No 03. Chapter 2. Chapter Outline. Gross Domestic Product. Measuring Macroeconomic Variables

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1 No 03. Chapter 2 Measuring Macroeconomic Variables Chapter Outline National Income Accounting: The Measurement of Production, Income, and Expenditure (Gross Domestic Product) Saving and Wealth Real GDP, Price Indexes, and Inflation Interest Rates Gross Domestic Product Our usual measure of aggregate economic activity is Gross Domestic Product, GDP. GDP is the market value of final goods and services produced within a nation during a fixed period of time 1

2 Measuring Activity: The National Income Accounts Economic activity in a given period can be measured in three ways: Value of output produced Income received by the producers of output Spending by the purchasers of output Each of these three approaches yields an identical numerical measurement. The Expenditure Approach to Measuring GDP Measure output as the sum of expenditures on products categorized as consumption, investment, government spending, and net exports: Y = C + I + G + NX GDP in the United States, 2002, Expenditure Approach 2

3 The Income Approach to Measuring GDP When firms take in revenue, that revenue is paid out to workers, owners of inputs other than labor, creditors of the firm, and the owners of the firm. The Income Approach to Measuring GDP National Income: Compensation of employees Proprietor s income Rental income Corporate profits Net interest Measuring GDP in the United States, 2002, Income Approach 3

4 Private Disposable Income Private Disposable Income equals Y + NFP + TR + INT T Y: GDP NFP: Net factor payments from abroad TR: Transfers received from the government INT: Interest payments to households on the government s debt. T: Taxes Government Sector Income The part of GDP not at the disposal of the private sector is net governmental income (tax revenue, less transfers and interest payment on the government debt: Net Governmental Income = T TR INT Aggregate Saving Private saving is private disposable Income less consumption. Government saving is government receipts less government outlays (equivalently, government income less government purchases, or the budget surplus). National saving is private saving plus government saving. 4

5 Aggregate Saving Uses of Saving From the preceding slide: S = S + S = Y + NFP C G pvt govt Also recall: Y = C + I + G + NX So: S = I + NX + NFP Saving and Investment Consider a closed economy, such that net exports and net factor payments from abroad are equal to zero. Then: S = Y C G S = I 5

6 Real and Nominal Measures In a given year, we measure GDP and related income measures in terms of current market values in dollars; i.e., nominal measures. However, market values (prices) change over time. To compare economic activity correctly over time, we wish to distinguish movements in GDP due to output changes from those due to price changes. If GDP is adjusted for changes in prices over time, we are measuring it in real terms. An Example Table 2.3 considers the calculation of nominal GDP in two years for an economy that produces just two goods. Table 2.3 Production and Price Data 6

7 Output Growth Growth rate of real output is calculated as a percentage rate of change: GrowthRate Y Y Y t t 1 = t 1 100% Example Contined Table 2.4 illustrates the calculation of real GDP and growth rates of real GDP using the same data: Real GDP calculates the value of output at base year prices. Actually, these calculations are done twice, once for each possible choice of a base year. For a moment, consider just the case where the base year is arbitrarily assumed to be year 1. Real Output: Alternative Base Years 7

8 GDP Deflator Define the GDP Deflator (a price index): NominalGDP GDPDeflator = 100 RealGDP For the preceding data, the GDP deflator in year 2, when the base year is year 1, is 66, ,000 = Inflation Inflation is an annualized percentage rate of change in the price level. Using the GDP deflator to measure the price level, and using the measures in the upper panel of Table 2.4, inflation over the time from year 1 to year 2 is measured as a percentage rate of change: % = 6.5% 100 Chain-weighting Because of the problem noted above (that real GDP growth rates are sensitive to the choice of a base year), the Bureau of Economic analysis has now adopted a procedure called chainweighting to measure real GDP (and consequently the deflator). Essentially, it assumes that the correct growth rate going from year 1 to year 2 is an average of the two rates calculated in the upper and lower panels of Table 2.4. The averaging method is rather odd, so we do not pursue it here. 8

9 Consumer Price Index The consumer price index (CPI) is another price index (like the GDP deflator). It differs in the goods included to measure price changes as well as in the method of calculation. Its measurement is based on the change in the cost of a standard (base year) bundle of consumer goods over time. Percentage changes in the CPI are also used to measure inflation. Interest Rate The rate of interest is a rate of return promised by a borrower to a lender. There are many interest rates, differing by the nature and length of a loan, however most interest rates move up and down together. In our theory, we will usually assume that there is a single interest rate. Real and Nominal Interest Rates We earlier made a distinction between real and nominal magnitudes for measures of output or income. We also distinguish real and nominal interest rates, but the nature of the correction differs. A nominal rate of interest measures a percentage return in terms of dollars; a real rate of interest measures a percentage return in terms of goods (the real purchasing power of dollars). 9

10 Calculating a real rate of interest The real rate of interest is the nominal rate of interest minus the inflation rate. The expected real rate of interest is the nominal rate of interest minus the expected inflation rate. e r = i π The End 10