1. CHAPTER 6 Measuring GDP, Inflation, and Economic Growth
Chapter 23 in Economics

2. Learning Objectives
Distinguish between the stocks of capital and wealth and the flows of production, income, investment and saving
Explain why aggregate income, expenditure, and product are equal
Explain how GDP is measured

3. Learning Objectives (cont.)
Explain how the Consumer Price Index (CPI) and GDP deflator are measured
Explain how the shortcomings of the CPI and the GDP deflator as measures of inflation

4. Learning Objectives (cont.)
Explain how real GDP is measured
Explain the shortcomings of real GDP growth as a measure of improvements in living standards

5. Learning Objectives
Distinguish between the stocks of capital and wealth and the flows of production, income, investment and saving
Explain why aggregate income, expenditure, and product are equal
Explain how GDP is measured

6. Gross Domestic Product
Gross domestic product (GDP) is the value of the aggregate production of goods and services in a country during a given time period.

7. Gross Domestic Product
Flows and Stocks
1) A flow is the quantities per unit of time.
GDP
2) A stock is a quantity that exists at a point in time

8. Gross Domestic Product
Flows and Stocks
Capital is the key macroeconomic stock.
Capital
The plant, equipment, buildings, and inventories of raw materials and semifinished goods that are used to produce other goods and services.

9. Gross Domestic Product
Depreciation
The decrease in the stock of capital that results from wear and tear and obsolescence.
Otherwise known as capital consumption

10. Gross Domestic Product
Gross Investment
The total amount spent on adding to the stock of capital and on replacing depreciated capital
Net Investment
The amount spent on adding to the stock of capital
Gross Investment minus Depreciation

11. Capital and Investment4 3 2
Initial
capital
less
depreciation
Initial
capital 1
Sewing machines

12. Capital and Investment4 3
Initial
capital 2
Initial
capital
less
depreciation
Initial
capital 1
Sewing machines
Jan. 1, 1997
Time

13. Capital and Investment4 3
Initial
capital
Depreciation 2
Initial
capital
less
depreciation
Initial
capital
less
depreciation
Initial
capital 1
Sewing machines
Jan. 1, 1997
During 1997
Time

14. Capital and Investment4
Gross
Investment 3
Initial
capital
Depreciation 2
Initial
capital
less
depreciation
Initial
capital
less
depreciation
Initial
capital 1
Sewing machines
Jan. 1, 1997
During 1997
Time

15. Capital and Investment4
Gross
Investment
Net
investment
during 1997 3
Initial
capital
Depreciation 2
Initial
capital
less
depreciation
Initial
capital
less
depreciation
Initial
capital 1
Sewing machines
Jan. 1, 1997
During 1997
Dec. 31, 1997
Time

16. Learning Objectives
Distinguish between the stocks of capital and wealth and the flows of production, income, investment and saving
Explain why aggregate income, expenditure, and product are equal
Explain how GDP is measured

17. Gross Domestic Product
Wealth is another macroeconomic stock
Wealth
The value of all the things that people own
Related to their earnings (a flow)

18. Gross Domestic Product
Consumption Expenditure
The amount spent on consumption goods and services
Saving
The amount of an income after meeting consumption expenditures

19. Gross Domestic Product
Income, Expenditure, and the Value of Production
1) Households sell their labor, capital, land, and entrepreneurship to firms
2) Firms sell consumer goods and services
3) Firms buy and sell capital goods
4) Firms borrow to finance investment

20. Gross Domestic Product
Governments
Government purchases are purchases of goods and services by governments
Paid for with tax revenue
Net taxes are taxes paid to governments minus transfer payments received from governments and minus interest payments from the government on its debt.

21. Gross Domestic Product
Rest of World Sector
Net exports is the value of exports minus the value of imports
Gross Domestic Product
Production can be valued by what:
Buyers pay for it
It costs producers to make it

22. The Circular Flow of Income and Expenditure

23. Learning Objectives
Distinguish between the stocks of capital and wealth and the flows of production, income, investment and saving
Explain why aggregate income, expenditure, and product are equal
Explain how GDP is measured

24. Gross Domestic Product
Expenditure Equals Income
Y = C + I + G + NX

25. Gross Domestic Product
How Investment is Financed
1) National saving is the amount of saving by households and businesses plus government saving
National saving = S + (T – G)
2) Borrowing from the rest of the world

26. Gross Domestic Product
Measuring U.S. GDP
1) Expenditure Approach
2) Income Approach

27. Gross Domestic Product
Expenditure Approach
Uses data on consumption expenditure, investment, government purchases, and net exports

28. Gross Domestic Product
Expenditure Approach
Personal consumption expenditures are the expenditures by households on goods and services produced in the United States and the rest of the world

29. Gross Domestic Product
Expenditure Approach
Gross domestic investment is expenditure on capital equipment and buildings by firms and expenditure on new homes by households. Also, it includes the change in inventories.

30. Gross Domestic Product
Expenditure Approach
Government purchases of goods and services are the purchases of goods and services by all levels of government.
Does not include transfer payments

31. Gross Domestic Product
Expenditure Approach
Net exports of goods and services are the value of exports minus the value of imports

32. GDP: The Expenditure Approach
Amount
in 1996
(billions of Percentage
Item Symbol dollars of GDP
Personal consumption expenditures C 5,
Gross private domestic investment I 1,
Government purchase of goods and services G 1,
Net exports of good and services NX –99 – 1.3
Gross domestic product Y 7,

33. Gross Domestic Product
Expenditures Not in GDP
1) Intermediate goods and services
2) Used goods
3) Financial assets

34. Gross Domestic Product
Income Approach
Measures GDP by summing the incomes that firms pay households for the resources they hire

35. Gross Domestic Product
Income Approach
Compensation of employees is the payment for labor services
Includes net wages and salaries plus taxes withheld on earnings plus fringe benefits such as social security and pension fund contributions

36. Gross Domestic Product
Income Approach
Net interest is the interest households receive on loans they make minus the interest households pay on their own borrowing
Rental income is the payment for the use of land and other rented inputs.

37. Gross Domestic Product
Income Approach
Corporate profits are the profits of corporations.
Proprietors’ income is a combination of all of these.

38. Gross Domestic Product
Net Domestic Income at Factor Cost
The sum of the five categories of income
We must convert factor cost to market prices.

39. Gross Domestic Product
Income Approach
Indirect taxes are taxes paid by consumers when they buy goods and services
Due to this additional cost, the market price is greater than the factor cost value for measuring GDP.

40. Gross Domestic Product
Income Approach
Subsidies are payments by the government to a producer.
Due to this payment, the factor cost is greater than the market price for measuring GDP.
We must convert from Net Domestic Product to Gross Domestic Product.

41. Gross Domestic Product
Income Approach
Net profit of businesses--profit after subtracting depreciation—is a component of aggregate incomes.
To get gross domestic product, we must add depreciation to aggregate income.

42. Learning Objectives (cont.)
Explain how the Consumer Price Index (CPI) and GDP deflator are measured
Explain how the shortcomings of the CPI and the GDP deflator as measures of inflation

43. Aggregate Expenditure, Output, and Income
100 80 60 40
Percentage of GDP 20

44. Aggregate Expenditure, Output, and Income
100 NX G
GDP 80 I C 60 40
Instructor Notes:
1) The red bar illustrates the components of aggregate expenditure as well as their relative magnitudes.
2) Net exports, the smallest component, is shown here as a positive quantity, but in some years it is negative.
3) The figure illustrates the equality between aggregate expenditure, aggregate income, and GDP (the yellow bar).
Percentage of GDP 20
Aggregate
expenditure
GDP

45. Aggregate Expenditure, Output, and Income
100 NX G 80 I C 60 40
Percentage of GDP 20
Aggregate
expenditure

46. GDP: The Income Approach
Amount in Percentage
Item (billions of dollars of GDP
Compensation of employees 4,
Net Interest
Rental Income
Corporate Profits
Proprietors’ income
Indirect taxes less subsidies
Capital consumption (depreciation)
Gross domestic 7, product

47. Learning Objectives (cont.)
Explain how the Consumer Price Index (CPI) and GDP deflator are measured
Explain how the shortcomings of the CPI and the GDP deflator as measures of inflation

48. Aggregate Expenditure, Output, and Income
100 NX G
GDP
Depreciation
Indirect taxes
less subsidies 80 I
Proprietor’s
incomes
Interest C
Profits 60
Rent
Wages and other
labor income 40
Percentage of GDP 20
Aggregate
expenditure
GDP
Aggregate
income

49. Gross Domestic Product
Valuing the Output of Industries
Value added is the value of a firm's production minus the value of the intermediate goods that the firm buys from other firms.

50. Value Added and Final Expenditure
Farmer’s
value added
Farmer
Intermediate
expenditure
Final
expenditure

51. Value Added and Final Expenditure
Farmer’s
value added
Farmer
Intermediate
expenditure
Value
of wheat
Miller’s
value added
Miller
Final
expenditure

52. Value Added and Final Expenditure
Farmer’s
value added
Farmer
Intermediate
expenditure
Value
of wheat
Miller’s
value added
Miller
Final
expenditure
Value
of flour
Bakers
value added
Baker

53. Value Added and Final Expenditure
Farmer’s
value added
Farmer
Intermediate
expenditure
Value
of wheat
Miller’s
value added
Miller
Final
expenditure
Value
of flour
Bakers
value added
Baker
Wholesale
value of bread
Grocer’s
value added
Grocer

54. Value Added and Final Expenditure
Farmer’s
value added
Farmer
Intermediate
expenditure
Value
of wheat
Miller’s
value added
Miller
Final
expenditure
Value
of flour
Bakers
value added
Baker
Wholesale
value of bread
Grocer’s
value added
Grocer
Retail value of bread;
Final Expenditure on bread
Consumer

55. The Price Level and Inflation
The inflation rate is the percentage change in the price level from one year to the next.
Two Main Price Indexes
Consumer Price Index
GDP Deflator

56. The Price Level and Inflation
Consumer Price Index
Measures the average level of prices of the goods and services that a typical urban family buys.
Published monthly by the Bureau of Labor Statistics
Must use a base period ( )

57. The CPI: A Simplified Calculation
Base Period Current period
Base-period basket Price Expenditure Price Expenditure
5 pounds of oranges $0.80/pound $4
6 haircuts $11.00 each $66
100 bus rides $1.40 each $140
Total expenditure $210

58. The CPI: A Simplified Calculation
Base Period Current period
Base-period basket Price Expenditure Price Expenditure
5 pounds of oranges $0.80/pound $4 $1.20/pound $6
6 haircuts $11.00 each $66 $12.50 each $75
100 bus rides $1.40 each $140 $1.50 $150
Total expenditure $210 $231

59. The CPI: A Simplified Calculation
Base Period Current period
Base-period basket Price Expenditure Price Expenditure
5 pounds of oranges $0.80/pound $4 $1.20/pound $6
6 haircuts $11.00 each $66 $12.50 each $75
100 bus rides $1.40 each $140 $1.50 $150
Total expenditure $210 $231
CPI
$210.00
´ 100 = 100
$231.00
´ 100 = 110

60. The Price Level and Inflation
The GDP Deflator
Measures the average level of prices of all the goods and services that are included in GDP
GDP deflator =
Nominal GDP
Real GDP
´ 100

61. The Price Level and Inflation
Nominal GDP is GDP valued in the current year’s prices.
Real GDP is GDP in a base year (1992) scaled up by the growth rate of real GDP since the base year.

62. The Price Level and Inflation
The GDP Deflator can now be calculated.
GDP deflator =
$146
$109.5
´ 100 =

63. The U.S. GDP Balloon
1996

64. The U.S. GDP Balloon
GDP
deflator
1996

65. The U.S. GDP Balloon
GDP
deflator
1992
1996

66. The Biased CPI The sources of bias are: 1) New goods bias
2) Quality change bias
3) Commodity substitution bias
4) Outlet substitution bias

67. The Biased CPI
In 1996, a Congressional Advisory Commission on the CPI said the CPI overstates inflation by 1.1 percentage points.
The GDP deflator uses price indexes to estimate quantities, so it too is somewhat biased.

68. The Biased CPI The three primary consequences of the bias are:
1) It distorts private contracts
2) It increases government outlays
3) It biases estimates or real earnings

69. Two Measures of Inflation

70. CHAPTER 8 Employment and Unemployment
Chapter 25 in Economics

71. Employment and Wages Population Survey
Every month, the U.S. Census Bureau surveys 60,000 households and asks a series of questions about the age and job market status of its members.
Called the Current Population Survey

72. Employment and Wages Population Survey
The working age population is the total number of people aged 16 years an over who are not in a jail, hospital, or some other form of institutional care.

73. Employment and Wages Population Survey
The working age population is divided into those in the labor force and those not in the labor force.
The labor force is divided into the employed and the unemployed.

74. Employment and Wages
To be counted as unemployed, a person must be available for work and must be in one of three categories:
1) Without work but has made specific efforts to find a job within the previous four weeks

75. Employment and Wages
To be counted as unemployed, a person must be available for work and must be in one of three categories:
2) Waiting to be called back to a job from which he or she has been laid off

76. Employment and Wages
To be counted as unemployed, a person must be available for work and must be in one of three categories:
3) Waiting to start a new job within days

77. Population Labor Force Categories90
180
270
Population (millions)

78. Population Labor Force Categories
Instructor Notes:
1) The population is divided into the working-age population and the young and institutionalized. 90
180
270
Population (millions)

79. Population Labor Force Categories
Young and
institution-
alized
Working-age population
Instructor Notes:
1) The population is divided into the working-age population and the young and institutionalized.
2) The working-age population is divided into the labor force and those not in the labor force. 90
180
270
Population (millions)

80. Population Labor Force Categories
Young and
institution-
alized
Working-age population
Not in
labor force
Labor force
Instructor Notes:
1) The population is divided into the working-age population and the young and institutionalized.
2) The working-age population is divided into the labor force and those not in the labor force.
3) The labor force is divided into the employed and the unemployed 90
180
270
Population (millions)

81. Population Labor Force Categories
Young and
institution-
alized
Working-age population
Not in
labor force
Labor force
Instructor Notes:
1) The population is divided into the working-age population and the young and institutionalized.
2) The working-age population is divided into the labor force and those not in the labor force.
3) The labor force is divided into the employed and the unemployed
Employment
Unemployment 90
180
270
Population (millions)

82. Employment and Wages Three Labor Market Indicators
The unemployment rate
The labor force participation rate
The employment-to-population ratio

83. Employment and Wages
The unemployment rate is the percentage of the people in the labor force who are unemployed.
Unemployment rate =
Number of
people unemployed
Labor force
´ 100

84. Employment and Wages
The unemployment rate is the percentage of the people in the labor force who are unemployed.
Labor force = Number of people employed
+ Number of people unemployed

85. Working age population
Employment and Wages
The labor force participation rate is the percentage of the working-age population who are members of the labor force.
Labor force
participation rate =
Working age population
´ 100

86. Employment and Wages Discouraged Workers
People who are available and willing to work but have made not made specific efforts to find a job within the previous four weeks.

87. Employment and Wages
The employment-to-population ratio is the percentage of people of working age who have jobs.
Employment-to-
population ratio =
Number of people
employed
Working-age
population
´ 100

88. Employment, Unemployment, and the Labor Force: 1960–1996
Instructor Notes:
1) The unemployment rate increases in recessions and decreases in expansions.
2) the labor force participation rate and the employment to population ration have upward trends and fluctuate with the business cycle.
3) The employment-to-population ration fluctuates more than the labor force participation rate and reflects cyclical fluctuations in the unemployment rate.
4) Fluctuations in the labor force participation rate arise mainly because of discouraged workers.

89. Unemployment and Full Employment
People become unemployed if they:
1) Lose their jobs and search for another job.
2) Leave their jobs and search for another job.
3) Enter or reenter the labor force to search for a job.

90. Unemployment and Full Employment
Job losers are people who are laid off, either permanently or temporarily.
Biggest source of unemployment
Numbers fluctuate considerably
Job leavers are people who voluntarily quit their jobs.
Smallest and most stable source of unemployment

91. Unemployment and Full Employment
Entrants are people who are entering the labor force.
Reentrants are people who have previously withdrawn from the labor force.
Reentrants/entrants are a large component of the unemployed
Numbers fluctuate mildly

92. Unemployment by Demographic Group
Black males 16-19
Black females 16-19
White males 16-19
White females 16-19
Business cycle peak
Black males 20 and over
Black females 20 and over
Business cycle trough
Instructor Notes:
1) Black teenagers experience unemployment rates that average three times those of white teenagers, and the unemployment rates of teenagers are much higher than those of people aged 20 years and over.
2) Even in a business cycle trough, when unemployment is at its highest rate, only 6 percent of whites aged 20 years and over are unemployed.
White males 20 and over
White females 20 and over 10 20 30 40
Unemployment rate

93. Homework Solutions a. 1990 nominal GDP = $440 1998 nominal GDP = $770
b. Price index 1990 = 100 Price index for 1998 =
c. Inflation rate = = 36.36%
d. Real GDP 1990 = 440/1.00 = $ Real GDP 1998 = 770/1.36 = $566

94. Unemployment and Full Employment
There are three(four) types of unemployment:
1) Frictional
2) Structural
3) Cyclical
4) Seasonal

95. Unemployment and Full Employment
Frictional Unemployment
Arises from normal labor turnover — people entering and leaving the labor force and the creation and destruction of jobs
Influenced by unemployment benefits

96. Unemployment and Full Employment
Structural Unemployment
Arises when changes in technology or international competition change the skills needed to perform jobs or change the locations of jobs
Typically lasts longer than frictional

97. Unemployment and Full Employment
Cyclical Unemployment
Arises from the fluctuations of the business cycle
Increases during a recession and decreases during and expansion
The natural rate of unemployment excludes cyclical unemployment

98. Unemployment and Full Employment
Full employment exists when the unemployment rate equals the natural rate of unemployment.
It fluctuates periodically
Economists disagree about the size of the natural rate and the extent to which it fluctuates

99. Aggregate Supply Natural Rate of Unemployment
The unemployment rate that exists at full employment
In 1997 it was about 5.5%

100. Aggregate Supply
Potential GDP is the quantity of real GDP supplied when unemployment is at its natural rate and there is full employment.

101. Types of Inflation -Demand Pull-
Price Level AS
PL2
PL1
AD2
AD1
Output (GDP)

102. Types of Inflation -Cost Push-
Price Level
AS2
AS1
PL2
PL1 AD
Output (GDP)