Measuring Macroeconomics PDF

Chapter 2 Measuring the Macroeconomy By Charles I. Jones Media Slides Created By Dave Brown Penn State University  2.1 Introduction In this chapter, we learn: – The importance of gross domestic product (GDP) – The composition of GDP, and how...

Chapter 2 Measuring the Macroeconomy By Charles I. Jones Media Slides Created By Dave Brown Penn State University  2.1 Introduction In this chapter, we learn: – The importance of gross domestic product (GDP) – The composition of GDP, and how it has changed over time. – How to use GDP to examine the evolution of living standards  National income accounting – Method of aggregating the production of diverse goods into a single measure of overall economic activity. National accounting – State of an economy at a given time. – Changes to an economy over time. 2.2 Measuring the State of the Economy Gross domestic product (GDP) – The market value of the final goods and services produced in an economy over a certain period. United States GDP – $12.5 trillion in 2005 – $15.7 trillion in 2012 ($50,000 per person)  Production measure of GDP – The number of goods produced in the economy. Expenditure measure – The total purchases in the economy. Income measure – All the income earned in the economy. All three approaches give identical measures of GDP. Thus: Production = Expenditure = Income  The Expenditure Approach to GDP The national income accounting identity states: Where Y = GDP (in dollars) C = consumption I = investment G = government purchases NX = net exports = exports – imports  Net exports (trade balance) for the United States is negative. The recent trade deficit indicates that the United States is borrowing goods from the rest of the world. As the trade balance has turned negative, consumption has increased as a share of GDP recently.  The Income Approach to GDP The income approach – 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.  The Income Approach to GDP Depreciation – The deterioration of the capital stock due to wear and tear. GDP – depreciation = net domestic product.  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.  The Production Approach to GDP 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. What Is Included in GDP and What’s Not? Only goods and services that are transacted through markets are included in GDP. GDP does not include: – Government transfer payments to individuals. Social Security, Medicare, unemployment insurance – A measure of the health of a nation’s people. – Changes in environmental resources.  Questions By how much does GDP rise in each of the following scenarios? Explain. a)You spend $4,000 on college tuition this semester. b)You buy a used car from a friend for $2,500. c)The government spends $100 million to build a dam. d)Foreign graduate students work as teaching assistants at the local university and earn $5,000 each. e) A computer company buys parts from a local distributor for $1 million, assembles the parts, and sells the resulting computers for $2 million. f) A real estate agent sells as house for $200,000 that the previous owners had bought 10 years earlier for $100,000. The agent earns a commission of $6,000. g) During a recession, the government rises unemployment benefits by $100 million. h) A new US airline purchases and imports $50 million worth of airplanes from the European company Airbus.  2.3 Measuring Changes over Time Nominal GDP – A measure of GDP when prices and quantities have not been separated. Real GDP – Actual quantity of goods and services.  A Simple Example: Where Real GDP Doesn’t Change To compute GDP across time, we must use one year’s price. – Real GDP will be measured in a certain year’s dollars – Nominal GDP is measured in current dollars. Consider Apples and Computers:  A Simple Example: Where Real GDP Doesn’t Change If the quantity of goods and services produced does not change, but prices do change – Nominal GDP will change. – Real GDP will not change. A Second Example: Where Real GDP Changes The magnitude of the change in real GDP will depend on the year’s prices we select to calculate real GDP. Quantity Indexes: Laspeyres, Paasche, and Chain Weighting Calculating real GDP changes over time: The Laspeyres index – Calculates changes in real GDP using the initial prices. The Paasche index – Calculates changes in real GDP using the final year prices. Over long-time intervals the two indexes can result in substantial differences.  The Fisher index (chain weighting) is the preferred approach to calculating real GDP. – Average of the Laspeyres and Paasche index. – 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.  Price Indexes and Inflation Recall the formula for nominal GDP: The GDP deflator is the price level that satisfies the equation. We could compute this formula for two different years to calculate a price change. We could also use the following math trick: The inflation rate is the percentage change in the price level.  Using Chain-Weighted Data 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.  Questions 2016 2017 % Change 2016-2017 Quantity of oranges 100 105 ? Quantity of boomerangs 20 22 ? Price of oranges ($) 1 1.10 ? Price of boomerangs ($) 3 3.10 ? Nominal GDP ? ? ? Real GDP in ’16 price ? ? ? Real GDP in ’17 price ? ? ? Real GDP in chained ? ? ? prices, benchmarked to 2017  Summary National income accounting provides systematic measures of aggregate economic activity. Gross domestic product (GDP) is the key overall measure of economic activity in an economy. – Can be viewed as total expenditure, total income, or total production in an economy. The expenditure approach to GDP makes use of a fundamental national income identity: Y = C + I + G + NX which says that total spending is the sum of spending on consumption, investment, government purchases, and net exports.  The income approach shows that labor’s share of GDP is relatively stable over time at about two-thirds. In the production approach, it is only the value of final production that counts. – Equivalently, GDP is the sum of value added at each stage of production.  Nominal GDP refers to the value of GDP measured in current prices in a given year. Real GDP involves computing GDP in two different years using the same set of prices. – Think about real GDP as being adjusted for inflation. Changes in real GDP therefore reflect changes in actual production rather than changes in prices.  Chain weighting allows us to compare changes in real GDP over time by gradually updating prices. By linking the chain of comparisons in this way, we construct a more accurate measure of real GDP.  This concludes the Lecture Slide Set for Chapter 2 Macroeconomics Third Edition by Charles I. Jones W. W. Norton & Company Independent Publishers Since 1923