal Home Loan Mortgage Corporation rate
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Real Versus Nominal Interest Rates
• A nominal interest rate makes no allowance for inflation
• The real interest rate is the amount of extra purchasing power a lender must be paid for the rental of his/her money– The ex ante real interest rate is adjusted
for expected changes in the price level – The ex post real interest rate is adjusted
for actual changes in the price level
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Real Versus Nominal Interest Rates (cont’d)
• The Fisher equation:
e = + i r
e
= nominal interest rate
= nominal interest rate
= expected inflation
i
r
eor = - r i
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Real Versus Nominal Interest Rates (cont’d)
• Example: For a one-year loan with a 4% nominal interest rate (i=4%) and you expect the inflation to be 6% in a year ( =6%), then:
• When the real interest rate is low, there are greater incentives to borrow and invest, but fewer incentives to lend.
= 4% - 6% = -2%r
e
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The Important Distinction Between Real and Nominal Interest Rates
• Credit markets are where households and businesses get funds (credit) from each other
• Because the real interest rate reflects the real cost of borrowing, it is likely to be a better indicator of the incentives to borrow, invest, and lend in credit markets than nominal interest rates
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FIGURE 2.6 Real and Nominal Interest Rates (Three-Month Treasury Bill), 1955-2010