Macroeconomics - Measuring Macroeconomic Data

Measuring Macroeconomic Data

Preview

• The chapter will cover:

  • Different approaches to measuring gross domestic product.

  • Real versus nominal GDP.

  • How to measure inflation.

  • How to measure unemployment.

  • Different interest rates.

Measuring Economic Activity: National Income Accounting

• Gross Domestic Product (GDP): The total value of goods and services produced in an economy, serving as the broadest measure of economic activity.

• National Income Accounting: An accounting system that measures economic activity and its components.

• Fundamental Identity of National Income Accounting: Total Production = Total Expenditure = Total Income.

Measuring GDP: The Production Approach

• GDP is the current market value of all final goods and services produced in an economy during a fixed period of time.

  • Current Market Value: Adds up different goods using their market prices, reflecting the value of goods.

    • Higher product price, higher contribution to GDP. For example, one Ferrari contributes more to the GDP than one apple.

  • All: Includes all items produced in the economy with exceptions:

    • Nonmarket goods and services, which do not have a market price (e.g., household services produced within a family).

    • Goods and services produced in the underground economy.

    • Many nonmarket goods and services are counted in GDP by their imputed values, such as rental prices.

  • Final: Includes only the value of final goods.

    • Including the value of intermediate goods would lead to double counting.

    • For example, a paper company sells paper to a greetings card company. The paper is an intermediate good, and the card is a final good. The market value of the card includes the market value of the paper. If the unit cost of paper is £1, and the card is sold at £2, only the £2 is included in GDP.

  • Goods and Services: Includes tangible goods (clothing, food etc.) and intangible services (haircut, house cleaning etc.).

  • Produced: Includes goods and services newly produced in the current period.

    • For example, buying a 3-year-old car from a dealership: the cost of the used car is not included in the GDP, but the value of the services provided by the car dealership is included in the GDP.

  • In an Economy: Measures the value of production within a country, regardless of the nationality of the producer.

    • For example, if a U.K. citizen owns a factory in Germany, the production at their factory is NOT part of UK GDP, but it is part of Germany’s GDP.

  • During a Fixed Period of Time: Measures the value of production within a specific interval of time (year, quarter).

    • GDP is a flow, which is an amount per a given unit of time (by contrast, a stock is a quantity at a given point in time).

  • In the case of producing only apples and oranges, we multiply their prices and quantities, and then add them up: $GDP = (price \text{ of apples } \times quantity \text{ of apples}) + (price \text{ of oranges } \times quantity \text{ of oranges})$

Capital Goods

• A capital good (e.g., a robot) is used in the production of other goods and is not used up in the stages of production.

• New capital goods are classified as final goods because they are not included in spending on other final goods, and yet their production is part of economic activity.

Inventory Investment

• Inventory investment is the change in inventories (firms’ holdings of raw materials, unfinished goods, and unsold finished goods) over a given period of time.

• Inventory investment is included in GDP for the same reason that we include capital goods.

Value-Added Technique

• Value added is the value of a firm’s output minus the cost of the intermediate goods purchased by the firm.

• By adding up the value added from each firm, we get the final value of the goods and services produced.

• For example: the paper company sells paper at £1 to the greetings card company while the card is sold at £2.

  • If calculated as before: GDP = final good’s price = £2

  • If using VA: GDP = VA paper company + VA card company = £1+£1 = £2

Policy and Practice: Can GDP Buy Happiness?

• Is GDP the best measurement of national well-being?

• In 1972, the king of Bhutan proposed the replacement of GDP by “gross national happiness” that incorporates factors such as spirituality and culture.

• In 1990, the United Nations began to rank countries on a so-called human development index, which is a combination of life expectancy, education, literacy, educational participation, and GDP.

• In 2008, a French economic commission led by Nobel Prize winner Joseph Stiglitz called for modifications to GDP with factors such as political freedom, physical safety, and work-life balance.

Box: Stocks Versus Flows

• A stock is often an accumulation of flows over time.

• Examples:

  • Inventory investment is a flow, which accumulates into the stock of inventories.

  • Saving is a flow, which accumulates into a person’s wealth.

Measuring GDP: The Expenditure Approach

• GDP is the total spending on currently produced final goods and services in the economy.

• National income identity: $Y = C + I + G + NX$

  • Where:

    • $Y$ = GDP = total production (output)

    • $C$ = consumption expenditure

    • $I$ = investment

    • $G$ = government purchases of goods & services

    • $NX$ = net exports = exports – imports

Consumption Expenditure

• Total spending for currently produced consumer goods and services.

• Consumption was 68.7% of GDP in 2012.

• Basic categories:

  1. Consumer durables

  2. Nondurable goods

  3. Services

Investment

• Spending on currently produced capital goods that are used to produce goods and services over an extended period of time.

• Investment was 15.2% of GDP in 2012.

• Basic categories:

  1. Fixed investment

  2. Inventory investment

  3. Residential investment

Box: Meaning of the Word Investment

• For non-economists, an investment normally refers to the purchase of common stocks or bonds.

• For economists, investment spending refers to the purchase of physical assets, such as new machines or new houses—purchases that add to GDP.

Government Purchases

• Spending by the government on currently produced goods and services.

• Government purchases were 19.2% of GDP in 2012.

• Government consumption includes government purchases for short-lived goods and services like health care and police.

• Government investment includes spending for capital goods like buildings and computers represents.

• Pure government transfers (e.g., Social Security and Medicare) are excluded from G.

Net Exports

• Net exports (or trade balance) are exports minus imports.

• Why subtract imports from GDP?

  • Spending on imports is included in consumption expenditure, investment, and government purchases but is not produced in this country.

Changes in the Spending Components of GDP Over Time

• Consumption grew steadily as a share of GDP from 1970 to 2012.

• Investment is much more volatile than other components of GDP.

• Government purchases have remained quite stable at around 20% of GDP.

• Net exports have been negative.

Box: An International Comparison of Expenditure Components

• The United States differs from other countries by having the highest share of GDP going to consumption, the lowest share of investment, and net exports have been negative.

• By contrast, China has the lowest share of consumption, the highest share of investment, and the largest share of net exports.

Measuring GDP: The Income Approach

• Compensation of Employees: Wages and salaries of employees, and employee benefits.

• Corporate Profits: Profits after taxes of corporations.

• Other Income: Income of the self-employed, royalty income, and net interest earned by individuals, etc.

• Depreciation: The loss of value of capital from wear and tear.

  • Net domestic product = GDP – depreciation

• Net Factor Income: Wages, profits, and rent paid to U.S. residents by foreigners minus factor income paid by U.S. residents to foreigners.

Income Measures

• National Income = Compensation of employees + other income + corporate profits

• Gross National Product (GNP) = national income + depreciation

  • Total income earned by U.S. residents

• Gross Domestic Product (GDP) = GNP + net factor income

  • Domestically produced measure of gross product

Real Versus Nominal GDP

• Nominal GDP: The production of goods and services valued at current market (nominal) prices.

• Real GDP: The production of goods and services valued at constant prices.

  • Answer to the hypothetical question: what would be the value of the goods and services produced this year if we valued these at prices in some specific year in the past

  • It is adjusted for price changes

• $\text{Real GDP} = \frac{\text{Nominal GDP}}{\text{Price Level}}$
  $or Nominal GDP = Price Level \times Real GDP$

• Note: we call this price level GDP Deflator

• If 2005 is the base year, then real GDP for the year 2014 is: $Real GDP \text{ in } 2014 = (price \text{ of apples in } 2005 \times quantity \text{ of apples in } 2014) + (price \text{ of oranges in } 2005 \times quantity \text{ of oranges in } 2014)$

• Raw data on GDP tends to fall in cold and snowy months, therefore, economic statistics like GDP data are seasonally adjusted to account for regular seasonal fluctuations within a year.

Measuring Inflation

• Price indexes are measures of the price level.

• Examples:

  • Consumer Price Index (CPI)

  • Personal Consumption Expenditure Deflator

  • GDP Deflator (or implicit price deflator)

Consumer Price Index

• A measure of the overall prices of consumer goods and services bought by a typical consumer, i.e., a cost of living index.

• Calculated monthly by the Bureau of Labor Statistics using a basket of thousands of consumer goods and services.

• Steps to calculate the CPI:

  1. Fix the basket: determine which prices are most important to a typical consumer

  2. Find the prices: find the prices of each of the goods and services in the basket for each point in time

  3. Compute the basket’s cost: use prices to calculate the cost of basket at different times

  4. Choose a base year and compute the index: price of basket in each year divided by the price of basket in the base year X 100

PCE Deflator

• Current level of prices relative to the level of prices in the base year of all goods and services bought by consumers.

• $\text{PCE Deflator for Year y} = 100 \times \frac{\text{Nominal PCE in Year y}}{\text{Real PCE in Year y}}$

GDP Deflator

• Current level of prices relative to the level of prices in the base year of all goods and services produced domestically.

• $\text{GDP Deflator for Year y} = 100 \times \frac{\text{Nominal GDP in Year y}}{\text{Real GDP in Year y}}$

Inflation Rate

• The inflation rate is the % rate of change of the price level over a particular period:

• $\pi<em>t = \frac{P</em>t - P<em>{t-1}}{P</em>{t-1}} = \frac{\Delta P<em>t}{P</em>{t-1}}$

• where:

  • $\pi_t$ = inflation rate in period t

  • $P_t$ = period level at time t

Percentage Change Method and the Inflation Rate

• Because:

  • $\% \text{ Change in } (x \times y) = (\% \text{ Change in } x) + (\% \text{ Change in } y)$

• We know that:

  • $\% \text{ Change in Nominal GDP} = (\% \text{ Change in the Price Level}) + (\% \text{ Change in Real GDP})$

• Because the % change in the price level is the inflation rate, while the % changes in nominal and real GDP are the growth rate:

• $\text{Inflation Rate} = (\text{Growth Rate of Nominal GDP}) - (\text{Growth Rate of Real GDP})$

Measuring Unemployment

• The unemployment rate is the percentage of people in the civilian population who want to work but who do not have jobs.

• The Bureau of Labor Statistics classifies each adult over age 16 into:

  1. Employed

  2. Unemployed

  3. Not in the labor force

• Discouraged workers (those who would live to work but have given up looking, and those who have voluntarily left the labor force)

• $\text{Labor Force} = \text{Number of Employed} + \text{Number of Unemployed}$

• $\text{Labor-Force Participation Rate} = \frac{\text{Labor Force}}{\text{Adult Population}}$

• $\text{Employment Ratio} = \frac{\text{Employed}}{\text{Adult Population}}$

Measuring Interest Rates

• An interest rate is the cost of borrowing, or the price paid for the rental of funds

• Interest rates are returns for holding debt securities, such as bonds.

Macroeconomics In The News: Interest Rates

• Interest rates that receive media attention are:

  • Prime rate

  • Federal funds rate

  • London Inter-Bank Offered Rate (LIBOR)

  • Treasury bill rate.

  • Ten-year Treasury bond rate

  • Federal Home Loan Mortgage Corporation rate

Real Versus Nominal Interest Rates

• A nominal interest rate makes no allowance for inflation.

• The real interest rate is the amount of extra purchasing power a lender must be paid for the rental of his/her money

  • The ex-ante real interest rate is adjusted for expected changes in the price level

  • The ex-post real interest rate is adjusted for actual changes in the price level

• The Fisher equation: real interest rate

• $i = r + p^e$

  • $i$ = nominal interest rate

  • $r$ = real interest rate

  • $p^e$ = expected inflation

• $\text{or } r = i - p^e$

• Example: For a one-year loan with a 4% nominal interest rate ($i=4\%$) and you expect the inflation to be 6% in a year ($p^e = 6\%$), then:

• $r = 4\% - 6\% = -2\%$

• When the real interest rate is low, there are greater incentives to borrow and invest, but fewer incentives to lend.

The Important Distinction Between Real and Nominal Interest Rates

• Credit markets are where households and businesses get funds (credit) from each other.

• Because the real interest rate reflects the real cost of borrowing, it is likely to be a better indicator of the incentives to borrow, invest, and lend in credit markets than nominal interest rates.