LECTURE NOTES. Chapter 2: Measurement of Macroeconomic Variables. 1. The National Income Accounts

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1 LECTURE NOTES Chapter 2: Measurement f Macrecnmic Variables 1. The Natinal Incme Accunts Natinal accunts: (1) prductin side and (2) incme side Incme side measures the prceeds f the prductin side. Prductin side = Incme side Prduct side GDP (Grss dmestic prduct) GNP (Grss natinal prduct) Fr the U.S., Incme side NI (Natinal incme) Page 1 f 9

2 2. Grss Dmestic Prduct GDP is a measure f all [dmestically] currently prduced final gds and services evaluated at market prices. Currently prduced: A flw measure f utput value per time perid (quarter, year) f gds and services prduced during this time perid. Exchange f already prduced huses r cars d nt enter GDP (already prduced/measured) Exchange f assets such as stcks r bnds d nt enter GDP (n new prductin) Final gds and services The value f intermediate gds and services is already included in the value f final gds and services. Tw exceptins: (1) currently prduced capital gds and (2) inventry investment. Capital gds are nly partially cnsumed in the prductin prcess (depreciatin). GDP depreciatin = net dmestic prduct Currently prduced gds (intermediate r final) that have nt been sld. Because GDP measures the value f current prductin, this has t be included. Clarificatin: Intermediate gds: Cnsumed in the prcess f prductin (the flur used t bake a cake) Factrs f prductin: Nt cnsumed, but depreciated, in the prcess f prductin; land, labr, and capital gds (the ven used t bake a cake) Evaluated at market prices Prices are the cmmn denminatr fr all gds. Withut prices GDP cannt be calculated. Therefre, nn-prices gds (r unbserved activities) cannt be part f GDP (undergrund ecnmy, envirnment, etc.) In thery, an ecnmy with n gds: Three gds ecnmy example, let x, y, and z dente the three prduced gds. Let prductin be 5x, 10y, and 20z. Then GDP is: Remember: prices are ratis (nt nly a mnetary value)! In practice: ( ) Real GDP: current prductin evaluated at cnstant prices Nminal GDP (NGDP): current prductin evaluated at current prices Expenditure apprach: Page 2 f 9

3 Cnsumptin (C): husehld sectr s demand fr utput fr current use. Durable gds (cars, TVs) Nn-durable gds (fd, clthing) Cnsumer services (medical services, haircuts.) Investment (I): purchases f the business sectr plus residential cnstructin (ie. huses) Fixed investment Residential cnstructin Inventries Gvernment purchases (G): Current utput that ges t the gvernment (federal, state, and lcal) Nt all gvernment expenditures are part f GDP It has t be a currently prduced gd r service Shuld nt be a transfer such as Scial Security (that s nt prductin) Net exprts (NX): Ttal exprts minus imprts Exprts add the current utput that is cnsumed abrad (and therefre des nt appear in C nr I). Imprts subtract the purchase f gds and services prduced abrad. Imprts d nt reduce GDP, it fixes its value t represent dmestic utput. What GDP is nt? Nnmarket prduct activities are left ut The undergrund ecnmy is left ut GDP is a flw measure, nt a stck measure. GDP is nt a welfare (W) measure. All else equal GDP is nt intended t measure happiness Page 3 f 9

4 3. Natinal Incme Natinal incme is the earnings by the factrs f prductin (land, labr, and capital) frm current prductin Page 4 f 9

5 4. Persnal and dispsable incme Persnal Incme is the incme received by persns (nt firms) frm all surces (nt nly wages -> different frm labr incme) Dispsable Incme is Persnal Incme after taxes Persnal Incme = Natinal Incme incme that is nt received by persns (firm prfits nt distributed as dividends, emplyer retentins) + incme received by persns frm surces ther than current utput (ie. interests, dividends, transfers, etc.) Persnal Savings = Dispsable Incme Taxes Cnsumptin Interest paid Transfers t freigners (net) Page 5 f 9

6 5. Sme Natinal Incme Accunting Identities Simplificatins The freign sectr (NX) is mitted Indirect taxes and ther discrepancies between GDP and GNP are ignred, utput (Y) equals incme. Depreciatin is ignred, All business prfits are paid as dividends, all taxes are assessed by the husehld. Therefre, Then, net taxes: ( ) ( ) Persnal dispsable incme equals incme (utput) minus net taxes (different frm desired investment) Because utput equals incme Expenditures equals incme Page 6 f 9

7 6. Measuring Price Changes: Real versus Nminal GDP GDP changes nly when quantity prduced changes NGDP changes when either quantity prduced r prices change Let dente the years Let be the base year. Let be the number f gds and services prduced Implicit GDP deflatr: A price index that measures the prices f gds and services included in GDP If [nte: there are n units assciated t the GDP deflatr] GDP deflatr measures accumulated inflatin since the base year GDP deflatr vs CPI GDP deflatr measures all prices The prices weights in each price index differ. GDP deflatr, depends n utput. CPI, depends n husehld cnsumptin Chain-Weighted Real GDP Tw prblems with GDP (when lking at a time series) The weights given t different sectrs change. Gds and services prduced in 1900 is significantly different frm gds and services prduced in the year 2000 Changes in relative prices affect cnsumptin. Fr example, the fall in relative prices in cmputers shifts the expenditures f husehlds (substitutin and incme effects) The Chain-Weighted Real GDP slves these tw issues by mving the base year. It is calculated as a grwth rate, nt as ttal value Three steps: Step 1: Calculate a Laspayre grwth rate: Step 2: Calculate a Paasche grwth rate: Step 3: Calculate the Chain-Weighted Real GDP: Nte. Apply lg: ( ) ( ) The Chain-Weighted Real GDP is the average f tw grwth rates Page 7 f 9

8 7. The Cnsumptin Price Index and the Prducer Price Index CPI (Cnsumer Price Index) measures the retail prices f a fixed market based f several thusand f gds and services purchased by husehlds Cre-CPI is the CPI withut the price f energy and fd (cmmdities). This islates CPI frm prices defined in the internatinal markets PPI (Prducer Price Index) measures the whlesale prices f apprximately 3,000 items. PPI includes intermediate gds Mvements in PPI may signal future mvements in CPI Page 8 f 9

9 8. Measures f Cyclical Variatin in Output Ptential utput is the level f utput at the natural rate f unemplyment f factrs f prductin Business cycle is utput fluctuatins arund ptential utput Can utput be mre than ptential utput? Yes, because the natural rate f unemplyment is mre than zer N unique way t define a cycle Ex-pst: Yu can measure peak-t-trugh Ex-ante: Hw d yu knw yu re in a recessin? Remember: Ecnmic grwth is an increase in ptential utput (GDP) nt an increase in utput After a crisis, an increase in GDP but nt in ptential GDP is ecnmic recvery, nt ecnmic grwth Page 9 f 9