CHAPTER 2 The Data of Macroeconomics

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Macroeconomic Data
(chapter 2)

CHAPTER 2 The Data of Macroeconomics
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Learning objectives
In this chapter, you will learn about how
we define and measure:
Gross Domestic Product (GDP)
the Consumer Price Index (CPI)
the Unemployment Rate
CHAPTER 2 The Data of Macroeconomics
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THE MEASUREMENT OF GROSS
DOMESTIC PRODUCT
Gross domestic product (GDP) is a measure
of the income and expenditures of an
economy.
It is the total market value of all final
goods and services produced within a
country in a given period of time.
CHAPTER 2 The Data of Macroeconomics
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THE MEASUREMENT OF GROSS
DOMESTIC PRODUCT
GDP is the Market Value . . .
Output is valued at market prices.
. . . Of All Final . . .
It records only the value of final goods, not
intermediate goods (the value is counted
only once).
. . . Goods and Services . . .
It includes both tangible goods (food,
clothing, cars) and intangible services
(haircuts, housecleaning, doctor visits).
CHAPTER 2 The Data of Macroeconomics
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THE MEASUREMENT OF GROSS
DOMESTIC PRODUCT
. . . Produced . . .
It includes goods and services currently
produced, not transactions involving
goods produced in the past.
. . . Within a Country . . .
It measures the value of production within
the geographic confines of a country.
CHAPTER 2 The Data of Macroeconomics
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THE MEASUREMENT OF GROSS
DOMESTIC PRODUCT
. . . In a Given Period of Time.
It measures the value of production that
takes place within a specific interval of
time, usually a year or a quarter (three
months).
CHAPTER 2 The Data of Macroeconomics
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THE COMPONENTS OF GDP
GDP includes all items produced in the
economy and sold legally in markets.
CHAPTER 2 The Data of Macroeconomics
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THE COMPONENTS OF GDP
What Is Not Counted in GDP?
GDP excludes most items that are produced
and consumed at home and that never
enter the marketplace.
It excludes items produced and sold illicitly,
such as illegal drugs.
CHAPTER 2 The Data of Macroeconomics
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Gross Domestic Product
Two definitions:
1. Total expenditure on
domestically-produced
final goods and services
2. Total income earned by
domestically-located
factors of production
CHAPTER 2 The Data of Macroeconomics
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Why expenditure = income
In every transaction,
the buyers expenditure
becomes the sellers income.
Thus, the sum of all
expenditure equals
the sum of all income.
CHAPTER 2 The Data of Macroeconomics
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THE COMPONENTS OF GDP
GDP (Y) is the sum of the following:
Consumption (C)
Investment (I)
Government Purchases (G)
Net Exports (NX)
Y = C + I + G + NX
CHAPTER 2 The Data of Macroeconomics
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The Circular Flow
I ncome ($)
Labor
Goods (bread)
Expenditure ($)
Households Firms
CHAPTER 2 The Data of Macroeconomics
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Figure 1 The Circular-Flow Diagram
Spending
Goods and
services
bought
Revenue
Goods
and services
sold
Labor, land,
and capital
Income

= Flow of inputs

and outputs

= Flow of dollars
Factors of
production
Wages, rent,
and profit




FIRMS
Produce and sell
goods and services
Hire and use factors
of production




Buy and consume
goods and services
Own and sell factors
of production
HOUSEHOLDS


Households sell
Firms buy
MARKETS
FOR
FACTORS OF PRODUCTION


Firms sell
Households buy
MARKETS
FOR
GOODS AND SERVICES
Copyright 2004 South-Western
CHAPTER 2 The Data of Macroeconomics
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Consumption (C)
durable goods
last a long time
ex: cars, home
appliances
non-durable goods
last a short time
ex: food, clothing
services
work done for
consumers
ex: dry cleaning,
air travel.
def: the value of all goods
and services bought by
households. Includes:
CHAPTER 2 The Data of Macroeconomics
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Investment (I)
def1: spending on [the factor of production] capital.
def2: spending on goods bought for future use.
Includes:
business fixed investment
spending on plant and equipment that firms will
use to produce other goods & services
residential fixed investment
spending on housing units by consumers and
landlords
inventory investment
the change in the value of all firms inventories
CHAPTER 2 The Data of Macroeconomics
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Investment vs. Capital
Capital is one of the factors of production.
At any given moment, the economy has a
certain overall stock of capital.
Investment is spending on new capital.
CHAPTER 2 The Data of Macroeconomics
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Investment vs. Capital
Example (assumes no depreciation):
1/1/2002:
economy has $500b worth of capital
during 2002:
investment = $37b
1/1/2003:
economy will have $537b worth of capital
CHAPTER 2 The Data of Macroeconomics
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Government spending (G)
G includes all government spending on
goods and services.
G excludes transfer payments
(e.g. unemployment insurance payments),
because they do not represent spending on
goods and services.

CHAPTER 2 The Data of Macroeconomics
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An important identity
Y = C + I + G + NX
where
Y = GDP = the value of total output
C + I + G + NX = aggregate expenditure
CHAPTER 2 The Data of Macroeconomics
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A question for you:
Suppose a firm
produces $10 million worth of final goods
but only sells $9 million worth.

Does this violate the
expenditure = output identity?
CHAPTER 2 The Data of Macroeconomics
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Why output = expenditure
Unsold output goes into inventory,
and is counted as inventory investment
whether the inventory buildup was
intentional or not.
In effect, we are assuming that
firms purchase their unsold output.
CHAPTER 2 The Data of Macroeconomics
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GDP:
An important and versatile concept
We have now seen that GDP measures
total income
total output
total expenditure
the sum of value-added at all stages
in the production of final goods
CHAPTER 2 The Data of Macroeconomics
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GNP vs. GDP
Gross National Product (GNP):
total income earned by the nations factors of
production, regardless of where located.
GNP= GDP+ Factor payment payments from abroad
factor payments to abroad
Gross Domestic Product (GDP):
total income earned by domestically-located factors of
production, regardless of nationality.
(GNP GDP) = (factor payments from abroad)
(factor payments to abroad)

CHAPTER 2 The Data of Macroeconomics
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Other Measures of Income
Net National Product (NNP) = GNP Depreciation
National Income (NI) =NNP Indirect Business Taxes (i.e. sales tax).
NI has five components like (i) compensation of employees, (ii)
proprietors income, (iii) Rental income, (iv) Corporate profits
and (v) net interest (the interest domestic business pay and
receive, plus interest earned from foreigners)
Personal Income (NI) = NI Corporate profit Social insurance Net
interest +Dividends +Government Transfers to Individuals +Personal
Interest Income.
Disposable Personal Income (DPI) = PI Personal tax and Nontax
payments (i.e. parking tickets)
CHAPTER 2 The Data of Macroeconomics
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Discussion Question:
What explains why GNP
differs from GDP for some of
the following countries?
CHAPTER 2 The Data of Macroeconomics
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Real vs. Nominal GDP
GDP is the value of all final goods and
services produced.
Nominal GDP measures these values
using current prices.
Real GDP measure these values using
the prices of a base year.
CHAPTER 2 The Data of Macroeconomics
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Real GDP controls for inflation
Changes in nominal GDP can be due to:
changes in prices
changes in quantities of output
produced
Changes in real GDP can only be due to
changes in quantities,
because real GDP is constructed using
constant base-year prices.
CHAPTER 2 The Data of Macroeconomics
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Practice problem
Compute nominal GDP in 2002 and 2003
Compute real GDP in each year using
2002 as the base year.
2002 2003
P Q P Q
good A $1 10 $2 15
good B $10 3 $15 4
CHAPTER 2 The Data of Macroeconomics
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Answers to practice problem
Nominal GDP multiply Ps & Qs from same year
2002: $1 x 10 + $10 x 3 = $40
2003: $2 x 15 + $15 x 4 = $90
Real GDP multiply each years Qs by 2002 Ps
2002: as above: $40
2003: $1 x 15 + $10 x 4 = $55 (2002$)
So in real terms, GDP did not rise as much as
it would seem from nominal terms.
CHAPTER 2 The Data of Macroeconomics
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GDP Deflator
The inflation rate is the percentage
increase in the overall level of prices.
One measure of the price level is
the GDP Deflator, defined as
Nominal GDP
GDPdeflator =100
Real GDP

CHAPTER 2 The Data of Macroeconomics

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Understanding the GDP deflator
Example with 3 goods
For good i = 1, 2, 3
P
it
= the market price of good i in month t
Q
it
= the quantity of good i produced in month t
NGDP
t
= Nominal GDP in month t
RGDP
t
= Real GDP in month t
CHAPTER 2 The Data of Macroeconomics
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Understanding the GDP deflator
t
t
NGDP
GDPdeflator
RGDP
= 100
1t1t 2t2t 3t3t
t
PQPQPQ
RGDP
+ +
= 100
1t 2t 3t
1t 2t 3t
t t t
Q Q Q
P P P
RGDPRGDPRGDP
(
| || || |
= + +
( | | |
(
\ .\ .\ .

100
The GDP deflator is a weighted average of prices.
The weight on each price reflects
that goods relative importance in GDP.
Note that the weights change over time.
CHAPTER 2 The Data of Macroeconomics
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Working with percentage changes
EX: If your hourly wage rises 5%
and you work 7% more hours,
then your wage income rises approximately 12%.
USEFUL TRICK #1 For any variables X and Y,
the percentage change in (X Y )
~ the percentage change in X
+ the percentage change in Y
CHAPTER 2 The Data of Macroeconomics
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Working with percentage changes
EX: GDP deflator = 100 NGDP/RGDP.
If NGDP rises 9% and RGDP rises 4%,
then the inflation rate is approximately 5%.
USEFUL TRICK #2
the percentage change in (X/Y )
~ the percentage change in X
the percentage change in Y
CHAPTER 2 The Data of Macroeconomics
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Consumer Price Index (CPI)
A measure of the overall level of prices
Published by the Bureau of Labor
Statistics (BLS)
Used to
track changes in the
typical households cost of living
adjust many contracts for inflation
(i.e. COLAs)
allow comparisons of dollar figures from
different years
CHAPTER 2 The Data of Macroeconomics
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How the BLS constructs the CPI
1. Survey consumers to determine composition
of the typical consumers basket of goods.
2. Every month, collect data on prices of all
items in the basket; compute cost of basket
3. CPI in any month equals
Cost of basket inthat month
100
Cost of basket inbaseperiod

CHAPTER 2 The Data of Macroeconomics

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The composition of the CPIs basket
16.2%
40.0%
4.5%
17.6%
5.8%
5.9%
2.8%
2.5%
4.8%
Food and bev.
Housing
Apparel
Transportation
Medical care
Recreation
Education
Communication
Other goods and
services
CHAPTER 2 The Data of Macroeconomics
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Understanding the CPI
Example with 3 goods
For good i = 1, 2, 3
C
i
= the amount of good i in the CPIs basket
P
it
= the price of good i in month t
E
t
= the cost of the CPI basket in month t
E
b
= cost of the basket in the base period
CHAPTER 2 The Data of Macroeconomics
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Understanding the CPI
t
b
E
CPI inmonth
E
= 100 t
1t1 2t2 3t3
b
PC+PC+PC
E
= 100
3 1 2
1t 2t 3t
b b b
C C C
P P P
E E E
(
|| || ||
= + +
( | | |
(
\. \. \.

100
The CPI is a weighted average of prices.
The weight on each price reflects
that goods relative importance in the CPIs basket.
Note that the weights remain fixed over time.
CHAPTER 2 The Data of Macroeconomics
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CPI vs GDP deflator
There are three differences between CPI and GDP deflator
1. GDP deflator measures the prices of all goods and services
produced, whereas the CPI measures the prices of only the
goods and services bought by consumers.
2. GDP deflator includes only those goods produced
domestically. Imported goods are not part of GDP and do not
show up in the GDP deflator.
3. The CPI assigns fixed weights to the prices of different goods,
whereas GDP deflator assigns changing weights. In other
words, the CPI is computed using a fixed of goods, whereas
the GDP deflator allows the basket of goods to change over
time as the composition of GDP chnages.
CHAPTER 2 The Data of Macroeconomics
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Reasons why
the CPI may overstate inflation
Substitution bias: The CPI uses fixed weights,
so it cannot reflect consumers ability to substitute
toward goods whose relative prices have fallen.
Introduction of new goods: The introduction of
new goods makes consumers better off and, in effect,
increases the real value of the dollar. But it does not
reduce the CPI, because the CPI uses fixed weights.
Unmeasured changes in quality:
Quality improvements increase the value of the dollar,
but are often not fully measured.
CHAPTER 2 The Data of Macroeconomics
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The CPIs bias
The Boskin Panels best estimate:
The CPI overstates the true increase in the
cost of living by 1.1% per year.
Result: the BLS has refined the way it
calculates the CPI to reduce the bias.
It is now believed that the CPIs bias is
slightly less than 1% per year.

CHAPTER 2 The Data of Macroeconomics
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CPI vs. GDP deflator
prices of capital goods
included in GDP deflator (if produced domestically)
excluded from CPI
prices of imported consumer goods
included in CPI
excluded from GDP deflator
the basket of goods
CPI: fixed
GDP deflator: changes every year
CHAPTER 2 The Data of Macroeconomics
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Two measures of inflation
16

14

12

10

8

6

4

2

0

-
2
Percentage
change
1948 1953 1958 1963 1968 1973
Year
1978 1983 1988 1993 1998
CPI
GDP deflator
CHAPTER 2 The Data of Macroeconomics
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Measuring Unemployment:
Categories of the population
employed
working at a paid job
unemployed
not employed but looking for a job
labor force
the amount of labor available for producing
goods and services; all employed plus
unemployed persons
not in the labor force
not employed, not looking for work.
CHAPTER 2 The Data of Macroeconomics
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Two important labor force concepts
unemployment rate
percentage of the labor force that is
unemployed
labor force participation rate
the fraction of the adult population
that participates in the labor force
CHAPTER 2 The Data of Macroeconomics
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Compute percentage changes in labor
force statistics
Suppose
the population increases by 1%
the labor force increases by 3%
the number of unemployed persons
increases by 2%
Compute the percentage changes in
the labor force participation rate:
the unemployment rate:
2%
1%
CHAPTER 2 The Data of Macroeconomics
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Employed workers help produce GDP,
while unemployed workers do not.
So one would expect
a negative relationship between
unemployment and real GDP.
This relationship is clear in the data
Okuns Law (Observation)
CHAPTER 2 The Data of Macroeconomics
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Okuns Law
1951
1984
1999
2000
1993
1982
1975
Change in
unemployment rate
10
-3
-2
-1 0 1 2 4 3
8
6
4
2
0
-2
Percentage change
in real GDP
Okuns Law states
that a one-percent
decrease in
unemployment is
associated with two
percentage points
of additional growth
in real GDP
CHAPTER 2 The Data of Macroeconomics
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Chapter Summary
1. Gross Domestic Product (GDP) measures
both total income and total expenditure on
the economys output of goods & services.
2. Nominal GDP values output at current prices;
real GDP values output at constant prices.
Changes in output affect both measures, but
changes in prices only affect nominal GDP.
3. GDP is the sum of consumption, investment,
government purchases, and net exports.
CHAPTER 2 The Data of Macroeconomics
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Chapter Summary
1. The overall level of prices can be measured
by either
the Consumer Price Index (CPI),
the price of a fixed basket of goods
purchased by the typical consumer
the GDP deflator,
the ratio of nominal to real GDP
2. The unemployment rate is the fraction of the
labor force that is not employed.
When unemployment rises, the growth rate
of real GDP falls.
CHAPTER 2 The Data of Macroeconomics
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