Macro Lecture 2: Gross Domestic Product

Transcription

1 Macro Lecture 2: Gross Domestic Product Motivating Macroeconomics Thus far, we have been studying microeconomics. In micro, we try to understand how one particular market or one particular firm behaves. It appears that applying microeconomics to the labor market does not allow us to explain persistent unemployment, however. Consequently, we shall now take a different approach by exploiting the relationship between unemployment and production in the economy as a whole: Unemployment Up Employment Down Production Down Unemployment Down Employment Up Production Up Macroeconomics focuses on aggregate production, production in our economy as a whole, growth in the economy as a whole, unemployment in the economy as a whole, inflation in the economy as a whole, etc. We begin by introducing some basic concepts that we use to measure how much our economy is producing, how fast it is growing, etc. You hear these statistics cited frequently on the evening news, in newspapers, magazines, etc. We suspect that you do not know precisely what they mean. So, this appears to be a good place to start. Gross Domestic Product: How many goods and services does the economy produce? Gross Domestic Product (GDP) is designed to measure how many goods and services an economy produces. In the U.S., the Department of Commerce releases GDP figures every quarter. So, four times a year, the evening news reports on the GDP. Exactly what do GDP figures represent? Nominal GDP Nominal GDP for 2014 = Sum of the market values of all final goods and services produced in the United States during 2014 = P2014 Auto Q2014 Auto + P2014 Beer Q2014 Beer Let us parse the definition: Sum: It should be clear what a sum means. Market value: The market value is just the price of the good times the quantity produced. Produced in the U.S.: We only consider production in the U.S. Final goods and services: The term final goods and services requires some explanation. Final goods and services When the Department of Commerce calculates GDP, it makes a distinction between final and intermediate goods. Intermediate goods are those goods that produced in 2014 which were then used to produce other goods in the same year. For example, wheat is typically an intermediate good because wheat is used to produce flour. Most of the flour produced is also an intermediate good because most of the flour produced in the U.S. is used to produce bread. The bread is a final good. If the Department of Commerce were to count not only the bread, but also the flour that is used to make the bread, and the wheat that is used to make the flour, it would be double (or more accurately triple) counting. It would be counting the wheat in the flour and the flour in the bread twice. To avoid double counting only the value of final goods is included in GDP calculations.

2 2 Calculating GDP To calculate GDP, the Department of Commerce divides the users of final goods into three categories: households; firms; governments. It then measures how many final goods each category purchases. Households purchase food, clothing, entertainment, etc. for the purpose of consumption; that is, households purchase consumption goods. Firms purchase machines, tools, factories, etc. for the purpose of investment; that is, firms purchase investment goods. We call the purchases that federal, state, and local governments make government purchases. Now, let us consider the data for 2014 reported in table 2.1 (all figures are in billions of dollars): U.S. Household Purchases of Final Goods and Services (Consumption) 11,930 U.S. Firm Purchases of Final Goods and Services (Investment) 2,850 U.S. Government Purchases of Final Goods and Services 3,180 Federal 1,220 National defense 760 Nondefense 460 State and local 1,960 Total 17,960 Table 2.1: Household, firm, and government purchasing data 2014 Now, let us use the information from the table 2.1 to calculate GDP in the U.S. during 2014: Nominal U.S. Household U.S. Firm U.S. Government GDP = Purchases of + Purchases of + Purchases of for 2014 Final G&S (C) Final G&S (I) Final G&S (G) = 11, , ,180 = 17,960 It looks like GDP equals $16,790 billion. But wait. The goal of GDP is to measure how many final goods and services are produced in the U.S. Some of the purchases that U.S. households, firms, and governments make are for goods that are produced abroad, our imports: American households purchase BMW s produced in Germany, Volvos produced in Sweden, wine produced in France, etc. Shouldn t we subtract our imports? Also, some of the goods that are produced in the U.S. are shipped abroad and are not consumed in the U.S., our exports: American wheat is shipped abroad, American computers are shipped abroad, etc. Therefore, shouldn t we add exports? To obtain an accurate measure of U.S. production, we must add exports and subtract imports for the figure we just calculate. We call the difference between exports and imports net exports. The 2014 figures for exports and imports are: U.S. Exports of Final Goods and Services 2,340 U.S. Imports of Final Goods and Services 2,880 Therefore, U.S. Net Exports of Final Goods and Services = 2,880 2,340 = 540 Nominal U.S. Household U.S. Firm U.S. Government U.S. Net GDP = Purchases of + Purchases of + Purchases of + Exports of for 2014 Final G&S (C) Final G&S (I) Final G&S (G) Final G&S (NX) = 11, , , = 17,420 In 2014, nominal GDP was $17,420 billion.

3 3 Two Roles of the Government in the Macro Economy Purchasing of final goods and services. The Federal government purchases rifles, bullets, etc. for the military; state government purchase asphalt to build and maintain highways; local governments purchase the services of teachers for public schools. Affecting the disposable income of households. Disposable income refers to the amount of income household have available to spend. Federal, state, and local governments affect this in two ways: o Governments decrease the disposable income of households by collecting taxes: Income taxes, property taxes, etc. o Governments increase the disposable income of households by distributing transfer payments: Social Security benefits, unemployment insurance, welfare payments, etc. The Role of Federal, State, and Local Governments Before moving on, let us reconsider the government s role in the economy. First, table 2.2 reports that state and local governments purchase more final goods and services than does the federal government. U.S. Government Purchases of Final Goods and Services 3,180 Federal 1,220 National defense 760 Nondefense 460 State and local 1,960 Table 2.2: U.S. government purchases of final goods and services Also, note that most of the federal government s purchases go for defense; that is, most of the federal government s purchases are spent on military personnel, guns, munitions, aircraft, ships, etc. But wait a second. According to table 1.5 the federal government is spending $1,230 billion, yet isn t the federal budget well over two trillion dollars? What is going on here? All federal government s outlays can be divided into two broad categories: Purchase of final goods and services; Transfer payments. The federal government not only purchases final goods and services, it also administers transfer programs. These programs transfer income from one group of Americans to another. The largest transfer program is Social Security which transfers income from those who are working primarily to those who are retired. The federal budget figure that is cited on the evening news includes not only the purchase of goods and services, but also transfer payments, total Federal outlays. The Federal deficit equals all federal outlays less Federal receipts: Total Federal Total Federal Federal Deficit = Government Outlays Government Receipts ã 3,600 é 2,775 = 825 Federal Purchase of Federal Transfer + Final G&S Payments 1,220 2,380 We shall return to this later in the semester.

4 4 Great Depression: Unemployment and Nominal GDP Now, recall how we motivated macroeconomics. Since applying microeconomics to the labor market does not allow us to explain persistent unemployment, we took a different approach by exploiting the relationship between unemployment and production in the economy as a whole: Unemployment Up Employment Down Production Down Unemployment Down Employment Up Production Up Let us now see how well that approach works. By considering the Great Depression as reported in table 2.3: Year Nominal GDP (billions of dollars) Unemployment Rate (%) Table 2.3: Unemployment and nominal GDP data Based on these years, it appears that the new approach works: Between 1933 and 1937 the unemployment consistently fell and nominal GDP consistently rose. In 1938, the unemployment rate rose and nominal GDP fell from 87 to 94 billion dollars. Between 1938 and 1944 the unemployment consistently fell and nominal GDP consistently rose. But now we will consider a more recent case in which it does not work which prompts us to introduce a modified notion of gross domestic product.

5 5 Nominal GDP and Unemployment: A Puzzle A Puzzle: Table 2.4 reports a puzzle. Year Nominal GDP Unem Rate (%) , , Table 2.4: Nominal GDP and the unemployment rate for 2007 and 2008 GDP increased but the unemployment rate increased also. How could this occur? Let us review the definition of nominal GDP: Nominal GDP for 2007 = Sum of the market values of all final goods and services produced in the United States during 2007 = P2007 Auto Q2007 Auto + P2007 Beer Q2007 Beer = 14,480 Nominal GDP for 2008 = Sum of the market values of all final goods and services produced in the United States during 2008 = P2008 Auto Q2008 Auto + P2008 Beer Q2008 Beer = 14,720 Nominal GDP can increase for two reasons: the Q s can rise. the P s can rise. Why did we introduce the notion of GDP in the first place? We wanted a way to measure how many goods and services the economy as a whole was producing. But a rising nominal GDP need not necessarily indicate that the economy is producing more. We have a problem don t we. Real GDP Real GDP solves our problem. It modifies the definition of nominal GDP so that changes in real GDP reflect only the changes in the Q s, the quantity of goods and services produce. To see how, we begin with the definition of nominal GDP: Nominal GDP for 2014 = Sum of the market values of all final goods and services produced in the United States during 2014 = P2014 Auto Q2014 Auto + P2014 Beer Q2014 Beer = $17,420 If nominal GDP rises because the Q s increase, then the rising nominal GDP would indeed indicate that the economy was producing more goods and services. But GDP could rise as a consequence of rising prices, P s, with the Q s remaining the same or even falling. In this latter case, a rising GDP would not indicate a robust, growing economy. Since both an increase in the Q s and an increase in the P s can cause a rise in nominal GDP, nominal GDP itself cannot tell us what is happening to the Q s, the production of goods and services. For this reason, we shall now introduce a new concept, real GDP, which can only rise when the Q s increase. Consequently, when real GDP increase we can conclude confidently that our economy is producing more goods. Real GDP is what nominal GDP would have equaled if prices had not changed from their base year values. Currently, the base year used by the Department of Commerce is 2009: Real GDP for 2014 = Sum of the market values of all final goods and services produced in the United States during 2014 evaluated at base year (2009) prices = P2009 Auto Q2014 Auto + P2009 Beer Q2014 Beer = $16,090

6 6 Now, calculate real GDP for 2007 and 2008 Real GDP for 2007 Real GDP for 2008 = P2009 Auto Q2007 Auto + P2009 Beer Q2009 Beer = $14,875 = P2009 Auto Q2008 Auto + P2009 Beer Q2008 Beer = $14,835 The Q s, production, had to fall because the P s the prices were the same. Year Nominal GDP Real GDP Unem Rate (%) ,480 14, ,720 14, Table 2.5: Nominal GDP, real GDP, and the unemployment rate for 2007 and 2008 As table 2.5 reports nominal GDP rose and the fact that real GDP fell in 2008; that is, nominal GDP rose while the production of goods and services in the economy actually fell. This resolves our puzzle; production fell in 2008 and unemployment rose.

7 7 Figure 1.11 illustrates real GDP and its components since 1930: Figure 2.1: Real GDP and its components: Of course some of this growth is attributable to population growth; accordingly, the per capita figures are illustrated in figure 1.12: Figure 2.2: Real per capita GDP and its components: Terminology: Henceforth, whenever we refer to GDP, consumption, etc. we will be referring to real GDP, real consumption, etc. unless we explicitly say otherwise.

8 8 Measuring the Health of the Economy Some Complications Table 2.6 reports labor market statistics issued by the Bureau of Labor Statistics for December 2014 and January 2015: Dec 2014 Jan 2015 Difference Noninstutitional Population 249, , Labor Force 156, ,180 1,050 Not in Labor Force 92,900 92, Employed 147, , Unemployed 8,690 8, Unemployment Rate (%) Labor Force Participation Rate (%) Table 2.6: Labor market statistics December 2014 and January 2015 (thousands) Economists React to the January Jobs Report: Astonishingly Strong Wall Street Journal February 6, 2015 The report earned a 10 out of 10 in our eyes and suggests that labor markets remain extremely strong as fears of an early-year slowdown prove unfounded.. Gennadiy Goldberg, TD Securities Employment growth is astonishingly strong;.ignore the increase in the unemployment rate; month-to-month, it is just noise. What matters is payroll growth, and the numbers are huge. With every indicator we follow screaming that payrolls will be very strong for the foreseeable future... Ian Shepherdson, Pantheon Macroeconomics Before long, the U.S. economy is going to run into a problem that was unimaginable just six months ago: we might run out of people to employ. Guy LeBas, Janney Montgomery Scott January was another strong month across a breadth of industries confirming that our economic recovery is becoming robust. Job growth is strong and the labor force participation rate ticked up slightly, indicating that people who Noninstitution Population Up 700,000 have given up looking for work are beginning to start looking again... Bill Spriggs, AFL- Labor Force Up 1,050,000 CIO Question: How can we explain the enthusiastically positive comments about the economy when the unemployment rate rose? Answer: The reason for the optimism was the decline in those Americans not in the labor force which declined by more than a quarter of a million individuals as illusted in figure 2.3. Apparently, more of those who in December were not seeking a job decided to do so. The belief is that they did those was the fact that the prospects of getting a job had improved. In other words, workers who previously had given up on finding a job, discouraged workers, we now encouraged by the improving economy and rejoined the labor force. Not in Labor Force Down 350,000 entrants Employed Up 760,000 Unemployed Up 290,000 Figure 2.3: Labor market changes December 2014 to January 2015