Measurement Chapter 2 Topics in Macroeconomics 2 Economics Division University of Southampton February 8, 2008 Chapter 2 1/42 Topics in Macroeconomics
Gross Domestic Product Introduction Gross Domestic Product (GDP) Dollar value of final output produced during a given period of time within the borders of a country (Log) Real GDP Per Capita (year 2003 pounds) 4.4 4.3 Log RGDP per capita 4.2 4.1 4.0 3.9 3.8 3.7 3.6 3.5 1900 1906 1912 1918 1924 1930 1936 1942 1948 1954 Year 1960 1966 1972 1978 1984 1990 1996 2002 Chapter 2 3/42 Topics in Macroeconomics
Approaches to Measure GDP Introduction Product approach Sum of value added to goods and services in production across all productive units in the economy Expenditure approach Adds all spending on goods and services in the economy Income approach Adds up all incomes received by economic agents contributing to production NOTE: All three measures must add up to the same value (up to measurement error of course) Chapter 2 4/42 Topics in Macroeconomics
A Simple Economy Measuring GDP Introduction Consider an economy composed of the following agents: A corn producer Uses labour to produce corn A pig producer Uses corn and labour to grow pigs Consumers Supply labour, consume corn and pigs, provide loans A government Taxes firms and workers, uses labour to produce government supplied goods or services Chapter 2 6/42 Topics in Macroeconomics
Producer 1 Measuring GDP Introduction Corn Producer Total revenue Wages interest on loans Taxes 20 million 5 million 0.5 million 1.5 million Produces 10 million bushels of corn which are sold for 2 per bushel From these 6 million bushels are sold to the pig producer and 4 million to consumers Pays wages of 5 million to workers (who are the consumers) Pays 0.5 million in interest on a loan (to some consumers) Pays 1.5 million in taxes to the government Chapter 2 7/42 Topics in Macroeconomics
Producer 2 Measuring GDP Introduction Pig Producer Total revenue Cost of feed corn Wages Taxes 30 million 12 million 4 million 3 million Buys 6 million bushels of corn from the corn producer at 2 per bushel These are intermediate goods Pays wages of 4 million to workers Pays 3 million in taxes to the government Sells all its production to consumers (20 million kg at 1.50 per kilo) Chapter 2 8/42 Topics in Macroeconomics
Producers: After-Tax Profits Introduction After-Tax Profits Corn producer Pig producer Total 13 million 11 million 24 million After-Tax Profits = Total revenue - Wages - Interest - Cost of intermediate inputs - Taxes Before-Tax Profits = 24 + 4.5 = 28.5 million Chapter 2 9/42 Topics in Macroeconomics
The Government Measuring GDP Introduction Government Tax revenue From producers From consumers Wages 4.5 million 1 million 5.5 million The Government collects taxes from consumers and producers Uses the tax revenue to pay government workers (some consumers) to build a bridge Chapter 2 10/42 Topics in Macroeconomics
Consumers / Workers Introduction Consumers Wage income Interest income Taxes Profits distributed by producers 14.5 million 0.5 million 1 million 24 million Consumers work for the producers and government, earning a total of 14.5 million in wages Receive 0.5 million in interest from the corn producer Pay 1 million in taxes to the government Receive after-tax profits of 24 million from producers (consumers own the production units) Chapter 2 11/42 Topics in Macroeconomics
Introduction GDP Using the Product or Value Added Approach GDP Using the Product Approach Value added corn Value added pigs Value added government GDP 20 million 18 million 5.5 million 43.5 million GDP is the sum of value added to goods and services in production across all productive units in the economy We need to subtract intermediate goods to avoid double counting Value added for the government is problematic: usually set to the cost of the inputs since we don t have market prices for most goods produced by the government Chapter 2 12/42 Topics in Macroeconomics
Introduction GDP Using the Expenditure Approach GDP Using the Expenditure Approach Consumption (C) 38 million Investment (I) 0 Government expenditures (G) 5.5 million Net exports (NX) 0 GDP 43.5 million GDP = Total Expenditures = C + I + G + NX Consumers spend all their income ( 8 million on corn and 30 million on pigs) The government spends all its income There is no investment nor international trade in this example Chapter 2 13/42 Topics in Macroeconomics
Introduction GDP Using the Income Approach GDP Using the Income Approach Wage income Before-tax profits Interest income GDP 14.5 million 28.5 million 0.5 million 43.5 million GDP = Total Income = Y = C + I + G + NX GDP is also the sum of all incomes received by economic agents contributing to production Chapter 2 14/42 Topics in Macroeconomics
Gross National Product (GNP) Introduction Gross National Product (GNP) Dollar value of final output produced by domestic factors of production, regardless of where production takes place Net Factor Payments Income paid to domestic factors of production by the rest of the world - Income paid to foreign factors of production by the domestic economy GNP = GDP + Net Factor Payments Chapter 2 15/42 Topics in Macroeconomics
Introduction Problems with Measures of GDP Problems and things that are left out of GDP measures Inequality Non-market activity (home production) Underground economy Problems with value-added of the government and service sector Chapter 2 16/42 Topics in Macroeconomics
Nominal vs Real GDP Nominal and Real GDP Price Indices Nominal GDP Measures GDP in the current year in terms of current prices Real GDP at constant prices (base-year prices) Measures GDP in the current year in terms of prices of a base year One problem with this measure is that the base year used matters Chain-weighted Real GDP Essentially uses a rolling base year (eg. average price of two consecutive years) This is what is used by Statistics Canada Chapter 2 18/42 Topics in Macroeconomics
Data for the Example Nominal and Real GDP Price Indices Quantities and Prices 2002 2003 2004 Apples Oranges Apples Oranges Apples Oranges Quantity 50 100 80 120 100 160 Price 1.00 0.80 1.25 1.60 2.00 2.00 Nominal GDP in 2002: 50* 1.00 + 100* 0.80 = 130 Nominal GDP in 2003: 80* 1.25 + 120* 1.60 = 292 Nominal GDP in 2004: 100* 2.00 + 160* 2.00 = 520 Chapter 2 20/42 Topics in Macroeconomics
Nominal GDP and GDP Growth Nominal and Real GDP Price Indices Nominal GDP and GDP Growth 2002 2003 2004 Nominal GDP ( ) 130 292 520 GDP growth (%) 124.6 78.1 GDP Growth from 2002 to 2003 = 292/130-1 GDP Growth from 2003 to 2004 = 520/292-1 Chapter 2 21/42 Topics in Macroeconomics
Nominal and Real GDP Price Indices Real GDP at Constant Prices: Base-Year = 2002 Quantities and Prices 2002 2003 2004 Apples Oranges Apples Oranges Apples Oranges Quantity 50 100 80 120 100 160 Price 1.00 0.80 1.25 1.60 2.00 2.00 Real GDP in 2002 (this is nominal GDP from before): 130 Real GDP in 2003: 80* 1.00 + 120* 0.80 = 176 (these are 2002 ) Real GDP in 2004: 100* 1.00 + 160* 0.80 = 228 Chapter 2 22/42 Topics in Macroeconomics
Nominal and Real GDP Price Indices Real GDP at Constant Prices: Base-Year = 2003 Quantities and Prices 2002 2003 2004 Apples Oranges Apples Oranges Apples Oranges Quantity 50 100 80 120 100 160 Price 1.00 0.80 1.25 1.60 2.00 2.00 Real GDP in 2002: 50* 1.25 + 100* 1.60 = 222.5 (these are 2003 ) Real GDP in 2003 (this is nominal GDP from before): 292 Real GDP in 2004: 100* 1.25 + 160* 1.60 = 381 Chapter 2 23/42 Topics in Macroeconomics
Nominal and Real GDP Price Indices Real GDP at Constant Prices: Base-Year = 2004 Quantities and Prices 2002 2003 2004 Apples Oranges Apples Oranges Apples Oranges Quantity 50 100 80 120 100 160 Price 1.00 0.80 1.25 1.60 2.00 2.00 Real GDP in 2002: 50* 2.00 + 100* 2.00 = 300 (these are 2004 ) Real GDP in 2003: 80* 2.00 + 120* 2.00 = 400 Real GDP in 2004 (this is nominal GDP from before): 520 Chapter 2 24/42 Topics in Macroeconomics
Real GDP at Base-Year Prices Nominal and Real GDP Price Indices Real GDP at Base-Year Prices 2002 2003 2004 Base Year = 2002 Real GDP ( ) 130 176 228 Real GDP growth (%) 35.4 29.5 Base Year = 2003 Real GDP ( ) 222.5 292 381 Real GDP growth (%) 31.2 30.5 Base Year = 2004 Real GDP ( ) 300 400 520 Real GDP growth (%) 33.3 30.0 Chapter 2 25/42 Topics in Macroeconomics
Chain-Weighted Real GDP Nominal and Real GDP Price Indices Quantities and Prices 2002 2003 2004 Apples Oranges Apples Oranges Apples Oranges Quantity 50 100 80 120 100 160 Price 1.00 0.80 1.25 1.60 2.00 2.00 Average prices from 2002 to 2003: Apples: 1.125 Oranges: 1.20 Average prices from 2003 to 2004: Apples: 1.625 Oranges: 1.80 Chapter 2 26/42 Topics in Macroeconomics
Chain-Weighted Real GDP Nominal and Real GDP Price Indices Quantities and Prices 2002 2003 2004 Apples Oranges Apples Oranges Apples Oranges Quantity 50 100 80 120 100 160 Avg Price 1.125 1.20 1.625 1.80 Real GDP using 2002 2003 rolling prices: 2002: 50* 1.125 + 100* 1.20 = 176.25 2003: 80* 1.125 + 120* 1.20 = 234.00 Real GDP growth from 2002 to 2003: 32.8% Real GDP growth from 2003 to 2004: 30.2% Chapter 2 27/42 Topics in Macroeconomics
Nominal and Real GDP Price Indices Chain-Weighted Real GDP at 2002 Constant Prices Chain-Weighted Real GDP 2002 2003 2004 Real GDP ( ) 176.25 234.00 304.67 GDP growth (%) 32.8 30.2 2002: 176.25 (this is Real GDP using 2002 2003 rolling prices) 2003: 176.25*(1 + 32.8%) = 234.00 2004: 234.00*(1 + 30.2%) = 304.67 Chapter 2 28/42 Topics in Macroeconomics
Nominal and Real GDP Price Indices Nominal and Real (Chain-Weighted) GDP Chapter 2 29/42 Topics in Macroeconomics
Implicit GDP Price Deflator Nominal and Real GDP Price Indices Implicit GDP Price Deflator = Nominal GDP Real GDP 100 By convention, the price deflator is 100 in the base year (if there is a base year) Of course, the implicit GDP price deflator depends on the measure of real GDP Chapter 2 31/42 Topics in Macroeconomics
Implicit GDP Price Deflator Nominal and Real GDP Price Indices Implicit GDP Price Deflator 2002 2003 2004 Base Year = 2002 100 165.9 228.1 % increase 65.9 37.5 Base Year = 2003 58.4 100 136.5 % increase 71.2 36.5 Base Year = 2004 43.3 73.0 100 % increase 68.5 37.0 Chain-weighted 73.8 124.8 170.7 % increase 69.2 36.8 Chapter 2 32/42 Topics in Macroeconomics
Nominal and Real GDP Price Indices Consumer Price Index (CPI): Base-Year = 2002 Quantities and Prices 2002 2003 2004 Apples Oranges Apples Oranges Apples Oranges Quantity 50 100 80 120 100 160 Price 1.00 0.80 1.25 1.60 2.00 2.00 CPI in 2002: 100 CPI in 2003: 100*(50* 1.25 + 100* 1.60)/130 = 171.2 (71.2% increase from 2002) CPI in 2004: 100*(50* 2.00 + 100* 2.00)/130 = 230.8 (34.8% increase from 2002) Chapter 2 33/42 Topics in Macroeconomics
Nominal and Real GDP Price Indices Inflation from CPI and Implicit GDP Price Deflator Inflation 2003 2004 Base Year = 2002 65.9 37.5 Base Year = 2003 71.2 36.5 Base Year = 2004 68.5 37.0 Chain-weighted 69.2 36.8 CPI 71.2 34.8 Chapter 2 34/42 Topics in Macroeconomics
Nominal and Real GDP Price Indices Figure 2.3: Inflation from CPI and Implicit GDP Deflator Chapter 2 35/42 Topics in Macroeconomics
Nominal and Real GDP Price Indices Problems measuring Real GDP and the Price Level Relative prices change over time The quality of goods changes in over time New goods appear all the time Chapter 2 36/42 Topics in Macroeconomics
Some Definitions Measuring GDP Savings, Wealth, and Capital Labour Market Measurement Private disposable income Y d Y d = Y + NFP + TR + INT T TR: Transfers from the government to the private sector INT : Interest on government debt T : Taxes Private sector saving S p S p = Y d C = Y + NFP + TR + INT T C Government saving S g S g = T TR INT G National saving S S = S p + S g = Y + NFP C G S = C +I+G+NX +NFP C G = I +NX +NFP = I +CA Chapter 2 38/42 Topics in Macroeconomics
Nation s Wealth Measuring GDP Savings, Wealth, and Capital Labour Market Measurement The set of assets held by the country as a whole Plants, equipment, and structures Housing (and durables?) Wealth can be accumulated in 2 ways (S = I + CA) Though investment, as addition to the nation s capital stock Through current account surpluses, as Canadians accumulate claims on foreigners Wealth and capital are stocks Investment and current account are flows Chapter 2 39/42 Topics in Macroeconomics
Labour Market Measurement Savings, Wealth, and Capital Labour Market Measurement Individuals can be in one of three labour market pools Employed Worked full-time or part-time during the last week Unemployed Not employed during the last week but actively searched for work during the last 4 weeks Out of the labour force Neither employed nor unemployed Unemployment rate = Participation rate = Number unemployed Labour force Labour force Total working age population Chapter 2 41/42 Topics in Macroeconomics
Labour Market Tightness Savings, Wealth, and Capital Labour Market Measurement Unemployment rate is potentially useful as a measure of market tightness - degree of difficulty firms face in hiring workers But there are two potential problems: Discouraged workers Search intensity Chapter 2 42/42 Topics in Macroeconomics