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Measuring Economic
Activity: GDP and
Unemployment
Principles of Macroeconomics
Dr. Gabriel X. Martinez
Ave Maria University
Introduction
• “Real GDP, the value of goods and services
•
•
produced in the U.S., grew at an annual rate of
1 percent in the fourth quarter….”
“The unemployment rate last month rose to 6.1
percent, its highest level since….”
“Inflation appears subdued as the consumer
price index registered an increase of only 0.2
percent last month…”
Copyright c 2004 by The McGraw-Hill
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
2
Gross Domestic Product:
Measuring the Nation’s Output
• Measuring economic variables is essential.
– You are a tenth-century doctor.
– Your best guess at human anatomy is pig’s
anatomy.
– Your best guess at a good cure is leeches.
Copyright c 2004 by The McGraw-Hill
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
3
Copyright c 2004 by The McGraw-Hill
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
4
Gross Domestic Product:
Measuring the Nation’s Output
• Measuring economic variables is essential.
– We cannot understand the economy without
precise measurement of economic activity.
– Governments cannot use economic policy if
they don’t know what is happening.
– Firms and individuals need precise
information.
Copyright c 2004 by The McGraw-Hill
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
5
The Three Faces of GDP
Production
Market
value of
all final
goods
and
services
produced
in a
country
during a
given
period
Expenditure
Income
Consumption
Labor Income
=
=
Investment
Government
purchases
Capital
Income
Net exports
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
6
The Production Approach to
GDP
agriculture
mining
othergovernment
services
utilities
hotel and food
arts and
construction
entertainment
health care
education
administrative and
waste services
management
of
companies
professional
services
manufacturing
real estate, rental
and leasing
wholesale
finance and
insurance
Copyright c 2004 by The McGraw-Hill
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transportationretail
and
warehousing
information
Chapter 18: Measuring Economic
Activity: GDP and Unemployment
8
Gross Domestic Product:
Measuring the Nation’s Output
• Gross Domestic Product (GDP)
– The market value of the final goods and
services produced in a country during a given
period.
– We’ll examine each part of this definition in
detail.
Copyright c 2004 by The McGraw-Hill
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
9
Gross Domestic Product:
Measuring the Nation’s Output
• The Market Value …
– Market value is used to aggregate the
quantities of different goods and services into
one measurement.
– We use prices, at current levels, for
aggregation.
• E.g., we could use today’s prices to measure
today’s GDP.
Copyright c 2004 by The McGraw-Hill
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
10
Market Value and GDP
Quantity
Unit
Price
Market
Value
PxQ
Apples
4
$0.25
$1.00
Bananas
6
$0.50
$3.00
Shoes
3
$20.00
$60.00
Total $64.00
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
11
Gross Domestic Product:
Measuring the Nation’s Output
• Market Value
– More expensive items receive a higher weight
than cheaper items.
– Suppose production of cheap items falls but
production of expensive items rises: GDP will
often rise.
Copyright c 2004 by The McGraw-Hill
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
12
Market Value and GDP
Quantity
Unit
Price
Market
Value
PxQ
Quantity
Unit
Price
Market
Value
PxQ
Apples
4
$0.25
$1.00
3
$0.25
$0.75
Bananas
6
$0.50
$3.00
3
$0.50
$1.50
Shoes
3
$20.00
$60.00
4
$20.00
$80.00
Total $64.00
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
$82.25
13
Gross Domestic Product:
Measuring the Nation’s Output
• Market Value
– Many goods and services that do not have
market value are not counted in GDP.
• That is, goods and services that cannot be bought
and sold (such as care of one’s own children and
homemaking) do not count.
• If I pay someone to take care of my children, the
quality of child care may decline, but GDP will rise.
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
14
Percentages of American Men and Women over
Age 16 Working Outside the Home, 1960 - 2001.
• Increase in female labor force participation increases the demand for
housekeeping and child care.
• Unpaid household work is not counted in GDP.
• Paid household work is counted in GDP.
• The increase in female labor force participation has overstated GDP growth.
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
15
Gross Domestic Product:
Measuring the Nation’s Output
• Market Value
– Goods and services provided by the
Government do not have market value, but
they are counted in GDP.
• But they do have dollar figures attached to them.
• One could imagine that these goods and services
could be bought and sold, even if they often are
not.
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
16
See Excel Handout
“Calculating Nominal
GDP”
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
17
Gross Domestic Product:
Measuring the Nation’s Output
• … of Final Goods or Services …
– Not all goods and services that can be bought
and sold are counted.
– Intermediate goods (non-durable goods used
to produce other goods) are not counted.
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
18
Gross Domestic Product:
Measuring the Nation’s Output
• Final Goods or Services
– Goods or services consumed by the ultimate
user; because they are the end products of
the production process, they are counted as
part of GDP.
• Intermediate Goods or Services
– Goods or services used up in the production
of final goods and services and therefore not
counted as part of GDP.
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
19
Gross Domestic Product:
Measuring the Nation’s Output
• Final Goods and Services: Example
• Milling Co. pays $0.50 for wheat to make flour.
• Bakery pays $1.20 for flour to make bread.
• Bakery sells bread for $2.00
• Contribution to GDP = $2.00
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
20
Gross Domestic Product:
Measuring the Nation’s Output
• Value Added
– For any firm,
Market Value
of Good or
Service
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Cost of Inputs
bought from
other firms
Chapter 18: Measuring Economic
Activity: GDP and Unemployment
Value
Added
21
Value Added in Bread
Production
Company
Revenues – Cost of purchased inputs = Value added
ABC Grain
$0.50
$0.00
$0.50
General Flour
$1.20
$0.50
$0.70
Hot’n’Fresh
$2.00
$1.20
$0.80
Total
$2.00
•The grain and flour are produced in 2002
•Bread is produced in 2003
•$1.20 is added to 2002 GDP
•$0.80 is added to 2003 GDP
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
22
Gross Domestic Product:
Measuring the Nation’s Output
• Final Goods and Services
– Getting a haircut
• Barber charges $10 for a haircut
• Barber pays his assistant $2
• Contribution to GDP = $10
– The contribution of the assistant is included
in the final market value of the haircut.
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
23
Gross Domestic Product:
Measuring the Nation’s Output
• Example:
– Capital Good
• A long-lived good, which is itself produced and
used to produce other goods and services.
–
–
–
–
–
Tools.
Buildings.
Factories.
Machines.
Software.
• Newly produced capital goods are classified as
final goods.
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
24
Gross Domestic Product:
Measuring the Nation’s Output
• … Produced Within a Country …
– Domestic
• Only production that takes place within a
country’s border.
• Examples
– Cars produced in the U.S. by foreign owned companies
are counted.
– Car produced in Mexico by U.S. owned companies are
not counted.
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
25
Gross Domestic Product:
Measuring the Nation’s Output
• … During a Given Period
– Given Period
• Counts only goods produced during the defined
period such as a calendar year.
• Examples
– The sale of used goods is not counted.
– Real estate commissions, earned this year, on a house
produced 3 years ago, are counted (but the sale of the
house is not).
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
26
The Expenditure Approach to
GDP
The Expenditure Method for
Measuring GDP
• Every good that is produced must be
purchased.
– If it is a consumer good, by consumers.
– If it is a capital good, by firms.
– If it is a government good, by governments.
• So measuring the market value of
production is identical to measuring the
dollar value of expenditures.
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
28
Expenditure Components of
U.S. GDP, 2001 (billions of dollars)
Consumption
Durable goods
69.30%
1,586.0
15.73%
1,858.0
18.43%
-348.9
-3.46%
835.9
Nondurable goods
2,041.3
Services
4,109.9
Investment
Business fixed investment
1,201.6
Residential investment
444.8
Inventory investment
-60.3
Government purchases
Net exports
Exports
1,034.1
Imports
-1,383.0
Total: Gross domestic product
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6,987.0
Chapter 18: Measuring Economic
Activity: GDP and Unemployment
10,082.2 100.00%
29
The Expenditure Method for
Measuring GDP
• Consumption Expenditure, or simply
Consumption
– Spending by households on goods and
services, such as food, clothing, and
entertainment.
• Consumer durables
• Consumer nondurables
• Services
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
30
The Expenditure Method for
Measuring GDP
• Investment
– Spending by firms on final goods and
services, primarily capital goods and housing.
• Business fixed investment
– Increases the country’s capacity to produce.
• Residential investment
• Inventory investment
– Inventories accumulate if sales are less than production.
– Inventory is treated as “bought” by firms.
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
31
The Expenditure Method for
Measuring GDP
• Investment
– Purchases of new capital (durable goods used
to produce other goods).
• Financial investment
– Purchases of stocks (and so), which involve
buying existing capital.
– This is not investment in our sense.
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
32
The Expenditure Method for
Measuring GDP
• Government Purchases
– Purchases by federal, state, and local
governments of final goods and services.
• Does not include transfer payments.
• Does not include interest paid on government
debt.
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
33
The Expenditure Method for
Measuring GDP
• Net Exports
– Exports minus imports
• Exports
– Goods and services produced domestically but
sold abroad.
• Imports
– Goods and services produced abroad but
bought domestically.
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
34
The Expenditure Method for
Measuring GDP
• Y = gross domestic product, or output
• C = consumption expenditure
• I = investment
• G = government purchases
• NX = net exports
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
35
The Expenditure Method for
Measuring GDP
• The Expenditure Method for Measuring
GDP
Y  C  I  G  NX
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
36
The Expenditure Method for
Measuring GDP
• Example
– An economy produces 1 million cars valued at
$15,000 each.
• From the production side, this is …
– GDP = 1 million x $15,000 = $15 billion
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
37
The Expenditure Method for
Measuring GDP
• From the Expenditure side …
– 700,000 sold to consumers
• C = 700,000 x $15,000 = $10.5 billion
– 200,000 sold to businesses
• I = 200,000 x $15,000 = $3.0 billion
– 50,000 sold to government
• G = 50,000 x $15,000 = $.75 billion
– 30,000 exported – 5,000 imported
• NX = 25,000 x $15,000 = $.375 billion
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
38
The Expenditure Method for
Measuring GDP
• From the Expenditure side (cont.)…
– 975,000 sold
– 25,000 inventory
• Additional I = 25,000 x $15,000 = $0.375 billion
• GDP = C + I + G + NX
– $10.5 + (3.0 +0.375) + .75 + .375 = $15.0
billion
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
39
The Income Approach to GDP
The Income Method for Measuring
GDP
• Every purchase means someone earns
income:
– If I buy a pen, the bookstore earns $0.60.
– If Ford buys a factory, the builder earns $60
million.
– If the government buys a highway, the
contractor earns $600 million.
– If Americans buy French computers, the
French earn $50,000.
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
41
GDP and the Incomes of
Capital and Labor
• GDP = Labor Income + Capital Income
– Labor income
• Equals 75% of GDP
• Includes:
– Wages
– Salaries
– Income of the self-employed
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
42
GDP and the Incomes of
Capital and Labor
• GDP = Labor Income + Capital Income
– Capital income
• Equals 25% of GDP
• Includes:
–
–
–
–
Profits
Rent
Interest
Royalties
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
43
Percentage of Aggregate Income
Received by Income Quintiles, 2001
Quintiles
Lowest
2nd
3rd
4th
Highest
Perfect
Equality
20
20
20
20
20
Income
3.5
8.8
14.5
23.1
50.1
Source: US Census Bureau, Current Population Survey, 2002 Annual Demographic Supplement
A “Quintile” is a fifth of the population. So the poorest 20% of all Americans is the
“lowest quintile”; the next-poorest 20% is the “second quintile,” and so on. The
richest 20% is the “highest quintile.”
Copyright c 2004 by The McGraw-Hill
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
44
The Three Faces of GDP
Production
Market
value of
final
goods
and
services
Expenditure
Income
Consumption
Labor Income
=
=
Investment
Government
purchases
Capital
Income
Net exports
Copyright c 2004 by The McGraw-Hill
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
45
Nominal GDP versus Real GDP
Prices and Quantities in 2000
and 2004
Quantity of
pizzas
Price of
pizzas
Quantity of
calzones
Price of
calzones
GDP
2000
(10
x
$10)
+
(15
x
$5)
= $175
2004
(20
x
$12)
+
(30
x
$6)
= $420
Observations
•Physical production of each good doubled
•GDP increased by 2.4 times
•Aha!! Prices also rose
•Market-Value GDP overstates economic growth
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
47
Nominal GDP versus Real
GDP
• Nominal GDP
– A measure of GDP in which the quantities
produced are valued at current-year prices.
– Nominal GDP measures the current dollar
value of production.
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
48
Nominal GDP versus Real
GDP
• Real GDP
– Real GDP measures the actual physical
volume of production.
– To do this, we must eliminate the effect of
changing prices. How?
– The quantities produced are valued at the
prices in a base year rather than at current
prices. This is Real GDP.
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
49
Prices and Quantities in 2000
and 2004
Quantity of
pizzas
Price of
pizzas
Quantity of
calzones
Price of
calzones
GDP
2000
(10
x
$10)
+
(15
x
$5)
= $175
2004
(20
x
$12)
X
+
(30
x
$6)
X
= $420
X
(20
x
$10)
+
(30
x
$5) = $350
Observations
•Physical production of each good doubled
•Real GDP also doubles.
•We use the prices of the year 2000.
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
50
See Excel Handout
“Real versus Nominal
GDP”
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
51
Nominal GDP, Real GDP, and
Inflation
Real GDP Growth Rate

Nominal GDP Growth Rate – Inflation Rate
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
52
5.00%
4.00%
3.00%
2.00%
1.00%
-2.00%
Real GDP growth rate
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Nominal GDP growth rate
Chapter 18: Measuring Economic
Activity: GDP and Unemployment
Inflation Rate
53
Jan-04
Jan-02
Jan-00
Jan-98
Jan-96
Jan-94
Jan-92
Jan-90
Jan-88
Jan-86
Jan-84
Jan-82
Jan-80
Jan-78
Jan-76
Jan-74
Jan-72
Jan-70
Jan-68
Jan-66
Jan-64
Jan-62
Jan-60
Jan-58
Jan-56
Jan-54
Jan-52
Jan-50
-1.00%
Jan-48
0.00%
GDP and Well-Being
Real GDP is not the Same
as Economic Well-Being
• GDP doesn’t take into account
– The increase in Leisure Time.
– Nonmarket Economic Activities.
– Environmental Quality and Resource
Depletion.
– Increases or decreases in the Quality of Life
– Poverty and Economic Inequality
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
55
Real GDP is related to
Economic Well-Being
• Higher GDP often leads to more
– Life expectancy at birth
– Doctors per person
– School enrollments
– Literacy
• Higher GDP also leads to less
– Infant mortality
– Incidence of AIDS
– Undernourishment
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
61
Unemployment
The Unemployment Rate
• Measuring Unemployment
– The Bureau of Labor Statistics (BLS) surveys
60,000 randomly selected households each
month.
– Those 16 years and over are placed in one of
three categories:
• Employed
• Unemployed
• Out of the labor force
– The BLS estimates how many people in the
U.S. fit into each category.
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
65
The Unemployment Rate
• Measuring Unemployment
– Labor force = employed + unemployed
unemployed
Unemployme nt rate 
labor force
labor force
Participation rate 
population 16 and over
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
66
Working-Age Population
Frictional
Employed
Labor Force
Unemployed
Homemakers, Retired People, Disabled,
Discouraged Workers, Students
Ages 0 - 15
Structural
Cyclical
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
67
U.S. Employment Data,
July 2002 (in millions)
Employed
134.04
Plus:
Unemployed
Equals: Labor force
8.35
142.39
Plus:
Not in labor force
71.63
Equals:
Working-age (over 16) population
214.02
Unemployment rate
= unemployed/labor force = 8.35/142.39 = 5.9%
Participation rate
= labor force/working-age population = 142.39/214.02 = 66.5%
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
68
The U.S. Unemployment
Rate since 1960
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
69
The Unemployment Rate
• The Cost of Unemployment
– Economic
• People don’t receive income. Resources are not
utilized.
– Psychological
• Loss of self-esteem, depression, suicide.
– Social
• Increases in crime, drug use, etc.
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
70
The Unemployment Rate
• The Duration of Unemployment
– The impact of unemployment is influenced by
how long individuals have been unemployed.
• The unemployment spell: time without
employment while in the labor force.
• The duration of unemployment: length of spell.
• Long-term unemployed: 6 mths or more
• Chronically unemployed: in and out of work, in and
out of the labor force.
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
71
The Unemployment Rate
• In July 2002:
– Official unemployment rate = 5.9%
– Including discouraged workers and
involuntary part-time worker = 9.4%
• Discouraged Workers
– People who say they would like to have a job
but have not made an effort to find one in the
last four weeks
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
72
Workers, Wages, and
Unemployment in the
Modern Economy
Unemployment:
Types, Causes,
and Costs
Types of Unemployment and Their
Costs
• Three kinds of unemployment
– Frictional Unemployment
• Due to minor problems
– Structural Unemployment
• Due to lack of skills, etc.
– Cyclical Unemployment
• Due to recessions
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
74
Types of Unemployment and Their
Costs
• Frictional Unemployment
– The short-term unemployment associated
with the process of matching workers with
jobs
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
75
Types of Unemployment and Their
Costs
• Characteristics of Frictional Unemployment
– Short-term
– May lead to a better match between the
worker and job
– Necessary in a dynamic economy
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
76
Types of Unemployment and Their
Costs
• Structural Unemployment
– Long-term and chronic unemployment that
exists even with the economy is producing at
a normal rate
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
77
Types of Unemployment and Their
Costs
• Causes of Structural Unemployment
– Lack of skills, language barrier, discrimination
– Long-term mismatch
– Structural features of the labor market, such
as technological change.
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Types of Unemployment and Their
Costs
• Cost of Structural Unemployment
– Loss in economic output
– May not develop new skills
– Psychological damage
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Chapter 18: Measuring Economic
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Types of Unemployment and Their
Costs
• Cyclical Unemployment
– The extra unemployment that occurs during
periods of recession
– May lead to discouraged workers
– But it may be an occasion for far-reaching
change and re-training.
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Impediments to Full Employment
• Labor Unions
– Benefits
• Reduced worker exploitation
• Support progressive labor legislation
• Increase productivity
• Promote democracy in the workplace
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
82
Impediments to Full Employment
• Labor Unions
– Costs
• Unions cause otherwise competitive labor markets
to function inefficiently.
• Unions may prevent companies from competing in
the global economy.
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Chapter 18: Measuring Economic
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Impediments to Full Employment
• Unemployment Insurance:
– Helps to reduce the costs of unemployment.
– May give the unemployed an incentive to
search longer and less intensely.
– Unemployment benefits must balance the
benefit of providing support to the worker
with the cost of reducing the incentive to
work.
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Chapter 18: Measuring Economic
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84
Unemployment
• Economic Naturalist
– Why are unemployment rates so high in
western Europe?
– Europe has significant Structural Rigidities
• Regulated labor markets
– It’s difficult to fire or hire people.
• High minimum wages
• Generous unemployment benefits
• Powerful labor unions
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
87
Unemployment Rates in Western
Europe, 1980 - 2001
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
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What You’ve Learned Today
• The meaning and measurement of GDP.
• The meaning of: market value, final good,
capital good, and domestic.
• The components of aggregate
expenditure.
• Basics of income distribution.
• The difference between real and nominal
GDP.
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
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What You’ve Learned Today
• The difference between GDP and welfare.
• The meaning and measurement of
unemployment.
• The types, causes, and costs of
unemployment.
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Chapter 18: Measuring Economic
Activity: GDP and Unemployment
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