MACROECONOMICS. The Data of Macroeconomics. N. Gregory Mankiw. PowerPoint Slides by Ron Cronovich. Modified for EC 204 by Bob Murphy

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1 2 MACROECONOMICS N. Gregory Mankiw Modified for EC 204 by Bob Murphy PowerPoint Slides by Ron Cronovich 2013 Worth Publishers, all rights reserved

2 IN THIS CHAPTER, YOU WILL LEARN: the meaning and measurement of the most important macroeconomic statistics:! Gross Domestic Product (GDP)! The Consumer Price Index (CPI)! The Unemployment Rate 1

3 Gross Domestic Product: Definition The market value of all final goods and services produced within an economy in a given period of time. A single statistic for capturing how well the economy is performing. 2

4 Gross Domestic Product: Expenditure and Income Two ways to measure:! Total expenditure on domestically-produced final goods and services.! Total income earned by domestically-located factors of production. Expenditure equals income because every dollar a buyer spends becomes income to the seller. 3

5 The Circular Flow Income ($) Labor Households Firms Goods Expenditure ($) 4

6 Gross Domestic Product: Expenditure and Income! One caveat:! Measurement of income and expenditure is imperfect.! Difference in GDP and Gross Domestic Income (GDI) is called the Statistical Discrepancy. See Supplement 2-1 5

7 Value added Value added: The value of output minus the value of the intermediate goods used to produce that output 6

8 Final goods, value added, and GDP! GDP = value of final goods produced = sum of value added at all stages of production.! The value of the final goods already includes the value of the intermediate goods, so including intermediate and final goods in GDP would be double counting. 7

9 The expenditure components of GDP! Consumption, C! Investment, I! Government spending, G! Net Exports, NX An important identity: Y = C + I + G + NX value of total output aggregate expenditure 8

10 Consumption (C) definition: The value of all goods and services bought by households. Includes:! Durable Goods last a long time e.g., cars, home appliances! Nondurable Goods last a short time e.g., food, clothing! Services intangible items purchased by consumers e.g., dry cleaning, air travel 9

11 U.S. consumption, 2011 Consumption Durables Nondurables Services $ billions 10,726 1,163 2,484 7,079 % of GDP

12 Investment (I)! Spending on capital, a physical asset used in future production! 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 11

13 U.S. Investment, 2011 Investment Business fixed Residential Inventory $ billions 1,916 1, % of GDP

14 Investment vs. Capital Note: Investment is spending on new capital. Example (assumes no depreciation):! 1/1/2012: Economy has $10 trillion worth of capital! during 2012: Investment = $2 trillion! 1/1/2013: Economy will have $12 trillion worth of capital 13

15 Stocks vs. Flows A stock is a quantity measured at a point in time. E.g., The U.S. capital stock was $10 trillion on January 1, Flow Stock A flow is a quantity measured per unit of time. E.g., U.S. investment was $2 trillion during

16 Stocks vs. Flows - examples stock a person s wealth # of people with college degrees the govt debt flow a person s annual saving # of new college graduates this year the govt budget deficit 15

17 Government spending (G)! G includes all government spending on goods and services.! G excludes transfer payments (e.g., unemployment insurance payments), because they do not represent spending on goods and services. 16

18 U.S. Government Spending, 2011 Government Spending - Federal Non-defense Defense - State & local $ billions 3,031 1, ,798 % of GDP

19 Net exports (NX)! NX = Exports Imports! Exports: the value of good and services sold to other countries! Imports: the value of goods and services purchased from other countries! Hence, NX equals net spending from abroad on our goods and services 18

20 U.S. Net Exports, 2011 Net Exports of Goods and Services $ billions % of GDP Exports 2, Goods 1, Services Imports 2, Goods 2, Services

21 NOW YOU TRY An expenditure-output puzzle? Suppose a firm:! produces $10 million worth of final goods! only sells $9 million worth! Does this violate the expenditure = output identity? 20

22 Why output = expenditure! Unsold output goes into inventory, and is counted as inventory investment whether or not the inventory buildup was intentional.! In effect, we are assuming that firms purchase their unsold output. 21

23 GDP: An important and versatile concept We have now seen that GDP measures:! total income! total output! total expenditure! the sum of value added at all stages in the production of final goods 22

24 GNP vs. GDP! Gross National Product (GNP): Total income earned by the nation s factors of production, regardless of where located! Gross Domestic Product (GDP): Total income earned by domestically-located factors of production, regardless of nationality GNP GDP = factor payments from abroad minus factor payments to abroad! Examples of factor payments: wages, profits, rent, interest & dividends on assets 23

25 NOW YOU TRY Discussion Question In your country, which would you want to be bigger, GDP or GNP? Why? 24

26 GNP vs. GDP in select countries, 2010 Country GNP GDP GNP GDP (% of GDP) Bangladesh 109, , Japan 5,601,557 5,458, China 5,957,012 5,926, United States 14,635,600 14,586, India 1,712,645 1,727, Canada 1,549,652 1,577, Greece 292, , Iraq 77,842 82, Ireland 171, , GNP and GDP in millions of current U.S. dollars

27 Other Measures of Income! Net National Product = GNP Depreciation! National Income = NNP Statistical Discrepancy! National Income = Compensation of Employees + Proprietors Income + Rental Income + Corporate Profits + Net Interest + Indirect Business Taxes! Note: Supplement 2-7 describes recent change in definition of National Income to include Indirect Business Taxes. 26

28 Components of National Income,

29 Other Measures of Income! Personal Income = National Income - Indirect Business Taxes - Corporate Profits - Social Insurance Contributions - Net Interest + Dividends + Government Transfers to Individuals + Personal Interest Income! Disposable Personal Income = Personal Income - Personal Tax and Nontax Payments! Disposable Personal Income is what households and noncorporate businesses have to spend (or save). 28

30 Real vs. 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 the prices of a base year. 29

31 Real GDP controls for inflation! Changes in nominal GDP can be due to:! changes in prices! changes in quantities of output produced! Changes in real GDP can only be due to changes in quantities.! **One way to calculate real GDP is by using constant base-year prices. 30

32 Real vs. Nominal GDP GDP t = n P it Q it RGDP t = i=1 n P ib Q it i=1 31

33 U.S. Nominal and Real GDP, $16,000 $14,000 (billions) $12,000 $10,000 $8,000 $6,000 Real GDP (in 2005 dollars) $4,000 $2,000 Nominal GDP $

34 GDP Deflator! Inflation rate: the percentage increase in the overall level of prices! One measure of the price level: GDP deflator Definition: GDP deflator = 100 Nominal GDP Real GDP 33

35 NOW YOU TRY GDP deflator and inflation rate Nom. GDP Real GDP GDP deflator Inflation rate 2010 $46,200 $46,200 n.a ,400 50, ,300 52,000! Use your previous answers to compute the GDP deflator in each year.! Use GDP deflator to compute the inflation rate from 2010 to 2011, and from 2011 to

36 NOW YOU TRY Answers Nom. GDP Real GDP GDP deflator Inflation rate 2010 $46,200 $46, n.a ,400 50, % ,300 52, %! Use your previous answers to compute the GDP deflator in each year.! Use GDP deflator to compute the inflation rate from 2010 to 2011, and from 2011 to

37 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%. 36

38 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%. 37

39 Measuring Economic Growth RGDP t / RGDP t 1 = = n P Q / P Q ib it ib it 1 i=1 n i=1 P ib Q it 1 n i=1 n i=1 Q / Q it it 1 P ib Q it 1 38

40 Measuring Economic Growth RGDP t / RGDP t 1 = n i=1 P ib Q it 1 n i=1 Q / Q it it 1 P ib Q it 1 1+ g t n i=1 = ω Q / Q i it it 1 39

41 Measuring Economic Growth A problem arises when using fixed base-year weights: Growth will vary depending on base year chosen. Rapidly growing sectors with declining relative prices will be weighted too much as base year becomes further and further in the past. Opposite for slowly growing sectors. 40

42 Chain-Weighted Real GDP! Over time, relative prices change, so the base year should be updated periodically--which BEA used to do.! In essence, chain-weighted real GDP updates the base year every year, so it is more accurate than fixed base-year GDP.! Official measure of GDP now produced by BEA.! See Supplement

43 Chain-Weighted Real GDP Step 1: Rewrite as: [1+ g t ] t-1 = 1+ g t n i=1 n i=1 P it-1 Q it 1 n i=1 Q it / Q it 1 P it-1 Q it 1 = ω t-1 it-1 Q it / Q it 1 42

44 Chain-Weighted Real GDP Step 2: Rewrite as: [1+ g t ] t = 1+ g t n i=1 n i=1 P it Q it 1 n i=1 Q it / Q it 1 P it Q it 1 = ω t it Q it / Q it 1 43

45 Chain-Weighted Real GDP Step 3: [1+ g t ] = {[1+ g t ] t [1+ g t ] t-1 } 0.5 To get level of real GDP, use nominal GDP for a given year and apply growth rate: RGDP t = 1+ g t 1+ g t 1 1+ g t 2 1+ g t 3 GDP t-4 Real GDP is measured here in year t-4 dollars. 44

46 When is the Economy in a Recession?! Rule of Thumb: Two quarters of decline in Real GDP! National Bureau of Economic Research uses more nuanced approach (see Supplement 1-3):! Monthly Indicators rather than Quarterly.! A significant decline in activity spread across the economy, lasting more than a few months, visible in industrial production, employment, real income, and wholesale-retail trade. 45

47 115 Various Measures of Output, 2000:Q1 to 2014:Q3, Indexed to 2007:Q4 = Index Value Average of GDP&GDI GDP GDI Year

48 10.00 Annualized Quarterly Change in Various Measures of Output, 2000:Q1 to 2014:Q Percent GDP GDI Average of GDP&GDI Year

49 Monthly Change in Employment (thousands)

50 Real Personal Income Net of Transfers (billions of 2005 dollars, seasonally adjusted annual rate)

51 Change in Industrial Production (monthly percent change at an annual rate) 30% 20% 10% 0% -10% -20% -30% -40% -50%

52 Monthly Real Retail Sales (millions of 2005 dollars)

53 Consumer Price Index (CPI)! A measure of the overall level of prices! Published by the Bureau of Labor Statistics (BLS)! Uses:! tracks changes in the typical household s cost of living! adjusts many contracts for inflation ( COLAs )! allows comparisons of dollar amounts over time 50

54 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 100 Cost of basket in that month Cost of basket in base period 51

55 The composition of the CPI s basket Food and bev. Housing 16.9% 7.1% 6.0% 3.2% Apparel Transportation 3.6% 3.6% 3.4% Medical care Recreation Education 15.3% Communication Other goods and services 41.0%

56 Understanding the CPI CPI = E t E B = n i=1 n i=1 n Q P ib ib = i=1 n i=1 Q ib P it Q ib P ib P / P it ib Q ib P ib 53

57 Understanding the CPI CPI = E t n i=1 = γ P / P E ib it ib B where the weights are given by: γ ib = n i=1 Q ib P ib Q ib P ib 54

58 Understanding the CPI The CPI is a weighted average of prices relative to their value in the base period. The weight on each price relative reflects that good s relative importance in the CPI s basket. Note that the weights remain fixed over time. 55

59 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. 56

60 10000 Figure 1 The CPI and Measures of the Price of Light 1800 = Log-scale CPI Traditional Price True Price

61 Table 1 The True Price of Light (price per 1000 lumen hours) Current Real (1992) Price Price Year (cents) (cents)

62 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.! See Supplements 2-10 and

63 Figure 1 Comparing the Official CPI and CPI-RS (annual percentage change) Offical CPI CPI-RS Source: U.S. Department of Labor, Bureau of Labor Statistics. Data are annual percent change.!

64 Consumer Price Inflation Measures (12-Month Percent Change) Jan 2000 Jan 2002 Jan 2004 Jan 2006 Jan 2008 Jan 2010 Jan 2012 Jan 2014 CPI Chained CPI Jan 2000 Jan 2002 Jan 2004 Jan 2006 Jan 2008 Jan 2010 Jan 2012 Jan 2014 Core CPI Chained Core CPI Source: Bureau of Labor Statistics

65 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 58

66 Two measures of inflation in the U.S. Percentage change from 12 months earlier CPI 2 0 GDP deflator

67 Categories of the Population: From the Household Survey (CPS)! 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 60

68 Two important labor force concepts! Unemployment rate percentage of the labor force that is unemployed (see Supplement 2-12 for alternative measures of the unemployment rate)! Labor Force Participation Rate the fraction of the adult population that participates in the labor force, i.e. is working or looking for work 61

69 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 62

70 Two measures of employment growth 6% Percentage change from 12 months earlier 4% 2% 0% -2% -4% household survey establishment survey -6%

71 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. 64

72 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. 65

73 Alternative Inflation Measures 12-Month Percent Change Jan 2000 Jan 2002 Jan 2004 Jan 2006 Jan 2008 Jan 2010 Jan 2012 Jan 2014 CPI Chained CPI Source: Bureau of Labor Statistics

74 Alternative Core Inflation Measures 12-Month Percent Change Jan 2000 Jan 2002 Jan 2004 Jan 2006 Jan 2008 Jan 2010 Jan 2012 Jan 2014 Core CPI Chained Core CPI Source: Bureau of Labor Statistics