Introduction to Macroeconomics Chapter 4 Measuring Output of the Macroeconomy

Chapter 4. Measuring the Macroeconomy 1. Measuring Total Output 2. How to Measure GDP 3. GDP Accounting Complications Nominal and Real GDP Measuring Price Changes 6. Empirical Applications Introduction to Macroeconomics

1. Measuring Total Output Monetary Measure of Value GDP versus GNP Omissions from GDP - does not measure social welfare Introduction to Macroeconomics

1. Measuring Total Output Monetary Measure of Value Quantity times Price equals Market Value Cars 1,000 x $20,000 = $20,000,000 Dolls 10,000 x $ 10 = $ 100,000 Total Value of Output = $20,100,000 Introduction to Macroeconomics

1. Measuring Total Output GDP versus GNP Nominal Gross Domestic Product (GDP) - the market value of final goods and services (i.e., sold to final consumers) produced by a nation during a specific period, usually 1 year. Nominal Gross National Product (GNP) - the market value of final goods and services produced by labor and property supplied by the residents of a nation during a specific period, usually 1 year. Toyota plant Ford plant in Tennessee in Mexico GDP included excluded GNP excluded included Introduction to Macroeconomics

1. Measuring Total Output Omissions from GDP GDP is a poor measure of social welfare: Leisure Home and volunteer labor (non market production) Depletion of nonrenewable resources Unregulated pollution Distribution of income Differences in preferences Social Welfare Examples not in text. Distribution of income. Some economists suggest that redistribution of income from the very rich to the very poor raises the welfare of the poorer persons more than it reduces the welfare of the rich so that in total there is an increase in society’s net welfare. A country with a lower GDP per capita may have a “better” distribution of income. Preferences - Aunt on isle of Mull (West Coast of Scotland). One road goes around the island. Many houses do not have electricity. No lawnmower - sheep. A country with lower GDP per capita may prefer it that way. Introduction to Macroeconomics

Circular Flow Expenditure Approach Income Approach 2. How to Measure GDP Circular Flow Expenditure Approach Income Approach Introduction to Macroeconomics

2. How to Measure GDP Circular Flow of Income and Expenditures Resources Business Firms Households Goods and Services Expenditures Solid Lines - Flow of Money Dashed lines - Flow of Goods and Services Introduction to Macroeconomics

2. How to Measure GDP Expenditure Approach GDP = Consumption Spending (C) + Private Domestic Investment (I) + Government Spending (G) + Exports - Imports (net exports, NX) GDP = C + I + G + NX Introduction to Macroeconomics

2. How to Measure GDP Expenditure Approach: Expenditure Shares 2002 U.S. Nominal Gross Domestic Product Government Spending 18.8 % Consumption 69.9 % Investment 15.2 % Net Exports = - 4.1 % (not shown in slide) Introduction to Macroeconomics

2. How to Measure GDP Expenditure Approach: Consumption U.S. Japan 1999 U.S. 68.2 % Japan 60.1 % Consumption: Durable goods: cars, appliances Non-durable goods: food, gasoline Services: haircuts, lawyers, education Is this a valid comparison between US and Japan? What other explanations for differences in consumption? - Government spending socialized medicine education Introduction to Macroeconomics

2. How to Measure GDP Expenditure Approach: Government U.S. Japan 1999 U.S. 17.6 % Japan 18.4 % Government spending includes: Salaries of government workers Spending on roads, schools, etc. Does not includes: Transfer payments (e.g., social security, unemployment benefits) Payment on Federal debt Introduction to Macroeconomics

2. How to Measure GDP Expenditure Approach: Investment Japan U.S. 1999 U.S. 17.9 % Japan 20.0 % Investment = production and accumulation of goods for future use in production processes. Capital resources = any resources that are used to produce other goods and are themselves produced. Investment represents a foregone opportunity for consumption Investment includes Purchases of durable plant and equipment by firms New homes Inventory change (may be positive or negative) Investment does not include: purchases of financial capital (e.g., stocks and bonds) purchase of land investment in human capital (education) Gross versus Net Investment Net = Gross - depreciation Discussed under Accounting Complications Introduction to Macroeconomics

2. How to Measure GDP Expenditure Approach: Net Exports Japan U.S. Net Exports = Exports - Imports Also called Trade Balance U.S. imports more than it exports 1999 U.S. - 3.7 % Japan 1.5 % Introduction to Macroeconomics

2. How to Measure GDP Income Approach National Income = GDP (with corrections) Personal Income = National Income (with corrections) Personal Income - Personal income taxes - Social Security withholding = Disposable Personal Income Introduction to Macroeconomics

3. GDP Accounting Complications Double Counting Depreciation Introduction to Macroeconomics

3. GDP Accounting Complications Double Counting Intended for “final” use excludes intermediate products Value Added excludes used goods Introduction to Macroeconomics

3. GDP Accounting Complications Depreciation Gross Investment - Depreciation = Net Investment Gross Domestic Product (GDP) = Net Domestic Product (NDP) Depreciation Net investment (In) = Gross Investment (Ig) - Depreciation NDP = GDP - Depreciation GDP = C + Ig + G + NX NDP = C + In + G + NX Introduction to Macroeconomics

Definitions Sample Problem GDP Growth 4. Nominal and Real GDP Introduction to Macroeconomics

4. Nominal and Real GDP Definitions Nominal GDP Value of output measured at actual prices (current dollar output) Does not correct for inflation Real GDP Value of output based on prices of some base period (“constant” dollar output) eliminates effect of inflation Introduction to Macroeconomics

4. Real GDP Sample Problem Was the economy better or worse off in 1994 compared with 1992? What was the rate of inflation between 1992 and 1994? Introduction to Macroeconomics

4. Real GDP Definition of Nominal GDP = Current year Quantities x Current year Prices Introduction to Macroeconomics

4. Real GDP Sample Problem: 1992 Nominal GDP = 1992 Quantities x 1992 Prices = 1992 Spending on Food Housing Fun Machines = 4 • $12 + 3 • $9 + 3 • $4 + 2 • $20 = $48 + $27 + $12 + $40 = $127 Introduction to Macroeconomics

4. Real GDP Sample Problem: 1994 Nominal GDP = 1994 Quantities x 1994 Prices = 1994 Spending on Food Housing Fun Machines = 5 • $14 + 3 • $10 + 4 • $5 + 2 • $20 = $70 + $30 + $20 + $40 = $160 Introduction to Macroeconomics

4. Real GDP Definition of Real GDP = Current year Quantities x Base year Prices Introduction to Macroeconomics

4. Real GDP Sample Problem: 1992 Real GDP = 1992 Quantities x 1992 Prices Food Housing Fun Machines = 4 • $12 + 3 • $9 + 3 • $4 + 2 • $20 = $48 + $27 + $12 + $40 = $127 Introduction to Macroeconomics

4. Real GDP Sample Problem: 1994 Real GDP = 1994 Quantities x 1992 Prices Food Housing Fun Machines = 5 • $12 + 3 • $9 + 4 • $4 + 2 • $20 = $60 + $27 + $16 + $40 = $143 Introduction to Macroeconomics

4. Real GDP Sample Problem: GDP Growth Growth in Nominal GDP = (160 - 127) • 100 = 26% 127 Growth in Real GDP = (143 - 127) • 100 = 13% Introduction to Macroeconomics

5. Measuring Price Changes Price index GDP deflator Consumer price index Problems with price indexes Introduction to Macroeconomics

Measuring Price Changes Price indexes Price Index: a measure of the change in the average level of prices GDP Deflator Base-year prices Quantities variable Imports excluded Consumer Price Index Base year quantities Prices variable Imports included CPI Market basket 1993-95 Consumer Expenditure Survey of over 30,000 families Collects monthly prices on 71,000 goods and services at about 22,000 retail outlets Survey of 35,000 rental units to determine cost of housing Introduction to Macroeconomics

Measuring Price Changes GDP deflator GDP Deflator = Nominal GDP • 100 Real GDP 1992 GDP Deflator = 127• 100 = 100.0 127 1994 GDP Deflator = 160 • 100 = 111.9 143 Introduction to Macroeconomics

Measuring Price Changes Inflation Change in Average Level of Prices = Percent Change in GDP Deflator Inflation from 1992 to 1994 = (1994 Deflator - 1992 Deflator) • 100 1992 Deflator = (111.9 - 100.0) • 100 = 11.9% 100.0 Introduction to Macroeconomics

Measuring Price Changes Problems with price indexes Substitution bias - changes in relative prices between goods (butter vs margarine) between stores (small vs large discounters) Quality changes and new products Chain-weighted indexes Why are changes in cost of living so hard to measure? literally millions of goods and services available in modern market economies a single supermarket may contain 30,000 differently price items WalMart store over 40,000 CPI overstated by about 1.1 percent due to Substitution bias: between goods - 0.4 percent between stores - 0.1 percent Quality changes and new products - 0.6 percent Introduction to Macroeconomics

6. Empirical Applications Use Real rather than Nominal values Compare Per Capita rather than Aggregates Compare Growth Rates rather than Levels Two types of empirical studies: Longitudinal - time trends Examining single sector at different points in time - use Real or Real per capita to eliminate effects of both inflation and population differences Comparing sectors over a period of time use Real growth rates or Real per capita growth rates Cross-sectional Comparing different sectors at same point in time - either nominal or real OK Comparing different geographic areas (e.g., countries) - use per Capita Nominal or Real Purchasing power parity corrects for differences in average price levels Indexes - not mentioned in text but used in earlier slides. Consumption as a share of total GDP. Eliminates problem of differences in population. Differences in inflation between the part and the whole can usually be ignored. Introduction to Macroeconomics

6. Empirical Applications Compare Per Capita rather than Aggregates Introduction to Macroeconomics

6. Empirical Applications Compare growth rates rather than levels Introduction to Macroeconomics