1. slide 0 Chapter 2: The Data of Macroeconomics

2. slide 1 Gross Domestic Product (GDP) the Consumer Price Index (CPI Unemployment rate

3. slide 2 National Income Accounting- measure the economy’s overall performance

4. slide 3 Business firms- measures its flows of income and expenditures regularly Usually every 3 months or annually

5. slide 4 National Income Accounting- operates in much the same way as the economy as a whole. NSO NSCB NEDA

6. slide 5 This accounting enables the economists and policymakers to: A. Assess the health of the economy by comparing levels of production at regular intervals.

7. slide 6 Track the long-run course of the economy whether it has grown, been constant, or declined.

8. slide 7 Formulate policies that will safeguard and improve the economy’s health.

9. slide 8 Gross Domestic Product Definition: Value of total final goods and services produced in an economy in a given period of time (measure of economic activity) There are two ways to compute it: Total income of everyone in the economy Total expenditures on the economy ’ s goods and services These two measures must be equal: Expenditure of buyers = Income of sellers

10. slide 9 Why expenditure = income In every transaction, the buyer ’ s expenditure becomes the seller ’ s income. Thus, the sum of all expenditure equals the sum of all income. In every transaction, the buyer ’ s expenditure becomes the seller ’ s income. Thus, the sum of all expenditure equals the sum of all income.

11. slide 10 The Circular Flow

12. slide 11 Gross Domestic Product (GDP) Example: an economy with two goods, apples and oranges GDP = (p apples ×q apples ) + (p oranges ×q oranges ) = ($0.50 × 4) + ($1.00 × 3) = $5.00 Quantity producedMarket Price Apples4$0.50 Oranges3$1.00

13. slide 12 Gross Domestic Product (GDP) Intermediate Goods Value Added = value of firm’s output minus value of intermediate inputs Rancher Sells Meat to McDonald’s $0.50Value added = $0.50 – $0.00 = $0.50 McDonald’s sells hamburger $1.50Value added = $1.50 – $0.50 = $1.00

14. slide 13 Gross Domestic Product (GDP) GDP is the value of all FINAL goods and services produced and sold in the economy = $1.50 GDP is also equal to the sum of value added in all stages on production = $0.50 + $1.00 = $1.50

15. slide 14 The expenditure components of GDP consumption investment government spending net exports

16. slide 15 An important identity Y = C + I + G + NX where Y = GDP = the value of total output C + I + G + NX = aggregate expenditure

17. slide 16 Consumption ( C ) durable goods last a long time ex: cars, home appliances non-durable goods last a short time ex: food, clothing services work done for consumers ex: dry cleaning, air travel. def: the value of all final goods and services bought by households. Includes:

18. slide 17 U.S. Consumption, 2005

19. slide 18 Investment ( I ) def1: spending on [the factor of production] capital. def2: spending on goods bought for future use. Includes:  business fixed investment spending on plant and equipment that firms will use to produce other goods & services  residential fixed investment spending on housing units by consumers and landlords  inventory investment the change in the value of all firms ’ inventories

20. slide 19 U.S. Investment, 2005

21. slide 20 Investment vs. Capital Capital is one of the factors of production. At any given moment, the economy has a certain overall stock of capital. Investment is spending on new capital.

22. slide 21 Investment vs. Capital Example (assumes no depreciation) :  1/1/2002: economy has $500b worth of capital  during 2002: investment = $37b  1/1/2003: economy will have $537b worth of capital

23. slide 22 Stocks vs. Flows stockflow a person ’ s wealtha person ’ s saving # of people with# of new college college degreesgraduates FlowStock More examples:

24. slide 23 Government spending ( G ) G includes all government spending on goods and services. G excludes transfer payments (e.g. unemployment insurance payments), because they do not represent spending on goods and services.

25. slide 24 Government spending, 2005

26. slide 25 Net exports ( NX = EX - IM ) def: the value of total exports (EX) minus the value of total imports (IM)

27. slide 26 GDP: An important and versatile concept We have now seen that GDP measures  total income  total output  total expenditure  the sum of value-added at all stages in the production of final goods

28. slide 27 Some Issues of GDP Home production Illegal activities Underground economy Environment Quality

29. slide 28 GNP vs. GDP Gross National Product (GNP): total income earned by the nation ’ s factors of production, regardless of where located Gross Domestic Product (GDP): total income earned by domestically-located factors of production, regardless of nationality. (GNP – GDP) = (factor payments from abroad) – (factor payments to abroad)

30. slide 29 (GNP – GDP) as a percentage of GDP for selected countries, 1997.

31. slide 30 Real GDP Is GDP a good measure of well-being/economic activity? Recall that: GDP = (p apples ×q apples ) + (p oranges ×q oranges ) Higher GDP does NOT imply higher well-being  GDP can increase if prices increase, with no change in quantities Real GDP = measure of output keeping prices constant

32. slide 31 Real GDP In the previous example: Quantity 2002 Price 2002 Quantity 2003 Price 2003 Apples4$0.507$0.40 Oranges3$1.002$1.20

33. slide 32 Real GDP Let 2002 be the base-year, i.e., real GDP will be calculated using 2002 prices

34. slide 33 Real GDP Now with 2003 as base-year: Notice that, at the base-year: Real GDP = Nominal GDP

35. slide 34 Real GDP Issue: results are sensitive to the choice of base year Base year 2002, Real GDP goes from $5.00 to $5.50 (growth rate = 10%) Base year 2003, Real GDP is the same in both years (growth rate = 0) Solution: Chain-weighting Take the average of the growth rates = 5%

36. slide 35 Real GDP Then use this growth rate to calculate Real GDP in 2003: RGDP 2003 = $5.00*(1 +.05) = $5.25 RGDP 2002 = $5.00 Advantages: It does not depend on the base year Prices are updated as time passes

37. slide 36 GDP Deflator Reflects changes in the overall price level  how price changes between current year and the base year

38. slide 37 GDP Deflator In our example, using 2002 as base year: = $5.20/$5.50 = 0.945

39. slide 38 GDP Deflator  Price level decreased 5.5% from 2002 to 2003

40. slide 39 Consumer Price Index (CPI) Measures changes in the price level, i.e., inflation More specifically, measures how the cost of a given consumption basket evolves over time (cost of living) The bundle includes goods and services consumed by a typical consumer

41. slide 40 Consumer Price Index (CPI) For example, suppose a typical consumer buys 5 apples and 2 oranges: In other words, the cost of this basket is 2% lower in 2003 relative to 2002 (the base year)

42. slide 41 CPI vs. GDP Deflator CPIGDP Deflator Includes only goods and services bought by consumers Includes all final goods and services produced by country Includes imports bought by consumers Includes only goods generated domestically

43. slide 42 CPI vs. GDP Deflator CPIGDP Deflator Fixed weights (Laspeyres index) Changing weights (Paasche index) Tends to overstate the increase in cost of living when prices rise Tends to understate the increase in cost of living when prices rise

44. slide 43 Two measures of inflation 16 14 12 10 8 6 4 2 0 - 2 Percentage change 194819531958196319681973 Year 19781983198819931998 CPI GDP deflator

45. slide 44 Reasons why the CPI may overstate inflation Substitution bias: The CPI uses fixed weights, so it cannot reflect consumers ’ ability to substitute toward goods whose relative prices have fallen. Introduction of new goods: The introduction of new goods makes consumers better off and, in effect, increases the real value of the dollar. But it does not reduce the CPI, because the CPI uses fixed weights. Unmeasured changes in quality: Quality improvements increase the value of the dollar, but are often not fully measured.

46. slide 45 CPI vs. GDP deflator prices of capital goods included in GDP deflator (if produced domestically) excluded from CPI prices of imported consumer goods included in CPI excluded from GDP deflator the basket of goods CPI: fixed GDP deflator: changes every year