measuring macroeconomic activity chapter 11. measuring gross domestic product (gdp) the...

Measuring Macroeconomic Activity

Chapter 11

Measuring Gross Domestic Product (GDP)

• The comprehensive measure of the market value of all currently produced final goods and services within a country in a given period of time by domestic and foreign supplied resources.

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall 2

The Circular Flow of Economic Activity

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall

3

Foreign Sector

Domestic Market for currentlyProduced goods and services

Government Sector

Financial Markets

Resource Markets

Firm SectorHousehold Sector

XM

Borrowing

G

Revenue

ExpensesIncome,Wages,Rent,Interest,Profit

CI

TB

TP

Borrowing

Borrowing

S

National Income Accounting System

• A system of accounts developed for each country, based on the circular flow, whose purpose is to measure the level of economic activity in that country.

• The U.S. national income accounting system is operated by the Bureau of Economic Analysis (BEA) in the U.S.Department of Commerce.


Final vs. Intermediate Goods and Services

• Final goods and services are goods and services that are sold to their end-users.

• Intermediate goods and services goods and services that are used in the production of other goods and services.


5

Real vs. Nominal GDP

• Nominal GDP is the value of currently produced final goods and services measured in current year prices.

• Real GDP is the value of currently produced final goods and services measured in constant prices, or nominal GDP adjusted for price level changes.


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Nominal and Real GDP, 2000 & 2001

VARIABLE 2000 2001

Nominal GDP $9,817.0 billion $10,128.0 billion

Percent Change 3.17

Real GDP $9,817.0 billion $9,890.7 billion

Percent Change 0.76

GDP Deflator (price changes) 100 102.40

Percent Change 2.40


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Nominal vs. Real GDP, 1985-present


US Real GDP and Recessions


9

Expenditure or Output Approach to Measuring GDP

• Measuring overall economic activity by adding the expenditure on the output produced in the economy.

GDP = C + I + G + (X – M)


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Personal Consumption Expenditures (C)

• The total amount of spending by consumers on durable goods, nondurable goods, and services in a given period of time.


Real Personal Consumption Expenditures, 1985 - present


Gross Private Domestic Investment (I)

• The total amount of spending on nonresidential structures, equipment, and software; residential structures; and business inventories in a given period of time.


Real Gross Private Domestic Product, 1985 - present


Government Consumption Expenditures and Gross Investment (G)

• The total amount of spending by federal, state, and local governments on consumption outlays for goods and services and for depreciation charges for existing structures and equipment and on investment capital outlays for newly acquired structures and equipment in a given period of time.


Real Government Consumption Expenditures and Gross Investment, 1985 - present


Net Export Spending (X – M)

• The total amount of spending on exports minus the total amount of spending on imports in a given period of time.


Real Net Export Spending, 1985 - present


Gross Domestic Product and Its Components, 2007

COMPONENT VALUE IN BILLIONS OFDOLLARS (% OF GDP)

GROSS DOMESTIC PRODUCT (GDP) 13,807.5

PERSONAL CONSUMPTION EXPENDITURES (C ) 9,710.2 (70.3)

GROSS PRIVATE DOMESTIC INVESTMENT (I ) 2,130.4 (15.5)

GOVERNMENT CONSUMPTION EXPENDITURES ANDGROSS INVESTMENT (G)

2,674.8 (19.4)

NET EXPORTS OF GOODS AND SERVICES (F ) 707.8 (5.1)


Earnings or Income Approach to Measuring GDP

• Measuring overall economic activity by adding the earnings or income generated by selling the output produced in the economy.

GDP = compensation of employees + proprietor’s income + rental income +

corporate profits + net interest


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National Income• Compensation of employees: the wages and salaries and the fringe

benefits paid by employers to employees.• Proprietors’ income: the income of unincorporated businesses, such as

medical practices, law firms, small farms, and retail stores.• Rental income : the income households receive from the rental of their

property.• Corporate profits: the excess of revenues over costs for the incorporated

business sector of the economy.• Net interest: the interest private businesses pay to households for lending

money to the firms minus the interest businesses receive plus interest earned from foreigners.


National Income

COMPONENT VALUE IN BILLIONS OF DOLLARS(% OF NATIONAL INCOME)

GROSS DOMESTIC PRODUCT 13,807.5

Less: Depreciation expenditures 1,618.0

Less: Statistical discrepancy 81.4

EQUALS: NATIONAL INCOME 12,270.9

Compensation of employees 7,812.3 (63.6)

Proprietor’s income 1,056.2 (8.6)

Rental income 40.0 (0.3)

Corporate profits 1,642.4 (13.4)

Net interest 664.4 (5.4)


National Income, continued

COMPONENT VALUE IN BILLIONS OF DOLLARS(% OF NATIONAL INCOME)

Less: Income earned, but not received 4,321.0

Plus: Income received, but not earned 3,713.3

EQUALS: PERSONAL INCOME 11,663.2

Less: Personal taxes 1,492.8

EQUALS: DISPOSABLE INCOME 10,170.5

Personal consumption expenditure ($9,710.2)plus other outlays ($402.9) 10,113.1

Personal saving 57.4


23

Other Important Macroeconomic Variables

• Price level measures– GDP deflator– Consumer price index– Wholesale price index

• Employment and unemployment


A C T I V E L E A R N I N G A C T I V E L E A R N I N G 11

GDP and its componentsGDP and its componentsIn each of the following cases, determine how much GDP and each of its components is affected (if at all).

A. Debbie spends $200 to buy her husband dinner at the finest restaurant in Boston.

B. Sarah spends $1800 on a new laptop to use in her publishing business. The laptop was built in China.

C. Jane spends $1200 on a computer to use in her editing business. She got last year’s model on sale for a great price from a local manufacturer.

D. General Motors builds $500 million worth of cars, but consumers only buy $470 million worth of them.


AnswersAnswers

A. Debbie spends $200 to buy her husband dinner at the finest restaurant in Boston.

Consumption and GDP rise by $200.

B. Sarah spends $1800 on a new laptop to use in her publishing business. The laptop was built in China.

Investment rises by $1800, net exports fall by $1800, GDP is unchanged.

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AnswersAnswersC. Jane spends $1200 on a computer to use in her

editing business. She got last year’s model on sale for a great price from a local manufacturer.

Current GDP and investment do not change, because the computer was built last year.

D. General Motors builds $500 million worth of cars, but consumers only buy $470 million of them.

Consumption rises by $470 million, inventory investment rises by $30 million, and GDP rises by $500 million.

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GDP Deflator

• The GDP deflator compares the price of each year’s output of real goods and services to the price of that same output in a base year. It is a broad measure of price changes because it reflects the changes in consumption patterns over time included in GDP.


Consumer Price Index (CPI)

• A measure of the combined price consumers pay for a fixed market basket of goods and services in a given period relative to the combined price of an identical basket of goods and services in a base period.


Producer Price Index (PPI)

• A measure of the prices firms pay for crude materials; intermediate materials, supplies, and components; and finished goods.


Measures of Employment and Unemployment

• Labor force• Number employed• Number unemployed• Unemployment rate• Discouraged workers


Labor Force

• The civilian labor force is composed of those individuals 16 years of age and over who are working in a job (employed) or who are actively seeking employment (unemployed).


Employed

• Persons 16 years of age and over who, in the survey week, did any work as an employee, worked in their own business, profession, or farm; or worked without pay at least 15 hours in a family business or farm.


Unemployed

• Persons 16 years of age and over who do not currently have a job, but who are actively seeking employment.


Unemployment Rate

• Proportion of the labor force that is unemployed.

UR = (number of unemployed ÷ labor force) x 100


Discouraged Workers

• Persons 16 years of age and over who are not currently seeking work because they believe that jobs in their area or line of work are unavailable or that they would not qualify for existing job openings.


Natural Rate of Unemployment

• The minimum level of unemployment that can be achieved with current institutions without causing inflation to accelerate


UNEMPLOYMENT 38

labor force participation rate

labor forceadult population

= 100 x

Labor Force Statistics

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

Unemployment rate (“u-rate”): % of the labor force that is unemployed

u-rate# of unemployed

labor force= 100 x


Calculate labor force statisticsCalculate labor force statistics

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Compute the labor force, u-rate, adult population, and labor force participation rate using this data:

Adult population of the U.S.by group, June 2008

# of employed 145.9 million

# of unemployed 8.5 million

not in labor force 79.2 million

Labor force = employed + unemployed

= 145.9 + 8.5

= 154.4 million

U-rate = 100 x (unemployed)/(labor force)

= 100 x 8.5/154.4

= 5.5%


AnswersAnswers

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Population = labor force + not in labor force

= 154.4 + 79.2

= 233.6

LF partic. rate = 100 x (labor force)/(population)

= 100 x 154.4/233.6

= 66.1%


AnswersAnswers

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MEASURING A NATION’S INCOME 42

GDP and Economic Well-Being

• Real GDP per capita is the main indicator of the average person’s standard of living.

• But GDP is not a perfect measure of well-being.

Major Macroeconomic Policy Issues

• What factors influence the spending behavior of the different sectors of the economy?

• How do behavior changes in these sectors influence the level of output and income in the economy?

• Can Policy Makers Maintain Stable Prices, Full Employment, and Adequate Economic Growth over Time?

• How Do Fiscal, Monetary, and Balance of Payments Policies Influence the Economy?

• What Impact Do These Macro Changes Have on Different Firms and Industries?



Real versus Nominal GDP• Inflation can distort economic variables like

GDP, so we have two versions of GDP: One is corrected for inflation, the other is not.

• Nominal GDP values output using current prices. It is not corrected for inflation.

• Real GDP values output using the prices of a base year. Real GDP is corrected for inflation.


EXAMPLE:

Compute nominal GDP in each year:

2005: $10 x 400 + $2 x 1000 = $6,000

2006: $11 x 500 + $2.50 x 1100 = $8,250

2007: $12 x 600 + $3 x 1200 = $10,800

Pizza Latte

year P Q P Q

2005 $10 400 $2.00 1000

2006 $11 500 $2.50 1100

2007 $12 600 $3.00 1200

37.5%

Increase:

30.9%


EXAMPLE:

Compute real GDP in each year, using 2005 as the base year:

Pizza Latte

year P Q P Q

2005 $10 400 $2.00 1000

2006 $11 500 $2.50 1100

2007 $12 600 $3.00 1200

20.0%

Increase:

16.7%

$10 $2.00

2005: $10 x 400 + $2 x 1000 = $6,000

2006: $10 x 500 + $2 x 1100 = $7,200

2007: $10 x 600 + $2 x 1200 = $8,400


EXAMPLE:

In each year,• nominal GDP is measured using the (then) current

prices. • real GDP is measured using constant prices from the

base year (2005 in this example).

yearNominal

GDPReal GDP

2005 $6000 $6000

2006 $8250 $7200

2007 $10,800 $8400


EXAMPLE:

• The change in nominal GDP reflects both prices and quantities.

yearNominal

GDPReal GDP

2005 $6000 $6000

2006 $8250 $7200

2007 $10,800 $8400

20.0%

16.7%

37.5%

30.9%

The change in real GDP is the amount that GDP would change if prices were constant (i.e., if zero inflation).

Hence, real GDP is corrected for inflation.

Nominal and Real GDP in the U.S., 1965-2007

$0

$2,000

$4,000

$6,000

$8,000

$10,000

$12,000

1965 1970 1975 1980 1985 1990 1995 2000 2005

Billions

Real GDP (base year

2000)

Nominal GDP

49


The GDP Deflator• The GDP deflator is a measure of the overall

level of prices. • Definition:

One way to measure the economy’s inflation rate is to compute the percentage increase in the GDP deflator from one year to the next.

GDP deflator = 100 x GDP deflator = 100 x nominal GDP

real GDP


EXAMPLE:

Compute the GDP deflator in each year:

yearNominal

GDPReal GDP

GDP Deflator

2005 $6000 $6000

2006 $8250 $7200

2007 $10,800 $8400

2005: 100 x (6000/6000) = 100.0

100.0

2006: 100 x (8250/7200) = 114.6

114.6

2007: 100 x (10,800/8400) = 128.6

128.6

14.6%

12.2%


Computing GDPComputing GDP

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Use the above data to solve these problems:

A. Compute nominal GDP in 2007.

B. Compute real GDP in 2008.

C. Compute the GDP deflator in 2009.

2007 (base yr) 2008 2009

P Q P Q P Q

Good A $30 900 $31 1,000 $36 1050

Good B $100 192 $102 200 $100 205


AnswersAnswers

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A. Compute nominal GDP in 2007.

$30 x 900 + $100 x 192 = $46,200

B. Compute real GDP in 2008.

$30 x 1000 + $100 x 200 = $50,000

2007 (base yr) 2008 2009

P Q P Q P Q

Good A $30 900 $31 1,000 $36 1050

Good B $100 192 $102 200 $100 205


AnswersAnswers

54

C. Compute the GDP deflator in 2009.

Nom GDP = $36 x 1050 + $100 x 205 = $58,300

Real GDP = $30 x 1050 + $100 x 205 = $52,000

GDP deflator = 100 x (Nom GDP)/(Real GDP)

= 100 x ($58,300)/($52,000) = 112.1

2007 (base yr) 2008 2009

P Q P Q P Q

Good A $30 900 $31 1,000 $36 1050

Good B $100 192 $102 200 $100 205


CPI vs. GDP deflatorCPI vs. GDP deflator

In each scenario, determine the effects on the CPI and the GDP deflator.

A. Starbucks raises the price of Frappuccinos.

B. Caterpillar raises the price of the industrial tractors it manufactures at its Illinois factory.

C. Armani raises the price of the Italian jeans it sells in the U.S.

55


AnswersAnswers

A. Starbucks raises the price of Frappuccinos.The CPI and GDP deflator both rise.

B. Caterpillar raises the price of the industrial tractors it manufactures at its Illinois factory.The GDP deflator rises, the CPI does not.

C. Armani raises the price of the Italian jeans it sells in the U.S.The CPI rises, the GDP deflator does not.

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MEASURING THE COST OF LIVING 57

• In our example, – year T = 12/1964, “today” = 12/2007– Min wage = $1.15 in year T– CPI = 31.3 in year T, CPI = 211.7 today

Correcting Variables for Inflation:Comparing Dollar Figures from Different Times

Amount in today’s

dollars

Amount in year T dollars

Price level today

Price level in year T= x

$7.78 $1.15211.731.3

= xThe minimum wage in 1964 was $7.78

in today’s (2007) dollars.


Converting to “today’s dollars”Converting to “today’s dollars”

Annual tuition and fees, average of all public four-year colleges & universities in the U.S.

– 1986-87: $1,414 (1986 CPI = 109.6)– 2006-07: $5,834 (2006 CPI = 203.8)

After adjusting for inflation, did students pay more for college in 1986 or in 2006? Convert the 1986 figure to 2006 dollars and compare.

58


AnswersAnswers

Annual tuition and fees, average of all public four-year colleges & universities in the U.S.– 1986-87: $1,414 (1986 CPI = 109.6)– 2006-07: $5,834 (2006 CPI = 203.8)

59

Solution

Convert 1986 figure into “today’s dollars”

$1,414 x (203.8/109.6) = $2,629

Even after correcting for inflation, tuition and fees were much lower in 1986 than in 2006!

MEASURING THE COST OF LIVING

60

How the CPI Is Calculated

1. Fix the “basket.”The Bureau of Labor Statistics (BLS) surveys consumers to determine what’s in the typical consumer’s “shopping basket.”

2. Find the prices.The BLS collects data on the prices of all the goods in the basket.

3. Compute the basket’s cost.Use the prices to compute the total cost of the basket.


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How the CPI Is Calculated4. Choose a base year and compute the index.

The CPI in any year equals

5. Compute the inflation rate.The percentage change in the CPI from the preceding period.

100 xcost of basket in current year

cost of basket in base year

CPI this year – CPI last year

CPI last yearInflation

ratex 100%=


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EXAMPLE basket: {4 pizzas, 10 lattes}

$12 x 4 + $3 x 10 = $78

$11 x 4 + $2.5 x 10 = $69

$10 x 4 + $2 x 10 = $60

cost of basket

$3.00

$2.50

$2.00

price of latte

$122009

$112008

$102007

price of pizza

year

Compute CPI in each year

2007: 100 x ($60/$60) = 100

2008: 100 x ($69/$60) = 115

2009: 100 x ($78/$60) = 130

Inflation rate:

15%115 – 100

100x 100%=

13%130 – 115

115x 100%=

using 2007 base year:


CalculatCalculate the CPIe the CPI

63

CPI basket: {10 lbs beef, 20 lbs chicken}

The CPI basket cost $120 in 2004, the base year.

A. Compute the CPI in 2005.

B. What was the CPI inflation rate from 2005-2006?

price of beef

price of chicken

2004 $4 $4

2005 $5 $5

2006 $9 $6


AnswersAnswers

64

A. Compute the CPI in 2005:

Cost of CPI basket in 2005= ($5 x 10) + ($5 x 20) = $150

CPI in 2005 = 100 x ($150/$120) = 125



price of beef

price of chicken

2004 $4 $4

2005 $5 $5

2006 $9 $6


AnswersAnswers

65

price of beef

price of chicken

2004 $4 $4

2005 $5 $5

2006 $9 $6



B. What was the inflation rate from 2005-2006?

Cost of CPI basket in 2006= ($9 x 10) + ($6 x 20) = $210

CPI in 2006 = 100 x ($210/$120) = 175

CPI inflation rate = (175 – 125)/125 = 40%


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What’s in the CPI’s Basket?

43%

17%

15%

6%

6%

6%4% 3% Housing

Transportation

Food & Beverages

Medical care

Recreation

Education andcommunicationApparel

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