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Topics
 Aggregate Output (Standard Measure)
 GDP vs GPI discussion
 The Other Major Macroeconomic
Variables (Unemployment and Inflation
Rate)
Economics 302 Lecture 2
Aggregate Output
Aggregate Output (national income
and product accounts, or NIPA)
 Gross Domestic Product (GDP)
 The
value of the final goods and services
produced in an economy during a given
period
Economics 302 Lecture 2
Aggregate Output
Defining GDP: Three Approaches
1) Final good
2) Value added
3) Income
Economics 302 Lecture 2
Aggregate Output
GDP: The final goods approach
Firm 1: Steel Company
Revenues from sales
Expenses (wages)
Profit
What is GDP?
$100
$80
$20
$310 or $210
Firm 2: Car Company
Revenues from sales
Expenses
Wages
Steel purchases
Profit
Economics 302 Lecture 2
$210
$170
$70
$100
$40
Aggregate Output
Defining GDP
 Answer:
$210
 If
both firms are summed ($100 + $210)
the $100 in steel is counted twice
 Counting
only the final good (cars) includes
the intermediate good (steel)
Economics 302 Lecture 2
Aggregate Output
Question for Discussion
 What would GDP be if the firms
merged?
Economics 302 Lecture 2
Aggregate Output
Defining GDP: Three Approaches
2) Value Added Approach
Value added
= value of production - value of intermediate goods
Economics 302 Lecture 2
Aggregate Output
Two Firm Example
 Steel
 No
intermediate goods
 Value
added = $100
Economics 302 Lecture 2
Aggregate Output
Two Firm Example
 Cars
 Intermediate
 Value
goods (steel) = $100
added = $210 - $100 = $110
Economics 302 Lecture 2
Aggregate Output
Two Firm Example
GDP ($210) 
Value added steel ($100)  value added cars ($110)
Economics 302 Lecture 2
Aggregate Output
 Defining GDP
 Final goods approach  Value added approach
 Sum of the value of final goods 
Sum of the value added along the
production chain
Economics 302 Lecture 2
Aggregate Output
 Defining GDP
 Approach
1 & 2 define GDP from the
production side
Economics 302 Lecture 2
Aggregate Output
 Defining GDP
3) GDP from the income side
Economics 302 Lecture 2
Aggregate Output
Consider
 Revenues after payment for
intermediate goods
 Some
pay indirect taxes (sales taxes)
 Some
pay workers (labor income)
 Remainder
to the firm (capital income)
Economics 302 Lecture 2
Aggregate Output
Defining GDP
 GDP from the income side
GDP (income)  indirect taxes
 labor income
 capital income
Economics 302 Lecture 2
Aggregate Output
GDP: Income Approach
Firm 1: Steel Company
Revenues from sales
Expenses (wages)
Profit
$100
$80
$20
Firm 2: Car Company
Revenues from sales
Expenses
Wages
Steel purchases
Profit
Economics 302 Lecture 2
$210
$170
$70
$100
$40
Aggregate Output
 Income (steel)
 Income (car)

Labor = $80

Labor = $70

Capital = $20

Capital = $40
$100
$110
GDP (income)  $100  $110  $210
Compared to:
GDP (value added - -$210)  value added steel ($100)
 value added car ($110)
Economics 302 Lecture 2
The Composition of GDP by
Type of Income, 1960 and 1998
In Percent
1960
1998
Labor income
66%
65%
Capital income
26%
27%
8%
8%
Indirect taxes
Economics 302 Lecture 2
Aggregate Output
Defining GDP – A Summary
 Output Approach = Income Approach
 Final
goods & value added = sum of
indirect taxes + labor income + capital
income
Economics 302 Lecture 2
Aggregate Output
Nominal & Real GDP
 Recall
 GDP
= the value of final goods and
services produced
 Value
is the price of the final good
Economics 302 Lecture 2
Aggregate Output
Nominal & Real GDP
 Therefore,
 GDP
= Price x Quantity of final goods
produced
Economics 302 Lecture 2
Aggregate Output
Questions for Discussion
 If price increases and quantity remains
constant, what happens to the value of
final output?
Economics 302 Lecture 2
Aggregate Output
Observation
 Higher prices bias the GDP
measurement of production upward
over time.
Economics 302 Lecture 2
Aggregate Output
 Nominal & Real GDP (correcting for
inflation)
 One
Year
1991
1992
1993
good economy
Quantity of Cars
10
12
13
Price of Cars
Nominal GDP
$10,000
$12,000
$13,000
$100,000
$144,000
$169,000
Economics 302 Lecture 2
Aggregate Output
 Nominal & Real GDP (correcting for
inflation)
 One
Year
1991
1992
1993
good economy
Quantity of Cars Price of Cars Nominal GDP(% increase)
10
12
13
$10,000
$12,000
$13,000
Economics 302 Lecture 2
$100,000
$144,000
$169,000
(--)
(44%)
(17.4%)
Aggregate Output
Nominal GDP = Pcars x Qcars
Question
Did the real output of cars increase
44% from 1991 to 1992?
Economics 302 Lecture 2
Aggregate Output
Calculating Real GDP
 Real GDP = value of final goods in
constant prices
Economics 302 Lecture 2
Aggregate Output
Real GDP in Units
Production of cars
 1991 -- 10,000
 1992 -- 12,000 (20% increase)
 1993 -- 13,000 (8.33% increase)
Economics 302 Lecture 2
Aggregate Output
Real GDP in 1992 $s
Car Production x 1992 Prices
 1991 -- 10 x $12,000 = $120,000
 1992 -- 12 x $12,000 = $144,000 (20% increase)
 1993 -- 13 x $12,000 = $156,000 (8% increase)
Note: Nominal 1992 GDP = Real 1992 GDP
Economics 302 Lecture 2
Aggregate Output
Calculating Real GDP in Practice
 Accounting for all final goods
 Weighted
average of the output of final
goods
 Relative
 Must
prices serve as weights
consider the change in relative prices
 U.S.
Real GDP is Real GDP in chained
(1992) dollars
Economics 302 Lecture 2
Nominal and Real
U.S. GDP, 1960-1998
Economics 302 Lecture 2
Aggregate Output
Observations
 The increase in real GDP is less than
nominal GDP
 More variation in real GDP than nominal
GDP
Economics 302 Lecture 2
Aggregate Output
Synonyms for GDP Accounting
 Nominal GDP
 Dollar
 GDP
GDP
in current dollars
Economics 302 Lecture 2
Aggregate Output
Synonyms for GDP Accounting
 Real GDP
 GDP
in terms of goods
 GDP
in constant dollars
 GDP
adjusted for inflation
 GDP
in 1992 dollars
Economics 302 Lecture 2
Aggregate Output
Technical Notes: For the Course
 GDP growth in year t -- rate of change in real
GDP in year t
 GDP growth = (yt - yt-1)/yt-1
 Expansions -- periods of positive growth
 Recessions -- periods of negative growth
(2 consecutive quarters)
Economics 302 Lecture 2
The Other Major
Macroeconomic Variables
The Unemployment Rate
number unemployed (U )
Unemployme nt Rate (u ) 
labor force (L)
Labor Force (L )  employed (N )  unemployed (U )
Economics 302 Lecture 2
The Other Major
Macroeconomic Variables
Counting the Unemployed
 Current population survey
 60,000
households monthly
 Employed
-- job holders
 Unemployed
-- job seekers
Economics 302 Lecture 2
The Other Major
Macroeconomic Variables
Counting the Unemployed
 1998
N  131.4
U  6.2
6.2 (U )
u  4.5% 
131.4 (N )  6.2(U )
Economics 302 Lecture 2
The Other Major
Macroeconomic Variables
Macro Terms
Unemployed and Discouraged Workers
labor force (L)
Participation Rate 
adult population (16 )
Economics 302 Lecture 2
The Other Major
Macroeconomic Variables
What Do You Think?
 Can the unemployment rate rise when
the number of employed increases?
Economics 302 Lecture 2
Change in the U.S. Unemployment Rate
versus U.S. GDP Growth 1960 - 1998
Economics 302 Lecture 2
The Other Major
Macroeconomic Variables
Economic Policy Implications
 If unemployment is too high -- high
growth policy must be pursued to reduce
it
 If unemployment is too low -- low growth
policy is required
Economics 302 Lecture 2
The Other Major
Macroeconomic Variables
Social Implications of Unemployment
 Unemployment rates and duration vary
by population groups
 Certain groups incur a disproportionate
share of the unemployed when
unemployment increases
Economics 302 Lecture 2
The Other Major
Macroeconomic Variables
 The Inflation Rate
A
sustained rise in the price level
 Two Measures of the Price Level
 GDP
Deflator
 Consumer
Price Index (CPI)
Economics 302 Lecture 2
The Other Major
Macroeconomic Variables
The GDP Deflator
 Average
 GDP
price of final goods produced
deflator in year t = Pt
nominal GDPt $Yt
Pt 

Real GDPt
Yt
Economics 302 Lecture 2
The Other Major
Macroeconomic Variables
The GDP Deflator
 Pt
is an index number
• P1993 = 102.6 (1992 = 100)
 Index
numbers are used to measure rate of
change over time
Pt  Pt - 1
Rate of inflation 
 %Pt
Pt - 1
Economics 302 Lecture 2
The Other Major
Macroeconomic Variables
The GDP Deflator
$Yt
Pt 
Yt
$Yt  Pt  Yt
Economics 302 Lecture 2
The Other Major
Macroeconomic Variables
The Consumer Price Index (CPI)
 Average prices of goods consumed
 The CPI is not equal to the GDP deflator
 Some
final goods are sold to business,
government, and foreigners
 Some
consumer goods are imported
Economics 302 Lecture 2
The Other Major
Macroeconomic Variables
The Consumer Price Index (CPI)
 Published monthly
 Involves several steps
Economics 302 Lecture 2
The Other Major
Macroeconomic Variables
Steps in Calculating the CPI
1) Consumer expenditure survey to determine
a market basket of items
2) Bureau of labor statistics (BLS) field
workers price the items monthly (85 cities,
22,000 stores)
3) A base period is chosen, currently 1982-84
Economics 302 Lecture 2
The Other Major
Macroeconomic Variables
Steps in Calculating the CPI
Price in time period
4) CPI 
 100
Base price (1982 - 84)
5) 1998 CPI = 163 (1982-84 = 100)
Economics 302 Lecture 2
Inflation Rate, Using the CPI
and the GDP Deflator, 1960, 1998
Economics 302 Lecture 2
Change in the U.S. Inflation Rate versus
the U.S. Unemployment Rate, 1970-1998
Economics 302 Lecture 2
The Other Major
Macroeconomic Variables
The Phillips Curve
 Low unemployment --inflation rate
increases
 High unemployment -- inflation rate
decreases
Economics 302 Lecture 2
The Other Major
Macroeconomic Variables
Why Do Economists Care About Inflation?
 Prices and wages do not rise
proportionately




Inflation creates market distortions due to:
Regulation
Taxation
Uncertainty for business investment
Economics 302 Lecture 2
What Do Macroeconomists
Care About?
The Central Question of Macroeconomics
 What determines the level of aggregate
output?
 Demand
 Supply
 Government,
education, and savings
Economics 302 Lecture 2
Macroeconomic Analysis
The Central Question of Macroeconomics
 What determines the level of aggregate
output?
 Short-run
(a few years) -- demand
 Medium-run
(10+ years) -- supply
 Long-run
(50+ years) -- government,
education, savings
Economics 302 Lecture 2