Download Ch. 5

Frank & Bernanke
3rd edition, 2007
Ch. 5: Measuring Economic Activity:
GDP and Unemployment
1
Why Measure A Nation’s
Income
To have a sense of an economy’s size.
 The well being of a citizen, on average,
depends on the nation’s income and its
population.
 As the income of the society increases,
the average person will have a higher
standard of living.

One can drown in a lake of 3-ft average
depth.
 Standard of living may not necessarily be
the goods and services a household can
consume.

2
Definition of GDP

Gross Domestic Product is the market value
of all the final goods and services produced
within a country in a year.





How do you determine the value of child care?
How do you include the production of steel or
plastics?
How do you include the sales of existing homes?
How do you account for $4 million paid at an
auction for a Van Gogh painting?
How do you account for government services?
3
Market Value




Suppose we live in an economy where only
hamburgers, colas and cookies are
produced.
Prices are: hamburgers $2; colas $1;
cookies $0.50.
If this economy produces 100 hamburgers,
150 colas and 200 cookies, what is the
market value?
What is the market value if 200
hamburgers, 100 colas and 100 cookies
are produced?
4
Percentages of American Men and Women
over Age 16 Working Outside the Home
• Increase in female labor force participation increases the demand for
housekeeping and child care.
• Unpaid household work is not counted in GDP.
• Paid household work is counted in GDP.
• The increase in female labor force participation has overstated GDP growth.
5
Gross Domestic Product:
Measuring the Nation’s Output

Economic Naturalist
Why has female participation in the labor
market increased by so much?
 What explains the trends illustrated in the
previous figure?

 Hint:
The concept of comparative advantage
6
Why GDP Is Equal to Income?

How is my contribution to the US economy
calculated?


The amount of educational service I create is
equal to my gross income.
How is the income of a real estate agent
calculated?

When she sells a 25-yr old house, she gets a
percent of the price as a payment for her
services.
7
Why GDP Is Equal to Income?

How is the GDP contribution of the
textbook company calculated?
After they pay the author, the paper company
and the ink company, the amount of revenue
they get from textbook sales plus the value of
their book inventory (unsold books) is their
contribution to the US GDP.
 Their contribution is equal to wages, salaries,
rent, interest and profits they pay.

8
Value Added
Calculate the contribution of the
following activities to GDP.
 Farmer sells cotton for $100.
 Cotton is processed into thread and
sold for $130.
 Thread is made into cloth and sold for
$200.
 Cloth is made into shirts and sold for
$300.

9
Circular Flow
Consumption expenditures of households
Firms
Households
Income (wages, salaries, rent, interest, profit)
earned by households
10
Circular Flow
Upper flow is equal to GDP.
 Lower flow is equal to income.
 If GDP < Income, businesses will
reduce production and create less
income.
 If GDP > Income, businesses will want
to expand production and create more
income.

11
12
How Can We Measure GDP?
Expenditure Approach: the upper flow.
Y = C + I + G + NX
 Income Approach: the lower flow.
Y = Sum of factor incomes
Y = Wages + Salaries + Rent + Interest +
Profits

13
Components of Expenditure
Approach

Consumption includes spending on
food, entertainment, shelter, health
care, transportation, clothing, household
items, insurance, education.
14
Components of Expenditure
Approach

Investment includes purchases made by
firms to generate future income.
Machinery, tools, buildings, trucks and
cars are part of investment if they are
bought to generate future income. By
convention, newly built houses and
inventory are included under investment.
15
Components of Expenditure
Approach

Government purchases are expenditures
of federal, state and local governments on
goods and services plus their payrolls.
16
Components of Expenditure
Approach
Net exports is exports minus imports.
 Dell Computer sales in China are part of
US exports.
 Dell Computer purchases of plastic molds
for their computers from China are part of
US imports.

17
GDP
http://www.bea.gov/bea/dn/nipaweb/TableView.asp#Mid
18
Labor and Capital Income
Source: http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=economic_indicators&docid=05de01.txt
19
The Three Faces of GDP
Production
Market
value of
final
goods
and
services
Expenditure
Income
Consumption
Labor Income
=
=
=
=
Investment
Government
purchases
Capital
Income
Net exports
20
A GDP Increase Always Increases
The Size of the Economy
WRONG!
 What if GDP in 2005 were 1000, in 2006
were 1500 but inflation was 50%?
 In this case, the increase in GDP is solely
attributable to price increases, not
improving the well being (standard of
living) of the average citizen.

21
Nominal vs. Real Measures
In macroeconomics, most variables are
measured in real terms, not nominal terms.
 Real variable eliminates the effect of
inflation.
 Nominal variable includes the effect of
inflation.
 GDP comparisons are always made with
real GDP.
 Nominal GDP uses current prices.
 Real GDP uses base year prices.

22
Real and Nominal GDP
The Economy Produces 2 Goods: Pizza and Soda
Year
1997
1998
1999
Pp
10
11
13
Qp Ps
1000 2
1000 3
1200 4
Qs Nominal GDP
5000 $20,000.00
6000 $29,000.00
7000 $43,600.00
Real GDP GDP Deflator
$20,000.00
100.0
$22,000.00
131.8
$26,000.00
167.7
Nominal GDP is calculated by adding the amounts spent on each
Product. Real GDP is calculated by using the prices of pizza and
Soda from 1997 o calculate the amounts spent in future years.
GDP Deflator is Nominal GDP/Real GDP.
23
Real and Nominal GDP
24
What Is Wrong With Real GDP?



Real GDP increases if you sell your services
rather than provide them free.
If you build a house through Habitat for
Humanity your work doesn’t count as part of
GDP. If you get paid for the same work, it
counts.
If you pollute during production and someone
pays to clean the environment, the GDP will
be higher than if the producer tried to reduce
pollution during production so no clean-up
was necessary.
25
Underground Economy
If market transactions cannot be tracked
by data collectors, they may be ignored.
 Transactions with high cash usage and
no paper trail can remain hidden from
the government.
 GDP may actually be much higher than
government statistics if there is a large
underground economy.

26
Real GDP is not the Same
as Economic Well-Being

Leisure Time
Shorter work week
 Start working later
 Retire earlier

27
Real GDP is not the Same
as Economic Well-Being

Nonmarket Economic Activities
Household production
 Volunteer services
 Nonmarket activities are more important in
poor countries
 Underground economy

28
Real GDP is not the Same
as Economic Well-Being

Environmental Quality and Resource
Depletion
Benefits of environment quality are not
measured.
 GDP is not adjusted for resource depletion.

29
Real GDP is not the Same
as Economic Well-Being

Quality of Life
Crime rates
 Traffic congestion
 Civic organizations
 Open space

30
Real GDP is not the Same
as Economic Well-Being

Poverty and Economic Inequality

GDP does not capture the effects of income
inequality
31
GDP & Basic Indicators of Well-Being
All developing
countries
Least developed
countries
GDP per person
(U.S. dollars)
3,530
1,170
25,860
Life expectancy at
birth (years)
64.5
51.7
78.0
Infant mortality rate
(per 1,000 live births)
61
100
6
Under-5 mortality rate
(per 1,000 live births)
89
159
6
Doctors
(per 100,000 people)
78
30
252
Incidence of HIV/Aids
(% in 15-49 age group)
1.3
4.3
0.3
Undernourished
people (%)
18
38
Negligible
Primary enrollment
rate (as % of age group)
85.7
60.4
99.9
Secondary enrollment
rate (as % of age group)
60.4
31.2
96.2
Adult literacy rate (%)
72.9
51.7
98.6
Indicator
Industrialized
countries
32
http://hdr.undp.org/hdr2006/statistics/
33
How Does the Government Measure
Unemployment?
• Bureau of Labor Statistics (Department of
Labor) collects information every month.
• The first Friday of every month at 8:30 AM
eastern time, the unemployment rate for the
previous month is announced.
• People of age 16 and older are classified as
either EMPLOYED or UNEMPLOYED or
NOT IN THE LABOR FORCE.
34
How Does the Government Measure
Unemployment?
• Employed
– Any one working for pay.
– It may be full-time or part-time.
• Unemployed
– Temporary lay-off.
– Waiting to start a job.
– Looking for a job.
• Not in the labor force
–
–
–
–
Retirees
Students
Homemakers
Inmates
35
The Unemployment Rate

Measuring Unemployment

Labor force = employed + unemployed
unemployed
Unemployme nt rate 
labor force
labor force
Participation rate 
population 16 and over
36
U.S. Employment Data,
July 2002 (in millions)
Employed
134.04
Plus:
Unemployed
Equals: Labor force
8.35
142.39
Plus:
Not in labor force
71.63
Equals:
Working-age (over 16) population
214.02
Unemployment rate = unemployed/labor force = 8.35/142.39 = 5.9%
Participation rate = labor force/working-age population = 142.39/214.02 = 66.5%
37
http://stats.bls.gov/news.release/empsit.nr0.htm
38
http://data.bls.gov/PDQ/servlet/SurveyOutputServlet
39
The Unemployment Rate

The Cost of Unemployment
Economic
 Psychological
 Social

40
The Unemployment Rate

The Duration of Unemployment

The impact of unemployment is influenced by
how long individuals have been unemployed.
 The
unemployment spell
 The duration of unemployment
 Long-term unemployed
 Chronically unemployed
41
The Unemployment Rate

Unemployment Spell


A period during which an individual is
continuously unemployed
Duration

The length of an unemployment spell
42
The Unemployment Rate

The Duration of Unemployment
Discouraged workers
 Involuntary part-time workers
 In July 2002:

 Official
unemployment rate = 5.9%
 Including discouraged workers and involuntary
part-time worker = 9.4%
43
The Unemployment Rate

Discouraged Workers

People who say they would like to have a job
but have not made an effort to find one in the
last four weeks
44