Download Measuring Economic Aggregates

Introduction to Gross Domestic
Product
Learning Objectives
• Define gross domestic product and explain
how it is measured using the expenditure
approach.
• Explain the difference between nominal and
real GDP.
Real GDP
13,000
11,000
9,000
7,000
5,000
3,000
1,000
1947:1 1953:1 1959:1 1965:1 1971:1 1977:1 1983:1 1989:1 1995:1 2001:1 2007:1
4.2
Log Real GDP
4.1
4
3.9
3.8
3.7
3.6
3.5
3.4
3.3
3.2
Jan-47 Jan-52 Jan-57 Jan-62 Jan-67 Jan-72 Jan-77 Jan-82 Jan-87 Jan-92 Jan-97 Jan-02 Jan-07
GDP Dating Exercise
• Describe the empirical facts before you (ie.
GDP generally increases).
• Identify peaks, valleys what happened.
• Is there regularity in the frequency of
changes?
Expansion and Contraction:
The Business Cycle
• An expansion, or boom, is the
period in the business cycle from
a trough up to a peak, during
which output and employment
rise.
• A contraction, recession,
or slump is the period in
the business cycle from a
peak down to a trough,
during which output and
employment fall.
Real GDP, 1900-2002
Real GDP, 1970 I-2003 II
Macroeconomic Concerns
• Three of the major concerns of
macroeconomics are:
– Inflation
– Unemployment
– Output growth
Output Growth:
Short Run and Long Run
• The business cycle is the cycle of shortterm ups and downs in the economy.
• The main measure of how an economy is
doing is aggregate output:
– Aggregate output is the total quantity of
goods and services produced in an economy
in a given period.
Output Growth:
Short Run and Long Run
• A recession is a period during which aggregate
output declines. Two consecutive quarters of
decrease in output signal a recession.
• A prolonged and deep recession becomes a
depression.
• Policy makers attempt not only to smooth
fluctuations in output during a business cycle but
also to increase the growth rate of output in the
long-run.
The Components of
the Macroeconomy
• Everyone’s
expenditure is
someone else’s
receipt. Every
transaction must
have two sides.
An Overview of National Income and Product
Accounting (NIPA)
•
•
•
Detailed calculations were first
worked out by Simon Kuznets
during the Great Depression
Large quantities of data
collected and organized from a
variety of sources around the
country
These data are summarized,
assembled into a coherent
framework, and reported by
the government
Gross Domestic Product and Gross National
Product
• GDP is the market value of all newly produced
final goods and services produced by
resources located in the United States,
regardless of who owns those resources
Final and Intermediate Goods and
Services
• Final goods and services sold to ultimate, users
– Cotton shirts are a final good
• Intermediate goods and services are purchased for further
reprocessing and resale
– Cotton is intermediate good
• Keeping final goods and intermediate goods separate in our
thinking allows us to avoid double counting
Calculating GDP
GDP can be computed in two ways:
• The expenditure approach: A
method of computing GDP that
measures the total amount spent
on all final goods during a given
period.
• The income approach:
The Expenditure Approach
• The expenditure approach calculates
GDP by adding together the four
components of spending. In equation
form:
GDP  C  I  G  ( EX  IM )
The Circular Flow of Income and
Expenditure
X-M
consumption (C)
Investment (I)
S
Financial
markets
Gov’t (G)
transfer payments
Disposable income
taxes
C+I+G+X-M
aggregate income
= GDP
Categories of Expenditures
• Consumption (C)
– All household purchases (blue jeans, twinkies, etc.)
• Investment (I)
– Purchases not used for current consumption (newly built
homes,plant, new inventories)
• Government Purchases (G)
– Examples include missile systems and paper clips
• Net Exports (X - M)
– Net exports = exports (X) - imports (M)
Personal Consumption Expenditures
• Personal consumption expenditures (C) are
expenditures by consumers on the following:
– Durable goods: Goods that last a relatively long
time, such as cars and appliances.
– Nondurable goods: Goods that are used up fairly
quickly, such as food and clothing.
– Services: Things that do not involve the
production of physical things, such as legal
services, medical services, and education.
Gross Private Domestic Investment
• Investment refers to the purchase of
new capital.
• Total investment by the private sector is
called gross private domestic
investment. It includes the purchase of
new housing, plants, equipment, and
inventory by the private sector.
Gross Private Domestic Investment
• Nonresidential investment includes expenditures by
firms for machines, tools, plants, and so on.
• Residential investment includes expenditures by
households and firms on new houses and apartment
buildings.
• Change in inventories computes the amount by
which firms’ inventories change during a given
period. Inventories are the goods that firms
produce now but intend to sell later.
Government Consumption
and Gross Investment
• Government consumption
and gross investment (G)
counts expenditures by
federal, state, and local
governments for final goods
and services.
Net Exports
• Net exports (EX – IM) is the difference
between exports and imports. The
figure can be positive or negative.
– Exports (EX) are sales to foreigners of U.S.produced goods and services.
– Imports (IM) are U.S. purchases of goods
and services from abroad).
Classify each of these scenarios
•
•
•
•
•
•
•
•
You buy an old house
You buy some marijuana from a friend
You buy stock in GM
A Japanese firm buys City Brewery
The government makes a welfare payment
You buy a used car
A business fails to sell some of its inventory
A business buys a new truck
Components of GDP, 2002: The Expenditure Approach
BILLIONS
OF
DOLLARS
Personal consumption expenditures (C)
Durable goods
Nondurable goods
Services
Gross private domestic investment (l)
Nonresidential
Residential
Change in business inventories
Government consumption and gross
investment (G)
Federal
State and local
Net exports (EX – IM)
Exports (EX)
Imports (IM)
Total gross domestic product (GDP)
Note: Numbers may not add exactly because of rounding.
Source: U.S. Department of Commerce, Bureau of Economic Analysis.
PERCENTAGE
OF GDP
7303.7
871.9
2115.0
4316.8
1543.2
1117.4
471.9
3.9
1972.9
69.9
8.3
20.2
41.3
14.8
10.7
4.5
0
18.9
693.7
1279.2
 423.6
1014.9
1438.5
10446.2
6.6
12.2
 4.1
9.8
13.8
100.0
Current and Historical Data
• US data (BEA)
– http://www.bea.doc.gov/bea/newsrel/gdp499p.htm
• Historical US Data
– http://eh.net/hmit/gdp/
• International
– http://www.stls.frb.org/publications/iet/
– http://www.odci.gov/cia/publications/factbook/
GDP and Social Welfare
• Society is better off when crime
decreases, however, a decrease in crime
is not reflected in GDP.
• An increase in leisure is an increase in
social welfare, but not counted in GDP.
• Nonmarket and household activities are
not counted in GDP even though they
amount to real production.
GDP and Social Welfare
• GDP accounting rules do not adjust for
production that pollutes the environment.
• GDP has nothing to say about the
distribution of output. Redistributive
income policies have no direct impact on
GDP.
• GDP is neutral to the kinds of goods an
economy produces.
The Underground Economy
• The underground economy is the
part of an economy in which
transactions take place and in
which income is generated that is
unreported and therefore not
counted in GDP.
Gross National Income per Capita
• To make comparisons of GNP between countries,
currency exchange rates must be taken into account.
• Gross National Income (GNI) is a measure used to
make international comparisons of output. GNI is
GNP converted into dollars using an average of
currency exchange rates over several years adjusted
for rates of inflation.
• GNI divided by population equals gross national
income per capita.
Per Capita Gross National Income for Selected
Countries, 2002
COUNTRY
Switzerland
Japan
Norway
United States
Denmark
Ireland
Sweden
United
Kingdom
Netherlands
Austria
Finland
Germany
Belgium
France
Canada
Australia
Italy
Spain
Greece
U.S. DOLLARS
36,970
35,990
35,530
34,870
31,090
28,880
25,400
24,230
COUNTRY
Portugal
South Korea
Argentina
Mexico
Czech
Republic
Brazil
South Africa
Turkey
24,040
23,940
23,840
23,700
23,340
22,640
21,340
18,770
18,470
14,860
11,780
Colombia
Jordan
Romania
Philippines
China
Indonesia
India
Pakistan
Nepal
Rwanda
Ethiopia
Source: The World Bank Atlas, 2002.
U.S. DOLLARS
10,670
9,400
6,860
5,540
5,270
3,060
2,900
2,540
1,910
1,750
1,710
1,050
890
680
460
420
250
220
100
Accounting for Price Changes
Nominal Versus Real GDP
• Nominal GDP is GDP measured in current
dollars, or the current prices we pay for
things. Nominal GDP includes all the
components of GDP valued at their current
prices.
• When a variable is measured in current
dollars, it is described in nominal terms.
Real GDP
• Real GDP is the value of GDP measure in terms
of dollars of fixed purchasing power
• Real GDP is measured in the dollars of the
base year
• The base year is a reference year against
which other years are measured
The Simplest Example of a Price Index
(One Product)
Year
1994
1995
1996
Price of Bread
in Current Year
(1)
$1.25
$1.30
$1.40
Price of Bread
in the Base Year
Price Index
(2)
(3) = (1)/(2) x 100
$1.25
100
$1.25
104
$1.25
112
The GDP Price Index, Nominal GDP, and Real
GDP
• The GDP price index is a comprehensive price
index of all goods and services included in the
gross domestic product
Nominal GDP  GDP price index  real GDP
Calculating Real GDP
• A weight is the importance attached to an
item within a group of items.
• A base year is the year chosen for the weights
in a fixed-weight procedure.
• A fixed-weight procedure uses weights from a
given base year.
Calculating Real GDP
A Three-Good Economy
(1)
(2)
PRODUCTION
YEAR 1
YEAR 2
Q1
Q2
(3)
(4)
PRICE PER UNIT
YEAR 1
YEAR 2
P1
P2
(5)
(6)
(7)
(8)
GDP IN
YEAR 1
IN
YEAR 1
PRICES
P1 x Q1
GDP IN
YEAR 2
IN
YEAR 1
PRICES
P1 x Q2
GDP IN
YEAR 1
IN
YEAR 2
PRICES
P2 x Q1
GDP IN
YEAR 2
IN
YEAR 2
PRICES
P2 X Q2
Good A
6
11
$.50
$ .40
$3.00
$5.50
$2.40
$4.40
Good B
7
4
.30
1.00
2.10
1.20
7.00
4.00
Good C
10
12
.70
.90
7.00
8.40
9.00
10.80
$12.10
$15.10
$18.40
$19.20
Total
Nominal
GDP
in year 1
Nominal
GDP
in year 2
The Problems of Fixed Weights
The use of fixed price weights to
estimate real GDP leads to problems
because it ignores:
1. Structural changes in the economy.
2. Supply shifts, which cause large decreases
in price and large increases in quantity
supplied.
3. The substitution effect of price increases.
Hypothetical Data Used to Develop Chain-Weighted
Indexes
Good
Twinkies
Fuel Oil
Cable TV
Units of Output
Year 1
10000
5000
200
Year 1 Output at
Good
Year 1 Prices
Twinkies $
4,900
Fuel Oil $
5,000
Cable TV $
4,000
$
13,900
Price per Unit
Year 2
Year 1
15000 $
0.49 $
4000 $
1.00 $
200 $
20.00 $
Year 2 Output at
Year 1 Prices
$
7,350
$
4,000
$
4,000
$
15,350
Year 1 Output at
Year 2 Prices
$
4,500
$
7,500
$
4,000
$
16,000
GDP Price Index
Year 2
0.45
1.50
20.00
Year 2 Output at
Year 2 Prices
$
6,750
$
6,000
$
4,000
$
16,750
104.7
Calculating the GDP Deflator
• The GDP deflator is one measure of the overall
price level. The GDP deflator is computed by
the Bureau of Economic Analysis (BEA).
• Overall price increases can be sensitive to the
choice of the base year. For this reason, using
fixed-price weights to compute real GDP has
some problems.
Appendix
• Slides after this point will most likely not be covered in
class. However they may contain useful definitions, or
further elaborate on important concepts, particularly
materials covered in the text book.
• They may contain examples I’ve used in the past, or slides I
just don’t want to delete as I may use them in the future.
Introduction to Macroeconomics
• Macroeconomists often reflect on
the microeconomic principles
underlying macroeconomic
analysis, or the microeconomic
foundations of macroeconomics.
Government in the Macroeconomy
• Fiscal policy refers to government policies
concerning taxes and spending.
• Monetary policy consists of tools used by the
Federal Reserve to control the quantity of money in
the economy.
• Growth policies are government policies that focus
on stimulating aggregate supply instead of
aggregate demand.
The Components of
the Macroeconomy
• The circular flow diagram
shows the income received
and payments made by
each sector of the
economy.
The Methodology of Macroeconomics
• Connections to microeconomics:
– Macroeconomic behavior is the sum of all
the microeconomic decisions made by
individual households and firms. We
cannot understand the former without
some knowledge of the factors that
influence the latter.
Measuring Economic Aggregates
Gross Domestic Product and Gross National
Product
• GDP is the market value of all final goods and
services produced by resources located in the
United States, regardless of who owns those
resources
• GNP is the market value of all final goods and
services produced by resources supplied by
U.S. residents and firms, regardless of location
Calculating GDP
GDP can be computed in two ways:
• The expenditure approach: A method of
computing GDP that measures the total
amount spent on all final goods during a
given period.
• The income approach: A method of
computing GDP that measures the income—
wages, rents, interest, and profits—received
by all factors of production in producing final
goods.
Gross Private Domestic Investment
• Remember that GDP is not the market
value of total sales during a period—it is
the market value of total production.
• The relationship between total
production and total sales is:
GDP = final sales + change in business inventories
Consumer Price Index
•
The consumer price index is a
measure over time of the cost
of a fixed “market basket” of
consumer goods and services
Good
Quantity
Twinkies
365
Fuel Oil
500
Cable TV
12
Price
(Base Year)
$
0.49
$
1.00
$
20.00
Cost in
Base Year
$ 178.85
$ 500.00
$ 240.00
$ 918.85
Price
(Current Year)
$
0.45
$
1.50
$
20.00
Cost in
Current Year
$
164.25
$
750.00
$
240.00
$ 1,154.25
CPI
125.6
Review Terms and Concepts
base year
change in business inventories
compensation of employees
corporate profits
current dollars
depreciation
disposable personal income, or after-tax
income
government consumption and gross
investment (G)
gross domestic product (GDP)
gross investment
gross national income (GNI)
gross national product (GNP)
gross private domestic investment (I)
income approach
durable goods
indirect taxes
expenditure approach
intermediate goods
final goods and services
national income
fixed-weight procedure
national income and product accounts
Review Terms and Concepts
net exports (EX – IM)
personal saving
net factor payments to the rest of the
world
personal saving rate
net interest
net investment
net national product (NNP)
nominal GDP
nondurable goods
nonresidential investment
personal consumption expenditures (C)
personal income
proprietors’ income
rental income
residential investment
services
subsidies
underground economy
value added
weight
Skip The slides that follow
• We skipped some of the slides for time
consideration and some because it is material
I do not care to cover.
The Components of
the Macroeconomy
• Transfer payments are payments made by
the government to people who do not
supply goods, services, or labor in exchange
for these payments.
The Three Market Arenas
• Households, firms, the government,
and the rest of the world all interact in
three different market arenas:
1. Goods-and-services market
2. Labor market
3. Money (financial) market
The Three Market Arenas
• Households and the government purchase goods and
services (demand) from firms in the goods-and services
market, and firms supply to the goods and services market.
• In the labor market, firms and government purchase
(demand) labor from households (supply).
– The total supply of labor in the economy depends on the sum of
decisions made by households.
The Three Market Arenas
• In the money market—sometimes called the financial
market—households purchase stocks and bonds from
firms.
– Households supply funds to this market in the expectation of
earning income, and also demand (borrow) funds from this market.
– Firms, government, and the rest of the world also engage in
borrowing and lending, coordinated by financial institutions.
Financial Instruments
• Treasury bonds, notes, and bills are
promissory notes issued by the federal
government when it borrows money.
• Corporate bonds are promissory notes
issued by corporations when they
borrow money.
Financial Instruments
• Shares of stock are financial instruments
that give to the holder a share in the
firm’s ownership and therefore the right
to share in the firm’s profits.
– Dividends are the portion of a corporation’s
profits that the firm pays out each period to
its shareholders.
Review Terms and Concepts
aggregate behavior
dividends
microeconomics
aggregate demand
expansion or boom
monetary policy
aggregate output
fine tuning
recession
aggregate supply
fiscal policy
shares of stock
business cycle
Great Depression
stagflation
circular flow
hyperinflation
sticky prices
contraction, recession, or
slump
inflation
supply-side policies
macroeconomics
transfer payments
microeconomic
foundations of
macroeconomics
Treasury bonds, notes,
bills
corporate bonds
deflation
depression
unemployment rate
Inflation and Deflation
• Inflation is an increase in the overall price level.
• Hyperinflation is a period of very rapid increases in
the overall price level. Hyperinflations are rare, but
have been used to study the costs and consequences
of even moderate inflation.
• Deflation is a decrease in the overall price level.
Prolonged periods of deflation can be just as
damaging for the economy as sustained inflation.
Unemployment
• The unemployment rate is the percentage of
the labor force that is unemployed.
• The unemployment rate is a key indicator of
the economy’s health.
• The existence of unemployment seems to
imply that the aggregate labor market is not in
equilibrium. Why do labor markets not clear
when other markets do?
Unemployment Rate, 1970 I-2003 II
Percentage Change in the GDP Deflator (FourQuarter Average), 1970 I-2003 II
Introduction to Macroeconomics
• Microeconomics examines the behavior of individual
decision-making units—business firms and
households.
• Macroeconomics deals with the economy as a
whole; it examines the behavior of economic
aggregates such as aggregate income, consumption,
investment, and the overall level of prices.
– Aggregate behavior refers to the behavior of all
households and firms together.
Introduction to Macroeconomics
• Microeconomists generally conclude that
markets work well. Macroeconomists,
however, observe that some important prices
often seem “sticky.”
• Sticky prices are prices that do not always
adjust rapidly to maintain the equality
between quantity supplied and quantity
demanded.
The Roots of Macroeconomics
• The Great Depression was a
period of severe economic
contraction and high
unemployment that began
in 1929 and continued
throughout the 1930s.
The Roots of Macroeconomics
• Classical economists applied microeconomic
models, or “market clearing” models, to
economy-wide problems.
• However, simple classical models failed to
explain the prolonged existence of high
unemployment during the Great Depression.
This provided the impetus for the
development of macroeconomics.
The Roots of Macroeconomics
• In 1936, John Maynard Keynes published The General
Theory of Employment, Interest, and Money.
• Keynes believed governments could intervene in the
economy and affect the level of output and employment.
• During periods of low private demand, the government can
stimulate aggregate demand to lift the economy out of
recession.
Recent Macroeconomic History
• Fine-tuning was the phrase used by Walter
Heller to refer to the government’s role in
regulating inflation and unemployment.
• The use of Keynesian policy to fine-tune the
economy in the 1960s, led to disillusionment
in the 1970s and early 1980s.
Recent Macroeconomic History
• Stagflation occurs when the overall price level
rises rapidly (inflation) during periods of
recession or high and persistent
unemployment (stagnation).
Aggregate Supply and
Aggregate Demand
• Aggregate demand is the total
demand for goods and services in
an economy.
• Aggregate supply is the
total supply of goods and
services in an economy.
• Aggregate supply and
demand curves are more
complex than simple
market supply and demand
curves.
Government in the Macroeconomy
• There are three kinds of policy that the
government has used to influence the
macroeconomy:
1. Fiscal policy
2. Monetary policy
3. Growth or supply-side policies