2 The Data of Macroeconomics

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1 2 The Data of Macroeconomics 1 Why do we need data? Observations of real world Theories to explain real world - based on data Theories are tested against new data Level of detail and simplifications in models MAIN MACRO DATA Gross Domestic Product (GDP): the market value of all final goods and services produced within an economy in a given period of time. Consumer price index (CPI): measures the level of prices. Unemployment rate: the fraction of workers who are unemployed. 2 1

2 2 ways of viewing GDP How to measure GDP? Income, Expenditure And the Circular Flow Total income of everyone in the economy (wages and profits, too) Total expenditure on the economy s output of goods and services Income $ Households Labor Goods Firms Expenditure $ For the economy as a whole, income must equal expenditure. GDP measures the flow of dollars in this economy. 3 1) GDP measures the value of the economic activity in one number. Production: apples and oranges. Value: measured at market prices. Thus, if we produce 4 apples and 3 oranges, then $0.50 $1.00 GDP = (Price of apples Quantity of apples) + (Price of oranges Quantity of oranges) = ($0.50 4) + ($1.00 3) GDP = $5.00 2) Used goods are not included in the calculation of GDP. 3) Inventories: depends on if the goods are stored or if they spoil. If they spoil, GDP remains unchanged. If they are stored, their value is included in GDP. When the goods are finally sold out of inventory, they are considered used goods (and are not counted). 4 2

3 4) Intermediate goods are not counted in GDP the value of intermediate goods is already included in market price. Value added of a firm = value of the firm s output value of intermediate goods the firm purchases. 5) Goods not sold in the marketplace are valued by their imputed value as an estimate. (home ownership, government services,...) 6) NOMINAL AND REAL GDP Nominal GDP : value of final goods & services measured at current prices Change over time: either because of a change in the amount (real value), or a change in the prices. Hence: nominal GDP is Y = P y, where P is the price level and y is real output (goods and services) Real GDP: value of goods & services measured at constant prices. or, y = Y P Similarly: W = nominal wage = P w, w = real wage = w/p 5 EXAMPLE: Nominal and real GDP in the apple and orange economy. Now: 2003 prices and 2004 prices. Base-year: 2002 prices. Year - Quantity & Price of Apples; Quantity& Price of Oranges: $ $ $ $ $ $1.5 Nominal GDP in 2002 = 0.5 x x 80 = =130 Nominal GDP in 2003 = = 0.6 x x 95 = = (2003 Price of Apples 2003 Quantity of Apples) + (2003 Price of Oranges 2003 Quantity of Oranges) Nominal GDP in 2004 = 0.9 x x 90 = =229.5 Real GDP in 2003 = (2002 Price of Apples 2003 Quantity of Apples) + (2002 Price of Oranges 2003 Quantity of Oranges) = 0.5 x x 95 = 150 Real GDP in 2004 = 0.5 x x 90 =

4 GDP Deflator = Nominal GDP Real GDP Nominal GDP measures the current dollar value of the output of the economy. Real GDP measures output valued at constant prices. The GDP deflator, also called the implicit price deflator for GDP, measures the price of output relative to its price in the base year. It reflects what s happening to the overall level of prices in the economy. Example: Apple Orange economy Nominal GDP in 2003 = 170.5, Real GDP in 2003 = 150 GDP deflator = = 1.14 Prices increased by 14 % on average 7 In some cases, it is misleading to use base year prices that prevailed 10 or 20 years ago (i.e. computers and college). In 1995, the Bureau of Economic Analysis decided to use chain-weighted measures of real GDP, with base year changing Check real GDP levels for the Apple &Orange economy Prices for 2003: P(A) = ( ) / 2 = 0.55 P (O) = ( ) / 2 = 1.05 Real GDP foron. 2003: = 110 x x 1.05 = = = continuously over time. Average prices in 2001 and 2002 are used to measure real growth from 2001 to Average prices in 2002 and 2003 are used to measure real growth from 2002 to 2003 and so 8 4

5 Y = C + I + G + NX Total demand for domestic output (GDP) is composed of Consumption spending by households Investment spending by businesses and households Government purchases of goods and services Net exports or net foreign demand This is the called the national income accounts identity. 9 COMPONENTS OF THE INCOME IDENTITY What is consumption? Household purchases of durable goods, non-durable goods and services What is investment? Things bought for future use, New capital, and not a reallocation of assets! Business fixed investments Residential fixed investments Inventory investment Government purchases: Expenditure on new goods and services by the federal or state or local governments 10 5

6 Example of the Income Identity, USA, Gross national product (GNP): add receipts of factor income from the rest of the world, (wages, profit, and rent) and subtract payments of factor income to the rest of the world. GNP = GDP + + Factor Payments from Abroad Factor Payments to Abroad (Factor: Factors of Production, inputs...) GDP measures total income produced domestically, GNP measures total income earned by nationals (residents of nation). Net national product (NNP) = GNP depreciation of capital Depreciation: the consumption of fixed capital, the amount of the economy s stock of plants, equipment, and residential structures that wears out during the year 12 6

7 Examples of GDP, GNP, NNP, year 2001 Country Afghanistan China Population Million GDP $, billion GDP per capita GNP per capita NNP as % of GNP Depreciation % of GNP India Hungary United Arab Emirates USA United Kingdom Income Categories National Income = NNP Indirect Business Taxes. (e.g, sales taxes which the consumer pays but the firm never gets) Structure of national income: Compensation of employees (70%). Wages and fringe benefits earned by workers. Proprietors income (9%).The income of noncorporate businesses, such as small farms, mom-and-pop stores, and law partnerships. Rental income (2%).The income that landlords receive, including the imputed rent that homeowners pay to themselves, less expenses, such as depreciation. Corporate profits (12%).The income of corporations after payments to their workers and creditors. Net interest (7%).The interest domestic businesses pay minus the interest they receive, plus interest earned from foreigners. Personal Income = National Income Corporate Profits + Dividends Social Insurance Contributions + Government Transfers to Individuals Net Interest + Personal Interest Income Disposable Personal Income = Personal Income Personal Tax and Nontax Payments (to government) 14 7

8 The Consumer Price Index (CPI) turns the prices of many goods and services into a single index measuring the overall level of prices. The CPI in our apple and orange economy The typical consumer buys 5 apples and 2 oranges every month. Then the basket of goods consists of 5 apples and 2 oranges. ( 5 Current Price of Apples) + (2 Current Price of Oranges) CPI = ( Price of Apples) + ( Price of Oranges). In this CPI calculation, 2002 is the base year. CPI (2003)= (5 x x 1.1) (5 x x 1) = = GDP deflator measures the prices of all goods produced, 2. CPI measures prices of goods and services bought by consumers (not the prices of goods bought by firms or the government ) 3. GDP deflator includes only those goods and services produced domestically. 4. Imported goods don t show up in the GDP deflator, but may be included in CPI 5. The CPI assigns fixed weights to the prices of different goods, whereas 6. the GDP deflator assigns changing weights. 16 8

9 The labor force is defined as the sum of the employed and unemployed, and the unemployment rate is defined as the percentage of the labor force that is unemployed. The labor force participation rate is the percentage of the adult population who are in the labor force. Unemployment Rate = Number of Unemployed Labor Force 100 Labor-Force Participation Rate = Labor Force Adult Population

10 The negative relationship between unemployment and GDP is called Okun s Law, after Arthur Okun, the economist who first studied it. In short, it is defined as: Percentage Change in Real GDP = 3 % 2 the Change in the Unemployment Rate If the unemployment rate remains the same, real GDP grows by about 3 percent. For every percentage point the unemployment rate rises, real GDP growth typically falls by 2 percent. Hence, if the unemployment rate rises from 6 to 8 percent, then real GDP growth : % Change in Real GDP = 3% 2 (8% 6%) = 1% 19 Gross domestic product (GDP) Consumer Price Index (CPI) Unemployment Rate National income accounting Stocks and flows Value added Imputed value Nominal versus real GDP GDP deflator National income accounts identity Consumption Investment Government Purchases Net Exports Labor force Labor-force participation rate Okun s Law 20 10

11 Task for next week: (Read Book p2-p14 as background introductory text ) Read Book p15-p39 Choose one (!) of the following tasks and work it out for next week: Problem 6 (p38-39) Problem 8 (p 39) Problem 9 (p 39) 21 11