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Measurement of Output, Employment & Prices Why Measurement Matters • Before we get into models of economic behaviour we need to look some definitions and some issues in measurement • Measurement economic quantities may seem boring… – But it can give crucial insight even without a model of behaviour – Example: we will look at include the current crisis MACROECONOMIC MEASUREMENT • Need to Look at three sets of measurements 1. Here we will look at the National Income and Expenditure Accounts (NIE) 2. Also the measurement of external transactions: Balance of Payments 3. Prices 4. Employment NIE Identity • We measure macroeconomic activity primarily by looking at annual (or quarterly) flows of Output (O), Income (Y) and Expenditure (E). • These are different ways of measuring the same thing, so they sum to identical totals – Basic Identity: YO E • Think of why this is the case – Income and Product are identical: Product is Value-Added in Production, i.e sales minus purchases from other firms, which = payment of incomes to Factors (Wages, Interest…) – Expenditure equals Income, because any production not sold is counted as Inventory Investment, and is thus part of Expenditure (the firm purchases its own output from itself) • Note this is an identity not an equilibrium condition – An identity holds for all values – An eqm condition holds only for some values i.e. in eqm – Distinction important later NIE: GDP vs GNP • Open economy: GNP v GDP – GNP GDP + NFIA – (NFIA is net factor inc from R.O.W., i.e. inflows minus outflows) – GNY GNP + EUtrasfers – EUtaxes – GNDY GNP + NTA (NTA is all net Transfers from R.O.W. incl EU) – GDP + NFIA + NTA GNDY – Note: Irish GNP was approx 85% of GDP (2007) – For many other countries the distinction is not relevant – Can lead to lots of debate of which is best measure in Ireland NIE: SAVINGS & INVESTMENT IDENTITY • The Income Identity – YC+S+T – Accounting rule: Income is either spent saved or taxed • The Expenditure Identity – E= C + I + G + NX – Accounting rule: add up the components of expenditure • Combine the two – C + I + G + NX C + S + T • Thus: – or: • • • • (G – T) (S – I) – NX (G – T) + NX (S – I) etc. clearly, adding in net foreign factor and transfer income, including them in the totals for T and S etc as appropriate, and changing signs we get: (T - G) + (S - I) NX BOP Current A/C Note: the 2 left hand expressions are National Savings Note: we could also add in NFIA & For Trans NIE: SAVINGS & INVESTMENT IDENTITY • This is often known as the twin deficits identity • Even though it doesn’t involve any model or description of economic behaviour it can be informative • Implication: a current account surplus can only occur if there is an excess of national savings • Application 1: The US – The US has trade deficit (esp with China) – This is inescapable given it has insufficient savings – China surplus equates to surplus Chinese savings • Application 2: Ireland’s Bubble – We had a bubble (high investment) – Insufficient savings – So high current account deficit Savings 35.00% 30.00% Personal 25.00% Corporate Gov 20.00% Inv CA 15.00% 10.00% 5.00% 0.00% 1995 -5.00% -10.00% 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 EMPLOYMENT AND UNEMPLOYMENT • • • • • The labour force (L) = employed (E) + unemployed (U) The unemployment rate u% = U/L or U/(E + U) Letting the population of Labour-force Age = P, we also have: The Labour force participation rate: LFPR% = L/P Measuring Employment and Unemployment – Surveys: household QNHS in Ireland, quarterly household survey (CPS in USA); business surveys for employment. – Administrative: “Live Register” (Ireland); related to benefit claimants • • • The precise details of how surveys and other measures are constructed will differ from country to country. Survey methods are generally more comparable. Key Issue: have to “want” to work to be unemployed as distinct from not working Surveys try to capture this: “active search” – Issue of how active – Discouraged worker effects • Claimant counts do not – may include people NILF Prices • (See Gordon: Appendix to Ch 2) • Some components of GDP have well-known measures of inflation: the CPI for household consumption • For a more comprehensive measure the implicit price deflator for GDP is used: this relates to all items in the GDP • A price index is a weighted average measure of price changes • Two questions arise: (i) what is included (ii) what kind of weighting system to use • For Consumption the Irish CPI includes a measure of housing costs, the Eurozone HIPC does not (why?) • Generally if an index uses base-year weights (Laspeyre), the resulting inflation is higher than if current year weights are used (Paasche) • Nearly all Consumer Price indices are Laspeyre. LASPEYRE AND PAASCHE INDICES • A Laspeyre index of prices uses the quantities prevailing in some base (e.g. survey) year to weight prices. The index takes the form: • (p1q0 / p0q0)x100 • Note: base-year quantities (q0) are used to compare prices in the two years (p1 and p0 ) • A Paasche index of prices uses the quantities prevailing in the terminal year to weight prices. The index takes the form: • (p1q1/ p0q1)x100 • Note: current-year quantities (q1) are used to compare prices in the two years (p1 and p0) • As relatively cheaper are substituted for dearer goods, the Laspeyre index of prices has an upward substitution bias. THE IMPLICIT GDP DEFLATOR • Instead of constructing an index directly, we take the ratio of nominal to real GDP. • For simplicity let real GDP be this year’s output at last year’s (base year) prices • So the index is: (p1q1 / p0q1) • Note that this is similar in form to a Paasche index of prices. • In some cases the calculation is refined and the implicit deflator is an average (geometric mean) of a Laspeyre and Paasche indices. • As the real to nominal GDP ratio is re-calculated each year, the weighting of the quantities is updated and the resulting implicit deflators are chained together to give a cumulative index over time. • The result is a lesser degree of substitution bias