Web: www.bea.doc.gov Monthly revisions, annual revisions in July, benchmark changes every years. Gross Domestic Product (Measure of Economic Activity) Gross domestic product (GDP) total value of all final goods and services produced in the U.S. Most important economic indicator, can identify economic strengths and weaknesses. It is used by forecasters to project future economic activity, by business leaders for business planning and sales forecasting, by money managers for investment strategies, and policymakers to alter macroeconomic policies. GDP = final sales + D Inventory Self-Sustaining Economic Expansion: Economic growth => employment => HH income => HH consumption => production => Cycle can be interrupted by an outside shock (war, oil embargo,... ) employment => HH income => self-generating growth cycle Nominal GDP values output in current dollars (PY) Real GDP describes output in constant dollars (chain weighted) Y = C + I + G + X M Increase in Y leads to higher living standards. Increase in P leads to lower living standards. D(PY) = DPY 1 + DYP 1 + DPDY D(PY) = DPY 1 + DYP 1 + DPDY P 1 Y 1 P 1 Y 1 P 1 Y 1 P 1 Y 1 D(PY) = DP + DY + P 1 Y 1 P 1 Y 1 if DP and DY are small DY = D(PY) DP Y 1 P 1 Y 1 P 1 -------------------------------------------------------------------------------------------------------------------------- Market Analysis: Bonds: Compare GDP data to market expectations. If DY/Y < expectations => DP/P => D Bonds => i Bonds Stocks: If DY/Y > expectations => future corporate sales => future profits => P Stocks Dollar: If DY/Y > expectations => future corporate sales and interest rates => demand for U.S. stocks and bonds => Demand for dollars => dollar appreciates.
The Circular Flow Diagram
U.S. Economic Output (Real GDP - Quarterly Growth Rate) 6.. GDP Growth 2% Maximum Sustainable Growth Rate. 4.6 4. 3.9 4. 4. 3. 3. 2. 1.7 2.7 2. 2.9 2.7 1.9 2.8 3.1 2.6 2.3 2. 2. 1.4 2. 2. 1.9 1..8.8.9.8..1. :1 11:1 12:1 13:1 14:1 1:1 16:1 17:1-1. -1. -2. Source: Department of Commerce. -1.2
6% % 4% 3% 2% 1% % -1% -2% -3% -4% -% -6% -7% -8% GDP Output Gap vs. Federal Funds Rate Recession Output Gap (Left Axis) Federal Funds Rate (Right Axis) 9 96 97 98 99 1 2 3 4 6 7 8 9 11 12 13 14 1 16 17 7.% 6.% 6.%.%.% 4.% 4.% 3.% 3.% 2.% 2.% 1.% 1.%.%.% Source: CBO & Federal Reserve. The U.S. economy is experiencing a negative 1.2% output gap, allowing the Federal Reserve to maintain its low interest rate policy. The output gap is the difference between actual GDP (or actual output) and potential GDP. If the output gap is positive it is called an inflationary gap and indicates the growth of aggregate demand is outpacing the growth of aggregate supply possibly creating inflation; if the calculation yields a negative number it is called a recessionary gap possibly signifying deflation.
4th Quarter 216 GDP Spending = C + I + G + X M % of total = (69.3) (16.7) (17.) (12.7) (-16.1) Growth rate = (2.) (.7) (1.2) (-4.3) (8.3) Contribution = (1.7) + (1.7) + (.2) + (-.) + (-1.2) = 1.9% Components of GDP PERSONAL CONSUMPTION EXPENDITURES, OR CONSUMPTION Consumption Spending by households on goods and services, not including spending on new houses. GROSS PRIVATE DOMESTIC INVESTMENT, OR INVESTMENT Investment Spending by firms on new factories, office buildings, machinery, and inventories, and spending by households on new houses. GOVERNMENT CONSUMPTION AND GROSS INVESTMENT, OR GOVERNMENT PURCHASES Government purchases Spending by federal, state, and local governments on goods and services. NET EXPORTS OF GOODS AND SERVICES, OR NET EXPORTS Net exports Exports minus imports.
3 2 2 1 - - -1-2 -2-3 11. 8 8. 6. 8. 8 4. 4. 3 4. 6 Real Personal Consumption Expenditures 17. 4 -. 3. 6. 4 4.. 9 4. 1. 6 (Durable Goods) 4 6-. 4 7 8-1. 2 9 11 12 13 14 1-16. 6 17-2. 4-2. 6 -. 9-11. 7. 7-2. 8 2. 6-7. 1 12. 412. 9 6. 7. 4. 2. 2 12. 11. 4 2. 8. 6. 7 8. 1 4. 4. 4 9. 2. 1 13. 8. 68. 7. 6 6. 2 4. 2 4. Annualized Quarter Growth Rate 11. 6. 9 9. 8 % Change From Quarter One Year Ago 3 2 2 1 - - -1-2 -2-3
3 Business Fixed Investment (Nonresidential Structures) 31 3 2 1 2 6 24 2 16 1 13 7 7 4 2 12 8 26 2 14 2 17 7 2 4 12 2 1 - -1-2 -3 4 6 7 8 9 11 12 13 14 1 16 17-2-2-3 -3-3 -2-4 -6 - -4 - -8-7 -9-2 4-2 - 2-72 7-3 - 2 7 Annualized Quarter Growth Rate - 12-1 % Change From Quarter One Year Ago - -1-2 -3
4 3 3 2 2 1 - - -1-2 -2-3 -3-4 -4-13.4 4.8 9.8 7.6.6 4. 2.9 Residential Investment 4 -.96 7 8 9-11.7 12 13 14 1 16 17-1.4-3.7-4. - 4.1-1.1-17.4-17. - 18.7-2. - 2 3.2-16.4-18.3-2 7.9-2 9.3-2 1.9-3- 3.33.2 2 1..3 2 3.2-12.2 7.8-3.7 11.6 8.1.3 2 7. Annualized Quarter Growth Rate 3.6 2 2.2 14.8 11.9.7 % Change From Quarter One Year Ago 6.1 14.8 13.4 11.7 12.6 11.3 11. 3.6 7.8-7.8.2 4 3 3 2 2 1 - - -1-2 -2-3 -3-4 -4 -
8 6 4 2-2 -4-6 -8 - Government Expenditures (Federal and State & Local) 4 6 7 8 9 11 12 13 14 1 16 17 State & Local % Change From Quarter One Year Ago Federal % Change From Quarter One Year Ago 8 6 4 2-2 -4-6 -8 -
3 2 2 1 - - -1-2 -2-3 13 2 6 8 12 16 8 19 7 7 1313 13 Exports 4 6-1 7 8 9 11 12 13 14 1-1 16 17-3 -3-3 -4 - -6-2 - 2 8 1 1 24 6 12 13 2 6 4 4 3 2 4 3 12 9 2 Annualized Quarter Growth Rate % Change From Quarter One Year Ago 3 2 3 2 2 1 - - -1-2 -2-3
Imports 3 2 2 1 - - -1-2 -2-3 17 13 4 13 9 7 3 1 1 2 2 19 16 1 11 11 8 4 3 3 3 3 6 2 2 3 1 1 2 2 2 1 1 4 6 7 8 9 11 12 13 14-1 1-1 16 17 - -4-4 -8-1 - 1 Annualized Quarter Growth Rate % Change From Quarter One Year Ago 3 2 2 1 - - -1-2 -2-3
Annual % Change in U.S. Economic Output (Real GDP - Chainweighted 29$) 6% % 4% 3% 2% 3.1% 2.9% 3.8% 3.4% 1.8% 4.7% 4.% 4.4% 4.1% 4.1% 3.7% 3.1% 2.9% 2.% 3.8% 3.3% 2.8% 2.7% 1.8% 1.8% 2.% 2.4% 2.6% 2.% 2.2% 1.6% 1.% 1.6% 1% 1.% % -1% -.% -.3% -2% -3% -2.8% -4% 86 87 88 89 9 91 92 93 94 9 96 97 98 99 1 2 3 4 6 7 8 9 11 12 13 14 1 16 17 Source: Department of Commerce.
2 1 - - 49 2 3 23 1 Change in Private Inventories 6 17 116 67 9 8 8 49 39 2 32 9 114 4 94 94 81 77 71 6 3 6777 71 6 741 34 32 38 21 24 16 12 3 7 8-6 9-13 - -22-27 -2-21 -16 11 12-6 13-14 1-2 -21-23 -14 16 17-16 -26-33 -43-47 -46 - -8 - - -67-77 -71-72 17 7 49 42-1 -2-2 -14-19 -26 Change in Inventories Change in the Change in Inventories Source: Department of Commerce.
6% GDP, Inventory & Final Sales (Growth Rates) 6% % 4% 3% 2% 1% % -1% -2% -3% 1.8% 4.6% 2.% 2.3% 1.% 3.3% 1.9% 4.1% 1.9% 2.% 3.% 3.% 2.8% 1.6% 2.% 2.7% 2.1% 1.% 3.1% 2.6% 1.4%.9% 1.4% 1.9%.8% 1.6%.8%.9%.8% 1.% -.2%.3%.9%.7% 1.% 1.2%1.2%2.6%.7%.7% -.2%.1%.3%.2%.% 1.%.1% -.1% -.%-.6% -.4% -.4% -1.% -1.2% -1.8% -2.1% -1.9% -.6% -1.2% -1.% 2.9% 4.6% -4% Source: Department of Commerce. 2.8% 3.1% 4.% 4.%.% 2.3% 2.% 2.6% 3.% 11 12 13 14 1 16 17 Final Sales Contribution Inventories Contribution GDP 1.9% % 4% 3% 2% 1% % -1% -2% -3% -4%
Domestic Production, Y = Foreign Production, M=1 Inventory Sales, C + I + G + X 69 + 16 +18 +12
Equilibrium Condition Q.S. = Q.D. Y + M = C + I + G + X 216 $ Trillion $18. + $2.7 = $12.7 + $3. + $3.3 + $2.2 Divide by Y (18. trillion) to get relative perspective % + 1% = 69% + 16% + 18% + 12% For heuristic reasons, multiply by + 1 = 69 + 16 + 18 + 12 Or = 69 + 16 + 18 + 12 1 Y = C + I + G + X - M
Circular-Flow Diagram Government purchases of goods and services Government Government borrowing Consumer spending Taxes Government transfers Private savings Households Wages, profit, interest, rent Factor Markets Financial Markets GDP Investment Firms Wages, profit, interest, rent Borrowing and stock issues by firms Exports Imports Rest of the world Foreign borrowing and sales of stock Foreign lending and purchases of stock
Two Ways of Measuring GDP: The two methods of calculating GDP are summarized below: Expenditure Approach Personal consumption expenditures + Gross private domestic investment + Government consumption and gross investment + Net exports of goods and services = GDP Resource Cost-Income Approach Aggregate income: Employee Compensation Income of self-employed Rents Profits Interest + Non-income cost items: Indirect business taxes and depreciation + Net income of foreigners = GDP
GDP estimates include an imputation for the value of owner-occupied housing. If you buy the home you were formerly renting, GDP does not go down. Statisticians make an estimate of what you would have paid if you rented whatever you live in, whether it s an apartment or a house. To be accurate, estimates of GDP must take into account the value of housing that is occupied by owners, as well as the value of rental housing. GDP: What s In and What s Out Included domestically produced final goods and services (including capital goods) new construction of structures changes to inventories Not Included intermediate goods and services inputs used goods financial assets like stocks and bonds foreign-produced goods and services
Real GDP versus Nominal GDP Calculating Real GDP Real GDP The value of final goods and services evaluated at base year prices. Nominal GDP The value of final goods and services evaluated at current year prices. The GDP Deflator Price level A measure of the average prices of goods and services in the economy. GDP deflator A measure of the price level, calculated by dividing nominal GDP by real GDP, and multiplying by. GDP deflator Nominal GDP Real GDP x
CPI Inflation Gauge (Measure of price inflation in retail goods and services) Web address: www.bls.gov/cpi/ No monthly revision, annual revision in February. CPI: Inflation affects the following activities Costs of doing business Investment decisions Retirees quality of life Labor contracts & rental contracts Government macroeconomic policy Social security benefits, food stamps, alimony, child support payments CPI is an index number which leads to a historical perspective of inflation. (1982-84 =) Inflation Explanations: Monetarist View excessive money supply growth. Too many dollars, chasing to few goods. If DM/M > DY/Y then DP/P > Keynesian View AD > AS => shortage => Prices inflation is a function of the state of the business cycle and level of production slack/idle capacity/resource scarcity Core-CPI - best measure of underlying inflation 2 Population Groups: CPI-W (wage earners & clerical workers) 32% of population benchmark for pay increases in collective bargaining agreements and for yearly cost-of-living adjustments on social security checks. CPI-U (all urban workers)
Deflationary Spiral: CPI Inflation Gauge (Measure of price inflation in retail goods and services) prices => corporate profits => job layoffs => household income => consumption spending => inventories => prices Forecasting Tool: Business can anticipate future technology and medical costs Investors can reassess investment strategies Union leaders use inflation forecasts in pay negotiations CPI is a lagging economic indicator 6 Other Price Gauges: PCE, Producer Prices, Import Prices, Employment Cost Index, Unit Labor Costs, GDP deflator. --------------------------------------------------------------------------------------------------------- Unexpected increase in inflation Bond Market: bond demand => bond price => nominal interest rates Stock Market: nominal interest rates => borrowing costs => profits=> stock prices Federal Reserve nominal interest rates => borrowing costs => profits => stock prices Firms prefer an increase in output rather than an increase in prices to boost revenues FX Market: AD > AS => unexpected inflation Y => r => exchange rate (good investment environment) DP/P => i => exchange rate (erodes dollar-based investments held by foreigners)
6% Inflation (CPI) (year over year % growth) 6% % % 4% 4% 3% 3% 2% 2% 1% 1% % -1% -2% -3% 1 2 3 4 6 7 8 9 11 12 13 14 1 16 17 Headline Core (excludes food and energy) Federal Reserve's Core CPI 2.% Target % -1% -2% -3%
Consumer Price Index Expenditure Share of Growth Components Total m/m y/y All Items %.3 2.1 Food 14. -.2 Meat, poultry, fish, eggs 2 -.4 -.4 Fruits, vegetables 1-1.1-2.4 Energy 7 1..4 Motor fuel 3 2.9 9.1 Electricity service 4..7 All Items (less food & energy) 79%.2 2.2 Commodities (less food/energy) 19. -.6 Apparel 3 -.7 -.1 New Vehicles 4.1.3 Used Vehicles 2. -3. Services (less energy) 6.3 3.1 Shelter 33.3 3.6 Rent 8.3 4. Owners Equivalent Rent 24.3 3.6 Medical Care 7.1 3.9 Transportation 6.6 2.8
Price Indexes and the Aggregate Price Level The aggregate price level is a measure of the overall level of prices in the economy. To measure the aggregate price level, economists calculate the cost of purchasing a market basket. A price index is the ratio of the current cost of that market basket to the cost in a base year, multiplied by. The inflation rate is the yearly percentage change in a price index, typically based on the Consumer Price Index, or CPI, the most common measure of the aggregate price level. The consumer price index measures the cost of the market basket of a typical urban American family.
Is the CPI biased? The U.S. government takes considerable care in measuring consumer prices. Nonetheless, many economists believe that the consumer price index systematically overstates the actual rate of inflation. One reason is the fact that the CPI measures the cost of buying a given market basket. Yet, consumers typically alter the mix of goods and services they buy (substitution effect), reducing purchases of products that have become relatively more expensive and increasing purchases of products that have become relatively cheaper. The second reason arises from innovation. By widening the range of consumer choice, innovation makes a given amount of money worth more.
Chapter 7 Problems: 2, 3,, 7, 9, 12 Econ 2 Homework 3 Due Friday, February 3 in Discussion