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Thinking Like an Economist
Basic Questions: Macro
 Macroeconomic
 How
Questions
can sufficient growth be attained
so that the well being of society
increases?
 How should productive capacity be
utilized so that there will be full
employment with stable prices?
The Economy as a Circular
Flow
Resources
Income
Firms
Households
Expenditures
Goods and Services
Measuring GDP
What Is GDP?

GDP, Gross Domestic Product, is the
total dollar value of all final goods and
services produced in a country during a
year.
Current market prices are used to
aggregate different outputs to a dollar
total.
 Government purchases, many of which
do not occur in markets, are valued at
their cost of production.

What Is GDP?
Only final goods and services are included.
Intermediate goods are not included to
avoid double counting.
 The measure is an annual flow, a rate of
production. A GDP of $10 trillion implies
that the economy is producing $10 trillion
worth of goods and services per year.
 GDP measures production by U.S. citizens
and foreigners alike inside the geographic
borders of the USA and thus unequivocally
reflects economic activity in the USA.

Real and Nominal GDP

Nominal GDP

The market value of a nation’s final output
based on current prices for the goods and
services produced during the year.
• Nominal GDP in 2001 = the sum of all the
goods and services produced in 2001 multiplied
by their 2001 prices

Real GDP

An estimate of the value of a nation’s final
products adjusted for changes in prices
since some base year.
Components of GDP:
Expenditure Viewpoint
 Consumption
Non-durable Goods (last less than 3 years)
 Durable Goods (last more than 3 years)
 Services

 Gross
Domestic Investment
Non-residential Investment (plant and
equipment)
 Inventory Change
 Residential Investment

Components of GDP:
Expenditure Viewpoint
 Government
Spending
Local and State
 Federal

 Net

Exports
Exports Minus Imports
Components of GDP:
Income Viewpoint
 Employee
Compensation
 Income
from the sale of labor
services during the year.
• It includes wages, salaries, and fringe
benefits such as employer provided
insurance and employer contributions
to pension funds.
Components of GDP: Income
Viewpoint
 Net

Interest
The portion of business receipts used to
pay for borrowed funds that finance
investment purchases.
 Rental

Income
Rental income is earned by those who
supply the services of land, mineral rights,
and buildings for use by others.
Components of GDP: Income
Viewpoint
 Profits.
 Profits
of corporations and
unincorporated business
•
Profits = Total revenues - Indirect
business taxes - Capital consumption
allowance - labor costs - net interest rents paid
Components of GDP:
Expenditure and Income
 Expenditure
 GDP
= C + I + G + (X-M)
 Income
 NI
 Since
=W+i+R+p
NI and GDP measure
aggregate production, they must
be equal.
GDP = NI 2001
Consumption
6,987.1
Durable Goods
Nondurables
Services
835.9
2,041.3
4,109.9
Investment
Nonresidential
Residential
Inventory Change
1,586.0
1,201.6
444.7
-60.3
Government
1,858.0
Federal
State & Local
628.1
1,229.9
Net Exports
Exports
Imports
GDP
-348.9
1,034.1
1,383.0
10,082.2
Employee Compensation
5874.9
Corporate Profits
731.6
Proprietors’ Income
727.9
Net Interest
649.8
Rental Income
137.9
National Income
8,122.1
+ CCA
1329.3
+ Indirect Business Taxes
774.8
+ Business Transfers
42.5
- Subsidies
-47.3
+Statistical Discrepancy
-117.3
GNP
10,104.1
+Net Foreign Payments
-21.9
GDP
10,082.2
The Economy as a Circular
Flow
Resources
Income
Firms
Households
Expenditures
Goods and Services
What GDP Is Not
 It
is not a measure of a nation’s
overall welfare. Why?
 Some
things are produced but never
sold and so are not included in GDP.
 GDP places no value on leisure
 Some expenditures are hidden from
data collectors
What GDP Is Not
 Production
of some goods and services
while increasing GDP can have a
negative effect on the environment
 Some items are included that do not
reflect net benefits to society.
• Environmental clean-ups bring us back to
the pre-damage state. These expenditures
are included with no offsetting reduction to
reflect the cost of pollution.
Macroeconomic Problems
Unemployment
Inadequate Growth
Inflation
Unemployment
 The
unemployment rate is the
number of unemployed people,
expressed as a percentage of the labor
force.
 Labor
Force = (Civilian noninstitutional population over age 16
minus people not in the labor force
(students, homemakers, retirees,
discouraged workers)
Definitions
Labor Force = Number of Employed + Number of Unemployed
Unemployment Rate = Number of Unemployed
Labor Force
X 100
Labor Force Participation Rate = Labor Force
X 100
Adult Population
Types of Unemployment
 Frictional
Unemployment
 Occurs
due to normal turnover in the
labor market. People changing jobs.
 Structural
Unemployment
 Refers
to workers who are not employed
because their skills are not in demand.
 Cyclical
Unemployment
 Occurs
cycle.
due to changes in the business
Natural Rate of
Unemployment

The natural rate of unemployment is the
percentage of the labor force that can normally
be expected to be unemployed for reasons
other than cyclical fluctuations in real GDP.

The natural rate of unemployment is related to the
willingness of workers to voluntarily separate
from their jobs, job loss, the duration of
unemployment periods, the rate of change in the
pattern of demand, and changes in technology.
Costs of Unemployment
 Loss
in productivity is measured by the gap
between potential GDP and actual GDP.
 A conservative
estimate of the cumulative gap
between actual and potential GDP over the
years 1974-1992 (evaluated in 1987 prices) is
approximately $1300 billion.
 At 1993 levels, this loss in output would be
about 3 months’ worth of production.
Inflation
 Inflation
refers to a sustained rise in
the average level of prices.
 Inflation
does not mean that all prices
are rising. Some prices may be
falling, but on average the overall
level of prices is rising.
Inflation
Creeping inflation is an inflation that
proceeds for a long time at a moderate
and fairly steady pace.
 Galloping inflation is an inflation that
proceeds at an exceptionally high rate,
often for only a brief period.


In 1993, Brazil experienced inflation rates
of 2,700%
The Costs of Inflation

The main cost of inflation is the loss of
efficiency that results because inflation
distorts price signals. For example…

People invest in assets designed to protect
them against inflation, such as real
estate, rather than in productive
investments that enhance the growth and
efficiency of the economy.
The Costs of Inflation
Business collect bills more promptly, using
resources that could otherwise have been
used to produce goods and services.
 Individuals reduce money holdings, which
is inconvenient and misallocates the
individual’s personal resources of time,
energy , and leisure.
 In the case of hyperinflation, inflation over
100%, the currency system breaks down
and the economy reverts to barter.

Purchasing Power and
Inflation
 Inflation
erodes the purchasing
power of a given sum of money.
 Assume
you have $10,000 and the
price level is 1.
• In current dollars, you have $10,000,
and in constant dollars you have
$10,000.
Purchasing Power and Inflation
 Now
let the price level rise to 2.
• In current dollars, you still have
$10,000, but in constant dollars you
now have ??? ?
 The
rise in the price level has
decreased the purchasing power of
your money.
Price Indexes
 Consumer
Price Index (CPI)
 The
CPI is calculated by observing
changes in the cost of purchasing a
typical bundle of consumer goods and
services.
• The CPI is a weighted average of all prices,
with the weights given by the relative
importance of different goods or services in the
typical bundle of purchases.
Price Indexes
 GDP
Deflator
 The
GDP deflator is the ratio of GDP
valued at current prices and GDP
valued at base year prices. For
example, if 1992 is the base year, the
GDP deflator is:
• (GDP valued in 1999 prices/GDP valued in
1992 prices)100
The GDP Deflator and the
CPI

There are 4 major differences between
the GDP deflator and the CPI.

The CPI reflects prices of only consumer
goods and services: The GDP deflator
includes prices of all output.
The GDP Deflator and the CPI
The CPI incorporates prices of imports:
The GDP deflator does not.
 The CPI is calculated by tracking over
time the cost of a fixed basket of goods
and services: The GDP deflator allows
the output basket to change.
 Once published, the CPI is never revised:
The GDP deflator changes with GDP
revisions.

Which Movies Were Most
Profitable?
E.T.
 Gone with the Wind
 Forrest Gump
 Star Wars
 Jurassic Park
 Empire Strikes Back
 The Sting

Movies: Receipts in Current
Dollars







E.T.
Jurassic Park
Forrest Gump
Star Wars
Empire Strikes Back
The Sting
Gone with the Wind
$357.77
$354.16
$336.38
$273.30
$200.50
$128.67
$ 76.35
Movies: Year Released







The Empire Strikes Back
Gone with the Wind
Forrest Gump
The Sting
Jurassic Park
E.T.
Star Wars
1980
1939
1994
1973
1993
1982
1977
Movies: Adjusted for Inflation







Gone with the Wind
Star Wars
E.T.
The Sting
Jurassic Park
The Empire Strikes Back
Forrest Gump
$859
$628
$552
$397
$375
$361
$343
Millions of 1996 Dollars
Movies: Receipts in Constant
Dollars








Receipts in $1996 = Nominal receipts x (1996 price
level/Year movie released price level).
Gone with the Wind $76.35 x 108/9.61 = $859
Star Wars
$273.3 x 108/47 = $628
E.T.
$357.77 x 108/70 = $552
The Sting
$128.67 x 108/35 = $397
Jurassic Park
$354.16 x 108/102= $375
Empire Strikes Back $200.5 x 108/60 = $361
Forrest Gump
$333 x 108/105 = $343
Movies: Receipts in Current
Dollars








Nominal Receipts = Inflation adjusted receipts x (Year
movie released price level/1996 or base price level).
E.T.
$552 x 70/108 = $357.77
Jurassic Park
$375 x 102/108 = $354.16
Forrest Gump
$346 x 105/108 = $336.38
Star Wars
$628 x 47/108 = $273.30
Empire Strikes Back $361 x 60/108 = $200.55
The Sting
$397 x 35/108 = $128.67
Gone with the Wind $859 x 9.6/108 = $ 76.35
The
End