Macroeconomic Measures

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Macroeconomic Measures
The focus of this lecture is the macroeconomic
measures. Students should understand the
significance of Gross Domestic Product, Price
levels, and unemployment in our economic
systems. OBJECTIVES 1. Understand price level
and how to calculate inflation rate. 2. Measure
unemployment rate and explain its content. 3.
Define Gross Domestic Product (GDP) and
understand GDP computation. 4. Evaluate the
validity of GDP as a measure of economic welfare
and productivity.   TOPICS Please read all
following topics. PRICES AND INFLATION UNEMPLOYMEN
T GDP DEFINITION COMPUTATION OF GDP AND OTHER
NATIONAL ACCOUNTS
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Price and Inflation
One of the macroeconomic goals is price
stability. It means that the average price level
remains relatively stable. Price level is a
weighted average of the prices of all good and
services. A price index provides us with a
reliable estimate of the price level. The most
common price indices adopted by economists are
consumer price index and GDP deflator. Consumer
Price index (CPI) tracks the prices of a
representative market basket of consumer goods.
CPI (Total dollar expenditure on market
basket in current year/ Total dollar expenditure
on market basket in base year) X 100 Base year
is a benchmark year that serves as the basis for
price comparisons. The CPI compares the current
prices of the market basket to the prices of
those goods in base year. Here is a simple
example of CPI computation. Assuming there are
only 3 items in the market basket of Country
A. Market Basket              1995
prices     1995 Quantity        1996 
prices            1996 Quantity Toys              
                    10             
      3                                10        
                   3           Pencils           
                        2                   5  
                               2.2                
         5 Books                                
   5                    8                        
          5.1                         8 Total
dollar expenditure on market basket in 1995
10x3 2x5 5x8 80 Total dollar expenditure
on market basket in 1996 10x3 2.2x5
5.1x8 81.8 Set 1995 as our base year, then
1996 CPI (81.8 / 80) X 100 102.25
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Price and Inflation
Real value of an economic variable can be found
using the CPI (or any price indexes). Nominal
dollar income or dollar prices in different years
can be compared using the real value
concept. Real value (Nominal value / CPI) X
100 Using the data from the above example if an
individual's annual income was 40,000 in 1996,
his real income (40,000 / 102.25) X 100
39119.80   Inflation is a rising general level
of prices. It is an economic instability, which
the U.S. government has to face. Inflation rate
(current years price index last years
price index) / (last years price index) X
100 Using the data from the above example 1995
(base year) CPI 100 and 1996 CPI
102.25 Inflation rate between 1996 and 1995
(102.25 100) / 100 X 100 2.25   Rule of 72
is a short cut for calculating the time it takes
for the price level to double. of years for
price level to double 72 / inflation rate. For
example,  inflation rate in the above example is
2.25, then the number of years for the price
level to double is about 32 years. (72/ 2.25 32)
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Unemployment

• High unemployment rate is one of the results of
  an economic downturn. It is defined as the
  percentage of the labor force which is not
  employed. Population is divided into 3 groups
• those under age 16 or institutionalized,
• those not in the labor force,
• the labor force which includes those age 16 and
  over who are willing and able to work.
• Part-time workers and discouraged workers who
  want a job, but are not actively seeking one,
• are not in the labor force. So they are not
  included in the unemployment rate.
• Unemployment rate (U) (unemployed workers of
  the labor force / labor force) X 100
• The economic cost of unemployment can be
  calculated by using Okuns law
• GDP Gap ( ) ( U Un ) X 2  where Un natural
  rate of unemployment
• As we can see that the size of the labor force is
  crucial in determining the unemployment rate.
  Therefore, the Labor Force Participation rate is
  often calculated to see the percentage of the
  civilian non-institutional population that is in
  the labor force. Group 2 (those not in the labor
  force) and Group 3 (the labor force which
  includes those age 16 and over who are willing
  and able to work) form the non-institutional
  population.
• Labor Force Participation rate () (Labor force
  / non-institutional population) X 100

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Three Types of Unemployment
Three types of unemployment are 1. Frictional
unemployment (Uf) includes those looking for jobs
or waiting to take jobs soon. It indicates the
mobility in the labor market. 2. Structural
unemployment (Us)is due to changes in the
structure of demand for labor, such as geographic
distribution of job changes or obsolescence of
certain skills. 3. Cyclical unemployment(Uc) is
caused by the recession phases of the business
cycle. Full employment does not mean zero
unemployment, it means cyclical unemployment rate
is zero. At this rate, job seekers are equal to
job openings. This is also called the natural
rate of unemployment (Un) where real GDP is at
its potential GDP. Un does not stay the same but
depends on the demographics of the labor force.
The current Un of U.S. is about 4-5. U
UfUsUc Un UfUs
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GDP
Gross Domestic Product (GDP) measures the total
market value of all final goods and services
produced within a country in one year. 1.
Intermediate goods (goods that are input in the
production of other goods) are not included in
GDP to avoid double counting. In another words,
only the value added is counted. Example We
use seed to produce wheat, wheat to produce
flour, and flour to produce bread. In order to
produce 5000 worth of bread, we need 3500 worth
of flour, which require 2500 worth of wheat,
which require 1000 worth of seed. The value
added in each process is illustrated below Seed
----------------------- 1000 ----------- Value
added 1000 0 1000 Wheat --------------------
- 2500 ------------Value added 2500 1000
1500 Flour ----------------------- 3500
------------Value added 3500 2500
1000 Bread ---------------------- 5000
------------Value added 5000 3500 1500 The
sum of Value added 1000 1500 1000 1500
5000. The sum of value added is the value of the
final product, bread in the above example.
Therefore, value added approach is the same as
counting only the value of the final products.
2. GDP only counts the value of final products
produced within a geographical boundary of a
country. If U.S. citizens are working in Canada,
they do not contribute to the U.S. GDP, but
Canadas GDP and U.S. GNP. Gross National Product
(GNP) is the total market value of all final
goods and services produced annually by the
citizens of a country. 3. GDP sums the dollar
value of what has been produced in the economy
over the year, not what was actually sold. For
example, used car sales are not included.
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GDP
4. GDP was not designed to be a measure of well
being of the society. GDP omits the
following a. Non-marketable goods and services
tasks that do not involve market transactions,
such as baby sitting, house cleaning, lawn mowing
etc. Some very useful output is excluded because
it is unpaid employment. b. Underground
activities illegal or cash transactions have no
record. Governments estimates on these
transactions are not accurate. c. Sales of used
items GDP measures only current output. Used car
and thrift stores transactions are not
counted. d. Financial transactions trading
existing assets, such as stock or bond
purchases. e. Transfer payments either
government or private transfer payments are not
included because goods and services are not
produced in this process. Examples are social
security benefits or kids allowances. f.
Leisure individuals consume leisure, just as
they consume all the other tangible goods, which
generate satisfactions. But leisure has no price
tag, so it is not included in GDP. g. Social
costs production processes may cause pollution.
Polluted air and water may have social costs like
bad air quality, and cancer patients. These
social costs reduce our economic well being. If
money is not spent to clean up the oil spill or
to cure the cancer patients, those expenses are
not added to the GDP. h. GDP does not measure
quality or nature of the product, which
contributes to the satisfaction level of the
consumers. Nominal GDP simply adds the dollar
value of the product it makes no differences if
the product is a weapon, or a book. Per capita
real GDP ( real GDP / population) gives more
information on the standard of living.
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GDP Calculation
Two approaches of calculating GDP What is spent
on a product is the income to those who helped to
produce and sell it. GDP can be measured either
from the expenditure approach or the income
approach. 1. Expenditure approach The economy is
divided into four sectors household, business,
government, and foreign sector. C Consumption is
the expenditures of the household sector. It
includes spending on 1) durable goods which last
for more than one year, 2) non-durable goods, and
3) services. I Investment is the expenditure of
the business sector, including 1) purchases of
new capital goods which are equipment or tools
that aids in the production process, 2) changes
in business inventories, 3) purchases of new
residential housing. G Government Purchases is
the expenditure of the public sector, such as
education and defense expenses. Transfer payments
are not included. If Governments expenditure is
greater than taxes collected from business and
household sector, government is having a deficit
if governments expenditure is smaller than the
taxes collected, government is having a surplus
if the two amounts are equal, governments budget
is balanced. When there is a budget deficit,
government needs to borrow debt from the
business, household or the foreign sectors.
Governments debt is usually higher in recession
than in an expansion phrase of the business cycle
because government needs funding to finance their
deficit. Xn Net Exports is the differences
between exports (goods and services sold to the
foreign markets) and imports (goods and services
produced and imported from abroad). Xn X M
(Xexports, Mimports) Computing GDP GDP C
I G Xn
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GDP Calculation
2. Income approach All final goods and services
are produced using factors of production. By
summing up the factor payments, we can find the
value of GDP. Some adjustments are required to
balance the account. Compensation of employees
includes the wages, salaries, fringe benefits,
Social Security contributions, and health and
pension plans. Rent is the income of the property
owners. Interest is the income of the money
capital suppliers. Proprietors Income is the
income of incorporated business, sole
proprietorships, and partnerships. Corporate
Profits is the income of the corporations
stockholders whether paid to stockholders or
reinvested. Sum of the above items is the
National Income (NI). Adjustments Indirect
business Taxes (general sales taxes, business
property taxes, license fees etc.) should be
added to NI. They are not considered to be
payments to a factor of production, but they are
part of total expenditures. Depreciation is
another cost, which should be added. Net foreign
factor income (income earned by the rest of the
world income earned from the rest of the world)
should be added to adjust GNP to GDP. Computing
GDP GDP Compensation of employees Rent
Interest Proprietors Income Corporate
Profits Indirect business taxes Depreciation
Net foreign factor income Some statistical
discrepancy should be considered to balance
expenditure and income approach.
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Nominal Vs Real GDP
Nominal GDP Sum of (Price X Quantity) for every
item produced in the economy, using the current
years price. When comparing nominal GDP figures
between different years, you cannot determine
whether the increase is due to the increase in
price level or increase in output. Real GDP is
adjusted for price level, that is, GDP measured
at the same price level. Real GDP (Nominal
GDP / price index) X 100 If real GDP increases
from one year to the next, then economic growth
has occurred. Growth rate (Real GDP of last
year Real GDP of earlier year) / Real GDP of
earlier year X 100 The rise and fall of GDP
over time is referred to as the business cycle.
Phases of the business cycles are peak,
recession, trough, recovery, and expansion (when
economy has expanded beyond the initial peak).
The U.S. economys longest growth period is
from 1991 to 2001. From the second quarter of
2001, the U.S. economy has entered a recession.
According to the statistics in the second quarter
of 2002, U.S. is experiencing a growth rate of
1.1 annually.
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GDP Example
The following table illustrates an example of the
computation process of GDP and some other
national accounts.
Personal consumption expenditures 245 Compensation of employees 223
Net foreign factor income earned 4 Indirect business taxes 18
Transfer payment 12 Undistributed corporate profits 21
Rents 14 Personal taxes 26
Consumption of fixed capital (depreciation) 27 Corporate income taxes 19
Social security contributions 20 Corporate profits 56
Interest 13 Government purchases 72
Proprietors' income 33 Net private domestic investment 33
U.S. exports of goods and services 20 Personal savings 20
Dividends 16 U.S. imports of goods and services 9

Expenditure approach Income approach
GDPCIgGXn GDPWAGERENTINTERESTOWNERS' INCOMECORPORATE PROFIT ADJUSTMENTS GDPWAGERENTINTERESTOWNERS' INCOMECORPORATE PROFIT ADJUSTMENTS
C Personal consumption expenditures 245 WAGE Compensation of employees 223
IgInDep Net private domestic investment 33 RENT Rents 14
Consumption of fixed capital (depreciation) 27 INTEREST Interest 13
Gross private domestic investment 60 OWNER'S INCOME Proprietors' income 33
G Government purchases 72 CORPORATE PROFIT Corporate profits 56
  U.S.exports of goods and services (X) 20 ADJUSTMENTS Indirect business taxes 18
U.S.imports of goods and services(M) -9 Consumption of fixed capital (depreciation) 27
XnX-M Net export (Xn) 11 Net foreign factor income earned 4

Gross domestic product 388 Gross domestic product 388

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Additional National Accounts
Net domestic product NDP GDP
Depreciation 361 - 4 - 18 361 National
income NINDP-Net foreign income earned in U.S.-
Indirect tax 388 -27 339 Personal
income PI NI - S.S. - Corporate income taxes -
Undistributed corporate profit Transfer
payment 339 - 20 -19 - 21 12
291 Disposable Income DI PI - Personal tax
291 - 26 265
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Business Cycle
Business cycles are the rises and falls of real
GDP over time. Business Cycles are divided into
four or five phases. Some textbooks combine the
recovery and expansion into the same phase and
called that expansion phase. 1. Peak This
occurs when real GDP is at a temporary
maximum. 2. Recession Two consecutive quarterly
decline in total output (real GDP) is called 
recession. 3. Trough This is the bottom of the
recession. After this point, GDP will start
rising. 4. Recovery This is the period between
trough and the peak when real GDP is expanding
. 5. Expansion If real GDP rises beyond the
recovery, this period is referred to as
expansion. By observing the AD and AS model,
business cycles can be determined. If the real
GDP is below full employment GDP, the economy is
in recession. Trough will be reached before the
economy rebounds to the full employment level. If
the economy's AD is strong enough to expand the
real GDP to a new level, then recovery and
expansion will be experienced before the economy
reaches a temporary new high, peak.