Macroeconomics

Practical Questions
 Gross Domestic Product
The circular flow shows two ways of measuring GDP.
GDP Equals Expenditure Equals Income
Total expenditure on final goods and services equals GDP.
GDP = C + I + G + X – M.
Aggregate income equals the total amount paid for the use
of factors of production: wages, interest, rent, and profit.
Firms pay out all their receipts from the sale of final
goods, so income equals expenditure,
Y = C + I + G + (X – M).
Table 21.1 on shows the expenditure approach with data
(in billions) for 2010.
GDP = $11,729 + $2,714 + $3,139  $538 = $17,044 billion
 Real versus Nominal GDP
• Inflation
can distort economic variables like
GDP, so we have two versions of GDP:
One is corrected for inflation, the other is not.
• Nominal GDP values output using current
prices. It is not corrected for inflation.
• Real GDP values output using the prices of
a base year. Real GDP is corrected for
inflation.
EXAMPLE:
Pizza Latte
year P Q P Q
2005 $10 400 $2.00 1000
2006 $11 500 $2.50 1100
2007 $12 600 $3.00 1200

Compute nominal GDP in each year:

Increase:
2005: $10 x 400 + $2 x 1000 = $6,000
37.5%
2006: $11 x 500 + $2.50 x 1100 = $8,250
30.9%
2007: $12 x 600 + $3 x 1200 = $10,800
EXAMPLE:
Pizza Latte
year P Q P Q
2005 $10 400 $2.00 1000
2006 $11 500 $2.50 1100
2007 $12 600 $3.00 1200
Compute real GDP in each year,
using 2005 as the base year:
Increase:
2005: $10 x 400 + $2 x 1000 = $6,000
20.0%
2006: $10 x 500 + $2 x 1100 = $7,200
16.7%
2007: $10 x 600 + $2 x 1200 = $8,400
EXAMPLE:
Nominal Real
year GDP GDP
2005 $6000 $6000
2006 $8250 $7200
2007 $10,800 $8400

In each year,
• nominal GDP is measured using the (then)
current prices.
• real GDP is measured using constant prices
from the base year (2005 in this example).
EXAMPLE:
Nominal Real
year GDP GDP
2005 $6000 $6000
37.5% 20.0%
2006 $8250 $7200
30.9% 16.7%
2007 $10,800 $8400
• The change in nominal GDP reflects both prices
and quantities.
 The change in real GDP is the amount that
GDP would change if prices were constant
(i.e., if zero inflation).
Hence, real GDP is corrected for inflation.
Computing GDP
2007 (base yr) 2008 2009
P Q P Q P Q
Good A $30 900 $31 1,000 $36 1050
Good B $100 192 $102 200 $100 205

Use the above data to solve these problems:

A. Compute nominal GDP in 2007.
B. Compute real GDP in 2008.

9
Answers
2007 (base yr) 2008 2009
P Q P Q P Q
Good A $30 900 $31 1,000 $36 1050
Good B $100 192 $102 200 $100 205
A. Compute nominal GDP in 2007.
$30 x 900 + $100 x 192 = $46,200

B. Compute real GDP in 2008.

$30 x 1000 + $100 x 200 = $50,000
10
• Calculating Growth Rates
•The economic growth rate is the annual percentage
change of real GDP. ( New – old )/old )*100
•The economic growth rate tells us how rapidly the
total economy is expanding
•The standard of living depends on real GDP per
person.
•Real GDP per person is real GDP divided by the
population.
•Real GDP per person grows only if real GDP grows
faster than the population grows.
Employment and Unemployment
Population

Working-age Non-working-
population age population

People in the People not in the

The elderly
Children
labor force labor force

Employment Unemployment
 Employment and Unemployment
•The Unemployment Rate
The unemployment rate is the percentage of the
labor force that is unemployed.
The unemployment rate is
(Number of people unemployed ÷ labor force)  100.
In June 2010, the labor force was 153.7 million and
14.6 million were unemployed, so the
unemployment rate was 9.5 percent.
The unemployment rate increases in a recession
and reaches its peak value after the recession ends.
 Employment and Unemployment
•The Employment-to-Population Ratio
The employment-to-population ratio is the
percentage of the working-age population who have
jobs.
The employment-to-population ratio is
(Employment ÷ Working-age population)  100.
In June 2010, the employment was 139.1 million
and the working-age population was 237.7 million.
The employment-to-population ratio was 58.5
percent.
 Employment and Unemployment
•The Labor Force Participation Rate
The labor force participation rate is the
percentage of the working-age population who are
members of the labor force.
The labor force participation rate is
(Labor force ÷ Working-age population)  100.
In 2008, the labor force was 154.6 million and the
working-age population was 233.8 million.
The labor force participation rate was 66.1 percent.
Price Level, Inflation, and Deflation
•Constructing the CPI
Constructing the CPI involves
three stages:
 Selecting the CPI basket
 Conducting a monthly price
survey
 Calculating the CPI
 Price Level, Inflation, and Deflation
•The Monthly Price Survey
Every month, BLS employees check the prices of
the 80,000 goods in the CPI basket in 30
metropolitan areas.
•Calculating the CPI
1. Find the cost of the CPI basket at base-period
prices.
2. Find the cost of the CPI basket at current-period
prices.
3. Calculate the CPI for the current period.
 Price Level and Inflation
Let’s work an example of the
CPI calculation.
In a simple economy, people
consume only oranges and
haircuts.
The CPI basket is 10
oranges and 5 haircuts.
The table also shows the
prices in the base period.
The cost of the CPI basket in
the base period was $50.
Price Level and Inflation
Table 22.1(b) shows the
fixed CPI basket of
goods.
It also shows the prices
in the current period.
The cost of the CPI
basket at current-period
prices is $70.
Price Level, Inflation, and Deflation
The CPI is calculated using the formula:
CPI = (Cost of basket at current-period prices ÷
Cost of basket at base-period prices) *100.
Using the numbers for the simple example,
CPI = ($70 ÷ $50) *100 = 140.
The CPI is 40 percent higher in the current
period than it was in the base period.
Price Level, Inflation, and Deflation
•Measuring the Inflation Rate
The major purpose of the CPI is to measure
inflation.
The inflation rate is the percentage change in
the price level from one year to the next.
The inflation formula is:
Inflation rate = [(CPI this year – CPI last year) ÷
CPI last year]  100.