Topic 2:

Macroeconomic Data
(chapter 2) revised 9/15/09

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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

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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

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 Why expenditure = income

In every transaction,
the buyer’s expenditure
becomes the seller’s income.
Thus, the sum of all
expenditure equals
the sum of all income.

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 The Circular Flow
Income($)

Labor

Households Firms

Goods(bread)

Expenditure($)

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 Consumption (C)
def: the value of all goods • durable goods
and services bought by last a long time
households. Includes: ex: cars, home
appliances
• non-durable goods
last a short time
ex: food, clothing
• services
work done for
consumers
ex: dry cleaning,
air travel.

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 U.S. Consumption, 2001

% of
$ billions
GDP
Consumption $7,064.5 69.2%
Durables 858.3 8.4
Nondurables 2,055.1 20.1
Services 4,151.1 40.7

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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
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 U.S. Investment, 2001

% of
$ billions
GDP
Investment $1,633.9 16.0%
Business fixed 1,246.0 12.2
Residential fixed 446.3 4.4
Inventory -58.4 -0.6

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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.

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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

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Stocks vs. Flows
Flow Stock

More examples:
stock flow
a person’s wealth a person’s saving
# of people with # of new college
college degrees graduates
the govt. debt the govt. budget deficit
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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.

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 Government spending, 2001
% of
$ billions
GDP
Gov spending $1,839.5 18.0%
Federal 615.7 6.0
Non-defense 216.6 2.1
Defense 399.0 3.9
State & local 1,223.8 12.0

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 Net exports (NX = EX - IM)
def: the value of total exports (EX)
minus the value of total imports (IM)
U.S. Net Exports, 1960-2000
50

-50

-100
$ billions

-150

-200

-250

-300

-350

-400
1960 1965 1970 1975 1980 1985 1990 1995 2000

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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

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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?

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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.

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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

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 GNP vs. GDP
 Gross National Product (GNP):
total income earned by the nation’s factors of
production, regardless of where located

 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)

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 Discussion Question:

What explains why GNP

differs from GDP for some of
the following countries?

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(GNP – GDP) as a percentage of GDP
for selected countries, 1997.
U.S.A. 0.1%
Bangladesh 3.3
Brazil -2.0
Canada -3.2
Chile -8.8
Ireland -16.2
Kuwait 20.8
Mexico -3.2
Saudi Arabia 3.3
Singapore 4.2

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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.

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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.

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 Practice problem

2002 2003
P Q P Q
good A $1 10 $2 15

good B $10 3 $15 4

 Compute nominal GDP in 2002 and 2003

 Compute real GDP in each year using
2002 as the base year.

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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 year’s 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.

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 U.S. Real & Nominal GDP, 1967-2001
11,000
10,000
(billions of U.S. dollars)

9,000
8,000
7,000
6,000
5,000
4,000
3,000
2,000
1,000
0
1965 1970 1975 1980 1985 1990 1995 2000
NGDP (billions of $) RGDP (billions of 1996 $)

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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
GDP deflator = 100 
Real GDP

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 Understanding the GDP deflator
Example with 3 goods
For good i = 1, 2, 3
Pit = the market price of good i in month t
Qit = the quantity of good i produced in month t
NGDPt = Nominal GDP in month t
RGDPt = Real GDP in month t

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 Understanding the GDP deflator
NGDPt P1t Q1t  P2t Q2t  P3t Q3t
GDP deflator  100   100 
RGDPt RGDPt
  Q1t   Q2t   Q3t  
 100     P1t    P2t    P3t 
  RGDPt   RGDPt   RGDPt  

The GDP deflator is a weighted average of prices.

The weight on each price reflects
that good’s relative importance in GDP.
Note that the weights change over time.

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Working with percentage changes
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

EX: If your hourly wage rises 5%

and you work 7% more hours,
then your wage income rises approximately 12%.

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Working with percentage changes
USEFUL TRICK #2
the percentage change in (X/Y )
 the percentage change in X
 the percentage change in Y

EX: GDP deflator = 100  NGDP/RGDP.

If NGDP rises 9% and RGDP rises 4%,
then the inflation rate is approximately 5%.

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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 household’s cost of living
– adjust many contracts for inflation
(i.e. “COLAs”)
– allow comparisons of dollar figures from
different years

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How the BLS constructs the CPI
1. Survey consumers to determine composition
of the typical consumer’s “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 in that month
100 
Cost of basket in base period

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The composition of the CPI’s “basket”
Food and bev.
5.8% 5.9%
Housing 17.6%
2.8%
Apparel 2.5%
4.5% 4.8%
Transportation

Medical care

Recreation
16.2%
Education

Communication
40.0%
Other goods and
services

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 Understanding the CPI
Example with 3 goods
For good i = 1, 2, 3
Ci = the amount of good i in the CPI’s basket
Pit = the price of good i in month t
Et = the cost of the CPI basket in month t
Eb = cost of the basket in the base period

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 Understanding the CPI
Et P1t C1 + P2t C2 + P3t C3
CPI in month t  100   100 
Eb Eb
 C1   C2   C3  
 100    P1t    P2t    P3t 
 Eb   Eb   Eb  

The CPI is a weighted average of prices.

The weight on each price reflects
that good’s relative importance in the CPI’s basket.
Note that the weights remain fixed over time.

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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.

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 The CPI’s bias
 The Boskin Panel’s “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 CPI’s bias is
slightly less than 1% per year.

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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

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 Two measures of inflation
Percentage
change 16

14 CPI
12

10

6
GDP deflator
4

-2
1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998
Year

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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.

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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

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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: 2%
the unemployment rate: 1%

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 Okun’s Law (Observation)
 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…

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 Okun’s Law Okun’s Law states
that a one-percent
Percentage change decrease in
in real GDP
10 unemployment is
associated with two
8
1951 percentage points
6 1984 of additional growth
2000
4 in real GDP
1999

2 1993
1975
0

-2 1982

-3 -2 -1 0 1 2 3 4
Change in
unemployment rate
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 Chapter Summary
1. Gross Domestic Product (GDP) measures
both total income and total expenditure on
the economy’s 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.

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 Chapter Summary
4. 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
5. The unemployment rate is the fraction of the
labor force that is not employed.
When unemployment rises, the growth rate
of real GDP falls.
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