Notes II: Measuring the Economy
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1 Notes II: Measuring the Economy Julio Garín Intermediate Macroeconomics Spring 2018 Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
2 Preliminaries While the GDP and the rest of the national income accounts may seem to be arcane concepts, they are truly among the great inventions of the twentieth century Paul A. Samuelson and William D. Nordhaus Why do we care about economic activity? Why do we care about income? It is closely related with higher standards of living. GDP simultaneously measures: 1. Total income of everyone in the economy. 2. Total expenditure on the economy s output of goods and services. 3. Total production of goods and services. Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
3 Circular-Flow Diagram Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
4 Gross Domestic Product and its Components Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
5 GDP I Gross Domestic Product (GDP) is the market value of all final goods and services produced within a country in a given period of time. You cannot compare burritos and markers. GDP uses market prices. It its comprehensive. GDP includes all items produced in the economy and sold legally in markets. For instance, it includes the value of housing services provided by the economy s stock of housing. What about transactions within the family? GDP only includes final goods. Intermediate goods that increase inventories add to GDP. Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
6 GDP II GDP includes both tangible goods and intangible services. GDP only includes goods and services currently produced. What about new cars? What about used ones? GDP measures the value of production within the geographic confines of a country. What about an American producing in Canada? What about an Uruguayan producing in America? GDP measures the value of production that takes place within a specific interval of time. Usually a year or a quarter. When GDP is reported at a quarterly frequency, it usually represents GPD at an annual rate. Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
7 The Components of GDP To understand how the economy is using its scarce resources, economists study the composition of GDP among various types of spending. GDP is divided into five components: GDP t = Remember: GDP is equivalently also a measure of both expenditure and income. Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
8 A Closer Look into GDP Components Consumption, C, is spending by households on goods and services, with the exception of purchases of new housing. Investment, I, is the purchase of goods that will be used in the future to produce more goods and services. It includes spending on capital equipment, inventories, and structures, including household purchases of new housing. Government purchases, G, includes spending on goods and services by local, state, and federal government. It includes the salaries of government workers as well as expenditures on public works. It does not include transfer payments. Net exports, NX, equal the foreign purchases of domestically produced goods (exports, X ) minus the domestic purchases of foreign goods (imports, IM.) Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
9 GDP as Value Added Table: Example from the Oil Industry Stage of Production Value of Sales Value Added Oil Drilling $ Refining Shipping Retail Sale Total Value Added 3.47 Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
10 What Counts and What Doesn t? For each question, identify which component GDP these are counted toward and how GDP changes. 1. I build a new home in the Village. 2. Super King Market has beer that has been sitting on the shelf for 12 months. It s getting stale, so it goes on sale. CNC students flock the store and purchase all of it. 3. You buy Apple stock on E-trade. 4. Salaries paid to soldiers. 5. Social Security benefits for the retired. 6. You buy an Australian surfboard. Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
11 Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
12 It is a capital mistake to theorize before one has data. Insensibly one begins to twist facts to suit theories, instead of theories to suit facts. Sherlock Holmes Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
13 Where and How? Google is your friend: St. Louis Fed: Federal Reserve Economic Data (FRED). Bureau of Labor Statistics (BLS). U.S. Bureau of Economic Analysis (BEA). Census Bureau. Example: GDP. Consumption. Investment. Saving: For now, just use Microsoft Excel. Arrange the data in columns. First column should always have the time periods. Select cell B2 and: View Freeze Panes Freeze Panes. Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
14 Looking at the Data Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
15 GDP and its Components Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
16 Expenditure Shares of U.S. GDP Share of GDP (%) Consumption Investment Governmnet Net Exports Time Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
17 Within Consumption % of C Services Goods Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
18 Within Consumption % of C Services Durables Nondurables Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
19 Within Fixed Investment Residential Nonresidential Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
20 Within Nonresidential Structures Equipment Intellectual property products Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
21 Fixed Investment (As % of Investment) Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
22 Change in Private Inventories % of GDP Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
23 Within Government Expenditures Share of GDP.5.4 State and Local Federal Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
24 Within Government Expenditures 1.0 State and Local Federal Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
25 Net Exports Components Share of GDP Exports Imports Net Exports Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
26 Expenditure Approach Table: GDP and its Components (Annualized 2016Q2) Total Per Person Share of GDP (Billions of $) (in $) (Percent) GDP 18,438 57, Consumption 12,688 39, Investment 2,972 9, Government Purchases 3,267 10, Net Exports , Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
27 GDP Billions of $ 16,000 Nominal GDP 12,000 8,000 4, Time Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
28 Real and Nominal Variables Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
29 Motivation Nominal GDP 1994: $7,476.7 Billions of dollars. Nominal GDP 2014: $17,599.8 Billions of dollars. If GDP grew then at least one of following must be true: 1. The economy is producing more goods and services. 2. The same goods and services are being sold at higher prices. As economists, we would like to isolate these two effects. Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
30 Real Vs. Nominal Money, M, is an unit of account and numeraire. Nominal price: denominated in units of money. We care about real variables. Prices denominated in terms of goods. In a single good world real output is just the quantity. In a multi-good world this is not straightforward to compute. Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
31 Real Vs. Nominal GDP We refer to nominal GDP when prices and quantities have not been separated out. Real GDP is the total output in an economy, in a given period of time, corrected for any change in prices. In the NIPA, this is equivalent to constant dollar GDP. Formally: nominal GDP = price level real GDP. Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
32 Some Formulae Nominal GDP in year t : NGDP t = n y s,t p s,t. s=1 Real GDP in year t using year B prices: Y t = n y s,t p s,b. s=1 Money is still a numeraire, but now we can make comparisons across time. Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
33 GDP Deflator We can define an implicit price index as: P t = NGDP t RGDP t 100. By construction, it is equal to 100 in the base period. This index is also known as an implicit GDP deflator. The GDP deflator is a measure of the level of prices of all new, final goods and services produced within a country in a given period of time. It can be used to take inflation out of nominal GDP. It can deflate nominal GDP from the rise that is due to increases in prices. Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
34 Chain-Weighting Issues with the previous calculation: Choice of base year is arbitrary. Relative prices change over time. To correct for this issue, NIPA uses a chain-weighting scheme for calculating real GDP. Calculate the real GDP using different base years. Obtain growth rates. Calculate a geometric average of those growth rates. From the averages obtained above, create a new series of real GDP. Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
35 Real and Nominal GDP 16,000 Nominal GDP Real GDP 12,000 8,000 4, Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
36 Deflator, Real, and Nominal GDP 16,000 Nominal GDP Real GDP Deflator , ,000 4, Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
37 Per Capita and Decomposing Nominal GDP Growth We usually express variables after dividing by the total population. Why? Using previous notation and the properties of logarithms and growth rates we can obtain: gt NGDP gt Y /L + π t + gt L In the data we have the following annual growth rates: Population: 1.2%. Inflation: 3%. Nominal GDP: 6%. Real GDP: 3%. Per capita Real GDP: 2%. Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
38 CPI Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
39 CPI The consumer price index (CPI) is a measure of the overall cost of the goods and services bought by a typical consumer. Data on the prices of thousands of goods and services is collected monthly by the Bureau of Labor Statistics (BLS). Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
40 CPI and Inflation CPI ( =100) Inflation Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
41 Problems in Measuring the Cost of Living Substitution bias. When prices change over time, they do not all change proportionally. Consumers respond to these changes. The index will tend to measure a much larger increase in the cost of living than consumers actually experience. Introduction of new goods. As new goods are introduced, consumers have more choices, and each dollar is worth more. Since the basket is fixed, it does not reflect the increase in the value of a dollar that arises from the introduction of new goods. Unmeasured quality change. If the quality changes over time, and the price remains the same, the value of the currency also changes. Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
42 Two Measures of Inflation CPI Inflation GDP Deflator Inflation Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
43 Labor Markets Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
44 Aggregate Labor Market Notation L: Population. E: Employment (E L). h: Average hours worked per employee. N: Total hours worked. n: Hours worked per capita. U: Unemployment. LF : Labor force. u: Unemployment rate. lf : Labor force participation rate. Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
45 Labor-Force Participation Ratio Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
46 LFP Ratio Men Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
47 LFP Ratio Women Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
48 LFP Ratio All Total Men Women (Right) Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
49 Employment-Population Ratio Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
50 E/P Men Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
51 E/P Women Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
52 E/P Both Men (Left) Women Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
53 E/P All Men (Left) Women Total Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
54 Unemployment Rate Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
55 Unemployment Rate: By Sex Males Women Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
56 Unemployment Rate: By Age Ages (Right) Women 20 and Older Men 20 and Older Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
57 Unemployment Rate: By Race Hispanic Black White Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
58 Unemployment Rate: By Education Achievement High School Less Than High School Some College At Least College Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
59 Limitations of Unemployment Hard to interpret. Unemployment may fall for the wrong reasons. It does not reflect part time work. Hours worked per capita or employment-population ratio are better measures of strength of labor market. Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
60 Working with Logs Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
61 Revisiting Real GDP (Per Capita Quarterly) 45,000 40,000 35,000 30,000 25,000 20,000 15,000 10, Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
62 Revisiting Real GDP (Annual) 14,000 12,000 10,000 8,000 6,000 4,000 2, Not easy to tell how bad the last recession was. Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
63 Natural Logs and Growth Rates Most of the time, it is more convenient to work with natural logs. First difference of the ln series is approximately the growth rate of the original series. Allows for unitless interpretation of the series. Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
64 Natural Log of GDP (Annual) What about now? Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
65 GDP Per Capita (Quarterly) What are the main features here? GDP grows over time. The growth rate is not constant. Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
66 What are the Challenges? We should separate the long-term behavior from the short-run fluctuations. From an economic growth perspective, what is more important? By detrending a series we can separate the trend from the cycle. Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
67 GDP Per Capita and its Trend Trend GDP What are those fluctuations? Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
68 Cycle What happens when the cycle is negative? It is below the trend. Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
69 Cycle and Recessions Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
70 Log GDP, its Trend, and its Cycle Log GDP Per Capita Trend Cycle Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
71 Book Material Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
72 Chapters 1. GLS: Chapter 1. Macroeconomic Data. Intermediate Macroeconomics Notes II - Measuring the Economy Spring / 72
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