Measuring Economic Performance Su, Chapter 4

What do we do with all that data? Measure the performance of the economy Learn more about economic performance and the economy by comparing the behavior of aggregates with the behavior of components

Output (and Capacity) Two most common measures of aggregate output are –Gross Domestic Product: From National Income and Product Accounts. Quarterly and Annual frequency. Value of production –Index of Industrial Production: From FRB. Monthly. Quantity of units produced.

Gross Domestic Product Can be decomposed by Expenditures or Income Expenditures Side –Y = C + I + G + X Must distinguish Real vs. Nominal Let Q i represent t he quantity of good or service i produced and Pi represent the price of good or service i –Nominal GDP =  Q i P i –Real GDP =  Q i P i base Real corrects for changes in P.

Per Capita Adjustments Often, GDP is shown in Per Capita (or Per Person) terms. Typically done when comparisons are made across countries, to control for differences in size –Real Per Capita GDP = (  Q i P i base )/Population

Decomposition of Expenditures Side C: Consumption Expenditures –Largest Component I: Investment Spending G: Government Spending

Other Important Categories –Net Exports –Change in Business Inventories Both are relatively small, but important to business cycles Importance is masked in annual data, because high frequency movements are most important

Components of National Income Personal Income: Payments made to households –Wages/Salaries, Proprietors’ Income, Dividends, Interest, Transfer Payments, SSI Contributions Disposable Income: Personal Income less taxes –Used for Personal Outlays and Personal Savings National Income: Wages/Salaries + Employer Contributions to SSI + Rent Income + Corporate Profits + Net Interest

Potential GDP and Capacity Utilization Capacity Utilization = (Actual Output)/(Potential Output) Potential Output: What the economy is capable of producing when all factors of production are fully employed Must be estimated. It cannot be easily measured or directly observed. Typically estimated based on an aggregate production function GDP = f(K,L) Indicates possible future inflation when utilization rate is high.

Labor Force Data Population (POP) Labor Force (LF): Working or Actively Looking Employment (EMP): Working

Important Ratios Participation Rate: LF/POP –Willingness to work Employment Rate: EMP/LF Unemployment Rate: 1- (EMP/LF) The “Natural Rate” of Unemployment –Level of Unemployment associated with full capacity –Must be estimated. Most estimates are around 5% - 6%

Interest Rates Nominal Interest Rates: Observed Real Interest Rates: Not observed. Economically important. Must estimate. Fischer Equation Real Interest Rate = Nominal Interest Rate - Expected Inflation Rate Expected Inflation Rate: How to calculate?