ec 204 slides to accompany chapters 1 and 2

The Data of Macroeconomics 1

EC 204

Slides to Accompany Chapters 1 and 2


Gross Domestic Product

Two Perspectives:

1. Total Expenditure on domestically-produced final goods and services.

2. Total Income earned by domestically-located factors of production.


Gross Domestic Product

Precise Definition: “Market value of all final goods and services produced within an economy in a given period of time.”


Issues in Measuring GDP

• Adding apples and oranges

• Used goods

• Inventories

• Intermediate goods and value added

• Housing and other imputations

• Real versus Nominal


Nominal and Real GDP

NGDPt = PitQit

RGDPt = PioQit

where summation is over i.


Fixed Base-Year Weighting

RGDPt = PioQit

1+gt = RGDPt/RGDPo = [PioQit]/[PioQio] = i[Qit/Qio]

where

i = PioQio/ [PioQio]


Computer Prices and Problems Measuring Real GDP

Price of Computers Declined Sharply in 1980s to 1990s

Implying That Base Year Price of Computers Is Much Higher Than Current Year Price

Leads to Bias Upward in Real GDP for Recent Years

Leads to Bias Downward in Real GDP for Earlier Years

New Chain-weighted Measure of Real GDP Allows for More Frequent Updating of Prices


Chain-weighted Real GDP• Over time, relative prices change, so the base year should

be updated periodically.• In essence, “chain-weighted Real GDP” updates the base

year every year. • This makes chain-weighted GDP more accurate than

constant-price GDP.• See Supplements 2.1, 2.2, 2.4, and 2.6 for more information

on GDP.• See Supplements 1.2 and 1.3 for a discussion of using GDP

growth to predict the outcome of Presidential elections and a discussion of how to tell when we are in a recession.

http://www2.bc.edu/~murphyro/EC204/ChapSupps.html

http://www2.bc.edu/~murphyro/EC204/ChapSupps.html


Chain-Weighted Real GDPExample: Two goods: Apples (A) and Oranges (O).

Growth Rate Using a Fixed Base-Year Measure:

Growth Rate Using a Chain-Weighted Measure:

“Chain” the Growth Rates to get the Level (Index) of Real GDP:


GDP Price IndexSimilar approach allows measurement of the overall rate of change for the prices of goods and services in GDP:

“Chain” the Inflation Rates to get the GDP Price Index:


Real GDP, Nominal GDP and the GDP Price Index

And, if one chooses a base year where in which to set real and nominal GDP equal:

Thus, the simple rule for approximating percent change continues to hold:

Change in Price = Percent Change in Nominal GDP minus Percent Change in Real GDP


Percent Change in Chain-type Real GDP(quarterly at annual rate)

-2%

-1%

0%

1%

2%

3%

4%

5%

6%

7%

8%

2000 2001 2002 2003 2004 2005


GDP and the Components of Expenditure, 2004

Total

(billions of dollars) Per Person (dollars)

Gross domestic product....... 11734.3 39925.2 Personal consumption expenditures. 8214.3 27948.6 Durable goods................... 987.8 3360.9 Nondurable goods................ 2368.3 8058.0 Services........................ 4858.2 16529.7 Gross private domestic investment. 1928.1 6560.2 Nonresidential................ 1198.8 4078.8 Residential................... 673.8 2292.6 Change in private inventories... 55.4 188.5 Net exports of goods and services. -624.0 -2123.1 Exports......................... 1173.8 3993.8 Imports......................... 1797.8 6116.9 Government consum ption and gross investment............. 2215.9 7539.5 Federal......................... 827.6 2815.9 National defense.............. 552.7 1880.5 Nondefense.................... 274.9 935.3 State and local................. 1388.3 4723.6


Expenditure Components: Share of GDP, 2004

70.0%

16.4%

-5.3%

18.9%

-15%

-5%

5%

15%

25%

35%

45%

55%

65%

75%

Consumption Investment Net Exports GovernmentPurchases


Consumption, 2004

$ billions % of GDP

Consumption 8214.3 70.0%

Durables 987.8 8.4%

Nondurable s 2368.3 20.2%

Servic es 4858.2 41.4%

$ billions

% of GDP

Consumption 8214.3 70.0%

Durables 987.8 8.4%

Nondurable s 2368.3 20.2%

Servic es 4858.2 41.4%


Investment, 2004

$ billions % of GDP

Investment 1928.1 16.4% Business fixed 1198.8 10.2% Residential fixed 673.8 5.7% Inventory 55.4 0.5%

$ billions

% of GDP

Investment 1928.1 16.4% Business fixed 1198.8 10.2% Residential fixed 673.8 5.7% Inventory 55.4 0.5%


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.


Stocks vs. Flows

stock flow

a person’s wealth a person’s saving

# of people with # of new collegecollege degrees graduates

the govt. debt the govt. budget deficit

Flow Stock

More examples:


Government spending, 2004

$ billions

% of GDP

Gov spending 2215.9 18.9% Federal 827.6 7.1% Defense 552.7 4.7% Non-defense 274.9 2.3% State & local 1388.3 11.8%

$ billions

% of GDP

Gov spending 2215.9 18.9% Federal 827.6 7.1% Defense 552.7 4.7% Non-defense 274.9 2.3% State & local 1388.3 11.8%


Net exports (NX = EX - IM)

U.S. Net Exports, 1960-2004

-700

-600

-500

-400

-300

-200

-100

0

100

1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004


An important identity

Y = C + I + G + NX

where: Y = GDP = the value of total output

C + I + G + NX = aggregate expenditure


Why does output = expenditure?

• Unsold output goes into inventory, and is counted as “inventory investment”……whether the inventory buildup was intentional or not.

• In effect, we are assuming that firms purchase their unsold output.


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)


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

U.S.A. 0.1% Bangladesh 3.3 Brazil -2.0 Canada -3.2 Chile -8.8 Ireland -16.2 Kuwait 20.8 Mexico -3.2 Saudi Arabia 3.3 Singapore 4.2


GDP = C + I + G + NX

GNP = GDP + Factor Payments From Abroad – Factor Paymentsto Abroad

NNP = GNP – Depreciation

Some Useful Identities


National Income = NNP – Indirect Business Taxes

Personal Income = National Income– Corporate Profits– Social Insurance Contributions– Net Interest+ Dividends+ Govt. Transfers to Individuals+ Personal Interest

Disposable Personal Income = Personal Income

– Personal Tax and Non-tax Payments

Other Measures of Income


Components of National Income2004

Compensation of Employees

72%

Proprietors' Income

9%

Rental Income1%

Corporate Profits13%

Net Interest5%


Personal Saving Rate

-2

0

2

4

6

8

10

12

1980 1983 1986 1989 1992 1995 1998 2001 2004

Percent of Personal Disposable Income


Consumer Price Index (CPI)• A measure of the overall level of prices

• Published by the Bureau of Labor Statistics (BLS)

• Used to – track changes in the

typical household’s cost of living– adjust many contracts for inflation

(i.e. “COLAs”)– allow comparisons of dollar figures from

different years


How the BLS constructs the CPI

Surveys consumers to determine composition of the typical consumer’s “basket” of goods.

Every month, collect data on prices of all items in the basket; compute cost of basket

CPI in any month equals the cost of this basket divided by its cost in the “base” year multiplied by 100.


16.2%

40.0%

4.5%

17.6%

5.8%

5.9%

2.8%

2.5%

4.8%

Food and bev.

Housing

Apparel

Transportation

Medical care

Recreation

Education

Communication

Other goods and

services

The Composition of the CPI’s “Basket”


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.


The CPI’s bias

• The Boskin Panel’s “best estimate”:The CPI overstates the true increase in the cost of living by 1.1% per year.

• Result: the BLS has refined the way it calculates the CPI to reduce the bias.

• It is now believed that the CPI’s bias is slightly less than 1% per year.


GDP Deflator (Price Index) versus CPI

• GDP Price Index measures prices of all goods and services produced, CPI only measures prices of goods and services bought by consumers.

• GDP Price Index includes only goods produced domestically, CPI includes imports.

• Weighting used to compute indexes differs: GDP Price Index uses changing weights, CPI uses fixed weights.


Alternative Inflation Measures

0

2

4

6

8

10

12

14

16

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004

Percent Change

GDP Price Index

PCE Price Index

CPI


Categories of the population• employed

working at a paid job

• unemployed not employed but looking for a job

• labor force the amount of labor available for producing goods and services; all employed plus unemployed persons

• not in the labor force not employed, not looking for work.


Two important labor force concepts

• unemployment rate percentage of the labor force that is unemployed

• labor force participation rate the fraction of the adult population that ‘participates’ in the labor force


Three Groups of the PopulationMillions, 16 years & older

2004

139.3

8.1

76.0

Employment

Unemployment

Not in Labor Force

Population = 223.4


Three Groups of the Population(16 years and older)

2004

62%

4%

34%

Employment

Unemployment

Not in Labor Force


Three Groups of the Population16 years and older

2002

63%

4%

33%

Employment

Unemployment

Not in Labor Force


Unemployment and Employment(Millions, 2004)

139.3

8.1

Employment

Unemployment

Labor Force = 223.4


Unemployment and Employment(Percent of Labor Force, 2004)

94.5%

5.5%

Employment

Unemployment


Unemployment Rate

0

2

4

6

8

10

12

196019641968197219761980198419881992199620002004

Percent of Labor Force


Okun’s Law

19511984

1999

2000

1993

1982

1975

Change in unemployment rate

10

-3 -2 -1 0 1 2 43

8

6

4

2

0

-2

Percentage change in real GDP

Okun’s Law states that a one-percent decrease in unemployment is associated with two percentage points of additional growth in real GDP

Okun’s Law states that a one-percent decrease in unemployment is associated with two percentage points of additional growth in real GDP

ec 204 slides to accompany chapters 1 and 2

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