1. Economics 302 Lecture 2 Topics Topics Aggregate Output (Standard Measure) GDP vs GPI discussion The Other Major Macroeconomic Variables (Unemployment and Inflation Rate)

2. Economics 302 Lecture 2 Aggregate Output Gross Domestic Product (GDP) The value of the final goods and services produced in an economy during a given period Aggregate Output (national income and product accounts, or NIPA)

3. Economics 302 Lecture 2 Aggregate Output 1) Final good 2) Value added 3) Income Defining GDP: Three Approaches

4. Economics 302 Lecture 2 Aggregate Output Firm 1: Steel Company Revenues from sales$100 Expenses (wages)$80 Profit$20 Firm 2: Car Company Revenues from sales$210 Expenses $170 Wages$70 Steel purchases$100 Profit$40 What is GDP? $310 or $210 GDP: The final goods approach

5. Economics 302 Lecture 2 Aggregate Output Answer: $210 If both firms are summed ($100 + $210) the $100 in steel is counted twice Counting only the final good (cars) includes the intermediate good (steel) Defining GDP

6. Economics 302 Lecture 2 Aggregate Output What would GDP be if the firms merged? Question for Discussion

7. Economics 302 Lecture 2 Aggregate Output 2) Value Added Approach Value added = value of production - value of intermediate goods Defining GDP: Three Approaches

8. Economics 302 Lecture 2 Aggregate Output Steel No intermediate goods Value added = $100 Two Firm Example

9. Economics 302 Lecture 2 Aggregate Output Cars Intermediate goods (steel) = $100 Value added = $210 - $100 = $110 Two Firm Example

10. Economics 302 Lecture 2 Aggregate Output Two Firm Example

11. Economics 302 Lecture 2 Aggregate Output Defining GDP

12. Economics 302 Lecture 2 Aggregate Output Defining GDP Approach 1 & 2 define GDP from the production side

13. Economics 302 Lecture 2 Aggregate Output Defining GDP 3) GDP from the income side

14. Economics 302 Lecture 2 Aggregate Output Revenues after payment for intermediate goods Some pay indirect taxes (sales taxes) Some pay workers (labor income) Remainder to the firm (capital income) Consider

15. Economics 302 Lecture 2 Aggregate Output GDP from the income side Defining GDP

16. Economics 302 Lecture 2 Aggregate Output Firm 1: Steel Company Revenues from sales$100 Expenses (wages)$80 Profit$20 Firm 2: Car Company Revenues from sales$210 Expenses $170 Wages$70 Steel purchases$100 Profit$40 GDP: Income Approach

17. Economics 302 Lecture 2 Income (steel) Labor = $80 Capital = $20 $100 Income (car) Labor = $70 Capital = $40 $110 Aggregate Output Compared to:

18. Economics 302 Lecture 2 The Composition of GDP by Type of Income, 1960 and 1998 Labor income66%65% Capital income26%27% Indirect taxes8%8% In Percent 19601998

19. Economics 302 Lecture 2 Aggregate Output Output Approach = Income Approach Final goods & value added = sum of indirect taxes + labor income + capital income Defining GDP – A Summary

20. Economics 302 Lecture 2 Aggregate Output Recall GDP = the value of final goods and services produced Value is the price of the final good Nominal & Real GDP

21. Economics 302 Lecture 2 Aggregate Output Therefore, GDP = Price x Quantity of final goods produced Nominal & Real GDP

22. Economics 302 Lecture 2 Aggregate Output If price increases and quantity remains constant, what happens to the value of final output? Questions for Discussion

23. Economics 302 Lecture 2 Aggregate Output Higher prices bias the GDP measurement of production upward over time. Observation

24. Economics 302 Lecture 2 Aggregate Output Nominal & Real GDP (correcting for inflation) One good economy YearQuantity of CarsPrice of CarsNominal GDP 199110$10,000$100,000 199212$12,000$144,000 199313$13,000$169,000

25. Economics 302 Lecture 2 Aggregate Output Nominal & Real GDP (correcting for inflation) One good economy YearQuantity of CarsPrice of CarsNominal GDP(% increase) 199110$10,000 $100,000 (--) 199212$12,000 $144,000 (44%) 199313$13,000 $169,000 (17.4%)

26. Economics 302 Lecture 2 Aggregate Output Nominal GDP = P cars x Q cars Question Did the real output of cars increase 44% from 1991 to 1992?

27. Economics 302 Lecture 2 Aggregate Output Real GDP = value of final goods in constant prices Calculating Real GDP

28. Economics 302 Lecture 2 Aggregate Output 1991 -- 10,000 1992 -- 12,000 (20% increase) 1993 -- 13,000 (8.33% increase) Real GDP in Units Production of cars

29. Economics 302 Lecture 2 Aggregate Output 1991 -- 10 x $12,000 = $120,000 1992 -- 12 x $12,000 = $144,000 (20% increase) 1993 -- 13 x $12,000 = $156,000 (8% increase) Real GDP in 1992 $s Note: Nominal 1992 GDP = Real 1992 GDP Car Production x 1992 Prices

30. Economics 302 Lecture 2 Aggregate Output Accounting for all final goods Weighted average of the output of final goods Relative prices serve as weights Must consider the change in relative prices U.S. Real GDP is Real GDP in chained (1992) dollars Calculating Real GDP in Practice

31. Economics 302 Lecture 2 Nominal and Real U.S. GDP, 1960-1998

32. Economics 302 Lecture 2 Aggregate Output The increase in real GDP is less than nominal GDP More variation in real GDP than nominal GDP Observations

33. Economics 302 Lecture 2 Aggregate Output Nominal GDP Dollar GDP GDP in current dollars Synonyms for GDP Accounting

34. Economics 302 Lecture 2 Aggregate Output Real GDP GDP in terms of goods GDP in constant dollars GDP adjusted for inflation GDP in 1992 dollars Synonyms for GDP Accounting

35. Economics 302 Lecture 2 Aggregate Output GDP growth in year t -- rate of change in real GDP in year t GDP growth = (y t - y t-1 )/y t-1 Expansions -- periods of positive growth Recessions -- periods of negative growth (2 consecutive quarters) Technical Notes: For the Course

36. Economics 302 Lecture 2 The Other Major Macroeconomic Variables The Unemployment Rate

37. Economics 302 Lecture 2 Current population survey 60,000 households monthly Employed -- job holders Unemployed -- job seekers The Other Major Macroeconomic Variables Counting the Unemployed

38. Economics 302 Lecture 2 1998 The Other Major Macroeconomic Variables Counting the Unemployed

39. Economics 302 Lecture 2 Unemployed and Discouraged Workers The Other Major Macroeconomic Variables Macro Terms

40. Economics 302 Lecture 2 Can the unemployment rate rise when the number of employed increases? The Other Major Macroeconomic Variables What Do You Think?

41. Economics 302 Lecture 2 Change in the U.S. Unemployment Rate versus U.S. GDP Growth 1960 - 1998

42. Economics 302 Lecture 2 The Other Major Macroeconomic Variables If unemployment is too high -- high growth policy must be pursued to reduce it If unemployment is too low -- low growth policy is required Economic Policy Implications

43. Economics 302 Lecture 2 The Other Major Macroeconomic Variables Unemployment rates and duration vary by population groups Certain groups incur a disproportionate share of the unemployed when unemployment increases Social Implications of Unemployment

44. Economics 302 Lecture 2 The Other Major Macroeconomic Variables The Inflation Rate A sustained rise in the price level Two Measures of the Price Level GDP Deflator Consumer Price Index (CPI)

45. Economics 302 Lecture 2 The Other Major Macroeconomic Variables Average price of final goods produced GDP deflator in year t = P t The GDP Deflator

46. Economics 302 Lecture 2 The Other Major Macroeconomic Variables P t is an index number P 1993 = 102.6 (1992 = 100) Index numbers are used to measure rate of change over time The GDP Deflator

47. Economics 302 Lecture 2 The Other Major Macroeconomic Variables The GDP Deflator

48. Economics 302 Lecture 2 The Other Major Macroeconomic Variables Average prices of goods consumed The CPI is not equal to the GDP deflator Some final goods are sold to business, government, and foreigners Some consumer goods are imported The Consumer Price Index (CPI)

49. Economics 302 Lecture 2 The Other Major Macroeconomic Variables Published monthly Involves several steps The Consumer Price Index (CPI)

50. Economics 302 Lecture 2 The Other Major Macroeconomic Variables 1) Consumer expenditure survey to determine a market basket of items 2) Bureau of labor statistics (BLS) field workers price the items monthly (85 cities, 22,000 stores) 3) A base period is chosen, currently 1982-84 Steps in Calculating the CPI

51. Economics 302 Lecture 2 The Other Major Macroeconomic Variables 5) 1998 CPI = 163 (1982-84 = 100) Steps in Calculating the CPI

52. Economics 302 Lecture 2 Inflation Rate, Using the CPI and the GDP Deflator, 1960, 1998

53. Economics 302 Lecture 2 Change in the U.S. Inflation Rate versus the U.S. Unemployment Rate, 1970-1998

54. Economics 302 Lecture 2 The Other Major Macroeconomic Variables Low unemployment --inflation rate increases High unemployment -- inflation rate decreases The Phillips Curve

55. Economics 302 Lecture 2 The Other Major Macroeconomic Variables Prices and wages do not rise proportionately Inflation creates market distortions due to: Regulation Taxation Uncertainty for business investment Why Do Economists Care About Inflation?

56. Economics 302 Lecture 2 What Do Macroeconomists Care About? What determines the level of aggregate output? Demand Supply Government, education, and savings The Central Question of Macroeconomics

57. Economics 302 Lecture 2 Macroeconomic Analysis What determines the level of aggregate output? Short-run (a few years) -- demand Medium-run (10+ years) -- supply Long-run (50+ years) -- government, education, savings The Central Question of Macroeconomics