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No 03. Chapter 2
Measuring Macroeconomic
Variables
Chapter Outline
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National Income Accounting: The
Measurement of Production, Income, and
Expenditure (Gross Domestic Product)
Saving and Wealth
Real GDP, Price Indexes, and Inflation
Interest Rates
Gross Domestic Product
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Our usual measure of aggregate economic
activity is Gross Domestic Product, GDP.
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GDP is the market value of final goods and
services produced within a nation during a fixed
period of time
Measuring Activity: The
National Income Accounts
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Economic activity in a given period can be
measured in three ways:
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Value of output produced
Income received by the producers of output
Spending by the purchasers of output
Each of these three approaches yields an
identical numerical measurement.
The Expenditure Approach to
Measuring GDP
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Measure output as the sum of expenditures
on products categorized as consumption,
investment, government spending, and net
exports:
Y  C  I  G  NX
GDP in the United States, 2002,
Expenditure Approach
The Income Approach to
Measuring GDP
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When firms take in revenue, that revenue is
paid out to workers, owners of inputs other
than labor, creditors of the firm, and the
owners of the firm.
The Income Approach to
Measuring GDP
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National Income:
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Compensation of employees
Proprietor’s income
Rental income
Corporate profits
Net interest
Measuring GDP in the United
States, 2002, Income Approach
Private Disposable Income
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Private Disposable Income equals
Y  NFP  TR  INT  T
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Y: GDP
NFP: Net factor payments from abroad
TR: Transfers received from the government
INT: Interest payments to households on the
government’s debt.
T: Taxes
Government Sector Income
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The part of GDP not at the disposal of the
private sector is net governmental income
(tax revenue, less transfers and interest
payment on the government debt:
Net Governmental Income  T  TR  INT
Aggregate Saving
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Private saving is private disposable Income
less consumption.
Government saving is government receipts
less government outlays (equivalently,
government income less government
purchases, or the budget surplus).
National saving is private saving plus
government saving.
Aggregate Saving
Uses of Saving
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From the preceding slide:
S  S pvt  S govt  Y  NFP  C  G
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Also recall:
Y  C  I  G  NX
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So:
S  I  NX  NFP
Saving and Investment
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Consider a closed economy, such that net
exports and net factor payments from
abroad are equal to zero. Then:
S  Y C G
SI
Real and Nominal Measures
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In a given year, we measure GDP and related
income measures in terms of current market
values in dollars; i.e., nominal measures.
However, market values (prices) change over
time.
To compare economic activity correctly over
time, we wish to distinguish movements in
GDP due to output changes from those due to
price changes.
If GDP is adjusted for changes in prices over
time, we are measuring it in real terms.
An Example
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Table 2.3 considers the calculation of nominal
GDP in two years for an economy that
produces just two goods.
Table 2.3 Production and Price
Data
Output Growth
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Growth rate of real output is calculated as
a percentage rate of change:
Yt  Yt 1
GrowthRate 
100%
Yt 1
Example Contined
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Table 2.4 illustrates the calculation of real
GDP and growth rates of real GDP using the
same data:
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Real GDP calculates the value of output at base
year prices.
Actually, these calculations are done twice, once
for each possible choice of a “base” year. For a
moment, consider just the case where the base
year is arbitrarily assumed to be year 1.
Real Output: Alternative Base
Years
GDP Deflator
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Define the GDP Deflator (a price index):
NominalGDP
GDPDeflator 
100
RealGDP
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For the preceding data, the GDP deflator in year
2, when the base year is year 1, is
66, 000
100  106.5
62, 000
Inflation
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Inflation is an annualized percentage rate of
change in the price level.
Using the GDP deflator to measure the price
level, and using the measures in the upper panel
of Table 2.4, inflation over the time from year 1 to
year 2 is measured as a percentage rate of
change:
106.5  100
100%  6.5%
100
Chain-weighting
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Because of the problem noted above (that real
GDP growth rates are sensitive to the choice of
a base year), the Bureau of Economic analysis
has now adopted a procedure called chainweighting to measure real GDP (and
consequently the deflator).
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Essentially, it assumes that the correct growth rate
going from year 1 to year 2 is an average of the two
rates calculated in the upper and lower panels of
Table 2.4.
The averaging method is rather odd, so we do not
pursue it here.
Consumer Price Index
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The consumer price index (CPI) is another price
index (like the GDP deflator).
It differs in the goods included to measure price
changes as well as in the method of calculation.
Its measurement is based on the change in the cost
of a standard (base year) bundle of consumer goods
over time.
Percentage changes in the CPI are also used to
measure inflation.
Interest Rate
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The rate of interest is a rate of return
promised by a borrower to a lender.
There are many interest rates, differing by the
nature and length of a loan, however most
interest rates move up and down together.
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In our theory, we will usually assume that there is
a single interest rate.
Real and Nominal Interest
Rates
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We earlier made a distinction between real and
nominal magnitudes for measures of output or
income.
We also distinguish real and nominal interest
rates, but the nature of the correction differs.
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A nominal rate of interest measures a percentage
return in terms of dollars; a real rate of interest
measures a percentage return in terms of goods (the
real purchasing power of dollars).
Calculating a real rate of
interest
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The real rate of interest is the nominal rate of
interest minus the inflation rate.
The expected real rate of interest is the
nominal rate of interest minus the expected
inflation rate.
r  i 
e
The End