1. Intermediate Macroeconomics
Chapter 2
Measuring the Macroeconomy

2. Measuring the Macroeconomy
1. Measuring Total Output
2. How to Measure GDP
3. Measuring Price Changes
Intermediate Macroeconomics

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

4. 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 $ = $ ,000
Total Value of Output = $20,100,000
Intermediate Macroeconomics

5. 1. Measuring Total Output GDP versus GNP
Nominal Gross Domestic Product (GDP) - the market value of final goods and services 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
Parse GDP definition
Market value – earlier slide, dollar value
Final goods and services – excludes intermediate goods
Produced – excludes used goods
By a nation – distinguishes from GDP
Intermediate Macroeconomics

6. 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
Leisure – European worker vacation days
Home and volunteer labor – home remodeling, production in less developed countries.
Additional examples not in text.
Depletion of nonrenewable natural resources. When nonrenewable resources like oil and minerals are extracted and sold, their total sale value is included in GDP in the final products produced from them. But, the reduction in wealth in terms of the abundance of nonrenewable natural resources is not recognized.
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.
Intermediate Macroeconomics

7. Expenditure Approach Income Approach 2. How to Measure GDP
Intermediate Macroeconomics

8. 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
Intermediate Macroeconomics

9. 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
Intermediate Macroeconomics

10. 2. How to Measure GDP Expenditure approach: Expenditure Shares
2003 U.S. Gross Domestic Product
Government Spending
18.9 %
Consumption
70.5 %
Investment
15.1 %
Net Exports = % (not shown in slide)
Intermediate Macroeconomics

11. 2. How to Measure GDP Expenditure Approach: Consumption
recession
Real Consumption
excluding durables
Real consumption of nondurables + services, which accounts for over 85% of total consumption, appears less volatile that real GDP.
Consumption:
Durable goods: cars, appliances
Non-durable goods: food, gasoline
Services: haircuts, lawyers, education
Real GDP
recession
recession
Intermediate Macroeconomics

12. 2. How to Measure GDP Expenditure Approach: Investment
Gross Investment
= Net Investment
+ Depreciation
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 Investment = Gross Investment - depreciation
Intermediate Macroeconomics

13. 2. How to Measure GDP Expenditure approach: Government
U.S. Government Spending Share of GDP
Government spending includes:
Salaries of government workers
Spending on roads, schools, etc.
Does not include:
Transfer payments (e.g., social security, unemployment benefits)
Payment on Federal debt
2003 = 18.9%
2000 = 17.5%
1996 = 18.1%
1992 = 20.0%
1988 = 20.4%
Intermediate Macroeconomics

14. 2. How to Measure GDP Expenditure Approach: Net exports
Trade
Deficit
Imports
Post
World War 2
Surplus
Exports
W W 2
Source: Bureau of Economic Analysis,
Intermediate Macroeconomics

15. 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
Intermediate Macroeconomics

16. 3. Measuring Price Changes
Nominal and Real GDP
GDP Deflator
Consumer Price Index
GDP Deflator / CPI Differences
Problems with Traditional Price Indexes
Chain-weighted Price Index
Price Index: a measure of the change in the average level of prices
Intermediate Macroeconomics

17. 3. Measuring Price Changes Nominal and Real GDP
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
Intermediate Macroeconomics

18. 3. Measuring Price Changes Sample problem
Was the economy better or worse off in 1994 compared with 1992?
What was the rate of inflation between 1992 and 1994?
Intermediate Macroeconomics

19. 3. Measuring Price Changes Definition of Nominal GDP
= Current year Quantities
x Current year Prices
Intermediate Macroeconomics

20. 3. Measuring Price Changes Sample problem: 1992 Nominal GDP
= 1992 Quantities x 1992 Prices
= 1992 Spending on
Food Housing Fun Machines
= 4 • $ • $9 + 3 • $ • $20
= $48 + $27 + $12 + $40
= $127
Intermediate Macroeconomics

21. 3. Measuring Price Changes Sample problem: 1994 Nominal GDP
= 1994 Quantities x 1994 Prices
= 1994 Spending on
Food Housing Fun Machines
= 5 • $ • $ • $ • $20
= $70 + $30 + $20 + $40
= $160
Intermediate Macroeconomics

22. 3. Measuring Price Changes Definition of Real GDP
= Current year Quantities
x Base year Prices
Intermediate Macroeconomics

23. 3. Measuring Price Changes Sample problem: 1992 Real GDP
= 1992 Quantities x 1992 Prices
Food Housing Fun Machines
= 4 • $ • $9 + 3 • $ • $20
= $48 + $27 + $12 + $40
= $127
Base year assumed to be 1992
Intermediate Macroeconomics

24. 3. Measuring Price Changes Sample problem: 1994 Real GDP
= 1994 Quantities x 1992 Prices
Food Housing Fun Machines
= 5 • $ • $9 + 4 • $ • $20
= $60 + $27 + $16 + $40
= $143
Base year assumed to be 1992
Intermediate Macroeconomics

25. 3. Measuring Price Changes Sample problem: GDP growth
Growth in Nominal GDP
= ( ) • 100 = 26%
127
Growth in Real GDP
= ( ) • 100 = 13%
Intermediate Macroeconomics

26. 3. Measuring Price Changes Definition of GDP Deflator
GDP Deflator = Nominal GDP x 100
Real GDP
or,
Real GDP = Nominal GDP x 100
GDP Deflator
GDP deflator - rice index that measures change in average level of prices of all goods and services counted in the GDP
Intermediate Macroeconomics

27. 3. Measuring Price Changes Sample problem: GDP deflator
127
1994 GDP Deflator = 160 • 100 = 111.9
143
Base year assumed to be 1992
Intermediate Macroeconomics

28. 3. Measuring Price Changes Inflation Rate from the GDP Deflator
Change in Average Level of Prices
= Percent Change in GDP Deflator
Inflation from 1992 to 1994:
= (1994 Deflator Deflator) • 100
1992 Deflator
= ( ) • 100 = 11.9%
100.0
Intermediate Macroeconomics

29. 3. Measuring Price Changes Consumer Price Index
Use base year (“market basket”) of goods and compare the total cost of the market basket between two years.
Market basket includes only goods and services consumed by households.
Market basket includes imported goods and services.
Intermediate Macroeconomics

30. 3. Measuring Price Changes Consumer Price Index
Was the economy better or worse off in 1994 compared with 1992?
What was the rate of inflation between 1992 and 1994?
CPI:
Machines not included.
Base year quantities (market basket) rather than base year prices used.
Intermediate Macroeconomics

31. 3. Measuring Price Changes Consumer Price Index
= 1992 Quantities x 1992 Prices
= 4 • $ • $9 + 3 • $4
= $48 + $27 + $12
= $87
= 1992 Quantities x 1994 Prices
= 4 • $ • $ • $5
= $56 + $30 + $15
= $101
CPI = (1994 / 1992) x 100
= (101 / 87) = 116
Intermediate Macroeconomics

32. 3. Measuring Price Changes GDP Deflator / CPI Differences
All goods included
Base-year prices
Quantities variable
Imports excluded
Consumer Price Index
Includes only consumer goods
Base year quantities
Prices variable
Imports included
CPI Market basket
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
Intermediate Macroeconomics

33. 3. 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 percent
between stores percent
Quality changes and new products percent
Intermediate Macroeconomics