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The Data of Macroeconomics Chapter 2 of Macroeconomics, 7th edition, by N. Gregory Mankiw ECO62 Udayan Roy This chapter reviews ECO11 • What do the following macroeconomic variables represent? How are they measured? – Gross Domestic Product (GDP) – The Consumer Price Index (CPI) – The Unemployment Rate Gross Domestic Product • Total expenditure on domestically-produced final goods and services. • Total income earned by domestically-located factors of production. Expenditure equals income because every dollar spent by a buyer becomes income to the seller. The Circular Flow of Income and Expenditure Income ($) Labor Households Firms Goods Expenditure ($) The expenditure components of GDP • consumption, C • investment, I • government spending, G • net exports, NX The national income identity: Y = C + I + G + NX value of total aggregate output expenditure Consumption (C) Consumption is the value of all – durable goods goods and services bought by last a long time households. It includes: e.g., cars, home appliances – nondurable goods last a short time e.g., food, clothing – services work done for consumers e.g., dry cleaning, air travel U.S. consumption, 2008 $ billions % of GDP Consumption $ 10,057.9 70.5% Durables 1,023.2 7.2 Nondurables 2,965.1 20.8 Services 6,069.6 42.6 Investment (I) • This is spending on goods bought for future use (i.e., capital goods) • It includes: – Business fixed investment Spending on plant and equipment – Residential fixed investment Spending by consumers and landlords on housing units – Inventory investment The change in the value of all firms’ inventories U.S. Investment, 2008 $ billions % of GDP Investment $1,993.5 14.0% Business fixed 1,552.8 10.9 Residential 487.7 3.4 Inventory –47.0 –0.3 Government spending (G) • G includes all government spending on goods and services. • It excludes transfer payments (e.g., unemployment insurance payments), because they do not represent spending on goods and services. U.S. Government Spending, 2008 $ billions % of GDP Govt spending $2,882.4 20.2% - Federal 1,071.9 7.5 Non-defense 337.0 2.4 Defense 734.9 5.2 - State and local 1,810.4 12.7 Net Exports: NX = EX – IM • It is the value of total exports (EX) minus the value of total imports (IM) 20% NX 16% exports 12% imports 8% 4% 0% -4% -8% 1950 1960 1970 1980 1990 2000 2010 Real and Nominal GDP • GDP is the value of all final goods and services produced. • nominal GDP measures these values using current prices. • real GDP measure these values using constant prices (the prices of a base year). NOW YOU TRY: Real & Nominal GDP 2006 2007 2008 P Q P Q P Q good A $30 900 $31 1,000 $36 1,050 good B $100 192 $102 200 $100 205 Compute nominal GDP in each year. Compute real GDP in each year using 2006 as the base year. NOW YOU TRY: Real & Nominal GDP 2006 2007 2008 P Q P Q P Q good A $30 900 $31 1,000 $36 1,050 good B $100 192 $102 200 $100 205 (30 900) + (31 1000) + (36 1,500) + Nominal (100 192) = (102 200) = (100 205) = GDP $46,200 $51,400 $58,300 (30 900) + (30 1000) + (30 1,500) + Real (100 192) = (100 200) = (100 205) = GDP $46,200 $50,000 $52,000 2006 2007 2008 NOW YOU TRY: Nominal Real & Nominal GDP $46,200 $51,400 $58,300 GDP Growth 11.26 13.42 Rate % [(51,400 – 46,200) / 46,200] ✕ 100 = 11.26 Real $46,200 $50,000 $52,000 GDP Growth 8.23 4.00 Rate % Value for the year value for previous year Growth Rate 100 value for previous year 2006 2007 2008 NOW YOU TRY: Nominal Real & Nominal GDP $46,200 $51,400 $58,300 GDP Growth 11.26 13.42 Rate % GDP Deflator = Nominal Real GDP / Real GDP $46,200 $50,000 $52,000 GDP It is a measure of the overall price level Growth 8.23 4.00 Its growth rate is a Rate % measure of the rate of GDP inflation 1.00 1.03 1.12 Deflator As an approximation, the GDP Deflator’s growth Growth rate = growth rate of 2.80 9.06 Rate % Nominal GDP – growth rate of Real GDP U.S. Nominal and Real GDP, 1960-2009 $16,000 $14,000 $12,000 (billions) $10,000 $8,000 Real GDP $6,000 (in 2000 dollars) $4,000 Nominal GDP $2,000 $0 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 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%. Two arithmetic tricks for working with percentage changes 2. percentage change in (X/Y ) percentage change in X percentage change in Y EX: GDP deflator = 100 NGDP/RGDP. If NGDP rises 9% and RGDP rises 4%, then the inflation rate is approximately 5%. • The growth rate of the ratio of two variables equals the difference of their growth rates. • The growth rate of the product of two variables equals the sum of their growth rates. • The growth rate of a variable raised to an exponent, is the growth rate of the variable times the exponent. If Z = X × Y then gz = gx + gy z new zold z new The growth rates here are in decimal gz 1 form: for example, if X grows at the rate zold zold of 5%, then gx = 0.05. The product of two decimals is small enough to be ignored: for example, 0.05 × 0.04 = z new xnew ynew 1 gz 0.0020. zold xold yold 1 g z (1 g x )(1 g y ) 1 gz 1 gx g y gx g y gz gx g y gx g y gz gx g y If Z = X ÷ Y then gz = gx – gy x z y z y x gz g y gx gz gx g y If Z = Xa then gz = a × gx x x x z x a a times gz gx gx gx a gx a times Chain-Weighted Real GDP • Over time, relative prices change, so the base year should be updated periodically. • In essence, chain-weighted real GDP updates the base year every year, so it is more accurate than constant-price GDP. • Your textbook usually uses constant-price real GDP, because: – the two measures are highly correlated. – constant-price real GDP is easier to compute. Consumer Price Index (CPI) • It is a measure of the overall level of prices • It is published by the Bureau of Labor Statistics (BLS) • The CPI is used to: – track changes in the typical household’s cost of living – adjust many contracts for inflation (“COLAs”) – allow comparisons of dollar amounts over time How the BLS constructs the CPI 1. Survey consumers to determine composition of the typical consumer’s “basket” of goods 2. Every month, collect data on prices of all items in the basket; compute cost of basket 3. CPI in any month equals Cost of basket in that month 100 Cost of basket in base period NOW YOU TRY: Compute the CPI Typical consumer’s basket: 20 pizzas, 10 compact discs prices: For each year, compute pizza CDs the cost of the basket 2002 $10 $15 the CPI (use 2002 as the 2003 $11 $15 base year) 2004 $12 $16 the inflation rate from the 2005 $13 $15 preceding year NOW YOU TRY: Compute the CPI and Inflation Rate Typical consumer’s basket: 20 pizzas, 10 compact discs pizza CDs cost CPI inflation 2002 $10 $15 2003 $11 $15 2004 $12 $16 2005 $13 $15 Cost of typical consumer' s basket in current period CPI 100 Cost of typical consumer' s basket in base period CPI in current period CPI in preceding period Inflation 100 CPI in preceding period NOW YOU TRY: Compute the CPI and Inflation Rate Typical consumer’s basket: 20 pizzas, 10 compact discs pizza CDs cost CPI inflation 2002 $10 $15 $350 2003 $11 $15 $370 2004 $12 $16 $400 2005 $13 $15 $410 Cost of typical consumer' s basket in current period CPI 100 Cost of typical consumer' s basket in base period CPI in current period CPI in preceding period Inflation 100 CPI in preceding period NOW YOU TRY: Compute the CPI and Inflation Rate Typical consumer’s basket: 20 pizzas, 10 compact discs pizza CDs cost CPI inflation 2002 $10 $15 $350 100 2003 $11 $15 $370 105.71 2004 $12 $16 $400 114.29 2005 $13 $15 $410 117.14 Cost of typical consumer' s basket in current period CPI 100 Cost of typical consumer' s basket in base period CPI in current period CPI in preceding period Inflation 100 CPI in preceding period NOW YOU TRY: Compute the CPI and Inflation Rate Typical consumer’s basket: 20 pizzas, 10 compact discs pizza CDs cost CPI inflation 2002 $10 $15 $350 100 2003 $11 $15 $370 105.71 5.71 2004 $12 $16 $400 114.29 8.11 2005 $13 $15 $410 117.14 2.50 Cost of typical consumer' s basket in current period CPI 100 Cost of typical consumer' s basket in base period CPI in current period CPI in preceding period Inflation 100 CPI in preceding period The composition of the CPI’s “basket” Food and bev. 6.2% 17.4% 5.6% Housing 3.0% Apparel 3.1% 3.8% Transportation 3.5% Medical care Recreation Education 15.1% Communication Other goods 42.4% and services Why the CPI may overstate inflation • Substitution bias: The CPI uses fixed weights, so it cannot reflect consumers’ ability to substitute toward goods whose relative prices have fallen. • Introduction of new goods: The introduction of new goods makes consumers better off and, in effect, increases the real value of the dollar. But it does not reduce the CPI, because the CPI uses fixed weights. • Unmeasured changes in quality: Quality improvements increase the value of the dollar, but are often not fully measured. The size of the CPI’s bias • In 1995, a Senate-appointed panel of experts estimated that the CPI overstates inflation by about 1.1% per year. • So the BLS made adjustments to reduce the bias. • Now, the CPI’s bias is probably under 1% per year. CPI vs. GDP Deflator Prices of capital goods: – included in GDP deflator (if produced domestically) – excluded from CPI Prices of imported consumer goods: – included in CPI – excluded from GDP deflator The basket of goods: – CPI: fixed – GDP deflator: changes every year Two measures of inflation in the U.S. 15% CPI from 12 months earlier Percentage change 10% 5% GDP deflator 0% 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 Categories of the population • employed working at a paid job • unemployed not employed but looking for a job • labor force the amount of labor available for producing goods and services; all employed plus unemployed persons • not in the labor force not employed, not looking for work Two important labor force concepts • unemployment rate percentage of the labor force that is unemployed • labor force participation rate the fraction of the adult population that “participates” in the labor force NOW YOU TRY: Computing labor statistics U.S. adult population by group, May 2009 Number employed = 140.57 million Number unemployed = 14.51 million Adult population = 235.45 million Use the above data to calculate the labor force the number of people not in the labor force the labor force participation rate the unemployment rate NOW YOU TRY: Answers data: E = 140.57, U = 14.51, POP = 235.45 labor force L = E +U = 140.57 + 14.51 = 155.08 not in labor force NILF = POP – L = 235.45 – 155.08 = 80.37 unemployment rate U/L x 100% = (14.51/155.08) x 100% = 9.4% labor force participation rate L/POP x 100% = (155.08/ 235.45) x 100% = 65.9% The establishment survey • The BLS obtains a second measure of employment by surveying businesses, asking how many workers are on their payrolls. • Neither measure is perfect, and they occasionally diverge due to: – treatment of self-employed persons – new firms not counted in establishment survey – technical issues involving population inferences from sample data Two measures of employment growth 8% household survey from 12 months earlier 6% establishment survey Percentage change 4% 2% 0% -2% -4% 1960 1970 1980 1990 2000 2010 Chapter Summary • Gross Domestic Product (GDP) measures both total income and total expenditure on the economy’s output of goods & services. • Nominal GDP values output at current prices; real GDP values output at constant prices. Changes in output affect both measures, but changes in prices only affect nominal GDP. • GDP is the sum of consumption, investment, government purchases, and net exports. Chapter Summary • The overall level of prices can be measured by either: – the Consumer Price Index (CPI), the price of a fixed basket of goods purchased by the typical consumer, or – the GDP deflator, the ratio of nominal to real GDP • The unemployment rate is the fraction of the labor force that is not employed.

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