Measuring Output and The Price Level

Close look at the measures of the “big two” goal variables -- real GDP and the price level (to compute the inflation rate).

Data complied at the National Income and Product Accounts (NIPA)

Measuring Output -- Gross Domestic Product (GDP)

Gross Domestic Product -- The total market value of all currently produced final goods and services over a period of time.

Nominal GDP -- GDP in current dollars

Real GDP -- GDP in constant dollars (of a base year).

Aspects of GDP Definition

“Over a Period of Time” GDP is a flow measure.

“Currently Produced” GDP excludes the following

-- sales of used items

-- transfer payments

-- purchases of stocks, bonds,

or land

“Market Value” -- the transaction must be recorded and have a specific dollar figure attached GDP excludes

-- illegal purchases -- household production (example – fixing your own car)

Final Goods and Services and Measuring GDP

Example -- Production of a pair of shoes.

GDP and Making ShoesStep Value Value Added

Farmer 3 3

Packing Plant 7 4

Tannery 13 6

Shoe

Manufacturer 25 12

Wholesaler 40 15

Retailer 75 35

Total 163 75

What Real GDP (Y) Signifies

Total Production or Output of final goods and services

Total Sales on Final Goods and Services (Approximately)

Total Income (Approximately) Correlated With Total Employment

Computing GDP (Y) -- The Expenditure Approach

Operative Equation:

Y = C + I + G + X - M

Consumption (C)

Defined as consumer purchases of final goods and services

components of consumption

-- nondurable goods

-- durable goods

-- serviceslargest component of GDP

Investment (I)

Business Purchases of New Plant and Equipment

New Residential HousingChanges In Inventories

Output Versus Sales -- The Approximation Example -- $18,000 car, produced in 2000,

sold in 2001

Year C I G (X-M) Y2000 $0 $18 $0 $0 $182001 $18 -$18 $0 $0 $0

Bottom Line – The car is counted in the year it was produced (as a change in inventory), not the year it was sold.

Investment Goods Versus Intermediate Goods

The Similarity -- Transactions between businesses.

The Conceptual Difference -- Producing Final Goods (Investment) Versus Being Part of a Final Good (Intermediate Good).

The Operational Difference – Investment goods (e.g. shoe machines) are used repeated times; intermediate goods (e.g. leather) are used just once.

Government Purchases of Goods and Services (G)

Not the same as government expenditure (does not include transfer payments)

In the US, the government is a purchaser, not a producer.

Net Exports (X-M)

Net Exports = Exports (X) - Imports (M)Exports are, by definition, all final goods

and services (last sale in US).Gross National Product (GNP) versus

Gross Domestic Product (GDP) – different accounting of multinational firms (firms operating in a country other than their origin – e.g. a Honda plant in Ohio).

Real GDP and the Quality of Life

Real GDP does not account for the following changes:

-- leisure time

-- quality differences

-- crime

-- environmental impacts

More Quality of Life Variables Not in Real GDP

-- nonmarket production activities

(I) household production

(II) underground economy

-- income distribution

Disposable Income and (Personal) Saving

Disposable Income (YD) -- total consumer income after taxes.

(Personal) Saving (S)

S = YD - CThe Saving Rate -- (S)/(YD)

Measuring The Price Level

Measures of the Price Level (P)

-- Consumer Price Index (CPI)

-- GDP Deflator

Common Features: Price Level Measures

They are indexes -- compare current prices with those of a given base year.

They consist of a ratio of weighted expenditure of prices of selected goods and services (market basket) in current year to a weighted average of prices in the base year.

Weights are based upon quantities of

goods and services in the market basket.

Inflation Rate = Percentage Change in the Index.

Example: Inflation Rate for 2000

Inflation Rate2000 = P2000 - P1999

P1999

Distinctions in Price Level Measures

What’s in the market basket?Method of computation -- fixed

weight index versus chain weight index.

Measure #1 -- The Consumer Price Index (CPI)

Market Basket: Set of goods and services purchases by consumers.

Fixed Weight Index

Computing a CPI

Example -- Compute the CPI for 2000 with 1992 as the base year.

CPI2000 =

(Cost of 1992 Market Basket

Purchased in 2000)

(Cost of Actual Consumer

Purchases in 1992)

Biases in CPI (as a Fixed Weight Index)Entry Bias -- goods leaving and entering

the market basket.Quality Bias -- different quality of the

same goods.Outlet Bias -- retail vs outlet prices?Substitution Bias -- changing quantities

over time due to demand response to goods that have become relatively expensive.

Implications -- CPI Bias

CPI inflation overstates the true inflation rate.

Implication -- reforming Social Security.

Measure #2 -- The GDP Deflator

Market Basket -- set of final goods and services that are used to compute GDP (macro measure of price level).

Chain Weight Index -- reduces biases associated with fixed weight index.

Converting Nominal GDP to Real GDP Example -- find Real GDP 2000

Real GDP2000 = Nominal GDP2000

GDP Deflator2000

Real GDP for other years is computed the same way.

Real GDP Growth = Percentage Change in Real GDP.

Sources to Obtain Macroeconomic Data

The Economic Report of the President (Historical Data)

Economic Indicators (Recent)

Some Websites for Macro Data and Information

www.federalreserve.gov (Federal Reserve)

www.stls.frb.org/fred (Federal Reserve Economic Data)

www.bea.doc.gov (Bureau of Economic Analysis)

www.dismal.com (neat macro stuff)