econ chapter 23

Getting Started in Macroeconomics

• Macroeconomics deals with statistics about the entire economy (GDP, exports,

total income, inflation, unemployment, etc)

• Goal: explain economic changes that affect many households, firms, and markets

simultaneously

• Macroeconomics, though, is very closely tied to microeconomics

Gross Domestic Product (GDP)

• Keep in mind that GDP can be measured either as income or expenditures

o Think back to the circular flow diagram where for every buyer there is a

seller, but now see how GDP is shown

o For every expenditure there is income – money spent on something may

be money lost for one but it’s income for another

o Given this fact, we can view GDP as total income or total

expenditures – regardless of the choice, they will be equal since total

income equals total expenditures

• This circular flow idea is certainly over-simplified, as there is more going on with

people’s money, but there is still always a buyer and a seller when money

changes hands

Measurement of GDP

• GDP is the market value of all final goods and services produced within a

country in a given period of time...break it down!

o Market value – market prices reflect the value of goods, so goods that

have more value will contribute more to the GDP

o All goods – everything is included

• There are sticky spots, though – for instance, non-rental housing is

assigned a rental value

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• Some products are excluded since measurement is too difficult –

for instance, illegal drug sales and home grown foods

o Final goods – only when at the last stage of production will goods be

counted

• Intermediate goods – goods used to make final goods

• Intermediate goods are not counted in the GDP as GDP only

includes the value of final goods

• EX: a laptop’s touchpad is an intermediate good while the laptop is

a final good

o Goods and Services – not only goods are involved

• EX: buying a CD or going to a concert, both contribute to GDP

o Produced – currently produced, not in the past

• EX: buying a new car contributes to GDP while buying a used car

from another person does not

o Within a Country – only goods and services produced inside a country

count toward GDP

• EX: cars manufactured in the USA count toward GDP but cars

manufactured in China do not, even if by a US company

• We’ll learn later about the difference between GDP and GNP

(Gross National Product), because cars manufactured by a US

company abroad would count toward GNP

o In a Given Period of Time – usually three months or one year, but

regardless it’s usually reported as an annual rate

• Seasonal adjustment – modifying GDP data to account for the fact

that the economy produces more goods and services during some

times of the year

• Reported GDP figures are always seasonally adjusted

• EX: Black Friday to Christmas is usually the high point for sales

• To repeat, whether measured as income or measured as expenditures, GDP will

be the same...except of course in the case of bad data

o Statistical discrepancy – difference between the income method and the

expenditure method, due to differences in data sources

The Components of GDP

• The equation of all equations: � = � + � + � + ��

o Y = income/expenditures = GDP

o I = investment

o C = consumption

o G = government spending

o NX = net exports = exports – imports

• Each dollar of expenditure in GDP is placed into one of those four categories, so

the equation must always hold

• Consumption

o Represents spending by households on goods and services

• Households are the key player here

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o Durable goods included, such as cars and refrigerators

o Nondurable goods included, such as food and clothes

o Services are included, such as haircuts, car care, and medical care

o Education is also counted here (not investment)

• Investment

o Represents the purchase of goods that will be used in the future to

produce more goods and services

• Firms are the key player here

• Do not think of investment as stocks, bonds, etc

o Includes purchases of capital equipment, inventories and structures

o Purchase of a new house is counted here (not consumption)

o More about Inventory

• Think of inventory as a firm buying a good for itself

• These goods are investments for the firms

• A sale of an inventory item would be a negative entry for the firm

and a positive expenditure for the buyer

• Government Spending

o Represents spending on goods and services by local, state, and

federal governments

• The government is the key player here

o Includes salaries of government workers

o Includes spending on public projects

o Excludes transfer payments – these payments, like welfare or Social

Security, are not exchanges since they simply transfer money from one

party to another

• Net exports

o Represents the purchases of domestically produced goods by foreigners

(exports) minus the domestic purchases of foreign goods (imports)

• All are involved here

o When a domestic household, firm or government purchases a foreign

good, there is no change in GDP

• The increase in consumption (household), investment (firm) or

government spending will be offset by the decrease in net exports

(since imports – negatively valued – are rising)

Real Versus Nominal GDP

• When we study changes over time, we need to account for changes in

pricing

o If total spending rises from 2007 to 2008, we could say that the gains are

because the economy really is producing more goods and services...or we

could say that the prices are just higher in 2008 than 2007

o Economists try to equate different times so they can be easily compared

• Real GDP – the value of the goods and services produced this year at another

year’s prices

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o Uses constant base-year prices to place a value on the economy’s

production of goods and services

o EX: GDP for 2008 with prices from 2007

• Nominal GDP – the value of the goods and services produced this year at current

prices

o Uses current prices to place a value on the economy’s production of

goods and services

o EX: GDP for 2008 with prices from 2008

• See Page 500 in text for a numerical example

• Real GDP is a better tool for measuring the well-being of the economy

o Reported GDP is usually real GDP

• The GDP Deflator

o GDP Deflator = )*+,-./ 123

45./ 123

× 100

o GDP deflator for base year is always 100 (nominal = real if year is the

same)

o The GDP deflator measures the current level of prices relative to the

level of prices in the base year

• It does not reflect quantities produced

o Consider situation 1: pricing does not change, but quantities produced

increase from year 1 to year 2 – in this case, the real and nominal GDPs

will rise together, so the deflator will be constant

o Consider situation 2: prices rise but the quantities produced remain the

same from year 1 to year 2 – in this case, the nominal GDP will be greater

than the real GDP (which stays the same) so the deflator rises

• In either situation, note that the price changes are what drive

the deflator

o Understanding the Numbers

• If base year is 100 and year 2 is 150, we say that the price level is

50% higher in year 2

o See page 503 in text for a graph of GDP over time – what do you think will

happen after 2010?

• Introduction to Inflation

o The inflation rate measures changes in price levels

o We will look further into the topic of inflation and price levels soon, but

with the GDP deflator, we can get a measure of inflation by calculating

inflation rate = GDP deflatorF − GDP deflatorH

GDP deflatorH

× 100

Is GDP a Good Measure of Economic Well-Being?

• See page 504 in text for an interesting Kennedy quote

• Basic argument: GDP may not measure some things we value, but countries

with higher GDPs can generally afford those things we value

• What about work versus leisure? The argument is that we could work every day,

and we’d see growth in GDP, but at what cost?

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• Some facts about GDP

o Child care by day care counts, child care by a mom does not

o Chef’s meal at a restaurant counts, same meal at home does not

o Work to build a house counts, but not if it’s volunteer work (EX: Habitat

for Humanity)

o Damage to the environment doesn’t count, so GDP can rise if firms ignore

the regulations on pollution

o The statistic GDP per person can be misleading, since it’s just an average

(this statistic is simply the GDP divided by the population)

o We will learn more specifically about GNP in Chapter 25, but you can just

replace the word “within” with the word “by” to get this definition:

GNP is the market value of all final goods and services produced by a

country in a given period of time