CHAPTER Measuring the Economy

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CHAPTER Measuring the Economy

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• Measuring the Economy
• Important Macroeconomic Variables
• Output
• Gross Domestic Product
• Price Level
• Consumer Price Index
• GDP Deflator
• Unemployment

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• The Data of Macroeconomic Goals
• High Growth
• Avoiding Large Swings in Output
• Low Unemployment
• Low Inflation
• International Considerations
• Balance of Trade
• Exchange Rate

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Important Macro Variables Output
Gross Domestic Product is the market value of all
final goods and services produced within a
country within a year.
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Three Ways to Calculate GDP

• Summing the value that each firm adds to the
  production of goods and services
• Adding expenditures for goods and services bought
  for their final use
• Measuring income that results from the production
  of goods and services

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Calculating GDP An Example
Suppose the total output of the economy is 10
pair of blue jeans that sold for 400. The jean
company paid 80 in wages and 100 for cotton to
a farmer. The farmer paid 25 in wages. What
is GDP?
Cotton Farmer Blue Jean Co. Sale of cotton
100 Sale of jeans 400 Wages 25
Wages 80 Material 100 Profit
75 Profit 120
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Calculating GDP An Example
Cotton Farmer Blue Jean Co. Sale of cotton
100 Sale of jeans 400 Wages 25
Wages 80 Material 100 Profit
75 Profit 120
Value added approach
The farmer adds 100 of value and the blue jean
company adds 300 of value for a total GDP of
400.
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Calculating GDP An Example
Cotton Farmer Blue Jean Co. Sale of cotton
100 Sale of jeans 400 Wages 25
Wages 80 Material 100 Profit
75 Profit 120
Expenditures approach
Consumers pay 400 for the jeans, so GDP is 400.
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Calculating GDP An Example
Cotton Farmer Blue Jean Co. Sale of cotton
100 Sale of jeans 400 Wages 25
Wages 80 Material 100 Profit
75 Profit 120
Income approach
Total wages paid are 25 80 105 Total
profit is 75 120 195 So GDP
105 195 400
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The Circular Flow
goods services
goods services
goods market
firms
households
expenditures
expenditures
wages, rent, profit
costs
factor market
factors of production
factors of production
The circular flow diagram shows that total
output in the economy equals total income earned
from the production of that output.
Imports
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GDP and Its Components, 2000
Billions of Dollars of GDP Personal
consumption expenditures 6,757.3
68 Gross private investment 1,832.7
18 Net exports of goods and services -370.7
-4 Government consumption expenditures
and gross investment 1,743.7 18 Gross
domestic product 9,963.1 100 Depreciation
1,257.1 Net domestic product 8,706
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National Income and Its Components, 2000
Billions of Dollars of NI Employee
compensation 5,638.2 70 Proprietors
income 710.4 9 Profits
946.2 12 Interest 567.2
7 Rents 140.0 2 National Income
8,002.0 100 -net foreign factor income
-(-4.3) depreciation 1,257 indirect
business tax 769.6 statistical
discrepancy -69.9 gross domestic
product 9,963.1
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Real vs. Nominal GDP

• Nominal GDP
• Market value of all goods and services produced
  measured in current prices
• Increases in nominal GDP may be caused by
  inflation, as well as increases in production
• Real GDP
• Market value of all goods and services produced
  measured in constant prices
• Nominal GDP adjusted for inflation

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Real and Nominal GDP, 1959-2000
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Calculating Nominal and Real GDP
Year Product Quantity Price
Nominal Real GDP
GDP
?P1Q1 ? P1Q1
1 T-shirts 20 10 (20)(10)
(20)(10) Blue Jeans 10 40
(10)(40) (10)(40)

600 600 ?P2Q2
? P1Q2 2 T-shirts 24 11
(24)11) (24)(10) Blue Jeans
12 45 (12)(45)
(12)40) 804 720
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Changes in Real and Nominal GDP
Year Nominal GDP Real GDP 1 600 600
2 804 720
? Nominal GDP
? Real GDP
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Differences Between Preliminary and Final GDP
Estimates
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Chain-Weighted GDP
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Important Macro Variables Price Level

• Price Level
• The average price of goods and services produced
  in an economy
• Inflation
• Measures the rate of change of the price level

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Important Price Measures

• Consumer Price Index (CPI)
• Measures prices of goods and services bought by
  the average consumer
• GDP Deflator
• Measures prices of all goods and services
  produced in the U.S.
• Producer Price Index (PPI)
• Measures prices paid by domestic producers for
  production of goods and services

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Differences in CPI and GDP Deflator
CPI GDP Deflator
CPI includes imports GDP deflator includes
only domestic goods and services
CPI measures only products GDP deflator
measures all goods bought by consumers and
services
CPI is a fixed market basket GDP deflator
includes all goods and services produced
that year
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Measurement Issues That May Cause the CPI to
Overstate Inflation

• The CPI doesnt measure improvements in the
  quality of products.
• It takes a while for new products to be included
  in the CPI.
• Consumers may substitute cheaper goods for more
  expensive ones, but the CPI market basket doesnt
  change very often to reflect these changes.

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Important Macro Variables Unemployment

• Employed
• People who are working for at least 15 hours per
  week
• Unemployed
• People who are not working but are actively
  seeking work
• Labor force employed unemployed

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Finding the Unemployment Rate
Total Civilian Population 275 million
Incapable of Working 65 million
Noninstitutional Population 210 million
(over 16 years old)
Not in Labor Force 69 million
Labor Force 141 million
Unemployed 5.7 million
Employed 135.3 million
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Macroeconomic Policy Goals

• High Growth
• Smooth Growth of Output
• Low Unemployment
• Low Inflation

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Data of Goals High Growth

• Economic growth is measured by the average
  percentage change in real GDP or real GDP per
  capita over time.
• Real GDP per capita in the U.S. has risen by
  about 2 annually since 1947.
• Since 1960, real GDP per capita has grown faster
  in other developed countries than in the U.S.

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Growth in Real Output per Person in OECD Countries
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Real Growth per Person in Developing Nations
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Data of Goals Stable Output

• Business cycles occur when output deviates from
  its average annual growth rate of 3 percent.
• Recessions occur when output grows by less than
  3 annually.
• Expansions occur when output grows by more than
  3 annually.

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U.S. Fluctuations in Real GDP Around Its Trend
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Business Cycles Since 1945
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Business Cycles in Japan, Germany, and the United
Kingdom
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Data of Goals Low Unemployment

• In the U.S. the unemployment rate has ranged from
  3 to 10 since World War II.
• The appropriate goal for unemployment
• Keep unemployment low, but not below the point at
  which inflation will begin to increase.
• The unemployment rate has been lower in the U.S.
  than in other industrialized countries, except
  Japan.

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Unemployment in the OECD and Select Countries
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Goals of Policy Low Inflation

• Since 1950 inflation in the U.S. has ranged from
  1.5 to 14 per year.
• In the late 1990s the policymakers were satisfied
  with inflation at 2 per year.
• Inflation in other industrialized and less
  developed countries has been greater than that in
  the U.S.

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Inflation in OECD Countries
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Inflation in Selected Developing Countries
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International Factors in Macro Policy

• Trade Balance
• Imports provide cheaper goods for consumers, but
  may cause a decrease in domestic production.
• Exports increase domestic production, but can
  lead to inflation
• Exchange Rates
• The price at which one currency is traded for
  another
• Determines prices paid for imports and exports

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Balance of Trade

• The U.S. usually had trade surpluses before 1973
  and trade deficits after 1973.
• The importance of trade has increased over time
• In 1949, exports and imports were 4 of GDP
• In 1998, exports were 11 of GDP and imports were
  13 of GDP

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Exports and Imports in the U.S.
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Exports and Imports for OECD and Selected
Countries
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Exchange Rates

• The U.S. has a flexible exchange rate system,
  where the market, not the government, determines
  exchange rates.
• The value of the dollar decreased in the 1970s,
  increased in the early 1980s, and fell in the
  early 1990s.
• When the value of the dollar falls, U.S. exports
  are cheaper and imports from other countries are
  more expensive.

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Trade-weighted Value of the Dollar