measuring a nation’s income gdp and other measures · measuring a nation’s income gdp and other...

Principles of MacroeconomicsModule 2.1

Measuring a Nation’s IncomeGDP and Other Measures

Gross Domestic ProductThemarketvalueofallfinalgoodsandservicesproducedwithinacountryinagivenperiodof

time.• GDPmeasureshowwellaneconomyisdoingovertime

• GDPmeasureshowwellaneconomyisdoingcomparedtoothereconomies

• GDPmeasuresfluctuationsintheeconomy

Breakdown of GDP• MarketValue:theamountofmoneyneededtobuyallgoodsandservicesproducedintheeconomyatmarketprices

• Finalgoodsandservices:Productsthatareforfinalsale–notintermediategoodsusedintheproductionofothergoods

• Inacountry:Countsonlygoodsproducedwithinthelegalgeographicalboundariesofacountryregardlessofwhomakesthem

• Inagivenperiod:Countsonlygoodsproducedwithinthatcurrentyearorquarter(notgoodsproducedinthepast)

Components of GDPOutputEquation:Y=C+I+G+NX

• Y=OutputorGDPAmountofgoodsandservicesproducedbyaneconomy

• C=ConsumptionSpendingongoodsandservicesbyhouseholds

• I=InvestmentSpendingoncapitalgoodsbyfirms

• G=GovernmentSpendingSpendingongoodsandservicesbythegovernment

• NX=NetExportsExports- Imports

Nominal GDP vs. Real GDPNominalGDP:Thevalueofoutputatcurrentprices–takesintoaccountpricechangeandquantitychange

NGDP=P1*Q1 +P2*Q2 +P3*Q3 +….+Pn*Qn

RealGDP:Thevalueofoutputatconstantprices– takesintoaccountonlyquantitychange

RGDP=Pb*Q1 +Pb*Q2 +Pb*Q3 +….+Pb*Qn

Pb=pricesatbaseyear

Consideraneconomythatproducescalculators,andpens.Usingthefollowingtabledetermine:• NominalGDPeachyear• RealGDPifthebaseyearis2011.

Calculators Pens

Price Quantity Price Quantity

2011 $20 100 $5 300

2012 $20.50 105 $5.25 350

2013 $21.75 107 $5.80 425

Test your Understanding

Calculators Pens NominalGDPP Q PxQ P Q PxQ

2011 $20 100 $2,000 $5 300 $1,500 $3,500

2012 $20.50 105 $2,153 $5.25 350 $1,838 $3,990

2013 $21.75 107 $2,327 $5.80 425 $2,465 $4,792

NominalGDP=PxQ


RealGDP=P(2011)xQ

Calculators Pens RealGDPP Q PxQ P Q PxQ

2011 $20 100 $2,000 $5 300 $1,500 $3,500

2012 $20.50 105 $2,100 $5.25 350 $1,750 $3,850

2013 $21.75 107 $2,140 $5.80 425 $2,125 $4,265


Change in GDP

• ChangeinnominalGDP– reflectschangesinbothpricesandquantitiesproduced

• ChangeinrealGDP– reflectsonlychangesinquantitiesproducedRealGDPis“corrected”forinflation

Growthinproduction– growthinrealGDP!Incomeandeconomicwellbeing isrising!

Growth in GDP

NominalGDP Growth Real

GDP

2011 $3,500 $3,500

2012 $3,990 $3,850

2013 $4,792 $4,265

Growth in GDP

NominalGDP Growth Real

GDP Growth

2011 $3,500 - $3,500 -

2012 $3,990 14.0% $3,850 10.0%

2013 $4,792 20.1% $4,265 10.8%

Using GDP to understand prices•

Calculating Inflation with GDP

Inflation:Percentagechangeinpricelevelsfromlastyeartothisyear.

NOMINALGDP REALGDP GDP

Deflator Inflation

2011 $9,500 $9,5002012 $11,030 $10,2502013 $12,532 $10,715




Deflator Inflation

2011 $9,500 $9,500 100 -2012 $11,030 $10,2502013 $12,532 $10,715




Deflator Inflation

2011 $9,500 $9,500 100 -

2012 $11,030 $10,250 107 7.6%

2013 $12,532 $10,715




Deflator Inflation

2011 $9,500 $9,500 100 -2012 $11,030 $10,250 107 7.6%2013 $12,532 $10,715 117 8.2%

Key Takeaways• GDPisoneofthemostimportantmeasuresusedbyeconomiststogaugewhatis

happeningwiththeeconomy

• Itaccountsforconsumption,investment,governmentspendingandnetexports

• RealGDPcontrolsforchangingpriceswhilenominalGDPiscalculatedusingactualpricesobservedintheeconomyinthatyear

PrinciplesofMacroeconomicsModule2.2

Measuring the Cost of Living Inflation, CPI, and Prices

Cost of Living• Anothermeasureofwhatishappeningintheeconomyisthecostofliving

• Pricesofmanygoodsandserviceschangeindifferentdirections– someincrease,somedecrease,somestaythesame

• Whenthemajorityofpricesincrease– inflation!Useapriceindextomeasureoverallpricesinan

economy

TheConsumerPriceIndex(CPI)• Measuresthetypicalconsumer’scostofliving

• CPIismadeupofafixedbasketofgoodswhosepriceschangeyearoveryear

• Thechangeinpricesforthebasketofgoodsindicatesinflation

How the CPI Is Calculated1. Fixthe“basket.”

DeterminewhatgoodsmakeitintothebasketQuantityofgoodsremainsconstant

2. Findtheprices.DeterminethepricesofeachgoodPriceschange

3. Computethebasket’scost.Costofeachgood=quantityofeachgoodinbasketxpriceofeach

goodCostofthebasket=sumofeachcost

How the CPI Is Calculated4. Chooseabaseyearandcomputetheindex.

5. Compute the inflation rate.

Cost of basket in current yearCost of basket in base year

CPI this year – CPI last yearCPI last year

Inflationrate x 100%=

X100CPI=

Consider an economy where the typical consumer consumes 10 lbs. of beef and 20 lbs. of chicken. These are the two goods in the CPI basket.

• What is the CPI each year if the base year is 2010?• What is the inflation rate in 2011 and 2012?

price of beef price of chicken

2011 $4 $42012 $5 $52013 $9 $6



PxQBeef PxQChicken CostoftheBasket CPI

2011 $40 $802012 $50 $1002013 $90 $120

QofBeef:10lbsQofChicken:20lbs



2011 $40 $80 $1202012 $50 $100 $1502013 $90 $120 $210

AddupcostBeefandChickentogether



2011 $40 $80 $120 1002012 $50 $100 $150 1252013 $90 $120 $210 175

CostofBasketCostofBasketinbase



2011 $40 $80 $120 1002012 $50 $100 $150 1252013 $90 $120 $210 175

Inflation:PercentageChangeinCPI2010- 2011:(125– 100)/100=25%2011– 2012:(175– 125)/100=40%

Real vs. Nominal Values• NominalValueofGoods:Thevalueofthegoodatthecurrentprice

• RealValueofGoods:Thevalueofthegoodcontrollingforpricechanges–Valueofthegoodiscorrectedforinflation

• RealInterestRates=NominalInterestRates–InflationRate

Real vs. Nominal ValuesIfyouhave$10,000instudentdebtataninterestrateof5%

In1year:youwillowe$10,000+$500=$10,500Thisisthenominalvalueofyourdebt

Butwhatifinflation is2%?Whatifinflation is10%?


– Theinflationrate=2%andthenominalinterestrate=5%– Realinterestrate=5%- 2%=3%– Realvalueofdebt=$10,000+$300=$10,300

– Withinflation:therealvalueofyourdebtislower


– Theinflationrate=10%andthenominalinterestrate=5%– Realinterestrate=5%- 10%=- 5%– Realvalueofdebt=$10,000+(-$500)=$950

– Thehighertheinflation:themoreiteatsawayatthevalueofyourdebt

Real vs. Nominal ValueRealvs.Nominal

Value Goodfor: Badfor:

HighInflationRealValuelessthan

NominalValueDebtors

SaversConsumersCreditors

ZeroInflationRealValueEqualto

NominalValue

NegativeInflation(Deflation)

RealValueGreater thanNominalValue

SaversCreditors Debtors

Types of InflationDemandPullInflation:Inflationisdrivenbythedemand-sideoftheeconomy

• Rapidincreasesinconsumptionorinvestmentspending• Suddenincreaseinexports• Largeincreaseingovernmentspending• Excessivemoneygrowthfuelinginvestment/spendingbubble

Types of InflationCostPushInflation:Inflationisdrivenbythesupply-sideoftheeconomy

• Increaseincostofimportantgoodsusedinproduction• Factorsofproduction/resourcepricesincrease• Productionbecomesmoreexpensive– finalgoodsbecomemoreexpensive

Costs of Inflation• Menucosts:

–Costtobusinessesofactuallychangingtheirprices• Shoe-leathercosts

–Cost oftimeandeffortthatpeoplespendtryingtocounter-acttheeffectsofinflation,suchasholdinglesscashandhavingtomakeadditionaltripstothebank.

• Dropinpurchasingpower–Aspricesrise,valueofmoneyfalls,sowhatyoucanbuywiththesameamountofmoneydeclines

Key Takeaways• TheCPIshowsthecostofabasketofgoodsandservicesthatmostconsumerspurchase.

• Thoughimperfect,itprovidesadecentreflectiononthecostoflivinginacountryandhowitchanges

• Withthepriceindex(CPIorGDPdeflator)wecancalculateinflationandadjustforthevalueofgoodsovertime

PrinciplesofMacroeconomicsModule2.3

Unemployment

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UnderstandingtheLaborMarket

• Thelabormarketreflectsthenumberofjobsandnumberofworkersinaneconomy

• Ifthereisamismatch,shortfall,ordifferencebetweenworkersandjobsavailable,theeconomyexperiencesunemployment

• Twotypesofunemployment– cyclical(whatisactuallyreported)andnatural(estimated)

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LaborForceStatistics

Labor force:% of the labor force that is unemployed

LF # of unemployed + # of employed =

95

LFPR labor forceadult population

= 100 x

LaborForceStatistics

Labor force participation rate (LFPR): % of the adult population that is in the labor force

Unemployment rate (μ): % of the labor force that is unemployed

μ # of unemployedlabor force

= 100 x

96

Country

AdultPopulation

LaborForce

EmployedPeople

UnemployedPeople

UnemploymentRate

Labor-ForceParticipationRate

CountryA

74,938 53,930 5,130

CountryB

38,530 2,429 8.80% 71.60%

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TestyourUnderstanding

CountryAdult

PopulationLaborForce

EmployedPeople

UnemployedPeople

UnemploymentRate

Labor-ForceParticipation

Rate

CountryA 74,938 53,930 48,800 5,130 9.51% 72.00%

CountryB 38,530 27,600 25,171 2,429 8.80% 71.60%

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FindUnemploymentRate:5,130/53,930=9.51%

CountryAdult


EmployedPeople

UnemployedPeople

UnemploymentRate


Rate

CountryA 74,938 53,930 48,800 5,130 9.51% 72.00%

CountryB 38,530 27,600 25,171 2,429 8.80% 71.60%

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FindLaborForceParticipationRate:

53,930/74,938=72%

CountryAdult


EmployedPeople

UnemployedPeople

UnemploymentRate


Rate

CountryA 74,938 53,930 48,800 5,130 9.51% 72.00%

CountryB 38,530 27,600 25,171 2,429 8.80% 71.60%

100


Find“EmploymentRate”:100%- 9.51%=90.49%

MultiplybyLaborForce:53,930*90.49%=48,800

CountryAdult


EmployedPeople

UnemployedPeople

UnemploymentRate


Rate

CountryA 74,938 53,930 48,800 5,130 9.51% 72.00%

CountryB 38,530 27,600 25,171 2,429 8.80% 71.60%

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FindLaborForce:38,530*71.6%=27,600

CountryAdult


EmployedPeople

UnemployedPeople

UnemploymentRate


Rate

CountryA 74,938 53,930 48,800 5,130 9.51% 72.00%

CountryB 38,530 27,600 25,171 2,429 8.80% 71.60%

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Find“EmploymentRate”:100%- 8.8%=91.2%

MultiplybyLaborForce:27,600*91.2%=25,171

LimitationsoftheUnemploymentRate

• Itexcludesdiscouragedworkers.• Itdoesnotdistinguishbetweenfull-timeandpart-timework,orpeopleworkingparttimebecausefull-timejobsnotavailable.

• SomepeoplemisreporttheirworkstatusintheBLSsurvey

• Cannotaccountforthedifficultyinfindingajobafteralongbreakinemployment

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CyclicalUnemploymentvs.theNaturalRate

Naturalrateofunemployment• Thenormalrateofunemploymentaroundwhichtheactualunemploymentratefluctuates

Cyclicalunemployment• Thedeviationofunemploymentfromitsnaturalrate

• Associatedwithbusinesscycles

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0

2

4

6

8

10

12

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

U.S.Unemployment,1960–2012

Natural rate of unemployment

Unemployment ratepe

rcen

tage

of l

abor

forc

e

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WhyaNaturalRateofUnemployment?Evenwhentheeconomyisdoingwell,thereisalwayssomeunemployment:

Frictionalfactors• Occurswhenworkersspendtimesearchingforthejobsthatbestsuittheir

skillsandtastes• Short-termformostworkers

Structuralfactors• Occurswhenthereisamismatchbetweenskillsofworkersandskillsrequired

forjobs• Industriesexpandorcontractwithnewtechnologycreatingnewemployment

opportunitiesthatmakesomeproductsandjobsobsolete• Barriersexistinthelabormarketthatcreateunemployment

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Structuralvs.FrictionalUnemployment• JeremygraduatedfromhisMBAinDecember.HeislookingforajobinBoston.

• MinimumwagelawsincreaseinNYCto$15perhour.McDonald’sreplacesitsservicestaffwithelectronicterminalswherecustomerscanplacetheirorder.

• Sarahwaslaidofffromherpositioninapublishinghouse.Sheisapplyingtodifferentpositionstomakeacareerchange.

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Structuralvs.FrictionalUnemployment• FRICTIONAL:JeremygraduatedfromhisMBAinDecember.HeislookingforajobinBoston.

• STRUCTURAL:MinimumwagelawsincreaseinNYCto$15perhour.McDonald’sreplacesitsservicestaffwithelectronicterminalswherecustomerscanplacetheirorder.

• FRICTIONAL:Sarahwaslaidofffromherpositioninapublishinghouse.Sheisapplyingtodifferentpositionstomakeacareerchange.

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• TheemploymentsituationforUSworkerswhosemanufacturingfirmhasmovedoperationstoMexico.

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• STRUCTURAL:TheemploymentsituationforUSworkerswhosemanufacturingfirmhasmovedoperationstoMexico.

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SomeCausesofStructuralUnemployment

• TechnologicalAdvancements-- Automationofjobseliminatesthedemandforlabortofillthosepositions

• UnemploymentInsurance– Governmentprovidestemporarypaymenttransferstoalleviatethehardshipofunemployment

• MinimumWageLaws –Mandatesonwagescreateamismatchbetweenworkers thatwantjobsandjobsavailableattheminimumwages

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• Unions – Collectivebargainingandunionrepresentationmakesitdifficultforemployerstoadjusttheirdemandforlaborinresponse tomarketconditions

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• EfficiencyWages- Employerssometimeschoose topayworkersmorethantheequilibriumwage

• Promotesworkereffort• Attractshigherqualityapplicantsfortheposition• Minimizesworkerturnover

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KeyTakeaways• Unemploymentintheeconomyisinevitable– thereisalwayssomeoneinbetweenjobsorlookingforthenextjob

• Thelevelofnaturalunemploymentvariesbetweencountriesbecauseofstructuralunemploymentorcertainbarriersthatexistinthelabormarket

• Theunemploymentratediffersfromthenaturalrateduetoshorttermfluctuationsintheeconomy(businesscycles)whichalsoreflectfluctuationsinoutput

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measuring a nation’s income gdp and other measures · measuring a nation’s income gdp and other...

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