Econ 311 Intermediate Macroeconomics Professor Eschker Fall 2014
Today s Topics Finish math refresher GDP Deflator Chain Weighting
News CBO Projection: Budget Deficits in Future Years to be Smaller than Previous Forecast The Congressional Budget Office (CBO) released new budget projections today An Update to the Budget and Economic Outlook: 2014 to 2024. The projected budget deficits have been reduced for most of the next ten years, although the projected deficit for 2014 has been revised up slightly (by $14 billion). NOTE: In the previous update, the CBO revised down their projection of the deficit for fiscal 2014 from 3.7% to just under 2.9% of GDP. The federal budget deficit for fiscal year 2014 will amount to $506 billion, CBO estimates, roughly $170 billion lower than the shortfall recorded in 2013. At 2.9 percent of gross domestic product (GDP), this year's deficit will be much smaller than those of recent years (which reached almost 10 percent of GDP in 2009) and slightly below the average of federal deficits over the past 40 years. CBO's current economic projections differ in some respects from the ones issued in February 2014. The agency has significantly lowered its projection of growth in real GDP for 2014, reflecting surprising economic weakness in the first half of the year. However, the level of real GDP over most of the coming decade is projected to be only modestly lower than estimated in February. In addition, CBO now anticipates lower interest rates throughout the projection period and a lower unemployment rate for the next six years. http://www.calculatedriskblog.com/#dkl1bdb3cglkjf7i.99
National income accounting Method of aggregating the production of diverse goods into a single measure of overall economic activity. Gross domestic product (GDP) The value of the final goods and services produced in an economy over a year. The most looked at statistic in regards to overall economic health of a country 2014 II GDP is $17,295 billion $54,640 per capita
www.bea.gov http://research.stlouisfed.org/fred2/
3 Equivalent ways to measure GDP Production measure of GDP The value of goods produced in the economy. Expenditure measure The total purchases in the economy. Income measure All the income earned in the economy.
Expenditures The national income accounting identity states: Where Y = GDP (in dollars) C = consumption I = investment G = government purchases NX = net exports = exports imports
Housing in NIPA Just like any investment Long lived, so not intermediate good Depreciates New Residential is part of Investment But other consumer durables not included Flow of housing service is part of Consumption Includes imputed owner occupied rent Estimated from periodic surveys (imprecise) Income from sales of new housing/rent/owner occupied rent is Income Sale of used house is NOT in GDP (except realtor commission, inspection fees, etc.)
The income approach Income Measures the sum of all income earned in the economy. Capital Inputs into production other than labor that are not used up in the production process. Firms increase capital through investment.
Depreciation The deterioration of the capital stock due to wear and tear. GDP depreciation = net domestic product
When calculating income, we need to distinguish between profits and economic profits Profits Normal competitive return on inputs. Economic profits Above-normal returns associated with prices that exceed those that prevail under perfect competition. In perfect competition, economics profits are zero
Total shares of GDP to inputs: Share of GDP to Labor: two-thirds Share of GDP to Capital: one-third. Labor s share of GDP has remained approximately constant over time.
5 types of income by percent of all income Wages (71%) Corporate Profits (12%) Proprietor s Income (10%) Net Interest (5%) Rent (1%)
Value Added There is no double counting in GDP; only the final sale of goods and services count. Value added The amount each producer contributes to GDP. The revenue generated by each producer minus the value of intermediate products. Only new production of goods and services counts toward GDP.
Exercise: A farmer grows a bushel of wheat and sells it to a miller for $1.00. The miller turns the wheat into flour and sells it to a baker for $3.00. The baker uses the flour to make a loaf of bread and sells it to an engineer for $6.00. The engineer eats the bread. Compute & compare value added at each stage of production and GDP
Note: Final Sales are GDP minus changes in inventory
Size of Pie versus How Pie is Sliced
Economics Efficiency refers to how large is the pie Equity refers to how the pie is sliced
Two arithmetic tricks for working with percentage changes 1. For any variables X and Y, percentage change in (X Y ) percentage change in X + percentage change in Y EX: If your hourly wage rises 5% and you work 7% more hours, then your wage income rises approximately 12%.
2. percentage change in (X/Y ) percentage change in X percentage change in Y
Over Time Nominal GDP A measure of GDP at today s prices. current dollars Real GDP GDP adjusted for inflation If actual goods and services produced don t change, then no change in Real GDP benchmarked dollars or constant dollars
GDP Deflator (implicit price deflator) One price level is the GDP deflator, defined as GDPdeflator nominal GDP real GDP
The inflation rate is the percentage increase in the overall level of prices. The inflation rate over one year is the growth rate of the Price Index: inflation rate Price Index t 1 Price Index - Price Index t t where t is the year and t+1 the following year
The inflation rate is the percentage change in the price level. Or we could also use the following math trick: _
Nom. GDP Practice problem Real GDP GDP deflator Compute the GDP deflator in each year. Use GDP deflator to compute the inflation rate from 2006 to 2007, and from 2007 to 2008. Inflation rate 2006 $46,200 $46,200 n.a. 2007 51,400 50,000 2008 58,300 52,000
Answers to practice problem Nominal GDP Real GDP GDP deflator Inflation rate 2006 $46,200 $46,200 1.000 n.a. 2007 51,400 50,000 1.028 2.8% 2008 58,300 52,000 1.121 9.1%
Calculating Real GDP 1. A Laspeyres index uses initial prices. 2. A Paasche index uses final year prices. Over long-time intervals the two indexes can result in substantial differences.
Laspeyres Index c = i initial p q i c i Paasche Index c = where i is the good p is the price q is the quantity c is the current year i final p q i c i
Practice problem 2006 2007 P Q P Q DVDs $30 900 $31 1,000 DVD players $100 192 $102 200 Compute nominal GDP in each year. Compute real GDP using Laspeyres and Paasche Indexes. Compute growth rate of real GDP using Laspeyres and Paasche Indexes.
Answers to practice problem nominal GDP multiply Ps & Qs from same year 2006: $46,200 = $30 900 + $100 192 2007: $51,400 = $31 1000 + $102 200 Growth rate = (51,400-46200)/46200 =.1126 = 11.26% real GDP (Laspeyres) multiply each year s Qs by 2006 Ps 2006: $46,200 = $30 900 + $100 192 2007: $50,000 = $30 1000 + $100 200 Growth rate = (50,000-46200)/46200 =.0823 = 8.23% real GDP (Paasche) multiply each year s Qs by 2007 Ps 2006: $47,484 = $31 900 + $102 192 2007: $51,400 = $31 1000 + $102 200 Growth rate = (51,400-47,484)/47484 =.0825 = 8.25%
The Fisher index (chain weighting) is the preferred approach to calculating real GDP. Geometric Average of the Laspeyres and Paasche index. Geometric average X *Y NOTE: Book shows arithmetic average instead! Arithmetic average X Y 2
Preferred because new goods are invented while others become obsolete making early or recent prices inaccurate. Can be applied on a year-by-year basis if we compute real GDP each year.
Chain weighting allows us to compare changes in real GDP over time by gradually updating prices. We link the chain of comparisons.
Chain Weighted real GDP (Laspeyres) Growth rate = 8.23% real GDP (Paasche) Growth rate =8.25% Geometric Average growth rate = (8.23*8.25)^1/2 = 8.24% What is real chain weighted GDP in each year benchmarked to 2007? Real GDP 2007 = Nominal GDP 2007 = $51,400 (always!) Real GDP 2006: What would real GDP have to be in 2006 so that it grows 8.24% and becomes? 51,400? Real GDP 2006 * (1.0824) = 51,400 or GDP = $47,487
Main reason for using chain-weighted data: Prices of computers rapidly changing in 1990s. Main disadvantage: The sum of real C, I, G, NX will not equal real chain-weighted GDP because the prices used in constructing the components are different. General rule to follow: For particular components of GDP, we look at the ratio of nominal variables. When you want real rates of economic growth, use the chain-weighted real measures.
In Class Problem