Notes II: Measuring the Economy

Notes II: Measuring the Economy Julio Garín Intermediate Macroeconomics Spring 2018 Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 1 / 72

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 2018 2 / 72

Circular-Flow Diagram Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 3 / 72

Gross Domestic Product and its Components Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 4 / 72

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 2018 5 / 72

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 2018 6 / 72

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 2018 7 / 72

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 2018 8 / 72

GDP as Value Added Table: Example from the Oil Industry Stage of Production Value of Sales Value Added Oil Drilling $1.87 1.87 Refining 2.47 0.60 Shipping 2.97 0.50 Retail Sale 3.47 0.50 Total Value Added 3.47 Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 9 / 72

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 2018 10 / 72

Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 11 / 72

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 2018 12 / 72

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 2018 13 / 72

Looking at the Data Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 14 / 72

GDP and its Components Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 15 / 72

Expenditure Shares of U.S. GDP Share of GDP (%) 40 30 20 10 0 Consumption Investment Governmnet Net Exports 70 68 66 64 62 60-10 1970 1975 1980 1985 1990 1995 2000 2005 2010 Time Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 16 / 72

Within Consumption % of C 68 64 Services Goods 60 56 52 48 44 40 36 32 1930 1940 1950 1960 1970 1980 1990 2000 2010 Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 17 / 72

Within Consumption % of C 100 80 Services Durables Nondurables 60 40 20 0 1930 1940 1950 1960 1970 1980 1990 2000 2010 Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 18 / 72

Within Fixed Investment 100 80 Residential Nonresidential 60 40 20 0 50 55 60 65 70 75 80 85 90 95 00 05 10 Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 19 / 72

Within Nonresidential 100 80 60 40 20 Structures Equipment Intellectual property products 0 50 55 60 65 70 75 80 85 90 95 00 05 10 Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 20 / 72

Fixed Investment (As % of Investment) 110 105 100 95 90 85 80 50 55 60 65 70 75 80 85 90 95 00 05 10 Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 21 / 72

Change in Private Inventories % of GDP 3 2 1 0-1 -2 50 55 60 65 70 75 80 85 90 95 00 05 10 Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 22 / 72

Within Government Expenditures Share of GDP.5.4 State and Local Federal.3.2.1.0 1930 1940 1950 1960 1970 1980 1990 2000 2010 Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 23 / 72

Within Government Expenditures 1.0 State and Local Federal 0.8 0.6 0.4 0.2 0.0 1930 1940 1950 1960 1970 1980 1990 2000 2010 Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 24 / 72

Net Exports Components Share of GDP.16.12 Exports Imports Net Exports.08.04.00 -.04 1930 1940 1950 1960 1970 1980 1990 2000 2010 Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 25 / 72

Expenditure Approach Table: GDP and its Components (Annualized 2016Q2) Total Per Person Share of GDP (Billions of $) (in $) (Percent) GDP 18,438 57,817 100 Consumption 12,688 39,787 68.8 Investment 2,972 9,320 16.1 Government Purchases 3,267 10,243 17.7 Net Exports -490-1,537-2.6 Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 26 / 72

GDP Billions of $ 16,000 Nominal GDP 12,000 8,000 4,000 0 50 55 60 65 70 75 80 85 90 95 00 05 10 Time Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 27 / 72

Real and Nominal Variables Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 28 / 72

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 2018 29 / 72

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 2018 30 / 72

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 2018 31 / 72

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 2018 32 / 72

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 2018 33 / 72

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 2018 34 / 72

Real and Nominal GDP 16,000 Nominal GDP Real GDP 12,000 8,000 4,000 0 50 55 60 65 70 75 80 85 90 95 00 05 10 Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 35 / 72

Deflator, Real, and Nominal GDP 16,000 Nominal GDP Real GDP Deflator 120 100 12,000 80 8,000 4,000 60 40 20 0 0 50 55 60 65 70 75 80 85 90 95 00 05 10 Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 36 / 72

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 2018 37 / 72

CPI Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 38 / 72

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 2018 39 / 72

CPI and Inflation.14.12.10.08.06.04.02.00 CPI (1982-84=100) Inflation 320 280 240 200 160 120 80 40 -.02 0 50 55 60 65 70 75 80 85 90 95 00 05 10 Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 40 / 72

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 2018 41 / 72

Two Measures of Inflation.14.12 CPI Inflation GDP Deflator Inflation.10.08.06.04.02.00 -.02 50 55 60 65 70 75 80 85 90 95 00 05 10 Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 42 / 72

Labor Markets Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 43 / 72

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 2018 44 / 72

Labor-Force Participation Ratio 68 66 64 62 60 58 50 55 60 65 70 75 80 85 90 95 00 05 10 Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 45 / 72

LFP Ratio Men 88 84 80 76 72 68 50 55 60 65 70 75 80 85 90 95 00 05 10 Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 46 / 72

LFP Ratio Women 65 60 55 50 45 40 35 30 50 55 60 65 70 75 80 85 90 95 00 05 10 Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 47 / 72

LFP Ratio All 88 84 80 76 72 68 64 60 56 Total Men Women (Right) 50 55 60 65 70 75 80 85 90 95 00 05 10 70 65 60 55 50 45 40 35 30 Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 48 / 72

Employment-Population Ratio 66 64 62 60 58 56 54 50 55 60 65 70 75 80 85 90 95 00 05 10 Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 49 / 72

E/P Men 88 84 80 76 72 68 64 60 50 55 60 65 70 75 80 85 90 95 00 05 10 Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 50 / 72

E/P Women 60 55 50 45 40 35 30 50 55 60 65 70 75 80 85 90 95 00 05 10 Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 51 / 72

E/P Both 88 84 Men (Left) Women 65 60 80 55 76 50 72 45 68 40 64 35 60 50 55 60 65 70 75 80 85 90 95 00 05 10 30 Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 52 / 72

E/P All 88 65 84 60 80 55 76 72 68 Men (Left) Women Total 50 45 40 64 35 60 50 55 60 65 70 75 80 85 90 95 00 05 10 30 Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 53 / 72

Unemployment Rate 11 10 9 8 7 6 5 4 3 2 50 55 60 65 70 75 80 85 90 95 00 05 10 Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 54 / 72

Unemployment Rate: By Sex 11 10 Males Women 9 8 7 6 5 4 3 92 94 96 98 00 02 04 06 08 10 12 Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 55 / 72

Unemployment Rate: By Age 12 10 8 6 Ages 16-19 (Right) Women 20 and Older Men 20 and Older 30 25 20 15 10 4 2 5 0 50 55 60 65 70 75 80 85 90 95 00 05 10 Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 56 / 72

Unemployment Rate: By Race 24 20 Hispanic Black White 16 12 8 4 0 1975 1980 1985 1990 1995 2000 2005 2010 Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 57 / 72

Unemployment Rate: By Education Achievement 18 16 14 High School Less Than High School Some College At Least College 12 10 8 6 4 2 0 92 94 96 98 00 02 04 06 08 10 12 Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 58 / 72

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 2018 59 / 72

Working with Logs Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 60 / 72

Revisiting Real GDP (Per Capita Quarterly) 45,000 40,000 35,000 30,000 25,000 20,000 15,000 10,000 55 60 65 70 75 80 85 90 95 00 05 10 Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 61 / 72

Revisiting Real GDP (Annual) 14,000 12,000 10,000 8,000 6,000 4,000 2,000 0 30 35 40 45 50 55 60 65 70 75 80 85 90 95 00 05 10 Not easy to tell how bad the last recession was. Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 62 / 72

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 2018 63 / 72

Natural Log of GDP (Annual) 9.6 9.2 8.8 8.4 8.0 7.6 7.2 6.8 6.4 30 35 40 45 50 55 60 65 70 75 80 85 90 95 00 05 10 What about now? Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 64 / 72

GDP Per Capita (Quarterly) 10.8 10.6 10.4 10.2 10.0 9.8 9.6 9.4 55 60 65 70 75 80 85 90 95 00 05 10 What are the main features here? GDP grows over time. The growth rate is not constant. Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 65 / 72

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 2018 66 / 72

GDP Per Capita and its Trend 10.8 10.6 Trend GDP 10.4 10.2 10.0 9.8 9.6 9.4 55 60 65 70 75 80 85 90 95 00 05 10 What are those fluctuations? Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 67 / 72

Cycle.08.06.04.02.00 -.02 -.04 -.06 -.08 55 60 65 70 75 80 85 90 95 00 05 10 What happens when the cycle is negative? It is below the trend. Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 68 / 72

Cycle and Recessions.08.06.04.02.00 -.02 -.04 -.06 -.08 55 60 65 70 75 80 85 90 95 00 05 10 Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 69 / 72

Log GDP, its Trend, and its Cycle Log GDP Per Capita Trend Cycle 10.8 10.4 10.0.08.04 9.6 9.2.00 -.04 -.08 55 60 65 70 75 80 85 90 95 00 05 10 Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 70 / 72

Book Material Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 71 / 72

Chapters 1. GLS: Chapter 1. Macroeconomic Data. Intermediate Macroeconomics Notes II - Measuring the Economy Spring 2018 72 / 72