Transcript GDP

ECN 2003
MACROECONOMICS 1
CHAPTER 2
THE DATA OF
MACROECONOMICS
Assoc. Prof. Yeşim Kuştepeli
 This chapter focuses on the three economic statistics
that economists and policymakers use most often.
Gross domestic product or GDP tells us the nation’s
total income and the total expenditure on its output
of goods and services. The consumer price index,
CPI, measures the level of prices. The
unemployment tells us the fraction of workers
who are unemployed.
Assoc. Prof. Yeşim Kuştepeli
Measuring the Value of Economic Activity:
Gross Domestic Product
 GDP is considered the best measure of how well the
economy is performing. The goal of GDP is to summarize
in a single number of dollar value of economic activity in
a given period of time.
 There are two ways to view this statistic. One way to view
GDP is as the total income of everyone in the economy.
Another way is as the total expenditure on the economy’s
output of goods and services. Economy as a whole
income must equal expenditure. Because every
transaction has both a buyer and seller, every dollar of
expenditure by a buyer must become a dollar of income
to a seller.
Assoc. Prof. Yeşim Kuştepeli
Income, Expenditure, and the Circular Flow
 Imagine an economy that produces a single good,
bread, from a single input, labor. Figure 1 illustrates
all the economic transactions that occur between
households and firms in this economy.
 The inner loop in Figure 1 represents the flow of
bread and labor. The households sell their labor to
the firms. The firms use the labor of their workers to
produce bread, which the firms in turn sell to the
households. Hence, labor flows from households to
firms, and bread flows from firms to households.
Assoc. Prof. Yeşim Kuştepeli
 The outer loop in Figure 1 represents the corresponding
flow of dollars. The households buy bread from the firms
(who themselves are part of the household sector).
Hence, expenditure on bread flows from households to
firms, and income in the form of wages and profit flows
from firms to households.
 GDP measures the flow of dollars in this economy. GDP
is the total income from the production of bread which
equals the sum of wages and profit, the top half of the
circular flow of dollars. GDP is also the total expenditure
on purchases of bread, the bottom half of the circular
flow of dollars.
Assoc. Prof. Yeşim Kuştepeli
 A stock: is a quantity measured at a given point in
time, whereas a flow is a quantity measured per unit
of time.
 GDP is probably the most important flow variable in
economics: it tells us how many dollars are flowing
around the economy’s circular flow per unit of time.
Assoc. Prof. Yeşim Kuştepeli
Some Rules for Computing GDP
 Adding Apples and Oranges
 GDP combines the value of these goods and services into a
single measure.
 To compute the total value of different goods and services, the
national income accounts use market prices because these
prices reflect how much people are willing to pay for a good or
service. Thus, if apples cost $0,5 each and oranges cost $1
each, GDP would be;
 GDP= (price of apples x quantity of apples) + ( price of
oranges x quantity of oranges)
= ($0,5 x 4) + ($1 x 3) = $5
Assoc. Prof. Yeşim Kuştepeli
 Used Goods
 GDP measures the value of currently produced goods and
services. Thus, the sale of used goods is not included as a part
of GDP.
 The treatment of inventories
 When a firm increases its inventory of goods, this investment
in inventory is counted as expenditure by the firms owners
and added in GDP.
 A sale of inventory however is a combination of positive
spending (the purchase) and negative spending (inventory
disinvestment) so it does not influence GDP.
Assoc. Prof. Yeşim Kuştepeli
 Intermediate Goods and Value Added
 GDP includes only the value of final goods.
 The reason is that the value of intermediate goods is already
included as a part of the market price of final goods in which
they are used. To add the intermediate goods to the final
goods would be double counting that is the meat would be
counted twice. Hence GDP is the total value of final goods and
services produced.
 One way to compute the value of all final goods and services is
to sum the value added at each stage of production. The value
added of a firm equals the value of the firm’s output less the
value of the intermediate goods that the firm purchases.
Assoc. Prof. Yeşim Kuştepeli
 Housing services and other imputations
 Some goods are not sold in the market place and therefore do
not have market prices. We must use an estimator of their
value. Such an estimate is called an imputed value.
 GDP also includes the rent that homeowners pay to
themselves. Imputation also used for valuing the government
services. No imputation is made for the value of goods and
services sold in the underground economy.
Assoc. Prof. Yeşim Kuştepeli
Real GDP versus Nominal GDP
 Consider once again the economy that produces only apples
and oranges. In this economy GDP is the sum of the value of
all the apples and value of oranges produced. That is;
 GDP= (price of apples x quantity of apples) + ( price of
oranges x quantity of oranges)
 If all prices doubled without any change in quantities, GDP
would double. Yet it would be misleading to say that the
economy’s ability to satisfy demands had doubled, because
the quantity of every good produced remains the same.
Economists call the value of goods and services measured at
current prices nominal GDP.
Assoc. Prof. Yeşim Kuştepeli
 A better measure of economic well-being would tally the
economy’s output of goods and services and would not be
influenced by the changes in prices.
 Economists use real GDP which is the value goods and
services measured using a constant set of prices. Real GDP
shows what would have happened to expenditure on output if
quantities had changed but prices had not.
 We could begin by choosing a set of prices, called base-year
prices, such as the price that prevailed in 1998. Goods and
services are then added up using these base-year prices to
value the different goods in both years. Real GDP for 1998
would be :
Assoc. Prof. Yeşim Kuştepeli
 Real GDP= (1998 price of apples x 1998 quantity of apples) +
(1998 price of oranges x 1998 quantity of oranges)
 Real GDP in 2000 would be;
 Real GDP= (1998 price of apples x 2000 quantity of
apples) + (1998 price of oranges x 2000 quantity of
oranges)
 Because the prices are held constant, real GDP varies from
year to year only if the quantities produced vary.
 Real GDP provides a better measure of economic well-being
than nominal GDP.
Assoc. Prof. Yeşim Kuştepeli
The GDP Deflator
 The GDP deflator also called the implicit price deflator for
GDP.
 GDP Deflator= Nominal GDP / Real GDP
 The GDP deflator reflects what’s happening to the overall
level of prices in the economy.
 Nominal GDP = Real GDP x GDP deflator
 Nominal GDP measures the current dollar value of the
output in the economy. Real GDP measures output valued at
constant prices. The GDP deflator measures the price of
output relative to its price in the base year.
Assoc. Prof. Yeşim Kuştepeli
The Components of Expenditure
 The national income accounts divide GDP into four broad
categories of spending.




Consumption (C)
Investment (I)
Government purchases (G)
Net exports (NX)
 Y = C+ I +G + NX
 This equation is an identity- en equation that must hold
because of the way the variables are defined. It is called the
national income accounts identity.
Assoc. Prof. Yeşim Kuştepeli
 Consumption: goods and services bought by households.
nondurable goods, durable goods and services.
 Investment: goods bought for future use. business fixed
investment, residential fixed investment and inventory
investment.
 Government Purchases: goods and services bought by
federal, state and local governments. military equipment,
highways, and the services that government workers provide. It
does not include transfer payments to individuals, such as
Social Security and welfare.
 Net Exports: Net exports are the value of goods and services
exported minus the value of goods and services imported.
Assoc. Prof. Yeşim Kuştepeli
Other Measures of Income
 GNP = GDP + Factor payments from abroad – Factor
payments to abroad
 Whereas GDP measures the total income produced
domestically, GNP measures the total income earned by
nationals. (residents of a nation)
 Net National Product=NNP= GNP – Depreciation
 Depreciation is called the consumption of fixed capital.
Because the depreciation is a cost of producing the
output in the economy, subtracting depreciation shows
the net result of economic activity.
Assoc. Prof. Yeşim Kuştepeli
 National Income= NNP – Indirect Business Taxes
 Sales tax is an example of indirect business taxes.
 Compensation of employees: wages and earnings of workers
 Proprietor’s income: The income of non-corporate business.
 Rental Income: The income that landlords receive including
the imputed rents.
 Corporate Profits: The income of corporations after payments
to their workers and creditors.
 Net Interest: The interest domestic business pay minus the
interest they receive, plus interest earned from foreigners.
Assoc. Prof. Yeşim Kuştepeli
 Personal Income = National income
-Corporate profits
-Social insurance contributions
-Net interest
+ Dividends
+ Government transfer to individuals
+ Personal Interest Income
 Disposable Income = Personal income– Personal
Tax and Nontax payments
Assoc. Prof. Yeşim Kuştepeli
Measuring the cost of living: The consumer
price index
 The commonly used measure of the level of prices is the consumer price
index. (CPI)
 The CPI turns the prices of many goods and services into a single index
measuring the overall prices.
 The CPI is the price of the basket of goods and services relative to the price
of the same basket in some base year.
 CPI = (5 x Current Price of apples) + (2 x Current price of oranges) / (5 x
1992 prices of apples) + (2 x 1992 price of oranges)
 In this CPI, 1992 is the base year. The index tells us how much it costs now
to buy 5 apples and 2 oranges relative to how much it cost to buy the same
basket of fruit in 1992.
 Another index is the producer price index, which measures the price of a
typical basket of goods bought by firms rather than consumers.
Assoc. Prof. Yeşim Kuştepeli
The CPI versus the GDP Deflator
 The GDP deflator and the CPI give somewhat
different information about what’s happening to the
overall level of prices in the economy. There three
key differences between the two measures.
 1) GDP deflator measures the prices of all goods and
services produced, whereas the CPI measures the
prices of only the goods and services bought by
consumers. Thus, an increase in the price of goods
bought by firms or the government will show up in
the GDP deflator but not in the CPI.
Assoc. Prof. Yeşim Kuştepeli
 2)GDP deflator includes only those goods produced
domestically. Imported goods are not part of GDP
and do not show up in the GDP deflator.
 3) The CPI assigns fixed weights to prices of different
goods, whereas the GDP deflator assigns changing
weights. In other words, the CPI is computed using a
fixed basket of goods, whereas the GDP deflator
allows the basket of goods to change over time as the
composition of GDP changes.
Assoc. Prof. Yeşim Kuştepeli
 Economists called a price index with a fixed basket of goods a
Laspeyres index and a price index with a changing basket a
Paasche index.
 When prices of different goods are changing by different amounts, a
Lasperyres (fixed basket) index tends to overstate the increase in
the cost of living because it does not take into account that
consumers substitute less expensive goods for more expensive ones.
 Paasche (changing basket) index tends to understate the increase in
cost of living. While it accounts for the substitution of alternative
goods, it does not reflect the reduction in consumers’ welfare from
such substitutions.
 The difference between the GDP deflator and the CPI is usually not
large in practice.
Assoc. Prof. Yeşim Kuştepeli
Measuring Joblessness: The unemployment Rate
 A person is employed if he or she spent most of the previous
week working at a paid job, as opposed to keeping house,
going to school, or doing something else.
 A person is unemployed if he or she is not employed and is
waiting for the start date of a new job, is temporarily layoff, or
has been looking for a new job.
 A person who fits into neither of the first two categories, such
as student or retiree, is not in the labor force.
 A person who wants a job but has given up looking– a
discouraged worker– is counted as not being in the labor
force.
Assoc. Prof. Yeşim Kuştepeli
 The labor force is defined as the sum of the employed and
unemployed, and the unemployment rate is defined as the
percentage of the labor force that is unemployed. That is
 Labor Force = Number of employed + number of unemployed
 Unemployment Rate = (Number of unemployed / Labor
force) x 100
 A related statistics is the labor force participation rate, the
percentage of the adult population that is in the labor force:
 Labor Force participation rate = (Labor force / Adult
population) x 100
Assoc. Prof. Yeşim Kuştepeli
Unemployment, GDP, and the Okun’s Law
 The negative relationship between unemployment and GDP is
called Okun’s Law, after Arthur Okun, the economist who first
studied it.
 For every percentage point the unemployment rate rises, real
GDP growth typically falls by 2 percent.
 Let’s assume the real GDP grows by 3 %due to population
growth, capital accumulation and technological progress. In
addition let’s think that unemployment rises from 6% to 8%.
 Percentage Change in real GDP = 3% – 2 x ( %8– %6) = -1%
 In this case, Okun’s law says that GDP would fall by 1 percent,
indicating that the economy is in a recession.
Assoc. Prof. Yeşim Kuştepeli